Property Development and Section 12J

The Section 12J tax allowance has introduced an exciting new asset class that has attracted over R6 billion within a very short period of time. Let’s explore how this can benefit developers.

What is Section 12J?

In short, Section 12J investments are a way to boost the economy by providing a tax incentive for investors. The capital raised is used to fund local small and medium-sized enterprises (SMEs) that are believed to have long-term growth potential. The aim is to encourage investors to participate in the capitalisation of these businesses, which will stimulate economic growth and create jobs. The benefit to investors is that they can see a return on their full investment as well as a tax deduction on the amount invested.

This differs from equity shares traded on the stock exchange, as Section 12J investments are essentially private equity shares. These usually have a much higher risk factor, but they generate a higher return. The risk, however, is significantly reduced through the upfront tax deduction, which would offset poor returns. A minimum investment is usually upward of R100,000 (specific to each company) and will need to be held for at least five years to receive the 12J tax deduction.

As an example, an individual investor in the highest tax bracket invests R1 million into an approved venture capital company (VCC). The investor will receive a tax credit of up to R450,000 at the end of the financial year. What this means is that an investor will have 100% of their investment working for them, but only have risk exposure on 55% of their original investment amount.

Potential benefit to developers

Section 12J VCCs are excellent vehicles for assisting developers and companies in raising finance for their projects. Section 12J VC companies cannot invest in immovable property except in the hospitality industry, so projects are limited to hotels, serviced apartments, student residences and mixed-use developments that include a hospitality aspect.

This veers off the traditional process of selling off units at discounted prices in order to raise capital, although this may still be done.

Of course, Section 12J VC companies are not limited to just the property sector. Other great opportunities to expand their investments to other sectors include:

• car rentals
• asset rentals
• franchising
• mining and contract mining
• plant and equipment rental
• manufacturing
• renewable energy
• logistics.

Registering a Section 12J VCC

Although there are many benefits to registering a Section 12J VCC, there are challenges in the process as well as with ongoing compliance. It’s not simply a matter of registering a parent company that can invest in subsidiaries. Some of the nuances are that:

• No investor into the Section 12J VCC may be a ‘connected person’ in respect of the Section 12J VCC. This essentially means that no taxpayer can own 20% or more of the shares in the Section 12J VCC (directly or indirectly).
• No more than 20% of the capital raised through the issue of shares may be invested into any one investee company.
• An investee company cannot be a ‘controlled group company’, meaning that a Section 12J VCC cannot own 70% or more of the equity shares in an investee company.
• To be recognised by SARS, the Section 12J VCC must be registered in accordance with section 7 of the Financial Advisory and Intermediary Services Act, 2002 (FAIS), meaning that the company must have a ‘key individual’ in its employment, the Financial Services Conduct Authority (FSCA) must issue it with a licence, and it must be registered with SARS as a VCC.

These limitations ensure that the Section 12J legislation is not simply used by wealthy individuals as a way to avoid taxation, and the VC company cannot just be used to channel money between entities.

With only around 160 approved Section 12J VCCs, there is definitely opportunity for new businesses to enter the market and take advantage of the incentivised process of raising capital, and in turn invest in SMEs to stimulate the economy, create new jobs and generate good returns.

Bottom line

The Section 12J asset class has already boosted the economy tremendously, but time may be running out because its efficacy in achieving the desired outcomes will be assessed in the next few years, so we may see changes to the legislation. As it stands, only those who invest prior to 30 June 2021 will be able to claim the upfront tax deduction, which implies that those wishing to raise capital via Section 12J should not wait too long.