Structure
Structuring Guidance
Mirror Structures
This legal structure involves the establishment of an offshore company, and for all the South African and international shareholders to hold a common or identical shareholding in both the South African company, and the offshore company. Both companies and all the shareholders often conclude a stapling agreement: meaning that the shares in each of the companies cannot be separately traded. In effect, each share in one company is indivisibly linked to a corresponding share in the other company. This is intended to create a single point of exit/entry for the group, and therefore synthetically mimicking a conventional holding structure.
Prior to 2021, South African business owners were not permitted to own shares in an offshore holding company which owned a South African company, because South African “Exchange Controls” placed restrictions on the ability of South Africans to hold offshore companies which in turn own South African subsidiaries. Since 2021 though, offshore holding companies are now possible (see the next section describing foreign holding company structures). Unfortunately, the process of creating that structure can imply various funding and tax costs, and also requires various upfront and annual reporting obligations to SARB. The result is that Mirror Structures are still fairly common place.
The advantage of the Mirror Structure is that the initial cost of set up is low. There are few South African regulatory requirements (none, in fact, in many cases), and the offshore company can simply be established, replicating the South African company’s shareholding.
The challenge with setting up Mirror Structures is the “stapling” of the shares in both companies. Remember, the goal is to “staple” each share in the South African company to a share in the offshore company. But this goes further, the structure must effectively duplicate the economic rights in the South African company – this means replicating share classes and the shareholders’ other rights contained in shareholders agreement and memorandum of incorporation.
Many South African companies have raised funding in to mirror structures, but they can be awkward to present to international investors. Additionally, a material portion of future investment funds may have to flow to the South African company (not just the offshore company). This is because the investor must receive precisely the same shareholding and shareholder rights in both the South African company and the offshore company. So, the Investor will be required to show that it invests into the South African company at fair market value unless the investor agrees to a structure in which they only get shares in the offshore company, with a deferred right to invest into The South African company. These structures may also present difficulties for intra-group loan funding, certainly where The South African company seeks to loan funds to the offshore company.
Foreign HoldCo Structures
Foreign HoldCo Structures use a “conventional” foreign holding company as the ultimate holding company which in turn owns the South African company and any other subsidiaries across the globe. This international legal structure takes advantage of the development in South African Exchange Controls in January 2021, in terms of which SARB appeared to announce a complete lifting of the loop restriction, which previously limited a South African’s ability to set up an offshore holding company of their South African business. In principle, this permits South Africans to present their international businesses in the conventional manner.
However, SARB has seen evidence of abuse of this permission in the SA market. SARB has warned that they are preparing and issuing updates to the regulations “to provide more clarity”. Our participation in the SA Start Up Act Movement has given us the fortunate opportunity to engage with SARB and motivate for offshore holding companies to be allowed specifically for the purposes of facilitating growth fund raising. In the meantime, consensus is clear that the current legal framework provides that Foreign HoldCo Structures are legal, and that if done at a fair valuation of the South African company, on arms length terms for cash, no advance permission is required. Users should just take care to note that “clarification” is likely, which could impact their existing structures or their structure planning.
In SARB’s documentation, and discussion, the following conditions are clearly expected by SARB for setting up an offshore HoldCo:
- The “transaction” (in which the HoldCo acquires the shares in the South African company) must be reported to an Authorized Dealer (the client’s bank’s SARB representative) “as and when the transaction is finalized”;
- An “annual progress report” must be filed with SARB via your Authorized Dealer;
- The group must provide evidence that the transaction was concluded at arm’s length basis, for a fair and market-related price;
- The purpose of the structure must be to unlock growth funding from international sources.
These conditions will need to be fulfilled by reporting the structure to SARB, explaining the process, the value of the South African company, showing the cash flows and demonstrating that the goal is to raise international investment.
To summarize then, your offshore company requires to purchase your South African company, at fair and market-related price. This amount must be paid to the shareholders, in cash. This can imply that the offshore company has to raise a significant amount of cash, for this purpose. Those shareholders who are South African may also incur a capital gain (if their shares have appreciated in value), and may have to pay capital gains tax on that gain. Typically, investors will require a cash flow mechanism that ensures that those funds flow back to the offshore company (net of capital gains tax).
The SA Start Up Act Movement has motivated for these structures to be allowed as share-for-share exchanges (in which shareholders in the South African company swap their shares for shares in the offshore company). This would at least reduce the amount of cash required to be raised by the offshore company for this purpose. However, even share-for-share swaps would result in a taxable capital gain if the shareholders have experienced an appreciation in the value of their shares. Again, The SA Start Up Act Movement has motivated for deferment of capital gains tax, using mechanisms similar to the role over relief provisions of the Income Tax Act.
Tax considerations – the South African Income Tax Act was amended to anticipate Foreign HoldCos, to ensure that South African’s did not avoid dividend withholding taxes merely because they now held their South African shares through an offshore holding company. The provision is complex, but the intention is to ensure that this structuring solution does not create tax leakage. High Growth companies don’t typically pay dividends at all, but consult with your tax advisors if this may apply to you.
