Wondering how to offset Naspers/Prosus capital gain? Here’s a bright idea….

The first interview we published with our business partner, 12J company Bright Light Solar, unpacked how smart structuring and focus translated into an effective 21% return for investors. In this follow up discussion with the company’s founder, former hedge fund professional Kevin Shames, we explore how the 12J tax incentive works and the practicalities of how taxpayers would claim their benefit. For more information directly from the Shames and his team, click here. – Alec Hogg

Welcome to Kevin Shames from Bright Light Solar. Since we did our first interview, there’s been enormous interest from the Biznews community. When exactly is your prospectus available and when do people get the chance to invest and enjoy the tax benefits?

The prospectus will be available from the beginning of January – closing date is the 25th of February – we then issue IT3b’s to investors by the 28th of February, so that when they’re making a tax filing on the 28th of February, they’ve already got the IT3b to allow them to make that deduction immediately.

The IT3b’s is the certificate one usually gets from a bank?

Correct. That’s the certificate confirming that you have invested into a registered section 12J company and it has got all the details, allowing an investor to claim that deduction immediately by the provisional tax payments submission on the 28th of February.

12J – Where does it all come from? What was the motivation behind it?

12 J refers to a section of the Income Tax Act. It was initially set up to create employment opportunities in South Africa by National Treasury recognizing that most employment opportunities are created through small and medium enterprise. Section 12J companies have two regulators, the FSCA – which was the old FSB – and now the Financial Sector Conduct Authority. We are financial services providers and we are also regulated by SA Revenue Services in terms of Section 12J of the Income Tax Act. It’s a highly regulated vehicle and the ultimate reason behind it was to create a tax incentive to allow investors to invest in a structure that is promoting investment into small and medium enterprise with the objective of creating employment.

In the UK, one of our partners is a company called Triple Point and they do something similar. They have a fund where you invest in small and medium enterprises and there’s a good yield and a tax benefit. Is this similar to a 12J model?

It is modelled on that. There was a lot of analysis done of the UK legislation and they thought it was a good opportunity to try it here. I think it’s been enormously successful.

There’s no thoughts in the UK of getting rid of it and yet there is a suggestion that SA’s 12J opportunity may not continue beyond 2021.

In terms of the legislation there is a sunset clause that says the current version of Section 12J will expire on the 30th of June 2021. To clarify what that means, anyone who invests in a station 12J company before the 30th of June 2021 gets to claim their 100% deduction against their taxable income. That will never be at risk. But anyone who invests after June 2021 – if it is not extended – will then not be able to claim that section 12J allowance. It’s there as a place marker where National Treasury have said that the current version of Section 12J will expire in June 2021 and whether or not they choose to extend it will depend on the perceived success in achieving the objectives that were initially set out by the government.

It’s a contested space, politics in South Africa. So those objectives are going to be very closely scrutinised. What has been the impact on employment?

I don’t have those numbers handy but certainly what the section 12J association – a voluntary self-regulating body – is collating, is all the information from the individual section 12J companies, as to the amount of people that have been employed both directly and indirectly as a result of the investments made. This information is fed back to National Treasury to allow them to make an informed decision come June 2021. That decision will need to be made – probably in the February 2021 budget – where we’ll get clarity as to whether the current version of Section 12J will be extended beyond June 21 or whether it will cease to exist in its current form.

I guess that’s an industry wide issue – to show how many jobs have been created – but from your perspective – Bright Light Solar – how many jobs are you guys creating?

We have 12 people directly employed in Bright Light Solar and we have a number of indirect employment opportunities that have been created which are measured in man hours. We know how many man hours it takes to install a kilowatt PV, it’s multiplied by the number of kilowatts that we have installed which gives us the number of indirect man hours. We also assess the number of man hours for the maintenance of our installations, because we own these installations for 25 years. The way that we maximize the benefits out of them is by regular cleaning, checking of the cabling, making sure the frames are secure.

We know all about maintenance through the electricity and power grids of South Africa, but from that perspective – that’s into the future – for those who are investing now, who get your prospectus in the next few days and want to make an investment, how is the security of that relative to the tax benefits, i.e. are they assured of receiving an IT3b every year which says you can claim this against your tax?

So the first thing is they only get an IT3b once – for their initial investment – so that don’t get to claim it every year (you claim it in the year in which you invest) and it is deducted against your taxable income. That means your taxable income comprises of your employment income and it also includes things like capital gains.

So if you for example have sold Naspers shares and moved into Prosus and are now facing a capital gains tax event, you can manage that capital gains tax events by investing in a section 12J which will be allowed to be deducted against their capital gains tax from the taxable income.

Interesting point because there are a lot of people in that situation given the listing of Prosus offshore. So anyone who has held the Naspers shares for the last few years is going to be sitting with a big capital gains problem come the end of the tax year.

Absolutely. And anyone who sold a property, a business, who sold any shares that have made capital gains, that have received bonuses – and are reluctant to pay the 45% tax (if they had a marginal tax rate) – you can manage all of that by investing in a Section 12J company.

You get your IT3b once, and what happens to the income that you would earn presumably on your investment?

The IT3 allows you to deduct 100% of your investment capital against your taxable income in the year in which you invest. That happens by 28th February 2020, thereafter what you will receive is dividend income – which we pay every 6 months in the first year – because we need to deploy that, so we’re looking at a dividend yield in year 1 between 5% and 6%, thereafter that jumps up to 9%. These numbers are after dividends withholding tax – we’ve already deducted the 20% dividend withholding tax before we then pay that amount over – and that 9% dividend yield then grows through the holding period before an investor then chooses to exit. The one thing I do need to stress is one of the provisions of Section 12J says that if you sell your investment within 5 years from the date on which you invest it, there is a recoupment of 100% of what you initially claimed. So the critical thing is that an investor needs to look at this as at least a 5 year investment. It’s not a short term tax planning opportunity where you invest in February 2020, you disinvest in March 2020 and you claim your tax deduction. It doesn’t work like that, you have to hold it for at least 5 years otherwise the investor will suffer a recoupment.

As a taxpayer I’m delighted to hear that Treasury put that in, otherwise it’ll just become a loophole.

Obviously it gives us the opportunity – as a section 12J company to invest knowing that we’ve got this committed capital for at least 5 years.

The way it works, you put in your R100, you then get your tax deduction in year one – which means that your capital investment is less than R100 depending on your marginal income tax rate – and then your dividend that you receive is (that yield you were talking about) is that based on the R100? In other words on the total?

Correct.

So the actual return that you’re going to get depends on your own taxable income?

It does. We have assumed that an investor is at a marginal tax rate of 45%. If someone is at a 38% tax rate, we would adjust our IRR calculations to be able to give them the indications. So the 21% after tax return is based on an individual investor or a trust investor that is paying tax at a 45% tax rate. Interestingly, if it’s a company and they’re paying a 28% tax rates, the upfront deduction benefit that they get is 28% but then there’s no dividend withholding tax over the period because companies are exempt from dividend withholding tax. So the difference being that you get a smaller affronted deduction but you then get a higher dividend yield over the period which then makes up for that small upfront deduction.

If you’re planning this as an investor, would it be best for you – if you’re a high income earner – to actually do this through a company or do it through your own name?

It really depends on where you’ve got a tax problem. Last time we discussed these new caps that have come in, so as an individual you are now capped at R2.5m as a deduction and as a company at R5m. If you for example – as an individual – have a tax problem greater than R2.5m in your individual taxpayer status, you can only claim up to R2.5m in your individual capacity. If you for example also have a trust and a company and they all have tax problems you can invest in all of those, as well as for example in your spouse’s name.

Kevin Shames is the founder of Bright Light Solar. This special Podcast was brought to you by Bright Light Solar VCC. For more information on how the 21% effective return works, click here.