Buy your franchise with a tax deduction

  • April 26, 2018 10:38 am
  • News

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imageBe smart in your plans to buy a franchise and you
could save by getting a tax break. Picture: iStock

If you are looking to buy a small business, make sure you are using the tax breaks available, writes Maya Fisher-French

Under section 12J of the Income Tax Act, individuals can invest in qualifying venture capital companies (VCCs) and receive a 100% tax deduction on the amount invested, as long as the investment is held for five years.

This has been a great opportunity for high-net-worth investors to diversify their investment portfolio into growth sectors, such as junior mining and renewable energy.

It also creates a tax-effective opportunity for small businesses, especially for franchises, hotel and student accommodation and asset-rental businesses.

“The uptake of the structure has been phenomenal among the more financially informed, but the wider market needs to be educated on the incentive and how to use it, as it will empower small business and individuals,” says Jonty Sacks of Jaltech, a boutique financial consulting firm with expertise in the formation and management of section 12J venture capital companies.

Sacks explains that, for example, if you wanted to buy into a franchise business, normally you would pay the franchisor directly and receive no tax deduction on the price paid. By using section 12J, you could invest the money into a VCC which, in turn, purchases the franchise, allowing you to deduct the purchase price from your taxable income.

If the franchise costs R2 million, by investing through the VCC, that amount would be fully tax deductible from your income. Depending on your tax rate, it could save you as much as R900 000, making the investment far more affordable.

Sacks explains that the investor receives a specific A-class shareholding in the VCC, which gives the investor/shareholder the right to instruct the VCC to make investments on behalf of the A-class shareholders.

All economic benefit (growth and dividends) is ring-fenced for the A-class shareholders.

The investor still has control of the franchise, except that they have received a significant tax deduction for the investment.

Using tax deductions to encourage people to invest in new businesses will have a knock-on effect of stimulating growth in jobs and the economy. This is particularly beneficial for asset rental businesses such as car fleets used for either car rental or Uber-type businesses.

Sacks says while one can predict the cash flow from an asset rental business, typically these are lower-risk, lower-return investments.

However, by providing the tax deduction, the net effect to the investor is to boost the internal rate of return by an additional 9%, assuming a personal tax rate of 45%.

Student and hotel accommodation are another popular form of venture capital companies. Sacks has created a student accommodation and hotel fund through which investors can buy a unit in a development, benefit from the rental income and are able to write off the initial investment against their income.

There are costs in using a VCC, so you need to take these into account. Jaltech charges 4% of funds invested in the 12J. That means that instead of receiving a 45% tax deduction, the investor receives 41%.

There is also a 1.5% fee on funds under management per year. For an investment of R1 million, there would be an annual fee of R15 000.

Qualifying investments

Certain businesses may not benefit from section 12J, so you need to first check that the business you wish to acquire does not contravene these rules:

  • The gross value of the target company may not exceed R50 million;
  • It may not earn more than 20% of its income from investment income;
  • The majority of its trade must be within South Africa;
  • In terms of immovable property, only hotels, serviced apartments, holiday homes and student residences are allowed;
  • The financial services sector, or any trade in financial or advisory services, is not included, except for investing in technology within this sector; and
  • No trade is allowed in respect of gambling, liquor, tobacco, arms or ammunition.

 

Source: City Press https://city-press.news24.com/

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