By Willem van der Merwe, Global Solutions Specialist
It is well known that many South Africans invest at least a portion of their assets outside of South Africa. High net worth individuals often prefer to denominate a portion of their assets in a foreign currency and some will measure their wealth in one of the world's major currencies. The offshore investment discussion is one that any individual looking to preserve their wealth needs to have.
Another reason for investing abroad is the diversification of assets, which aids in hedging against, amongst other things, financial, political and geographic risks.
Many investors will have an idea of the assets they want to invest in and will often be assisted by an investment adviser who can identify and suggest investment options.
The structuring and how the investment should be owned is equally as important - if not more so -but is a less explored topic.
To decide on how an investment should be structured now and for generations to come, is a decision investors often struggle with. There are various options and in this article we explore the options of investing directly in your personal name, via investment products such as endowment wrappers, or investing in an offshore trust. Investors are often confused with the options available and what the differences and benefits of the various options are.
What are some of the typical structuring or ownership options?
1. Personal capacity
In its simplest form, an investor can invest in his/her personal name. These investments typically include unit trusts, ETFs or direct equity holdings and stockbroking accounts. Although the main benefit of investing in your personal name is the simplicity, it can also result in low costs and the investor having complete control of the investment. However, from an estate planning perspective, it would rarely be advisable to hold any long-term offshore asset in one's personal name as this would expose the asset to all kinds of risks associated with a personal estate. These risks that we are already familiar with, include claims from creditors, divorce claims, succession issues and death taxes to name a few. With foreign interest and dividends being part of the investors' worldwide income, they form part of taxable income in South Africa and can be subject to exemptions in certain cases. If the investor sells or withdraws part of the offshore investment, the gain is subject to capital gains tax in South Africa. The maximum effective rate of capital gains tax for an individual is 18%.
A risk that some investors might not be that familiar with, that is specifically relevant when investing abroad, is situs tax. In addition to South African estate duty, an investor may also be liable for death taxes in those jurisdictions where the assets are situated, even if the owner of the assets is a non-resident in that jurisdiction. Most notably, these taxes are relevant in the United States of America (US) and the United Kingdom (UK). With an increased death tax exposure of up to 40% in the US and UK for a South African investor, it is crucial to consider how to mitigate these increased tax exposures. South Africa has DTAs with some countries, including the US and the UK, that allow for estate duties to avoid double taxation. The options below are often considered to mitigate this risk although other options would also be available.
2. Endowment wrapper
An alternative is to invest in an Endowment Life wrapper ('wrapper'). A wrapper is a long-term policy with underlying assets typically invested with the offshore branch of a South Africa life insurance company, such as Old Mutual International, Sanlam Glacier or Momentum International. The wrapper benefits from reduced rates at which tax is payable in South Africa, referred to as the 'five funds approach'. The tax administration is conveniently taken care of by the life insurance company and the wrapper will, in most cases, mitigate the situs tax exposure referred to above.
In addition to the lower tax rates and convenience, the ownership of the wrapper or its proceeds on death will be transferred by the life insurance company to a nominated beneficiary. The wrapper, therefore, does not have to be administered by the executor of a deceased estate, resulting in a saving of executors' fees. On the other hand, the wrapper and all growth on the investment continues to form part of the individual's estate and is included in the deceased estate for tax purposes. No saving is achieved for estate duty purposes in South Africa. The administration of the wrapper comes at an additional cost, usually between 0.3%-0.4% of the assets held, which is a relevant factor when comparing costs of various options.
3. Offshore trust
The last option explored in this article, is investing in an offshore trust where assets are administered by appointed trustees. FNB International Trustees ('FNBIT'), based in Guernsey, will perform this role when an offshore trust is established for our investors. An offshore trust, such as a South African trust, is a separate legal entity where assets are administered by the appointed trustees for the benefit of the beneficiaries identified in the trust deed.
One of the important characteristics of a trust is that the assets are no longer owned by the investor and investment decisions are ultimately made by the trustees. We recommend that the person establishing the trust, often the investor, provides FNBIT with a Letter of Wishes. This will provide guidance to the trustees as to how they wish the assets to be dealt with after their death. As the assets are administered for the benefit of the beneficiaries, there is scope to provide inputs on how assets are invested and what factors FNBIT should consider in the administration without compromising their discretionary powers.
An offshore trust is a long-term estate planning vehicle and provides flexibility to accommodate the dynamic circumstances of the investor, their family and the ever-changing world. The trust can be used to consolidate the wealth of the investor and can hold assets in various jurisdictions around the world, such as company shares in the US or fixed property in the UK. With recent exchange control changes, the offshore trust will now also be able to hold South African assets. The benefit of using a trust is that the assets are protected from the risks associated with an individual estate. The assets, including the growth of the assets, do not form part of the investor's estate and by holding assets outside of the individual's estate, death taxes can be reduced over time. The trust will have the ability to mitigate situs tax risks, either by holding the assets directly in the trust or by making use of an investment holding company, depending on the circumstances.
Another important realisation is that although there are clear estate planning benefits for an offshore trust, it is not a magic wand that can make taxes disappear. Just as the other structuring options have tax implications, the methods of transferring assets into a trust will have tax implications that should be considered. Assets can either be donated or loaned to the offshore trust. Where assets are donated to a trust, donations tax would apply, depending on the donation amounts, and other income tax rules could also be triggered. The assets would then no longer be part of the individual's estate. Where assets are loaned to the trust, which is more often the funding method used, the loan remains an asset in the estate of the investor. It is advisable that the loan attracts market related interest, which is taxable on an annual basis in the hands of the lender. Where the loan is denominated in foreign currency, such as USD or GBP, the market-related interest would be linked to the interest rates of the relevant currency. This option therefore requires tax reporting and administration on the part of the person making the loan.
Another benefit of the offshore trust is that the trust is effectively administered and tax resident in Guernsey, and thus benefits from the tax neutrality in Guernsey. In practical terms this means that the investment would not suffer any taxes in Guernsey. Whilst the assets are invested in the structure, the investor should not have South African tax implications on the investment, as it is no longer owned by the investor, but owned by the trust. This provides an ideal structure to grow the investments for generations to come and the Funding Tool illustrates what this benefit looks like over the long term.
The investors' tax implications are on the loan mentioned above, and further tax implications should be considered when receiving distributions from the trust or where an interest free loan has been used. Depending on the specific planning, the loan implications might no longer be relevant for future generations, providing an ideal investment growth structure to the beneficiaries of the trust. It is again advisable to discuss the tax implications of funding an offshore trust with a tax practitioner.
"But what is the cost of an offshore trust?"
This is usually the next question of any investor. There is often a perception that offshore trusts are unaffordable and in order to avoid this perceived cost, investors may seek other alternatives that might not speak to their needs. Contrary to popular belief, an offshore trust can be very cost effective, especially considering the role it plays in a wealth preservation plan. The cost would typically depend on the assets held and the level of administration that is required from the trustees.
Where the trust is used to hold an investment portfolio, the administration fees offered by FNBIT typically range on a decreasing sliding scale from 0.5%-0.1%, depending on the investment amount and the nature of the investment. What differentiates FNBIT from competitors in the market, is that some of the fee options include all the general administration of the trust. Without activity-based fees on these fee options, transparency and certainty is provided, and investors will not be surprised by an invoice at the end of the year.
With investment amounts more than R20million - where the trust will typically benefit from the lower end of the sliding scale - trustee administration costs can be significantly lower than other investment options referred to above. With more complex structures and assets, trustee administration fees would typically be charged on a time-spent basis.
It is clear that the options available have different characteristics and any investment decision should ideally be taken within the context of an investor's estate planning strategy and their specific needs.
If an investor wants to retain complete control of the assets, for instance, a trust may not be appropriate. If the investor is looking for a flexible long-term generational structure maximising the assets available over one and two generations, it is likely that a trust will fit the bill.
Any decision should thus be approached with a clear understanding of the assets available and the investor's current and future objectives.
Key takeaway
The benefit of using a trust is that the assets are protected from the risks associated with an individual estate.
Offshore trusts managed by FNBIT are effectively administered and tax resident in Guernsey, and thus benefit from the tax neutrality in Guernsey.
FNB International Trustees FNBIT Registration No. 3080. Licensed by the Guernsey Financial Services Commission to conduct Fiduciary Business. FNBIT is a member of the FirstRand Group.
