In view of the relaxation in exchange control announced by the Minister of Finance in the Medium-Term Budget Policy Statement, presented to Parliament during October 2009, South African residents may now invest up to R4 million abroad. Questions are often raised as to the fiscal consequences of making an investment abroad and, furthermore, the manner in which such investment should be structured. In addition, it must be remembered that during 2003 qualifying persons were allowed to apply for exchange control and tax amnesty, which attracted approximately 43 000 applications. The window period for applying for amnesty has long since passed, but the tax consequences flowing from the applications submitted to the authorities are complex and are often misunderstood. This article seeks to identify some of the issues that should be considered when reviewing the tax consequences arising out of funds owned by an off-shore trust, for which the donor applied for and received amnesty, as well as the consequences facing a South African investor choosing to place their foreign investment allowance in an off-shore trust.
exchange control
Currently, as pointed out above, private individuals who are taxpayers in good standing and over the age of 18 years, may invest up to an amount of R4 million outside the Common Monetary Area ("CMA"), comprising South Africa, Lesotho, Namibia and Swaziland. It must be remembered that before the funds may be transferred from South Africa to the foreign country, the investor must obtain a "tax clearance certificate (in respect of foreign investments)" from the South African Revenue Service ("SARS"), which is to be presented to the investor’s local bank.
Besides the R4 million foreign investment allowance, exchange control is prepared to consider applications by private individuals to invest in fixed property located in member states of the Southern African Development Community, comprising Angola, Botswana, Democratic Republic of the Congo, Lesotho, Malawi, Mauritius, Mozambique, Namibia, South Africa, Swaziland, Tanzania, Zambia and Zimbabwe. Income earned on the foreign investments made under the allowance available, may be retained abroad by South African residents and there is no requirement to inform the exchange control authorities of such income. Clearly, the income will attract South African tax which requires the investor to disclose that income for tax purposes to SARS.
South African investors are, under no circumstances, allowed to utilise the foreign investment allowance or any other funds held legitimately abroad for the purpose of re-investing those funds directly or indirectly back into the CMA for any purposes whatsoever. Thus, a South African investor is, therefore, prohibited from advancing funds from South Africa to a foreign trust with the purpose of on-lending those funds to a South African entity or individual.
South African companies are now permitted to invest up to R500 million abroad. An application must, in such cases, be submitted to an Authorised Dealer, that is, the Exchange Control Department of the company’s commercial bank. It must be noted that the allowance is only available to South African companies and is aimed at encouraging the expansion of South African operations in foreign countries.
The purpose of the allowance available to companies is not to allow natural persons to invest in passive investments personally, but is aimed at encouraging South African companies, creating similar operations to those in place in South Africa, in a foreign country for the ultimate benefit of the South African economy.
donations tax
It must be pointed out that should the South African resident choose to contribute the foreign investment allowance to an off-shore trust, donations tax will become payable on the funds so donated in accordance with section 54 of the Income Tax Act, Act 58 of 1962, as amended ("the Act").
Currently, the first R100 000 of donations made by a taxpayer are exempt from donations tax in accordance with section 56(2)(b) of the Act. Thus, were the investor to donate their foreign investment allowance of R4 million to a foreign trust, donations tax would be payable at the rate of 20% on the amount of R3.9 million, that is, donations tax of R780 000. Under section 56 of the Act, the donations tax is required to be paid to the Commissioner: SARS within three months or such longer period as the Commissioner may allow from the date on which the donation takes effect. It is, therefore, not in the interests of the investor to donate funds to a foreign trust as this will result in donations tax becoming payable.
loan of funds by South African resident to foreign trust or company
Instead of donating the funds to a foreign trust, the South African resident may advance the funds to either a foreign company or trust. In these circumstances, it is important that the South African resident receives interest on the loan advanced to the foreign entity, at a market-related rate, which interest will be taxable in South Africa. Where the investor fails to levy interest on the loan advanced to a foreign entity, the provisions of section 31 must not be overlooked. The effect of section 31, which contains the transfer pricing and thin capitalisation rules, will result in the South African investor being taxed on imputed interest equal to a market-related rate of interest that would be charged by a resident to a non-resident as if such persons were dealing on an arm’s length basis. Thus, the investor should either charge the foreign entity interest at a market-related rate or will be subjected to tax on deemed interest under section 31 of the Act.
deeming provisions contained in section 7 of the Act
Where the investor makes an interest-free loan available to a foreign trust, SARS can rely on section 7(8) of the Act to deem any income derived by the foreign trust to be taxable in the hands of the investor. Thus, if the foreign trust receives the foreign investment allowance from the South African resident via an interest-free loan and acquires fixed property from which rentals are earned or purchases interest-bearing bonds, the income derived by the trust will, in such circumstances, fall to be taxed in the hands of the investor in South Africa.
investment in a foreign company
Where the investor chooses to acquire shares in a foreign company and that company utilises the funds received from the foreign investment allowance to acquire foreign assets, any income derived by that company will, generally, under the controlled foreign company rules contained in section 9D of the Act, be fully taxed in the hands of the investor in South Africa. As pointed out above, if the investor makes an interest-free loan available to a foreign company in which they are interested, the investor will be deemed to have received interest at a market-related rate under section 31 of the Act.
attribution rules contained in the Eighth Schedule to the Act
The Eighth Schedule to the Act, contains the so-called "attribution rules" which mirror the deeming income rules contained in section 7 of the Act. Thus, where an investor makes an interest-free loan available to a foreign trust and the trust realises a capital gain on the disposal of assets owned by it, that gain may, in certain circumstances, be attributable to and thus taxed in the hands of the South African investor. This is in accordance with the provisions contained in paragraph 72 of the Eighth Schedule to the Act. The attribution rule applies where a resident has made a donation, settlement or other disposition to any person which is not a resident. The rule will apply where the investor makes an out-and-out donation to a trust, or advances funds to a non-resident trust on an interest-free basis. Where the capital gain is attributable to a donation settlement or other disposition, the gain will fall to be taxed in the hands of the South African resident investor.
capital gains tax ("CGT") on the realisation of foreign currency assets
Where the South African investor acquires foreign assets personally, and subsequently disposes of those assets, CGT will arise on the gain realised on the disposal of those assets. In addition, if the proceeds received on the sale of the foreign assets are retained abroad, and returned to South Africa at a time when the Rand has declined in value, a further capital gain will arise which will fall to be taxed in accordance with the rules contained in paragraphs 84 to 96 of the Eighth Schedule to the Act. The rules regulating the CGT consequences on the realisation of foreign currency assets are complex, and fall beyond the scope of this article. However, investors need to be aware of the fact that where funds are held in one currency and converted into another, CGT will become payable in South Africa on such an event. Furthermore, as and when foreign assets are repatriated to South Africa, CGT will arise should the base cost of the foreign currency asset be less than the proceeds received at the time that the assets are converted into South African Rand.
estate duty
Where the investor chooses to invest in foreign assets personally, any increase in value of the foreign assets will constitute part of the estate of the person upon their death. Where funds are advanced to a foreign trust or a foreign company owned by a foreign trust, the growth in the assets will not belong to the investor in South Africa personally and will, therefore, not constitute part of the person’s assets for estate duty purposes. It must be remembered that where a person received amnesty pertaining to assets owned by a foreign trust, the fact that amnesty was obtained does not detract from the fact that the foreign assets are owned by a foreign trust and, which, therefore, fall outside of the natural person’s estate for estate duty purposes on that person’s death.
Where the investor acquires the foreign assets personally, any increase in value in the foreign assets will, therefore, attract estate duty on the death of that person.
amnestied trusts and assets for which amnesty was obtained
Applicants who received amnesty on foreign assets owned personally or via a foreign trust must not overlook the fact that any income derived on those foreign assets continue to be taxable in South Africa. The income derived by a foreign trust for which amnesty was obtained will fall to be taxed in South Africa so long as the amnesty applicant remains alive. Upon the person’s death, the person is deemed to have disposed of the assets owned by the trust for CGT purposes and any income received by that trust after the death of the person, will no longer fall into the South African tax net. Thus, any income or capital gains realised by a foreign trust for which amnesty was secured, continues to be taxable in South Africa whilst the applicant is alive.
Once the amnesty applicant passes away, the beneficiaries of the foreign trust will only be taxable in South Africa to the extent that they receive amounts from the trust, which have not previously been taxed in South Africa. It is important that the trustees of the foreign trust disclose the nature of awards to beneficiaries in South Africa so that those persons may properly comply with the tax laws of the country. Clearly, where the beneficiaries receive income from the foreign trust which was not previously taxed in South Africa, such income will fall to be taxed in this country. Where, however, the awards relate to amounts taxed in the hands of a deceased amnesty applicant, no further tax can arise on such amounts. Where the beneficiary receives the award of capital gains realised by the foreign trust on the disposal of foreign assets, such amounts will attract CGT in South Africa at a maximum rate of 10%. The trustees of the foreign trust should, therefore, ensure that they make adequate disclosure to beneficiaries in South Africa so that they fully understand the nature of awards received for tax purposes in South Africa.
conclusion
The increase in the foreign investment allowance from R2 million to R4 million represents an opportunity for South Africans to invest reasonable sums abroad. It is important when deciding to invest off-shore, that the investment is structured correctly so as to manage the income tax and estate duty consequences that will arise from that investment. Furthermore, the CGT rules relating to foreign currency assets are complex and must not be overlooked.
Beric Croome - Executive
