Hybrid offshore pensions are not immune to tax
PEOPLE send money offshore for a variety of reasons, many of which are sensible: you may want a hedge against the feeble rand, a global choice of investments, a pot of money for your kids studying at Oxford, or one for you in case South Africa goes belly up and you have to leave in a hurry.
Over the years, this has become much easier – exchange control limits have become more and more generous. At present there is a discretionary allowance of R1 million per adult per year. If you go through the paperwork with the South African Revenue Service (SARS) and get clearance, you can take out R10 million a year, and you can take even more if you are in SARS’s good books and ask very nicely.
But there’s a corollary to this generosity on the part of the government: SARS has tightened up on taxing South Africans on their offshore investments.
This brings us to the one nonsensical reason for taking money offshore: to evade or avoid tax.
What you might have been able to get away with in the past you cannot get away with today under the increasingly stringent anti-tax-avoidance legislation here and globally.
No matter where your money is invested, you cannot escape your obligations to SARS if you are a South African tax resident. Those obligations include donations tax, tax on income, capital gains tax and estate duty.
Of the various vehicles for investing offshore, one has come under scrutiny by SARS: the foreign pension trust. Typically, this is a hybrid structure that has characteristics of both a trust and a retirement annuity, based in a low-tax jurisdiction such as Guernsey.
It allows you to make lump-sum or regular contributions, as you would into a retirement annuity in South Africa.
You then have a vested right to withdrawals after retirement age, in some instances as low as 50 years.
SARS ruling
In a recent ruling (Binding Class Ruling 080) following an application by an unnamed company to market such a product, SARS made it very clear that the structure is not regarded by SARS as a retirement fund. There are no tax concessions on contributions or on investment growth, and capital gains tax is payable, as is estate duty. One concession by SARS, according to the ruling, is that contributions are not regarded as donations (which would incur donations tax).
While the ruling pertains only to the product in the application, it does send out warning bells to several offshore-based companies marketing this type of product, the investors who have put large sums of money into them, and potential investors who are looking at ways of investing offshore.
The ruling reinforces what many clear-headed financial advisers and tax consultants have been saying for a while: offshore pension trusts are being marketed to South Africans for tax and estate planning benefits that may have applied in the past, but do not apply any more. They may avoid the high inheritance taxes of jurisdictions such as the UK or US and may save you having to draw up an offshore will, but so do other offshore investment products that are more SARS-friendly.
In a recent article, “SARS pours cold water on offshore tax gimmicks” (www.iol.co.za), tax attorneys Colleen Kaufmann and Monique Carvalho at Tax Consulting South Africa write: “For every compliant structure we review; there is a magnitude of ill-conceived, tax-driven products. These products lack technical substance and are designed by salespeople. Promises are made of remarkable tax benefits and the sales process is smooth and like a well-oiled machine, coming with all the bells and whistles to show legitimacy and the promise of a tax loophole.”
A strong selling point has been the premise that these products are not subject to estate duty. The SARS ruling puts paid to such a notion:
“When an investor dies prior to normal retirement date, the vested personal right will constitute ‘property” in terms of section 3 of the Estate Duty Act. The right will form part of the deceased investor’s dutiable estate.
“On the death of an investor after normal retirement date, the right to an annuity will constitute ‘property’ as defined in the Estate Duty Act … [and] will fall within the dutiable estate of the deceased investor. The investor will be deemed to have disposed of the right to an annuity for market value.”
Opaque nature
Charles McAllister, a Certified Financial Planner and executive director of Centric Wealth in Cape Town, is also critical of these offshore pension trusts. He says that, apart from the tax issues, a big concern is their opaqueness regarding the underlying investments and costs.
“There appears to be very little oversight by the trustees over the underlying investments, which may include funds not approved by our local regulator, the Financial Sector Conduct Authority. For offshore funds to be marketed in South Africa, they have to be approved by the FSCA, and there is a good reason for that – so that an individual has recourse,” McAllister says.
Worryingly, costs and sales commissions on the underlying investments, which would come out of your capital and which may be relatively high, may not be fully disclosed.
McAllister says that although the SARS ruling pertains to a specific product, it would be remiss of a financial adviser not to make a client interested in this type of investment aware of the possible implications.
“The environment has changed so dramatically that you can’t set up a structure for 10 years any more and ignore it. You have to review these things every single year. The question here is, once you’re locked in, how do you unbundle something like this? I don’t know if you really can,” he says.