IMPERMISSIBLE EXCHANGE CONTROL “LOOP STRUCTURES”

a3_bMany 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)

FINANCIAL ASSISTANCE TO DIRECTORS

A2_bA company lending money to its directors may not be as simple a process as it may initially appear to be – not even in the case of so-called “one-man” companies. There is various requirements in the Companies Act, 71 of 2008, to be adhered to, as well as certain potential pitfalls in the Income Tax Act, 58 of 1962, that one should be aware of.

Section 45 of the Companies Act regulates the lending of money by companies to their directors. The scope of the provision also extends much further than a loan itself: it covers any form of “financial assistance” to directors, which specifically includes “lending money, guaranteeing a loan or other obligation, and securing any debt or obligation”.

The board of directors of a company must authorise the financial assistance to be provided to a director, and the board resolution to this effect must be circulated to all shareholders as well as trade unions representing employees of the company. The company’s board must further be satisfied that the financial assistance is fair and reasonable to the company, and further that the company will be solvent and liquid thereafter. They must also ensure that this is not in contravention of the company’s Memorandum of Incorporation. If in breach of any of these conditions, the directors may potentially be held personally liable for any damages.

From a tax perspective, a director of a company is by definition also an employee of that company. This means that the director may be liable for tax on a fringe benefit if a loan is extended to him or her which does not bear market-related interest rates. For purposes of the Income Tax Act, this will be the case where the loan bears interest at less than the repo rate plus 100 basis points (see paragraph 11(1) of the Seventh Schedule to the Income Tax Act). The value of any such fringe benefit will be included in the director’s gross income for tax purposes and taxed accordingly.

Fringe benefits are not the only potential tax concern for companies with loan accounts in favour of themselves against a director. Quite often directors are also shareholders in a company (which is especially the case for small and medium-sized companies). In this case, an interest free loan, or one with interest below the repo rate plus 100 basis points, will give rise to a deemed dividend in the hands of the director-shareholder. Effectively, the deemed dividend will be the interest charged too little. This amount will be calculated on an annual basis, and attract dividends tax at 15% (section 64E(4) of the Income Tax Act) which will be for the director’s account.

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. (E&OE)

TAX FREE INVESTMENT SAVINGS ACCOUNTS

A4_bOur clients will have noted the various advertisements on radio and in the media generally of financial service providers inviting the public to invest in their respective so-called ‘tax free savings’ investment products. These accounts are made possible by section 12T of the Income Tax Act, 58 of 1962, introduced in 2015 as an initiative by National Treasury to encourage a savings culture in the South African public through making use of these predetermined and specific income tax concessions linked to these accounts.

In essence, all amounts received from tax free savings are exempt from income tax and specifically:

  • Dividends paid to such accounts will not attract dividends tax;
  • Realisation of assets in tax free savings accounts will not give rise to capital gains or losses (and are thus effectively exempt from the capital gains tax regime); and
  • Any amounts received will be exempt from income tax.

The tax free savings regime however only applies to natural persons and deceased estates of persons who had during their lives contributed amounts towards these ‘tax free savings’ accounts. The regime is therefore not available to companies or trusts. Contributions to such accounts are limited though to R30,000 annually as well as a total of R500,000 during a person’s lifetime. Where these amounts are exceeded, the excess amount shall be deemed to be taxable income of the contributing individual, and which is prescribed to be taxed at 40%. (Interestingly, this amount appears to have been overlooked by the Legislature when it recently increased the maximum marginal income tax rates of individuals from 40% to 41%…) This is quite an onerous provision, and care should thus be taken that these amounts are not breached by individuals contributing to these tax free savings. Transfers between tax free savings accounts by an individual are however not included in the R30,000 or R500,000 limitations, as well as any income received from tax free savings capital. The limitations therefore only apply to new capital being introduced into an individual’s tax free savings viewed cumulatively.

It is questionable whether the initiative goes far enough and is as lucrative as may seem at first blush. Natural person taxpayers will be reminded that they are already afforded an annual R30,000 effective rebate from capital gains tax (the first R30,000 of capital gains/losses realised in a tax year is ignored for capital gains tax purposes), and further that an annual interest exemption of R23,800 (R34,500 in the case of individuals older than 65) applies notwithstanding the section 12T concessions.

When taking into account that financial products perceived as conservative are typically those approved by the Financial Services Board as ‘tax free investment savings accounts’, it does not naturally follow that after-tax profits from tax free savings will necessarily exceed savings in the conventional form.

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)