This article was first published in the second quarter 2017 edition of Personal Finance magazine.
For South African investors wishing to access global markets and hedge against volatile exchange rates, externalising assets offshore can present great opportunities. However, when planning what companies or funds to invest in, you should consider what the tax implications would be if you were to pass away suddenly. Unlikely as this may be, it always makes sense to ensure that your investments are structured in a tax-efficient fashion and preserved for future generations.
It is well known that double-taxation conventions (DTCs) are in place between South Africa and the United Kingdom and the United States, and these apply to estate duty (known as inheritance tax, or IHT, in the UK and estate tax in the US). Nevertheless, individuals who are domiciled in South Africa and invest in UK or US shares should be aware that there is the possibility of punitive tax rates in the event of the death of the investor. The possibility of an estate getting caught by UK IHT or US estate tax depends on the type of investments, the value of those investments and the beneficiary of the estate.
These examples illustrate the kind of problems that could arise in either jurisdiction.
When an individual dies domiciled in South Africa and owning shares in UK-registered companies listed on the London Stock Exchange, the value of those shares will be subject to assessment for IHT by the UK tax authority.
The current threshold, also known as the “nil rate band”, for which no UK IHT is payable, is £325 000. Subject to certain exemptions and reliefs that might apply, any amount over this threshold is subject to inheritance tax at 40 percent.
A surviving spouse may be able to use his or her predeceased spouse’s nil-rate band and leave up to £650 000 free of IHT. There is also an unlimited spouse exemption.
The following example is designed to illustrate how a share portfolio can be caught by UK IHT:
Robert is domiciled in South Africa and owns a portfolio of individual UK-registered shares valued at £1 million. Robert is not married and plans to pass his estate to his children, so he wants to find out if his UK portfolio is exposed to UK IHT.
In accordance with the DTC between South Africa and the UK, the convention states that shares registered in the UK will be taxable in the UK even if an individual is domiciled in South Africa. So in this case, the UK IHT would be calculated as follows:
• Total value of the UK shares: £1 million
• Less the nil-rate band of £325 000 = £675 000
• Less UK IHT at 40 percent = £270 000
If estate duty were levied in South Africa as well, Robert would be able to apply for a credit from the South African Revenue Service (Sars) up to the value of the estate duty paid in the UK.
Robert is keen to keep his UK shares and seeks advice on how to shelter his offshore portfolio from IHT. Here lies a common pitfall. He is told that he can avoid exposure to IHT by arranging for a nominee registered outside the UK to hold the UK-registered shares. In fact, if the UK stock portfolio were held in a nominee capacity only, the beneficial ownership of the shares would remain in Robert’s personal estate and would still be subject to IHT.
South Africans investing in US stocks should tread very carefully, because the implications of poor estate planning could be severe.
US tax law considers a South African-domiciled individual who is also a non-US citizen as a “non-resident alien” (NRA). The threshold (estate tax exemption amount) for an NRA is set dangerously low at only $60 000, with the top estate and gift tax rate set at 40 percent. The DTC between South Africa and the US for estate duty/estate tax operates so that the US has the privilege of taxing stocks in companies that are registered in the US.
The result is that if a South African who is considered an NRA passes away owning US stocks valued at over $60 000, a punitive tax could be lurking just around the corner. To add insult to injury, the US does not offer the unlimited spouse exemption offered in the UK, so even if the US shares pass to a lawful spouse, there is no spouse exemption – unless the surviving spouse is a US citizen.
The following example is designed to illustrate an unexpected tax liability for a South African investor:
Mara is married to Brian and owns a nominee investment portfolio in her sole name, which is registered in the UK. The investment portfolio contains a number of individual US-registered stocks valued at $500 000. Both Mara and Brian are domiciled in South Africa and are South African citizens.
Mara passes away and her will leaves her entire worldwide estate to her spouse, Brian. Although the nominee investment account is registered in the UK, this does not shift the situs/location of the US stocks and, for the purposes of US tax law, Mara is still considered to own $500 000 of US stocks at death. In these circumstances, there will be no spouse exemption in the US and estate tax will be levied on the US stocks in accordance with a unified rates schedule for the date that Mara passed away. Depending on the value of the US stocks owned at death, the estate tax rate could be up to 40 percent.
Planning for the future
To avoid possible death taxes in the UK and the US, tax planning measures for South African-domiciled investors can include using certain authorised unit trusts or open-ended investment companies that are exempt from UK and US death taxes.
Another option is to choose investments that are not situated in the UK or US, but invest in UK and US shares. For example, certain life policies registered outside of the UK and US may provide good estate planning opportunities. Depending on the value of the investments, investors might also consider certain offshore trust structures.
South African investors should not be discouraged from diversifying offshore, or from investing directly in UK and US shares, but are advised to check with their professional advisers that they are investing in a tax-efficient way, particularly in relation to estate planning.
Oliver Phipps is a member of the Fiduciary Institute of Southern Africa and a partner at Lester Aldridge Solicitors in the UK.