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Q1 2024 - (released May 2024)

SA's quarterly Private Equity & Venture Capital magazine


South Africa’s Exchange Control Amendments fall short of industry needs

by Adrian Dommisse


On 26 February this year, following the 2024 Budget Review, the South African Reserve Bank (SARB) published draft amendments to exchange controls, in response to vigorous lobbying by stakeholders in South Africa’s tech startup industry.


In this article, I summarise the current landscape for a high-growth technology company seeking to raise funding from offshore investors, primarily dealing with the South African exchange controls that must be navigated.

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Before delving into the details, a spoiler alert: those of us excited by the strategic opportunities presented by the liberalisation of exchange controls have been left disappointed by the draft amendments. Upon close examination, there appears to be a persistent misalignment between the legislature and the operational realities and global ambitions of high-growth firms aiming to establish themselves globally.

The Position Today

Currently, a South African company can restructure to be wholly-owned by an offshore holding company which is, in turn, owned by the original set of shareholders. I’ll refer to this as the “Permitted Loop” structure throughout this article.

This arrangement was made possible by significant liberalisation of exchange controls in January 2021. Prior to this, South Africans had to establish complex ‘mirror structures’ to legally have an international presence, which brought operational complexities and made explaining these structures to shareholders and investors challenging.


However, even the Permitted Loop has its challenges:


      -The Offshore Holding company must purchase the South African company at market value.


      -The Offshore Holding company must pay this market value in cash to the South African shareholders.


      -Setting up an Offshore Holding company is only ever permitted for the purpose of raising growth funding from offshore sources.


      -The Offshore Holding company still cannot take transfer of the intellectual property held by the South African company (without permission).

Let’s consider a realistic example from our firm’s clients. Client X is thrilled that an international investor wants to invest $5m. However, the investor is wary of South Africa’s unstable exchange rate history, complex exchange control rules, and ongoing debates about property ownership, including potential expropriation without compensation. The investor’s simple solution is for Client X to set up an offshore holding company. Yet, my client must then explain that a substantial portion of their investment must be used by the offshore holding company to buy out the current South African shareholders, who must face the dreaded capital gains tax implications. Furthermore, even if everything goes according to plan, the holding company ends up owning a South African company whose real value lies in technology software (intellectual property) still locked within South Africa, with all its associated risks.

So, the industry has tirelessly explained to SARB that if it truly wants South African companies to grow using international investment, we need three simple changes:


      -Allow the Offshore Holding company to “pay” for the South African company via a share-for-share swap, meaning SA selling shareholders receive shares in the offshore holding company instead of cash.


      -Let the SA selling shareholders defer their capital gains tax until they sell their shares in the offshore holding company, aligning with the treatment of similar restructures within South Africa.


      -Permit the SA company holding valuable intellectual property to transfer this IP to the holding company, structured as a sale at a genuine fair market value, on loan account—again, already allowed for companies within South African borders.

These proposals were detailed extensively by a coalition of dedicated lawyers, bankers, investors and entrepreneurs making up the industry lobby groups. We documented case studies, wrote motivations benefiting South Africa, and even drafted proposed changes to the law.


The Draft Amendments to Exchange Controls

Unfortunately, the response from the government was less rewarding than hoped. The draft proposals published for comment by SARB can best be described as adhering to an outdated command-and-control economic model. The new laws stipulate that you can grow your business globally as long as all

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your offshore activities remain South African tax and exchange control assets.

The published draft laws state explicitly that the government aims to allow the establishment of offshore entities “from a domestic base.” SARB quickly clarified their intention: any offshore company set up for the purpose of raising funding must not only be a SA tax resident, but it must also be “incorporated” and effectively managed and controlled from South Africa. The entity established offshore will then have extensive reporting obligations to SARB, including the status of foreign operations, reporting all agreements entered into, all funds raised and introduced, and providing their financial statements to FinSurve.


The underlying issue, which requires sensitive navigation, is the reluctance of international investors to invest directly into companies based in South Africa, thereby becoming entangled in the South African tax and exchange control systems. This reluctance stems from a substantial trust deficit regarding the South African government’s capacity to foster an environment conducive to growing investments.


This concern prompted us to propose a more straightforward mechanism for establishing an offshore holding company through share-for-share swaps. However, the response from the SARB was less accommodating than hoped. They continue to disallow share-for-share swaps, opting instead to permit the setup of an offshore subsidiary that must remain a South African tax resident. Additionally, we advocated for a simplified process to transfer intellectual property offshore, but the regulations continue to prohibit such movements.


In summary, the three main requests from the industry were not only ignored, but were also replaced with alternatives that starkly misalign with both the industry’s and the economy’s needs. While failure to effect change in legislation is not unusual, what stands out here is the government’s apparent lack of understanding – or empathy – for the needs of its constituents. Rather than adapting to facilitate growth, it has entrenched its stance on exchange control policies. I fear that this approach may accelerate divestment and deter new investments, rather than encourage economic expansion.


Dommisse is Founding Director | Dommisse Attorneys Inc.

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