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 foreign fund "must operate comparable (sic) fashion to a local collective investment scheme." It is not entirely clear what this phrase means but it is worth noting that the South African collective investment schemes, with their origins in the unit trust regime, operate in ways that on a technical level have little in common with their counterparts in popular international fund jurisdictions (the Cayman Islands, the British Virgin Islands, Luxembourg and Ireland). Furthermore, investment strategies that are compatible with the Collective Investment Schemes Control Act ("CISCA") are significantly more restrictive than foreign regulations. Hedge funds and private equity funds would, for example, probably not qualify if this leg of the test is interpreted to refer to CISCAregulated funds only. There is even an argument funds that are not targeted at the general public could not be managed by a local manager which would exclude the bulk of funds currently interested in Africa.
• Other than cash, the fund's sole assets must consist of listed financial instruments (or derivatives). The bulk of funds investing into Africa at this point in time do not focus on listed equities. This is in large part due to the fact that outside South Africa, there are relatively few listed African companies and because the kinds of returns that investors are looking for in Africa at this stage are primarily available from private equity investments rather than listed stocks. In practice this restriction will be relatively simple to circumvent for new fund setups with South African roots but existing foreign funds are unlikely to tolerate a bespoke structure for their African investments. As noted in Treasury's policy statement, foreign funds have other options and South African managers wishing to access this market may be under pressure to migrate to other jurisdictions (such as the UK, Switzerland and Mauritius).
• The fund must have no employees and no full-time directors. It is puzzling that Treasury insists on the foreign fund having no substance. None of the major international emerging markets funds will pass this leg of the test. Invariably, they have full-time directors and frequently also have employees who take responsibility for developing and implementing the global strategy of the fund and coordinating the investment managers in different regions.
• South African residents may not directly or indirectly own more than 10 per cent of the value of the interests in the fund. It is not entirely clear why this requirement is necessary given existing tax and exchange control rules designed to address tax avoidance by South Africans at the investor level. Moreover, it is not clear how a foreign fund might manage the risks this requirement implies. Would it, for example, be sufficient for the fund to require warranties from investors that they are not South African residents? To ensure that the exemption does apply, foreign funds will have to implement some kind of procedure to identify indirect and direct South African holdings, value these and impose restrictions on their investors. The question is whether they will be enthusiastic enough about employing the services of a South African manager to tolerate these.

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
Email: dlessing@werksmans.com

And Shayne Krige, Director at Werksmans Attorneys
Tel: +27 (0)21 405 5161
Fax: +27 (0)86 511 1342
Email: skrige@werksmans.com