By Uwe Meier CA (SA)
Overview of Section 12J
Section 12J was introduced by the South African Revenue Services as an investment tax incentive on investments in qualifying businesses.
The incentive gives investors the ability to deduct 100% of their investment against their taxable income in the year they invest. Investors can benefit from up to 45% immediate tax relief. This effectively reduces the cost of the investment by the tax saving, which significantly enhances the return on investment.
Investment through S12J, is estimated at around R7 billion into a range of private companies since 2015, hence very effectively contributing to economic growth and job creation in South Africa.
How it works
Taking the current tax year to end February, an investor who has a marginal tax rate of 45% would be able to save R450 000 of tax should they invest R1 million into an approved Section 12J company, with the caveat that they must hold the investment for a minimum period of five years. The investment is available to individuals, companies and trusts and can be offset against all types of taxable income, which makes it particularly attractive to those who have incurred capital gains tax during the year. For provisional taxpayers, who submit returns at the end of February, the tax benefit can even be deducted from the tax liability before provisional payments are made.
Opportunities for S12J in Franchising:
- Growth capital for franchisors and franchisees.
- Employee participation or management “buy-outs” or “buy-ins”.
- Investment syndications that wish to acquire franchised outlets, together with operators.
- Investment syndications that wish to co-invest in multiple franchised outlets, together with multiple operators.
Mr W runs a successful franchise group in Gauteng, which he wishes to expand into the Western Cape. In order to do the expansion, he requires R12,5 million. Mr W can raise the required capital through a S12J structure by bringing on board 5 new shareholders at R2,5 million each. The new shareholders can deduct 100% of their investment from taxable income in the year in which the investment is made.
Mr X has been running a successful franchise group for many years. He wishes to take a less active role and would like his 5 most trusted employees to buy into the franchise group. The 5 employees can invest in the franchise group by getting full tax relief against their taxable income to invest into Mr X’s franchise group.
Mr Y wishes to buy a franchise that costs R10 million to acquire or set up. He only has R5 million capital available. Mr Y has 5 co-investors lined up (with R1 million each to invest), who are willing to co-invest in the venture. Using a S12J structure, Mr Y will be able to fund the franchise. He will own 50% of the franchised outlet directly, whilst the investors will own 50% of the franchise through a S12J structure. The co-investors can deduct 100% of their investment from taxable income in the year in which the investment is made.
Mr Z owns a very successful franchised group. He has experienced slower growth in recent times, as potential new franchisees have not been able to raise the required capital. Mr Z can set up a syndication (consisting of at least 5 members) that co-funds new franchisees. The syndicated co-investors can deduct 100% of their investment from taxable income in the year in which the investment is made.
Benefits of investing through a S12J company:
- 100% deduction of investment capital from investors’ taxable income.
- Normal tax allowances still apply in the underlying investment company.
- Reduces the cost of the investment, which significantly enhances overall return on investment.
- No impermissible trades, i.e. “sin” industries, property holding companies and financial services businesses do not qualify for S12J.
- Limit of R2,5 million per individual taxpayer, limit of R5 million per corporate taxpayer.
- Minimum of 5 shareholders (per share class).
- No single shareholder may hold more than 20% of a class of shares (since October 2018).
- Connected parties collectively may not hold more than 50% of a class of shares.
- Investment must be between 31% and 69% of shares of the underlying entity.
- Limited to R50 million per investment (Asset value must be less than R50 million post investment).
- Highly regulated.
- Investment must be held for a minimum of 5 years, otherwise the sale of shares is fully taxed.
- If you sell your investment at the end of 5 years, you will be liable to pay capital gains tax with the entire investment calculated as a gain – however, there is no obligation to exit at that stage.
About the author: Uwe Meier CA (SA)
Uwe is the managing director of a corporate finance advisory firm, based in Durban. With over twenty years of operational, investment and corporate finance experience in a range of industries, he provides business owners with professional advice to position their business for a strategic sale or assists them to develop a long-term growth strategy. His proven process consistently helps clients grow their businesses and realise full value on exit. Uwe is a founder, director, and shareholder of Fundamental VCC.