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Invest and Save 100% of Your Tax Payable to SARS Section 12J funds were created in response to the South African Government offering tax incentives for private investors to support funds that support SME growth in South Africa. Three experts unpack the benefits of investing in 12J funds - particularly for high net worth individuals.

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THE EXPERTS

Clive Butkow is the former Chief Operating Officer (COO) of Accenture South Africa. He has 28 years' management consulting experience.

During his tenure at Accenture, he played numerous leadership roles, including MD of Accenture's Technology business, as well as MD of Accenture's Resources business.

He is currently the CEO of Kalon Venture Partners, a disruptive digital technology Venture Capital Fund (VCC). He sits on various boards of the VCC's underlying companies, and is chairman of one of the companies.

He also sits on the board of a large privately held ICT company. Kalon Venture Partners focuses on investing in disruptive digital technologies. Visit: www.kalonvp.com

Neill Hobbs is a Chartered Accountant CA(SA), Registered Auditor and Senior Business Rescue Practitioner. For the last 14 years, Neill has been a partner of Hobbs Sinclair, where his skills have been utilised in building an accounting practice specialising in tax structures.

Four years ago, Neill became a Business Rescue Practitioner and has taken on many successful appointments to date, which involved saving hundreds of jobs and returning the companies to profitability. His high level strategic management was a key driver that led to their success.

Neill is passionate about SMEs and has an interest in the South African Tax Act. He is a director and co-founder of Anuva Investments, a Section 12J VCC that has been operating since 2015.

Anuva's internal rate of return, excluding the tax break, was 26% at the end of February 2017, meaning that R1 million invested in February 2015 would have grown to R1,59 million in February last year. Visit: www.anuvainvestments.co.za

Gidon Novack is a socially-minded entrepreneur who has created innovative, high growth opportunities within large businesses and built new businesses from inception. He served as Joint-CEO of Comair from 2006 to 2011, and as CEO of Discovery's world-leading wellness programme (with a turnover of R2 billion) from 2012 to 2015.

Since 2015 he has spearheaded Lucid Ventures, a registered 12J operator with a focus on property-backed hospitality investments.

There is a strong global trend towards apartment style hotel accommodation, and Lucid invests in small units in new residential developments in high-demand urban areas and operates a hospitality business in those units. Visit: lucidventures.co.za

Q.What is a 12J Fund?

Clive Butkow: In 2009, the South African Government implemented a tax incentive for investors in enterprises through a Venture Capital Company (VCC) regime known as Section 12J.

These funds were set up to help early stage companies raise venture capital to stimulate economic growth and job creation. Section 12J was based on the Venture Capital Trusts (VCT) in the UK, which enable high net worth Individuals to save tax and rather invest in a VCT, which will then invest in start-ups. Individuals, trusts and companies can all invest in a Section 12J company and receive the respective tax deduction.

Neill Hobbs: The South African Revenue Services (SARS) has written Section 12J into the Tax Act, which offers taxpayers a 100% reduction in their taxable income in the year of investment for the amount they invest by way of a subscription for shares in a Section 12J VCC.

The VCC then invests into small and medium-sized enterprises (SMEs) with the added intention of creating jobs and securing employment. The VCC must be approved by both SARS and the Financial Services Board.

Q.Why is it tax deductible?

Gidon Novick: The legislation provides for a tax deduction providing the fund complies with the requirements of the Act. The intent of the incentive is to stimulate certain critical areas of the South African economy (such as tourism and hospitality) through SME growth in the sector.

Neill: Section 12J advocates investment into SMEs and junior mining exploration to act as a catalyst for a positive shift in the economy. We know that SMEs are a significant source of employment in the economy and provide a plethora of job opportunities and income security for households. This ultimately creates a positive iterative loop in the economy.

Q.How do the tax deductions work?

Clive: The total amount invested can be deducted from the tax- payers' taxable income. This results in a taxpayer (who is paying tax at the marginal rate of 45%), saving 45% of their investment by reducing their taxable income.

For example, a taxpayer who has a taxable income of R1 million and would normally pay R450 000 to SARS will rather pay the R1 million to the Section 12J company and pay zero tax. The caveat is that the taxpayer needs to hold their shares for five years in the relevant Section 12J fund, or SARS will recoup their tax saving.

The tax is deductible to incentivise taxpayers to rather invest in a Section 12J company and promote the growth of the South African economy than pay tax on their taxable income.

Q.This seems like a double benefit to investors? Is that correct and why?

Clive: There's definitely a double benefit, as the taxpayer receives a once off deduction from SARS in the year they invest in the Section 12J company, as well as an added benefit based on the performance of the Section 12J company.

Some companies are set up to invest their capital in higher risk ventures with others in lower risk ventures. The returns to investors range from 15% to 38% based on the nature of the fund and their investment strategy.

Gidon: The benefit to investors would be in the form of their tax deduction but importantly also their investment returns. Investors need to fully understand the nature of the investments the fund is making, the risks involved and their ability to cash out after the five-year minimum term, in other words, the liquidity of the investment.

Neill: Individual investors will get an immediate tax saving, up to 45% of the amount invested, in addition to any dividends and long-term capital growth. A Section 12J VCC provides self-interest value to the taxpayer in the tax saving and growth in investment, but in a broader sense, marries business value with societal value through the boost in the SME space.

Q.What questions should investors who are interested in investing in a 12J fund be asking?

Clive: The most important question is of the experience and reputation within the management team. Money follows management in the venture capital asset class. The management team needs to have experience in the investment strategy of their Section 12J fund.

At Kalon Venture Partners we only invest in disruptive digital technologies where the CEO and the board have significant experience in buying, building and selling technology companies. The CEO was the ex-COO of Accenture South Africa and prior to that led Accenture's technology business.

Another important consideration is how the Section 12J company creates liquidity for their investors as it's important for the investor to understand how and when the Section 12J company will pay dividends of the profits and surpluses on the sale of assets.

Lastly, investors must understand the governance and investment disciplines, systems and processes when making investments.

Gidon: What is the risk/return profile of the underlying investments? Who are the fund managers and what is their track record? What are the assets that underpin the investments? How will this fund make an impact on the South African economy and job creation? How will I get my money out after five years?

Neill: Confirm SARS and FSB approval. What is the VCC's investment strategy? The VCC's industry focus? What is the fund's launch date? Track record? Capital raised? Targeted return?

Number of investments made in qualifying companies? Annual financial statements published? Basis for valuing the underlying investment and the VCC's dividend policy and history? Fee structure? Minimum investment?


Q.What are the pros and cons of a 12J fund versus more traditional investment portfolios?

Neill: The benefit for a deduction in respect of a retirement annuity contribution is limited to R350 000 in a year, whereas the contribution and benefit of an investment into a Section 12J VCC is not capped and can be 100% of taxable income.

Many SMEs require capital and management support. With the support from the VCC team, stakeholder integration and interaction takes place on the factory floor, rather than just in the boardroom. The investor management team walks the walk with the SME.

A VCC investment should be viewed as a long-term investment. The proceeds on the sale of the VCC shares will be subject to full tax recoupment if the shares in the VCC are sold within five years from the date of investment.
If the shares are held for a period exceeding five years, the sales proceeds from the sale of the shares will only be subject to capital gains tax, albeit from a zero base.

Clive: A major pro for investors is the upfront tax advantage where there is no limit to the investment that you can make, unlike an RA, which is limited to a percentage of taxable income and capped. A second pro is the fact that investors can now diversify their portfolio with 12J investments and not only invest in the traditional capital markets.

Q.What is the amount you can invest into a 12J fund?

Neill: CIPC requires that if a VCC does not have a prospectus, then the minimum amount that can be invested is R1 million. The intention with this is to make sure that any general person from the public, who might not understand the investment they are investing into, does not invest more than is appropriate for them.

Clive: Our recommendation at Kalon Venture Partners is that an investor should not invest more than 7,5% to 10% of their net wealth into a Section 12J due to the higher risk profile of a venture capital investment.

Q.Is there a "right' time to invest in a 12J fund with regards to tax exemptions?

Clive: There is no right time to invest, however with the current rand strength we see this as a vital time to diversify one's portfolio. The most effective time to raise capital is at the tax year end on 28 February. An alternate time of the year that capital is raised is during the provisional tax season in August or September each year.

Gidon: An investor should only consider a 12J if they have the taxable income and don't need access to the funds they have invested for at least five years. Investments must be made before the tax year-end (ie 28 February) to qualify for the deduction in that year.

Neill: Section 12J is particularly attractive to high income earners. It's also attractive to those taxpayers who have made a capital gain, which will be subject to capital gains tax.

For example, an individual who realises a capital gain of R5 million in the 2018 tax year, will only have to invest the inclusion amount of 40% (R2 million) into a VCC to avoid capital gains tax completely in the 2018 tax year.

A VCC investment is the only recognised manner in which a corporate employee, who is subject to PAYE on their salary, can receive a refund of PAYE deducted by the employer.

Although there is no provision for a directive for the reduction of the PAYE amount, an employee who earns R2 million per annum, and makes a R2 million VCC investment, could receive a full refund of PAYE on the submission of their annual tax return.

The sunset clause is currently 30 June 2021. This means that funds invested before that date must remain in for the five-year period, but any funds invested into a 12J fund after that date will not enjoy the current tax benefits. This date could be re-assessed and extended.

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