5 Tax questions about offshore unit trust investments
It is more tax efficient to invest directly in an offshore unit trust in hard currency if the rand weakens while it is more efficient to invest in a rand-denominated offshore fund when the rand strengthens.
The tax you pay when investing offshore will largely depend on the manner in which you invest and the vehicles you use.
In this article, Carla Rossouw, tax manager at Allan Gray, answers five questions about offshore investing – specifically in relation to unit trusts.
1. What are the two common ways of investing offshore through a unit trust?
There are various options for investors who want to increase their offshore exposure. The two most common ways are to invest in a rand-denominated offshore fund with a South African fund manager or to invest directly in an international fund with an international manager or via an offshore platform.
A rand-denominated fund is a South African unit trust that invests in a fund or funds domiciled offshore. It is usually called a feeder fund or fund-of-fund.
For direct offshore investments, you need to follow a specific process. Any individual older than 18 years can take R1 million offshore for investment purposes each year without a tax clearance certificate from the South African Revenue Service (Sars). If investors want to externalise more than R1 million, they need to apply for a tax clearance certificate. If the amount exceeds R10 million, special permission will be required. As a result, investing directly offshore in hard currency will likely be more administratively burdensome than investing in a feeder fund.
2. What are the tax implications of rand-denominated offshore unit trust investments?
Two types of taxes might be payable – income tax and capital gains tax. An investor will pay tax on the interest as well as the dividends earned on the investment. Offshore dividends will be included in your taxable income and taxed at an effective rate of 20%, after an exemption for offshore dividends is taken into account. All foreign interest will be included in your taxable income and taxed at your marginal rate. There is no tax exemption for foreign interest.
As far as capital gains tax (CGT) is concerned, it is important to note that you will pay tax on the full capital gain – regardless of whether it was realised as a result of capital growth or currency movement.
3. What are the tax implications of investing in foreign currency in an offshore unit trust?
You will also be liable for income tax on the offshore interest and dividends in much the same way as a rand-denominated investment. The dividend income will be taxed at 20% and interest is fully taxable at your marginal rate. From an income tax perspective, the tax rules are the same. The big difference is the tax payable on capital growth – you won’t pay any tax on exchange rate movements if you invest directly offshore through a unit trust.
If you bought an offshore asset in hard currency, the capital gain or loss is firstly calculated in foreign currency and then converted to rand by using the average exchange rate published by Sars, or the exchange rate on the date of the sale. Since there is only one currency conversion, there is no tax payable on the exchange rate movement during the investment period.
It sounds complicated, but effectively it means it is more tax efficient to invest directly in an offshore unit trust in hard currency if the rand weakens while it is more efficient to invest in a rand-denominated offshore fund when the rand strengthens.
4. Are there any ways to reduce your tax liability when investing offshore?
I think most South Africans would like to pay less tax. South African tax residents pay tax on their worldwide income, but Sars does allow certain concessions. One example is the exemption on dividend income I mentioned earlier, which means you only pay 20% tax on offshore dividends. There are also a number of double-tax agreements between South Africa and certain offshore governments that provide relief for taxes paid offshore.
5. Are offshore investments and local investments on equal footing when it comes to estate duty?
South African tax residents pay estate duty of 20% regardless of where the assets are held. Estate duty levied on worldwide assets would naturally include offshore investments.
But while most investors are aware of the South African estate duty implications, a lot of people are unaware of the possible estate duty implications of offshore investments, particularly where the funds are domiciled in places like the USA or Great Britain. These jurisdictions levy inheritance tax or estate duty, which means that upon a South African investor’s death, his estate could be liable for estate duty in South Africa and the foreign jurisdiction – which effectively result in double taxation. Luckily there are certain double tax agreements in place, which could provide relief.
Investing offshore can be complex and investors should speak to an independent financial advisor about the potential benefits and pitfalls applicable to their personal situation.
Want to discuss various investment strategies, then give me a call Warren Basel on 082 490 5182 or email warrenb@oraclebrokers.com
