Jeff Miller
The ongoing devaluation of the Rand has South Africans jittery about leaving their money in this country, and consequently many are investing offshore.
One option available to local investors is a tax-efficient Rand-based investment stemming from the Section 12B SARS-approved tax deduction. How does a longer-term investment like this compare with an offshore investment with a similar profile?
Grovest, pioneers of alternative asset investing in SA, did the maths and compared a R1 million investment in its Twelve B Green Energy Fund with a 7% US dollar corporate bond over 10 years. “Not only does the Rand-based investment hold its own, but it beats the US bond option significantly across various metrics,” says Jeff Miller, CEO of Grovest. When comparing the net cash flows of the two investments, the Twelve B investment outperforms the bond by c.31%.
Additionally, when comparing the internal rate of return of the two investments, Twelve B once again far outperforms the bond, this time by c.85%.
What is the Twelve B Green Energy Fund?
Section 12BA (the enhanced 125% allowance) of the Income Tax Act allows for a tax deduction for certain qualifying assets used for electricity generation from renewable sources. SA individuals, trusts, companies and pension funds can write off 125% of their investment against their taxable income in the year the assets produce electricity. In February 2023, Grovest launched the Twelve B Green Energy Fund - the first Section 12B private equity fund in South Africa.
The bottom line
Investing R1 million over 10 years in the Twelve B Green Energy Fund instead of a USD corporate bond yielding 7% per annum, offers higher returns, while also unlocking large tax benefits.
Is it a fair comparison?
Both are compared as 10-year investments (although you can exit a Section 12B fund from year three - this is due to SARS ruling that the full 125% will be recouped if you exit in the first two years. You can exit a corporate bond at any time) and both offer bi-annual payouts and have moderate risk profiles.
When investing into the bond, you pay tax at the marginal rate, leaving only R550,000 for your investment. Whereas with the Twelve B Green Energy Fund, due to the enhanced 125% tax saving, you’re able to invest the full amount and de-risk more than half of it upfront.
Underlying assumptions
The investor is investing R1 million and is a South African taxpayer paying the highest marginal rate of 45%. The USD corporate bond is assumed to yield 7% per annum for 10 years.
The Rand is assumed to devalue at 6.5% per annum over the 10-year investment term. A rate of ZAR18 to the USD was assumed as a baseline for the calculations.
How investors exit the Twelve B Green Energy Fund after 10 years
In year ten, investors’ capital will be paid back and the underlying power purchase agreements (PPA) will be sold to a third party at a discount of 13.5% on future cash flows. This is standard practice, though Grovest’s last two R200 million portfolios sold at an average discount of 12.5% (showing 13.5% is a fair, conservative assumption). PPAs are typically 20-year contracts, leaving another 10 years of future earnings of the third party as investors exit the Twelve B Green Energy Fund.
The US corporate bond investment attracts capital gains tax in year 10, whilst with the Twelve B Green Energy Fund, investors will be required to account for recoupment of the accelerated depreciation up to a maximum of 100%. In both scenarios, the total cash received in this example over 10 years is net of tax and fees.
Qualifying investments
The Twelve B Green Energy Fund has a mandate to invest in solar panels, inverters and batteries in residential complexes, and commercial and industrial installations. Twelve B’s portfolio of assets is spread over several solar projects which are at different locations and have different end users. Each project is governed by a long-term PPA, which sets out the amount of energy generated at an agreed price over the term of the PPA. All projects are vetted by an experienced investment committee before they are approved.
The fund is regulated by the FSCA. It is managed and administered by Grovest, the pioneers of Section 12J, which brought the first Section 12J fund to the market in 2014. Today, Grovest is one of the largest administrators of Section 12J funds, with over R3.5 billion in assets under administration.
“The Twelve B Green Energy Fund is targeting an IRR to investors of 18% net of fees and taxes and has a moderate risk profile. The ability to write off the cost of the investment against taxable income provides downside protection and enhances overall returns for investors,” says Miller.
Second fund opens
The Twelve B Green Energy Fund recently closed Fund I. It has just launched Fund II, where as in Fund I, it is matching the capital raise to the deployment pipeline of projects secured.
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