Product choice used to be a binary decision with investors opting for one over another after considering the pros and cons that each offer. But as financial planning needs have become more sophisticated, advice has evolved, and many clients use products in combination with each other.
This has been enabled by the evolution of platform pricing whereby client and family level pricing allows for splitting of investments between different products and/or family members and movement between these products – without cost implications as circumstances change.
In one of our most recent Ninety One Masterclass webinars focusing on advanced advisor solutions, we introduced the audience to a case study featuring a client ‘Peter’ and his offshore investments to highlight this point. He is a 57-year old South African tax resident. Peter is single, has never married, and is godfather to his nephew (based in the UK) and two nieces (based in SA). In the webinar, we focused on a number of different elements of Peter’s offshore investments, but for the purposes of this article, we will only consider his $500 000 global share portfolio. He has held these shares for a number of years and experienced meaningful growth on the underlying shares. The new advisor was originally concerned about situs tax (estate duty in foreign jurisdictions). But after digging deeper into his circumstances, he determined that the source of the funds for the share portfolio was an inheritance that Peter received from a non-resident family member.
Red lights started flashing for the advisor who recognised that this brought section 4(e) of the Estate Duty Act into the equation. This states that any asset, situated outside SA, which was received either by way of donation or inheritance from a person, who at the time of the donation or date of death, was not ordinarily resident in the Republic, would be excluded from their SA estate for estate duty purposes.
The issues relating to situs can be problematic for any South African tax resident, but they become more pronounced under these circumstances. So, while Peter wasn’t exposed to estate duty here in SA on this particular asset, this did not mean that it would be free of inheritance tax in other jurisdictions. The high exposure to US shares within his portfolio meant that this asset would have significant exposure to US estate tax on his death.
Figure 1 identifies the risk that this poses to the capital value that can be inherited from Peter on his passing. The cumulative impact of fees and taxes associated with his current investment structure means that more than 50% of the capital value could be lost on his death.
Figure 1: Global share portfolio – assessing the risks that the current situation poses
Source: Ninety One calculations. For illustrative purposes only.
Another challenge associated with the process of probate and situs in the US is that the grant of probate (document required to release assets from the estate) cannot be issued until the inheritance tax bill has been paid. This can create a catch-22 situation if a person is relying on the asset to cover the estate tax liability.
Once Peter got over the initial shock, his advisor informed him that these challenges could be fixed but that in order to do so, he would need to incur capital gains tax (CGT). While Peter was not keen to pay the tax, he understood that CGT would be payable one day on this asset anyway and that the outlay for CGT was a fraction of the value of his exposure to situs. He also understood that by incurring CGT he could reset his base cost and move to a structure whereby his estate duty implications could be reduced to zero from close to 40% where it sits today.
The advisor then opened up the Ninety One ‘Offshore palette’, discussing the product options available to him.
1 Sell shares and move to Ninety One Global Investment Portfolio
The Ninety One Global Investment Portfolio is a flexible investment that is designed with South African tax residents in mind. The product is tax neutral, meaning the returns are taxed in the hands of the individual investor in whatever jurisdiction they reside. However, the South African nominee structure can be problematic on death for non-SA tax residents.
What are the pros and cons of moving to this product?
| Pros | Cons | |
|---|---|---|
| CGT to move | ||
| Foreign situs tax eliminated (not possible to hold situs assets) | ||
| South African estate duty applicable due to SA nominee structure | ||
| Succession can be dealt with via South African will | ||
| Executor fees applicable | ||
| CGT on death as the benefit is passing to someone other than a spouse |
Figure 2: Move to Ninety One Global Investment Portfolio
Source: Ninety One. For illustrative purposes only.
As you can see, the value that would be available to his family on death is higher than it would have been if he continued to hold his shares directly. However, in our view, this product may not be suitable because the South African nominee structure makes this a South African situs asset, which would bring it back into his SA estate again.
2 Sell shares and move to Ninety One International Investment Portfolio
The Ninety One International Investment Portfolio is a fully flexible investment designed for investors who have ceased or are ceasing to be South African tax residents. It may also be suitable for a client’s adult children living abroad where their SA advisor is still looking after the family’s affairs.
What are the pros and cons of moving to this product?
| Pros | Cons | |
|---|---|---|
| CGT to move | ||
| Foreign situs tax eliminated (not possible to hold situs assets) | ||
| South African estate duty avoided due to Guernsey nominee company – he shouldn’t have to pay due to section 4 (e) | ||
| Succession can be dealt with via South African will | ||
| Executor fees applicable on death | ||
| CGT on death as benefit passing to someone other than a spouse |
Figure 3: Move to Ninety One International Investment Portfolio
Source: Ninety One. For illustrative purposes only.
While the product is primarily designed for non-South African tax residents, it becomes incredibly useful for Peter for two key reasons. Firstly, because the nominee structure ensures that the asset will not sit in his estate in South Africa (due to section 4 (e) of the Estate Duty Act) or abroad. And secondly, because the structure makes it suitable to leave this asset to his nephew who is based in the UK.
3 Sell shares and move to Ninety One Global Life Portfolio
The Ninety One Global Life Portfolio is an offshore sinking fund policy that provides tax and estate planning benefits.
What are the pros and cons of moving to this product?
| Pros | Cons | |
|---|---|---|
| CGT to move to wrapper | ||
| Foreign situs tax eliminated – even if he continues to hold the shares via the wrapper (life company cannot die) | ||
| South African estate duty avoided due to section 4 (e) | ||
| Ability to nominate beneficiaries (primary and alternative) | ||
| Rollover for CGT on death where the beneficiary takes over the policy, life company remains the owner | ||
| No executor fees due to beneficiary nomination |
Figure 4: Move to Ninety One Global Life Portfolio
Source: Ninety One. For illustrative purposes only.
A comparison of the four graphs shows that the Ninety One Global Life Portfolio (Figure 4) has the greatest ability to preserve value on death.
So what did Peter do?
While on paper the Ninety One Global Life Portfolio appears to provide the best financial outcome, Peter needed to consider his family circumstances to come to a decision that would work for him. As a South African taxpayer in its own right, a policyholder fund is a great vehicle for a South African tax resident. However, it is less suitable for those who reside outside of the Republic as it could result in taxation in both jurisdictions. Depending on where the beneficiary resides, it can also be treated as income on death or as a Personal Portfolio Bond resulting in deemed capital gains on an annual basis.
On this basis, Peter decided that he would direct the proceeds of the sale into the Ninety One International Investment Portfolio and leave this asset to his nephew in the UK via his SA will. At the same time, he structured his other assets for the benefit of his nieces based in South Africa.
While the above highlights the inherent complexity of offshore investments, it demonstrates that these product decisions do not have to be permanent. Product providers with a broad ‘palette’ of investment product structures provide flexibility to cater for changes in personal or family circumstances. When dealing with offshore inheritance taxes, investors like Peter need to seek guidance from professional advisors to best tackle these challenges.