SOUTH AFRICA: FOREIGN INVESTMENT

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Foreign Investment in South Africa - An Overview - By Caroline Maxwell, London

Located at the southernmost tip of Africa, South Africa (GMT +2) is bordered by Namibia, Botswana, Zimbabwe and Mozambique, and totally encloses Lesotho. There are currently 11 official languages in South Africa, but for business purposes, English and Afrikaans are most often used.

Although the economy is in many areas highly developed, there are some weaknesses, partly because of remaining inequalities between the country's black and white residents, and partly due to the country's international isolation until the 1990s. The country could, then, be said to be in a state of transition, as the government, headed by President Thabo Mbeki seeks to address the inequities of previous regimes and foster good international trade relationships with other countries.

Efforts so far appear to have been successful, and South African business has become increasingly integrated into the international community; foreign investment into the area has grown substantially over the past few years as a result. With its advantageous location and a government receptive to foreign direct investment, South Africa certainly looks as though it is becoming an international force to be reckoned with.

The South African business infrastructure is generally well developed, and could be seen as a model for other African countries to follow. It includes an efficient physical infrastructure of roads, rail and air transport, a well developed communications network supported by reliable electricity supplies, and a substantial financial support structure for companies established in the country, including a network of merchant banks, brokers, and financial services specialists. Although the business infrastructure is not yet able to compete with those of the most developed western powers, it is certainly forging a path for other emerging markets countries to follow; increasing investment in telecommunications and technology should see it able to compete on an international level in the near future.

In common with almost every business jurisdiction, both on- and offshore, South Africa has hopes of becoming the e-commerce hub of its hemisphere. Although the groundwork has been laid, the industry still seems to be in the process of developing a coherent legislative framework and e-commerce strategy.

Although you wouldn't necessarily assume that South Africa's position at the very bottom of the African continent would be an advantage in terms of international business opportunities, it actually makes the country a very good trans-shipment point between the emerging markets of Central and South America and the newly industrialised nations of South and Far East Asia. South Africa is also ideally placed for access to countries in the Southern African Customs Union (SACU), and the Southern African Development Community (SADC), an alliance of 14 countries with a combined population of over 180 million.

For both international and domestic investors, there are many investment opportunities available in the modern South Africa: the country is the world leader in several specialised manufacturing areas: it produces and exports more gold than any other international competitor, and also exports considerable amounts of coal; and it leads in the field of mineral processing to form feralloys and stainless steels. Several other areas, such as tourism, agriculture and livestock development, construction, and the service industry are undergoing rapid growth at the moment, and look likely to attract substantial foreign investment over the next few years.

As previously mentioned, the leadership is receptive to foreign investment, and South Africa has made good progress in dismantling its old economic system, which was based on import substitution, high tariffs and subsidies, anti-competition measures, and widespread government intervention. The government has substantially reduced its role in the economy, and in the interests of promoting private sector investment competition, has reduced import taxes and subsidies to local firms, eliminated the punitive non-resident shareholders tax, removed certain limits on hard currency repatriation, and reduced the secondary tax on corporate dividends.

Virtually all business activities are open to international investors, although in a few sectors, ceilings have been placed on the permitted extent of foreign involvement, for example in the banking industry in which foreign equity investment is limited. At present, foreign investments are treated in essentially the same way as domestic investments, and receive national treatment for various investment incentives such as export initiative programmes, tax allowances, and trade regulations.

The main difference in treatment between domestic and foreign investment is in terms of the local borrowing restrictions imposed by the Exchange Controls authorities. The main difference in treatment between domestic and foreign investment is in terms of the local borrowing restrictions imposed by the Exchange Controls authorities. For business and investing purposes, a non-resident is known as an 'affected person', and where 25% or more of the firm's capital assets are paid to a non-resident, or the firm is 75% owned by a non-resident, it is deemed to be similarly 'affected'. At present, the maximum an 'affected' company can borrow locally is 50% of the company's effective capital (basically its net worth), plus an additional figure based on the following formula:

100 + SA Participation / Non-resident Participation x 100% of total effective capital

The rate of normal tax for companies in South Africa is 29%, with an additional 12.5% 'STC' (Secondary Tax on Companies) tax payable on net dividends (dividends paid less dividends received). The maximum effective rate of company tax and STC is 37.8%. This rate applies to companies that distribute all of their after-tax profits as dividends. Double taxation is avoided by the granting of a credit to companies for dividends received from South African companies that have already been subject to STC. Consequently, STC is effectively imposed on the distribution of operating profits.

However, from October 1, 2007, Secondary Tax on Companies (STC) will be replaced with a dividend tax at company level, the tax rate will be reduced from 12.5% to 10%, and the tax base will be broadened.

Branch profits tax (for companies which are not resident in South Africa, but do business there via a resident branch or subsidiary) is 35% (at the time of writing); they are exempt from STC.

Before 2001, companies were only obliged to pay local taxes on earnings arising in South Africa. However, as the result of legislative changes which took effect in 2001, SA-based multinationals are now taxed on their offshore earnings as well.

SARS has also targeted what it sees as abuses of transfer-pricing, hitting at international companies which use overseas subsidiaries to over-invoice costs to the home holding company, thus transferring profit out of the country. Legislation on transfer pricing was introduced in 1995 when exchange control regulations were relaxed. The law gives the SARS the power to adjust the value of offshore transactions where companies are related to one another and have entered into an international transaction.

Changes made to the South African corporate tax system in 2001 and 2002 have somewhat worsened the situation for foreign-owned companies which have tax residence in the country, although the 2003 and 2004 budgets ameliorated the situation to some extent.

Businesses were disappointed by the 2006/7 budget: although Trevor Manuel tweaked various tax thresholds to deliver several billion rand in personal income tax cuts, he decided against cutting corporate tax.

Despite corporate and personal income tax revenues running well ahead of government targets thanks to a growing economy and more efficient tax collection methods, Manuel resisted the temptation to loosen the fiscal reins, leaving most major tax rates on hold, including the 29% corporate tax rate and the unpopular secondary tax (STC) on companies.

The more visible measures affecting business included:

• Adjustments to tax brackets for qualifying small businesses with turnover less than R14 million, up from R6 million.
• A 150% deduction for R&D expenditure.
• A tax amnesty for small businesses (turnover not exceeding R5 million) in which taxes due for years ending up to 31 March 2004 will be waived.
• A 10% non-disclosure penalty will be payable in 2005.
• A reduction in the transfer duty for companies and trusts from 10% to 8% with effect from 1 March 2006.
• Proposal for an anti-avoidance rule in relation to the purchase of a company's shares by its subsidiary.

Manuel also announced a relaxation in exchange controls by increasing the offshore individual allowance from R750 000 to R2 million. In addition, the requirement of a 50% shareholding by South African corporate and parastatals investing in Africa has been reduced to 25%.

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