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Offshore investing: consider the tax, estate and continuity planning from the start

The reason we take funds offshore is generally to protect them – therefore offshore investments need to be done properly.

Dear valued investor,

The first part of our offshore investment series dealt with how and why investing offshore is not only essential to your portfolio, but also an incredible diversification opportunity.

Investing offshore allows you to spread your investment risk across different economies, regions, sectors and securities and to find more opportunities. Locally, there are approximately 1 300 funds registered with the Financial Sector Conduct Authority (FSCA). Globally, there are more than 200 000 different funds available. Similarly, there are approximately 350 stocks listed on the JSE’s main board, whereas there are roughly 60 000 equities listed globally.

When one area of the portfolio may be under pressure from region-specific risks, another area of the portfolio may be unaffected. This will support performance and reduce overall portfolio volatility. It also offers access to specialist sectors not available locally, for example, biotechnology and global brands like Microsoft, Nestlé and Johnson & Johnson.

When it comes to building, and optimising a resilient portfolio, the structure/vehicle through which you invest and the planning that comes with it, are equally important to the investment portfolio itself. Ensure that you take the possible tax implications, estate planning, as well as continuity planning into account from the start. The reason we take funds offshore is generally to protect them – therefore offshore investments need to be done properly.

The first point that needs to be understood, is what happens at the time of death, as the treatment of the investment upon the investor’s death may be different to SA and may vary depending on where the funds are domiciled.

Every country tries to maximise its tax revenue. For this reason, the place (situs) where an asset resides for tax purposes becomes extremely important. This becomes the link (nexus) that a country uses to tax an asset as income, capital gains, or wealth tax. As each country uses a different nexus, it is quite possible that more than one country can tax the same asset. When investing in offshore assets, it is therefore always important to take the situs rules of the relevant countries into consideration.

At the time of death – there are estate taxes that need to be provided for. For example, considering the UK and the US, the estate taxes in:

  • the UK, is called inheritance tax;
  • the US, estate taxes;
  • in South Africa, estate duties.

In the UK the first £325 000 of an estate is exempt from taxes, but thereafter it is taxed at 40%. As the estate is taxed on the same assets in South Africa, it will receive a rebate of 20% against local estate duties. Similarly to South Africa, everything bequeathed to your spouse is exempt.

In the U only the first $60 000 of an estate is exempt from taxes, with the residue taxed on a sliding scale up to 40%. The double taxation agreement with the US exempts shares taxed in the US from estate duties in South Africa. There is no relief for spousal bequests.

Determining the tax implication in the different jurisdictions will vary depending on which type of offshore asset you want to invest in. If we look at offshore shares specifically, where the company (of the share you are buying) is registered will determine the situs taxes to be paid. This applies to the UK and the US.

This is where the correct structure/vehicle comes in – and why we would advise in certain scenarios making use of an offshore endowment or sinking fund policy structure.

These policy structures can be used in some instances as a wrapper for your investments, and if they are suitable for your specific situation, they offer a few benefits:

  • Tax efficiency for high marginal income tax-paying individuals and trusts.
  • You can nominate beneficiaries, and therefore save on executors’ fees. They are also good vehicles for continuity planning because you can nominate beneficiaries.
  • You can protect offshore assets against higher death taxes in foreign jurisdictions.
  • You will have protection against creditors (Section 63 of the Long-term Insurance Act) (not afforded to sinking funds).
  • Ease of tax administration, especially for offshore investments, as all taxes are paid within the wrapper.

Offshore endowments and sinking funds still form part of your South African estate for estate duty purposes.

With a direct offshore investment (no wrapper) the offshore asset will be included in the deceased estate as property. Should the asset be taxed in an offshore jurisdiction, a credit can be provided should there be double taxation agreements between SA and the other country. Unfortunately, in some jurisdictions, inheritance tax can be as high as 40% for the non-resident investor’s assets, and this consideration should be taken into account carefully when deciding where to invest.

Another option to consider is whether an offshore trust may be suitable for offshore investments – this is an expensive route to follow and may not be suitable for your specific need.

Trusts separate the control of assets, the ownership of capital and the entitlement to the income from these. They are primarily used as a vehicle to protect assets. The main reasons to structure a trust are:

  • To provide for someone who is too young to look after their money (minors);
  • To provide for someone who is too ill to look after their money;
  • To pass on a valuable asset; and
  • In some cases – to mitigate inheritance tax.

For example, in the UK, the government has progressively tightened the rules on trusts to the point where their use to secure a tax benefit has become unattractive, and the costs of administering the trust expensive. Trusts can be expensive to maintain, and they are vulnerable to future changes in tax regulations – and they require very able trustees to administer them.

When it comes to expanding your offshore portfolio, speaking to a qualified wealth advisor has become more important than ever, as there are many technicalities that need to be considered. Offshore exposure is an invaluable component of your portfolio, and it offers many opportunities, but structuring your offshore investments according to your goals and needs is imperative.

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