In recent years, South African residents have increasingly invested offshore due to the easing of foreign exchange control regulations. These investors often use offshore investments to safeguard wealth for future generations.
But preserving wealth isn’t just about the returns you generate during your lifetime – it’s also about setting up structures that minimise fees and taxes on death. As the world becomes more interconnected, offshore financial planning becomes more complex, exposing investors to costs and processes they may not be aware of. One of the most significant concerns in offshore investments, with implications that can severely reduce value upon death, is situs.
What is situs?
Situs, Latin for ‘position’ or ‘site’, refers to where an asset is legally considered to be located and determines which jurisdiction has the primary right to tax the asset upon the owner’s death. Situs assets typically include cash, equity, immovable property, or companies incorporated in a jurisdiction or where the share register is maintained. Many countries levy situs taxes, but rates vary. For South African investors, exposure to UK cash, UK shares, and US shares is particularly problematic because the top inheritance tax rates in these jurisdictions at 40% are significantly higher than South Africa’s 20-25%.
Tax implications for South African residents
Upon death, South African resident’s worldwide assets are subject to estate duty. In South Africa, estate duty is currently levied at 20% for estates under R30 million and 25% for values over R30 million. However, the UK and the US also levy estate duties on certain situs assets. This means the South African estate may be liable for foreign inheritance taxes on offshore assets, depending on the situs asset rules of the foreign jurisdiction.
Types of assets and nil bands
To mitigate the effects of double taxation, South Africa has entered into double taxation agreements (DTAs) with several countries, such as the UK and the US. It’s important to note that the credit in respect of a DTA is not automatically applied; it’s the executor’s responsibility to ensure the correct process is followed. Failure to do so may result in paying both the 20%-25% South African estate duty and up to 40% situs tax. The legal liability for not doing so sits with the executor; therefore, they must be aware of any assets where situs would be applicable. Since the advent of FATCA and the Common Reporting Standards (CRS), the chances of evading these taxes have been very low.
Equally important is understanding the types of assets and the wealth levels that expose an investor to situs. The ‘nil band’ (the threshold below which a person is exposed to foreign inheritance taxes) varies by country. In the UK, the nil band for inheritance tax is £325,000, meaning any amount below that value held in the jurisdiction is free from inheritance tax (though it may still be subject to South African estate duty). A 40% inheritance tax is levied on situs assets over £325,000. The circumstances under which spouses receive exemptions are complicated in the UK and relate to the residency of both owner and beneficiary, requiring scrutiny.
Many global share portfolios have substantial exposure to US assets, subjecting non-residents to high estate taxes in the US. Exposure to situs tax is often greater on US assets as the nil band in the US is only $60,000, with taxes calculated on an 11-tier sliding scale. The US only provides a spousal exemption for US citizens, often creating unexpected tax liabilities for South African families when the benefit passes between spouses on death.
But what does this mean for investors?
Consider Gloria, a client who holds $1 million in a direct global share portfolio with 70% exposure to US equities. If Gloria were to die tomorrow, her estate would face approximately 33% estate tax on her US equities, despite having a South African spouse who could inherit from her (usually a rollover event for South African estate duty). As Gloria’s assets grow, this problem will worsen, and in time, her holdings may reach a point where 40% US estate tax is due. However, Gloria’s initial investment value was $500,000, making restructuring her investments difficult due to the capital gains tax (CGT) implications.
Figure 1 shows the trade-off between paying CGT now and moving the shares or proceeds to a policy wrapper like the Ninety One Global Life Portfolio, where situs will no longer apply, versus retaining her current structure.
Figure 1: Impact of paying CGT now versus situs tax later
Source: Ninety One.
Where the benefit changes hands twice on death, once to a spouse and then to the next generation, there is a considerable benefit to moving to the policy wrapper (Global Life Portfolio).
Key findings
- The initial CGT outlay to move means the policy wrapper starts with a lower value.
- When Gloria dies and the benefit passes to her South African spouse (point 1), the South African Estate Duty Act applies, making it a rollover event.
- The relative preservation of value compared to the direct portfolio is significant.
- When her spouse dies (point 2), the policy will be an asset in his estate, with South African estate duty applied at a maximum rate of 25% versus a maximum of 40% for direct US shares.
- The difference in end value equates to an additional 2.5% p.a. over the full 20-year period, leading to a much higher value for the second generation.
An offshore trust may also serve as a blocker for situs taxes, but this is not always effective. For instance, the UK introduced legislation imposing a 10-year anniversary charge on trusts. This results in taxing situs assets exceeding £325,000 at a flat rate of 6% every ten years where the settlor was not UK-domiciled when the trust was established. The legislation around this is incredibly complex and extends beyond the scope of this article.
Ninety One global products and foreign inheritance tax
Ninety One Global Investment Portfolio
South African estate duty and foreign inheritance tax on foreign assets may be payable depending on the situs asset rules of the applicable jurisdiction and the type of underlying investment held. While using a local nominee company can help investors avoid offshore probate, it does not offer protection from foreign inheritance tax as situs looks through the nominee company. Foreign tax authorities regard the investor on whose behalf the nominee company holds the investment as the beneficial owner. Consequently, Ninety One has decided not to offer shares via the product to ensure the situs tax does not apply to South African investors.
Ninety One Global Life Portfolio
No foreign inheritance tax will be payable on the death of a South African resident investor.
Ninety One Global Life (sinking fund) Portfolio
Serves as a ‘situs-blocker’ when investing in direct share portfolio holdings - the investor is not the owner of the underlying assets but owns a policy issued by IAL acting through its Guernsey branch. No inheritance tax is currently payable in Guernsey, where the product vehicle is domiciled. However, South African estate duty may be payable by the deceased estate of the South African resident investor.
Ninety One International Investment Portfolio (IIP)
The estate duty implications for the IIP depend on the investor’s jurisdiction. We have actively ensured that it is not possible to hold situs assets via the product, meaning inheritance tax outside their jurisdiction is not applicable.
The importance of professional advice
Situs taxes, with their intricate technical underpinnings, significantly impact investment outcomes. Understanding the complexities of situs taxation reveals a landscape of nuanced rules, jurisdictional variability, and asset-specific considerations. Investors can optimise situs tax management by navigating this terrain with technical insights enhancing their investment strategies, product, and trust structures.
Offshore investments are complex from an estate duty and foreign inheritance tax perspective, with rules varying by jurisdiction. Historically, the focus has been on the type of investment instruments used. However, as demonstrated, the wrong structure can undo these returns many times over on death.