Building offshore exposure into your portfolio allows you to achieve more diversification by accessing different jurisdictions, economies, and companies – and, thankfully, externalising your Rands is now more accessible and affordable than ever before. Offshore investing is no longer a privilege reserved for the impossibly wealthy, and South Africans now have enormous choice when it comes to gaining global investment exposure. Besides for considering the tax and estate planning implications of investing offshore, understanding the role your investment is destined to play in your overall portfolio is key to determining how best to externalise your money – keeping mind that your offshore investments should be viewed as part of your overall wealth creation strategy. In this article, we unpack the two primary offshore investment options available, how they work, and what each option entails.
(i) Direct offshore investing
What does it entail?
Direct offshore investing effectively means that you convert your Rands into the currency of the foreign jurisdiction and that your funds are physically transferred into an offshore investment account held in your name. In essence, this option entails the physical transfer of your funds out of South Africa and into a foreign-domiciled investment.
How much can be invested?
Generally speaking, South Africa tax residents are able to invest up to R11 million per year offshore. This includes a Single Discretionary Allowance (SDA) of R1 million and a Foreign Investment Allowance (FIA) of R10 million. While no tax clearance is required in respect of your R1 million SDA, to move all or part of your Foreign Investment Allowance offshore you will require a tax clearance certificate from the South African Reserve Bank. Any South African resident taxpayer over the age of 18 can qualify for these allowances, bearing in mind that your tax returns must be up-to-date and you must be in good standing with SARS in order to get approval. Once issued, your tax clearance certificate remains valid for a period of 12 months, although keep in mind that this 12-month period may not necessarily align with your annual allowances which expire at the end of December each year. As such, if you intend phasing in your annual allowances, be sure that you understand your time frame correctly.
How is it done?
Once you have your tax clearance, your investment provider will be able to assist you with obtaining a tax clearance certificate, converting your currency, moving your funds offshore, and then transferring them into an appropriate investment. Before doing so, however, it is important to understand the fees, commissions, and cost structures as these can vary significantly from platform to platform – and excessive fees can erode your investment returns. When externalising funds in this manner, it is important to keep track of how much you move offshore in a calendar year as any amount in excess of your allowance can be subject to penalties of between 20% and 40%. A significant advantage of investing through large asset managers is that you are likely to benefit from their bulk purchasing power which translates into lower investment fees.
When is it appropriate?
Typically, direct offshore investments are suitable for those who intend to access their capital offshore. So, if you have plans to emigrate to another country or wish to educate your children overseas, then investing directly in the intended jurisdiction would make sense. Direct offshore investing can provide you with access to currency if you have plans to travel or live abroad for extended periods of time, or if you have liabilities in a foreign country.
What are the tax implications?
Any disposal of your offshore investments triggers a capital gains event, with the gain being calculated as the difference between the value at the time of sale and the base cost of the purchase. This means that, if you sell part of your offshore investment, the difference between the proceeds of the sale and the base cost will be subject to CGT, and 40% of the interest will be added to your taxable income. In doing so, you will need to calculate the foreign capital gain (or loss) and then translate it into Rands using the exchange rate at the date of sale. As such, it is important to determine the extent of any CGT liability before disposing of any offshore assets to ensure that you avoid paying unnecessary tax. Remember, death is a capital gains event and, in the event of your passing, your foreign assets will be deemed to have been sold at market value which, in turn can trigger CGT. As a South African tax resident, you will be taxed on your worldwide assets and it is therefore imperative that you declare your direct offshore investments when filing your tax returns, keeping in mind that you pay income tax on the interest and dividends earned from your direct offshore investments.
Other considerations: Your Single Discretionary Allowance and Foreign Investment Allowance are not sequential meaning that you do not first have to use the one before being able to access the other. If you have plans to travel internationally, you may want to earmark your SDA for these purposes you do not require a tax clearance certificate to access this allowance, and then earmark your FIA for offshore investing.
(ii) Indirect offshore investing
What does it entail?
A Rand-based offshore investment is the simpler of the two options as you do not need to convert your money into another currency. By investing through a local, reputable LISP platform which has a mandate to invest in foreign assets, you can effectively use the platform’s foreign exchange capacity to send your money offshore on an asset swap basis without having to convert your money into another currency.
How much can be invested?
As you are not physically moving your Rands offshore, there is no limit to how much you are able to invest indirectly offshore. In addition, because you are not moving hard currency abroad, this option means that you do not need to access your SDA nor your FIA. Typically, the barriers to entry when it comes to indirect investing are lower than for direct investing in that the minimum investment levels are lower and monthly investment contributions can be set up as a debit order.
How is it done?
Generally speaking, this type of investment would involve investing in a local asset manager’s feeder fund or Rand-denominated hedge fund which is then invested abroad using the asset manager’s allowance on an asset swap basis. From an administrative perspective, indirectly investing offshore in this manner is cost-effective and convenient, and should entail no more administration that when setting up a local investment portfolio.
When is it appropriate?
If you are invested through an approved retirement fund such as a pension fund or retirement annuity, keep in mind that your ability to gain offshore exposure is limited by Regulation 28 of the Pension Funds Act. Limitations to indirect offshore exposure through products provided through a company’s life license, such as Endowment Policies or Living Annuities, may also exist. As such, indirect offshore investing is an excellent way of creating diversity in your investment portfolio without having to physically externalise your money.
What are the tax implications?
As in the case of direct offshore investing, you will be taxed on the income earned on your direct offshore investments. Similarly, any disposal of units will trigger a capital gain meaning that careful tax planning and simulation should take place before you make any decision to realise any part of your investment. On an indirect offshore investment, you are liable for tax on all gains on your original Rand investment, regardless of whether those gains are from capital growth or currency movement.
Other considerations: The funds invested in a living annuity structure are not regulated by Regulation 28 of the Pension Funds Act which means that you can structure your underlying investment portfolio to achieve as much offshore exposure as is necessary for your strategy, although this can only be done on an indirect basis and not through direct foreign investment.
When deciding, how and when to take money offshore, investors need to look further than the potential investment returns they hope to achieve. Other considerations should include one’s propensity for risk, short- to medium-term income needs, investment horizon, and one’s objectives. There is no doubt that international investment markets offer a diversity of opportunities that are not locally available, but it is important to be clear on what one hopes an offshore investment will achieve and to externalise appropriately.
Have a wonderful day.
Sue
