Is it time to revisit the SA Headquarter Company regime?

On 1 January 2011, with much fanfare, the South African Government unfurled its brand new tax incentive, the International Headquarter Company (HQC) Regime, designed to attract hordes of multinational enterprises to set up shop on its shores and make the country “the gateway to Africa”, as one optimistic National Treasury document, at the time, put it. Unfortunately, it was not to be. After almost ten years, the whole thing has turned out to be something of a damp squib with very few companies taking it up. Why? Well, the reasons vary from the over-strict, over-complicated qualifying requirements to fact the that other African countries, notably Mauritius and Botswana, had simpler and more rewarding holding company regimes in place.

But things have changed recently. The black-listing of Mauritius and Botswana by a number of international bodies [see previous article] which has prompted tax changes in both countries has made the South African incentive model seem a great deal more competitive. Now may therefore be the moment to relook at South Africa as a possible launching pad for African investment which means considering once again the pros and cons of using this tax incentive.

What is an HQC?

Actually, the term is something of a misnomer. What the incentive really encourages is the use by foreign companies of intermediate holding companies in South Africa’s jurisdiction – effectively an African base of operations for foreign enterprises as opposed to their “international headquarters” - which will then hold the group’s investments in subsidiaries or businesses in other parts of the African continent.

It should be said though that HQC’s are not only for foreign multinationals. South Africans looking to invest internationally are welcome to take advantage of these companies as well but some of the tax and exchange control benefits described below could be lost in some cases.

Benefits of the HQC regime

The benefits of an HQC are summarised below:

Dividends, interest, and royalties paid by the HQC to its foreign parent companies - Exempt from all SA withholding taxes

Capital gains on disposal of the HQC by the foreign parent companies - Exempt from SA capital gains tax (unless its “SA land-rich”)

Dividends received by HQC from foreign companies - Exempt from SA Normal Income Tax

Capital gains on the sale of shares by the HQC in foreign companies - Exempt from SA capital gains tax (unless its SA land-rich”)

Income earned by foreign companies controlled by HQC - Exempt from SA controlled foreign companies rules hence no imputation into HQC’s SA income

Interest and royalties received by the HQC by foreign companies and paid by the HQC to its foreign parent companies - Not subject to scrutiny under SA transfer pricing rules

Raising and deployment of capital offshore - Not subject to SA exchange control restrictions

It’s pretty clear from the above that a South African company that qualifies for the HQC incentive is effectively treated as a non-resident company for both South African tax and exchange control rules.

That means that the HQC is still subject to South African taxes on all its South African source income but earnings that do not derive from the country are free of South Africa taxes and currency restrictions.

Basically, this allows foreigners who wish to invest through a HQC a free flow of funds through South Africa with a minimal incidence of South African tax.

Requirements to qualify for the HQC regime

This all sounds great but there’s a catch, of course. The catch in the case of HQC’s is having to fulfil and maintain some rather strict, complex, and onerous requirements so as to elect to qualify for the benefits described above. What’s more is that all these requirements have to be met constantly throughout the tax year to avoid losing the benefits of HQC status. These are summarised below:

Tax residency of HQC - Tax resident in SA (i.e. incorporated and effectively managed in the country)

Minimum shareholding in HQC - Each shareholder must hold alone (or together with related parties), 10% or more

Maximum shareholding by South Africans (for exchange control freedoms to apply) - 20%

Maximum number of shareholders in HQC - 10

Minimum shareholding by HQC in foreign companies - 10% or more of the equity/ voting rights in foreign companies for them to be “qualifying assets”

Cost of total assets (excluding cash/ bank demand deposits) held by HQC (where assets exceed R50 000) - 80% or more must be attributable to equity in/loans to/intellectual property licensed to “qualifying assets” (see above)

Source of income (where HQC’s income exceeds R5m in a tax year) - 50% or more must derive from so-called “qualifying assets” (i.e. rental, services, dividends, interest, royalties, capital gains);

Administration - Annual report must be submitted to SA authorities setting out prescribed information

Will the HQC become a South African Cinderella story?

It’s widely suspected that it is these qualifying requirements which have resulted in the relative under-utilisation of this HCQ regime and the relegation, up until now, of this South African tax incentive to “ugly sister” status in relation to those provided by other countries.

However, the recent developments in South Africa’s competitors that were alluded to above, may yet render this ugly sister a great deal more attractive.

Mauritius, the former darling of African business-hub seekers, has, in particular, suffered. Alongside the reputational damage from its blacklisting, the concomitant alterations to its GBC regime, involving increased set-up costs as well as more stringent residence and substance requirements, are sure to alarm prospective investors.

As a result, many business-people may decide to give the South African HCQ incentive another chance to dance at the ball.