Tuesday, November 08, 2011

Although offshore jurisdictions such as Mauritius, the Cayman Islands and the British Virgin Islands are generally considered attractive for tax reasons, foreign investor-friendly regulatory regimes and the absence of exchange control restrictions, the South African Reserve Bank ("SARB") has introduced various exchange control relaxation measures that are aimed at making South Africa the preferred jurisdiction from which to raise and manage private equity investments into Africa.
As a general rule, the Exchange Control Regulations, 1961 (the "Exchange Control Regulations") promulgated under the Currency Exchanges Act, 1933 prohibit the export of capital without the permission of the Exchange Control Department of the SARB. In this regard, Exchange Control Circular No. 7/2010 currently regulates investment activities of South African private equity and venture capital funds into Africa. Private equity funds that are members of the South African Venture Capital Association, and are mandated to invest into Africa, may apply to the SARB for an annual approval to invest into Africa.
The following information must accompany such applications:

A copy of the local en-commandite partnership's mandate to invest into Africa or in the case of a local fund running parallel with an offshore fund, a copy of the co-investment agreement between the local and foreign partnership.

Cash flow projections for a 36 (thirty six) month period indicating the amount of capital to be exited from South Africa for investment purposes into Africa.

Confirmation that the local private equity fund will obtain a minimum of 10% (ten percent) of the voting rights in the respective investments into Africa.

Although these measures are laudable, it is submitted that the requirement to seek annual approval may create unnecessary administrative hurdles in the investment process and also impacts on timing and costs involved, especially if the relevant fund has a long-term investment horizon. It is therefore proposed that this annual approval requirement be replaced with annual reporting requirements akin to those which apply to foreign portfolio by South African institutional investors.
In addition, it is not clear whether these measures apply to private equity funds that are not organised as en-commandite partnerships, in other words, funds that are incorporated as private companies or other appropriate business vehicles. Accordingly, it is proposed that the types of business vehicles to which this requirement applies be broadened to include companies, trusts and other appropriate business vehicles. In addition, the legislature has deemed it necessary to amend the tax laws to establish South Africa as a holding company gateway into Africa through the introduction of a regional holding company regime which will entitle qualifying holding companies to tax relief in South Africa with effect from 1 January 2011.
In order to complement recent amendments to the tax laws, the Exchange Control Regulations have also introduced the concept of a headquarter company. Headquarter companies will be treated, for exchange control purposes, as non-resident companies other than for their reporting obligations. Head-quarter companies may therefore obtain investments or borrow from abroad and such funds may be deployed locally or offshore as per the funds' investment strategy. In this regard, the Minister has proposed that qualifying international headquarter companies be allowed to raise and deploy capital offshore without exchange control approval.
More recently in his Budget Speech of 23 February 2011, the Minister of Finance has proposed that offshore intermediary companies receive tax relief from the consequence of the application of the effective management test to remove the negative tax consequences associated with South African management being regarded as South African resident for income tax purposes. It is expected that this proposal will provide South African private equity funds with an incentive for the establishment of private equity funds which are managed from South Africa.
It is also expected that the proposed relaxation of exchange controls will make South Africa a more attractive country of choice for private equity funds that are classified as international headquarter companies to raise capital offshore without exchange control approval. Further, it is hoped that the SARB will introduce further exchange control relaxations so that it will not be necessary to use other traditionally preferred investment jurisdictions such as Mauritius, as the jurisdiction of choice and incorporation for private equity funds that are mandated to invest into Africa.
The proposed changes to South Africa's tax regime are expected to reinforce the country's position as the gateway of choice into Africa. The amendments relating to headquarter companies should tilt the balance back into South Africa's favour and diminish the tax advantages that jurisdictions such as Mauritius, which has been making headway in promoting itself as an investorfriendly route into the African continent.