Given the political and economic turbulence that has surrounded the democratisation of South Africa, it is unsurprising that so many South Africans have a desire for hard currencies and offshore solutions
Why do South Africans choose to invest abroad when South Africa is such a rich country, roughly twice the size of Texas, with natural resources including gold, uranium, gem diamonds and natural gas? With a population of around 45 million and irrigated land of 13,500 sqkm (compared to 1,080 sqkm in the UK) space is not a factor and neither is the variable but generally sub-tropical climate.
As most would know or guess, South Africa is not all paradise. Mortality rates are much higher than western countries - and life expectancy is around 44 years compared to the UK's 78 years. But these issues are not the main drivers for South Africans investing overseas in tax neutral jurisdictions such as Jersey, Guernsey and the Isle of Man. The main reason is because South Africans want economic and political stability, factors we take for granted.
They have been stung financially too often in the past and there is a widespread desire to have a financial safety net 'just in case' held by custodians of their own choosing. Since 1994, when minority rule ended, the rand has fallen from 5.72 ZAR to the GBP to 15.67ZAR - a 63% fall in purchasing power. It has since recovered to 11.48 to the GBP - a mere 50% fall in value (see chart).
Not surprisingly, there is a basic desire to invest in 'hard' currency, particularly when overseas travel and specialist services (for example, medical costs and school fees) are priced in USD and GBP. Collectively, this creates the wish to have money invested where it is likely to be spent. For many, the UK would be a first choice but tax considerations have meant that Jersey, Guernsey and the Isle of Man are the principle recipients of overseas investments by South Africans.
South Africa has seen a changing domestic financial environment over a period of years. Exchange control rules were tightened in 1997, followed by a switch to taxing income tax on worldwide income from investments in the following year. This was extended in 2001 when income tax moved to a worldwide residence basis from the previous source basis. Later the same year, capital gains tax was introduced by including a proportion of capital gains within the income tax computation. This accumulation of legislation was, in effect, acknowledged in 2003 when the South African Government announced an exchange control and income tax amnesty allowing undeclared offshore funds to be disclosed. Some took the opportunity to repatriate their funds but a large number did not because of the economic and political concerns outlined above. What this has highlighted is that there are substantial funds held in Jersey, Guernsey and the Isle of Man in settlements created by South African residents.
An issue facing such South African residents with declared overseas assets is the need for effective tax planning. This also affects offshore trusts established by South African settlers, and individuals of South African origin who intend to return there to live. Income tax can be levied at marginal rates of up to 40%, and capital gains can be taxed at up to 10%. Offshore life insurance policies, constructed as portfolio bonds, present a straightforward means of deferring these ongoing liabilities. No tax arises until proceeds are taken by full or partial surrender or in the event of a death claim. Whenever a profit element arises, it is only subject to the capital gains tax rate, rather than the full income tax rate.
The benefits of bonds
• Existing investment portfolios can be transferred into the policy: Because portfolio bonds can invest in a very broad range of assets (including collective investments managed by many of the world's leading investment houses, equities quoted on all major stock markets and fixed interest securities), in most cases current investment portfolios can be mirrored within the policy, allowing retention of the current investment structure. Note that the transferral of assets into the policy will be treated as a disposal for capital gains tax purposes.
• Retention of existing investment advice arrangements: Current investment advisers can be retained to manage the ongoing portfolio, subject to suitable regulatory authorisation.
• Investment switching freedom: Investments can be switched within the bond without triggering any liability to tax, so active investment management strategies can be pursued, unconstrained by taxation considerations.
• Straightforward reporting and administration: Until the policy is encashed, or benefits are withdrawn, there is nothing to report on the annual tax return. The policy provides regular summaries of all investments held and their value. Portfolio dealings with a single provider are simpler and may be more cost effective.
• Exchange rate advantages: Because investment gains for life policies are calculated first then converted into rand, gains made as a result of currency rate fluctuations escape capital gains tax. This also means that exchange rate losses would not be relieved from tax, but the overall effect of using a life policy is that losses or gains due to currency fluctuations are avoided. This is an important consideration for a currency as volatile as the rand.
• Tax control: Funds accumulate within the wrapper without any direct liability to tax. Partial withdrawals can be made on either an ad hoc or regular basis, but it is important to note that use of the encashment provisions and, in particular, the regular withdrawal facility, could lead to part of the withdrawal being taxable. Investors need to be aware of this risk and discuss it with their professional advisers.
The attractiveness of portfolio bonds can be further enhanced by adding additional lives assured, so extending the potential life of the policy and the financial planning benefits available.
For South African investors the offshore islands have always offered a safe haven in which investment freedom and currency choice could be secured. However, recent developments suggest clients will seek tax advice and that this advice might lead them one of three ways:
• Retain the safe haven status but suffer tax inefficiency by simply keeping current funds in the offshore islands.
• Trust in the future and repatriate assets for domestic tax efficiency at the expense of the economic and political uncertainty.
• Facilitate domestic tax efficiency for their offshore assets by changing the way in which assets are held.
There is a compelling need for professional advisers to ensure their South African clients avail themselves of financial planning solutions that will effectively mitigate their tax liabilities on offshore assets. We have found numerous situations where we have been brought in by advisers to discuss situations for helping South African clients and the opportunities available to them.
South African investors have been bitten financially in the past and there is a widespread desire to have a financial safety net.
South Africans with overseas assets need effective tax planning.
There is a need for advisers to ensure their South African clients avail themselves of financial planning solutions that will mitigate their tax liabilities on offshore assets.
Latest news and analysis
Drip-feed. Blend. De-risk
£92bn transferred since 2015
Achievements, charity work and other happy snippets