What is a Loop Structure?
A loop structure is broadly any arrangement through which a South African resident – a natural person, corporate entity or private equity fund – holds an interest in a non-resident (offshore) vehicle which, in turn, invests back into the Common Monetary Area (CMA) by acquiring South African assets, typically South African companies.
Until 2021 such structures were only permitted in very limited circumstances, such as where a South African resident held only up to 40% of the shares in a foreign company that held interests in South Africa.
To encourage inward investments into South Africa, however, the South African Reserve Bank (SARB) issued exchange Control Circular No. 1/2021, which served to lift the restriction on ‘loop structures’ in respect of individuals, companies and private equity funds that are tax resident in South Africa.
The legalisation of loop structures has created helpful estate planning opportunities for South Africans living outside South Africa. It should be noted that loop structure transactions must comply with exchange control regulations and involve continuous reporting commitments to the Financial Surveillance Department (FinSurv) of SARB.
What are the practical benefits of a Loop Structure?
Many South African tax residents who previously transferred funds abroad via various exchange control offshore allowances were obliged to establish offshore structures to hold their offshore assets, in addition to their onshore structures which held their South African assets.
This generally meant having mirror structures that were costly to set up and maintain, and which doubled the administrative and compliance burden.
The lifting of the prohibition on loop structures means that South Africans have been able, since 2021, to set up an offshore trust and company structure as their primary estate planning vehicle that is also capable of holding their assets in South Africa.
Tax efficient dividend streams
As a result of the reforms, a South African company can now legally transfer income streams abroad in the forms of dividends without transferring funds directly to the shareholders, which would require them to use their annual ZAR2 million Single Discretionary Allowance (SDA) or the annual ZAR10 million Foreign Investment Allowance (FIA).
If a loop structure is implemented correctly, funds can flow from a South African company as a dividend and be paid directly to an offshore company and/or trust.
This avoids the creation of a loan between the South African tax resident and the offshore company and / or trust, while the offshore structure further offers the potential for a reduction in dividend withholding tax if it is genuinely based in a jurisdiction that has a favourable double tax agreement (DTA) with South Africa. These jurisdictions include Cyprus, the UK, Mauritius and Singapore.
Historically, South Africans have paid dividend withholding tax at a rate of 20% on profits distributed from South African companies. If, however, such dividends are paid to a company that is tax resident in one of the jurisdictions above, the withholding tax can be reduced to just 5%.
Foreign inheritance
Where a South African 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.
FinSurv approval to retain foreign assets abroad will be granted subject to the condition that the foreign assets may not be placed at the disposal of other South African residents.
Previously, FinSurv approval would have been subject to the condition that the assets could not be used to invest in a loop structure, but this prohibition has now been removed.
Reporting Requirements for Loop Structure
A loop structure must be reported to an Authorised Dealer by the relevant South African tax resident. If, for example, a Cyprus company acquires the shares of a South African company, that company’s bank must submit a notification letter and supporting documentation to the Exchange Control Department of that bank.
The Exchange Control Department will inform the South African tax resident that the share certificate must be endorsed ‘non-resident’ within 30 days. The original share certificate issued to the Cypriot company will then need to be taken to the bank’s nominated branch to be endorsed as ‘non-resident’.
Failure to have the shares endorsed is a breach of the regulations and could be subject to penalties. Without the endorsement, the South African company cannot distribute any dividends to a non-resident shareholder. It will also affect the ability of a local purchaser to pay for the shares held by a non-resident shareholder in a South African company.
SARB approval in respect of an endorsement is only required in cases where it is has been more than 12 months since the acquisition of the relevant shares.
The Authorised Dealer must also 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 must include the name(s) of the South Africa-affiliated foreign investor(s), a description of the assets acquired, the name of the South African target investment company, the date of the acquisition, and the foreign currency amount introduced.
The Authorised Dealer must also submit an annual progress report to FinSurv, which will be requested from the representatives of the South African company.
All inward loans from South African-affiliated foreign investors must still comply with the current exchange control rules applying to inward foreign loans.
Tax considerations for a Loop Structure
The South African Revenue Service (SARS) introduced certain anti-avoidance measures under the Taxation Laws Amendment Act No. 23 of 2020 that were designed to prevent potential tax leakage arising from the lifting of the prohibition on loop structures.
The amendments, which came into force on 1 January 2021 under the Income Tax Act, apply in respect of dividends received or accrued to, or, any net capital gain of, any Controlled Foreign Company (CFC) on or after that date. A CFC is a foreign company in which more than 50% of the total participation rights or voting rights are directly or indirectly held or exercisable by one or more South African residents.
Previously, the CFC profits attributable to a South African tax resident excluded dividends received from South African companies. Under the amendments, such dividends are now included. Any dividends declared by the South African company should be subject to South African dividend withholding tax at 20%, or a reduced rate if there is a double taxation agreement (DTA) in place between South Africa and the country of tax residence of the CFC.
In respect of capital gains arising from the disposal of equity share capital in a CFC to a non-resident, the participation exemption on capital gains no longer applies to the extent that the value of the assets of that CFC is attributable to assets directly or indirectly located, issued or registered in South Africa.
Sovereign Loop Structuring Services in South Africa
If you are considering investing into an offshore entity with a loop structure component, Sovereign Trust (SA) can assist in setting up and administering the structure and ensuring that it is established in the most tax efficient manner.
It should be noted that using authorised foreign assets via a loop structure to reinvest back into South Africa may diminish diversification in respect of currency, geographical and market concentration risks. As such, it is strongly recommended that clients should first seek financial as well as tax advice and review their personal circumstances and overall investment plan.
Please contact us if you have any questions or queries and your local representative will be in touch with you as soon as possible.
