New benefits aim to woo company headquarters to South Africa

In January this year South Africa introduced a new international headquarter company (IHC) tax dispensation that it hopes will position it as an attractive international gateway for investment into the whole of Africa.

South Africa’s location, infrastructure, sizable economy, relative political stability and strength in financial services make it an ideal location for the establishment of regional holding companies for foreign multinationals. Furthermore, South Africa’s network of tax treaties and investment protection agreements provides ready access to other countries in the region.

The IHC regime

The IHC regime became effective on 1 January and offers foreign investors the following tax and exchange control benefits.

• Dividends received by an IHC are exempt from tax where the IHC holds more than 20% of the equity in the foreign company declaring the dividend.
• Similarly, any capital gain realized on disposal of shares in a foreign company is exempt from tax in the hands of an IHC, provided certain qualifying criteria apply. The most important of these are that the shares being disposed of were held for at least 18 months, that the IHC holds more than 20% of the equity shares in the foreign company at the time of the disposal, and that the shares are sold to a non-resident.
• Dividends distributed by an IHC to its shareholders are exempt from the normal secondary tax on companies of 10% (or dividend withholding tax once the dividends tax system comes into force on 1 April 2012). Foreign shareholders will therefore not be liable for any tax on dividends distributed by an IHC.
• There is currently no withholding tax on interest paid by an IHC, and the normal thin capitalization ratio of 3:1 applies to foreign shareholder funding. From 1 October, thin capitalization provisions will not apply to shareholder loans or funding, provided the foreign funding is used to extend debt funding to foreign companies in which the IHC holds at least 20% of the equity.
• There will also not be any withholding tax on interest in respect of shareholder loans, once the new interest withholding tax of 10% has been introduced in 2013.
• Royalties paid by an IHC are subject to 12% withholding tax, but this is reduced to zero under South Africa’s double tax treaties.
• South African controlled foreign company rules also do not apply provided that 50% or more of the shares in the IHC are held by non-residents.
• An IHC will be regarded as a non-resident for South African exchange control purposes and no exchange control restrictions will apply.

Criteria to be met

In order to qualify as a South African IHC, a company must have satisfied the following criteria since establishment:

1. each shareholder must have held 20% or more of the equity shares and voting rights since the inception of the company (a continuous test);
2. 80% or more of the tax value (base cost) of the total assets must represent shares and/or debt of the qualifying foreign companies; and
3. 80% or more of the total receipts and accruals (in the form of dividends, interest, royalties or management fees and sale proceeds upon disposal) must be derived from the qualifying foreign companies.

The legislation has been structured such that it will be difficult to restructure existing entities into the IHC regime. However, each company or group’s particular facts and circumstances need to be considered to determine whether it meets the qualifying criteria in its current form. In most instances, a new company will need to be created in order to comply with the continuous requirements.

Inhibiting factors

Despite the great strides taken towards making South Africa an attractive holding company jurisdiction, the broader tax system still makes it unattractive to conduct any centralized group functions from South Africa compared, for example, to Mauritius. Interest, management fees, royalties, other income and exchange differences are still subject to tax in the hands of the IHC at the normal corporate tax rate of 28%.

Another inhibiting factor is the working of South Africa’s foreign tax credit system. A major difficulty for many South African-based multinationals operating in Africa is that South Africa’s foreign tax credit system is quite restrictive and will often not allow foreign tax credits in respect of taxes paid in other African jurisdictions. This is particularly the case where centralized services are rendered from South Africa and charged to the African subsidiaries. Although African countries often levy withholding tax on payments for these services, South Africa would regard the services to have been rendered in South Africa, and would therefore regard the resultant income to be from a South African source. No foreign tax credit will be granted in respect of the foreign taxes paid on income from a source, or deemed to be from a source, in South Africa.

Further legislation expected

What is encouraging, though, is that the minister of finance, in his budget speech earlier this year, indicated that further enabling legislation will be passed to alleviate both of these fundamental restrictions on centralized group service activities, which could discourage the full utilization of the IHC tax regime. Draft legislation on these aspects was expected to be circulated for comment this month.

South Africa’s role in Africa and its extensive network of treaties, together with progressive centralized group holding company legislation, will make it a serious contender to be a preferred holding company jurisdiction for the continent. Given the notorious difficulty in structuring pan-African operations for multinationals, it is, however, likely that in the short to medium term, South Africa will continue to be used in conjunction with jurisdictions like Mauritius to provide the widest-ranging and most attractive benefits for structuring into Africa.