A surprise inclusion in South Africa’s Taxation Laws Amendment Bill of 2010 is a proposal to introduce a so-called “Regional Investment Fund Regime”. The broad object of the regime is to make South Africa an attractive location for the conduct of fund management activities and a gateway to investment into Africa. More specifically it would allow many of the investment management activities that are currently conducted outside of South Africa to be undertaken domestically and encourage new international investors to make use of South African managers for their investments into Africa. Maitland has lobbied for this change for some time and regards it as an encouraging development.
The problem that the regime seeks to address is that our income tax system creates a number of potential tax problems for foreign investors who use South African investment managers. Generally speaking, a foreign investor pays no tax on income and gains generated by his investments in South Africa but this may not be the case if the investor elects to employ a local fund manager or invest in a fund that is regarded as being tax resident in South Africa. These problems arise because an investor who employs a South African manager may be deemed to have a “permanent establishment” in South Africa for tax purposes or, in the case of an investment fund, regarded as being tax-resident if the fund’s “place of effective management” is in South Africa.
These problems are not unique to South Africa and many progressive tax jurisdictions such as the United Kingdom, the United
States and Australia have sought to address them by means of a “Fund Manager Exemption”. In broad terms, such exemptions serve to obviate the risk that an investor might acquire a local “tax footprint” merely by investing in a fund, or with a fund manager operating within the jurisdiction.
The motivation for the exemption is, of course, to attract fund management activities that would otherwise be conducted elsewhere and it barely needs stating that the fiscus benefits handsomely from taxes on the income of the fund manager and the related economic activities generated.
The UK exemption, which is framed in broad and generous terms, goes a long way to explain why London is the hub of European fund management and more than 80% of funds managed there are jurisdicted elsewhere.
The South African Treasury is obviously alive to the opportunities, particularly with regard to investment both into South Africa and the wider continent, and the new regime represents its response. Unfortunately it has chosen to frame its exemption in rather narrow terms to address specifi c problems identified in relation to limited partnerships and trust structures, rather than creating the exemption as a general principle across all structures.
This narrow approach will, unfortunately, serve to undermine many of the objectives that the regime seeks to achieve because:
- The vast majority of international funds are structured as companies and are, therefore, not covered by the regime. Trust fund structures are, in fact, rarely used outside South Africa and the use of limited partnership structures is generally limited to private equity funds.
- Where funds are structured as limited partnerships, the law normally requires that the general partner be a local entity. This applies in the case of Cayman Islands, the British Virgin Islands and Luxembourg, where the vast majority of international investment funds are located. It would, therefore, not be possible for a South African entity to act as the general partner of these funds.
- Even if it were possible for a South African entity to act as the general partner, there is often limited scope for doing this from a structural perspective. The South African manager may be just one of the managers of the fund and, consequently, the scope for being the general partner of the entire fund is limited. Also investors and promoters may sometime wish to retain effective control of the fund and would not want to appoint the manager as the general partner.
- Traditionally investment managers act under a contractual mandate, which gives them discretionary power to manage the portfolio on behalf of the fund.
By not addressing the contractual investment mandate, the proposed amendments would leave the bulk of investment management arrangements exposed to the problems that SARS has identified.
In our view, the best way to achieve SARS’ stated aims is to create a broad investment management exemption along the lines of that applied in the UK. In broad terms, the position should be that in a situation where a South African investment manager provides investment management services to foreign investors, the arms-length investment management fees will be subject to tax in South Africa. The fund (and its investors in the case of a tax-transparent vehicle) will not be deemed to be South African
tax resident and the income and gains generated by the fund will not be deemed to have a South African source. This will encourage funds investing into Africa to use South African firms to manage these assets, thereby creating jobs in South Africa and increasing the tax base.
Dale Lippstreu was one of the founding directors of Maitland’s Fund Services business in 1998, which today administers in excess of US$70 billion in assets on behalf of some 80 clients worldwide. He has over 25 years’ experience within the financial services industry including asset management and private banking.
Dale holds a B. Proc degree and represents Maitland at various industry associations and on government bodies including the Economic, Savings and Policy Board; the Market Architecture Board and the Technical and Operations Board of the Association of Savings and Investment South Africa (ASISA). Copyright. HedgeNews Africa – July 2010.
