The long-awaited relaxation of the rules relating to 'loop structures' has finally been announced and most South African residents may now invest in these structures.

However, such investments may still be subject to some form of supervision. It is also important to note that various tax measures are currently being introduced to address potential tax leakage arising as a result of the relaxation.

In his February 2020 budget speech, the Minister of Finance announced various proposed relaxations to the existing exchange control regime, including the relaxation of the rules relating to loop structures.

A loop structure arises where a South African exchange control resident (individual or company) has an interest in a foreign structure and that foreign structure directly or indirectly owns assets in the Common Monetary Area consisting of South Africa, Eswatini, Lesotho, Namibia and South Africa.

Until recently, these structures were permitted only in very limited circumstances, typically where South African exchange control residents in aggregate did not own more than 40% of the shares in the foreign company, regardless of the extent of ownership held by the foreign company in the South African assets, including resident companies.

In terms of Exchange Control Circular No. 1/2021 (Circular), the restrictions on loop structures pertaining to individuals, companies and private equity funds that are tax resident in South Africa have been further relaxed. The Circular does not refer to trusts and it thus seems that trusts will still not be permitted to invest in loop structures.

The changes outlined in the Circular apply with effect from 1 January 2021 and are summarised below.

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.

Foreign inheritance

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.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.