The South African Reserve Bank (SARB) has started implementing a new system for managing capital flows in South Africa, with changes starting in early 2021. In a circular issued on January 4 and entered Effective January 1, 2021, the SARB announced that the complete “loop structure” restriction for individuals and businesses that are tax residents in South Africa has been lifted to encourage foreign investment in the country. Denny Da Silva, Tax Specialist, Baker McKenzie in Johannesburg, discusses these changes below.
In line with the South African Reserve Bank’s (SARB) commitment to implement a new capital flow management system, changes began to take place in early 2021. In the first circular of the year, published on January 4, 2021 (circular), the SARB announced that as of January 1, 2021, the complete restriction of the “loop structure” for individuals and businesses that are tax residents in South Africa has been lifted to encourage foreign investment in South Africa.
The abolition is accompanied by reservations, however, in that these structures are subject to the normal criteria that apply to foreign investment in South Africa and must be reported to the Department of Financial Supervision (Finsurv).
A little history
Under Rule 10 (1) (c), no person may, except under the conditions imposed, enter into any transaction whereby capital or any interest in capital is directly or indirectly exported from South Africa. Thus, residents cannot (use funds or any other authorized foreign asset to) enter into any transaction or series of transactions, when the purpose and / or effect is to export capital directly or indirectly from Africa. South (i.e. to, directly or indirectly, through any structure or system of arrangement, acquire shares or any other asset / interest in a Common Monetary Area (CMA) country (transactions ).
These transactions –
- invariably involve the formation by (or at the request of) a resident of an offshore structure who – through reinvestment in the CMA – acquires shares or other interest in a CMA company or CMA asset
- contravene the Regulations, including Regulation 10 (1) (c), because they result in and / or have the potential to result in the direct or indirect export of capital abroad
“Loop structures” are usually created by an individual, trust or company resident in South Africa transferring authorized or unauthorized funds from South Africa to, for example, create a foreign trust or a foreign company. The trust or the foreign company would then invest directly or indirectly (via another offshore entity) the funds authorized or not in South Africa, thus creating a “loop structure”. The investment could take the form of South African stocks, loans or other assets. The returns accruing to the foreign company or trust on South African investments could take the form of dividends, interest or other amounts, resulting in the accumulation of profits from the investments of the trust or offshore company in South Africa.
Over the years, Finsurv has relaxed the restrictions around “loop structures”, initially with the relaxation of its policy on “loop structures” in the CMA by companies (Circular of exchange control no. ° 5/2018) and, more recently, the relaxation of its policy towards individuals. Finsurv published the exchange control circular n ° 18/2019, which is applicable to “loop structures” formed after October 30, 2019, and provides that individuals can individually or collectively acquire up to 40% of the capital and / or voting rights, whichever is greater, in a foreign target entity, which entity may, in turn, hold investments and / or make loans to any country in the CMA. Existing “loop structures” (ie created by individuals before October 30, 2019) and / or “loop structures” where the 40% stake is exceeded must be regularized with Finsurv. Failure to do so may result in a fine or imprisonment, or both. Exceptionally, and only with regard to “loop structures” formed after October 30, 2019, private, public and listed South African companies may, at the request of their authorized dealer, acquire up to 40% of capital and / or voting rights, whichever is greater, in a foreign target entity, which entity may, in turn, hold investments and / or make loans to any country in the CMA. This exemption does not apply to foreign direct investment where the South African company alone or where several South African companies collectively own an equity interest and / or voting rights in the foreign entity exceeding 40 percent in total.
Then, in his February 2020 budget speech, the Minister of Finance announced his intention to introduce a new system for managing capital flows over the next twelve months, with all foreign currency transactions permitted without hindrance, at the exception of a list of risk-based measures which is introduced. , including among others relaxation of exchange control requirements for “loop structures”. These changes would only be introduced after the amendment and introduction of the relevant tax provisions aimed at protecting the South African tax base.
The circular notes that, as of January 1, 2021, the Foreign Exchange and Stock Exchanges Handbook for Authorized Brokers (Handbook) is amended by removing restrictions on investment in “loop structures” by individuals and resident companies. (including private equity funds) provided that the investment is reported to an authorized dealer and the authorized dealer submits an annual progress report to Finsurv. Written confirmation from an independent auditor or appropriate documentary evidence, verifying that the transaction is concluded at arm’s length, at a fair price and on the market, must be submitted to the authorized dealer.
Once a “loop” transaction is completed, an authorized dealer must provide FinSurv with a report including among others:
- the name (s) of the affiliated South African foreign investor (s)
- a description of the assets to be acquired (including foreign loans, acquisition of shares and acquisition of property)
- the name of the target South African investment company, if applicable
- the date of acquisition
- the actual amount in foreign currency entered, including a transaction reference number
The circular also provides that current unauthorized “loop structures” created before January 1, 2021 must still be regularized with FinSurv, including those where the 40% threshold has been exceeded.
The other consequential changes are as follows:
- All incoming loans from South African affiliated foreign investors must comply with the guidelines issued in section I.3 (B) of the Handbook.
- Residents, who have been entitled to a foreign inheritance from a resident’s estate and who are required to declare these foreign assets inherited through an authorized dealer to Finsurv are now allowed, upon request, to keep the assets abroad. and invest in a “structure loop”, the only restriction currently applicable is that the assets cannot be made available to other residents.
- With respect to loans received from foreign lenders, these will no longer be subject to the restrictions that the loan funds may not represent or originate from the authorized foreign assets of a South African resident or that he may not. there is a direct / indirect South African interest in the foreign lender.
As noted above, the removal of the ban on “loop structures” was premised on the commitment that there would be adequate tax provisions in place to protect the South African tax base. In line with this commitment, changes to the Income Tax Act 1961 have been proposed and will come into effect on January 1, 2021, being primarily:
- Dividends received by a controlled foreign company (being a company where more than 50% of its shares, for example, are owned directly or indirectly by a South African resident) from a South African company will now be taxed at a ratio of number 20 for number 28 and taking into account any dividend tax paid.
- The divestiture of shares of a controlled foreign company will not qualify for the so-called equity exemption to the extent that the value of the assets of the controlled foreign company is derived from South African assets. In other words, a resident will only pay capital gains tax for the portion of the sale price that represents the value of South African assets.
While the removal of the ban on ‘loop structures’ is a welcome change and a step in the right direction, it comes with a caveat that it is not an absolute removal of the ban, in particular bearing in mind that structures that violated the restrictions on January 1, 2021 still need to be regularized. It would also appear that the restrictions would still apply to South African trusts seeking to set up “loop structures”. Then there is the fiscal caveat, which requires that the tax considerations of any “loop structure”, or any structure for that matter, must be carefully considered before being implemented.