A lot of hype has been created around the modernisation of South African exchange control regulations, which included major changes to the ‘loop structure’ provisions with effect from 1 January 2021.
The exchange control changes affecting ‘loop structures’ were foreshadowed by critical tax law changes to avoid a potential erosion of the South African tax base. When both tax and exchange control changes are taken into account – is it really worth the effort to ‘offshore’ the shareholding of your South African interests?
Before getting into more detail, let’s first understand the exchange control concept of a ‘loop structure’. A ‘loop structure’ is created where a South African exchange control resident (being either an individual or a company) invests in, or advances debt into the Common Monetary Area (being South Africa, eSwatini, Lesotho and Namibia), indirectly through an offshore structure.
Prior to 1 January 2021, not all ‘loop structures’ were regarded as impermissible though. Under the previous exchange control regime relating to ‘loop structures’, South African exchange control resident individuals and South African resident companies could hold up to 40% of the equity or voting rights in a foreign company. The foreign company was then permitted to ‘loop’ back, by investing or advancing debt into the Common Monetary Area. Where the 40% shareholding cap was not exceeded, no formal approval was required from either an Authorised Dealer or the Financial Surveillance Department of the South African Reserve Bank (FinSurv), being for all intent and purposes an ‘implement and observe’ approach from a regulatory perspective.
Where do we stand now? As from 1 January 2021, South African individuals, companies and private equity funds are allowed to invest or advance debt into South Africa through a 100% offshore ‘loop structure’. Sounds great so far, however the additional compliance and reporting burden to establish and maintain a ‘loop structure’ under the new regime, coupled with tax amendments, may cause an entrepreneur or investor to hit the brakes and re-evaluate whether having an offshore structure is worth the effort.
As stated above, the relaxation of the ‘loop structure’ provisions were foreshadowed by various critical tax amendments. Why are these tax amendments so important? Under the previous ‘loop structure’ regime, where the 40% shareholding cap existed, it was possible, subject to certain requirements being met, for a South African individual or company shareholder, holding at least 10% of the equity shares and voting rights in a foreign company, to receive foreign dividends on a tax-free basis. Although more requirements needed to be met, it was also possible for an individual or company holding at least 10% of the equity shares and voting rights, to dispose of their shares in the offshore company, on a capital gains tax-free basis.
To avoid the potential erosion of the South African tax base, tax amendments were made from 1 January 2021 to essentially remove the ability to receive tax-free foreign dividends or tax-free capital gains, where South African tax resident shareholders hold more than 50% of the shares in an offshore company, that in turn, invests or advance debt back into South Africa. Given that individual shareholders embarking on a ‘loop structure’ remain fully exposed to estate duty in South Africa, the onerous Controlled Foreign Company provisions and place of effective management considerations, careful planning is required to ensure efficiency from a commercial, regulatory and tax perspective.
To calculate the changes to your income tax, try out the Sasfin Tax Calculator.