What the change in “loop structure” rules mean

What the change in “loop structure” rules mean

• 15 February 2021
• Accounting
• Ciaran Ryan

In January 2021, the Financial Surveillance Department of the South African Reserve Bank (known as Finsurv) issued Exchange Control Circular No. 1/2021 (Circular) which lifts loop structure restrictions on SA exchange control residents that are “tax resident” in South Africa.

A “loop structure” is any arrangement under which a South African resident invests in an offshore vehicle which, in turn, invests in South African assets. In other words, a South African investing abroad in an entity which in turn invests back into SA, which creates a return flow or “loop” back into SA.

Previously, loop structures were permitted only in very limited instances, such as where SA residents held 40% or less of the shares in a foreign company that held interests back into SA.

For a country trying to attract foreign investment flows, placing ceilings on how much South Africans can invest in offshore structures planning to invest back in SA (or into the Common Monetary Area, which includes SA, Eswatini, Lesotho and Namibia) seems like an own goal. The new regulation changes this.

This will impact both individuals and companies. As Sovereign Trust points out, the move was first announced by Minister of Finance Tito Mboweni in his Budget Statement last February. It was then reiterated in his Medium Term Budget Speech (MTBS) delivered last October, when he said: “Work is well advanced to modernise the cross-border flows management regime to support South Africa’s growth as an investment and financial hub for Africa.”

The new rules became applicable on 1 January 2021 for companies, including private equity funds, that are tax resident in SA.

This means South Africans with authorised foreign assets will be able to invest back into SA provided that, where South African assets are acquired through an offshore structure, 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.

Related tax amendments

In a note to clients, Deloitte reports that certain related tax amendments have been introduced to address potential tax leakage which may result from the relaxation of the exchange control rules.

income earned by controlled foreign companies (CFCs) in terms of the Taxation Laws Amendment Act No. 23 of 2020, promulgated on 20 January 2021. The amendments come into operation on 1 January 2021 and apply in respect of dividends received or accrued to, or, any net capital gain of, any CFC on or after that date.

“The amendment applicable to dividends will apply if a CFC holds shares in a South African resident company (a loop structure). In this instance, a portion of the dividends received by the CFC will now be included in the CFC’s net income (i.e. become taxable). The portion to be included is determined in terms of a formula,which, simply, aims to prevent arbitrage in dividends tax rates that the loop structure facilitates,” says the Deloitte report.

The amendment applicable to net capital gains has been made to the participation exemption on capital gains arising from the disposal of equity share capital in a foreign company to a non-resident. In future, the participation exemption on capital gains will not apply to the disposal of any share in a CFC to the extent that the value of the assets of that CFC is attributable to assets directly or indirectly located, issued or registered in South Africa.

“South African exchange control residents should carefully consider the impact of these tax amendments when planning any increased shareholding in foreign companies which create loop structures.”

These changes to loop structure exchange control rules, and the related tax amendments, create both opportunities and risks for financial, tax and estate planning. 

The SA government, it seems, has taken the decision to stop trying to combat tax avoidance through the use of exchange controls rather than tax avoidance legislation, says Sovereign Trust.

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