For years, many of our South African clients raising capital have struggled to attract investment from offshore. It is a familiar story. Investors are willing to bet on South African companies. However, they would prefer to do it via an offshore holding company. This would typically be in an investment friendly jurisdiction with which they are familiar. Importantly, the jurisdiction of choice typically has a more favorable regulatory and tax regime than South Africa. For example, R&D tax credits. However, these structures have not been allowed thanks to the South African Reserve Bank’s infamous loop structure prohibition.
What is a Loop Structure?
A loop structure can be summarized as a structure where a South African has an interest in a foreign structure, and that foreign structure in turn (directly or indirectly) owns assets in South Africa.
Since 2018, South African exchange control has only permitted South Africans to hold no more than 40 per cent equity in a foreign structure which in turn has investments in South Africa. Previously, the permitted equity percentage threshold was even lower.
There is an exception to the loop structure restrictions. Unlisted South African technology, media, telecommunications, exploration and other R&D companies are allowed to establish an offshore company to raise foreign funding. Crucially, however, the established offshore company still has to be a tax resident of South Africa. The tax implications meant that this exception had little to no effect practically speaking. Our clients continue to implement complex, clunky (and expensive) alternative structures in order to establish an offshore presence, without falling foul of the Exchange Control Regulations.
Removal of Loop Structures
However, in October 2020, there was good news. The October medium term budget speech announced the “removal” of loop structure restrictions.
National Treasury stated that:
“the full ‘loop structure’ restriction has been lifted to encourage inward investments into South Africa, subject to reporting to Financial Surveillance Department of the South African Reserve Bank (FinSurv) as and when the transaction is finalized. This reform will be effective from 1 January 2021, provided that the entity is a tax resident in South Africa.”
Tax residency is accordingly still a requirement for any company wishing to set up a loop structure. Once again, we cannot realistically see any of our clients embracing this new exemption with any gusto.
No circulars have yet been issued amending our Exchange Control Manuals to make this “removal” of loop structure prohibitions effective. As at the date of writing, the loop structure restrictions are alive and well in the existing manuals. Hopefully publication of these amendments is imminent.
However, with the tax residency disclaimer in place, this “liberalization” may turn out to be a damp squib.
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