*This content is brought to you by Westbrooke Alternative Asset Management
By Jonti Osher and Dino Zuccollo*
Many South Africans are currently considering whether to reduce their February tax liability by taking advantage of the Section 12J tax deduction. For every R100 invested in a Section 12J company an investor (individuals, companies and trusts) can reduce their tax by up to R45 making the net investment only R55.
There are more than 100 registered Section 12J companies in South Africa and it is estimated that the market has raised more than R3.6bn in investments at the end of 2018. Westbrooke Alternative Asset Management is South Africa’s largest Section 12J manager responsible for almost half of the capital invested in Section 12J funds in the country. Here are the twelve most common questions asked by financial advisors and investors when making a Section 12J investment.
How does Section 12J help me to save tax?
Section 12J is an investment tax incentive which was introduced by SARS to boost the South African economy by encouraging investment into SMEs which operate in select industries. Individuals, companies and trusts can benefit from up to 45% immediate tax relief, reducing the cost of the investment while providing downside protection and enhancing overall returns. However, the investment must be held for at least five years. The Section 12J asset class is particularly attractive to those tax payers who have incurred capital gains tax, as the 40% inclusion rate for individuals allows investors to invest less than the total cash realised on a capital gains event.
However, a Section 12J investment carries a base cost of zero and therefore on exit from the investment, the investor will be liable for capital gains tax on the full proceeds.
Is this investment right for me?
If you are a South African tax payer, you could consider a Section 12J investment as your taxable income can be offset by this investment eg salaries, bonuses, capital gains tax, interest, rental income etc. Section 12J investments range from lower risk asset-backed investments to higher risk venture capital investments and it is therefore necessary to assess your risk appetite.
What are the risks?
As with any private equity style investment, an investment in a Section 12J company carries risk. It’s important, therefore, to assess the investment strategy of the Section 12J company to ensure you understand the associated investment risk as well as the expertise and track record of the asset manager. You can read more about Section 12J risk here.
Which Section 12J investment should I pick?
This is dependent on your desired risk / reward profile. Investors may also elect to invest in diversified Section 12J portfolios to spread risk. Westbrooke Alternative Asset Management has developed a recommended diversified portfolio of Section 12J funds that suit an investor’s requirements, all with a single manager. The options include the income, balanced and growth portfolios, which will each invest into an appropriate weighting of various Westbrooke Section 12J funds.
What is the minimum investment?
From what can be seen in the market, Section 12J investments start at around R100,000. Westbrooke’s minimum is R500,000.
What returns can I expect?
This depends on what fund you have invested in and the skill of the managers. Investors in lower risk strategies can expect to earn investment returns of 15% – 25% and investors in higher risk strategies can potentially expect investment returns of 40% per year or more. The investor would need to unpack the targeted investment returns quoted by the manager and also understand the assumptions used and the track record of the manager to achieve these returns. Section 12J is considered a private equity style investment which carries different levels of risk depending on the underlying investment strategy and there is the potential to lose your initial investment.
Can I use debt or gearing to make an investment into a Section12J company?
Yes, you may utilise a loan or gearing to make an investment into a venture capital company as long as you comply with Section 12J(3)(a) of the Income Tax Act. Most importantly, investors must be seen to be ‘at risk’ for their investment.
When and how do I claim my tax deduction?
An investment into an approved Section 12J company is 100% tax deductible in the tax year you invest. Investors can claim the tax relief by either reducing their estimate of taxable income when submitting provisional tax returns or by obtaining a tax refund through the annual income tax assessment. To benefit this year, your investment needs to be made by 28 February 2019.
What is the annual limit per investor for investment into a Section 12J company?
There is no annual limit but investors should not invest more than their taxable income.
What is the term of my investment?
The minimum term of the investment will be five years, however certain funds might carry a longer minimum investment period. Westbrooke places a five year minimum term on their Section 12J funds with a realisation period post the five years. Westbrooke clearly defines its exit strategy to ensure investors understand the route to liquidity on exit prior to making the investment. Make sure your Section 12J provider does too. It can take a number of months (or years) to receive your pay out post the stated target exit date
What if I invest and then I die or emigrate?
On death during the five year investment period, your investment will be treated as if you had sold your shares and SARS will recoup the tax benefit unless you specifically state that you have left your Section 12J investment to your surviving spouse in your will. Should you emigrate within the five year period, your investment will be treated as if you had sold your shares and SARS will recoup the tax benefit. You should consider these implications upfront before making your investment.
What are the fees?
Fees in Section 12J investments are not legislated so check this carefully when you invest. You can pay:
- An upfront capital raising fee (not charged by Westbrooke).
- An annual asset management fee. Westbrooke charges 2% of the total fund size.
- A performance fee on exit. Westbrooke shares in 20% of the upside on returns provided to the investor above the net capital invested plus a fund specific hurdle.
- Check whether targeted returns quoted by the manager are pre or post fees. Westbrooke quotes all returns post fees.
Because Section 12J investors are usually new to this asset class, Westbrooke has created an online investor toolbox to provide full information so that those interested can fully understand the incentive prior to investing.
To take advantage of the benefits of Section 12J, the final day for Westbrooke investment is 23 February 2019. For more information about Section 12J and Westbrooke’s investments strategies go to www.westbrooke.co.za/S12J.
- Jonti Osher and Dino Zuccollo are founder members of the Section 12J Association of South Africa and fund managers at Westbrooke Alternative Asset Management.