If you have offshore funds in a foreign bank kindly advise how we may invest it offshore? What would the tax implications be? Also, when our children inherit it what tax is due?
Thank you for the question. Converting funds into foreign currency is a good first step toward diversifying your portfolio and derisking against the volatile rand. However, foreign bank accounts are notoriously poor investment vehicles as interest rates on savings accounts are extremely low. For example, a savings account in SA should yield approximately 5% per annum, while those in the UK are likely to yield around 0.75%.
Consequently, there is a need to shift this money into an interest-generating vehicle, which can be done easily. Many South African-based asset managers offer offshore investment structures and have offshore houses based in jurisdictions like Guernsey or Bermuda. These institutions accept deposits in numerous currencies, including USD, GBP, EUR and AUD.
Furthermore, it would be in your interest to consider how offshore investment structures can help from both an estate and tax perspective. When considering tax, a popular offshore investment vehicle is a global endowment. An endowment offers investors with high marginal tax rates the opportunity to invest in a tax-efficient manner. In the case of individuals, income tax and capital gains tax are 30% and 12% respectively. Dividend-withholding tax (DWT) is levied at 20% for individuals.
Comparison of effective tax rates
|Income tax||Capital gains tax|
Another pertinent issue is how these structures can help from an estate duty perspective.
On death, South African residents are liable for estate duty based on their worldwide assets. Estate duty is levied at a rate of 20% on an estate value up to R30 million and at a rate of 25% on a value above R30 million.
Not so commonly known is that on death, both the UK and the US also levy an estate duty on certain situs assets, i.e. assets that are physically situated within their jurisdiction. In the UK, this is known as inheritance tax, while it’s called estate tax in the US. Collectively, they are known as situs taxes. This is important to note if you have assets in either country.
In the UK, a situs tax of 40% is levied on assets over the value of £325 000. Any amount falling below the £325 000 threshold is known as “the nil rate band” and is free from situs tax. There is no situs tax levied on assets left to a surviving spouse. Additionally, if the assets are left to the spouse, resulting in the £325 000 exemption remaining unused, the exemption rolls over to the spouse. The spouse will then have a £650 000 exemption on their death.
In the US, the threshold for situs tax is much lower at only $60 000, with the top tax bracket being 40%. In contrast to the UK, the US offers no spousal exemptions or rollovers unless the spouse is a US citizen.
Utilising an offshore endowment removes any potential situs issues relating to an investment in a foreign jurisdiction. Instead, these funds are deemed part of your South African estate, where you will pay estate duty ranging from 20% to 25%.
I trust that I have answered your question and provided you with some guidance for offshore investing. I recommend that you consult a financial advisor who can assist you with your specific requirements and get more information about liquidity, risk profile and tax efficiency.
Understanding the global tax consequences of a South African resident with offshore investments is complicated as legislation, treaty arrangements and the administrative rules and processes of an investment ‘house’ have to be considered.
As a South African tax resident, you are allowed a single discretionary allowance within a limit of R1 million per calendar year and a foreign capital allowance with a limit of R10 million per calendar year. The foreign capital allowance is, however, subject to a tax clearance from the South African Revenue Service (Sars).
Once the funds are in your foreign account, and subject to applicable rules and administrative requirements from the source state, you can invest directly into the chosen offshore investment vehicle.
The investment vehicle, the amount, and the place of such investment will determine what tax, and other costs, will apply while you are alive and also what taxes and other costs are applicable on your death.
It has to be noted that where South African residents have investments abroad, their estates could be liable for the payment of situs tax, even though the investor was at the time of their death neither tax resident nor domiciled in that particular country. In addition to the impact of income and capital gains taxes on offshore investments, the global estate duty consequences on such investments could add an additional level of complexity to the overall wealth, succession, investment planning and estate administration process.
By way of example, a tax resident in South Africa has to consider the potential effects of income tax, capital gains tax, dividends tax and estate duty on their worldwide assets, subject to possible rebates in terms of a double tax treaty with the contracting state. Australia has no inheritance or gift tax, but in certain circumstances an immediate income tax liability can arise upon death. New Zealand currently has no form of estate duty, inheritance tax or capital transfer tax. The UK and the US, in turn, currently levy estate taxes at a rate of 40% on the value exceeding £325 000 and $60 000 respectively.
It is however imperative to choose the optimal vehicle when investing, taking your risk capacity, situs, probate and other costs into consideration.
Also, consider whether your will takes into consideration your investments abroad or have you drafted a separate will for those offshore investments?
I would advise working with a registered tax and fiduciary practitioner with specialisation in multi-jurisdictional estates, together with your financial advisor, to ensure that you are structuring your estate to reflect your concerns and objectives.
There are a few questions raised that I will try to deal with.
First and foremost I must ask if the funds are legitimate? This may sound like a strange question but believe me, there are many people who have foreign funds that have not been declared to Sars. If you are a SA-registered taxpayer and the SA authorities are not aware of the funds then my first suggestion will be to legitimise the funds as soon as possible. Penalties for non-compliance are severe.
When it comes to investing funds offshore the same basic principles for investing locally apply, namely: what is the objective of the investment, what is the investment term, do you require liquidity, and how much risk (volatility) are you prepared to accept?
There are various offshore structures available and obviously many more investment choices than in the SA market. One must however be mindful of the tax liabilities in various jurisdictions and products.
You must be cognisant of the following:
- Different jurisdictions have different tax liabilities. As a South African taxpayer, you are taxed on your worldwide income which includes interest earned on foreign investments. Although SA has double taxation treaty agreements with many jurisdictions, you can end up with a tax liability in a foreign country as well as in SA. You should however not have to pay more tax than is required by the country with the highest tax bracket.
- There are various low-tax or no-tax jurisdictions, in particular in the Channel Islands, where you can invest in a tax-efficient manner. Be mindful that these jurisdictions are often still subject to situs tax as well as probate in the event of your death. In SA, estate duty amounts to 20%, whereas situs tax in the US amounts to 60% above a certain level and in the UK situs tax amounts to 40% above a certain level.
- The structure of the investment will determine what taxes, and how much tax, will be applicable on the returns on the investment and what death duties will apply in the event of your death. A popular choice is to opt for an endowment structure via a life-linked company where the ownership transfers to the next party by way of a beneficiary nomination. In this case, some of the taxes and costs will be eliminated; however, estate duty in SA will always apply since you are taxed on your worldwide assets. Be mindful however that endowments do have restrictions on liquidity in the first five years of ownership. An alternative is to invest on an ‘open platform’ where full liquidity is ensured. Where such a platform is administered in SA both probate and situs will be eliminated, while the funds will be considered as true offshore funds that can be paid out anywhere in the world. When using an ‘open’ platform capital gains tax will also apply on your death.
- A portfolio consisting of various asset classes can be constructed. The various platforms offer a wide range of choices which includes equities, bonds, cash and property at various risk levels. Many platforms also provide you with the choice of investing in unit trusts, exchange-traded funds (ETFs), hedge funds, and direct shares.
- Familiarise yourself with the minimum investment requirements of the various platforms and investment solutions. You can start an offshore investment with $1 500 in a suit of unit trusts, whereas a discretionary share portfolio may require $250 000+.
As you can see there are numerous factors to consider and the space provided to field your question is not enough to provide a fully comprehensive answer. I suggest that you contact a suitably qualified financial advisor who focuses on offshore investing to assist you.