In response to an announcement by the Minister of Finance – that the foreign capital allowance for private individuals resident in South Africa was increased to R4 million per resident per annum – many clients have made offshore investments. In this article three offshore investment options available to South African residents are discussed, as well as the income tax and estate planning consequences of each.
The announcement of the increased allowance by Mr Pravin Gordhan during his Medium Term Budget speech was welcomed widely. The allowance is naturally subject to residents obtaining a tax clearance certificate from the South African Revenue Services (SARS).
The three offshore investment options are:
- The funds can be invested offshore in the individual’s own name.
SA residents are taxed on their worldwide income, thus residents will have to declare all income earned on this investment in their annual tax returns. Residents will be taxed according to their rates of tax.
Should interest income be earned on the offshore investment and a withholding tax measure is applied in the offshore jurisdiction, double taxation relief may be available in terms of the relevant Double Taxation Agreement between South Africa and the other country. The alternative Section 6quat of the Income Tax Act also provides for unilateral relief from double taxation in such cases.
Should the resident die, there will be a deemed disposal of the investment for capital gains tax purposes in terms of para 40(1) of the Eighth Schedule of the Income Tax Act. Tax on capital gains, if any, will then become payable at an effective rate (maximum 10% of the gain).
- The funds can be loaned and advanced to an offshore trust.
A distinction must be made between commercially funded and non-commercially funded loans:
2.1 non-commercial funding: interest-free loans
According to Section 7 of the Income Tax Act (which deals with the so-called attribution rules), any income received or accrued to an offshore discretionary trust by virtue of any donation, settlement or gratuitous disposition, will, generally speaking, be taxed in the hands of the person who made that donation or disposition. The Supreme Court of Appeal has determined that the forbearance of interest on a loan is such a donation, settlement or disposition for purposes of the attribution rules. Section 7 thus ensures that any income received by the offshore trust is deemed to be that of the SA resident donor.
Similarly, paragraph 70 of the Eighth Schedule of the Income Tax Act provides that when a person has made a donation, settlement or other disposition in favour of an offshore discretionary trust, any gain attributable to that funding will be brought to account in the hands of the resident donor.
Should interest at a very low rate be levied on the said loan, the provisions of Section 31 of the Income Tax Act have to be taken into account. These determine that in cases where a South African resident makes a low-interest loan to an offshore trust (and the trust is a connected person in relation to the resident), SARS may deem the SA resident to have received a market-related interest on the loan.
2.2 commercial funding of the offshore trust:
Section 25B of the Income Tax Act embodies the conduit principle and provides that income which is received by, or which has accrued on behalf of, a beneficiary of a trust will be taxed in the beneficiary’s hands and will retain its nature (e.g. dividends or interest).
In terms of the provisions of the Income Tax Act, both the interest and dividends flowing from the offshore investment (made in the name of the offshore trust) will be taxed as income in the hands of the SA beneficiary as and when the SA beneficiary obtains a vested right to such income in the offshore trust.
Paragraph 80(3) of the Eighth Schedule of the Income Tax Act determines that where a SA resident receives a vested right to the capital of an offshore trust, the capital gain must be regarded as a capital gain in the hands of the SA resident in the year that the resident acquires a vested right to that capital gain.
The value of the loan will be an asset in the estate of the deceased. Should the value of the estate (for estate duty purposes) exceed R3.5 million, estate duty will become payable at the current rate of 20%.
The deceased will be entitled to bequeath the loan to his/her heir. The exchange control consequences of such a bequest must be carefully considered.
- The funds can be donated to an offshore trust.
In the case of a donation to an offshore trust, the resident donor will be liable for donations tax at a rate of 20%. The donor will have to pay this within three months from the donation becoming effective. As the donor has then been divested of his/her ownership, there will be no estate duty consequences.
Your attention is drawn to the provisions of section 25B(2A) of the Income Tax Act: when a resident acquires a vested right to capital of an offshore trust that represents accumulated income of the trust for previous years, that amount must be declared as income of the resident.
All of the above options need careful consideration and must be evaluated against the resident investor’s personal circumstances.
For further information contact Sonja Frank at the Stellenbosch office on tel. 021 882 8140 or e-mail firstname.lastname@example.org.