Client Question:

We’re considering Merchanting – what should we look out for, what is the best model?

Answer:

Outside South Africa, merchanting is sometimes called cross-trading or triangulation/triangular trade, perhaps even ‘drop shipping’, but within SA it is important to use the correct terminology, especially when working with your bank and service-providers.

Merchanting involves a middleman in South Africa buying from an off-shore supplier (A) and selling to an off-shore buyer (B), where both the supplier and buyer are not in South Africa and the cargo is routed directly from supply to demand.

There is an exception to, and an inclusion in this broad outline that you need to be aware of.

The exception is that any model that includes South Africa and one or more of Namibia, Lesotho or eSwatini is not classed as merchanting, but rather as an import or export, as applicable.

The inclusion is that goods brought into South Africa directly into bond for later export, or brought in for immediate transit through SA in bond (again, excluding Namibia, Lesotho and eSwatini cargoes) are classed as merchanting transactions and not as import and export events.

As the middleman has no interest in the goods other than to buy them for X and to sell them for the uplifted value of Y, the best contract terms are the C-prefixed group, and although the skilled merchant might do it slightly differently, the default terms are generally CIF, if the transaction is seafreight and regardless of the type or brand of commercial term you wish to use, or CIP if it is any other form of transport when you wish to work with the ICC’s Incoterms version of commercial terms. (Both give rise to a Customs c.i.f. value on the respective commercial invoices).

C-prefixed rules are the sale of documents, and as the merchant never controls the cargo, the merchant seeks only to control the documents.

As a rule of thumb: sell on whatever terms you buy or buy on whatever terms you sell. For example, if you buy CIF, sell CIF – all that changes is the value of the transaction.

One should never say never, so other terms do get used, but the question is looking for the ‘optimum’ model, so let’s leave the terms there.

The optimum model also assumes that it is permitted for the seller to arrange insurance cover and for the buyer to buy insurance cover from the seller. This is not always a true statement and many countries have restrictions around which party may or may not arrange cover – thus, CIF might need to be CFR and CIP might need to be CPT. These are High Risk modifications to the model – seek expert guidance if you find yourself in this situation.

The Golden Rule for ALL cross-border activity is “exchange control first”. You cannot be either VAT or Customs compliant if you are not ExCon compliant, but fortunately the rules around merchanting are very simple.

9.1 Merchanting trade (taken from the ExCon manual)

Business entities wishing to engage in merchanting trade transactions must apply to an Authorised Dealer. If approved, a condition would be that the time lag between paying funds to the foreign supplier (seller) and receiving funds from the foreign importer (buyer) must not exceed 60 days for trade with countries on the African continent and 30 days for trade with any other country.

Authorised Dealers must ensure that payment is received from the foreign importer (buyer), which must include the South African merchant’s profit and must be received in foreign currency or Rand from a Non-resident Rand account in the name of the non-resident and/or Rand from a vostro account held in the books of the Authorised Dealer.

A copy of the relative agreement entered into between the parties concerned or a commercial invoice from the seller together with a commercial invoice from the South African merchant must be produced to confirm the arrangements.

In instances where the above-mentioned requirements cannot be complied with, a written application must be submitted via an Authorised Dealer to the Financial Surveillance Department, for consideration.

Breaking down the above rules –

“…Business entities wishing to engage in merchanting trade transactions must apply to an Authorised Dealer. If approved, a condition…”

All merchanting models require prior approval (“…must apply…”) and the bank may decline to grant approval (“…If approved…”). The starting point to any model is therefore to speak with your banker and to be guided by them

“…that the time lag between paying funds to the foreign supplier (seller) and receiving funds from the foreign importer (buyer)…”

The ideal model is for the non-resident buyer’s payment to be received before the non-resident supplier needs to be paid – the outflow of forex is financed by the earlier and greater inflow of forex. But, as you can see, in the next statement –

“…time lag…must not exceed 60 days for trade with countries on the African continent and 30 days for trade with any other country….”

– an overlap is allowed, but the bank may direct that you have bank security (such as an L/C) from your end-user to manage the risk of default should an overlap be approved.

When you approach the bank, they will need to see the supplier’s contract or commercial invoice and the end buyer’s contract or your commercial invoice on them. Clearly more must come in that go out, and you must be able to motivate your margin if it is too low.

Note that merchanting involves the use of BoP category 110 for both the inflow and outflow payments.

It should be clear from the above that the middleman both pays and receives forex. If you are approached with any model where a second SA entity is involved (paying you locally, for example) do NOT proceed – refer the matter to your bankers.

If your contract terms include the international carriage costs, then be aware too that if you engage an SA logistics provider to manage and facilitate the model, they too must also have Exchange Control approval in place to do so. Your bankers may require their details from you.

For VAT purposes, the vendor’s supply to the end buyer is at the zero-rate, and the documents to be retained include the transport document showing that the goods moved from A to B and never came to SA, or the inward and outward Customs entries if the goods transited South Africa in bond.

Be aware of two important points in all of this.

Firstly, there is a Customs complication in that country B are paying the uplifted amount of Y for something that only has a market value of X, and country A are only being paid X for something that has a market value of Y.

Merchanting models may make sense to you, and to South Africa, both enjoying the differential you have created, but they may not make sense to the country of supply and the country of demand – Customs authorities at both ends can challenge the pricing of your model. Be aware of this.

If the model requires that the supplier and end-user are kept at arm’s length – i.e., they must not know who the other player is, and prices must not be disclosed, then the process of buying documents, neutralising the information on them, or replacing them entirely, before on-selling them at an uplifted value, is a skilled job.

Merchanting is not a natural extension or organic development of exporting, it is a whole new skill.

Get some training before you undertake the project, and if you cannot, then at a bare minimum engage with your bankers BEFORE you commit to anything.

Failure to adhere to Exchange Control is viewed in a very serious light.

Source: Freight Training