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Section 12J, are you really getting it?

22 November 2019 Zane De Decker, Flyt Hospitality
Zane De Decker, Flyt Hospitality

Zane De Decker, Flyt Hospitality

Unpacking an investment into a Section 12J Fund

We have recently taken our newly launched Section 12J property fund to the investment market. I’m a property specialist, with a bit of an asset management background, so the 12J structure really appealed to me when it first caught my interest. What I’m finding is that many people we are chatting to about the tax incentive really don’t fully understand its structure and workings. If it sounds too good to be true, it probably is, right? Wrong!

The glaring misconception is that 12J merely delays tax and investors get ‘nailed in the end’ with Capital Gains Tax (CGT), but this is not the case at all.

Based on an annual income of R2.5m, let’s break it down as an example.

Patricia earns R2.5 million per year and therefore falls in the 45% tax bracket; according to the tax table, R982 000 is the total tax due by her to SARS. Let’s say she invests R1million into a Section 12J fund. This R1m is treated as an ‘expense’ or tax-deduction, so her next tax return would look very different.

R2.5m income earned, less the R1million deduction, leaves Patricia with a balance of R1.5million taxable income, equating to a tax obligation of R532 000 and a tax saving of R450 000! Better yet, if she is a salary earner and pays PAYE, then her employer would have already paid the full R982 000 to SARS and in this case she would be due a refund from SARS of R450 000, thanks to her investment in a Section 12J fund. For self-employed individuals or companies who are subject to provisional tax, the R1million invested means they avoid paying the R450 000 and only need to pay tax of R532 000, as opposed to R982 000.

Okay, so that’s all good and well and any smart investor would grab this incentive in a heartbeat, but the confusion comes about when an investor is looking to cash in.

An investment into the The Flyt Hospitality fund is locked for 5 years, so let’s say (without considering any return on the invested amount) Patricia sells her shares in the fund after 5 years for the same value (R1million). Yes, that R1million is subject to Capital Gains Tax which is calculated at 40% of the gain. So 40% of R1million is R400 000 and Patricia would be required to pay her 45% tax due to SARS of R180 000.

The bottom line?

Of her R1million Patricia pays R180 000 tax five years down the line, rather than R450 000 upfront. The number cruncher in me calculates that as a R270 000 saving and a 60% reduction on her tax bill.

 

What is also important to remember is that not only have you reduced your tax burden, but you have delayed it too, by a minimum of five years. If you opt to stay in the investment fund after the five-year period (you don’t HAVE to sell), you have avoided paying that tax until such time as you do sell. In the mean time you enjoy the full benefits (capital growth and dividends) of the full investment amount. If you don’t sell your shares in the fund, you never pay the tax. Investors in the Flyt Hospitality fund who opt to stay in the fund, retain their investments at full value and receive dividends for as long as they remain invested in the fund.

I would even go as far as to break the Section 12J investment into three major opportunities:
1. 12J converts income tax into capital gains tax (resulting in 60% reduction of tax)
2. 12J delays this reduced tax obligation by at least 5 years (during which time you enjoy the benefits of having the full amount invested for your account)
3. You can stay as long as you want! Remaining in the fund means you keep your investment, you don’t pay the CGT and you earn dividends based on the gross (pre-tax) amount

Need any more convincing?

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