Shaun Harris
South Africans’ relatively new, partial freedom to invest offshore has been warmly welcomed this year, providing a growing flow of business for financial consultants and global unit trust management companies.
Increased investor knowledge and sophistication here now closely follow the wisdom that a long-term, low-risk portfolio must be well diversified, and that means putting a significant portion of investment assets into other currencies and regions of the world.
This principle has been warmly embraced by local investors, but sometimes without full consideration of the tax implications.
The truth is that our old favourite, the receiver of revenue, still wants a slice of local investors’ offshore investment performance, the collection of which is covered specifically in Section 9C and Section 9D of the Income Tax Act.
And, says Peter Wentzel, partner at Webber Wentzel Bowens and their European arm, Maitland & Company, South Africans have been relatively slow to wake up to the implications of this legislation – basically that investment income from abroad is going to be taxed as if it were earned in South Africa.
Taxes must be paid – that’s just one of the hard facts of life. But there’s nothing wrong with intelligently limiting your tax liability on offshore investments. It’s not illegal or wrong; just one more factor to consider in the investment process.
The tax applies not only to foreign investment income earned directly, says Wentzel, but also to investment income earned indirectly through a controlled foreign entity.
On a more technical note, the tax will also apply on acquiring vested rights to capitalised prior year investment income of a controlled foreign entity and on investment income of foreign third parties arising from assets donated or settled.
That seems to plug up all the holes, so the obvious starting point for a local offshore investor is not to earn investment income, defined, says Wentzel, as any income in the form of annuity, interest, rental income or royalty.
That rules out foreign bank deposits for offshore investors not wanting to be over- taxed on their foreign exchange allowance. Not that banks in the United Kingdom, Europe or the United States offer great returns on deposits (most will only give you a few per cent), but it is an easy and virtually risk-free method of investing offshore.
What are the options? Well, as in South Africa, tax does not apply to dividends from a foreign source. So equities are fine for the local investor with the stomach to commit capital to the shares of a foreign company.
It’s sensible to seek advice before buying foreign shares, but anyone choosing this route might be interested to know where London-based merchant bank Singer & Friedlander is investing.
Richard Killingbeck, who heads the overseas equities desk for the bank’s investment management company, says Singer & Friedlander is moving more money into Japan and continental Europe. It remains cautious on US equities and on emerging markets favours Latin America.
Another option, says Wentzel, is to invest in a roll-up money fund. This is basically an investment fund in the form of a company that buys into assets like bonds and money market funds.
The trick is that the investor does not get a return directly from the fund run by the company, but instead buys part of the company itself at net asset value. After a period this holding can be sold back to the company at net asset value. If the fund has performed well, the net asset value of the company would have increased, and this is how the investor gets his return.
Once again good advice is important, but a number of reputable roll-up funds can be found in most of the offshore centres. One of the favoured destinations at the moment seems to be the Isle of Man, that little island where the foul weather is more than compensated for by the wonderfully benign tax regime (the standard rate of tax for individuals and companies is 15%).
What’s out for the tax-sensitive offshore investor is direct investments in bonds, treasuries, gilts and redeemable preference shares, says Wentzel.
Trusts attract less tax, but you need expert assistance. Trustees must not earn investment income, and any lender to the trust and trustees must not be connected persons.
Another, more complicated, option is the substantive business enterprise exemption. This exemption can be sought for a permanent establishment conducting business offshore.
Wentzel warns, however, that the local receiver is strict about the “permanent” part of the definition. It’s no good just registering a company offshore and running it from South Africa. It must be a staffed office abroad, earning or generating income.
Wentzel says that, once again, the Isle of Man is one of the best jurisdictions to set up a substantive business enterprise. The island has been on a marketing drive in South Africa – John Aspden, chief executive of the Financial Supervision Commission (the regulator of the Isle of Man’s burgeoning financial services industry) was in South Africa last week, talking to potential investors.
Aspden wants our forex funds to flow through the island, and the authorities there seem to be doing all they can to accommodate offshore investors. With a long list of investment and asset management companies, including a few local names like Standard Bank, Old Mutual and Nedcor, the Isle of Man appears to be gaining popularity as an offshore investment zone for South Africans. There’s even a Van der Merwe listed in the local telephone book.
As they say when you leave the island, Manx for the memories – hope the same applies to investment profits too, and that they return with the minimum tax liability.