The investment that’s 100% tax deductible

The appeal of investing in a Section 12J company.

In the current market environment, astute investors are increasingly looking at alternative asset classes. In a low return world, where uncertainty is high, finding alternative sources of return is very appealing.

In this regard, a growing number of South Africans are investing in venture capital companies that operate under Section 12J of the Income Tax Act. Speaking at the Liberty Retire Well Master Class in Johannesburg on Thursday, Malcolm Segal of Grovest said that these kinds of companies are starting to gain traction thanks to the extremely enabling legislation.

“Under Section 12J the entire amount you invest is deductible from your taxable income in the year which you invest,” Segal explained. “And a section 12J tax certificate will be issued to investors together with the share certificate when the investment is made.”

As long as you remain invested for at least five years, this tax deduction will be permanent. There is also no limit to amount one can invest in these entities.

“You would, however, want to invest an amount that would ordinarily not exceed 5% to 7% of your assets,” Segal said. “And the amount should also fall within your taxable income.”

The appeal of the tax relief is obviously greatest for those in the highest tax bracket. This is currently 41%, but may well increase to as much as 45% next year as National Treasury looks to increase tax revenues.

The opportunity set

The appeal of investing in a venture capital company is, however, not limited to the tax break. It is also a potentially high growth opportunity.

“We are a very entrepreneurial society in South Africa,” Segal said. “Perhaps people don’t appreciate just how much there is in the entrepreneurial sector.”

He pointed out that for his entire business life, the political environment has been less than ideal, and yet the country has continued to produce outstanding entrepreneurs.

“We are seeing the most wonderful entrepreneurs coming through with excellent ideas – starting businesses, building businesses, and growing businesses,” Segal said. “The question a mature investor would ask is: how can I best gain access to those great companies of tomorrow? You could do this on a one-on-one direct basis if you come into contact with an entrepreneur, or you can invest your money on a tax efficient basis in a company that operates in a regulated environment, where there is a spread of risk, there is astute selection of opportunities and there is responsible post-investment management.”

By investing in a venture capital company, you would gain the benefits of diversifying your risk across a portfolio of companies. The investments would also be chosen by experienced managers who have selected the best opportunities from the dozens of companies that may have approached them for capital.

Investing in a Section 12J company also gives investors access to sectors that are limited or non-existent in the listed space on the JSE. For instance, Grovest runs a fund that invests only in renewable energy projects, and another that looks for impact investments that will deliver good long term returns. There are also venture capital funds that specifically target companies developing disruptive technologies.

Be aware of the risks

Investors looking to put money into Section 12J companies can take comfort from the fact that these companies have to be registered with both the South African Revenue Service and the Financial Services Board. There are therefore strict regulatory requirements that they have to meet.

The legislation also prescribes that no single investor can hold more than 20% of the issued share capital of any venture capital company, and that the entity itself may not hold more than 70% in any underlying company. These have been put in place to mitigate against some of the risks of investing in unlisted businesses in their early growth stages.

However, investors should be aware of looking for venture capital companies that have demonstrated a track record of returns. As always, it is vital to understand what you are buying, as well as the risk-return profile that you can expect.


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Conspicuous silence on costs.

I looked at a few of the S12J companies and was struck by the fact that there is typically an overt management fee of 3% but a less obvious dilution factor, either in free issues to the fund managers or special share classes with preferential rights. 20% seems to be the going rate. So of your 41% tax saving you get at best 18% while the fund managers pocket 23%. And some of them charge the investee companies as well.

So read the small print carefully. I suppose 18% is worth having but I resent subsidising lawyers & accountants to this extent.

End of comments.



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