Understanding the Section 12J tax benefit – Sunstone Capital Edu Series 3

Welcome to our third instalment of the Sunstone Capital Edu Series. In the first  two series we discussed the basics of Section 12J (S12J)  and movable asset investments . Today, we?thought it would be worthwhile to explore more of the detail  of the Section 12J tax benefits and limitations.

First off, a few important terms for you to clarify;

  1. Taxable income – The total amount of income earned in the year of assessment which is subject to income tax, less any allowable deductions.
  2. Tax liability – The total amount of tax owed to the receiver of revenue. 
  3. Year of assessment: This is the period in which your tax return is based on, also known as the “Tax year” – and it runs from 1 March – 28/29 February.
  4. Capital Gains Tax (CGT): This is the amount taxed on the profit realised on the sale of an asset, most common examples are the sale of 1 Property, 2 Shares – on the stock exchange or in a business.
  5. Inclusion rate: This is the rate at which a capital gain included in taxable income e.g. a capital gain for an individual has an inclusion rate of 40%, in the case of a R1 million capital only R400 000 is included in taxable income.

Next, how Section 12J works;

Section 12J works very similarly to a retirement annuity in that the amount invested is fully deducted from your taxable income, in the year of assessment, in which the investment is made. The main difference is that a retirement annuity has a cap limit, whereas  S12J does not limit the amount that can be invested and claimed. This helps reduce your tax liability and in some cases allows for a refund from SARS.

Each investor gets a share certificate and a tax certificate. The share certificate is what can be used to sell their shares in the S12J (either back to the fund or to another investor,) in order to facilitate an exit. The tax certificate is what can be sent as a supporting document to the receiver of revenue stating that a S12J investment has been made and that the full amount should be deducted from your taxable income.

Now, for two basic illustrative examples to show the practical application of the above deduction (for more in depth specific scenarios please get in touch with avi@grovest.co.za.)

Scenario 1

Investor 1, let’s call him John, works as an executive at a bank, and earnsR 1, 500 000 as a fixed salary. He earned a bonus of R 1,500 000 in the 2020 year of assessment (1 March 2019 – 29 Feb 2020). John decided to invest R1million into Sunstone Capital S12J. Assuming he has no other deductions –  his tax calculation before and after S12J will look as follows:

Before S12J After S12J
Taxable Income: R 3 000 000 Taxable income: R 2 000 000
Tax Liability: R 1.35 million (45% of R 3 million) Tax liability: R 900 000 (45% of R 2 million, 45% being their marginal tax rate, as per tax table below)
Tax Saving: 0 Tax Saving: R450,000 (45% of R 1million)

Scenario 2 

Investor 2 (an individual), lets call her Anne,  bought a business in 2008 for R1 Million and after running it successfully for 11 years sold it in July 2019 for R4 Million. Assuming that Anne earns a salary of R 1.5million, with no other deductions – her tax calculation will look as follows:

Capital Gain = Proceeds (R4 million) – Base cost (R 1 million) = R 3 million

The capital gain of R3 million has a 40% inclusion rate, this means that R1.2 million is included in her taxable income.

Taxable income = R 1.5 million + R 1.2 million = R 2.7 million  (ignoring any other exclusions)

Tax liability: 45% = R 2.7 million X 45% = R 1 215 000

This means that in order to negate the tax impact of the R3 million capital gain only R1.2 million (R3 million X 40%) needs to be invested into a S12J company

Key take home points:

  1. The S12J deduction has the most value when done by an individual who has attracted the highest marginal tax rate in that year 
  2. Most S12J’s assume you are taking the 45% tax benefit and that your risk capital is only 55% (100-45%). this is what returns are based on – in the event that you are in a lower bracket it will impact your rate of return (feel free to contact us to understand the effect on investment)
  3. A S12J investment can be used to offset taxable income not tax liability, this means that if you have a tax liability of R 2 million (and therefore taxable income of R4 444 444) and you invest R 2 million in a S12J, it won’t offset the full amount of tax due, but rather you will pay tax on R 2 444 444 (R 4 444 444 – 2 000 000) 
  4. S12J is an effective way to deal with large capital gains or other tax events that take place in the year of assessment, however, investment into a S12J can’t help with historical tax problems
  5. Any SA taxpayer can benefit from a S12J tax deduction (individuals, companies and trusts)

South African Individual Taxpayers – Tax Table

Income exceeding: Not Exceeding: Rates of tax (R)
R 0 R195 850 18% of taxable income
R195 851 R305 850 R35 253 + 26% of taxable income above R195 850
R305 851 R423 300 R63 853 + 31% of taxable income above R305 850
R423 301 R555 600 R100 263 + 36% of taxable income above R423 300
R555 601 R708 310 R147 891 + 39% of taxable income above R555 600
R708 311 R1 500 000 R207 448 + 41% of taxable income above R708 310
R1 500 001 and above R532 041 + 45% of taxable income above R1 500 000

If there are any questions or for more information, contact the author on avi@sunstonecapital.co.za
feel free to visit our website at www.sunstonecapital.co.za or sign up here to stay informed https://mailchi.mp/98a298bc3ac4/311s92uepf

Next post: The development of the 12J asset class – Edu Series 4