HQ in SA – a very viable proposition

A number of proposed changes to South Africa’s tax rules first published in May were greeted with considerable enthusiasm as it was felt they would reinforce South Africa’s credentials as a gateway for investment into Africa. The changes would give investors into Africa access to a tax regime that would encourage them to establish their African headquarters in South Africa.

The statements from National Treasury that accompanied the changes indicated a focus on three particular aspects of the South African tax regime as being significant barriers to South Africa’s ability to compete as the choice country for channelling investments into Africa.

· Controlled foreign company (CFC) rules – under the new regime, the CFC rules and the administrative burden that accompanies them would not apply to headquarter companies.

· Secondary tax on companies (STC) – headquarter companies would also not be subject to STC nor the proposed dividend tax and thus profits could be expatriated free of tax leakage.

· Thin capitalisation rules that serve to reduce the ability of foreign investors to finance their operations with debt – under the proposed changes headquarter companies could be financed with debt without restriction where that debt is used to finance their subsidiaries.

However, a more careful review of the proposed rules revealed a number of other issues that needed to be addressed before the rules would be effective in making South African sufficiently attractive as a headquarter company location, particularly when compared with Mauritius. Many of these were raised in comments to SARS whose response was published in early August and which was in turn followed up with a revised set of rules that have now been presented to Parliament for approval.

In addition to the three points addressed above, the principal characteristics of a headquarter company are now expected to be the following:

· A headquarter company may use its operating currency (which will frequently not be the Rand) as its currency for purposes of tax reporting and thus avoid being exposed to tax on currency fluctuations were it required to record its transactions in Rand for tax purposes.

· Indications are that the exchange control regulations will be amended so as to exclude headquarter companies from their ambit.

· As and when the withholding tax on interest payments is introduced (currently expected to be in 2013), that tax will not apply to interest paid by headquarter companies.

· Dispensation from the thin capitalisation rules has been confirmed in return for deductions of interest expense being limited to the interest income earned from subsidiaries.

· From a transfer pricing perspective, a headquarter company will not be required to retain an interest margin on any back-to-back loan arrangements with its subsidiaries.

· Dividends received by a resident from a headquarter company will not be taxed.

· Disposals on certain interests in a headquarter company will be eligible for an exemption from capital gains tax on the same basis as if it were a foreign company.

· To the extent that intellectual property licensed to it is not used in South Africa, royalties paid out by a headquarter company should be free of withholding tax.

It would appear that the government is serious about making South Africa attractive to investors into Africa while being conscious of its position as a member of the G20 and of the views of the OECD. National Treasury has done well to devise a headquarter company tax regime that reflects a careful balance between providing a facility for the free flow of capital to and from target investments and creating a tax regime that will not be accused of being a harmful tax practice.

Bearing in mind South Africa’s other advantages as a springboard to Africa, including its sophisticated banking, accounting and legal systems, ease of communications, the skills of its people and the generally high service quality, the new tax regime should make it very attractive as a place for establishing regional headquarters.