South Africa: Investment Incentives

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Investment Incentives in South Africa - By Caroline Maxwell, London

The South African government, understandably enough after decades of international isolation, is very keen to encourage foreign direct investment (FDI) into South Africa, and offers a range of taxation and other incentives in order to entice international (and in some cases domestic) investors. Here we will be looking at four of the major initiatives set up by the new regime: Industrial Development Zones (IDZ), the International Headquarter Company exemption, the Small and Medium Enterprise Development Programme (SMEDP), and the Strategic Investment Project (SIP) programme. In addition to these specific schemes, the Revenue Laws Amendment Act, passed in 2002, introduced strategic tax incentive measures to attract industrial investment to South Africa and to promote employment-generating projects in excess of R50m, by allowing those investing in manufacturing and IT a tax deduction of up to 100%.

Industrial Development Zones

Industrial Development Zones (IDZs) are purpose-built industrial estates providing facilities and services tailored for export-oriented industries. They are linked to international airports or ports, and run along similar lines to Export Processing Zones, which fall outside of domestic customs zones, and so are able to import items free of customs and trade restrictions, add value, and then export. Sites already earmarked for, or actually being used as IDZs include Richmond, East London, Durban, Coega, Saldanha, and the Johannesburg international airport. New investments locating in an IDZ can expect several benefits:

• Attractive regulatory regime and investment facilitation services provided by zone operators
  Duty free imports of capital goods and inputs, plus VAT exemption for exports
  Access to the government's incentive mechanism
  
• Effective infrastructure

IDZs usually consist of two zones of operation:

Designation of IHCs as non-resident for taxation purposes

After the proposal was announced, there was widespread concern that residence-based taxation (introduced in January of 2001), would deter companies from establishing their international headquarters in South Africa. Sensitive to this, the government decreed that any company qualifying as an International Headquarter Company (IHC) would be considered non-resident for taxation purposes. However, the criteria for qualification are quite stringent, and in order to qualify:

• All equity share capital must be held by non-residents;
  The indirect interest of South African residents and trusts must not exceed 5% in aggregate of the company's total equity share capital;
  
• 90% of the value of the company's assets must represent interests in non South African resident subsidiaries in which the IHC holds beneficially at least 50%

However, for qualifying international companies, the incentives are substantial - income from foreign subsidiaries is not be imputed to the IHC under the Controlled Foreign Entity provisions, dividends received from foreign subsidiaries and any other foreign-sourced income is not be liable for South African taxation, and dividends declared are not subject to the secondary company tax.

However as an IHC, to all intents and purposes, falls outside the South African income tax net, it is not able to make use of the country's extensive network of double taxation treaties, which may prove a problem when withholding tax on profits is applied which might otherwise have been reduced by the relevant treaty. Largely as a result of this last problem, the designation of ‘international headquarter company’ (IHC) was removed effective for years of assessment commencing on or after 1 June 2004.

Small and Medium Enterprise Development Programme (SMEDP)

N.B. The SMEDP was suspended on August 31, 2006. No applications for the SMEDP programme were accepted after this date and existing guidelines apply only to applicants accepted into the scheme prior to August 31, 2006.

The SMEDP is a programme designed to generate employment, and create opportunities for the introduction of new and advanced skills to South Africa, as well as to encourage foreign investment in the country. One of the programmes it offers provides incentives for those planning to expand existing South African based enterprises, or to start new projects in a range of sectors, including manufacturing, tourism, business services, information and communications, technology, and high value agricultural projects.

Eligible projects can claim an annual tax free cash grant of up to 10% of the qualifying investment cost, paid over two or three years if a labour usage criteria is met.

The rates for assistance are as follows:

- First R5 million (USD630,000 approx) investment 10% per annum
- Next R10 million (USD1.26m approx) investment 6% per annum
- Next R15 million (USD1.89m approx) investment 4% per annum
- Next R20 million (USD2.52m approx) investment 3% per annum
- Next R25 million (USD3,15m approx) investment 2% per annum
- Next R25 million investment 1% per annum.

Another incentive, offered to businesses with approved training programmes, is the Skills Support Programme, which can be accessed simultaneously with any other investment or competitiveness programmes. The SSP offers a three-year grant to the value of up to 50% of the cost of training new staff as the result of an expansion or new project. It also offers a capital grant for training equipment and course materials.The government is also very keen to stimulate domestic investment, as it believes that this is the key to foreign investment, as international investors, to a certain degree, follow the sentiment and mood of their domestic counterparts.

To this end, a number of Spatial Development Initiatives (SDIs or 'Investment Corridors') have been set in place to establish conditions that will be attractive to both domestic and international investors. SDIs have tended to be established outside the major industrial centres, and offer private/public partnerships designed to encourage economic growth, and create jobs in areas such as tourism and agriculture. However, the incentives offered to investors in these initiatives are 'soft' incentives, for example links with local suppliers, red tape reduction, etc, and as such will probably appeal more to domestic enterprises than international investors.

Strategic Investment Projects

The Strategic Investment Project program offers a tax allowance of up to 100 percent (a maximum allowance of R600 million (app. USD100 million) per project) on the cost of buildings, plant and machinery, for strategic investments of at least R50 million (app. USD85 million).

Although there was a delay in implementing the scheme, the trade and industry department announced in April 2002 that the scheme had come on stream after finalising the criteria for the evaluation of projects.

The SIP incentive is accessible to industrial projects participating within the following sectors:

• Manufacturing of products: all listed manufacturing activities excluding tobacco and tobacco related products; Computer and computer related activities: hardware consultancy, software consultancy and supply, data processing (excluding standard secretarial services), and database activities;
• Research and development activities: research and experimental development on natural sciences and engineering

The proposed project should:

• Comprise investment in new qualifying assets equal to or exceeding R50 million; Increase annual production of the relevant industry sector within South Africa; Not substantially displace products or jobs in the relevant sectors;Demonstrate long term commercial viability; Promote employment and production in the same economic sector in which the project is to be established;
• Not concurrently be benefiting from certain other schemes as per the relevant legislation.

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