Section 12J Exit Options

Jonty Sacks

For many South African taxpayers, the 30th of June 2021 marked the end of the highly popular Section 12J tax incentive.

This incentive provided taxpayers with a valuable tax-shielding mechanism to minimize their capital gains or income tax liabilities, and the opportunity to contribute positively to the South African economy. However, the incentive had a tax drawback in that investors were obligated to pay a maximum of 18% capital gains tax for every Rand received when exiting the investment, regardless of whether the investment returned a profit or not.

To illustrate, if an investor receives his/her original investment on exit (while they would have received up to a R450 000 tax benefit upfront), the investor would have a maximum capital gains tax liability of 18% of the original investment amount, regardless if the investment has grown or not.

At present, a significant number of Section 12J investments have reached the end of their 5-year investment term, leaving investors with a handful of investment alternatives that can help minimize or postpone their capital gains tax liability.

Option 1 – Section 12B solar investment

The Section 12B solar investment is the latest tax-deductible investment opportunity for taxpayers who are looking to reduce their tax liability and enjoy the stable returns associated with solar investments.

Akin to Section 12J investments, investors can claim a tax deduction on their investment value through Section 12B of the Income Tax Act by investing in a Section 12B solar investment. However, Section 12B provides investors with an enhanced 125% tax deduction relative to Section 12J.

To elaborate, if a taxpayer in the top tax bracket invests R1 million in a Section 12B solar investment, they can reduce their taxable income by R1.25 million, resulting in a tax saving or refund of R562 500.

Current Section 12J investors can exit their investment, receive their investment amount, and then reinvest the funds into a Section 12B solar investment. This move can be beneficial as investors can offset more than their Section 12J capital gains tax liability with the Section 12B refund.

The following comparison shows the difference between solely exiting a Section 12J investment versus exiting and reinvesting the funds into a Section 12B solar investment.

Assumptions: 1) the Section 12J investment returned R1m, 2) the investor is in the highest tax bracket, and 3) the annual capital gains tax exemption allowance has been utilised.

Option 2 – Section 42 rollover relief

Section 12J investors who are exiting have an alternative option available to them through Section 42 roll-over relief under the Income Tax Act. This provision allows investors to transfer their Section 12J investment interest into a Collective Investment Scheme (“CIS”) without incurring capital gains tax liability at the time of transfer, thereby delaying the tax liability until the investment term in the CIS ends. This investment would generally provide private debt exposure to investors with liquidity but could also provide other classes of investment.

Investors may be more inclined to choose this investment instead of a solar investment if they seek to avoid exposure to solar energy or desire an investment with a shorter lock-in period.

Option 3 – RA investment

The final option for exiting Section 12J investors is to invest in a retirement annuity, limited to a maximum of 27.5% of their remuneration, with a cap of R350,000 per year. By investing the maximum allowable amount of R350,000 in a retirement annuity, an investor in the highest tax bracket could potentially shield up to R157,000 in capital gains tax.

As illustrated above, there are several options available to exiting Section 12J investors who wish to decrease or delay their capital gains tax obligation. In our view, the most tax-efficient and cashflow-friendly alternative would be to invest in a Section 12B solar investment. Assuming the asset class and liquidity profile are suitable for the investor.

By way of illustration, where an investor receives R800,000 pre-tax from exiting a Section 12J investment, the investor would only need to invest approx. R257 000 in a Section 12B solar investment to reduce the capital gains tax liability of R144 000 to zero tax.

In contrast, alternative options such as investing in a retirement annuity would require approx. R325 000 (21% more than a Section 12B investment) and an investment in a Collective Investment Scheme would require R800 0000 (321% more than a Section 12B investment) to delay the tax event.

To conclude, there are various investment options available for investors who are exiting Section 12J investments, each with its own set of advantages and disadvantages. It is crucial for investors to make an informed decision based on their financial situation and objectives. Seeking advice from a professional financial advisor can help investors weigh their options and choose the most suitable investment option that can help reduce or delay their capital gains tax liability. It is always better to exercise caution and seek expert advice before making any investment decisions.