13sex Taxbreak promotes benefits for developers and investors alike

We’ve always known that the popular Section 12J had an expiry date, but we assumed (hoped) it would be extended. Well, it won’t be. So, if you want to take advantage of it, you had better move very, very fast to get in before the 30 June cut-off. But it’s not all bad news. While 12J is on the way out, Lucky 13sex is still around.

12J

There is a reason SARS has these incentives – they are (or are at least were intended to be) good for the economy.
Section 12J of the Income Tax Act was designed specifically to offer tax breaks to individuals or companies investing in ventures that would, otherwise, struggle to find finance. The intention was to provide funding for small to medium enterprises in a range of different industries, specifically with the intention of creating employment. The intended beneficiaries of the scheme were businesses like small-scale manufacturing, farming, renewable energy, franchises, and other somewhat marginal endeavours.

However, the sector that seems to have benefited the most is the hospitality sector, which – while it certainly does create employment – is not generally considered a high-risk investment. (Okay, that’s BC – Before Covid.) And the majority of 12J investors were putting their money into pretty solid prospects – mostly property – that probably could have found funding even without the incentives.

So it wasn’t long before the government realised that 12J wasn’t really serving its intended purpose. There are, of course, some exceptions, and it has helped many SMEs and land claims beneficiaries to create workable enterprises. But, mostly, it’s been a great tax break for investors and developers without the intended downstream benefits, which is why Treasury is pulling the plug.

13sex

Okay, 13sex only allows a 5% (or max 10%) deduction, which seems pretty mingy compared to 12J’s 100%, but it is not a one-off, it’s annual, and it seems to be tailor-made for residential developments. 13sex applies only to new builds (or to improved buildings) and the tax benefits apply only to people or companies that own at least five residential units that are rented out for income, so this is likely to benefit developments aimed at the investment market.

On a new build, the investor is eligible for an allowance of 55% of the purchase price and, on a renovated unit, 30%.

Here’s how it works:

1. Developer A buys a block of 10 flats for R20 million, spends R10 million improving it, and sells each flat for R4 million.
2. Investor B buys five units at R4 million each, totaling R20 million.
3. B is entitled to deduct 5% of 30% of their investment: 30% of R4 million is R1.2 million. That multiplied by five gives you R6 million.
4. B may deduct 5% of that (R300,000) from their income annually.

Developer X builds a new block of 20 flats across the road from A, spending R30 million, also selling each flat for R4 million.
Investor Y buys five flats, making their total investment R20 million – just like B.
However, Y is eligible for an allowance of 55% of the purchase price, so they save 5% of R11 million, which is R550,000 per annum.

In order to be eligible for the deductions, B and Y must rent out all the flats – let’s say they rent them at R10,000 per month, which will give them each a total income of R600,000, of which B can deduct R300,000 and Y can deduct R550,000. Not bad.

Where 13sex gets really sexy

Section 13sex is designed to improve the lot of ordinary South Africans, so – if you invest in affordable housing – you can claim 10% rather than five. For the purposes of 13sex, affordable housing is a house that sells for R300,000 or less, or an apartment that sells for R350,000 or less.
A condition of the Act is that the rent charged by the investor may not exceed 10% of the purchase price.

So let’s do those sums again – this time with an affordable house.
Developer C builds 20 new homes for R4 million, and sells each for R300,000, which totals R6 million, giving them a profit of R2 million.
Investor Z buys five units, spending a total of R1.5 million, which entitles them to an annual deduction of 10% of 55%, i.e. R82,500.
They rent each flat for R3,000 per month, which gives them a total income of R180,000, only R97,500 of which is taxable.

What this means for developers and investors

It is tempting to carefully study the regulations to simultaneously maximise tax benefits and profits, which sounds like a win-win situation, but it’s important to bear in mind the reasons for the tax breaks.
The intention is not to maximise profit, nor to increase sales, for developers, and it is not to offer tax breaks for wealthy investors.

The purpose of the tax breaks is to create employment and, in a best-case scenario, to provide housing.
This, combined with the profit maximisation and tax savings, creates a win-win-win situation. But, as has happened with J12, if the financial aspects outweigh the developmental ones, it will be revised – iteratively – until it works. So, as a developer or an investor, you can circumvent this by choosing developments that actively create employment and/or improve the lives of ordinary South Africans. That way, the win-win-win situation will be retained, rather than being subject to constant revision, which will facilitate better long-term planning.

This is just one of the reasons that investing in affordable housing is a good idea. There are many, many more.