Loop structures have always been perceived by the South African Reserve Bank (Sarb) and National Treasury as structures that enabled the illegal export of capital from South Africa and a way to reduce tax liabilities.
Earlier this month however the Sarb announced that from January 1 the full “loop structure” restriction has been lifted in order to encourage inward investment into SA.
This appears to be in line with the February 2020 announcement by Finance Minister Tito Mboweni that the exchange control regime would be replaced by a capital flow management regime.
Until now exchange control regulations prevented anyone, except with permission granted by Treasury and in accordance with certain conditions, from entering into any transaction whereby capital or any right to capital was directly or indirectly exported from SA.
It was a contravention of the regulations when residents set up offshore structures that reinvested into the Common Monetary Area (CMA) by acquiring shares or other interest in a CMA asset.
Werksmans Tax director Ernest Mazansky says the original prohibition of a loop was in place to protect the foreign currency reserves and capital from an exchange control point of view.
A loop structure is where a South African resident invests in an offshore structure (company or trust), which in turn invests into South African assets.
Mazansky, a member of the South African Institute of Tax Professionals’ international tax work group, is of the view that the Sarb’s Financial Surveillance Department has enforced the prohibition for the purpose of protecting the tax base rather than to protect the foreign currency reserves and capital outflows.
He explains that interest on a loan would normally be taxable at the rate of 45%. However, if the loan came from abroad the withholding tax might be limited to 15% (or less if the lender is resident in a country with a more favourable double taxation agreement with SA).
Furthermore, local dividends are normally taxed at the rate of 20%. However, if the investment came from a foreign company resident in a jurisdiction with a favourable double tax agreement, the withholding tax might be reduced to as low as 5%.
Shares sold in a South African company would be subject to capital gains tax (CGT); however, if held through an offshore structure they could usually be exempt from CGT.
“If there was any doubt about this motivation [that the prohibition was enforced to protect the tax base rather than for exchange control purposes] that doubt was dispelled in last year’s budget, where it was announced that the loop prohibition would be removed following amendments to the Income Tax Act,” says Mazansky.
Denny da Silva, tax specialist at Baker McKenzie, says in terms of the tax changes that are effective from the start of this year, dividends received by a controlled foreign company (where a South African resident owns more than 50% of the shares) from a SA company will now be taxed on a specific ratio, taking into account any dividend tax that has been paid.
The disposal of shares in a controlled foreign company will now be subject to CGT, as the participation exemption will no longer apply to the extent that the value of the assets of the controlled foreign company are derived from SA assets.
Requirement to report
Mazansky notes that where loop structure investments are made into SA, Lesotho, Eswatini and Namibia, it is only the transactions into SA that are required to be reported to the Sarb.
“On the basis that the loop prohibition was to protect the tax base, which is no longer necessary, this makes perfect sense, because an investment into another CMA country is simply a foreign investment for tax purposes, no different to any other foreign investment,” remarks Mazanksy.
Hugo van Zyl, exchange control expert and member of the South African Institute of Chartered Accountants’ exchange control sub-committee, warns South Africans not to overreact to, or abuse the new changes.
“Even if it is legal to make use of the loop structure to, for example, extract dividends from the SA company, it may not advisable in every situation.”
Van Zyl says it is important for taxpayers to seek advice on the tax consequences of any changes to their existing structures as there may be unintended tax consequences in the foreign country.
According to Van Zyl, the lifting of the full loop structure restriction may be beneficial for software developing companies. The change means that a South African developer will be allowed to place the ownership of the intellectual property (IP) in a US company that will be allowed to invest back into the SA company.
“Old Sarb rules restricted the SA developer to a 40% effective interest in the foreign distribution company,” says Van Zyl.
As of January 1, South African IP developers can now own the controlling shares in their foreign IP distribution company that partly of fully owns the SA-based intellectual property.