Doing business in South Africa

September 2010 | 10QUESTIONS | BOARDROOM INSIGHT

financierworldwide.com

FW speaks with Simon Venables at PricewaterhouseCoopers about doing business in South Africa.

FW: What do foreign companies need to know about establishing operations in South Africa?

Venables: South Africa is an economy with a combination of emerging market and developed market components. Foreign inward investment is actively encouraged by the South African Government in order to boost our economy’s profile and support growth targets. The rules and regulations regarding foreign investment in South Africa are not considered onerous. Based on an annual survey contained in the World Bank and International finance corporations’ report ‘Doing Business 2010’, South Africa was ranked 34th out of 183 countries in the ‘ease of doing business’ category. South Africa also serves as a strategic and efficient springboard into other sub-Saharan markets.

FW: How would you describe economic conditions in the country over the last 12 months?

Venables: The South African economy has rebounded from marginally negative GDP growth in 2009 to a growth rate of approximately 4.6 percent and 3.2 percent in the first and second quarters of 2010 respectively. Manufacturing remains a key sector of the economy and real sales values were almost 9 percent higher at the end of June than a year ago. Most importantly, the country’s leading business cycle indicator has increased by 25 percent between March 2009 and May 2010. Retail sales have also firmly recovered from a low in the last quarter of 2009, recording real growth of more than 7 percent up to mid-2010. South Africa’s sovereign risk rating has risen steadily to investment grade status, and South Africa’s foreign exchange reserves have continued to reach new highs over the past five years, facilitated by a robust export performance and a net inflow of almost R 1 trillion on the financial account of the balance of payments since 2004. This factor is key to the strength of the SA Rand, which gained 37 percent against the US dollar between March 2009 and August 2010. Meanwhile, for the first time in 50 years South Africa had to cope with supply shortages from cement and electricity to beverages and petroleum. This situation arose from the relatively rapid structural improvement in the economic growth trajectory and has acted as an incentive for a surge in private sector capital formation. The government has committed more than R 1 trillion of fiscal resources to maintenance and upgrading of the country’s infrastructure over the next seven years. Finally, it is important to recognise that South Africa and Africa remain driven by markets. By 2030 Africa is forecast to be a larger market than China and India.

FW: Which sectors seem to be performing well and offering the best opportunities for businesses at the moment?

Venables: Considering the record-breaking performance and broad-based nature of investment in capital formation since 2003, most of the key sectors in the South African economy offer excellent prospects for sound returns. Between 2003 and 2007, investment in new productive capacity and infrastructure in South Africa expanded at an average rate of more than 12 percent per annum in real terms. A cherry-picking exercise would nevertheless single out mining, which stands to benefit from the swift and strong recovery of the commodity price cycle. From a mineral resources perspective, SADC still enjoys more than 40 percent of world reserves in chrome, platinum, manganese, diamonds, gold, cobalt and vanadium. A number of manufacturing sectors also stand to benefit from a combination of record-low interest rates and industrial policy incentives. The latter include motor vehicles and components, mineral beneficiation and chemicals. The tourism and hospitality sectors should also experience a structural enhancement of business activity, following the successful hosting of the Soccer World Cup finals. Investing in South Africa also acts as a springboard to business opportunities in one of the world’s largest latent consumer markets, with SADC boasting vast reserves of virtually the full spectrum of natural resources and a combined population of approximately 270 million people. According to current estimates by the demographic experts at the United National Development Programme, the SADC population should expand to more than 340 million within the next decade, making it the third largest regional population in the world.

FW: Are South Africa’s banks showing an appetite to lend, or is access to financing limited?

Venables: South Africa has one of the most sophisticated banking systems in the world and did not experience the same trauma as many more developed economies. Prudent lending practices contributed to this. Access to finance is improving in corporate and retail market and solid asset classes and sound business plans will be supported by the banks and lending institutions in South Africa. There is low appetite for lending in property development. Interest rates continue to remain low in South Africa.

FW: Could you give us a snapshot of activity on South Africa’s capital markets at the moment? How would you describe investor appetite, IPOs and other capital raising initiatives?

Venables: IPOs are influenced by the continuing turmoil in world economies, low employment levels and muted expected GDP growth and deflation threats. A strong pipeline for potential new IPOs in South Africa exists but is unlikely to materialise in the short term until the pricing gap between sellers and investors narrows. Having said that, several new IPOs did take place during the year, including Life Healthcare Group which raised R5.25bn and has a current market capitalisation of approximately R14bn. In Life Healthcare Group’s case, approximately 40 percent was subscribed by foreign investors, which is a major vote of confidence in the company, the healthcare sector and in South Africa by the international investment community.

The JSE Limited is the 18th largest exchange in the world by market capitalisation. Six new company listings occurred during first six months of 2010 – five on the main board (including Wilderness Safaris on the Africa Board) and one on AltX – compared with four for the same period last year. This is in line with listings numbers on member exchanges of the World Federation of Exchanges. We have also experienced direct investment and enquiries from international companies in a broad range of sectors and from a broad range of foreign countries.

FW: How would you describe the legal and regulatory environment governing corporations and investment in South Africa? Have there been any major developments or reforms in recent months?

Venables: A new Companies Act was gazetted in South Africa in November 2008. The new Act was written subject to the finalisation of the accompanying regulations which are still subject to finalisation. There is an amendment bill to the Act that is currently out for public comment. It is expected that the new Act and its regulations will become effective within the next 12 months. There are more detailed requirements in respect of the roles and responsibilities of directors and prescribed officers and the associated liabilities for these officers. There is a specific chapter, Chapter 3, on Enhanced Accountability and Transparency that is applicable to a public company. Other company types may elect to comply with this chapter through their Memorandum of Incorporation. This chapter deals mainly with the audit committee, company secretary and auditors. There are also a number of changes in respect of the approval requirements for specific types of transactions that could have the effect of slowing down the decision making process. One of the most significant changes or additions in the new 2008 Companies Act is the introduction of an entire chapter devoted to business rescue proceedings – this is a substantial departure from a historic liquidation environment and allows distressed companies to a focus on preservation of value, particularly economic, enterprise and employment. Chapter 6, Business Rescue proceedings, replaces Judicial Management which has broadly been seen as ineffective, with few (if any) recorded success stories. Chapter 6 follows international principles of rescue and restructuring in jurisdictions such as the US and UK, where respectively ‘Chapter 11’ and ‘Administration’ are now mature legislative platforms having created an embedded culture of business recovery. It features international themes such as a Moratorium on legal proceedings (creditors claims) and cram down provisions to bind dissenting creditors. Chapter 6, like the 2008 Act, is subject to an amendment bill and like all new legislation has received mixed views on how it will apply in practice, however, is broadly accepted as an important step towards a international best practice scenario for companies in distress. In addition, the King III Report on Corporate Governance was released on 1 September 2009 and became effective on 1 March 2010. This is now seen as the leading code on corporate governance globally. The new code on corporate governance is principle based and should be implemented on an ‘apply or explain’ basis. The majority of the principles are suggested practices. Certain principles are ‘musts’ and are aligned to specific requirements of the new Companies Act that was gazetted in November 2008. All listed companies are required to report on the application of the principles contained in the report, in their annual report. This becomes applicable for financial periods beginning on or after 1 March 2010. Non-listed companies will need to evaluate the application of the code and reporting on their level of compliance, based on the expectations of their stakeholders.

FW: Are there any potential pitfalls in South African employment law which might take a foreign company by surprise?

Venables: South Africa has a sophisticated network of statutes regulating the employment environment, the result of which is that a number of important obligations have been placed on employers and certain rights of employees have been vigorously protected. The key statutes are the Labour Relations Act (LRA), the Basic Conditions of Employment Act (BCEA) and the Employment Equity Act (EEA). The Constitution of the Republic of South Africa underpins the interpretation and implementation of these statutes and together these statutes have created one of the most progressive labour law systems in Africa. The LRA’s key role is to protect the fundamental right to fair labour practices. A great deal of emphasis is placed on fair procedures relating to dismissals. Employers need to be aware of the correct procedures to be followed and strictly adhere to them. Documentation and record keeping is essential in this regard as access to affordable outside adjudicative bodies is readily accessible for all aggrieved employees. As a result, employers are often called upon to justify their actions. Labour disputes can be resolved through the Commission for Conciliation, Mediation and Arbitration or through certain independent alternative dispute resolution services. One has access to the Labour Court and the Labour Appeal Court to review certain arbitration decisions. There is limited access to the Supreme Court of Appeal and the Constitutional Court in respect of labour disputes. The LRA provides protection to employees in the event of a transfer of business and the reduction of staff on the basis of the employer’s operational requirements. If embarking on either of these processes, it is advisable to seek legal advice in respect of the employee’s entitlements, the employer’s obligations and the correct procedures that are to be followed. The LRA governs the process whereby employers, employees, trade unions and employer organisations can collectively bargain on wages, conditions of employment, workplace restructuring and retrenchments.

Employees’ freedom of association is protected under the Constitution and the labour law statutes and therefore there is a strong trade union presence in South Africa. In almost all sectors of the economy, employers will find themselves engaging with relatively representative trade unions over issues affecting their workforce. The labour force therefore has strong bargaining power. The BCEA prescribes minimum standards of employment such as payment of remuneration, working hours, sick leave, and termination of employment. The BCEA prescribes further that certain basic conditions of employment must be provided to employees in writing. Some prescribed minimum requirements may be varied by agreement, but only to the extent that the employee is not made worse off. The BCEA protects employees who earn less than an amount determined by the relevant Minister of Parliament , currently the threshold earnings are approximately R150 000. Lesser protection is provided to employees at management level. The basic conditions of employment may however, depending on the determination of the Minister of Labour, vary between industry sectors. Employers must keep abreast of the broad administrative requirements imposed on them by the BCEA. The purpose of the EEA is to promote equality in the workplace and to implement affirmative action. Affirmative action is aimed at promoting substantive equality by providing employment opportunities for previously disadvantaged persons. The idea is that all races and genders should be adequately represented in all levels of the workforce. Employers subject to the transformation provisions of the EEA will be faced with an extensive fine where such provisions are not complied with.

FW: Could you provide some insight into general business practices and corporate culture in South Africa, which foreign companies might find unfamiliar?

Venables: South African businesses can be described as entrepreneurial and the culture is one where both growth and broader participation by all South Africans is the current focus. South Africa has many pieces of legislation that most developed economies would be familiar with and also has certain unique business practices, such as those covering transformation of the economy. The Broad-Based Black Economic Empowerment Act, 2003 (BBBEE Act) in particular has the objective of promoting economic transformation in order to enable meaningful participation of black people in the economy. Seven elements have been developed in accordance with the BBBEE Act against which enterprises’ transformation is measured. These include ownership, management control, employment equity, skills development, preferential procurement, enterprise development and socioeconomic development. Compliance with the BBBEE initiatives is an essential part of doing business in South Africa.

FW: Have there been any recent government policies or incentives designed to benefit foreign companies?

Venables: Arguably, the most important policy thrust of the South African government is its emphasis on fiscal and monetary discipline, which has manifested itself in structurally lower inflation, a relatively low budget deficit and a stable and strong currency. More specifically, the second phase of the Industrial Policy Action Plan was announced earlier in 2010, in terms of which the Department of Trade and Industries will provide incentives to a selected number of industries that are believed to possess sustainable comparative advantages. Industries that have been targeted for government support include metals, motor vehicles, food processing, pharmaceuticals, clothing and textiles, and aviation. South Africa is also a gateway for funds in Africa. A number of jurisdictions have safe harbour rules or tax exemptions to attract investment funds and managers to their shores, for example, the UK, US, Singapore, Ireland and Luxembourg. South Africa is expected to follow suit, ensuring that the investment funds and their non-SA resident investors are not subject to South African tax, regardless of the fund manager’s operations in South Africa. Further, the introduction of the industrial policy project allowance (Section 12I) supports investment in manufacturing assets and supports the provision of training to personnel to improve labour productivity. S12I is available for the manufacturing sector in respect of greenfield projects but also expansions or upgrades of existing brownfield projects. For a project to qualify it must be solely or mainly for the manufacturing of products, articles or other things classified as such. Every project must satisfy, amongst other requirements, a minimum asset holding – R200 million for greenfield projects and R30 million or 25 percent of the cost of the pre-existing assets, limited to R200 million, for brownfield projects. Two types of allowances are available to qualifying projects, namely a capital incentive allowance – either 55 percent or 35 percent of the cost of the new and unused manufacturing asset in the year that the asset is brought into use depending on the nature of the project and with some limitations – and a training allowance, which involves a deduction of training costs per employee at R36 000 per employee over a period of six years with specific limitations depending on the nature of the project.

FW: Have there been any recent changes in the tax regime which have helped or hindered businesses?

Venables: South Africa is set to introduce a headquarter company regime in South Africa with effect from 1 January 2011 in respect of any year of assessment commencing on or after that date. The proposed regime will enable foreign companies to set up headquarters in SA without any significant tax exposure, thereby encouraging long-term investment into SA. Qualifying holding companies would be exempt from existing corporate tax laws in the following instances.

First, headquarter companies would not be subject to secondary tax on companies in respect of dividends remitted to foreign investors. Similarly, they would also not be subject to withholding tax under the new (yet to be introduced) dividend-withholding tax regime. Second, headquarter companies would not be subject to the controlled foreign company regime. Third, South Africa’s thin capitalisation rules are to be amended so that they do not apply to loans made by foreign investors to a headquarter company, where such funds are in return advanced by the headquarter company to its foreign subsidiaries. Finally, there would be a potential relaxation of exchange controls provided that certain requirements are met. In order for a South African resident company to qualify as a regional holding company, it will have to meet certain criteria such as that each investor is required to have a minimum 20 percent shareholding in the company and that at least 80 percent of the funds invested by the company is required to be invested in foreign subsidiaries in which the company had a shareholding of at least 20 percent. Meanwhile, one expected change is for the secondary tax on companies (STC) to be replaced by dividend tax (DT). The SA nominal corporate tax rate applicable to SA subsidiary and SA branch of a foreign company is 28 percent and 33 percent respectively. There is a 10 percent STC levied on SA subsidiaries on net dividends declared to shareholders. A SA branch is not liable to STC. Treaty relief does not apply to STC. It is expected that STC will be replaced by a 10 percent dividend withholding tax. Dividends paid by foreign companies listed in SA will in future be subject to DT. This applies only to the specific shares that are listed on the SA exchange. The DT will qualify for treaty relief and may be reduced to 5 percent under certain treaties. Another expected change, proposed a 2010 bill, relates to thin capitalisation rules. Financial assistance by a non-resident to its permanent establishment in South Africa will now also be subject to the thin capitalisation rules. This change effectively seeks to place foreign-owned South African branches on par with foreign-owned South African subsidiaries. The thin capitalisation rules empower the South African Revenue Service (SARS) to effectively re-characterise debt as equity by denying the deduction if there is excessive lending in relation to the capital. The total amount of the excessive interest will also be deemed to be a dividend. The level of debt is generally discretionary, but the default rule is a debt-equity ratio of 3:1. Currently, thin capitalisation does not apply to a parent or branch loan but only to loans between separate persons. A further development is the gradual liberalisation of exchange control. SADC loop structures refer to positions where a SA investor holds an interest in a foreign entity, which in turn earns income from a SADC-source, or dividends from a SADC company. These holding structures were generally not allowed by the SA Reserve Bank, but these loops are now permitted. Common Monetary Area loops are still prohibited. From 2013 a 10 percent withholding tax will be applied to interest. The National Treasury has reconsidered the entire issue in relation to the payment of interest to non-residents. It has now been indicated that, even though a number of tax treaties will have to be renegotiated, a withholding tax of 10 percent will be introduced in relation to interest payable to non-residents. The effective date of this withholding tax will probably be 1 January 2013. The withholding tax regime will be worded on the basis of the current withholding tax applicable to royalties. However, the relevant exemptions will still be retained, including South African debt that is listed on foreign exchanges. Interest charges associated with the export credit agency will also be exempt. Changes to transfer pricing will also be introduced from 1 October 2011. Section 31 of the South African Income Tax Act is proposed to be amended so as to widen its application quite considerably. The result will be that the SARS will no longer be restricted to adjusting a particular price on a particular cross-border transaction, but will be empowered to determine an overall tax result in a manner similar to section 80A, the general anti-avoidance provision. However, there is no reference to the methodology of any such potential determination, creating significant uncertainty for taxpayers. For example, unlike the position internationally, there is no reference to the application of the OECD Transfer Pricing Guidelines. This is of particular concern because South Africa is not a member of the OECD so is not obliged to adhere to these guidelines.

Simon Venables has been a partner in PricewaterhouseCoopers and a director of PricewaterhouseCoopers Corporate Finance since 1994. His is the leader of Transactions, South Africa, which incorporates the Corporate Finance, Transaction Services and Business Recovery Services divisions. With respect to Corporate Finance services, which is targeted primarily to the larger South African and Global Companies, Simon has and continues to be involved in identifying and implementing a range of value-adding advisory mandates from advising listed and unlisted companies on transactions, take-overs and mergers, BEE strategies and the implementation thereof, cross-border transactions, fundraising, negotiation support and high-level valuation advice including the provision of Fair & Reasonable opinions. He is a review partner of Corporate Finance Valuation mandates, and participating in key industry groups such as short-term insurance, mining, technology and media. He can be contacted on +27 (11) 797 5660 or by email: simon.venables@za.pwc.com.

THE RESPONDENT

Simon Venables

PricewaterhouseCoopers