With tough times prevailing in the rest of the world, Africa continues to be a popular destination for international capital. The continent remains a challenging environment for foreign investors and perhaps more than in any other region, investors are looking for expert investment managers to assist them in deploying their cash.
The local investment management industry has been unable to fully capitalise on this development as a result of South African tax laws. In essence, a foreign fund that employs a South African investment manager faces two tax risks. Firstly, it might become a South African tax resident and be required to pay tax locally on its worldwide income. Secondly, it risks having to pay tax in South Africa on investments having a South African source. This is because, unlike many other countries, South Africa does not have an investment management exemption in its tax law.
Treasury sought to address the issue in 2010 but the investment management exemption introduced in 2011 addressed only the source issue and then only in relation to a very small subset of the international fund market, namely funds structured as foreign limited partnerships. We noted our concerns with this approach in September 2011 (http://www.werksmans.co.za/keep-informed/ in-the-news/media-releases/tax-treatmentof- foreign-funds-hampers-sa-investme. html?Revision=en/19&Start=0).
The issue has been revisited by Treasury in their latest policy statement which recognises the residency concerns we raised noting that local tax rules make "South African local managers potentially unattractive for foreign funds, especially since all of the funds are derived from an offshore location that has other global options." Treasury's proposal, as set out in the budget speech, was to create a carve-out from the effective management test for foreign investment funds to remove the potential tax risks for the foreign fund and focus instead on taxing the management fees earned in South Africa.
The detailed amendments have now been published and they unfortunately again fall short of delivering on the promise of the policy statement. In order to qualify for the proposed exemption, the foreign fund must pass the following test:
The South African manager must be a licensed "financial services provider" under the Financial Advisory and Intermediary Services (FAIS) Act.
Although this test does not fully resolve the issues South African investment managers face, it is encouraging that Treasury has recognised the issue and its impact on the industry.
If the test set out above is that which is finally implemented, notwithstanding its failings, it will at least clarify the tax situation. This does create opportunities for structuring new offshore funds. Existing offshore funds will inevitably not restructure just so that they can employ a South African fund manager and will also not accept the risks associated with the way the exemption is formulated. As a result, the opportunities that the exemption present are likely to be exploited more by South African managers looking to set up their own offshore funds than by existing offshore funds looking to invest in Africa.
Written by Doelie Lessing, Director at Werksman Attorneys
Tel: +27 (0)21 809 6147
Fax: +27 (0)86 613 2136
And Shayne Krige, Director at Werksmans Attorneys
Tel: +27 (0)21 405 5161
Fax: +27 (0)86 511 1342