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A simple explanation of a Section 12J investment

on Thursday, 18 January 2018.

A simple explanation of a Section 12J investment

 

Please note this article was sponsored by Fairtree Capital

The main points:

  1. A taxpayer can make an investment in a Section 12J company and this investment is 100% tax deductible if held for a period of 5 years or longer.
  2. If the taxpayer is an individual with a marginal tax rate of 45% or a trust, the taxpayer can invest R1 million and will effectively be paying R550 000 (R1 million - R450 000) for the investment since the full investment amount is tax deductible in the year of investment (provided the taxpayer has taxable income of R450 000 or more).
  3. A company (excluding a SBC which will be taxed at different rates) can invest R1 million and effectively be paying R720 000 (R1 million - R280 000) for the investment since the full investment amount is tax deductible in the year of investment (provided the company has taxable income of R280 000 or more).
  4. When the section 12J investment is realised in the future, the base for the capital gain will be 0 due to the initial benefit of 100% tax deductibility.

What is a Section 12J company?

The government has identified small and medium-sized entities (SMEs) as a major contributor to future economic growth. One factor that hampers the growth of SMEs is a lack of access to equity funding.

In order to alleviate this problem the government has added Section 12J to the South African Income Tax Act as a catalyst for equity funding for SMEs. Section 12J provides a marketing vehicle to venture capital companies (VCCs) due to the tax incentive.

A Venture Capital Company (VCC) is a company that accepts investments from any taxpayer (individual, trust or company). The VCC manages the collective investment and make investments in SMEs.

The VCC will issue a certificate to the taxpayer for the amount of the investment. The taxpayer is then allowed to deduct their full investment against their taxable income in the relevant tax year.

The tax benefit which arises from Section 12J is thus an incentive for taxpayers to invest indirectly in SMEs.

Who are allowed to invest in a Section 12J Company?

Any taxpayer qualifies to invest in an approved VCC.

Are there any other tax implications?

As with any other investment on realisation the taxpayer will be liable for capital gains tax (CGT). However if the investor utilised the Section 12J deduction when they purchased the shares, the base cost will be reduced to zero on realisation. Therefore the capital gains tax liability is higher than it would have been for the same investment where the Section 12J deduction was not applied.

Taking the CGT into account, is an investment in a Section 12J company still beneficial?

Below is a comparison of a traditional investment in listed shares versus an investment in a Section 12J company. For both investments the following are assumed:  a 10% annual growth in value, a 5 year investment term, an individual tax payer with the maximum marginal tax rate of 45% and all other factors are constant.

 
Investment in listed shares
Investment in a Section 12J Company
Initial investment amount

1,000,000.00

1,000,000.00

With growth in capital year 1

1,100,000.00

1,100,000.00

With growth in capital year 2

1,210,000.00

1,210,000.00

With growth in capital year 3

1,331,000.00

1,331,000.00

With growth in capital year 4

1,464,100.00

1,464,100.00

With growth in capital year 5

1,610,510.00

1,610,510.00

     

Value on realisation

1,610,510.00

1,610,510.00

     
Capital gain tax implications:
   
     

Base cost

1,000,000.00

0.00

Realisation

1,610,510.00

1,610,510.00

Capital gain

610,510.00

1,610,510.00

     

Inclusion in taxable income @ 40%

244,204.00

644,204.00

Tax on capital gain @ 45%

109,891.80

289,891.80

     
Net rate of return over 5 year period
   
     

Net gain

500,618.20

320,618.20

Initial section 12J deduction adjusted for inflation of 6% per year

 

602,201.51

Total gain on investment

500,618.20

922,819.71

     

Net rate of return over 5 year period

0.50

0.92

 

 



The Section 12J investment has a net rate of return that is 42% higher than the traditional investment. Therefore even with the reduced base cost it is still beneficial.



We interviewed Fairtree Capital to find out more about their Section 12J company: Fairtree Capital Hospitality 

Fairtree Banner

Who is Fairtree Capital?

Fairtree Capital is an African investment manager that manages alternative and long only investment portfolios across all global asset classes for institutional clients and high net worth individuals. Based in Cape Town, South Africa, our firm commitment to a consistent investment philosophy has continued to deliver high-quality returns to investors since the inception of our first fund in 2003.

How does the Fairtree Capital Hospitality Section 12J company fit into Fairtree Capital?

Fairtree Capital Hospitality (Pty) Ltd is managed by Fairtree Capital.

Tell us more about Fairtree Capital Hospitality

The Company focusses on leveraged acquisitions of a diversified portfolio of hospitality properties with positive cash flows and significant capital appreciation potential which are positioned to benefit from the growth in the South African tourism industry.

The company’s focus will be in the hotel industry, where various opportunities exist given supply constraints, a weak South African currency and strong growth in the tourism market. The members of the board use their expertise, in association with its hotel management affiliates, to reposition and restructure properties for growth and to capitalise on the changing accommodation market with strong focus on new technology. The company will develop its investments into efficiently structured real estate investments, which operate at optimum capacity and then look to realise these investments at maximum value. The company’s primary focus area is South Africa with some international exposure.

Fairtree Hospitality will invest in Qualifying Companies operating in the hospitality industry with the following features:

  • Exciting business models;
  • Potential for expansion or capacity growth;vi
  • Defensible market positions;
  • Attractive entry prices and
  • Opportunities to add value

Who is the management team of the Fairtree Capital Hospitality company?

Kobus Nel - CA(SA), CFA - Director

Experience:

CA Articles : PricewaterhouseCoopers

Corporate finance team : Sanlam Ltd

Founder and Fund manager : Fairtree Capital

Joe Bester - CA(SA) - Director

Experience:

CA Articles : PricewaterhouseCoopers

Ma-Afrika Group : Financial manager and CFO

Ma-Afrika Hotels : COO

Christiaan Rossouw - Equity Analyst

Experience:

Realgrowth Property Development (Internship) : Financial Analyst

Allan Gray : Investment Consultant

What is the minimum investment that an investor can make?

R500 000

What is the expected annual return on the investment?

The expected return is CPI + 10% to 15%

Until when are you accepting investments in the company?

This tranche of the investments closes 01 March 2018, however if our target investment amount is reached before then, it may close sooner.

When will the investor receive their investment certificate for tax purposes?

As soon as the investment is made.

When will the investment be realised?

The investment will be locked in for a period of 6 years after which liquidation possibilities will be discussed with investors who would like to realise their investment.

What is the Corporate Service Fee that Fairtree Hospitality Company charge?

1% (Excluding VAT) on gross assets calculated as at each valuation date. The gross asset value of the Company will be calculated by using the sum of the gross initial value of the acquisitions of Investments made by the Company. For purposes of calculating the corporate services fee, the gross asset value of the Company will be escalated annually on 1 March by CPI + 2%. Where an Investment was acquired within the preceding year, this increase will be applied on a pro rata basis.

How risky are these investments?

The Fairtree Capital Hospitality Company is a Real Estate Private Equity vehicle and has a significantly lower risk profile than traditional Venture Capital Investments. The Company will be investing in established, profitable hospitality properties. The fact that there is significant underlying value in the physical properties, get investors tangible and secure underlying assets. 

Furthermore, the Directors will also be invested personally in the assets that the Company acquires. The Company is not a Venture Capital Company per its traditional definition, but is benefitting substantially by making use of the fact that Hospitality Property specifically falls within the ambit of the Section 12J Venture Capital Company requirements. 

How well regulated is the company?

The Company is a registered Venture Capital Company under Section 12J of the Income Tax Act. In order to obtain this registration, the Company had to acquire an FSB license and register with SARS. The Company is thus regulated by the FSB and by SARS specifically for the compliance with the Section 12J requirements.

What legislation does the company fall under?

The Company is structured as a Venture Capital Company and is regulated primarily by the The Companies Act, the FSB and SARS.

Where can an investor get more information on the company?

www.fairtreehospitality.com

Who can an investor contact for questions or to arrange to make an investment?

Joe Bester - This email address is being protected from spambots. You need JavaScript enabled to view it. or 

Christiaan Rossouw - This email address is being protected from spambots. You need JavaScript enabled to view it.

Please also feel free to post your comments or questions below and CH Consulting will route the questions to Fairtree Capital.

Further tax advice on the Section 12J investments

Please contact us at CH Consulting https://www.chconsulting.co.za/contact

Author: Chris Herbst - CH Consulting

Comments (2)

  • Salona

    26 November 2018 at 11:01 |
    Hi
    Do you have to be in the highest tax bracket to benefit from the S12J deduction? Does your taxable income have to be higher than the value of the investment?
    Thanks.

    reply

    • Chris Herbst

      03 December 2018 at 15:30 |
      Hi Salona,
      You will still benefit if you are not in the highest tax bracket, although it will affect your ROI. Depending on your investment strategy, it may make sense to limit your investment to the taxable income you have for a particular year and rather make another investment in the subsequent tax year.

      reply

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