South African exchange controls – still relevant to foreign investors
There is ongoing speculation as to whether, and exactly when, South Africa will completely abolish exchange control (excon) regulations. Despite significant relaxations in 1994, 1997 and 2009, the country still has exchange control restrictions. In this way, it is no different to most other countries on the African continent.
Michael Butler, PricewaterhouseCoopers Associate Director: International Tax, speaking at the PwC 2010 African Tax and Business Symposium in Dubai, cautions offshore investors to be aware of and informed on South African excon regulations when establishing operations here. “It is something that UK, American and European businesses do not usually have to be concerned about. However, in Africa and South Africa, they are a key feature of doing international business here.”
Butler explains that excon responsibility in South Africa lies with the South African Reserve Bank (SARB) – which in turn has partly delegated this mandate to the commercial banks as ‘authorised dealers’. “However, we see varying practices, and while some banks will make a decision on certain foreign currency approvals themselves, others will refer these up to the SARB.”
For companies looking to invest in SA, Butler explains that there are no restrictions on non-residents owning SA shares. “However, these shares must be endorsed as non-resident when the initial funds come into SA, and there must be a record of this funds flow. Compliance with these requirements will avoid problems regarding later related outbound payments such as dividends and capital repayments.”
Inward loans (which included preference share capital) from foreigners are also regulated and must be approved upfront by an authorised dealer. Butler notes that these loans are regulated in terms of what an offshore company may charge as an interest rate. “When the interest rate is foreign denominated, a third party may charge up to the base lending rate plus 2%, and on a shareholder loan this is limited to the base lending rate. For Rand denominated interest rates, a third party may charge up to SA prime plus 3%, and on a shareholder loan the maximum is SA prime. Whether a loan is denominated in Rands or a foreign currency depends on commercial factors including taxation, expected interest rates, anticipated currency fluctuations and hedging requirements.”
Butler explains that these interest rate caps promote the very purpose of exchange controls – to ensure that fair value has been received in South Africa and that the transfer of assets out of SA is limited and controlled. “The rate caps for third parties are more generous, as these would be market related commercial transactions – and they are lower for in-group loans as these related party transactions are seen by the SARB to be more open to excessive charges.”
One key point for foreign investors to heed is the prohibition on loan account set-off. “There can be hundreds of transactions between a South African company and its offshore parent,” says Butler. “These could relate to the movement of goods and inputs/outputs, research and development, management fees, loan interest, information technology, dividends, royalties, etc – and going in both directions. It is not simply a case of debiting and crediting one large in-group loan account and the creditor party settling this at the end of the financial year.
“Although it does make commercial sense to set-off in-group loan accounts on an ongoing basis, this is not permitted by the Reserve Bank when one party is based offshore. A singular large loan account would not enable the SARB to effectively monitor whether fair and genuine transactions are occurring between the connected parties and also monitor the inflows and outflows of transfers for balance of payment purposes. Hence every single transaction or invoice must be paid for separately, supported by relevant documentation. Many offshore investors may find all of these individual payments exceptionally impractical. However, this is the practise of the SARB to ensure fair value has been received, especially for outward repatriations.”
Butler cautions companies ignoring the prohibition on loan set-off. “There is the strong risk of an authorised dealer refusing to pay a net loan balance. Previously, a company would then apply to the SARB for special permission, asking for its indulgence regarding this noncompliance. These days, the stance of the SARB appears to be stricter and we have seen in practise that those applying set-off may not be given broad retrospective condonation for the loan as easily as previously. If the loan is due to an offshore parent it will then be prejudiced as it cannot access funds owing to it by its South African subsidiary.”
A key tenet of SA excon is that ‘arm’s length’ transfer pricing concepts apply. Depending on the nature of the payment, supporting documentary evidence is required and such charges must be justifiable. For example, management fees to recoup head office overheads cannot simply be charged by an offshore head office on an apportioned global turnover basis. They should rather be based on time spent on the South African operation, by what level of staff, at what salary, etc. Royalty remittances require SARB approval, and there should be Department of Trade and Industry approval for manufacturing royalty remittances (who apply a general ceiling of 6% on turnover – higher rates need SARB approval).
Butler highlights the imminent foreign exchange amnesty to be offered for past contraventions of SA excon. “The Exchange Control Department of the SARB is progressing with an Exchange Control Voluntary Disclosure Programme. Depending on the nature of the contravention, there may be administrative relief and the regularisation of prohibited transactions, however, there may be payment of a levy in some cases. This amnesty programme will be particularly relevant to the local offices of offshore companies in cases where prohibited loan account set-off has taken place.”