Over the years as international investors have searched for yield and found themselves looking towards Africa, many have invested with a long-term mindset focused on private and public equity strategies. Both strategies offer promising returns over the longer term, but the higher returns do not come without lack of liquidity and significant volatility.
Analysis & Strategy
Quite unexpectedly, the Panama Papers was raised at a recent society event I attended in Zimbabwe, and while the popular press has permeated even to the most unexpected areas – often without an accurate consideration of the facts – it made me think about how much is truly understood about the driving forces behind using offshore structures, and how alternative funds benefit Africa. Contrary to what one might read, using offshore structures extends well beyond tax neutrality considerations. This article considers the advantages of structuring through established and reputable offshore jurisdictions with a particular focus on the Cayman Islands.
Early this year, President Barack Obama signed into law the bipartisan Electrify Africa Act of 2015, essentially codifying the US President’s Power Africa Initiative that he began in 2013.
The South African Venture Capital (VC) industry shows an encouraging rise in the number of new fund managers, an increase in deal flow and in profitable exits, while deal size declines. The South African venture capital (VC) industry now represents almost R2bn in assets under management, with healthy confidence levels that are commensurate with reported rising deal activity, a pleasing exits record and a significant increase in VC fund managers and industry professionals.
Investors with a long term investment horizon may wish to consider investment opportunities in the development of commercial African real estate such as shopping malls, office blocks and warehouses. In frontier Africa (i.e. Africa outside of South Africa), new projects are typically delivered by developers at double digit yields (calculated as rent/total cost including land). And, importantly for international investors, these yields are in US dollars because rents in frontier Africa are normally paid in dollars or settled in local currency but referenced back to dollars. Applying leverage (we use a maximum of 60%), annual rental escalations of 3-4% and yield compression at time of exit, one can see that it is possible to achieve net compound investment returns in the high teens or more.
In structuring funds or investment holding vehicles for investments into sub-Saharan Africa, there are some key factors to take into account when deciding what jurisdiction to use as a base, write Laura Charkin (top), Partner; Adrian Brown (middle), Partner & Charlotte Haywood (bottom), Associate, King & Wood Mallesons Of prime importance (particularly with respect to regulation) is the location of the investment team and the role they will take in the structure - will they take investment decisions, or advise a separate investment decision maker? Also important is the tax position, with the general aim being to structure investments so that the investors are not in a worse position than they would have been if they had invested directly. Mauritius is for many the jurisdiction of choice, both for locating fund vehicles and investment holding vehicles, and this article compares Mauritius based structures against the position if investments were structured using a UK based corporate vehicle. We have focused on the tax position for Mauritius corporate vehicles as, even where a Mauritius Limited Partnership is used in a fund structure, investments will typically be made through a corporate investment holding company (HoldCo); we have generally assumed that a Mauritius HoldCo would hold a category 1 global business license (GBL1). Treaty networks Where the fund or HoldCo holds local investments in the sub-Saharan jurisdictions (the Investments), local withholding taxes may apply in respect of dividends, interest or capital gains received by Holdco, depending on the tax laws of the relevant jurisdiction. Double taxation treaties (DTTs) between the jurisdiction of the Investment and the jurisdiction of Holdco can operate to reduce or even eliminate the requirement to pay these local withholding taxes. Mauritius has a wide network of DTTs with sub-Saharan jurisdictions (the Mauritius DTTs), making Mauritius an attractive location for HoldCo. To benefit from the provisions of the Mauritius DTTs, Holdco must have sufficient “substance” in Mauritius to be considered to be treaty resident in Mauritius by both jurisdictions (i.e. not simply resident for “normal” tax purposes in Mauritius). This means giving careful thought to board composition in Mauritius, potentially hiring Mauritian directors, and considering how investment decisions will be made. By way of comparison, the UK has a similar breadth of DTTs (the UK DTTs) in place with sub-Saharan jurisdictions to that of Mauritius. Similarly, to benefit from the UK DTTs, HoldCo must be treaty resident in the UK, but if the investment team was based in the UK, this may be considerably easier to achieve. Of course there are some key target jurisdictions that have a DTT in force with the UK and not Mauritius (such as Nigeria), and equally vice versa (the Netherlands is always worth checking too in this context), and some sub-Saharan jurisdictions (such as Angola) have no useful DTTs in force at all. It can be seen that there is not much to separate the UK and Mauritius in terms of breadth of treaty network with sub-Saharan African jurisdictions, and in each case the applicable requirements for treaty residence need to be met. Why, then, is Mauritius more commonly used? The answer is that not only the general DTT coverage, but also the specific effects of the DTTs, in combination with local corporate taxes, need to be considered. As a general rule, both the UK DTTs and the Mauritius DTTs normally operate such that the overall tax leakage in respect of income returns from these jurisdictions will be the higher of (a) the local tax withheld (taking into account any treaty rate of withholding) and (b) Holdco’s applicable corporate tax on such amounts (for which see below). Even though the UK has a ‘unilateral relief’ credit system that can eliminate double tax even where there is no treaty in place, it is on the corporate tax side that it loses out to Mauritius. Local corporate tax rates UK resident companies are subject to corporation tax of 20% (18% from April 2020 onwards) on taxable profits. Available deductions (including for interest payments) may operate to reduce a company’s overall taxable margin, however this is subject to UK anti-avoidance rules on thin capitalization and transfer pricing. Mauritian companies are generally taxed at a rate of 15% on net income (excluding, broadly, capital gains, e.g. from the sale of shares). However, GBL1 holders can receive credits against Mauritian tax for any foreign tax paid on non-Mauritian income which may bring their effective tax rate to a maximum of 3%. This means that, overall, the tax “leakage” in a UK corporate investing in sub-Saharan Africa would typically be greater than in a Mauritius corporate. When you add this to the fact that UK withholding tax (currently at 20%) often applies to UK source interest paid by companies, the UK starts to look like a significantly less attractive HoldCo destination for tax purposes. By comparison, under the Mauritius GBL1 regime there should be no requirement to withhold tax on interest paid. VAT If HoldCo were a UK resident company, then if it is a relevant business person under UK VAT law, any services supplied to HoldCo (such as advisory or legal services) are likely to be considered to be supplied in the UK and subject to UK VAT at 20%. By contrast, if a UK investment adviser provides its services to a Mauritius HoldCo, neither UK VAT nor any reverse charge to Mauritian VAT should apply. Looking at the situation where a Mauritius based investment manager provides services to a Mauritius based entity, although Mauritius does have a goods and services tax of 15%, there is an exemption from this for certain investment management services which could apply again leading to Mauritius being more favorable than the UK in this respect. Regulatory The UK and EU regulatory regime will also affect the UK's suitability for investment vehicles. Funds and investment vehicles in the UK may be considered collective investment schemes and/or Alternative Investment Funds (AIFs) for the purposes of the EU’s AIFMD regulations – if so, they will need to be managed by an entity authorized by the UK’s Financial Conduct Authority. The process for obtaining FCA authorization (which may be obtained either by the vehicle itself or a third-party manager) can take several months and will involve, amongst other things, the formation of a business plan and compliance arrangements, the disclosure of financial and ownership information, the retention of a minimum amount of regulatory capital, and the payment of a £5,000 fee. The requirements of the AIFMD will depend on the nature and size of an AIF, but requirements may include the appointment of an independent depositary (to safeguard assets) and valuer (to value assets periodically), leverage limits, the maintenance of professional indemnity insurance, a duty of the manager to abide by certain fiduciary standards, and certain transparency, disclosure and record-keeping obligations – these requirements may prevent start-up funds from ever launching. Apart from a GBL1, if applicable, there are no special licenses required for HoldCo to provide equity investment and mezzanine finance to projects in sub-Saharan Africa from Mauritius. To obtain a GBL1, companies will need to demonstrate that they have at least two directors resident of Mauritius who are of sufficient caliber to exercise independent judgment, must maintain a principal bank account in Mauritius, must keep accounting records at a Mauritian registered office, and must prepare and audit financial statements in Mauritius. Of course these are minimum standards only and larger funds may have higher industry standards to adhere to in any event (or their investors will demand more). Use of 'offshore' structures Mauritius is by no means the only jurisdiction used for investment in Sub-Saharan Africa and, for vehicles that do not need to access a treaty network, the classic offshore locations such as the Cayman Islands and the Channel Islands remain popular. Other 'treaty' jurisdictions, such as Cyprus, are actively looking to improve the ‘usability' of their local regimes to attract new business of this type. In this context, Mauritius’ particular advantage lies where an ‘African’ based structure is required by certain development finance institutions, although some DFIs are now scrutinizing the use of GBL1s more closely. The OECD’s 'base erosion and profit shifting' initiative also means that fund managers will need to be careful to ensure that their Mauritius entities continue to operate as planned. Overall, it is clear why Mauritius has proven to be such a popular choice for investments into sub-Saharan Africa, as it has an advantage over both the classic ‘offshore’ tax havens (with few tax treaties) and classic ‘onshore’ jurisdictions (with higher tax rates). The regulatory environment there is similarly benign. All that said, managers intending to set up a fund or HoldCo in Mauritius will still need to give thought to substance tests, anti-avoidance legislation and OECD developments, as well as the developments in the industry and the views of their investors.
Investors seeking fair and equitable measurement should be aware of the various indices tracking African equity funds, according to Zack Bezuidenhoudt, CIPM Client Coverage: Sub-Saharan Africa and South Africa, S&P; Dow Jones Indices.
The AGF Top 30 Service Providers is our annual guide to the best-in-class fund services organizations, covering Africa. Ranging from fund administrators and technology providers to legal firms, auditors and prime brokers, these companies are at the forefront, helping give shape to the rapidly expanding market and helping funds navigate fast paced and challenging environment.
The AGF Asset Managers Top 40 is our annual guide to the most respected and influential figures in the African asset management industry. This year’s list comprises top local asset management firms in Africa and the global industry players, which run Africa-focused funds. This is the guide to both traditional asset management firms and hedge funds, as well as fund of funds and fund of hedge funds managers.
Agricultural investment funds have underscored public and private sectors’ interest to help address the resource constraints for achieving food security. Concerns over food security are not limited to Africa, and this is now a global worry. The World Bank anticipates that urban food markets will increase fourfold by 2030, to exceed $500bn, so food production needs to more than double to meet this growing demand.
Phatisa’s African Agriculture Fund (AAF) concluded its investment of $24m in Goldenlay in early 2012. The Phatisa deal team structured and negotiated a leveraged management buyout transaction, which resulted in the exit of Aureos (now known as The Abraaj Group). The structure of the investment was a combination of mezzanine and equity funding.
Industrial space, land and insurers are three things to ponder for anyone with an appetite for a piece of prime Lagos, Nigeria, finds Anne-Louise Stranne Petersen
Seeiso Matlanyane, Research Analyst, Prescient Investment Management, explains the idea behind hedging currency exposure, focusing on Kenyan shilling and Nigerian naira
Africa’s leading mezzanine debt provider, Vantage Capital, is in the final stages of closing its third mezzanine fund. AGF catches up with Colin Rezek, co-Managing Partner at Vantage, to discuss their success story