Capitalising on capital gains tax with Section 12J

If you are dealing with an astute financial advisor, it is very likely that steps are or have been taken to diversify your investment portfolio offshore. In doing so, advisors are often faced with the predicament as to which of their client’s investments to dispose of to create liquidity to invest offshore. One clear option is the down weighting of a client’s local listed equity portfolio, however, the capital gain tax event for many advisors is a deterrent. 

By balancing a client’s equity portfolio disposal with a partial investment in a Section 12J investment, financial advisors may start to consider their client’s liquidity options significantly differently.  

The upfront benefit of investing in a Section 12J investment is that the investor (provisional taxpayer or not) is entitled to deduct 100% of the investment against his/her taxable income. As capital gains fall within a taxpayer’s taxable income, financial advisors are able to balance a disposal of a listed equity, unit trust portfolio, property and/or business interest with a Section 12J investment in order to reduce the capital gains tax liability (or payment to SARS) by as much as R1 125 000 (for an individual investor).  

Following a discussion with Michael Westcott, CEO of Absolut Wealth Management. Michael explained that,

 “Section 12J has created an opportunity for a number of his clients and personally to shield a capital gains tax event following the disposal of a share portfolio.” 

By way of example, if a client elects to sell R10 000 000 of his listed share portfolio and as a result has a capital gain of R5 000 000 (less his/her annual exemption of R40 000), 40% (R2 000 000) must be included in his taxable income. The net effect is that the client would have a tax liability of approximately R900 000. 

 The client now has an option to invest approximately R2 000 000 in a Section 12J investment and reduce his/her tax liability to zero. This would leave the client with R8 000 000 to invest offshore, R2 000 000 invested onshore and no capital gains tax liability resulting in a saving of R900 000 which would have been paid to SARS. This example doesn’t just apply to listed equity but to the sale of any asset which would result in a capital gains tax event” 

One must be mindful that a Section 12J investment is not comparable from a risk profile to a listed equity investment, however, if the client’s intention is to exit investments, a Section 12J investment has its place in terms of shielding the tax liability and potentially earning a return from asset exposure that meets the client’s risk appetite. 

One aspect of Section 12J which is often misunderstood is the capital gains tax event on exit. Unlike with most other investments, when calculating capital gains tax, a Section 12J investment’s base cost must be reduced to zero. In other words, an investor at the highest marginal tax rate will likely pay 18% capital gains tax on his/her original investment amount when exiting the Section 12J investment. Most people, however, fail to take into consideration the fact that the same investor received 45% of his/her investment back in the form of an upfront tax refund. In other words, the investor’s net benefit is 27% (45% less 18%) on their investment amount plus time value of money having received 45% upfront. Effectively this amounts to an IRR of 8.3% per year through the SARS refund alone. 

Section 12J investments are without a doubt an investment option for high-income earners However, before getting too excited about the tax saving, taxpayers should consult a financial advisor who understands the underlying investments, how performance fees are calculated, whether the Section 12J investment has invested current funds under management and most importantly, the client’s financial and tax position. 

Jonty Sacks – Partner at Jaltech Fund Managers