A loop structure is a mechanism that a South African resident can use to hold a South African asset indirectly through a non-resident entity. Typically, a loop structure is created when a South African resident individual or corporate entity transfers authorised funds from South Africa, or uses authorised funds already abroad, to set up a foreign entity or structure. In this context, ‘authorised funds’ refers to funds that are held offshore legitimately, for example, a foreign inheritance or a foreign investment that was made using an annual offshore investment allowance. The foreign entity would then reinvest the authorised funds back into South Africa, either directly or indirectly (via another offshore entity), thereby creating a loop structure.

The reinvestment could be in the form of acquiring South African shares, assets or loan accounts. In some instances, the South African resident would export returns on the investment by way of, for example, the payment of dividends, profits, interest and/or loans to the foreign structure. The result of the loop structure is that the investment from the offshore structure into South Africa and the payment of dividends, profits or interest offshore results in the accumulation of value over and above the value of the initial investment made in the foreign entity.

Transactions creating loop structures contravene certain regulatory provisions, including Regulation 10(1)(c) of the Exchange Control Regulations, 1961. Regulation 10(1)(c) states that: ‘no one may enter any transaction whereby capital or any right to capital is directly or indirectly exported from South Africa, except with permission from Treasury and in accordance with any conditions Treasury may impose.’

As a result, these structures were permitted only in very limited circumstances, typically where South African exchange control residents did not own more than 40% of the shares in the foreign company. In addition, South African resident individuals were prohibited from establishing offshore trusts with South African resident discretionary beneficiaries or other offshore structures to acquire the 40% ownership in the offshore entity. See our previous communication relating to the announcement of exchange control reforms.

In January 2021, the South African Reserve Bank (SARB) issued Exchange Control Circular No.1/2021, which effectively lifted the restrictions on loop structures pertaining to individuals, companies and private equity funds that are tax resident in South Africa. The purpose of this is to support South Africa’s growth as an investment and financial hub for Africa and to encourage inward investments into South Africa.

In summary, it appears that all new loop structures created with authorised foreign assets, including foreign trust structures, are now allowed. However, we await further clarification on this in the new Capital Flow Management Manual to be finalised by SARB, subject to the completion of the required approval processes.

What are the rules?
 

According to the SARB Circular, individuals, companies and private equity funds may acquire 100% ownership of an offshore entity that invests into South Africa, subject to the following: 

• The investment must be reported to an authorised dealer, such as a local bank, when the transaction is finalised. The authorised dealer must submit an annual progress report to SARB’s Financial Surveillance Department (FinSurv).
• The authorised dealer must view an independent auditor’s report verifying that the transaction has been concluded on an arm’s-length basis and at a fair market-related price.
• When the transaction is complete, the authorised dealer must submit a report to FinSurv. This report should, among other things, 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.
• Existing unauthorised loop structures must still be regularised by FinSurv.

It is important to consider the related tax changes 
 

While loop structures have become permissible from an exchange control perspective, you should also consider some of the tax changes to prevent potential tax leakage arising from the removal of these restrictions. These amendments were specified in the Taxation Laws Amendment Act 2020, which was promulgated on 20 January 2021.

Dividends received from South African companies by Controlled Foreign Companies (CFCs) are now taxable 
 

What is a CFC?

• Where 1 or more South African resident(s) directly or indirectly hold more than 50% of the total participation rights or voting rights in a foreign company, that company (unless certain exemptions apply) will be regarded as a CFC. 
• In this case, a proportional percentage of passive income is taxed and included in the tax return of the South African tax resident shareholder. 
• If the CFC is reinvested back into South Africa by acquiring shares in a South African company, any dividends declared by the South African company should be subject to South African dividend withholding tax (DWT) at 20%, or a reduced rate if there is a double taxation agreement in place between South Africa and the country of tax residence of the CFC.
• Before 1 January 2021, the CFC profits attributable to the South African tax resident excluded dividends received from South African companies. Following the amendments, these dividends are now included. The tax payable by the South African tax resident on the attributable dividends should, however, be adjusted to ensure that this does not exceed an effective rate of 20%, considering the DWT already paid.

A capital gain resulting from the disposal of a share in a CFC is no longer exempt

• In terms of the Income Tax Act, a South African resident must disregard any capital gain or loss from the disposal of any equity share in any foreign company if certain conditions are met (for example, where the resident owns at least 10% of the shares in that foreign company).
• An amendment now states that this exemption will not apply to a capital gain resulting from the disposal of a share in a CFC, to the extent that the value of the assets of that foreign company is attributable to assets directly or indirectly located, issued or registered in South Africa.   

Deciding whether to make use of a loop structure should be done on a case-by-case basis
 

We generally recommend that our clients obtain international investment exposure as part of their overall investment strategy to help mitigate currency, geographical and market concentration risk through diversification. Using authorised foreign assets via a loop structure to reinvest back into South Africa diminishes diversification of these risk factors. As such, it is strongly recommended that you consider your personal circumstances and overall investment plan before deciding to reinvest into South Africa via a loop structure.
 

Contact us for expert advice
 

If you are considering investing into an offshore entity with a loop structure component, please consult your wealth manager about whether this is an appropriate option for you. If you are not a client yet, apply here or contact us on 0800 111 263.