PRIVATE EQUITY AFRICA YEARBOOK 2012/13. You think expansion into Africa. We think efficient, innovative and precise legal strategy.

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1 PRIVATE EQUITY AFRICA YEARBOOK 2012/13 You think expansion into Africa. We think efficient, innovative and precise legal strategy.

2 Our horizons are as broad as your business vision.

3 The Bowman Gilfillan Africa Group Bowman Gilfillan Africa Group is one of Africa s premier corporate law firms, employing over 400 specialised lawyers. The Group provides domestic and cross-border legal services to the highest international standards across Africa, through its offices in South Africa, Botswana, Kenya, Madagascar, Tanzania and Uganda. Differences in law, regulation and business culture can significantly increase the risk and complexity of doing business in Africa. Our aim is to assist our clients in achieving their objectives as smoothly and efficiently as possible while minimising the legal and regulatory risks. While reliable technical legal advice is always very important, the ability to deliver that advice in a coherent, relevant way combined with transaction management, structuring, negotiating and drafting skills is essential to the supply of high quality legal services. The Group has offices in Antananarivo, Cape Town, Dar es Salaam, Gaborone, Johannesburg, Kampala and Nairobi. Our office in Madagascar has francophone African coverage in Benin, Burkina Faso, Burundi, Cameroon, Chad, Central African Republic, Congo Republic, Gabon, Guinea, Ivory Coast, Mali, Niger, Rwanda, Senegal and Togo. We have a best friends relationship with leading law firm Udo Udoma & Bela-Osagie, in Nigeria, which has offices in Lagos, Abuja and Port Harcourt. We also have strong relationships and work closely with law firms across the rest of Africa which enables us to provide or source the advice clients require in any African country, whether on a single country or multi-jurisdictional basis. We act for corporations, financial institutions, state owned enterprises and governments providing clear, relevant and timely legal advice to assist clients achieve their objectives and manage their legal risks. The strength and depth of all the Group s practice area, eographical and sector specific teams are utilized to provide clients with the highest standards of service. In the cross-border arena the Group has extensive experience in the resources, energy, infrastructure, financial institutions and consumer goods sectors. Bowman Gilfillan Africa Group s South African, Kenyan and Ugandan offices are representatives of Lex Mundi, a global association with more than 160 independent law firms in all the major centres across the globe. This association gives access to firms which have been identified as the best in each jurisdiction represented.

4 Foreword KELEBOGILE MODISE Partner and Head: Private Equity Africa Practice, Our second edition of the private equity yearbook highlights significant changes in the South African regulatory sphere during 2012 and anticipates some of the regulatory changes relevant to private equity during This edition is published in conjunction with the Southern African Venture Capital Association (SAVCA) and the African Venture Capital Association (AVCA). In our first edition, we discussed the role of private equity in South Africa and throughout Africa, generally, and briefly dealt with the different modes of investment and fund structures typically used for fund formations and regulatory considerations for fund establishment in South Africa. In this edition, our South African team provides a tax overview of applicable provisions in respect of private equity investments, regulatory considerations and an update for the private equity industry. We also review the much debated amendments to Pension Funds Act in respect of private equity investments, as well as the introduction of the Category II license for private equity fund managers. We are delighted to share insights from David Ashiagbor, of the Commonwealth Secretariat, regarding African Pension Funds as a viable source of funding for private equity in Africa. In addition, we have contributions from AF Mphanga, a Ugandan firm and a member of the Bowman Gilfillan Africa Group, on regulatory considerations for making investments in Uganda, as well as an introduction to Mauritius, contributed by Appleby, in which the legal framework and developments in Mauritius, as an investment gateway into Africa, are discussed. With the increased competition between South Africa and Mauritius, as gate-ways for investment into the rest of Africa, South Africa has, during 2011 and 2012, made some compelling changes to its tax and exchange control regime, including the introduction of the head-quarter regime, and regulations for investments by pension funds with the amendments to Regulation 28 of the Pension Funds Act. With these efforts, and the widely anticipated relaxation of further exchange control regulations and tax exemption for managers (as non-resident) of foreign funds during 2013, South Africa is bound for success in narrowing the gap existing in comparison to the Mauritian investment landscape, and will likely emerge a success in the battle for the jurisdiction of choice into the rest of Africa. Recently, most funds that have been formed, that have international investors, have utilised a parallel fund structure, with Mauritius as a favoured jurisdiction for establishment of mirror investment corporate structures by international funders, and South Africa remaining the primary investment jurisdiction for fund establishment by development fund institutions, pension funds and other institutional investors. With the continued reform of the South African regulatory framework, we believe that South Africa will succeed in becoming the gateway jurisdiction of choice for most investments into the rest of Africa, by both locally based and international investors. We have seen increased interest and participation by pension funds in the establishment of private equity funds, especially in respect of funds with a Sub- Saharan focus, and are of the view that this trend will continue for the next few years to come, due to increased flexibility in respect of investments by pension funds through private equity funds. For 2013, we hope to see continued and increased appetite by investors, through investments in portfolio companies and the establishment of new funds, in the infrastructure, health and energy sectors. We anticipate investments in the health and education sectors, increased investment in the infrastructure, agriculture, agricultural products, mining and resources and technology sectors, clean energy, commercial property and housing sectors. These sectors have, during 2012, received the attention of private equity investors, and we expect continued investment in these sectors for Overall, we anticipate a year of greater activity in the private equity arena, particularly on the fund formations side due to increased appetite for emerging market investments, particularly by institutional investors, and due to increasing investor confidence in private equity as an asset class, market flexibility and increasing liquidity, and opportunities for exists in respect of early-on investments, we anticipate increased activity in the form of exists and new investments.

5 Editorial ERIKA VAN DER MERWE CEO: South African Venture Capital Association This promises to be an active year for the South African private equity industry. Capital raising has resumed for many fund managers and coincides with the gradual recovery in global investor sentiment. The newly amended South African pension fund regulation, which gives pension fund trustees scope to allocate up to 10% of assets under management to private equity, is promoting awareness of this alternative asset class: Private equity now is considered too significant to overlook. The portfolio diversification benefits of private equity, together with its favourable performance relative to listed equity, all suggest that the uptake by institutional investors will spread. One of the most energising developments for the industry is the announcement last year by the Government Employee Pension Fund (GEPF) Africa s largest pension fund -- that it will be investing up to 5% of assets under management into South African private equity, with a further 3% allocation to African private equity. The likely impetus for the private equity industry is significant and will be felt over several years to come. Fund managers will also continue to explore growth and diversification opportunities north of our border, with many already earmarking a fixed portion of their capital for deals outside South Africa. As was the case in 2012, though, most of the largest deals on the continent still will be found in South Africa. Private equity houses are expanding regionally in other ways too: Portfolio companies are being encouraged to increase their operations incrementally into the rest of the continent. Deep and long-established private equity skill sets in the South African market, combined with readily available legal and advisory services, a sophisticated and robust domestic banking system and increasingly active support from government for the asset class, will ensure that South Africa remains an important vantage point for private equity in the broader African region. In the meantime there is sufficient firepower in the industry to fund a lift in deal flow this year. Although private equity fund managers will, in general, look across all sectors for acquisition targets, there may be particular interest in deals that offer exposure to infrastructure, healthcare and education. Given lofty valuations in the listed market, most of this action is likely to be in the private market.

6 AVCA: Review MICHELLE KATHRYN ESSOMÉ CEO: African Venture Capital Association As Chief Executive of the African Venture Capital Association (AVCA) the only industry association dedicated to representing Africa on a global scale I am often called upon to go beyond the anecdotes on African growth to provide a real picture of the opportunities available across the continent. As an organization, we seek to develop the dialogue and delve into the detail to inform and to encourage private sector investment Review For global investors seeking returns in a difficult economic climate, Africa continues to offer a compelling proposition. The continent has seen more than 20% compound growth in FDI projects over the last years and this figure is set to grow. Sub-Saharan Africa in particular has received positive attention from several global players in emerging markets private equity in recent years, with Brazilian bank BTG Pactual Group announcing plans to raise US$1 billion for a private equity fund with a focus on the infrastructure and energy sectors in Africa in While the Emerging Market Private Equity Association s statistics note that private equity investment totals into sub-saharan Africa have remained relatively static over the year, moving from US$483 million in the first three quarters of 2011 to US$698 million in first three quarters of 2012, The Carlyle Group has subsequently completed its first African deal alongside two other investors in November 2012, in Tanzania-based agribusiness Export Trading Group. On the fundraising side, South Africa s Ethos Capital announced in January 2013 that it has beaten its targets and raised $800 million for its latest fund focused on South Africa and some of its fast-growing neighbouring countries proved a busy time for African private equity Outlook In April, AVCA will be convening private equity and venture capital players from around the globe in Cape Town, at our annual conference. At this event, we will be debating the most pertinent issues and opportunities facing the industry in Foremost among these is the need to illustrate how these African growth markets are driving returns. We will be launching the first Africa-focused Private Equity Performance Benchmarks, an essential step in addressing the need for data across the continent. We will also be looking more closely at the evolving profile of investment into Africa, how fund managers are driving value creation and, more importantly, mapping the African private equity landscape. All of these issues will be big themes for African private equity in The Association s tenth annual conference will be held in Cape Town on April 8-10th In addition, there are private equity master classes for investors and fund managers. For more details, see

7 Contents 1. Are African Pension Funds a Viable Source of Funding for African Private Equity? 2 2. South African Tax : Private Equity at a glance Acquisitions Funding of acquisitions Taxation of proceeds on disposal of shares in target company Executive compensation Carried interest Venture capital company incentive Headquarter companies South African Update: Regulatory Considerations Tax and regulatory challenges faced by SA private equity fund managers SA tax exposure for offshore private equity funds Effective management Permanent establishment Investments by retirement funds in private equity funds Providing financial services to private equity funds targeting pension funds: Is a Category II FSP license appropriate in all instances? Proposed limitation on the acquisition by a pension fund of a controlling interest in an entity Uganda at a Glance: An Overview of the Private Equity Industry Introduction to Mauritius : Private Equity Overview Regulation of companies in Mauritius Private equity legal update in Mauritius 42 Disclaimer: This handbook is not intended to constitute legal advice which can only be given having regard to particular facts and circumstances. Any liability that would or could arise from or of the contents hereof is hereby excluded. Always seek professional advice from a suitably qualified lawyer on any specific legal problem or matter. To keep track of private equity developments visit

8 1. Are African Pension Funds a Viable Source of Funding for African Private Equity? Sub-Saharan Africa has come to represent one of the biggest growth stories in emerging markets private equity. According to the Emerging Markets Private Equity Association (EMPEA), fundraising by fund managers for Sub-Saharan Africa rose from US$800 million in 2005 to over US$2.2 billion in 2008, before falling back to US$960 million in 2009 and rising to US$1.5 billion in saw fundraising fall slightly to $1.3 billion, with $490 million raised in the first half of Fundraising for Africa has been led by development finance institutions (DFI), international commercial banks, pension funds and even foreign private investors (family offices). According to an EMPEA / Coller Capital survey published in 2012, 21% of Limited Partners (LP) plan to begin Africa commitments within two years up from 16% in 2010, and placing the continent second only to Brazil. With increasing foreign interest in private equity in Africa, the issue of local capital (or lack of it) in private equity in Sub-Saharan Africa has become a hot topic for the industry. Issues such as regulation of African pension funds, their investment policies and allocations, and where the next generation of limited partners will come from, have come to dominate the agenda at African Private Equity conferences on and off the continent. This article explores whether African pension capital is a viable source of funding for the private equity industry in Sub-Saharan Africa. It draws on previous work by the author and others, and an on-going research project looking at regulation of pension funds in 12 countries across Sub-Saharan Africa. Regulation has long been seen as the main stumbling block to investment in PE by African pension funds. However, recent reforms in some of the continent s key markets are slowly creating an enabling environment for local institutional investors to participate in private equity. South Africa and its local institutional investors continue to play a leading role in this regard, with the promulgation of a revised Regulation 28 of the Pensions Fund Act in This allows retirement funds to invest up to 10% of assets under management in unlisted equities. This is up from a historical figure of 2.5%, which encompassed all alternative asset classes, to a universal figure of 15% for both private equity and hedge funds. Nigeria established its National Pension Commission (Pencom) to regulate and supervise the pension fund industry in 2004 as part of wide reaching reforms. Under regulations issued by Pencom in 2010, and revised in December 2012, prudential limits for private equity and alternative assets have been capped at 5% of assets under management. Other requirements include a minimum of 10 years experience for key principals of the fund manager, a minimum of 75% of the PE Fund to be invested in Nigeria, registration of the fund with the Nigerian SEC and a minimum investment of 3% 1 in the fund by the general partner (GP). Such restrictions, especially with respect to geography / jurisdiction are typical on the continent. For African pension capital to be a viable source of capital private equity (PE), the pension funds need to have the ability and the willingness to invest in the asset class. Their ability is affected by issues like regulation are they allowed to invest in alternative assets under what conditions and how much, their assets under management and their knowledge and understanding of the private equity. Their willingness to invest in private is affected by their evaluation of the risks involved in investing in PE, their assessment of how PE fits with their investment policy and strategy and their ability to identify managers they are willing to back. We will now examine some of these factors in turn. 1 This is reduced to 1% where DFIS are invested in the fund. 2 3

9 Some commentators have argued that these requirements are unnecessary and pose a few problems for general partners and pension funds alike. A 75% exposure requirement to Nigeria effectively creates a Nigeria fund, concentrating risk country, currency and political. They argue that Pencom should be encouraging pension funds to use private equity as a risk diversification tool, and that the 75% requirement in particular achieves precisely the opposite effect. The issue is slightly different from a regulators standpoint. Their first duty is to protect the pensions of their fellow citizens. In that context, it would be unwise to allow pension funds unfettered access to an asset class which neither they nor the regulators are fully familiar with. We only have to look to the origins of the global financial crisis to understand the potential damage that could cause. In that context, the softly approach taken by some regulators seems reasonable. The idea behind the additional restrictions in places like Nigeria is to get the pension funds to learn from experienced LPs (hence the requirement for DFIs) and then slowly lift these restrictions. From a market development point of view, it is hard to argue with that. It is also worth noting that despite these restrictions, some fund managers have successfully raised not insignificant sums from Nigeria. Yes the structuring has been perhaps more costly and complicated, but it can and has been done. Across other markets, Ghana is also undertaking pension fund reform; however these are still at a very early stage, with investment guidelines yet to be issued. In Botswana, the largest pension fund, Botswana Public Officers Pension Fund (BPOPF) has recently launched an alternative investment policy, with prudential limits for private equity set at 2.5%. In Kenya, pension funds may invest up to 10% in other assets, including private equity. Based on the above analysis, regulation in and of itself does not seem to be a barrier to African pension funds investing in private equity. Whilst the existing rules are far from perfect, they do not prohibit African pension funds from investing in private equity. The next issue that affects the ability of African pension funds to invest in PE is assets under money. Basically do they have sufficient assets under management to invest in the asset class how much can they realistically allocate to PE overall and to a specific fund? The table below shows assets under management, the maximum investment in PE as per the regulations, the capital available for deployment in PE and capital actually deployed in PE for South Africa, Nigeria and Kenya. Based on these three countries alone, there is a potential US$28 billion AUM ($b) available for private equity, of which only $5 billion has been invested, leaving $23 billion untapped. Whilst this may seem insignificant lot in comparison to larger Western PE Allocation (%) Capital Available South Africa Nigeria Kenya Total Capital Deployed LPs (the U.S.-based California Public Employees Retirement System (CalPERS) alone has a $50 billion allocation to PE); it would almost double the size of the African PE industry. With assets under management in countries like Nigeria growing at close to 30% per annum, and given that less than 5% of the population of Sub-Saharan Africa is covered by the pension plans, there is obvious scope for significant growth. However, the global industry figures hide wide variations across and within countries. Industry fragmentation is a major issue in many countries, with assets split across dozens of small pension funds, meaning that they can only make minimal investments, which can be below the minimum ticket size of many GP s. Discussions are underway in countries like Kenya and Nigeria about creating local fund of funds which would go some way to addressing these issues. Unlocking the potential of African pension funds to invest in PE also means addressing the many challenges that they face. First among these is the lack of awareness about the asset class across the continent. Even in South Africa, with its sophisticated financial markets, few pension funds have experience of or knowledge of private equity. Until African pension funds become more familiar with the asset class, the dream of an industry led by or with significant participation from local investors will remain just that. Pension funds, regulators and other stakeholders must be empowered with the right information which enables them to evaluate if and how private equity fits within their investment strategies and objectives. 4 5

10 It is in this context that the Commonwealth Secretariat has worked with the African Development Bank (AfDB), AVCA, and Aureos Capital to organise a series of regional roundtables on Private Equity in Africa over the past 2 years, to: 1. Introduce participants to private equity as an asset class; 2. Familiarise participants with the private equity industry in Africa and provide the opportunity to meet with fund managers, investors and other stakeholders; 3. Provide participants with an understanding of the structure of private equity funds, their operations and governance, and 4. Identify next steps to promote increase local participation in the private equity industry in Africa. Regional roundtables have been held East, Southern Africa and West Africa. A Pan-African workshop was also held as part of the AVCA conference in Accra in Country events have also been held in Kenya and Nigeria in partnership with their respective pension regulators. Most recently, a South African workshop was held in partnership with the Principal Officers Association. Feedback from these events has been overwhelmingly positive. The regional approach has worked well in terms of raising awareness of the private equity and the barriers to increased participation in the industry by domestic investors. However, different levels of awareness and country level regulation means that there are different priorities / needs amongst the countries, even within the same sub-region. There is no simple answer to whether African pension funds are a viable source of capital for African private equity. What is clear is that there is African money available for investment in private equity on the continent, and that this will increase significantly in the medium term. How much of this actually flows into the industry will depend significantly on the willingness and capacity of fund managers to invest time and energy in engaging with and understanding local investors and regulators: What are their issues? What are the risks from their point of view? How can fund managers, existing LP s and industry associations work with them to resolve these? On their part, African pension funds and regulators must continue to engage with the industry, to better understand the potential advantages and risks PE offers. How can they adapt their regulations to enable them to obtain the most benefit from PE whilst minimizing the risks? Is there a case for regulation at a regional rather national level? Whilst events like the Commonwealth Secretariat s Private Equity Roundtables have contributed significantly to starting this dialogue, much remains to be done. It is now up to the industry and its various stakeholders to take this forward. Specific recommendations for follow up activities have included: Education and capacity building at all levels for all stakeholders (including regulators, other institutional investors, policy makers and lawmakers) Policy makers in particular need a better understanding of private equity kind of environment in which it can thrive.; Practical assistance for the development of appropriate regulatory regimes and knowledge sharing amongst stakeholders, and Further research into private equity in Africa areas of focus would include performance benchmarks, regulation, etc. CONTRIBUTOR: David Ashiagbor (Commonwealth Secretariat) The views expressed in this article are the author s personal views and do not necessarily reflect the views of the Commonwealth Secretariat or that of any of its member governments. 6 7

11 2. South African Tax : Private Equity at a glance South Africa 2.1 Acquisitions South Africa applies a residence-based income tax system in terms of which South African residents are taxed on their worldwide income and non-residents are subject to income tax on income derived from a South African source. Residents are also subject to capital gains tax (CGT) on capital gains arising from the disposal of their worldwide assets, while non-residents are subject to CGT on capital gains arising from the disposal of immoveable property situated in South Africa or any interest in or right to immoveable property situated in South Africa, as well as in respect of the disposal of assets that are attributable to a permanent establishment of that nonresident in South Africa. 2.2 Funding of acquisitions Private equity acquisitions are generally funded by substantial debt, usually as a combination of senior debt, mezzanine debt and equity loans. The deductibility of interest expenditure on such loans depends primarily on whether the interest expense was incurred in the production of income as required by the Income Tax Act, 1962 (ITA). Dividend income is exempt from tax and is not income as defined in the ITA. Therefore, if the loan was raised to purchase shares, a deduction of the interest is generally not available. However, with effect from 1 January 2013 taxpayers may in certain circumstances, deduct interest incurred in respect of the acquisition of shares. In terms of a recent amendment to the ITA (section 24O of the ITA) where during any year of assessment an instrument as defined in the ITA (any interest bearing arrangement or debt) is issued, assumed or used by a company for the purpose of financing the acquisition by that company of an equity share in an operating company (any company that carries on business continuously, and in the course or furtherance of which it provides goods or services for consideration or a controlling group company in relation to such a company) in terms of an acquisition transaction (any transaction in terms of which a company acquires an equity share in an operating company and as a result of which that company, as at the close of the day of that transaction, becomes a controlling group company in relation to the operating company) or in substitution of an instrument issued, assumed or used for such a purpose, any interest incurred by that company in terms of that instrument is deemed to have been: incurred in the production of the company's income; laid out or expended for the purposes of trade; and incurred in respect of income received by or accrued to the company. The effect of the section is that interest incurred on debt used to acquire at least 70% of the equity shares in an operating company or a controlling group company in relation to an operating company will be deductible. The deduction of the interest will remain for as long as the acquiring company remains a controlling group company in relation to the target (operating) company. It must be noted that the deductions is only available in respect of wholly domestic acquisitions. The deduction of interest in relation to the direct acquisition of equity interests is subject to anti-avoidance provisions that were introduced into the ITA in These provisions, which are discussed in more detail below, initially applied to indirect acquisitions of equity acquisitions but have been amended to extend their application to direct acquisitions of equity interests. Prior to the introduction of the anti-avoidance provisions and section 24O into the ITA, to ensure that interest incurred in respect of the acquisition of shares was taxdeductible, debt pushdown structures were utilised. In such a structure, the acquisition of the shares in the target company by the local holding company would be followed by the transfer of the assets of the target company to a new subsidiary of the holding company, which raised third party loans for the acquisition of the assets. The interest on the money borrowed by the new subsidiary to acquire the assets was generally taxdeductible. The proceeds of the sale of the assets were then distributed to the holding company, which used the 8 9

12 amounts to repay the debt that was raised to purchase the shares. In addition, because the ITA contains specific provisions that provide tax rollover relief for restructuring transactions, the transfer of the assets under the debt pushdown structure usually qualified for the tax rollover relief. In general, the provisions provide a rollover or deferral of any tax payable by the target company arising from the disposal of its assets to another company that is part of the same group of companies. In June 2011, new restrictions were introduced into the ITA to restrict the tax deduction of interest incurred in respect of loans raised to fund the acquisition of assets in terms of a reorganisation transaction. The effect of the amendment (section 23K) was that interest associated with debt used to finance a reorganisation transaction, or debt that refinanced or substituted debt that was used to fund a reorganisation, would no longer be automatically deductible. Instead, the South African Revenue Service (SARS) could, on application by an acquiring company, issue a directive permitting the deduction of the interest. In considering the application for the directive, SARS will take into account the amount of interest incurred by an acquiring company in terms of a debt raised to fund an acquisition or reorganisation transaction, and all amounts of interest incurred, received or accrued in respect of all debt instruments issued, assumed or used directly or indirectly to fund a debt instrument in respect of which interest is incurred by the acquiring company. SARS may only issue a directive if and to the extent that it is, having regard to the criteria prescribed by regulations issued by the minister, satisfied that the issuing of the directive will not lead nor be likely to lead to a significant reduction of the aggregate taxable income of all parties who incur, receive or accrue interest in respect of all periods during which any amounts are outstanding in terms of debt. In determining whether a reduction of taxable income is significant, SARS will have regard to criteria prescribed by regulations issued by the Minster. With the introduction of section 24O, the application of section 23K has been extended to transactions involving the direct acquisition of equity interests. If the acquisition is financed by loans from a non-resident connected person, the deductibility of the interest will also be affected by the transfer pricing and thin capitalisation rules of section 31 of the ITA. In terms of the rules, which were amended with effect from April 2012, where a transaction, operation, scheme, agreement or understanding is entered into between or for the benefit of connected persons, one of which is a South African resident and the other a non-resident on non arm's-length terms and conditions, and it results or will result in a tax benefit for one of the parties to the transaction, SARS is empowered to determine the tax liability of the party deriving the tax benefit (defined to include the avoidance, postponement or reduction of any tax liability) as if the transaction, operation, scheme, agreement or understanding had been entered into on arm's-length terms. In other words, SARS is empowered to disregard the non-arm's length terms in determining the tax liability of the person. Interest is generally subject to income tax in the hands of a resident recipient, but in terms of section 10(1)(h) of the ITA, interest received by a non-resident is exempt from income tax unless the non-resident at any time during the year carried on business through a permanent establishment in South Africa. A withholding tax of 15% will apply with effect from 1 July 2013 in respect on interest payments to non-residents. Dividends declared by a South African company are as a general rule exempt from income tax. However, with effect from 1 April 2012, they are subject to dividend withholding tax (DWT), a rate of 15%. As DWT is a tax on the shareholder (unlike the now repealed Secondary Tax on Companies, which was a tax on the company declaring dividends) the rate of DWT can be reduced where a non-resident shareholder is resident in a country with a DTA that provides for a reduced rate of less than 15% in respect of dividends

13 2.3 Taxation of proceeds on disposal of shares in target company Shares could be held either as capital assets or as trading stock, depending on the intention of the shareholder as evidenced by the facts. Profits realised on the disposal of shares held as trading stock are subject to income tax, while the gains realised on the disposal of shares held as capital assets are subject to CGT. In view of the uncertainty as to the intention of a shareholder, the legislature introduced a safe harbour rule under section 9C of the ITA for both listed and unlisted shares in South African resident companies in terms of which profits from the sale of shares that have been held for at least 3 years will be regarded as being capital in nature and thus only be subject to CGT and not income tax. This does not mean that the proceeds on the disposal of shares held for less than 3 years will automatically be of a revenue nature depending on the circumstances, such proceeds may still be regarded as capital in nature. CGT is imposed on South African resident companies at an effective rate of 18.66%, which is significantly lower than the income tax rate of 28%. A non-resident will be subject to income tax at a rate of 28% in respect of the profits realised from the disposal of shares held (in a South African company) as trading stock, unless DTA protection applies. A non-resident will be subject to CGT at a rate of 18.66% in respect of profits realised from the sale of shares held as capital assets if the non-resident held at least 20% of shares in a company that held immoveable property, comprising at least 80% of the value of the shares held in the company or if the shares were attributable to a permanent establishment of that non-resident in South Africa. To reduce the risk that a local fund manager may create a permanent establishment for non-resident investors of a private equity fund conducted via a limited partnership or trust, the definition of a permanent establishment in the ITA (as defined in article 5 of the OECD Model DTA) is restricted by disregarding the activities of the partnership or trust in South Africa in respect of financial instruments in considering whether the foreign investors had a permanent establishment in South Africa. 2.4 Executive compensation The tax consequences of executive compensation schemes involving equity instruments are governed by section 8C of the ITA. The application of section 8C may have the effect that management will be required to pay income tax (at the maximum rate of 40%) either when an equity instrument is received by virtue of employment or when any gains are made as a result of the vesting of restricted equity instruments that are acquired by virtue of their employment. Vesting occurs when a restricted equity instrument becomes freely disposable. Equity instruments include options, shares, any financial instrument convertible to a share, or contractual rights or obligations the value of which is determined directly or indirectly with reference to a share. Section 8C may impact on management equity ownership schemes where the management is locked in, even if the management vehicle has participated on a fully funded basis (if, that is, they have paid market value for their shares). When structuring contractual relationships with any equity investments by management, expert tax advice should be obtained in this regard. 2.5 Carried interest Carried interest is typically derived in the form of a disproportionate share of the gains from the disposal of investments by the private equity fund. As indicated above, the ITA contains certain safe harbour rules in respect of the sale of shares in South African resident companies. The effect of these safe harbour rules is that the gain derived from the sale of any shares issued by certain South African resident companies after being held for at least 3 years will be treated a receipt of a capital nature. This treatment is subject to certain anti-avoidance rules contained in the tax legislation. Therefore, it is important to consider the application of the anti-avoidance provisions before placing reliance on these safe harbour rules

14 2.6 Venture capital company incentive In order to encourage equity finance investment by small and medium-sized businesses, a new incentive was introduced in section 12J of the ITA in In terms of section 12J, taxpayers may deduct expenditure actually incurred in acquiring equity shares issued by a venture capital company (VCC), subject to the conditions and limitations set out in section 12J. Non-company structures do not qualify as VCCs. To qualify as a VCC, and thus allow investors to claim the deduction, the company in question has to comply with certain requirements. For example, the company must be a resident, its sole object must be the management of investments in qualifying companies, its tax affairs must be in order, it must have complied with all relevant provisions of the laws administered by SARS, and it must be licensed in terms of section 7 of the Financial Advisory and Intermediary Services Act of The section also sets out criteria regarding the target companies in which the VCC may invest (qualifying companies). In terms of the section, a VCC may invest only in companies that do not carry on impermissible trades as defined in section 12J. In addition, the VCC must invest at least 80% of the funds in qualifying shares in companies that hold assets with a book value of not more than R20million or, if such company is a junior mining company, not exceeding R300million and must not invest more than 20% of invested funds in any one qualifying company. Approval as a VCC may be withdrawn should the VCC fail to comply with the requirements of section 12J(5) of the ITA, in which event an amount equal to 125% of the expenditure incurred by the investor will be included in the income of the VCC. 2.7 Headquarter companies In recognition of South Africa s economic position in Africa, the legislature amended the ITA to establish South Africa as a holding company gateway into Africa. The objective that is sought to be achieved by the legislation is the removal of what are considered to be significant barriers to South Africa s role as an ideal holding company jurisdiction. In order to remove the identified barriers, the legislature introduced a regional holding company regime (the concept of a headquarter company into the ITA) that will entitle qualifying holding companies to tax relief in South Africa. In order for a company to qualify for the proposed tax relief, it must satisfy the requirements of the definition of a headquarter company. These are: it must be a South African resident company; for the duration of the current tax year and all previous tax years, each shareholder (whether alone or together with any other company that forms part of the same group of companies as the shareholder) must have held at least 10% of the equity shares and voting rights in the company; at the end of the current tax year and all previous tax years of the company, at least 80% of the cost of its total assets must be attributable to any interest in equity shares in; any debt owed by; any intellectual property that is licensed to any foreign company in which the company (whether alone or together with any other company forming part of the same group of companies as the company) held at least 10% of the equity shares and voting rights; and where the gross income of the company for the current tax year exceeds R5million, at least 50% of that gross income must consist of any rental, dividend, interest, royalty or service fee paid or payable by the foreign company referred to above or any proceeds from the disposal of any interest in equity shares in or any intellectual property licensed to the foreign company

15 3. South African Update: Regulatory Considerations 3.1 Tax and regulatory challenges faced by SA private equity fund managers South Africa (SA) has established a vigorous regulatory environment for the general fund industry, in particular for collective investment schemes (CIS s) to protect local investors, address foreign investor fears and to protect the fiscus. Whilst most of the regulations are aimed at the collective investment fund regimes, they often present serious regulatory obstacles for private equity funds. Some of the regulations introduced with the intention of protecting local investors are in conflict with the objective to promote the use of SA fund managers. The Collective Investment Schemes Control Act (CISCA) CISCA regulates the establishment and administration of CISs in South Africa, as well as the solicitation of investments in South Africa for a foreign CIS. CISCA defines a CIS as: a scheme, in whatever form, including an open-ended investment company, in pursuance of which members of the public are invited or permitted to invest money or other assets in a portfolio, and in terms of which two or more investors contribute money or other assets to and hold a participatory interest in a portfolio of the scheme through shares, units or any other form of participatory interest; Members of the public is widely defined which means that many private equity fund entities may qualify as a CIS. Because the Executive Officer of the Financial Services Board was concerned about the way that it was being managed, the collective investment scheme business of the Rockland Targeted Development Investment Fund, a private equity fund, and its manager, Rockland Asset Management and Consulting (Pty) Ltd were placed under curatorship in However, the Financial Services Board (FSB) has expressed the view that an offshore fund entity such as company would not be regarded as a CIS as contemplated under CISCA, since members of the public will not be invited to invest in a portfolio of shares but in one class of shares issued by the company. We agree that such a company should not fall within the scope of the CISCA rules but it is not so certain that the definition in CISCA would not be applicable. On the assumption that the FSB view is correct, the question arises whether such a company would nevertheless be subject to regulations issued by the FSB in respect of investments in foreign CISs 2 on the basis that the company is treated as a CIS under the foreign legal system where it is established. Since the regulations were issued by the FSB as guidelines for the compliance with CISCA rules, we are of the view that such regulations cannot be relevant for an investor in such an offshore company. 3.2 SA tax exposure for offshore private equity funds The income or capital gains of a foreign fund company would only be exposed to SA tax if the asset disposed of was attributable to a permanent establishment in SA or if the income or gains were derived from immovable property or an interest in immovable property in SA. Furthermore, if the foreign company should be effectively managed in SA, it would be exposed to tax as a resident of SA. 3.3 Effective management In accordance with SARS Interpretation Note 6, the effective management of a company is determined primarily with reference to the place where the important management decisions are taken by directors and ongoing operational decisions are implemented by senior management. Therefore, the effective management an offshore private equity fund company could be in SA if the SA based fund manager had a discretionary mandate, 2 See, for example, Board Notice 80 of 2012 entitled Determination of Securities, Classes of Securities, Assets or Classes of Assets that may be included in a portfolio of a Collective Investment Scheme in Securities and the manner in which and limits and conditions subject to which securities or assets may be so included

16 i.e. had the ability to make important investment decisions on behalf of the fund and regularly made and implemented them in SA. Treasury has recognised that limiting the manager s power to make decisions in SA undermines the very purpose of utilising a local manager and has attempted to relax the effective management test for foreign investment funds to allow local investment managers to compete for or attract international clients. However, the concession proposed in the Taxation Laws Amendment Bill 2012 will only apply to a foreign investment entity which only provides for the exclusion of the management of passive entities which have no employees and no full time directors or trustees and have no more than 10% SA resident shareholders. This will seldom be the case for foreign investment funds. 3.4 Permanent establishment The activities of the SA manager/advisor could also expose the foreign fund to the risk of creating a permanent establishment in SA. The definition of a permanent establishment in the ITA contains a proviso which prescribes that in determining whether a qualifying investor in relation to a foreign entity conducts activities in SA, any act of that entity in respect of any financial instrument should not be ascribed to that qualifying investor, i.e. the activities of a SA fund manager on behalf of the foreign entity will not create a permanent establishment for the foreign investors. However, a qualifying investor is one that holds an investment in a tax transparent foreign entity and who does not participate in the management of the foreign entity. Therefore, it does not apply to a foreign investment company which is not tax transparent. If such a foreign fund company thus granted a discretionary mandate to a fund manager in SA, the activities of the fund manager/advisor may create a permanent establishment for the fund company in SA. This restricts the scope of SA fund managers to act for foreign fund companies. They could still act as advisors to that foreign company provided they did not have the authority to conclude contracts on behalf of the fund in SA. This may, however, now disqualify them from soliciting investments from SA pension funds if the FSB s interpretation of Regulation 28 is correct. 3.5 Investments by retirement funds in private equity funds Retirement funds, both local and foreign, are major investors in private equity funds both in South Africa and in foreign jurisdictions. Most, but not all, 3 retirement funds domiciled in South Africa are subject to regulation in terms of the Pension Funds Act, 1956 (the PFA) and, in particular, to PFA Regulation 28 which imposes asset allocation limitations on those retirement funds. With effect from 31 December 2011 a new Regulation 28 was published. It defines the term private equity fund as - a managed pool of capital that: a) has as its main business the making of equity, equity orientated or equity related investments in unlisted companies to earn income and capital gains; b) is not offered to the public as contemplated in the Companies Act, 2008 (Act No. 71 of 2008); c) is managed by a person licensed as a discretionary financial services provider as defined in the Code of Conduct for Administrative and Discretionary Financial Services Providers, 2003, or if a foreign private equity fund, managed by a person licensed as a Category 1 Financial services Provider that is authorised to render financial services [in] securities and instruments as defined in the Determination of Fit and Proper Requirements for Financial Services Providers, 2008; and d) is subject to conditions as may be prescribed. 3 For example the Government Employees Pension Fund (the biggest fund by both asset value and membership) is subject to regulation in terms of the Government Employees Pension Law,

17 Invitations to invest in a private equity fund will not be offered to the public if the invitations are issued only to financial institutions as defined in the Financial Services Board Act, 1990, such as retirement funds. The licenses contemplated in paragraph (b) of this definition are discussed in paragraph 3.6 below. The new Regulation 28 increases from 2.5% to 10% the maximum percentage of a retirement fund s assets by value that may be invested in private equity funds that fall within the scope of the above definition. However, it also provides that not more than 2.5% may be invested in a single private equity fund; not more than 5% may be invested in a fund of private equity funds; the amounts of a retirement fund s investments in private equity funds (including funds of private equity funds) and hedge funds (including funds of hedge funds) and other assets not specified in the schedule to Regulation 28 together may not exceed 15% of the value of the retirement fund s assets 4 ; a retirement fund may not commit capital to a private equity fund which is not constituted in a manner that will shield the retirement fund from losses in an amount greater than the amount of its capital commitment; while the look through principle must be applied when assessing a retirement fund s compliance with the asset allocation limitations in Regulation 28, the retirement fund s exposure to a private equity fund must be disclosed as an investment in the private equity fund and not in the assets in which the private equity fund has invested; a retirement fund s investment in a foreign private equity fund must be disclosed as an investment in a foreign asset for the purpose of measuring compliance with the Regulation 28 limit on foreign investments; and to fall within the scope of the definition of private equity fund, the private equity fund must comply with conditions determined by the registrar of pension funds. 4 See item 8 in the schedule to Regulation 28 which sets out the limits as follows: item 8 Categories of assets Hedge funds, private equity funds and any other asset not referred to in this schedule 8.1 Inside the Republic and foreign assets Bowman Gilfillan is able to advise on whether, when a retirement fund s exposure to a private equity fund is to be valued for the purpose of determining the pension fund s compliance with Regulation 28, account must be taken of either - (a) only the value of both the amount actually invested by it in the private equity fund in accordance with drawdown notices; or Limites being the maximum percentrage of aggregate fair value of total assets of fund Per issuer/entity, as applicable For all issuers/ entities 15% (a) Hedge funds 10% (i) Funds of hedge funds 5% per fund of hedge funds (ii) Hedge funds 2.5% per hedge fund (b) Private equite funds 10% (c) (i) Funds of private equity funds 5% per fund of private equity funds (ii) Pricate equity funds 2.5% per private equity fund Other assets not referred to in this schedule and excluding a hedge fund or private equity fund (b) both that value, and the amount of the balance of the pension fund s committed capital. Our team can also advise on amendments that could be made to the founding documents of the private equity fund in order to minimise the risk to a retirement fund investor that further draw downs on its capital commitment to the private equity fund may result in a violation by the retirement fund of the Regulation 28 limit on investments in private equity funds

18 On 15 March 2012 the Registrar of Pension Funds (PF Registrar) published the Conditions for Investments in Private Equity Funds referred to in the definition of private equity fund in Regulation 28 (the Conditions). In essence, they say that a retirement fund may only enjoy the higher limit on the permissible allocation of its assets to investments in private equity funds if and to the extent that each those private equity funds 1 is a member of a private equity fund industry body recognised by the registrar (although it is usually the managers of those funds, rather than the private equity funds themselves, that are members of such an organisation); and 2 is structured as 2.1 an en commandite partnership in which retirement funds are only en commandite (limited) partners and so cannot be held liable to creditors of the partnership for more than its capital contribution to the partnership; or 2.2 a bewind trust in relation to which retirement fund investors are co-owners in undivided shares of the trust assets and are only beneficiaries, not trustees; or 2.3 a company the assets and liabilities of which are limited to the assets and liabilities arising from its private equity investments; or a foreign private equity fund that takes the form of a limited partnership, an open-ended investment company or a company the assets and liabilities of which are limited to the assets and liabilities arising from its private equity investments; and if : 3 the assets of the private equity fund are verified at intervals not exceeding 6 months by means of scrip counts by auditors; 4 it has clear policies and procedures for determining the fair value of its assets, which ensures that those determinations are performed in a manner consistent with the Private Equity Valuation Guidelines and are verified at intervals of not more than 12 months by independent third parties; 5 it submits to the retirement fund at intervals not exceeding 3 months reports on the private equity fund s performance, activities, the value of its investments and any other information required to enable the pension fund to fulfil its reporting requirements; and 6 its annual financial statements of which are audited and made available to the pension fund within 120 days after the end of the private equity fund s financial year end. The Conditions also say that the board of a retirement fund must take the following into account before making a decision to invest in a private equity fund as defined: the private equity fund s investment strategy and objectives, investment and borrowing powers, restrictions and associated risks (including types and sources of leverage); the procedures by which the investment strategy and policy might be changed; details about the valuator, auditor, administrator of the private equity fund and any other service providers, requiring a description of the duties of the service providers and investor s rights should a failure arise; liquidity risk management of the private equity fund as well as the pension fund as investor, including redemption rights both in normal and exceptional circumstances, and how fair treatment is ensured across investors; the ownership of the assets; the level of management fees, performance fees and any initial charges or early redemption fees; the manager s risk and compliance management standards, including the necessary independence of these functions from portfolio management; and the liquidity profile of the private equity fund relative to the liquidity requirements and liability profile of the pension fund

19 Lastly, the Conditions confirm that the responsible person, manager, administrator or advisor of the private equity fund must disclose to the retirement fund- any possible conflict of interest that may arise or any direct or indirect benefit it may obtain or may have obtained as a consequence of any transaction concluded by the private equity fund or the acquisition or disposal of assets in the execution of the business of the private equity fund. Recognising that it would not be appropriate to require retirement funds to disinvest in haste from private equity funds that did not comply with the Conditions, in September 2012 the PF Registrar granted an extension until 31 December 2012 of the period within which private equity funds had to comply with the Conditions or face disinvestment by retirement funds. The notice in which the Conditions appear states that private equity funds that comply with the Conditions are now formally approved custodians of retirement fund assets as contemplated in section 5(2)(e) of the PFA. For these private equity funds this disposes of a thorny issue that was the subject of difficult legal debates between SAVCA and the PF Registrar during Providing financial services to private equity funds targeting pension funds: Is a Category II FSP license appropriate in all instances? Paragraph 3 of the Conditions Paragraph 3 of the Conditions states that: (1) A fund may only invest in a private equity fund on condition that any person rendering financial services whether discretionary or otherwise, to that private equity fund, whether local or foreign, is a discretionary FSP or a representative of such a discretionary FSP. (2) The responsible person of the private equity fund may only delegate any of the duties or responsibilities regarding the management of the private equity fund to a discretionary FSP or the representative of a discretionary FSP. Prior to the issue of the Conditions, most FSPs which provided financial services to private equity funds held a Category I FSP licenses. Following the issue of the Conditions, an FSP which renders services to a private equity fund (targeting pension funds) is required to hold a Category II FSP license. Initially, FSPs had until 30 September 2012 to obtain Category II FSP licenses. However the PF Registrar extended the implementation of paragraph 3 of the Conditions to 31 December In essence, after 31 December 2012, all FSP s providing financial services to private equity funds are required to hold a Category II FSP license Appointment of FSP s Paragraph 3 of the Conditions applies to persons rendering financial services to a private equity fund. The term financial services has a specific meaning under FAIS. In particular, the following services may be provided by a licensed FSP: advice only; or advice and intermediary services; or intermediary services only. FAIS defines advice as including any recommendation, guidance or proposal of a financial nature, furnished by any means or medium, to any client or group of clients: in respect of the purchase of any financial product; in respect of the investment in any financial product; 5 See PF Notice No 5 of 27 September

20 on the conclusion of any other transaction, including a loan, aimed at the incurring of any liability or the acquisition of any right or benefit in respect of any financial product; on the variation of any term or condition applying to a financial product; on the replacement of any financial product or on the termination of the purchase of or investment in any such irrespective of whether or not such advice is furnished in the course of or incidental to planning in connection with the affairs of the relevant client, or results in any such purchase, investment, transaction, variation, replacement or termination actually being effected. Advice under FAIS expressly excludes: factual advice given merely on the procedure for entering into a transaction in respect of any financial product, in relation to the description of a financial product, in answer to routine administrative queries, in the form of objective information about a particular financial product, or by the display or distribution of promotional material; and an analysis or report on a financial product that does not contain any express or implied recommendation, guidance or proposal that any particular transaction in respect of the relevant product is appropriate to the particular investment objectives, financial situation or needs of a client. An intermediary service is defined in FAIS as any act other than the furnishing of advice, performed by a person for or on behalf of a client or product supplier, the result of which is that the client may enter into or offer to enter into or enters into any transaction in respect of a financial product with a product supplier, or with a view to: buying, selling or otherwise dealing in (whether on a discretionary or non-discretionary basis), managing, administering, keeping in safe custody, maintaining or servicing a financial product purchased by a client from a product supplier or in which the client has invested; collecting or accounting for premiums or other moneys payable by the client to a product supplier in respect of a financial product; or receiving, submitting or processing the claims of a client against a product supplier. A FSP may provide the financial services under different categories of FSP licenses, namely Category I (for non-discretionary FSP s), Category II (discretionary FSP s), Category IIA (hedge fund FSP s); Category III (administrative FSP s) and Category IV (Assistance Business FSP). It is important to note that, in the private equity environment, it is not every service provider to the fund which has to obtain an FSP license. Some service providers may render purely administrative functions. 6 In those circumstances, the service providers should obviously not be required to comply with paragraph 3 of the Conditions. The problem arises where the FSP is required to provide nondiscretionary services (such as where the FSP has no discretion on the choice of investment; or simply provides advice to the private equity fund such as an investment advisor). In those circumstances it is arguable that paragraph 3 of the conditions should not apply. In essence, paragraph 3 of the Conditions should only apply to discretionary FSP s as that term is defined under FAIS. To require otherwise (as paragraph 3 of the Conditions is currently worded) is to totally ignore the current architecture of our financial services licensing regime. 6 E.g. provision of general secretarial and administrative services at meetings, including the recordal and distribution of minutes and the preparation and distribution of agendas; arranging and booking venues for general meetings of the board of a fund, keeping proper books of account and records in respect of the business, financial affairs and investments and all transactions entered into by the fund

21 3.6.3 Discretionary services The condition is that whether the person is rendering discretionary or nondiscretionary financial services, the person has to be authorised as a Category II FSP or a representative of a Category II FSP. Discretionary FSP has a specific meaning under the Codes of Conduct for Administrative and Discretionary FSP s (Codes of Conduct). 7 The term Discretionary FSP is defined in the Codes of Conduct as follows: discretionary FSP means a FSP - (a) that renders intermediary services of a discretionary nature as regards the choice of a particular financial product referred to in the definition of administrative FSP in this subsection, but without implementing any bulking; and (b) acting for that purpose specifically in accordance with the provisions of the Code set out in Chapter. A discretionary mandate can be contrasted with an execution only mandate. Execution only is described by the Financial Services Authority (FSA) in the United Kingdom as: a transaction executed by a firm upon the specific instructions of a client where the firm does not give advice on the investments relating to the merits of the transaction and in relation to which the rules on assessment of appropriateness ( COBS 10 ) do not apply. 8 It is possible that a private equity fund may wish to appoint an FSP to provide execution only services. Why should a private equity fund seeking investments from pension funds not be able to do so?? While it is understandable why a FSP rendering discretionary services would be required to obtain a Category II FSP license, it is not clear why a person rendering nondiscretionary services only, would be required to hold such a license. The requirement ignores the distinction between discretionary and nondiscretionary financial services recognised under FAIS. Also, such a requirement ignores the fact that obtaining a Category II FSP license is more onerous than obtaining a Category I FSP (for execution only services) and may add costs for a FSP which clearly has no business imperative to render discretionary services. In our view, there is nothing inherently unique about a private equity as an asset class to warrant the provision of financial services to such a fund to be treated differently from a FAIS licensing perspective. It should be open to a fund to appoint either a discretionary or a non discretionary FSP depending on the financial services required Delegation of functions As already mentioned above, the responsible person 9 of the private equity fund may only delegate any of the duties or responsibilities regarding the management of the private equity fund to a discretionary FSP or the representative of a discretionary FSP. Again, it is not apparent why a Category II FSP license is required from someone who renders non-discretionary services, on a delegated basis, to a private equity fund targeting pension funds. While ensuring that pension funds invest in private equity funds that are serviced by appropriately licensed FSP s is prudent, it is not apparent why the FSP s have to, in all circumstances, hold a Category II FSP license. A review of paragraph 3 of the Conditions, in order to align it with the current FAIS licensing regime, may be appropriate. 7 Notice 79 of January This means a general partner (in the case of a partnership); board of trustees (in the case of a trust); a board of directors (in the case of a company) etc

22 3.6.5 Exemption from compliance with specific obligations otherwise applicable to Discretionary FSPs On 13 December 2012 the registrar of financial services exempted each FSP in relation to the provision of financial services to a private equity fund from the obligation in terms of the Code of Conduct for Discretionary FSPs to ensure that its agreement with the private equity fund- (a) includes a general statement as to the risks associated with investments in local and foreign financial products if (i) the agreement was concluded before that date; and (ii) the FSP has informed clients [including the private equity fund itself?] in writing of the risks associated with investing in private equity funds and local and foreign financial products with particular reference to any currency risks within six months after 13 December 2012; and (b) is terminable by either party on notice of not more than 60 days if either (i) the agreement was concluded before 13 December 2012; or committed to the private equity fund can require the termination of the agreement on written notice of not more than 180 days, regardless of the reason for the termination; The registrar also exempted for the period ending on 30 June 2014 FSPs from the obligation to comply with the Determination of Fit and Proper Requirements published in terms of section 8 of FAIS, that is, the conditions with which an FSP must comply in order to be granted a FAIS license if the FSPs render financial services only to private equity funds. It may be that the registrar will use this exemption period to consult with stakeholders in the private equity sector on Long-term exemptions from compliance with elements of the Fit and Proper requirements for the granting of Category I and Category II licenses that should be granted to advisors to and managers of private equity funds that comply with specified conditions; or The establishment of a new private equity category of FSP license and the conditions under which such a license may be granted. (ii) investors which together have committed not less than 75% of capital 30 31

23 3.7 Proposed limitation on the acquisition by a pension fund of a controlling interest in an entity During 2012 National Treasury published for comment the draft Financial Services Laws General Amendment Bill The draft Bill proposes the amendment of various pieces of legislation including the PFA. The proposed amendments of the PFA will affect a retirement funds ability to invest in private equity funds and conversely, the ability of private equity funds to attract significant investments from pension funds. In particular, it is proposed that a new subsection (5D) be inserted in section 19 of the PFA saying the following: (a) Subject to this subsection, a fund shall not without the prior approval of the registrar, directly or indirectly, acquire or hold (i) an ownership interest exceeding 49 per cent in another entity; or (ii) shares or any other financial interest in another entity which results in the fund exercising control over that entity. (b) The approval referred to in paragraph (a) may be given subject to such conditions as the registrar may determine. (c) For the purposes of paragraph (a)(ii), a fund shall be deemed to exercise control over another entity if the fund (i) is directly or indirectly able to exercise or control the exercise of more than 35 per cent of the voting rights associated with the shares of that entity, whether pursuant to a shareholder agreement or otherwise; or (ii) has the right to appoint or elect, or control the appointment or election of, directors of that entity who control more than 35 per cent of the votes at a meeting of the board of that entity. If the Bill is passed by Parliament in its current form, of particular concern to retirement funds would be: (1) the definition and low thresholds for the deeming provisions in 5D(c), that is, the exercise of control, to come into operation; (2) whether a private equity fund in the form of a partnership or trust will be deemed to be an entity as contemplated in the section (the term entity is not defined); (3) how the retirement fund s indirect rights are to be determined in an underlying portfolio company; and (4) whether this amendment will to existing investments in private equity funds or only to new investments. If these proposed amendments are enacted and made applicable to existing investments, private equity funds will need to consider whether (a) they should assist their retirement fund investors to either apply for exemption from compliance with section 19(5D) or the approval by the registrar of their investments in the private equity funds if those investments will exceed the thresholds provided for in the section; and (b) if any of their retirement fund investors are unable to obtain those exemptions or approvals, the private equity funds founding documents should be amended to minimise the prejudice to those retirement funds that otherwise would be entailed in their premature disinvestment from the private equity funds. SA CHAPTER CONTRIBUTORS: Lele Modise (Partner), Rosemary Hunter (Partner), Wally Horak (Tax Specialist), Mogola Makola (Partner), Francisco Khoza (Partner), Simone Esch (Tax Advisor) and Luke Harber (Senior Associate) 32 33

24 4. Uganda At a Glance: An Overview of the Private Equity Industry Uganda Private equity transactions do not fall under a unique regulatory regime under Uganda law. Uganda s private equity industry is also relatively small and under developed. It is therefore difficult to get reliable statistics on the growth or otherwise of the private equity industry. However, anecdotal evidence indicates that private equity activity and transactions are generally on the rise in Uganda. Despite a slight slowdown over the last few years, Uganda's economy continues to grow faster than many economies Europe, North America and Asia. Growth is forecast based on the prospects of the nascent oil and gas sector as well as traditional opportunities in the areas of agriculture, agro-processing, horticulture, mining and fishing. There are challenges to the economy, largely in the areas of energy, infrastructure and high population growth rate. However to an investor, these challenges should be investment opportunities and several private equity actors have already recognised the opportunities that Uganda has to offer. Uganda does not have much upstream private equity activity. There are very few local private equity funds and even those that exist do most of their fund raising externally, looking to international, regional and national development finance institutions as well as to offshore private foundations and family offices. The liberalization of the pension sector in Uganda may see a change in this as local pension funds may become attractive local sources of private equity funds in the coming 5 10 years. The local private equity funds are mostly in involved at the SME end of the business, helping small and medium enterprises access capital in a market where the interest rates on bank loans is still very high. Some of the local funds have a social impact goals, seeking to empower women, the youth, the rural or urban poor and therefore are involved in unique areas such micro-lending, marketing of local crafts, seeds and renewable energy technologies. At this end of the spectrum, private equity transactions tend to be hard to discern from NGO activity. However there are still many opportunities for funds that are willing to look at investments below US $500, and the returns on capital as well as the measurable positive social impact have made this an attractive area for private equity players. The larger private equity players in Uganda tend to be regional players with funds to invest across Africa in general, or East Africa in particular. Of note is Egypt s Citadel Capital, which, through its special purpose vehicle, Africa Railways Limited, owns a 51% stake in Rift Valley Railways, a company which holds a 25-year concession to operate 2,352 kilometers of track linking the Indian Ocean port of Mombasa to the interiors of Kenya and Uganda, including the Ugandan capital of Kampala. In October 2012, it was reported that Citadel is looking to invest in Uganda's proposed US $2.5 billion oil refinery. Another notable high end private equity player in the region is CDC, which through its fund manager Actis owns Umeme Limited, the principal power distribution company in Uganda, which has a 25 year concession to distribute power to end users in Uganda from the state-owned Uganda Electricity Distribution Company Limited. In November 2012, Actis took Umeme to market with a partial IPO, representing about 38% of company s capital worth about US $66 million. Actis also manages CDC s majority stake in the Development Finance Company of Uganda Limited (DFCU Group), which through its DFCU Bank Limited and DFCU Leasing is a leading player in the local retail and commercial banking sector and the dominant player in asset leasing and finance. Over the last few years there have been market rumours of CDC-Actis intention to divest itself of all or most of its 60% stake in DFCU Limited but it has not happened. This may yet happen in As stated above, Uganda does not have much upstream private equity activity. In Uganda private equity transactions tend to manifest in the form of mergers and acquisitions saw the resurgence of mergers and acquisitions after a relatively slow Based on inquiries, our own market research as well as news reports, key sectors seeing growth and in which private equity players can expect to see action are: Infrastructure - including transport (major and truck roads as well as bridges) and telecoms (public telecom infrastructure); Energy including the major and mini hydroelectricity dams, thermal electricity generation as well as renewable energy; 34 35

25 Construction; Fast Moving Consumer Goods and Retail; Agriculture and Agro-processing; Manufacturing; Pharmaceuticals; Healthcare Services and Health Care Products; Retail Petroleum Supply; Financial Services including financial institutions, microdeposit taking financial institutions (MDFIs), micro-lending, insurance and pensions. The opportunities for growth and a relatively good return on investment will continue to attract private equity players to Uganda in 2013 in the more traditional sectors mentioned above. However there are new upcoming sectors, which may yet deliver some surprises. Key amongst these is the information communication technology sector. Young innovators in this area are beginning to make real money especially from writing smart phone apps, which are sold online. Some innovative funds like the Mara Launch Uganda Fund are moving into this area with funds and business mentoring for the tech start ups. Having looked at the upside, a few words about the challenges. Uganda continues to be plagued with bureaucracy and has a low World Bank Doing Business ranking. It is also crucial to note that Uganda s ranking in that internationally respected index has been falling in all key areas save for Getting Credit but including the very critical Protecting Investors, Paying Taxes and Enforcing Taxes. Levels of compliance with corporate governance best practices are not as high as they ought to be and this is the cause of many issues in due diligence. Widespread non-compliance with the tax laws also makes financial reporting less reliable than may incoming equity investors would like. On the regulatory side, there are a couple of things to look out for in 2013 from a private equity perspective. The Companies Act 2012, repealing the Companies Act Cap. 110 which was modeled on the English Companies Act 1948, is expected to come into force in This will help bring the corporate regulatory regime closer to what most international private equity investors are accustomed to as well as, hopefully, help the enforcement of better corporate governance standards. The slight relaxation of the rule on financial assistance for private companies should create more options in the structuring of private equity transactions. While the provision enabling the re-registration of a private company as a public company will make for easier exits by private equity investors. Uganda does not have any exchange controls save that under the Foreign Exchange Act 2004 any foreign exchange being remitted into and out of the country has to be channeled through a licensed financial institution or foreign exchange remittance company. No changes to this regulatory situation are expected in 2013 so foreign private equity investors can remit their money in and out of the country without any controls. The Anti-Money Laundering Bill remains a Bill over 10 years since its inception and Uganda remains the only country in the East African Community without a comprehensive antimoney laundering regime. Uganda also lacks a comprehensive competition regulatory regime. This not to say that anti-money laundering and competition are not matters of concern to investors at all. There are scattered laws and regulations which cover the respective areas. However private equity actors do not have to spend as much time and effort dealing with antimoney laundering and competition law compliance as they would in other jurisdictions. On the tax side, the individual sellers of equity to private equity players have to be aware of the fact that the Uganda Revenue Authority has become more vigilant in enforcing capital gains tax. The Income Tax (Amendment) Act 2010 means that ever since the 1st July 2010 any capital gain made by an individual from the sale of shares held in a private limited liability company is subject to capital gains tax. The rate of capital gains tax is 30% which has had and is likely to continue to have a major effect on private equity transactions as individual investors who hold shares in private limited liability companies the most common business vehicle in Uganda seek to gross up their prices. UGANDA CHAPTER CONTRIBUTOR: David Mphanga (member of the Bowman Gilfillan Africa Group) 36 37

26 5. Introduction to Mauritius : Private Equity Mauritius 5.1 Overview For the past decades, the global business industry in Mauritius has been quite active mainly for inbound investment into India, Africa and China. Since the double taxation treaty between Mauritius and India is more favourable compared to other jurisdictions, Mauritius has become the preferred jurisdiction for providing Foreign Direct Investment in India. As a result, many investment and/or hedge funds were incorporated in Mauritius. For example, under the India Singapore double taxation treaty (2005), a Singapore tax resident is not subject to Indian taxes on capital gains derived from the sale of shares in an Indian company and the changes introduced in 2005 put the Singapore DTAA on par with the India- Mauritius DTAA with respect to tax exemption on capital gains, however, it includes two important limitations on beneficial treatment for capital gains: (i) first, investors from Singapore do not receive an exemption from Indian capital gains tax if the affairs of the company were arranged with the primary purpose of taking advantage of the capital gains exemption (the so-called limitation on benefits ). Specifically, a shell/conduit company cannot avail itself of the capital gains exemption, but provides a safe harbour for companies listed in India or Singapore or a company with more than S$200,000 or Rs. 5 million of total annual expenditures on operations in Singapore in the preceding 24- month period; and (ii) a second important limitation ties the fate of the capital gains exemption under the Singapore DTAA to the India- Mauritius DTAA. Investors from Singapore will lose their capital gains exemption if India and Mauritius amend their DTAA to take away the corresponding exemption. With the global economy slowdown, volatile financial markets and the European debt crisis, 2012 has been a difficult year both for investors and fund managers. However, private equity activity in Mauritius continued to grow consistent with the general development of the Mauritius private equity industry in the context of long-term regional economic growth and development in Africa. Initial indications are that 2013 will be another reasonable year for Mauritius private equity transactions. According to the Mauritius Board of Investment 10 report 11, as at December 2010, the Mauritius Financial Services Commission had registered more than global business companies and around 750 global funds targeting mainly the promising emerging Asian and African countries. For the year 2011, the total newly licensed Global Business companies amounted to 2,332 compared to 2,052 newly licensed Global Business companies in 2012 according to the statistics of the Financial Services Commission. The number of global funds increased from 829 in 2011 to 936 as at December Subscription loan and third party financing of private equity in Mauritius are on the rise and showing no signs of slowing down in Due in large part to their strong performance during the financial crisis, with notably few reported incidences of investor defaults, these subscription loan facilities have experienced a sustained resurgence in Mauritius private equity transactions. Subscription loan or capital call financing is a loan facility provided to a private equity fund secured by the unfunded capital commitments of the fund's investors. Typically, a subscription loan facility is secured by a pledge by the fund (and, if applicable, the fund's general partner) of (i) the unfunded capital commitments of the fund's investors; (ii) the right of the fund to make capital calls upon and to enforce the unfunded capital commitments against, such investors; and (iii) the subscription accounts into which the capital contributions are funded. A lender's obligation to make a loan is generally contingent upon the fund's compliance with a borrowing base test, which 10 The national Investment Promotion Agency of the Republic of Mauritius falling under the aegis of the Ministry of Finance and Economic Development. 11 Mauritius, Your Preferred Financial Platform for Emerging Markets; Mauritius Board of Investment 2011; 38 39

27 requires that the outstanding indebtedness under the facility does not exceed the facility's borrowing base of eligible collateral. The capital commitments of the investors of a fund are contract rights arising from the limited partnership agreement or similar constituent documents of the fund, as well as the subscription agreements executed by such investors. The establishment and structuring of a facility require a comprehensive legal due diligence review of the underlying fund documents. Fund document provisions of critical importance to a subscription loan facility lender include: (i) language explicitly permitting borrowing facilities and the ability to pledge the unfunded capital commitments and related rights; (ii) an irrevocable and unconditional obligation of investors to fund capital calls without any defense, counterclaim or offset; (iii) an agreement by investors to deliver to the lender essential financial information and an "investor acknowledgment" pursuant to which such investors acknowledge the facility and the pledge of the fund's rights and remedies in respect of the unfunded capital commitments; and (iv) a prohibition on transfer of any investor's interest in the fund without the fund's (or general partner's) consent. The loan documentation can often address issues that arise in the due diligence of a fund's underlying documents. A number of less obvious fund document provisions can significantly impact a lender's rights and remedies. Fund documents generally empower a fund or its general partner to effect all or a portion of a portfolio investment through an alternative investment vehicle, or AIV. Investors are required to contribute capital directly to the AIV to the same extent, and on the same terms and conditions governing capital contributions to the fund. However, capital contributions made to an AIV reduce the unfunded capital commitments of the investors to the fund as if such capital contributions were made to the fund itself, yet they are funded into an account of the AIV instead of the fund's pledged subscription account. Such AIV capital calls diminish the lender's collateral without providing cash control over the contributed funds or contractual control over the ability to make such capital calls. One approach to mitigating such risk is to prohibit the establishment of any AIV pursuant to the loan documentation unless such AIV (i) is made a party to the loan documentation and pledges to the lender both the subscription account into which the proceeds of the capital calls will be remitted and its rights and remedies in respect of the unfunded capital commitments and (ii) enters into a control agreement with the lender and the account institution that maintains the AIV's subscription account, perfecting the lender's security interest in such account. Many of the private transactions of US investor companies involved debt financing, but they showed little consistency in the terms of the financings, reflecting varying commercial and structural challenges. The acquisition debt was typically borrowed by an acquisition vehicle with the borrower giving security over its assets (including shares in its Mauritius offshore subsidiaries of feeder fund) to secure repayment of the debt. The lenders spanned a wide range of financial institutions, from international investment banks to private equity investors. Each of the financings consisted of US dollar financing initially advanced, in most cases, on a bilateral basis by lenders incorporated overseas. Typically, lenders expect to receive a pledge of 100 per cent of the shares of any operating subsidiary of the borrower so that they can sell the entire borrower group to a purchaser upon an enforcement of the security. For example, late last year, PE firm Bain Capital Partners has agreed to purchase shares of NYSE-listed, Gurgaon-based BPO firm Genpact held by previous PE investors General Atlantic and Oak Hill Capital for approximately $1 billion. The move is a boost for an Indian private equity sector via Mauritius that has seen activity decline in the face of a wider economic downturn, with only about $4bn invested in the first six months of 2012 (Bain Capital Pays $1bn for Genpact stake, James Crabtree in Mumbai; August 3, 2012 The Financial Times Limited). It also follows wider worries about the health of the sector following taxation changes unveiled in India s national budget in March 2012, which were subsequently put on hold in the face of sustained criticism from foreign investors. However, other analysts warned that Bain Capital s move was unlikely to signal a return to higher levels of investment seen in Indian technology groups during the middle part of the last decade

28 5.2 Regulation of companies in Mauritius Mauritius statute law on companies is contained in the Companies Act 2001 (the Companies Act), which was modelled after its counterpart from New Zealand. The Companies Act has been regularly amended by the legislature to keep track of the changes in law having an incidence on Mauritius incorporated companies, the latest amendment being in line with the coming into force of the new Financial Services Act 2007 and the Insolvency Act 2009, which has had a direct bearing on global business companies in Mauritius. Global Business Licence 1 or GBL1 holders qualify for protection under the various tax treaties to which Mauritius is a party, providing they come within the definition of resident under the taxation laws of Mauritius. i.e., the GBL1 holder must be managed and controlled from Mauritius. A significant difference between a GBL1 and a GBL2 is that a GBL2 holder is exempted from the provisions of the Income Tax Act 1995 and is deemed to be non-resident for tax purposes. A GBL2 provides for greater flexibility and it is a suitable vehicle for holding and managing private assets. However it is not allowed to raise capital from the public or to conduct any financial services or to activities such as collective investments activities. 5.3 Private equity legal update in Mauritius The enactment of the Mauritius Limited Liability Partnerships Act 2011 (the LPA) which comes into effect on 15 December 2011 introduced a Mauritius legal entity, the Limited Liability Partnership (LP). This aimed to give local and international businesses a further choice when selecting the structure which best suited their needs. The LP structure has many advantages. LPs are legal persons distinct from their members. This means LPs, in their own names, can enter into contracts, own property, sue and be sued. There is enormous flexibility in the structure of an LP. Unlike a company, where many matters are laid down by statute, the constitution and governance of an LP are set out in the partnership agreement. This flexibility means that the LP partners are free to choose the structure which works best for them. The LPA largely follows English law principles, codifies and preserved the common law provisions relating to partnership, except to the extent that a contrary intention is agreed, expressly or implied between the parties. The LPA does not attempt to regulate the affairs of a partnership, leaving this to be agreed between the partners. However, to the extent that partnership agreement does not contain provisions concerning the relation between the partners and person dealing with them, the provisions of the LPA will apply accordingly. There are two types of partnerships under the LPA; general partnership, where all of the partners have unlimited liability for debts and obligations of the partnership; and limited liability partnerships, which meet the conditions laid down in the LPA, including having at least one general partner and where the limited partners will normally have limited liability for the partnership s debt and obligations provided they take no part in the management of the partnership. A Mauritius partnership may make an election to have a legal personality under section 11 of the LPA and such partnership shall be a legal person separate from its partners and shall have the power to own and deal with its separate property in accordance with the agreement of its partners. It shall have unlimited capacity, thus, removing ultra vires concerns. Subject to section 11 of the LPA (i) the acts of a general partner in connection with the business of the limited partnership shall bind the limited partnership in all respects; (ii) every general partner shall be jointly and severally liable with the other general partners for all debts and obligations of the limited partnership incurred while he is a general partner; (iii) a limited partnership may indemnify any partner or other person from and against all or any claims, demands and debts, unless otherwise provided in the partnership agreement. The ability of a partnership to hold property in the partnership name (rather than in the name of its individual partners) is of particular advantage to certain holding structures

29 The LPA provides that a limited partnership shall consist of (a) one or more general partners who (i) are admitted to the limited partnership as general partners in accordance with the partnership agreement; and (ii) shall be jointly and severally liable for all debts of the limited partnership without limitation; and (b) one or more limited partners who (i) are admitted to the limited partnership as limited partners in accordance with the partnership agreement; (ii) upon entering the limited partnership, make or agree to make capital contributions to the limited partnership; and (iii) subject to the LPA and the partnership agreement, shall not be liable for any debts of the limited partnership beyond the amount contributed or agreed to be contributed to the limited partnership. However, it should be noted that if a limited partner takes part in the management of the limited partnership, it will be liable as if it were a general partner. Nevertheless, pursuant to section 25(4) of the LPA a partner who is both a general and a limited partner in the same partnership has all the rights, powers and restrictions of a general partner, except that in respect to his contribution as a limited partner, it shall have the same rights of a limited partner against the other partners. When a partnership makes an election to have legal personality it does not fundamentally affect the relationship between its partners, which remain governed by the provisions of the partnership agreement and, where the agreement is silent, by the LPA. However, the ability for a partnership to exist as a separate legal entity facilitates the continuity of contractual relationships with third parties and makes it easier to tie in new partners to existing contractual relationships. For example, section 13 of the LPA provides that a partnership agreement shall be binding upon the partners and their assignees, and upon subsequent partners in the same manner as if those persons had themselves executed it. The LPA further provides that a partnership agreement may, to the extent specified in such agreement, provide rights to any person, including a person who is not a party to the partnership agreement (i.e., third party lender). It was envisaged that contracts would be drafted so as to give third parties protection via an express right to enforce where this was the parties intention. A third party (i.e. a lender not a party to a partnership agreement) may enforce that clause if either (a) the partnership expressly states that the third party shall have this right of enforcement or purports to protect the third party and (on a proper construction of the agreement) there is nothing to indicate that the contracting parties did not intend the term to be enforceable by that third party. Our view is that, the third party must be expressly identified in the agreement either by name, or as a member of a particular class or description e.g. lenders but need not be in existence at the time the agreement was entered into. The act of legally assigning capital contribution or commitment by the funds shall be protected by the LPA. Section 13 (5) of the LPA is intended to protect the legal rights of the bona fide third parties and to maintain the sound and stabilised development of the fund industry in Mauritius. MAURITIUS CONTRIBUTORS: Malcolm Moller (Partner), and Kate Li Kwong Wing Malcolm Moller Managing Partner Mauritius & Seychelles 9th Floor, Medine Mews La Chaussée Street Port Louis, Mauritius Tel Dir Tel Fax Dir Fax Dir Fax Business Registration Number: P Level 2B Caravelle House Manglier Street, Victoria, Mahe Seychelles Tel Fax mmoller@applebyglobal.com

30 Michelle Kathryn Essomé is CEO of the African Venture Capital Association. She brings 20 years of investment banking experience covering a wide range of marketing and origination roles in equities, fixed income and investment management with Merrill Lynch, Goldman Sachs, JPMorgan, Lehman Brothers and Nomura, including two years marketing private equity to investment consultants and UK LPs. Michelle has an MBA in Finance from Columbia Business School, where she was a Robert F. Toigo fellow, and a BBA in Finance from Howard University. She has worked in the US, UK and France, and is fluent in French. Erika van der Merwe joined the South African Venture Capital and Private Equity Association (SAVCA) in November She is a former financial journalist and was active in the print, online and broadcast media. Prior to her media career she had a short period in academia before joining Old Mutual Asset Managers as an economist in David Ashiagbor joined the Commonwealth Secretariat in May He leads the Secretariat s investment and private sector development programmes, including the Commonwealth Private Investment Initiative (CPII). CPII has helped to raise US$800 million for investment in Africa, South Asia and the Pacific through a series of private equity funds. David has been leading efforts to unlock local capital in Africa through a series of workshops for institutional investors, regulators and other stakeholders over the past two years. David previously worked for the International Finance Corporation (IFC) in Cote d Ivoire, Cameroon and South Africa. Prior to IFC, he was a Project Officer responsible for Infrastructure at the Agence Française de Développement in Ghana. David has also worked as an Analyst in the Corporate Finance Department CAL Bank in Accra, where he set up and managed the bank s brokerage subsidiary. Erika holds the Chartered Financial Analyst (CFA) accreditation and has a master s degree in economics from Cambridge University and from the former University of Natal. SAVCA is a non-profit member organisation whose objective is to promote venture capital and private equity in South Africa. It has over 90 members, who collectively account for about R120bn in assets under management

31 Contacts LELE MODISE Head: Private Equity Practice Tel David Anderson Tel JONATHAN LANG Tel Rosemary Hunter Tel Aneria Bouwer Tel Deon de Klerk Tel Mogola Makola Tel Wally Horak Tel Anne McAllister Tel Francisco Khoza Tel Neil Rissik Tel To view profiles of our team members, please visit

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