During January 2021, the prohibition against so-called loop structures was removed from the exchange control (ExCon) regulatory framework. In terms of Notice 1 of 2021, circulated by the South African Reserve Bank’s (SARB’s) Financial Surveillance Department (FinSurv), the removal of the prohibition took effect on 1 January 2021 for certain residents, most notably natural persons (but not local trusts).
A loop structure is a structure where an exchange control resident holds, for example, South African (SA) assets via an offshore structure, or where an SA resident has an interest in an SA asset indirectly via their interest in an offshore entity. We note that the concept of an asset is a broad one for these purposes.
This is important for several reasons: first, the prohibition against loop structures has for years been a significant planning impediment for SA residents. It is therefore a welcomed development that South Africans can now structure their estate plans and other ownership affairs free of such encumbrances.
In addition, and as is pointed out by the notice amending the prohibition against these structures, this should (amongst other things) facilitate inward investment by offshore entities in which SA residents have an ownership interest. It is believed that the funds available in these types of structures is substantial.
Furthermore, it creates interesting estate planning opportunities: Many South Africans who have been taking money abroad in terms of the various offshore allowances, have offshore estate planning structures as well as onshore structures, which house their local assets. This duplication is costly and unnecessary. The removal of the prohibition against loop structures assists South Africans in that they can avoid doubling up on these structures and, where desired (which is commonly the case), can have offshore as their primary estate planning base; and now this structure can also own the local assets.
Besides purely structural benefits, there are several immediate tax efficiencies that can be achieved by virtue of implementing these structures: An individual can, for example, now move income streams abroad legally, without necessarily having to move the funds via their personal estate. In other words, historically, most funds externalised, or externalised by natural persons, created an estate duty trap. However, if a loop structure is correctly planned, funds can be externalised without going via a natural person’s estate, thus reducing a potential future estate duty liability.
Moreover, there is a potential dividends tax reduction if an offshore structure is genuinely based in a jurisdiction which has a double-tax agreement with SA. Many of SA’s double-tax agreements limit SA’s ability to impose dividend withholding tax on profits distributed to offshore shareholders. This can assist South Africans who have traditionally been paying a very high 20% dividends tax on distributed profits.
Of course, transferring assets from SA into an offshore structure must be done legally by adhering to all reporting requirements. In this regard, on the formation of any loop, the loop structure must be reported to an authorised dealer by the SA resident involved. There are also annual reporting requirements that must be adhered to. However, no approval is required, which is material.
Managing any transfer taxes applicable to moving assets into offshore structures must be carefully considered. This is to ensure that the exercise does not lead to an unnecessarily heavy tax impact in the short term, when attempting to structure one’s estate planning, including the so-called loop structure.
Taxpayers should be mindful of the capital gains tax (CGT) cost of moving local assets into a loop structure. These may be managed in certain circumstances, but professional advice should be sought. It is also usually preferable to try and implement structures which do not require huge amounts of cash funding as part of the transfer of ownership. While this sounds aspirational, there are number of structures which can be used to limit CGT. These can be done on an unfunded basis, avoiding material cash flows between foreign and local banks. Such flows can be costly and are thus not desirable.
In summary, the amendments to the loop regime are hugely significant and must not be underestimated. All South Africans should be looking at their respective estates to determine whether their estate planning structure can be enhanced or improved by utilising loop structures in one form or another.