From 1 January 2021, there is no longer a prohibition on loop structures in South Africa. This is a significant exchange control relaxation that will impact many structures for both corporates and individuals, says Peter Dachs, executive at law firm ENSAfrica.
A loop structure is essentially an arrangement whereby a South African resident invests in an offshore vehicle which, in turn, invests in South African assets.
“Loop structures were previously prohibited on the basis that they created a channel for the direct or indirect export of capital from South Africa,” Dachs said.
“This prohibition has been in place for decades and has been the subject of much debate as well as various court cases. Limited exceptions have been made in the past, especially for inward listed vehicles.”
More recently, South African resident individuals and companies have been allowed to invest in up to 40% of an offshore vehicle that invests in South African assets.
“In terms of the new provisions, with effect from 1 January 2021, South African companies and South African resident individuals with authorised foreign assets may invest in South African assets provided that South African assets are acquired through an offshore structure, and the investment is reported to an authorised dealer.
“It will also be required to verify that the transactions are entered into on an arm’s length basis and for market value consideration.”
Dachs said that existing unauthorised loop structures must still be regularised with the Financial Surveillance Department of the South African Reserve Bank.
“It will be interesting to see how this relaxation is implemented in practice and whether, for example, it will apply in circumstances where a South African company wishes to sell shares in a South African subsidiary to a foreign buyer in exchange for shares in that foreign buyer. ”
Legal firm Bowmans provided a further explanation of the changes. These changes were outlined in a circular published by the South African Reserve Bank and apply with effect from 1 January 2021.
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.
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.
You can read the full SARB circular below.
Additional commentary by Esther Geldenhuys, Robyn Berger and Aneria Bouwer of law firm Bowmans.