By: Wynand du Preez, Regional Manager at PPS Specialist Support Services
In the past year, we have observed a considerable increase in clients that are interested in investing offshore.
Their reasons include emigration, the South African economic and political landscape and opportunities available in a much broader investment universe outside the borders of South Africa, which makes up only about 1% of world equity markets.
Investing offshore is great in principle and it could also provide access to a range of companies and sectors that are not available in South Africa, providing good diversification opportunity.
There are many ways for you as a South African tax resident to invest offshore, but the two most popular ways are to:
- invest in Rand-denominated offshore unit trusts (feeder funds); or
- convert the local currency into a foreign currency (like US dollars) and then invest directly in offshore assets such as shares, rental properties and/or unit trusts via an offshore platform.
Considerations when investing in a feeder fund
The benefits of investing via a feeder fund is that it will provide the desired offshore exposure and would not require consideration of annual South African Revenue Services (SARS) foreign investment allowances or South African Reserve Bank (SARB) clearance.
The drawbacks are that, firstly, some feeder funds have historically been more expensive than other local unit trusts or the underlying fund being invested in, due to an extra layer of costs. The extra layer of costs stem from the fact that the feeder fund often charges a fee to invest in the underlying fund.
The second drawback is that, at the sale of the assets, capital gains tax could be higher than a direct investment in foreign currency, as capital gains are taxed on the weakening Rand, as well as the growth received in foreign markets. This could be partly overcome by investing in a tax-free investment account with offshore feeder funds as the underlying investments. A tax-free investment account does not attract capital gains tax. As announced during the February 2020 National Budget Speech, the annual investment limit has been increased to R36 000 per tax year, and the lifetime limit remains at R500 000.
Considerations when investing directly in a foreign-domiciled fund
With a direct foreign currency investment, one of the benefits is that, at the sale of the assets, you only pay capital gains tax on the foreign market growth and not on the weakening of the Rand. Over long periods, this difference could be substantial.
Another benefit is that you will hold foreign currency and the costs of investing directly are often less than when using feeder funds. Having said that, you should bear in mind that the initial costs may be high, as it could be expensive to convert local currency to foreign currency. Foreign investments in offshore currency should thus ideally be investments with time horizons of 10 years and longer.
A potential drawback of a direct foreign investment is the administrative burden to apply for a foreign investment tax clearance allowance. SARS allows a single discretionary allowance of R1 million per annum. A further R10 million may be applied for, but then the investor would be required to obtain a foreign investment allowance tax clearance certificate from SARS.
If you’re a South African tax resident, the other taxes to be considered when investing offshore are dividends, interest, income tax on rental income and estate duty. Dividends declared by South African companies are taxed at 20% (Dividend Withholding Tax); dividends received from foreign companies are also taxed at an effective rate of 20% and are included in taxable income. Interest received from South African interest-bearing instruments, such as interest on cash deposits or bonds, is exempt up to an amount of R23 800 (if under age 65) and R34 500 (if over age 65). Thereafter, it is taxable at your marginal tax rate. Interest earned from a source outside of South Africa has no exemption and will be fully taxable. Rental income from local and foreign sources are included in your gross income, subject to certain deductions, such as water and electricity. Net rental income is therefore taxable at your marginal tax rate.
Going offshore should be part of your holistic financial plan
While offshore investments have become far more accessible in the last decade, this has caused some over-eager offshore investing that sometimes leads to regret, commonly associated with a product with unexpected volatility, unconsidered costs and an insufficient time horizon. One should bear in mind that if the Rand strengthens against the foreign currency, an investment loss could be incurred. Therefore, offshore investing should be considered as part of a holistic financial plan and the investor should ensure that they have a sufficient time horizon for the investment to come to fruition.
To avoid complexity and make smart decisions, it is recommended to seek advice from an accredited financial adviser.