Private equity: Debate about risks in Africa too generalised

Over the last few years much of the investment in projects in Africa has been driven by the development finance institutions. This has meant that we have seen a growing focus on addressing concerns of corruption, money laundering, environmental issues and CSR principles.

This has broadened well beyond government- or infrastructure-related projects. As more global investors become involved in Africa, the impact of legislation such as the US Foreign Corrupt Practices Act, the Dodd-Frank Act and more recently the UK Bribery Act is growing.

In support of these objectives, Mauritius has also been focusing on the development of partnership vehicles with legal characteristics designed to attract fund monies.

South Africa is seeking to compete with Mauritius in terms of making itself attractive as a gateway into Africa for private equity investors. Recent legislative measures to achieve this include the introduction of a headquarter company regime. Under this, many of South Africa’s more onerous tax provisions relating, for example, to transfer pricing, are waived for qualifying companies.

One of the challenges in structuring private equity investments in emerging markets is trying to use developed structures and investment instruments for which the regulatory framework in the host country doesn’t allow to be used. Patience and out-of-the-box thinking is required in dealing with regulators who can be reluctant to embrace innovative deal structures.

Some tax systems in Africa tend to be relatively unsophisticated in global terms, certainty with regard to tax treatment can be difficult to attain.

Issues such as whether carried interest and proceeds on the disposal of investments should be taxed at capital gains rates or normal income tax rates (in countries where a distinction exists) are likely to arise. The answers usually need to be found through the application of general principles, in the absence of specific relevant legislation or case law.

African countries tend to impose high levels of withholding tax on cross-border cash flows, including dividends, interest and management or advisory fees. Minimising these taxes through the use of appropriate tax treaties can present challenges because, with a few exceptions, most African countries have very few tax treaties. As with the legal systems generally, the influence of the colonial past can often be discerned in the choice of treaty partners and many treaties are very old.

Mauritius has deliberately sought to build an attractive treaty network with African countries and has been successful so far. However its treaties with some countries with robust economies such as Nigeria and Zambia are at the time of writing, signed but not yet in force.

As a result of this and other attractive tax features, Mauritius is often chosen as a gateway into Africa (especially sub-Saharan Africa) both by private equity funds and other foreign investors. If Mauritius can maintain its momentum in building its African treaty network, it has also provided legislative protection against certain potential South African tax exposures for investors in funds that make use of a South African GP.

However, these investor-friendly policies have been significantly undermined by a recent attack launched by the South African tax authorities on debt push down structures that have been used by private equity investors in South Africa for many years to compensate for South Africa’s lack of tax group relief (such relief is rarely available in Africa). This move illustrates the tax perils of deal structuring in Africa. Although these structures have been known to, and endorsed by, the tax authorities for some time, this has proven no protection in circumstances where the South African government is aggressively seeking to balance its budget.

Nonetheless, with appropriate advanced planning and a detailed understanding of the tax playing fields in the target jurisdiction, it is possible to design relatively tax efficient deal structures for African investments.

Roddy McKean and Anne Bennett are partners at Webber Wentzel.