Tax­ing rights do lit­tle to help our cause

In­vest­ment man­agers need to be able to work with­out at­tract­ing tax risk

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW - SHAYNE KRIGE

WITH high-re­turn in­vest­ments in emerg­ing mar­kets in the East and in South Amer­ica prov­ing in­creas­ingly scarce, Africa is be­com­ing a pop­u­lar desti­na­tion for in­ter­na­tional cap­i­tal.

The con­ti­nent re­mains dark for many for­eign in­vestors and, per­haps more so than in any other re­gion, in­vestors need in­vest­ment man­agers to as­sist them in de­ploy­ing their cash.

Given the dom­i­nance of the South African econ­omy, the coun­try is the most likely desti­na­tion for African cap­i­tal and South Africans hav­ing proven adept at man­ag­ing in­vest­ments else­where in Africa, lo­cal skills are also sought af­ter for in­vestors tar­get­ing the rest of Africa.

This is good news for SA. An ex­pand­ing in­vest­ment man­age­ment in­dus­try cre­ates jobs at all skill lev­els and at­tracts highly paid in­di­vid­u­als who pay taxes on the money they earn and the cash they spend lo­cally. Un­for­tu­nately, as things stand, this po­ten­tial is dif­fi­cult to tap be­cause hir­ing a South African in­vest­ment man­ager is a bad idea for a for­eign fund. It re­sults in two ma­jor tax con­se­quences for the fund.

Firstly, any in­come that is deemed to have a South African source, is tax­able in SA which, be­cause of the way our law is in­ter­preted may well be the case if the lo­cal man­ager has a dis­cre­tion to con­tract on be­half of the for­eign fund. This is a risk that is eas­ier to man­age in other ju­ris­dic­tions and it makes it very dif­fi­cult for a lo­cal man­ager to ful­fil a dis­cre­tionary man­date.

The sec­ond, and more se­ri­ous, is­sue re­lates to tax res­i­dency. A fund that has its “place of ef­fec­tive man­age­ment” will be deemed to be South African tax res­i­dent. In­ter­na­tion­ally, this is the place where the fund’s high-level strate­gic de­ci­sions are taken.

The South African Rev­enue Ser­vice’s (SARS) in­ter­pre­ta­tion dif­fers such that a fund will be ef­fec­tively man­aged where the in­vest­ment de­ci­sions are im­ple­mented rather than the place where the in­vest­ment ob­jec­tives, pol­icy and re­stric­tions are set. This is a South African prob­lem and although the note set­ting out SARS’s in­ter­pre­ta­tion is not law and is widely held to be in­cor­rect, it nev­er­the­less has a chill­ing ef­fect on the al­lo­ca­tion of in­vest­ment man­dates to South African man­agers who are un­der pres­sure to move their op­er­a­tions to places such as Lon­don, Geneva or Mau­ri­tius.

The UK is one of many coun­tries that have cre­ated an in­vest­ment man­age­ment ex­emp­tion in terms of which only the in­vest­ment man­age­ment fees paid to a UK-based man­ager are tax­able. The man­age­ment ac­tiv­i­ties nei­ther cre­ate a lo­cal source of prof­its nor do they re­sult in the fund be­com­ing UK tax-res­i­dent. Lon­don re­mains the de facto fi­nan­cial cap­i­tal of Europe and the global in­vest­ment man­age­ment hub de­spite the high cost of liv­ing and rel­a­tively high per­sonal tax li­a­bil­ity UK man­agers face.

In May 2010, the Trea­sury pro­posed changes to the In­come Tax Act which fo­cused on cre­at­ing a “re­gional in­vest­ment fund regime”. I would ven­ture that the de­mand for an African in­vest­ment fund struc­ture is rather small. In­vest­ment funds with a mul­ti­juris­dic­tional fo­cus are mo­bile en­ti­ties and usu­ally set up shop in ju­ris­dic­tions that have low tax and low reg­u­la­tion. A panoply of ju­ris­dic­tions of­fers at­trac­tive regimes for in­vest­ment funds. De- spite Mau­ri­tius’s at­tempts at at­tract­ing this busi­ness, the bulk of in­vest­ment funds tar­get­ing Africa are still set up in the Caribbean or Europe. It would be dif­fi­cult for SA to at­tract the ac­tual fund busi­ness. On the other hand, the in­vest­ment man­agers who man­age these funds are less mo­bile and in fact more in­ter­est­ing in terms of the tax­able rev­enues they gen­er­ate.

The pro­posal doc­u­ment does recog­nise that “the pos­si­bil­ity of cre­at­ing a tax­able South African per­ma­nent es­tab­lish­ment makes the coun­try unattrac­tive to for­eign in­vestors seek­ing to utilise [struc­tures] with a port­fo­lio man­ager within SA”, and pro­poses tax re­lief to rem­edy this sit­u­a­tion. The ac­tual im­ple­men­ta­tion has to date fallen some­what short of achiev­ing the stated aims. Although the amend­ment has been widely wel­comed as a pos­i­tive step, it has been crit­i­cised for:

Fo­cus­ing on the fund struc­ture rather than the re­la­tion­ship be­tween the fund man­ager and the fund prompt­ing the ques­tion as to why con­trac­tual in­vest­ment man­age­ment man­dates are not cov­ered;

Be­ing lim­ited to funds set up as part­ner­ships and trusts, ex­clud­ing funds set up as cor­po­rate en­ti­ties and es­sen­tially fo­cus­ing on for­eign pri­vate eq­uity funds; and

Deal­ing exclusively with the per­ma­nent es­tab­lish­ment is­sues that funds and their in­vestors cur­rently have and not ex­tend­ing to the is­sue of a fund's tax res­i­dence be­ing in SA by virtue of the dis­cre­tionary ac­tions of its South African man­agers.

In the 2011 bud­get speech, the min­is­ter of fi­nance in­di­cated that fur­ther amend­ments are in the pipe­line. SA’s com­pet­i­tive ad­van­tage lies in our in­fra­struc­ture and skills. These play to our abil­ity to pro­vide in­vest­ment man­age­ment ser­vices rather than our abil­ity to of­fer a com­pet­i­tive fund regime. The govern­ment would be well-ad­vised to play to SA’s strengths by at­tract­ing in­vest­ment man­agers rather than fo­cus­ing on in­vest­ment funds.

What the coun­try needs is a regime that al­lows in­vest­ment man­agers to con­duct dis­cre­tionary ac­tiv­i­ties, whether un­der a con­trac­tual man­date or through a par­tic­u­lar struc­tured par­tic­i­pa­tion, with­out cre­at­ing any tax risk for a for­eign fund. It is im­por­tant that the law is un­equiv­o­cal in re­la­tion to SA’s tax­ing rights so that in­vestors (in­di­vid­u­als or funds) are left in no doubt as to the con­se­quences for them of us­ing a lo­cal man­ager. When it comes to in­vest­ment man­age­ment ac­tiv­ity, it is not far-fetched to imag­ine Cape Town or Jo­han­nes­burg as the African equiv­a­lent of the City of Lon­don.

If SA does not re­act soon, this busi­ness will es­tab­lish it­self else­where and it re­mains to be seen whether the changes that are due in 2012 will, by cre­at­ing a true in­vest­ment man­age­ment ex­emp­tion, give the coun­try the tools it needs to cap­i­talise.

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