What taxes do I pay when I invest offshore?
Investing offshore allows you to diversify your portfolio and benefit from a broader universe of investment ideas, but what about the tax you may have to pay? As with any investment, it is important to get the full picture before you make any decisions. When you invest offshore, the tax you may be required to pay depends heavily on the way you choose to invest.
You get some offshore exposure when you invest in local unit trusts that are mandated to invest a percentage globally, and many of the companies listed on the JSE have operations around the world. But if you want more offshore exposure there are two ways to achieve this goal: invest in a rand-denominated offshore unit trust offered by a local manager or invest directly in foreign currency with a foreign manager or through an offshore platform. Each route has different benefits and downsides, and it is critical that you consider these carefully.
1. You use rands to invest in rand-denominated offshore unit trusts
- You use your investment manager’s offshore allowance. When you invest in rands, you are not required to obtain a tax clearance certificate from the South African Revenue Service (Sars). Managing foreign exchange headaches like this becomes your unit trust manager’s problem.
- You pay capital gains tax (CGT) on all gains. You pay tax on all gains on your original rand investment, regardless of whether those gains are from capital growth or currency movement.
- You pay tax on interest and dividends. Foreign dividends are included in your taxable income and are taxed at an effective rate of 20%. The full value of foreign interest is included in your taxable income.
2. You use foreign currency to invest in foreign funds
- You use your own foreign investment allowance. You can take up to R1 million offshore annually without having to apply for a tax clearance certificate, but if you want to invest more, you will have to apply for tax clearance from Sars.
- You may save on CGT. You don’t pay tax on currency movement while you are invested. When you sell assets bought in a foreign currency, the foreign capital gain or loss is first calculated and then translated into rands using either the average exchange rate (available on the Sars website) or the exchange rate on the date of sale.
This is easier explained with an example: you buy an investment in a foreign fund for $1m when the exchange rate is R10 to the dollar with a lump sum of R10m. A year later, you sell the investment for $1.5m when the exchange rate is R8/$ (in other words, the rand strengthened), which gives you R12m. The gain amounts to $500 000, which, for tax purposes, is converted at R8/$. Therefore the capital gain on the sale is R4m ($500 000 x R8). However, the commercial gain is only R2m [proceeds of R12m ($1.5m x R8) – cost of R10m ($1m x R10)].
By the same token, investors can reap rewards from currency gains. Taking the same example, but with an exchange rate equal to R8/$ when the units were bought and R10/$ when they are sold, results in a commercial gain of R7m and a capital gain for tax purposes of R5m. The amount not taxed is the change in the exchange rate multiplied by the number of units [$1m x (R10 – R8) = R2m].
In other words, if the rand weakens, it is more tax efficient to be invested directly offshore; if the rand strengthens, it is more tax efficient to be invested in a rand-denominated offshore unit trust.
- You pay income tax on foreign dividends and foreign interest. The tax rate on foreign dividends is 20% and interest on foreign investments is fully taxable.
Is there any way to pay less tax on offshore investments?
South Africa uses a residency-based system to calculate personal tax. This means that South African tax residents are required to pay tax in South Africa on their worldwide income. That said, the tax system does allow exemptions for certain types of income, and double taxation agreements, which give you credit for foreign taxes paid, are in place with many countries.
What happens when you die?
- Death taxes in South Africa. An estate duty of 20% is applied to South African residents’ worldwide assets on death. This includes any investments offshore, regardless of how they were made.
- Death taxes in foreign countries. For assets registered in some foreign countries, you may have to pay estate duties even if you are not a resident of that country. This is the case in the United Kingdom and the US.
- Generally, where inheritance tax or estate tax is levied on an investment by a foreign country, South African estate duty would also still apply. South Africa has double-tax agreements with some countries that make allowance for estate duties so that you don’t have to pay tax twice.
Investing offshore is more complex than local investing; consulting with a good independent adviser can help you to find a plan that works for your circumstances.
Carla Rossouw is tax manager at Allan Gray.
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