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Harsh reality sets in for Section 12J investor

14 May 2024 Jaltech Fund Managers
Jonty Sacks, partner, Jaltech Fund Managers

Jonty Sacks, partner, Jaltech Fund Managers

February 2024 marked the end of the 5-year investment term for numerous Section 12J investors. The Section 12J tax incentive became popular in 2014, and ended with Treasury not being prepared to extend the incentive beyond the June 2021 sunset.

Investors now facing two harsh realities. First, they now understand paying performance fees on ‘risk capital’. This is in essence where a handful of fund managers charged their investors a performance fee based on the tax saving, which ultimately resulted in low to negative return on investors’ capital. This has sparked outrage from many investors and financial advisors.  

The second is that investors now face the prospect of paying capital gains tax on exit as a consequence of being able to deduct 100% of their initial investment against their taxable income. 

Jonty Sacks, partner, Jaltech Fund Managers explains that, “There are three ways for investors to reduce their capital gains liability when exiting a Section 12J investment. They can invest in a:

  • retirement annuity as such an investment is tax deductible;
  • collective investment scheme which would offer investors Section 42 roll-over relief, thereby deferring the exit tax event; or
  • Section 12B solar investment which shields the tax consequence.” 

The choice between these options hinges on the investor’s objectives. If the primary goal is to mitigate the Section 12J exit tax, then a Section 12B investment generally emerges as the preferred route. 

This preference stems from the fact that opting for a Section 12B investment typically entails parting with only around 21% of the Section 12J capital to reduce the tax liability to zero. In contrast, a Section 42 investment necessitates committing 100% of the investor’s capital to defer the Section 12J exit tax. 

If the motivation for the new investment is solely driven by returns, then it could be argued that a Section 12B investment offers flexibility. 

The reason is that a Section 12B investment which is geared conservatively, allows an investor to receive an amount of up to 90% of their investment back in the first year through SARS refunds and cash inflows. This in turn will allow the investor to invest the proceeds less the Section 12J exit tax into an alternative investment. 

Comparative analysis 

Below is an analysis for an investor considering exiting a Section 12J investment, dividing a portion of the capital into a leveraged Section 12B investment, and utilizing Section 42 rollover relief.

  

Interestingly, given the large upfront tax benefit associated with Section 12B investments, the investor in the above example would only need to invest a portion of the R1 million returned to avoid paying capital gains tax on exit. The net result is that the investor would then generate a return on the capital which the investor would have largely had to pay to SARS. 

Investors who are considering a Section 12B investment must act promptly because the Section 12B incentive requires that the capital must be invested in energy-producing solar assets within this fiscal year. Failure to do so would restrict the deductibility of the investment in the hands of the investors based on the amount deployed. 

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QUESTION

As uncertainty prevails, and post-election business and consumer sentiment begins to ebb, how do you intend investing your clients’ funds through 2025?

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Diversify across regions, themes.
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Review clients’ long-term objectives.
Trust your DFM or fund managers.
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