February – where January goes to die. Sure there’s Valentine’s Day and it’s a short month, but it’s also the time of year to pay the piper, who in this case happens to be the South African Revenue Service.
It’s therefore no surprise that it’s also the time of year when you are faced with a barrage of calls and adverts from financial services companies encouraging you to invest in their products in order to minimize your tax bill. Thanks to the power of algorithmic advertising, my social media feeds are full of adverts and sponsored posts from product providers looking to ease my tax burden.
For me, this tax season has been particularly challenging as I actually have to take these products more seriously than usual. I received the final payment for the sale of my business in August last year, which means I am in for some serious pain, primarily in the form of capital gains tax.
So I did the research and these are some of the areas that caught my attention.
Contributions towards a pension, provident fund or retirement annuity, are tax deductible to limits of either R350 000, or 27.5% of your remuneration for the year. That’s a decent saving. While I knew this, I have been guilty in the past of not utilising this benefit to its full potential. I think one of the main issues that held me back was the fact that there are restrictions on how much of an RA fund can be held in offshore assets (30% – up from 25% last year). However, after some quick calcs, I realised that a R350 000 investment would not significantly impact my overall investment strategy of 70% offshore, 30% local.
The other problem I have with RA’s is the fact that you can’t access it until age 55. What I didn’t fully appreciate is that unlike most other investments, the income, dividends and capital gains in an RA are not subject to taxation during the period of investment. Sure you get hit on the back end to an extent when you cash in or draw an income from an annuity but in my case I get 13 years of growth before that happens.
So as with everything in life, there are pros and cons. In this case however, the pros win and I have moved ahead with the maximum contribution to my RA.
Most of you will know that you can claim deductions for contributions to medical schemes. What you may not know (I didn’t) is that the more dependents you have on your scheme, the more the tax credits are. Also new to me was that you can also claim for medical expenses not covered by your scheme. I had quite a lot of those in 2018, so that’s an unexpected win.
The interest income, dividends and capital gains on investments into a tax free savings fund are not taxed. You can invest up to R33 000 per year and a lifetime maximum of R500 000. While that sounds pretty enticing, the contribution isn’t tax deductible, so this product is not of immediate interest to me right now. It’s definitely something I will consider in the future however – every little bit helps.
Section 12J funds
This one did my head in way more than the others. I spent a lot of time researching these schemes, including engaging directly with a couple of the larger S12J funds such as Westbrooke, Anuva and Lucid.
Section 12J is an investment tax incentive which was introduced by SARS to boost the South African economy by encouraging investment into SMEs which operate in select industries. Individuals, companies and trusts can benefit from up to 45% immediate tax relief. So for every R100 invested into a S12J fund, you can reduce your tax bill by R45.
On the face of it, that sounds incredibly appealing…… but……. there are some worrying downsides.
Firstly, the investment must be held for at least five years. That’s quite a serious lock-in period so you have to be sure you won’t need the money before then. While you can technically withdraw the funds during the five year period in some cases, you will lose the tax benefit and the whole investment is then subject to CGT.
A Section 12J investment also carries a base cost of zero and therefore on exit from the investment, you will be liable for capital gains tax on the full proceeds. As such the tax benefit is not as big as it first appears.
One of the issues that worried me the most was liquidity, or lack thereof. Because most of the underlying investments are in property or other fixed assets, I’m not convinced it’s going to necessarily be that easy to get your money back after the five year lock in period. What if the property market is struggling at that point? I don’t want to hang on to the investment once the tax benefit is gone.
Most importantly however, is that none of the S12J funds convinced me that the underlying investments were completely sound. Because there are restrictions on what type of assets qualify as S12J compliant, fund managers are restricted in the assets they can have in their funds. There is also not a lot of diversification in terms of asset types in these funds. This means that you could land up with a fund that has poor quality assets in concentrated sectors. I subscribe to the school of thought that believes you should never make an investment just for the tax benefit. In this particular case, nobody could convince me that these funds were offering much more than that. I also wasn’t convinced that most of these investments would actually benefit the broader South African society in the form of meaningful job creation. So I’m out.
All in all, while tax is by no means an exilirating subject for me, I think the extra research and effort I put in was worth it. I feel comfortable that I have explored most of the key ways to (honestly) reduce my tax bill. I recommend you do the same with the help of your financial advisor.