Many people or companies with offshore activities will be aware of the existence of exchange controls imposed by the South African Reserve Bank and monitored by its Financial Surveillance Department. Yet despite being aware of its existence, many do not appreciate what transactions are permissible and what would constitute a contravention of the exchange control regulations. In practice we often encounter such illegal structures, even though it may have been innocently created. One typical structure often encountered, and which the South African Reserve Bank considers to be illegal, is the so-called “loop structure”.
Loop structures in essence involve a resident in the common monetary area (comprised of South Africa, Namibia, Swaziland and Lesotho, “the CMA”) investing via loan or shares back into the CMA through an entity non-resident in the CMA. For example, a structure whereby an individual owns shares in a UK company which in turn holds shares in a South African company will amount to an illegal loop structure.
Share investments do not represent the only mechanism through which loop structures may be created: loans held back into the CMA through offshore entities, or even contingent rights created by way of a discretionary trust may also give rise to a loop structure. To give another example: if an individual is a discretionary beneficiary of an offshore trust, and which trust directly or indirectly holds loans receivable against or shares investments in South African companies, that too would be considered a contravention of the prevailing exchange control regime.
In other words: a loop structure would be created where a South African resident holds South African investments (in whichever form) indirectly through an offshore entity.
Although there is no blanket prohibition against all offshore investments which give rise to loop structures, the South African Reserve Bank is loath to approve these and take the view that any such structure created without seeking its prior approval amounts to an illegal structure. An exception which is noted though in the recently published Currency and Exchange Guidelines for Business entities (published by the Reserve bank on 29 July 2016) involves companies which may hold between 10 to 20 per cent of the shares in an offshore entity, which may in turn hold investments in and/or make loans back to the CMA. (This dispensation does not apply though to foreign direct investments where the South African company on its own, or where several South African companies collectively, hold an equity interest and/or voting rights in the foreign entity of more than 20 per cent in total.)
It is true that many people are completely unaware of the prohibition against loop structures and that these have inadvertently been created in the past without those involved being aware of the illegal nature thereof. If one were to voluntarily come forward and declare such an illegal structure though, taking also into account that the loop was inadvertently created, the Financial Surveillance Department may very well allow transgressing persons to unwind the unintended loop structure without levying penalties (which could otherwise amount to as much as 40% of the capital illegally exported from the CMA). It would be important for individuals and companies alike to be aware of these potentially illegal structures and to be sure that steps are taken to have these resolved as soon as possible. Given the newly introduced special voluntary disclosure programme (VDP) announced by National Treasury and which extends beyond tax transgressions only, it may now be an appropriate time to take steps to have such transgressions rectified.
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)