Section 12J Investments don’t need to be difficult to understand, but typical articles explaining all the rules, requirements, laws and regulations, haven’t been written with the layperson in mind – but who said the layperson can’t be a savvy investor?
If you want to equip yourself to take advantage of the most tax efficient, 100% tax-deductible, investment opportunity of a lifetime, keep reading to find out more about how Section 12J works, and how these investments can help you reach your investment goals.
What is a Section 12J investment?
A Section 12J investment gives an investor the opportunity to invest in a tax-deductible investment vehicle.
SARS added Section 12J to the South African Income Tax Act to enhance the funding process for SMEs (Small Medium Enterprises), specifically because SMEs have been identified as one of the primary contributors to projected future economic growth.
By investing in a Section 12J venture capital company, the investor not only qualifies for a 100% deduction of the total investment amount from their taxable income in the relevant tax year, but they are also indirectly supporting local South African small-medium businesses.
How does a Section 12J Venture Capital Company (VCC) investment work?
If you are a taxpaying entity, be it an individual, trust or company, you can invest in a Section 12J company and get a 100% tax deduction for the sum invested during that financial year.
The company will issue a certificate that you can use for the tax deduction, essentially offering you a tax-free investment opportunity – but there are catches.
Double taxation, for example, is currently catching investors whose VCCs make changes within the portfolios during the investment term, as capital gains tax is payable in the event of the sale of the underlying portfolio companies.
When investors are paid out dividends, they are then taxed again (albeit for the first time“directly”) for capital gains or they pay dividends withholding tax.
It is also vital to note that, when the S12J investment reaches maturity and the investor withdraws from the VCC portfolio, the base for capital gain will be zero due to the initial benefit of 100% tax-deductibility.
So there are serious tax implications to a S12J investment, even though the tax-deductibility makes this investment vehicle attractive.
Also, this investment vehicle is considered medium to long term with a minimum investment period of 5 years to claim the tax benefits. If you decide to sell your investment, you will not be eligible to receive the tax deduction and will have to pay tax on the full amount.
The benefits for SME’s
VCCs fall into the SME category, thus will be eligible to qualify for the Section 12J.
The main advantage is that SMEs become a more attractive investment opportunity, which will lead to economic growth as more money starts to flow into small and medium businesses.
The tax benefit of investing in S12J companies is thus the primary incentive for taxpayers to invest indirectly in the SMEs who benefit directly from the increased access to equity funding.
What is the main purpose of a Section 12J investment?
- To provide a tax-deductible investment vehicle to potential investors in order to help stimulate the growth of SMEs by increasing their access to equity funding.
- To increase funding availability for SMEs that are a major contributor to economic growth in the country.
- To invest in S12J companies, and VCCs choose to market S12J investments due to the tax-deductible nature of the investment that the government offers in an effort to make the investment appear more appealing.
Why is Section 12J a good investment?
Section 12J investment has a higher average net rate of return than the average traditional investments mainly because the companies are in their earlier stages which have more potential for growth. The tax deduction also makes the total investment larger than it should’ve been if you invested after paying your taxes.
The legislation as it stands may or may not be extended beyond the initial termination date. So, in order to take advantage of this investment opportunity, investors must invest before June 2021.
Section 12J companies are also a great way to diversify your investment portfolio and to manage risk.
As the core focus of S12J investment is to conserve capital, investment managers typically don’t take undue risks with your investment. The main goal is not to get the highest returns, but to protect your wealth while helping businesses grow.
From a taxable income perspective, a Section 12J investment has low risk, high return possibilities with the deductible tax incentive and growth during the investment period. Every investment will undoubtedly have some risk, so it is best to do your homework beforehand.
Who is the Section 12J investment for?
- Someone looking to invest a minimum of between R100 000 and R1000 000
- If you are looking to diversify your investment portfolio
- Need a way to minimize taxable income
- An investor looking for an investment with no legislated cap on the amount of funds that any individual taxpaying entity may contribute toward the S12J company as an investor.
Available sectors for investment
Available sectors for investment include renewable energy, as renewable energy investors, as well as engineering, procurement and construction companies are increasingly becoming involved in section 12J investment opportunities in an effort to increase their competitiveness in the South African market. Similarly the hotel, lodge, student residence and apartments sector is available for smart investment within the confines of section 12J.
Moveable asset companies would also be well-advised to consider section 12J of the Income Tax Act as a potential vehicle for reducing their tax payable. Franchises are another sector available for investment as franchisors can structure their investments into the new franchise in terms of the section 12J VCC investment and in so doing qualify for the associated tax deduction.
By structuring their investments in the same way, investors or franchisees can receive a tax deduction of up to 28% for companies and up to 45% for individuals and trusts.
Private equity firms, family office and private individuals and companies who have invested in SMEs in South Africa but who haven’t taken advantage of the Section 12J structured invest through a VCC may be seriously missing out.
Provided the SME operates in a permissible sector, structuring your investment through a S12J VCC may well qualify you for a massive tax deduction you’re not qualifying for based on the current structure of your investment.
Restructuring your investment using section 12J could represent an enormous boost in your return on investment by reducing your tax liability substantially.
Finally, mining companies are able to utilise section 12J investment allowances and the associated tax deductions in their favour in multiple mining operations sectors including the acquisitions of mines, plants and equipment.
The available sectors for investment are then:
- Renewable energy
- Hotels, Lodges, Student Residence And Apartments
- Moveable Assets
- Private Equity Firms And Family Offices
To find out more about Section 12J investments and how you can get started, contact Destinata Holdings.