Reserve Bank eases exchange controls for loop structures – but there’s a tax catch, warns expert

This week, the South African Reserve Bank announced a relaxation of the rules relating to loop structures – which involve investments through foreign structures that in turn own assets in South Africa, eSwatini, Namibia and Lesotho. These structures are attractive to South African entrepreneurs looking for foreign investors. In this interview, Robyn Berger – a partner at law firm Bowmans – dissects the details for the BizNews community. – Jackie Cameron

South Africa: Exchange controls relaxed for loop structures

*From Bowmans

The long-awaited relaxation of the rules relating to ‘loop structures‘ has finally been announced and most South African residents may now invest in these structures.

However, such investments may still be subject to some form of supervision. It is also important to note that various tax measures are currently being introduced to address potential tax leakage arising as a result of the relaxation.

In his February 2020 budget speech, the Minister of Finance announced various proposed relaxations to the existing exchange control regime, including the relaxation of the rules relating to loop structures.

A loop structure arises where a South African exchange control resident (individual or company) has an interest in a foreign structure and that foreign structure directly or indirectly owns assets in the Common Monetary Area consisting of South Africa, Eswatini, Lesotho, Namibia and South Africa.

Read also: How to fix suspended exchange control circular, Regulation 28 – investment expert Nerina Visser. MUST READ!

Until recently, these structures were permitted only in very limited circumstances, typically where South African exchange control residents in aggregate did not own more than 40% of the shares in the foreign company, regardless of the extent of ownership held by the foreign company in the South African assets, including resident companies.

In terms of Exchange Control Circular No. 1/2021 (Circular), the restrictions on loop structures pertaining to individuals, companies and private equity funds that are tax resident in South Africa have been further relaxed. The Circular does not refer to trusts and it thus seems that trusts will still not be permitted to invest in loop structures.

The changes outlined in the Circular apply with effect from 1 January 2021 and are summarised below.

Individuals, companies and private equity funds

Individuals, companies and private equity funds may utilise authorised foreign assets to invest in South African assets through a loop structure,  subject to the following:

  • The investment must be reported to an Authorised Dealer, i.e. local bank, as and when the transaction(s) is finalised. An annual progress report must be submitted to the Financial Surveillance Department of the South African Reserve Bank (Finsurv) via an Authorised Dealer;
  • An Authorised Dealer must view an independent auditor’s report verifying that the transaction(s) is concluded on an arm’s length basis and at a fair and market-related price;
  • Upon completion of the transaction, the Authorised Dealer must submit a report to the Finsurv which should, among others, include the name(s) of the South African affiliated foreign investor(s), a description of the assets to be acquired, the name of the South African target investment company (if applicable), the date of the acquisition and the foreign currency amount introduced;
  • All inward loans from South African affiliated foreign investors must still comply with the current exchange control rules applying to inward foreign loans; and
  • Existing unauthorised loop structures (i.e. created prior to 1 January 2021), must still be regularised with the Finsurv.

Foreign inheritance

Where a resident has inherited foreign assets held by the deceased offshore in compliance with exchange control regulations, the resident may apply to Finsurv for approval to retain the assets offshore. Until recently, such approval would be subject to the condition that the assets may not be used to invest in a loop structure. The prohibition on the investment in loop structures has now been scrapped.

Inward foreign loans

Inward foreign loans received from foreign lenders will no longer be subject to the restriction that:

  • The loan funds may not represent or be sourced from a South African resident’s authorised foreign assets; and
  • There may not be any direct/indirect South African interest in the foreign lender.

All clients who are either currently invested in loop structures or who have been unable to make investments as a result of the loop structure restrictions, should carefully consider the impact of the proposed relaxations on their current or future investments.

It is particularly important for investors to obtain advice regarding the impact of the proposed tax changes on existing loop structures. As the proposed changes are intended to address potential tax leakage arising from the relaxation of loop structures, it could have a negative impact on the tax treatment of existing loop structures.

Read also: 

SA Reserve Bank Exchange Control Circular No. 1/2021 

South African resident individuals and companies loop structures 

Following the Minister of Finance’s announcement in the 2020 Medium Term Budget Policy Statement and in order to support South Africa’s growth as an investment and  financial hub for Africa, it is advised that the full ‘loop structure’ restriction has been  lifted to encourage inward investments into South Africa; subject to the normal  criteria applying to inward investments into South Africa and the reporting to the Financial Surveillance Department. 

This reform is effective from 2021-01-01 and applies to private individuals and  companies, including private equity funds that are tax resident in South Africa. 

The following amendments have been made in the Currency and Exchanges Manual  for Authorised Dealers (Manual): 

Section B.2(B)(i) 

The subsections (i), (j), (k) and (l) have been amended and replaced as follows: 

(i) Resident individuals with authorised foreign assets may invest in South Africa,  provided that where South African assets are acquired through an offshore  structure (loop structure), the investment is reported to an Authorised Dealer as and when the transaction(s) is finalised as well as the submission of an  annual progress report to the Financial Surveillance Department via an  Authorised Dealer. The aforementioned party also has to view an independent  auditor’s written confirmation or suitable documentary evidence verifying that  such transaction(s) is concluded on an arm’s length basis, for a fair and market related price. 

(j) Upon completion of the transaction in (i) above the Authorised Dealer must  submit a report to the Financial Surveillance Department which should, inter  alia, include the name(s) of the South African affiliated foreign investor(s), a  description of the assets to be acquired (including inward foreign loans, the  acquisition of shares and the acquisition of property), the name of the South  African target investment company, if applicable and the date of the 

acquisition as well as the actual foreign currency amount introduced including  a transaction reference number.  

(k) In addition, all inward loans from South African affiliated foreign investors must  comply with the directives issued in section I.3(B) of the Authorised Dealer  Manual. 

(l) Existing unauthorised loop structures (i.e. created by individuals prior to  2021-01-01) and/or unauthorised loop structures where the 40 per cent  shareholding threshold was exceeded, must still be regularised with the  Financial Surveillance Department. 

Section B.2(C)(i)(f) 

The current subsection (ee) has been deleted and replaced accordingly. New  subsections (ff), (gg) and (hh) have been added. The current subsections (ff) to (oo)  have been renumbered (ii) to (qq) while the current subsection (kk) has been  deleted. 

(ee) Corporates with authorised foreign assets may invest in South Africa, provided  that where South African assets are acquired through an offshore structure  (loop structure), the investment is reported to an Authorised Dealer as and  when the transaction(s) is finalised as well as the submission of an annual  progress report to the Financial Surveillance Department via an Authorised  Dealer. The aforementioned party also has to view an independent auditor’s  written confirmation or suitable documentary evidence verifying that such transaction(s) are concluded on an arm’s length basis, for a fair and market  related price. 

(ff) Upon completion of the transaction in (ee) above the Authorised Dealer must  submit a report to the Financial Surveillance Department which should, inter  alia, include the name(s) of the South African affiliated foreign investor(s), a  description of the assets to be acquired (including inward foreign loans, the  acquisition of shares and the acquisition of property), the name of the South  African target investment company, if applicable and the date of the  acquisition as well as the actual foreign currency amount introduced including  a transaction reference number.  

(gg) In addition, all inward loans from South African affiliated foreign investors must  comply with the directives issued in section I.3(B) of the Authorised Dealer Manual. 

(hh) Existing unauthorised loop structures (i.e. created by corporates prior to  2021-01-01) and/or unauthorised loop structures where the 40 per cent  shareholding threshold was exceeded, must still be regularised with the  Financial Surveillance Department. 

Section B.2(C)(ii)(e) 

The current subsection (gg) has been deleted and replaced accordingly. New  subsections (hh), (ii) and (jj) have been added accordingly. 

(gg) Corporates with authorised foreign assets may invest in South Africa, provided  that where South African assets are acquired through an offshore structure  (loop structure), the investment is reported to an Authorised Dealer as and  when the transaction(s) is finalised as well as the submission of an annual  progress report to the Financial Surveillance Department via an Authorised  Dealer. The aforementioned party also has to view an independent auditor’s  written confirmation or suitable documentary evidence verifying that such  transaction(s) is concluded on an arm’s length basis, for a fair and market  related price. 

(hh) Upon completion of the transaction in (gg) above the Authorised Dealer must  submit a report to the Financial Surveillance Department which should, inter  alia, include the name(s) of the South African affiliated foreign investor(s), a  description of the assets to be acquired (including inward foreign loans, the  acquisition of shares and the acquisition of property), the name of the South  African target investment company, if applicable and the date of the  acquisition as well as the actual foreign currency amount introduced including  a transaction reference number. 

(ii) In addition, all inward loans from South African affiliated foreign investors must  comply with the directives issued in section I.3(B) of the Authorised Dealer  Manual. 

(jj) Existing unauthorised loop structures (i.e. created by corporates prior to  2021-01-01) and/or unauthorised loop structures where the 40 per cent  shareholding threshold was exceeded must still be regularised with the  Financial Surveillance Department. 

Section B.2(G) 

The current subsection (ii) has been deleted and replaced accordingly. New  subsections (iii) and (iv) have been added while the current subsections (iii) and (iv)  have been renumbered accordingly. 

(ii) Private equity funds with authorised foreign assets may invest in South Africa,  provided that where South African assets are acquired through an offshore  structure (loop structure), the investment is reported to an Authorised Dealer as and when the transaction(s) is finalised as well as the submission of an  annual progress report to the Financial Surveillance Department via an  Authorised Dealer. The aforementioned party also has to view an independent  auditor’s written confirmation or suitable documentary evidence verifying that  such loop transaction(s) is concluded on an arm’s length basis, for a fair and market related price. 

(iii) The information called for in subsection (i) above must be furnished by the  Authorised Dealer to the Financial Surveillance Department and should, inter  alia, include the name(s) of the South African affiliated foreign investor(s), a  description of the assets to be acquired (including inward foreign loans, the  acquisition of shares and the acquisition of property), the name of the South  African target investment company, if applicable and the date of the  acquisition as well as the actual foreign currency amount introduced including  a transaction reference number.  

(iv) In addition, all inward loans from South African affiliated foreign investors must  comply with the directives issued in section I.3(B) of the Authorised Dealer  Manual. 

(v) Existing unauthorised loop structures (i.e. created by private equity funds prior  to 2021-01-01) and/or unauthorised loop structures must still be regularised  with the Financial Surveillance Department. 

Section B.2(L) 

The entire subsection has been deleted. 

Section B.17(D) 

The current subsections (ii), (iii) and (iv) have been amended while subsection (v)  has been deleted accordingly.  

(ii) The foreign assets inherited may, on application, to the Financial Surveillance  Department normally be retained abroad provided that the assets were held  abroad by the deceased in compliance with the provisions of the Regulations. 

(iii) The approval of the Financial Surveillance Department to retain such foreign  assets abroad will be granted subject to the condition that the foreign assets may not be placed at the disposal of other residents. 

(iv) Where it is disclosed to the Financial Surveillance Department that the foreign assets inherited were held by the deceased in a manner contrary to the  provisions of the Regulations, an application for regularisation of such assets  must be submitted via an Authorised Dealer to the Financial Surveillance Department. If approved, the retention of such assets abroad is subject to the  conditions that the assets will not be placed at the disposal of other residents. 

The amended Manual as well as guidelines documents for both individuals and  business entities may be accessed on the South African Reserve Bank website:  www.resbank.co.za by following the links: home>financial-surveillance>financial surveillance-documents>manuals.

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