Loop structures no longer illegal
BEWARE: TAXPAYERS SHOULD NOT OVERREACT The law of unintended consequences could kick in.
Loop structures have always been perceived by the SA 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, Sarb announced that from 1 January the full “loop structure” restriction has been lifted 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 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 SA Institute of Tax Professionals’ international tax work group, says 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 says interest on a loan would normally be taxable at 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 a low 5%.
Shares sold in a SA 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 effective from this month, 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.
Hugo van Zyl, exchange control expert and member of the SA 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 be 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.