Amendments in relation to purported loopholes in foreign capital participation exemption

Like many countries South Africa has a “participation exemption” which exempts returns in the form of both foreign dividends or foreign capital realised by South African residents, upon certain conditions being met. Under the foreign capital participation exemption, subject to certain exclusions, a person, other than a headquarter company is required to disregard any capital gain or capital loss determined in respect of the disposal of any equity share in a foreign company if certain requirements are met.

1 Mar 2023 3 min read Special Edition Budget Alert Article

At a glance

  • South Africa has a participation exemption for foreign dividends and capital gains, subject to certain conditions.
  • The exemption requirements include minimum ownership percentage, recipient qualifications, and a holding period.
  • National Treasury aims to amend the legislation to restrict the exemption in cases of group restructuring where the shareholders remain substantially the same.

These requirements relate to:

  • the percentage interest held by the South African resident disposer, which is required to, as a minimum, be 10% of both the “equity shares” and the voting rights in the foreign company (minimum interest test);
  • the nature of the recipient, which is required to not (i) be a South African resident, (ii) be a “connected person” in relation to the disposer, and (iii) form part of the same “group of companies” as the disposer (recipient test); and
  • a de minimis holding period for which the disposer is required to have held the shares in the foreign company, which is required to be a period of 18 months, unless the disposer is a company and the disposer acquired the shares in the foreign company from a foreign company that formed part of the same “group of companies” as the disposer, where the foreign company and group entity collectively held the shares in the foreign company for an aggregate period of 18 months (holding period test).

National Treasury has previously stated that the policy rationale for the foreign capital participation exemption was to incentivise South African’s who hold a meaningful interest in a foreign investment, and to generally encourage capital inflows to South Africa.

In terms of the Budget, National Treasury has said that certain transactions have been identified which qualify for the foreign participation exemption, although these arrangements do not align with the policy intent. National Treasury made specific mention of transactions involving group restructuring whereby the sale by the disposer is to a newly formed group company “although there is no change in ultimate shareholder”. National Treasury intends changing the tax legislation to not avail the foreign capital participation exemption to a disposer, if the sale of shares in the foreign company is to a recipient that is a non-resident entity group company or the shareholders are substantially the same as the shareholders of any company that forms part of the same group as the disposer.

It is not entirely clear what is intended to be achieved by National Treasury in this regard, since under the current construct of paragraph 64B of the Eighth Schedule to the ITA, which governs the foreign capital participation exemption, such a disposal of shares in the foreign company by the disposer will unlikely meet the recipient test, on the basis that such targeted recipient will likely, in any event, be a “connected person” in relation to the disposer or form part of the same “group of companies” as the disposer and therefore amount to a non-qualifying recipient.

The further foreign capital participation exemption provides for the disregard of a capital gain or capital loss which arises in respect of any foreign return of capital received or accrued to the disposer by a “controlled foreign company” as contemplated in section 9D of the ITA if the disposer meets the minimum interest test. National Treasury has also proposed applying the holding period test to this foreign capital participation exemption to align with the prior mentioned foreign capital participation exemption. A de minimis period to align the foreign capital participation exemptions is logical and therefore welcomed. 

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