The nature, benefits and availability of off-shore investments becomes increasingly attractive to South African investors. Investing in an off-shore portfolio means diversifying risk in terms of currency and a country’s political and economic stability. Investors are no longer limited to a local market but have the choice of investing where they perceive the best opportunities are for a good return on their investment. It therefore becomes more important to consider the protection and taxation of such investments for a South African resident or entity.
South Africa applies a residence-based system of taxation. Therefore, any world-wide receipts or accruals of a resident must be included in the resident’s taxable income in the financial year that the amounts are received or accrues to the taxpayer. The term “resident” is defined in section 1 of the Income Tax Act, hereafter referred to as the Act, and may be a natural person, company, close corporation, trust or any such entity established or formed within South Africa.
In case of a trust, or any other non-natural person, its residency is established by either:
(a) being incorporated, established or formed in South Africa, or
(b) because it has its place of effective management in South Africa.
Thus a trust registered with the Master of the High Court in South Africa will assume the status of a resident. To determine what is meant by effective management is a factual matter and all circumstances relating the administration of the entity will be taken into account, such as where the trustees resides and/or makes and implements decisions. The place where the assets of the trust are effectively managed is crucial.
Once it has been established that a trust registered in South Africa is a resident and taxed as such, we need to cross the next obstacle, that of double taxation on off-shore investments. This will incur when the receipt or accrual is taxed in both the country of residence and the country in which the investment is made. For example, the trust buys a property off-shore, the rental income will be taxed in South-Africa but will also be subject to taxation in the country of investment. Relief from double tax can take the form of either:
– Unilateral relief: where one of the countries grants tax credit for taxes already paid, or
– Bilateral relief: where the countries enter into Double Taxation Agreements to provide such relief to taxpayers.
It is very important that the investor be familiar or informed on the different tax options and consequences when making the off-shore investment. It is not surprising that more investors opt for structures such as off-shore trusts or hybrid companies. The creation and administration of off-shore entities are more costly and need to be set up with careful consideration of the provisions in the Act regulating accruals from such entities to residents.
Section 25B of the Act regulates capital distributions from off-shore trusts and provides that any off-shore trust’s accumulated non-capital profits must be included in a South African resident beneficiary’s income for income tax purposes. Therefore if a resident is a beneficiary of an off-shore trust, obtains a vested right to the capital of the trust and the capital is accumulated profits which have not been taxed in South Africa in any previous year of assessment, then that capital must be included in the income of the resident beneficiary in the year that it acquires the vested right. The ambit of this provision is very wide and effectively allows SARS to convert capital to income and include it in the taxation of a beneficiary even if the monies were never paid to that beneficiary.
Setting up an off-shore company has its own pitfalls. In terms of section 9D of the Act a resident is taxed on his portion of the income of a foreign company. This section was enacted to prevent the avoidance of taxation by residents using such entities as intermediaries. Such taxation is triggered when the company is seen as a Controlled Foreign Company (CFC). This is a an off-shore company in which a South African resident, directly or indirectly, holds more than 50% of the shares or more than 50% of the voting rights.
In light of the above it is evident that although off-shore investments has its advantages and appeals, it is very important that the entities used as vehicle for such an investment and how your South African trust is incorporated into such structure, be done with careful consideration and assistance from qualified professionals.