The line between tax havens and offshore financial centres is fairly fuzzy, with most of the latter operating in the former
Sarah Bullen
A tax haven is one of those emotive phrases that conjur up images from a John Grisham novel: Lotharios in tailored suits popping over to an island for a day, azure seas, catamarans and sultry cocktail nights.
A firm listed as something like SA Tasty Dried Fruits, Nassau, will usually inspire a bit of a wink-wink, nudge-nudge. There is a suggestion that it is a bit naughty and fits with the associated links of tax dodging or money laundering.
But it is precisely such images that tax havens are determined to bury. This starts by renaming themselves as “offshore financial centres”.
The line between tax haven and financial centre is a fairly fuzzy one, with most financial centres operating within tax havens.
The offshore centres are places where institutions and funds can offer investments that are tax-neutral and confidential.
Tax havens are absolutely tax free – meaning those individuals investing through a tax haven, or companies registered in one, do not pay tax there at all. Into this category fall the Overseas British Territories, including Bermuda, the British Virgin Islands, Gibraltar and the Cayman Islands – a grouping formed to lobby collectively for rights. Also popular tax havens are the British Crown Dependencies – Jersey, Guernsey and the Isle of Man, as well as the increasingly popular haven of cyberspace.
For South African investors, investing in a fund based in a tax haven has been made easy by access to subsidiaries of local banks and fund managers based in tax havens or tax-neutral locations. Most offshore branches of local institutions are based in these favourable locations, with the British Crown Dependencies proving the most popular destinations.
South Africans resident in the country pay tax on offshore investment income as though it is earned in South Africa. If the investment income is also taxed in the country where it is earned, double-tax treaties can mean some tax relief in South Africa. But mountains of paperwork accompany this manouevre.
This is why tax havens, or tax neutrality, is an important issue for investing offshore. It does not mean an investor is escaping the South African tax net, but it ensures that the investor will not be caught in another tax net. Of course, for a large number of South African investors offshore meant off the record and out of the taxman’s sight .
Income earned offshore used to be classified as either active or passive. The former was exempt from South African tax, which includes all profits earned from active business operations including dividends. Passive income – interest, royalties, annuities and rent – has been taxed at the same rate as if it was earned in South Africa since 1997.
However, in his February budget speech, Minister of Finance Trevor Manuel announced that the foundation of the tax system is to change from a source to a residence (worldwide) base from January 1 2001.
A resident-based tax system levies tax on all the income derived by its residents, regardless of the source of the income. Source-based taxation systems only demand residents pay tax on income derived within the country or source.
This change means that all income earned by a South African resident or citizen offshore will be taxed, except where they have paid tax in a country which has a double-tax treaty with South Africa. The change means that there is no longer a distinction between active and passive income.
The fact that residents are already paying tax on passive income means that the changes will not bring into effect any major changes to individuals with investments in tax havens.
The change does, however, have larger implications for companies based in tax havens and repatriating profits to South Africa. Previously no tax was levied on these profits, but from 2001 dividends from a foreign source become taxable in South Africa.
The change may also encourage South African multinationals to rethink their decision to situate in South Africa.
KPMG Tax Services senior consultant Jenny Alence explains that the absence of tax in South Africa on foreign-source income made South Africa itself an attractive location for multinationals to base their headquarters.
Alence uses the example of a South African company that sources from foreign suppliers setting up a procurement arm in Mauritius. This meant that the company could earn its income in Mauritius where it is taxed at 1,5% rather than 30% in South Africa. The firm could then repatriate its profits to South Africa in the form of tax-free dividends. A firm located in a tax haven would bypass any tax at all.
It is here where the changes in the tax dispensation will hit hard.
In its fifth interim report the Katz Commission recognised that the loophole in the tax laws had been a major drawcard in attracting foreign investment to South Africa. It expressed concern that a change to the existing tax dispensation could mean that multinationals taking advantage of the tax regime could pull out of the country when the hole was closed.
Alence, however, said the move to resident base of taxation brings South Africa in line with the rest of the world. “It does not make South Africa any more or less attractive to investors,” she said. “But it means that now decisions will be made on a commercial basis.”
However, for individuals taking advantage of the easy administration offered by tax havens, and for firms that never tried to divert income to a tax haven, no radical changes are on the cards come January.