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LOOP STRUCTURES – WHAT ARE THEY AND WHY DO THEY MATTER?

by Delon Small of Spence Attorneys

An investment into a foreign entity that develops into an investment loop (as a result of money coming back into the country through a loan and/or an investment from this foreign entity) creates a loop structure. This loop structure could possibly contravene South African exchange control regulations. It is important to know about loop structures and understand the South African law surrounding this. Those who lack insight on loop structures could experience untoward penalties and tax consequences. This piece briefly discusses and in turn provides readers with a high-level understanding of loop structures.


WHAT IS A LOOP STRUCTURE?

A loop structure is formed when an exchange control resident (natural or juristic person) of the common monetary area (the “CMA”) holds an investment in a foreign vehicle (i.e. a non-resident entity), which then holds an investment in and/or makes loans to an entity within the CMA. The CMA consists of South Africa, Lesotho, Eswatini, and Namibia.


ARE LOOP STRUCTURES PERMITTED?

A transaction that creates a loop structure can contravene local exchange control regulations. This structure allows a resident investor to be the ultimate beneficiary of funds which are paid to a foreign vehicle from a source within South Africa. Consequently, there is a potential infringement of the mentioned regulations, and tax leakage if protective tax measures are not in place.


Generally, when a loop structure is detected by the South African Reserve Bank, through its Financial Surveillance Department (the “Reserve Bank”), and the loop structure is not created in compliance with local regulations, the Reserve Bank will require for the investment to be unwound. This may result in untoward penalties and tax consequences. A local company may invest in a vehicle outside the CMA if an Authorised Dealer (most commercial banks) provides approval. This foreign direct investment must not exceed R1,000,000,000 (one billion Rand) per company per year. The said foreign vehicle may then hold investments in and/or make loans to any CMA country.


This investment loop is however subject to the condition that the foreign direct investment does not cause for a local exchange control resident to have more than 40% (in total) of equity interest and/or voting rights in the foreign target entity. If the investment exceeds the prescribed limit - permission for this foreign investment must be requested from the Reserve Bank.


The aforesaid dispensation for local companies has recently been extended to private individuals through circular 18/2019 dated 31 October 2019. Accordingly, private individuals may form part of a loop structure.


ARE THE LOCAL AUTHORITIES’ VIEWS ON LOOP STRUCTURES CHANGING?

The South African Revenue Service (the “SARS”), National Treasury and the Reserve Bank appear to be taking steps to lessen restrictions on loop structures. This includes implementing, among others, protective measures to avoid any tax leakage. Protective measures to prevent tax leakage through loop structures have been proposed in the Draft Taxation Laws Amendment Bill. This was released on 31 July 2020. In terms of the proposed amendments, a substantial tax burden would likely be imposed on loop structures. One such tax burden includes the amendment of section 9 of the Income Tax Act, 58 of 1962 (the “Act”). Parts of section 9 of the Act provide for the rules which apply to a controlled foreign company (“CFC”). A CFC is a non-resident company in which a South African Resident holds 50% or more of shares.


CLOSING THOUGHTS

Permitting loop structures promotes cross-border transactions which could greatly assist the South African economy. As noted above, there are regulations and/or guidance notes that exchange control residents must follow when they are involved in a loop structure. It seems that the local authorities intend to remove the prohibition on loop structures. However, given the protective measures (which include substantial tax burdens) that are intended to be implemented to avoid tax leakage, one questions whether South Africans would even benefit from the proposed relaxation of restrictions.


Considering the above, it is always best to seek advice from qualified professionals whenever contemplating a cross-border transaction. We at Spence Attorneys would be happy to assist you. Contact Delon Small, delon@spencelaw.co.za for further assistance on exchange control.


#SARB #loopstructures #Rosebank #Pinelands #attorney #exchangecontrol


(C) Spence Attorneys. This article is for information purposes only and should not be regarded as legal advice. Always seek legal advice from an attorney. Spence Attorneys will not be held liable for any person acting on the information contained in this article.

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