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The new Section 12T tax free savings account - a blessing or a curse...

by , 19 May 2015
Mention the words 'tax-free' and the harassed South African taxpayer jumps at whatever product this is referring to. Of course, I'm talking about the new Section 12T tax free savings account that is currently the talk of the investment town.

When I delve deeper into the legislation and the regulations attached to this new section, I'm left scratching my head and wondering why such a "generous" piece of legislation seemingly falls so very short in a number of vitally important areas.

I'm going to be focusing on the tax free savings account in two parts, in order to deal with two very pertinent parts of where I feel the legislation needs to be improved.

Read on for my findings...

As a brief summary, a tax free investment is a vehicle that SARS has designed to allow taxpayers to invest R30,000 per year into an investment account designated as a Section 12T tax free investment. All proceeds and income arising from this investment will be tax free (capital and revenue). Contributions to this account are limited to R500,000 in total per lifetime.
It will take you just over 16 years to reach the R500,000 maximum, and longer still if you happen to dip into your savings and withdraw any capital out of the investment in any year. Further, there is currently no basis for 'catching up' if you withdraw any amount from the investment, as the annual limit of R30,000 ignores all withdrawals during a tax year.  
The first thing I'm going to be looking at is the impression this new part of the Income Tax has given taxpayers, and why it can be considered to be a bit dangerous.

Read on for more...
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Attention tax professional
The new tax changes are here. Enforced by SARS, these regulations came into effect on 1 March and, according to experts, are an important structural change in tax legislation. And these changes are causing uncertainty and stress.
Ignorance of the law, especially when it comes to taxes you owe SARS, can be fatal to your business!
On paper, this tax free savings account sounds fantastic as a vehicle for long-term financial planning. But as always, there's a catch (well, more than one in this case), and taxpayers are advised to be very careful when selecting their provider.
What Section 12T doesn't  say is that any financial service provider (FSP) can put together and offer a Section 12T investment, provided the requirements in the regulations attached to Section 12T are met.
 This immediately creates a large problem for taxpayers, in that the general public know very little about financial instruments and how they function. Taxpayers who invest the same amount of money in different 12T investments will get very different returns at the end of the day, depending on how their FSP's product has performed over the long-term.
Yes, in a capitalist market we can expect different returns being earned on different investments. And this is where I feel one area of Section 12T is very lacking.
SARS has referred to this new vehicle as a 'tax free savings account' and the media have run with this description. The correct description is actually a tax free investment. The meaning of the words 'savings account' and that of 'investment' are understood by the public at large to be two very different things. When I think about a savings account, I immediately equate this to a normal bank account in which the capital is protected, whereas I know an investment usually carries no capital guarantee and I can stand to lose everything
And this brings me to the point: there is no control over minimum returns, or even any regulatory protection of capital invested in these 12T investments. It raises the question of what goal SARS was trying to achieve with Section 12T, because under the current legislation and regulations, it would seem to only benefit the informed and savvy investor. Invest with the wrong FSP, and you could end up with absolutely nothing to show for almost 16 years of investment!
Although the regulations make it a requirement that FSPs inform taxpayers as to the tax free investment they're offering, this is akin to saying FSP's are required to talk to you in French even if you don't understand a word they're saying (as long as they've spoken, they've done their job). Obviously, an unscrupulous FSP could use this vehicle to invest in high-risk areas, dramatically increasing the chances of you losing all your money investment.
Does the legislation compensate taxpayers if they happen to misunderstand high versus low risk, capital guarantees and derivatives? Of course not.  I feel using the words 'savings account' is thus misleading – it implies all 12T investments operate in a manner similar to a bank account where capital is protected, and this is not always the case.
This is a deviation from SARS's intended plans for the 12T investment as being a vehicle to invest long-term, and possibly for retirement considering it will take you at least 16 years to reach your maximum investment limit at current levels. Section 12T should have stipulated, as a minimum, some form of capital protection for investors, given the large number of taxpayers who will view this investment as a means to save up for retirement, and infer that these investments operate similarly to a bank account in that they are referred to as 'savings accounts'.
I can only hope that in 10 years time we don't read articles about the poor hard working citizen who has struggled to invest in a tax free savings account, and has lost a huge sum of money because he or she didn't understand the difference between a savings account and an investment.
I'm going to close with a simple example of some of the limitations I see with Section 12T, using Joe, Max and Alec. All three taxpayers invest R30,000 over a 10 year period.
Joe invested with a reputable investment house for 10 years, having worked in the investment industry beforehand and understanding how to select the best product for his money. His investment has seen fantastic growth, because he was lucky enough to invest with this particular house, and after 10 years it is now worth R700,000. Joe retires and cashes out his investment to settle his bond. No tax for Joe!
Max invested with his bank, which invested in low risk interest bearing accounts. After 10 years, Max's investment is now worth R400,000. Max retires and cashes out his investment. No tax for Max!
Alec invested with a small individual FSP who came recommended by his uncle. After 10 years, Alec's investment is now worth R50,000 because this guy invested in high-risk derivatives. Not only that, but this guy forgot to mention that his product lost its 12T designation 5 years ago and Alec owes taxes and penalties on interest earned during this period that he didn't know was taxable. Poor Alec.
Three taxpayers, using the same legislation to invest in a product specifically designated by SARS to be for long-term investment , and three very different outcomes.

Keep reading...
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There's nothing better than getting money back from SARS...
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If there's anything I can say to taxpayers thinking about investing in a 12T account, it's that 'tax free' doesn't mean anything. You could generate better returns through a taxed investment vehicle if it's the right one. For those set on investing - make sure you interrogate your FSP regularly to ensure that the product is still compliant and has its 12T designation, realize that unless specifically stated you could lose all your money invested, and keep shopping around – you are allowed to switch FSPs with no tax consequences if you can achieve a better result elsewhere.
SARS may have touted this tax free savings account as something the average taxpayer can look forward to. But it has fallen terribly short in protecting the very same taxpayer from some of the downfalls of a piece of legislation that really needed to grow a little bit more before having become effective.
Next time I'll be going into greater detail on another very large risk facing taxpayers that arises out of the 12T investments., and in particular what on earth happened in Alec's case above. Imagine your investment loses out on its 12T designation – what happens then? And what if it lost this designation many years ago? Will you have to fork over tax on all the income earned on this investment with the resulting penalties and interest?
Yes, of course you will. But I'll go into detail in my next editorial!

P.S. For five simple ways you can knock off R445 000 off your 2015 tax bill, simply click here...

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