The Minister of Finance and the South African Reserve Bank (SARB) have been hard at work these past few years modernising exchange controls. One of the first changes made in 2021 came in the form of an announcement in the Budget Speech of the intention to relax the exchange control rules on loop structures.
However, in order to counter concerns that loop structures would be used to circumvent South African tax, the Income Tax Act was amended by updating the controlled foreign company (CFC) tax rules. A CFC, in simple terms, means a foreign company which is more than 50% directly or indirectly held by South African tax residents. If the controlled foreign company made an investment or loan back into South Africa, the exchange control loop structure rules come into play.
What do all of these changes mean? Let’s clarify the loop structure updates and the exchange control implications thereof, as well as the new reporting requirements that have been implemented by the Financial Surveillance Department (FinSurv) of SARB.
Historically speaking, what was the problem with loop structures?
By definition, loop structures are workarounds through which a South African resident acquires and holds an interest in a foreign entity which in turn directly or indirectly invests in South African assets.
Individuals often use a foreign trust for this purpose, while in the context of venture capital, this involves investing in a foreign fund that holds shares in a South African company. The effect of this would be that a South African shareholder in such an arrangement would not receive their returns (whether in the form of dividends or capital gains) directly from the South African entity, but by means of the foreign entity.
Until the end of 2020, loop structures could only be used in a handful of circumstances, for example, where South African investors (whether individual or a company) held shares of less than 40% in a foreign company. South African employees could also participate in foreign share schemes. Such exceptions to the rule were relevant in private equity scenarios to enable South African investors and employees to partake in foreign investment vehicles.
The reporting requirements for new loop structures in South Africa are now as follows:
- Any loop structure created after 1 January 2021 must be reported to an Authorised Dealer (i.e., a local commercial bank) as and when such a transaction is finalised. The Authorised Dealer must then submit a report to FinSurv containing the following details: The name(s) of the South African affiliated foreign investor(s)
- A description of the assets to be acquired. This will also include inward foreign loans and the acquisition of property and shares.
- The name of the South African target investment company (if applicable)
- The date of the acquisition
- The foreign currency amount introduced and the transaction reference number
- An independent auditor’s report verifying that the transaction was concluded on an arm’s length basis for a fair and market-related price.
- An annual progress report on the loop structure must be submitted to FinSurv by the Authorised Dealer.
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If you are considering creating a loop structure, it is important to be aware of the exchange control reporting requirements as failure to comply with these requirements may result in penalties being imposed by the SARB. Our Exchange Control specialist has over 35 years’ exchange control experience which means we are perfectly positioned to assist you.
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