It’s not just about investment returns

BY WAYNE SOROUR Head: Sales and Distribution, Old Mutual International

As the world continues to grow into a global network, so do the global tax laws applicable to investors’ worldwide assets. Even though we have universally become much more integrated, failing to carefully consider the tax implications of where one invests could create unnecessary costs and expenses for the investor and their heirs.

The importance of diversification

It makes sense for South Africans to invest a portion of their wealth offshore and take advantage of the benefits of diversification. The primary benefit is the diversification associated with investing in global asset classes. The role of an investment portfolio is to reduce risk, which is particularly relevant when the assets out- or under-perform at different points in the market cycle. But more than this, in offshore markets investors have access to markets and sectors that are either simply not available in South Africa, or provide more choice through which South African investors can access a world of growth opportunities.

The purpose of investing offshore is to reduce the concentration risk that comes with exposing all your investments to one market.

Tax considerations

High-net-worth individuals (HNWIs) should take their annual allowance of R10m offshore. SARS and SARB clearance is required for this amount, it can be done every year, and there is no lifetime limit. So over ten years, they could invest R110m offshore as an individual or R220m as a couple. Clients can also use their discretionary R1m a year, which requires no clearance, to get that diversification and exposure. Money externalised in this way never has to be repatriated. It can be invested offshore or kept in a bank account for use when travelling. Also, a lot more South African children are getting educated and living abroad, and many families are establishing an education fund abroad for that purpose.

UHNWIs can apply to take out more than R10m a year if they submit a Special Concession application to SARS & SARB. A Tax Clearance Certificate, in the prescribed format, must always accompany the application, and they need to ensure that their tax affairs are 100% in order.

Rand hedging is also a factor, as many investors continue to measure their portfolio performance in rand rather than hard currency.

Estate considerations

Potential investors should look at the estate planning implications when investing offshore. Many people simply look for the best returns – but tax and inheritance issues are equally important. We have legal mechanisms that make offshore investing easier, with beneficiaries being nominated to inherit the assets abroad.

Jurisdictions such as the US and UK are increasingly eyeing the estates of non-citizens investing in certain assets physically situated within their jurisdiction, called the situs tax.

On death, South African residents are liable for estate duty based on their worldwide assets. Estate duty is currently levied at a rate of 20% in the case of an estate less than R30m, and at a rate of 25% on the value above R30m. However, both the UK and the US also levy an estate duty on certain situs assets. In the UK, this is known as inheritance tax, and in the US it’s called estate tax. Collectively, they are known as situs taxes.

In the UK, 40% inheritance tax will be levied on situs assets over the value of £325 000 (including fixed property). Any amount falling below the £325 000 threshold is known as ‘the nil rate band’ and is free from situs tax. Each individual receives this £325 000 exemption. In the US, the threshold for estate tax is much lower at only US$60 000. The top bracket for estate tax is 40% on US situs assets. In contrast to the UK, the US offers no spousal exemptions or rollovers, unless the spouse is a US citizen.

On death, HNWIs may be liable for 20% South African estate duty, as well as a potential 40% situs tax on their US and UK situs assets. Although there are double taxation agreements in place, this would still result in payment of a net tax of 40%, instead of the 20% estate duty payable in South Africa.

Asset swaps

Investors also need to ensure they have access to capital abroad, which is the primary reason for taking funds offshore. If the investor’s sole interest is the offshore return (as in the case of a pension fund), then an asset swap mechanism is the preferred vehicle. The major difference between capital physically taken abroad, and capital using an asset swap mechanism, is that in the case of the latter the money ultimately must be repatriated, having earned offshore returns in the interim. Asset swaps are more convenient for smaller amounts where there is little point in the effort of going through SARS and being audited.

Many people simply look for the best returns – but tax and inheritance issues are equally important

At Old Mutual International, we focus mainly on the direct route, but can access asset swap capability through relationships we have with several investment houses that do not use their full capability.

With an asset swap, an investor buys a randdenominated unit trust through a South African financial institution. The unit trust company then uses its asset swap capability to invest the funds offshore. The investment returns are repatriated and paid out in rand. Asset swaps are ideal for investors who do not need to physically move their funds offshore but would still like to profit from investing in overseas markets.

In conclusion, like every financial decision, investing offshore needs to be tailored to investors’ needs. To find the right fit, an investor must evaluate different scenarios in terms of their investment goals – and this should be done with the assistance of a financial planner to customise a unique plan for an investor’s lifestyle plan.