Investing in a foreign company?

In a number of recent international investment and acquisition transactions involving South African companies, the tax treatment of global depositary receipts (GDR) was an important aspect of the transaction.

A GDR is a certificate issued by a depository bank, which purchases shares of foreign companies and deposit these into an account. GDRs are instruments that represent ownership of an underlying bundle of shares. Prices of GDRs are often close to values of related shares, but they are traded and settled independently of the underlying shares. Several international banks issue GDRs, which are primarily traded on the International Order Book (IOB) of the London Stock Exchange.

GDRs facilitate the trade of shares, and are commonly used to invest in companies from developing or emerging markets, in particular where the country has legislation limiting the extent of foreign participation.

The crisp question from a South African tax perspective is whether or not a South African resident shareholder can apply South African tax relief provisions relating to shares and dividends, on the basis of its beneficial ownership of the underlying shares. Put differently, whether South Africa applies a "see-through" or substance over form approach, or whether GDRs are treated as separate financial instruments. To explain the relevance, consider the following two examples.

Where a South African resident holds at least 20% of the equity share capital and voting rights in a non-resident company, it may upon disposal of these shares (assuming all other requirements have been met) apply the participation exemption in terms of paragraph 64B of the Eighth Schedule, which will exempt the capital gains tax arising on disposal of the shares. Where a South African investor is forced, due to local holding restrictions, to hold its interest by way of GDRs, it will arguably not be able to avail of the exemption on disposal of the GDRs. In the case of the participation exemption there may, however, be room to argue that the disposal of the GDRs represents a disposal of "...any interest in the share capital of a company...". The prospect of succeeding in pursuing this argument will depend on the specific terms and conditions of the specific GDR.

Similarly, any foreign dividend received will be exempt from tax under section 10(1)(k)(ii)(dd) where the recipient holds more than 20% of the equity share capital and voting rights in the foreign dividend distributing entity. Again, any payments under the GDR to the South African holder of the GDRs will most likely not qualify for tax relief.

National Treasury's policy in this regard appears to be to treat the instrument as a independent instrument and not to look through to the shares underpinning the GDR. Approaches to effect legislative amendments to allow holders of GDRs access to these and other tax relief measures have thus far proved fruitless.

Apart from domestic legislation the use of GDRs also raises some interesting and challenging tax treaty interpretation issues which also need to be borne in mind in structuring international transactions.

*Bernard du plessis is an executive at Edward Nathan Sonnenbergs

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