Be Wary of Tax Obligations, Offshore Investors Urged

South Africans seeking to increase offshore exposure need to be aware of potential tax obligations arising from investments in foreign roll-up funds. So says Wouter Scholtz, a director of Mazars Moores Rowland, the tax, audit and advisory firm.

He says trustees and beneficiaries need to be especially vigilant if a trust holds shares in a roll-up fund, a 'fund of funds' more commonly referred to as an open ended investment company (OEIC) which has limited liability and is typically established in a tax haven.

“The shares issued to investors in an OEIC are not your normal shares,” says Scholtz. ”They are peculiar in that there are no dividend rights attached to the shares. A South African shareholder in an OEIC will only be taxed at the time he or she redeems shares – sensibly so, given that a redemption of units is the only way to get money out of a roll-up fund.

“If the redemption amount exceeds the issue price of the share, the difference will be a capital gain on the disposal of the share; if it is less than the issue price, the difference will be a capital loss.

“If the investor is an individual, only 25% of the capital gain will be included in taxable income, to be taxed at individual marginal rates. The practical effect of the 25% 'inclusion rate' is to reduce the effective rate of tax on the profit made on redemption of the share to a maximum of 10%.

“If the investor is a company, 50% of the capital gain will be included in the company's taxable income, to be taxed (currently) at 28%. The effective rate of tax will accordingly be 14%. “

Scholtz says most South African investors in foreign roll-up funds will be trusts.

“The inclusion rate – the percentage of the capital gain included in taxable income – will vary according to whether the capital gain is retained by the trust, or allocated in the year derived to beneficiaries of the trust.

“If the capital gain is retained by the trust, the inclusion rate will be 50%. This gives rise to an effective tax rate of 20% on capital gains derived by the trust.

“If the capital gain is distributed or credited by the trust to a resident individual beneficiary, the resident beneficiary) will be liable for CGT. The resident beneficiary will have the benefit of the 25% inclusion rate, giving rise to an effective rate of tax at most 10%.

“Capital gains derived by a trust will be taxed at the level of the trust, at an effective rate of 20% unless the trustees allocate that capital gain to a resident beneficiary in the financial year in which it was derived by the trust. This means, in the ordinary case, that before the end of February, capital gains must be allocated to resident beneficiaries if they are to be taxed at the lower 10% effective rate.”

Scholtz says that in the past, SARS has given trusts some latitude where capital gains are allocated after the end of the financial year.

“There has, however, never been any statutory basis for this latitude, and it appears that SARS has become increasingly strict about applying the letter of the law. It is accordingly vital that the trustees, before end February, determine how capital gains are to be allocated amongst beneficiaries.

“Capital gains allocated to non-resident beneficiaries will continue to be subject to tax at the level of the trust, at an effective 20% rate. The reduction of the effective rate to 10% is only available where capital gains are timeously allocated to resident beneficiaries.”