Investing in property in another country can be an appealing prospect, especially for South Africans. There’s the potential for a rental income in a foreign currency, which appears to offer stability and security in today’s topsy-turvy market; plus, having the option of another place to live may give you comfort.
But investing in offshore property is not so simple, especially when it comes to taxes on income and estate planning. There are lots of implications to consider, depending on the country in which you plan to invest. Here’s some of what you need to think about.
Inheritance taxes are handled differently all over the world. In South Africa, inheritance tax is called estate duty and is payable upon death. This is calculated at 20%, after an allowable deduction of R3,5m against the dutiable value of the estate. If the dutiable estate is worth more than R30m, the estate duty increases to 25%. Keep in mind that the value of the dutiable estate includes the value of all worldwide assets, and any property owned by a South African in a foreign jurisdiction is therefore included. Transfer between spouses are exempted, so the allowable deduction for two spouses is R7m.
In the UK, by comparison, inheritance tax is 40%, but only if the estate exceeds a £325 000 (R6,3m) threshold. Below this threshold, there is no inheritance tax. Transfers between spouses are exempted, so you can double the threshold to £650,000.
In the US, the inheritance tax is called estate tax. The threshold is $60,000 with no relief for transfers to spouses, and the tax rate starts at 18% and makes its way to 40%.
It’s also important to consider how the inheritance tax is levied. In many cases, it’s levied depending on the location of the property, and not just on the residence of the taxpayer. To continue with our UK example: an individual might be a resident taxpayer of South Africa, but will still be liable for UK inheritance tax if they own property in London. And herein lies the problem: the London property will also be included in the South African dutiable estate and is thus subject to South African estate duty, and on the face of it, resulting in double tax.
One of the only ways to prevent a double inheritance tax is to seek relief under an agreement with the foreign country concerned, to reduce or prevent double taxation with regards to estate duty. (There are similar agreements that seek to limit double taxation of income tax and capital gains tax – see below – but these do not extend to estate duty or inheritance tax.)
At present, South Africa ONLY has agreements dealing with inheritance taxes with SIX foreign jurisdictions, most notably the UK and the US. Other countries like Spain – popular for its Golden Visa programme – have no such agreement with South Africa, and investors likely face double taxation. The liability for inheritance taxes in another country will be allowed as a liability against the dutiable estate, but not as a credit against the estate duty owing to Sars.
The picture for taxes on income and capital gains is much rosier.
South Africans must pay income tax on any rental income earned. This also applies to other countries. As a non-resident investor in Portugal, for example, you will pay 28% of your net rental income to the Portuguese tax authority. Back home, as a South African resident taxpayer who is taxed on worldwide income, you’ll also have to declare any foreign rental income locally.
But fear not: it is possible to prevent double taxation in this regard. You can seek relief under the double tax agreement between South Africa and the foreign jurisdiction, which generally assigns tax rights to one or both countries.
Failing this relief, or should no such agreement exist between South Africa and the country you plan to invest in, you should claim a foreign tax credit using domestic provisions. Bear in mind that this credit is limited to taxes paid in South Africa – you can’t claim more than you would have paid locally, had the income been earned here.
The same principles could apply to capital gains tax (CGT), should the foreign property be sold. To prevent double taxation, you will have to enter into a double tax agreement or claim a foreign tax credit using domestic provisions.
Knowledge is power
Before you buy property abroad, it’s crucial to consult with a specialist who has intimate knowledge of the tax laws of the country in which you plan to invest. Take the example of Portugal again: there, you’re not allowed to deduct the mortgage interest of a rental property for tax purposes, whereas this practice is legal in South Africa and often the key ingredient to a healthy bottom line.
An international tax specialist can also help make sure that your will is watertight. South Africa has total freedom of testation – you can specify any heirs you please – but this is not the case in some European countries, Portugal included. Such countries have what is called a forced heirship regime, which limits the freedom of the testator. Only a portion of the assets may be freely bequeathed and the remainder must be allocated to specific persons, usually a spouse and/or children, who also inherit any liabilities associated with the property.
If you plan to invest in one of these countries, it’s advisable to consider drafting an offshore will to deal with your foreign assets. Depending on the location of the property, South Africans might be able to make use of the European Succession Regulation, which is applicable throughout the EU region (excluding the UK, Ireland and Denmark). This regulation allows an individual to choose between the succession law of the country in which the property is situated or the law of their country of nationality, and it could potentially allow a testator to circumvent the forced heirship regime.
Due consideration must also be given to domestic provisions and requirements for a valid will. Put simply, not all jurisdictions will accept a document drafted and signed in another country; or you might have to request sworn translations before probate is granted to allow the transfer of the asset to the nominated heirs. To ensure the validity of the will and to wind up the foreign estate, you might also have to hire a foreign attorney or executor, or both… And if you do have a foreign will, make sure it doesn’t contradict your South African will!
At the end of the day, it pays to be smart. Investing in foreign property can be tremendously exciting and financially rewarding, but there are potential pitfalls when it comes to tax and estate planning. If you want your offshore property to work, speak to a specialist who can guide you through the relevant legislation and make your investment as tax efficient and transferrable as possible.