Offshore investments are a key component of a well-diversified portfolio, but you need to understand how these investments are taxed.
Non-residents of South Africa are generally not taxed in this country on any capital gains made in respect of investments in South African-based assets, except immovable property or rights to that property. Unfortunately, the converse is not true for South African residents, who are taxed on all income, as well as capital gains on their foreign assets.
It is therefore important for South African residents who own foreign assets to understand both the foreign and South African tax consequences arising from such investments. The typical classes of offshore assets owned by South Africans are shares, immovable property, unit trusts, loans and business assets.
The two main tax issues to consider are, firstly, tax on the income flows, such as dividends, interest and rent from the assets, and, secondly, capital gains tax (CGT) on the disposal of these assets.
If you are a South African resident, you will be taxed on all income derived from these asset classes at a date which is the earlier of when you received the income, or if you have not yet received it, when you became entitled to it. The only real exception is in cases where you receive dividends from foreign shares and you hold at least 20 percent of the shares in the company declaring the dividends. In this case, the dividends will be exempt from tax.
It should be borne in mind that income flows from foreign assets may also be taxed in the foreign jurisdiction where such assets are located. Such tax is generally imposed by way of withholding tax on these income flows. In these circumstances, as a South African resident, you would be entitled to a tax credit against your South African tax bill in respect of the foreign tax you have paid. If any foreign tax is imposed on such income flows, it may be worth checking whether, in terms of South Africa's many double-taxation agreements with other nations, such tax was correctly imposed, or whether the double tax agreement in fact removes the other country's right to tax such income.
CGT is the other main tax issue for South African residents who hold foreign assets. Generally, the same CGT rules that apply to local assets apply to foreign assets. So, you first need to ascertain the "base cost" of the offshore asset. Generally, this would be the market value on October 1, 2001 if the asset was held at that date and if it has been valued appropriately. Alternatively, the base cost would typically be the amount of money that you, the South African resident, paid to acquire the asset.
When you dispose of the foreign asset, you would then be taxed on the difference between the base cost and the proceeds you realise when you dispose of it.
This all sounds familiar enough. However, the main differences between CGT on foreign-based assets and CGT on local assets relate first to the foreign tax implications and second to the South African tax treatment of any currency gains or losses.
Generally, foreign countries do not impose tax on capital gains that you, as a non-resident, make when you dispose of assets in that country. In addition, South Africa's double-taxation agreements often do not allow the foreign jurisdiction to impose its tax on capital gains made by South African residents.
The principal exception is in the case of immovable property, as foreign authorities will often tax the capital gains you, as a non-resident of that country, make and in this case, double-tax agreements do not remove these taxing rights. However, the good news is that you, as a South African resident, would then get a tax credit in respect of foreign tax paid against your South African CGT liability.
Currency gains or losses
In respect of currency gains or losses, you will generally need to work out the base cost of your foreign asset in rands in the year you acquired the foreign asset. In other words, you will need to translate the foreign currency cost of acquiring such an asset into rands in the year you acquired the asset. Likewise, when you dispose of the asset, you must generally translate the foreign currency proceeds into rands in the year that the foreign asset is disposed of.
Therefore, any gain in the value of the rand during the period in which you possess the asset means there will be less South African tax to pay. This is generally good news for South African-resident investors given the strengthening of the rand in recent years.
Therefore, although the value of your foreign assets may be worth less in rand terms, at least you have the comfort of knowing that you will pay less tax when you dispose of the asset. It was not always this way. In the past, the taxman ignored currency movements when calculating CGT on certain foreign assets.
A further issue to consider is housing your foreign assets in an offshore vehicle, such as a trust. The amnesty process may have somewhat tainted the use of offshore trusts. However, they are still appropriate investment vehicles in many instances.
There are a number of potential pitfalls which you should consider before you set up a foreign trust, particularly when it comes to placing assets in the trust, the tax risks and the costs involved. You should seek proper advice before embarking on any such exercise.
However, if such a trust is structured correctly, it will mean that any capital gains made on the assets will be made by the trust and not by you, the South African resident. Foreign trusts are generally located in tax havens and as a result, the capital gains made by the trust are often not taxed. The gains may also not be taxed in South Africa until a distribution is made by the trust to any South African resident beneficiary.
A final word of warning: It is important to understand the exact nature of the gain made on your foreign assets. Sometimes what are loosely referred to as capital gains could, for example, be regarded in law as dividends. In which case, the entire dividend, as opposed to merely the capital gain on the asset, may be taxed in the hands of the South African resident. Therefore, it is vital that you understand the exact nature of your investment, as well as the nature of the return thereon.
* Peter Dachs is a partner in the tax department at Sonnenberg Hoffmann Galombik in Cape Town.
This article was first published in Personal Finance magazine, 2nd Quarter 2006. See what's in our latest issue