Diversifying your investment portfolio internationally can offer you better risk-return characteristics over time and give you access to opportunities that are not available locally. In fact, we encourage clients to take a global view of their wealth. An international trust can help protect your global investments from costs such as estate duty. It is however important to understand the tax implications of international trusts for South African residents.

The easing of exchange controls has made international investing more accessible
There has been a gradual easing of exchange controls over the past 20 years. In the past, international exposure was mostly gained indirectly (where the proceeds must ultimately be returned to South Africa and paid in rand), in one of two ways:

1. investing in South African-based companies that have dual listings; or
2. investing via an institutional foreign investment allowance (known as ‘asset swap’ investments).

Today, South African resident individuals can obtain ‘direct’ exposure to international investments using the following exchange control allowances:

• R1 million annual discretionary allowance that can be used for various purposes (for example as a travel allowance); the unused portion can be used for investment purposes
• R10 million annual individual foreign capital allowance

In addition to this, the South African Reserve Bank is considering applications submitted on behalf of individuals to obtain permission to employ additional amounts – over and above these amounts – internationally.

South Africans must declare their global income and capital gains for tax purposes
South African residents are taxed on a residence-based system of taxation when investing internationally. This means that no matter where in the world your assets are situated or how they were acquired, you will be taxed on, and obliged to declare, your global income and accruals (capital gains).

You are also liable for estate duty on your international assets
South African residents are, with relatively few exceptions, liable for South African estate duty on their international assets, including assets acquired using the investment allowance facilities. Many South Africans are not aware of this fact, or the impact it can have. Estate duty rates in South Africa are currently at 20%, and these rates may increase even further while the rand depreciates. This means the rand value of international investments for estate duty purposes will likely increase over the years, thereby increasing liability to estate duty.

An international trust can help protect your international investment from estate duty liabilities
In light of this increasing liability, it is important to consider ‘pegging’ the value of the assets in rands for South African estate duty purposes. This can be achieved by setting up an international trust.

In addition to ‘pegging’ the value of the assets in rands, international trusts offer several other advantages:

• Continuity: The death of the settlor has no effect on the ongoing management of the trust or the trust assets.
• Orderly distribution after death: Probate formalities (including the related cost) as well as the attendant freezing of assets (possibly for a prolonged period) while the estate is being administered are avoided.
• Flexibility: The trust can be structured at the outset to allow for changes in regulations and best practice.
• Protection for dependants: This includes financial protection for minors or those with disabilities as well as planning for the education of children or grandchildren of the settlor.
• Protecting assets from seizure: The legal ownership is that of the trust and not the individuals, which makes seizure more difficult.
• To mirror South African planning: Due to exchange control regulations, South African trusts may not own direct international assets. This means an international trust is required for exactly the same reason why a South African trust is established.

It is advisable for an international trust to be managed offshore for tax purposes
If the ‘place of effective management’ of the international trust is not in South Africa, then the international trust will not be a taxpayer in its own right. It is therefore advisable to ensure that all trust-related decisions are taken and implemented by the trustees outside of South Africa. This includes all investment-related decisions as well as the implementation of these decisions.

Understanding how donations and loans are taxed is important
An international trust can be settled by way of a donation or a loan. With relatively few exceptions, a donation is taxed at 20%. The first R100 000 of the donation is free of donations tax. It is important to remember that the interest forgone on interest-free loans is treated as a donation and is subject to donations tax. In so far as South African trusts are concerned, this is the result of the recent introduction of section 7C of the Income Tax Act, which we wrote about in a previous edition of Fiduciary Focus. Loans to international trusts that fall into the definition of ‘affected transaction’ are however subject to section 31 of the Income Tax Act (see below).

South African residents are taxed in their own hands when involved with an international trust
According to current South African tax legislation, South African resident individuals are taxed in their own hands whenever they are involved with an international trust, whether it is as a funder and/or beneficiary. This is accomplished in three ways, depending on the role of the South African resident and the nature of the tax trigger:

1. Attribution provisions – triggered by donations (section 7(8) and/or paragraph 72)

• This applies when a South African resident is a funder of an international trust and makes a ‘gratuitous disposal’ such as a donation to the trust and the trust earns taxable income.
• Although an interest-free loan is not in itself a donation, the interest forgone (interest that could have been charged on the loan) could be viewed as a donation.
• Where a South African resident therefore enters into an interest-free loan with an international trust, any actual income earned or any realised gains will be attributed to the South African lender, but limited to the extent of the interest forgone. The same principle applies when the trust pays interest at a rate lower than the official interest rate.
• By paying the donations tax on the interest not charged, the gratuitous element of the disposition will have been eliminated by the operation of section 31, which removes the element of gratuitousness (donation, settlement or other disposition) that is necessary to trigger the attribution provisions.

2. Conduit principle (section 25B and paragraph 80)

• This applies when a South African resident is a beneficiary of an international trust and receives a distribution comprising taxable income from the trust, eg realised gains, interest, foreign dividends or property rental.

3. Transfer pricing provisions (section 31)

• This applies to any transaction, operation, scheme, agreement or understanding between a South African resident and an international trust with which the resident is involved (known as an ‘affected transaction’) that results in a tax benefit.
• The taxable income or tax payable from the tax benefit must be calculated as if the transaction had been entered into on terms and conditions that would have existed had those persons been independent persons dealing at arm’s length.
• The difference between any amount linked to the tax benefit and any amount that would have applied must be deemed to be a donation made between the resident and international trust. (This means the impact is very similar to the impact of section 7C as it relates to loan agreements, where the trust fails to pay interest on the loan or pays interest at a lower rate.)

Important considerations when applying an interest rate to a loan
Where interest is actually charged on a loan, the interest charged will be taxed in the South African lender’s hands. Where interest is charged at the official rate of interest there would be no tax benefit or ‘gratuitous disposal’. This means neither the transfer pricing provisions nor the attribution provisions would apply.

The following should be considered when applying an interest rate to such a loan:

• The actual interest rate is a function of the currency of the loan.
• Any interest accruing to a South African resident will be fully taxable in the resident’s hands.
• The loan is an asset for the purposes of calculating estate duty. Therefore, if the interest is capitalised on the loan – that is, the interest is not physically paid – the value of the loan will increase.

Please contact your relationship manager if you have any questions or if you would like to arrange a meeting with a fiduciary specialist for expert advice on international trusts.
 

Click on the links below to view the other articles online:

Estate planning > read more
Understanding the tax implications of buying a UK residential property

International > read more
The changing regulatory environment – no place to hide

Wills > Read more
Owning assets in a foreign country – is there a need to have a separate will?

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Disclaimer
The Fiduciary Focus Newsletter is intended for general information purposes only and should not be construed as tax, legal or accounting advice. This communication is based on our bona fide interpretation of legislation, rules, regulations and publications. Nedbank Private Wealth provides estate and tax planning advice; however, we do not provide tax, legal or accounting advice and you are requested to consult a professional tax advisor or professional in this regard.