Don’t let tax take you by surprise when you invest offshore
In this article, first published by Moneyweb, Trevor Lee reminded South African tax residents that they are required to pay tax in South Africa on their worldwide income. This article is the second in a two-part series about the practical details of investing offshore. The first was called ‘Five steps to investing offshore’ and is published below.
South Africa uses a residency-based system to calculate personal tax. This means that South African tax residents are required to pay tax in South Africa on their worldwide income. The tax system does allow exemptions for certain types of income, and some double taxation agreements, which give you credit for foreign taxes paid, are in place with many countries.
This means that once you have made your investments into your chosen funds, you have to monitor performance, and pay tax on interest and dividends. If you sell the investment or part of the investment, you could be liable for capital gains tax.
If you die, your foreign investments will be part of your South African estate, and you will have to pay estate duty, depending on the value of your assets, whether or not double taxation agreements are in place and other details.
Sars has recently updated its website notice (as of June 2 2020) on double taxation agreements and the countries with which South Africa has such agreements.
However, if you have to pay South African tax liabilities due on offshore dividends, capital gains or interest, you can settle the tax bill with domestic rand-based funds, without repatriating offshore investments.
Tax on foreign interest: The full value of foreign interest earned by interest-bearing investments or bank deposits should be included in your taxable income. Foreign and local interest is taxable at your marginal tax rate. Local interest is subject to age-related exemptions announced every year in the February budget.
Tip: Make sure that you know the rules for maintaining your foreign bank account. It is possible that a minimum balance might be required or that your account has to be ‘active’ in order to remain open. Different fee structures might kick in under different circumstances.
Tax on foreign dividends: All interest and dividends earned from offshore investments should be disclosed to Sars, while a range of exemptions may be available for certain investors.
Capital gains tax: If you sell or withdraw part of your foreign currency-based investment, the difference between the proceeds and base cost will be subject to capital gains tax; that is 40% of the difference will be added to your taxable income. If you are invested in a foreign currency-based investment, the calculation requires you to calculate the foreign capital gain or loss and then translate it into rands using the exchange rate at the date of sale.
Tip: Foreign rental income, salary earnings and foreign (unlisted) business profit income are also taxable at your SA marginal tax rate. Remember that with effect from March 2020, earnings of more than R 1.25 million earned by South Africans residents working abroad are no longer tax-exempt.
Estate duty: SA residents are liable for estate duty on a residence basis of taxation; in other words, worldwide assets are taken into account in determining the value of South Africans’ dutiable estates. As of February 2020, there is a basic deduction of R3.5 million permitted in the determination of an estate’s liability for estate duty. Estate duty is then payable at a rate of 20% on the net estate value over R3.5 million or 25% on the value of the net estate above R30 million. The value of the estate should include any investments or property offshore regardless of how the assets were accumulated.
In addition, SA residents with offshore investments may also be liable for death taxes in those jurisdictions which tax on a ‘source basis’ even if the owner of the assets is a non-resident in their jurisdiction.
South Africa has double tax agreements with some countries, including the US and the UK that make allowance for estate duties to avoid double taxation. However, these agreements do not necessarily mean that you will not be liable for estate duty in these countries.
Estate duty rules are complicated and the amount you could end up paying as a non-resident in either the UK or the US depends on a wide range of factors, including the following:
- Whether you leave your assets to a surviving spouse and the resident/ nationality status of your spouse.
- The vehicle of your investment; there are different rules for directly held shares, as opposed to unit trusts or ETFs (collectively called ‘authorised funds’) and if these funds are domiciled in either the US or the UK.
- The death tax rate in the UK and the US is 40%, compared to SA’s rate of 20%. Although the double tax agreements are designed to mitigate double taxation, as a non-resident with assets in either of these countries you could end up paying death taxes at the higher rate.
Tip: Not all countries have freedom of testation. In South Africa, freedom of testation can be challenged by the trustees of a retirement annuity (who are obliged to establish that the deceased’s dependents are provided for), in terms of the Maintenance of Surviving Spouses Act and in terms of possible contraventions of ‘Boni mores’ or public policy.
Up until recently, some Mediterranean countries had prescriptive inheritance laws for the inheritance of physical property. New European regulations came into effect in 2015, which granted individuals the right to elect the succession laws of their nationality.
If you buy property, make sure you understand inheritance laws and estate duty applicable in that country.
Structuring offshore investments in tax-efficient vehicles: Investing offshore through a South African offshore endowment might offer a solution to some investors. These endowments are registered under the Insurance Act 18 of 2017 and offer certain advantages with respect to taxes payable at death and the payment of capital gains tax. In addition, they are exempt from UK/US situs issues and they do not require UK probate or a foreign will. In short, the endowment structure could be useful when looking to invest directly into the US and UK. The benefits of endowments should be weighed against the additional cost and might not be suitable for all investors.
Please contact Rosebank Wealth Group to find out more.