With the growing economic interest in the undeveloped markets in Africa, many South African ("SA") companies are starting to expand their business operations into the "Dark Continent". To ring-fence potential exposure and often as a result of local regulatory requirements, the investments are usually made through the incorporation of companies in the various African jurisdictions (hereinafter referred to as the "African Companies"), with these companies conducting their business operations as distinct and fully operational enterprises in the respective African jurisdictions. As a result, the SA company's investment into Africa is largely limited to a combination of loan and equity funding, which are made from SA sources.
As investors look to make private equity investments into Africa, their aim is constantly to do so in a secure and tax efficient manner and, as a result, they are likely to seek out and rely on investment routes structured through Mauritius as a low-tax jurisdiction with Double Tax Agreements ("DTA") concluded with a large number of African countries. In this article, we draw a high-level comparison of what the SA tax and exchange control consequences would be where an equity investment is made into Africa by a SA company, either directly or via Mauritius.
scenario a: investing via Mauritius
step 1: Incorporation of a Mauritius company
When setting up an offshore company in Mauritius two potential types or categories of companies need to be considered, namely Mauritius GBL1 companies, which are tax resident companies holding a Category 1 Global Business License, and Mauritius GBL2 companies, which are non-tax resident companies for trading and investment purposes, holding a Category 2 Global Business License. Because the purpose of the Mauritius company would be to invest into Africa, a GBL1 company is generally selected, as only these companies have access to Mauritius' DTA network. As such, the Mauritius GBL1 company ("MauritiusCo") would enjoy the following benefits:
- Mauritius has a large number of existing double tax treaties
with countries across the world, including various African
countries, whilst other tax haven countries (such as Guernsey, the
British Virgin Islands and Jersey) do not provide any tax treaty
- the effective income tax rate for GBL1 companies in Mauritius
- capital gains are not subject to tax in Mauritius;
- there is no withholding tax on dividends, interest and
royalties payable by a GBL1 company to its non–resident
- from an effective management point of view, as more fully discussed below, Mauritius is very well-located as it is in close proximity to SA for travelling purposes and it is generally more convenient to establish a management structure in Mauritius.
step 2: SA exchange control requirements
Once MauritiusCo has been incorporated, it acquires the shares in the African Companies. The South African Exchange Control Regulations ("the Regulations") generally restrict SA residents from transferring capital out of SA for investment purposes, subject to certain exceptions. Such exception exists for SA companies that wish to make foreign direct equity investments outside SA in excess of 10%. Previously, the application process required approval from the Financial Surveillance Department of the South African Reserve Bank ("FSD"). However, as a result of a relaxation of the Regulations, Authorised Dealers (which are essentially the commercial banks in SA) are authorised to consider and approve applications for foreign direct equity investments where the value of such investments is below R500 million per applicant per calendar year. Accordingly, Authorised Dealers now adjudicate such applications and grant the necessary approvals to companies that meet the minimum requirements.
step 3: effective management of MauritiusCo
MauritiusCo will be a non-resident for SA income tax purposes and, as a result, only subject to tax in SA on SA sourced income. As a holding company, it is unlikely that MauritiusCo would have any SA sourced income. However, if a non-resident company becomes a SA tax resident, it will be subject to tax in SA on its worldwide income and it is, therefore, imperative that MauritiusCo retains its status as a "non-resident". A "resident" is defined in the SA Income Tax Act, Act 58 of 1962 ("the Act"), in the case of persons other than individuals, as a person which is incorporated, established, formed or which has its place of effective management in SA. Accordingly, notwithstanding the fact that MauritiusCo will be incorporated, established and formed outside of SA, if MauritiusCo is effectively managed from SA it will be regarded as a "resident" and it will be subject to tax in SA in its own right on its worldwide income (subject to certain exclusions), on the same basis as if it was a company incorporated and registered in SA.
Although the concept 'effectively managed' or 'effective management' is used by various countries across the world, as well as by the Organisation for Economic Co-operation and Development ("OECD"), it does not have a universal meaning. When a comparison is drawn between the international meaning of the concept of 'effective management' and the meaning provided by the South African Revenue Service in Interpretation Note No. 6 dated 26 March 2002 (currently being reviewed), it appears that the emphasis of the interpretation note is on the place where the day-to-day management of the company takes place, whilst the international guidelines focuses on the place of top-level and strategic management. Because of these different interpretations, for a foreign company to ensure that it is treated as being effectively managed outside of SA, it is important that as a minimum requirement both the day-to-day management and top-level management of MauritiusCo is situated outside of SA's borders.
step 4: controlled foreign company rules
Even if MauritiusCo is not a tax resident in SA, the income of MauritiusCo may be imputed to the resident shareholders in SA in terms of the provisions of section 9D of the Act in the event that MauritiusCo is regarded as a Controlled Foreign Company ("CFC"). Section 9D is a complex anti-avoidance provision which, in certain circumstances, taxes SA resident shareholders of a foreign company, which is a CFC, on the income accruing to that company, pro rata to their shareholding in that company.
A CFC is currently defined in section 9D(1) of the Act as any foreign company where:
- more than 50% of the voting rights are held, directly or
indirectly by one or more SA tax residents; or
- more than 50% of the total participation rights are held, directly or indirectly, by one or more SA tax residents.
There is no definition of the term "voting rights" in the Act and it is generally accepted that the term refers to shareholder voting rights. "Participation rights" are defined to include the right to participate in all or part of the benefits of the rights (other than voting rights) attaching to a share. This means that where SA residents are entitled to more than 50% of the profits in the foreign company through direct or indirect shareholding, such foreign company will be a CFC in relation to the SA resident shareholders.
As the SA company will generally hold most of the participation rights and the voting rights in MauritiusCo, MauritiusCo will be a CFC and the "net income" of MauritiusCo may be attributed to the SA company for SA tax purposes, unless MauritiusCo qualifies for any of the exemptions provided by section 9D. Furthermore, any subsidiary of MauritiusCo (i.e. the African Companies) that meets the aforementioned participation rights requirements will also be a CFC relating to the SA company, unless such subsidiary qualifies for any of the exemptions provided by section 9D. It is important to point out, however, that on 2 June 2011 the Draft 2011 Taxation Laws Amendment Bill was issued by National Treasury for comment, which contains some significant amendments to section 9D. As the amendments are currently only in draft format and may undergo several further amendments before being promulgated into legislation, this article deals with the current legislation as at the date of publication.
CFC and the position of African Companies In terms of section 9D(2) of the Act, the 'net income' of any CFC must be included in the taxable income of the SA residents in relation to the CFC based on their proportional participation rights in the CFC. There are certain exemptions in terms of which certain types of income are excluded from the CFC attribution rules. For example, in terms of section 9D(9)(b) of the Act, any amount attributable to any foreign business establishment ("FBE") of a CFC will not be included in determining the "net income" of the CFC. Broadly speaking, the FBE exemption would apply where a CFC has its own distinct enterprise, operating facilities and personnel. However, certain types of passive income accruing to a CFC will not fall within the FBE exemption and will remain taxable in SA. Passive income includes income in the form of dividends, interest, royalties, rental, annuities, insurance premiums or income of a similar nature.
Whether the African Companies are CFCs of the SA company will depend on their respective participation or voting rights. Assuming that the African Companies constitute CFCs in relation to the SA company, but have their own distinct enterprise and operations in the respective African jurisdiction, they should qualify for the FBE relief. Therefore, if the African Companies do not generate passive income, it is possible that none of the net income from any of the African Companies will be attributable to the SA company under the CFC rules.
CFC and dividends received by MauritiusCo from the
It is likely that initially MauritiusCo will only earn dividend income from the underlying African Companies. Accordingly, such dividend income will be required to be included in the determination of the 'net income' of MauritiusCo, irrespective of whether MauritiusCo has a FBE in Mauritius, which net income will then be taxable in the hands of the SA company. In accordance with section 9D(2A) of the Act, the 'net income' of a CFC in respect of a foreign tax year is an amount equal to the taxable income of that company determined in accordance with the provisions of the Act as if the CFC had been a SA taxpayer, and as if that company had been a SA resident for the purposes of certain sections of the Act. In other words, the 'net income' of MauritiusCo must be determined as if it was a SA resident, and therefore the receipt of dividends from the African Companies will be regarded as the receipt of foreign dividends in the hands of MauritiusCo.
In terms of the participation exemption contained in section 10(1)(k)(ii) of the Act, any foreign dividend received by or accrued to a person will be exempt from normal tax, if that person holds at least 20% of the total equity share capital and voting rights in the company declaring the dividend. If MauritiusCo therefore holds 20% or more of the shares in the African Companies, the receipt of dividends from these companies should qualify for the participation exemption as set out in section 10(1)(k)(ii) of the Act and should therefore not be subject to income tax in hands of MauritiusCo. Accordingly, no tax liability will arise in the hands the SA company.
CFC and dividends received and retained by MauritiusCo in foreign currency
Where the cash dividends received by MauritiusCo are retained as a deposit in an offshore bank account for use by MauritiusCo, such a deposit will constitute an 'exchange item' for purposes of section 24I of the Act if the deposit is not denominated in 'local currency'. Section 9D(6) of the Act provides that for purposes of section 24I, the local currency of a CFC for an item which is not attributable to a permanent establishment of the CFC outside of SA is the South African Rand.
As it is generally unlikely that MauritiusCo's activities in Mauritius would constitute a permanent establishment as per the requirements of the OECD Commentary, a US Dollar bank deposit held by MauritiusCo will be in foreign currency and will constitute an exchange item for purposes of section 24I read together with section 9D(6). This means that the SA company will, in accordance with the CFC rules, be required to account for realisation and translation foreign exchange gains and losses on a MauritiusCo's US Dollar bank account based on the movement in the Rand:US Dollar exchange rate from the date that amounts are received in the bank account and the date that amounts are paid out (realisation gains and losses) or the end of its financial year (translation gains and losses).
CFC and capital gains realised by MauritiusCo
Any disposal by MauritiusCo of the shares in the African Companies will attract capital gains tax (CGT) in its hands and be attributed to the SA company by virtue of the CFC rules. However, in terms of the participation exemption in paragraph 64B of the Eighth Schedule to the Act, any capital gain or loss made by MauritiusCo on the disposal of an interest in the equity share capital of a foreign company (i.e. in any of the underlying African Companies) will be disregarded if MauritiusCo held at least 20% of the equity share capital and voting rights in that foreign company immediately before, and for at least 18 months prior to the disposal, and the disposal of the equity shares is to a non-resident. A word of caution must be expressed in that paragraph 64B is one of the more complex CGT provisions due to the legislator's intent that this provision is not abused. The paragraph contains anti-avoidance provisions that apply depending on the identity of the purchaser of the foreign equity shares and it is, therefore, important that any SA investor seeks the appropriate advice upon any election to dispose of such shares.
step 4: the position of the African Companies
As expected, each African Company would be subject to tax in the relevant jurisdictions in which it operates. From a SA point of view the position would be as follows:
- Effective Management: The concept of
"effective management" as set out above for MauritiusCo
would apply equally to the African Companies. Accordingly,
provided the effective management is exercised outside of SA, the
African Companies will not be considered tax resident in SA.
- CFC legislation: As explained above,
if the African Companies do not generate passive income, it is
possible that none of the net income from any of the African
Companies will be attributable to the SA company under the CFC
- Dividends payable to MauritiusCo: Dividends paid by an African Company may be subject to withholding tax, which may be reduced in terms of the DTA between such country and Mauritius. In this regard it is imperative that each African jurisdiction be evaluated to determine what the position is of the DTA between such jurisdiction and Mauritius.
scenario b: direct investment from SA into Africa
As an alternative option, the SA company could invest in the African Companies directly, which would have the following SA tax consequences:
step 1: SA exchange control requirements
The Regulations described above will apply equally to any foreign direct investment in the African Companies.
step 2: effective management
The African Companies would conduct distinct and fully operational enterprises in their respective jurisdictions and, accordingly, it is assumed that the effective management of the African Companies is outside SA.
step 3: CFC position of the African Companies
Presumably, the African Companies will be CFCs of the SA company due to their respective participation or voting rights. However, provided the African Companies do not generate passive income, it is possible that none of the net income from any of the African Companies will be attributable to the SA company under the CFC rules.
CFC and dividends paid by the African Companies
The dividends paid by the African Companies to the SA company would be subject to withholding taxes, if any, in terms of the tax legislation of the particular African jurisdiction. Any withholding taxes on dividends may be reduced in terms of a DTA between SA and such country.
CFC and dividends received by the SA company
Any dividends received by the SA company from the African Companies will be classified as foreign dividends and will be taxable in its hands. However, the participation exemption in section 10(1)(k)(ii) of the Act would apply to the SA company and exempt the dividends from income tax in SA, provided the SA company holds at least 20% of the total equity share capital or voting rights in the underlying African Company.
CFC and disposal of the equity shares in the African Companies
Any disposal by the SA company of the shares in the African Companies will attract CGT in SA. However, as explained above, any capital gain or loss made by the SA company on the disposal of equity shares in any of the African Companies will be disregarded if the SA company holds more than 20% of the equity share capital and voting rights in the foreign company immediately before and for at least 18 months prior to the disposal, and the disposal of the equity shares is to a non-resident.
conclusionAny SA company seeking to invest or expand its operations into Africa, either directly or via Mauritius, should take account of the following:
- There may be certain strategic advantages from an SA Exchange
Control perspective for investing via Mauritius.
- The optimal investment structure from a tax perspective will
predominantly depend on the target jurisdiction of the African
Companies. To this end, the DTA network and respective tax rates
negotiated between the countries must be carefully considered and
compared to accurately determine which of the above structures
would optimise tax efficiencies.
- If other foreign investors will play a significant role, these investors generally require an investment via Mauritius. Having said that, the new International Holding Company regime in SA may also be an option that needs to be considered in terms of foreign investors.
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.