Repatriation of offshore funds
Repatriation of offshore funds needs to be considered from both a tax and exchange control perspective. In practice, however, it is also a psychological predicament for South African residents, given the cartwheeling nature of the Rand, coupled with economic and political uncertainty. Invariably these factors result in the smart money remaining offshore in hard currency.
On this particular topic, there is often a tax and exchange control naivety, which manifests in a basic misunderstanding of the mandates given to SARS and -the Financial Surveillance Department (FSD) of the South African Reserve Bank.
In simple terms, SARS is tasked with the collection of taxes and enforcement of tax legislation, whether or not funds are repatriated to South Africa, whereas the FSD’s mandate is to police the cross-border flow of funds, without regard to the tax consequences of a particular transaction. There is an element of cross-pollination between the two departments, especially on information flow but a mutually exclusive relationship exists pertaining to the issue of repatriation of funds to South Africa.
Following on the above, the purpose of this article is to address the typical tax and exchange control implications for individuals who have invested funds offshore and earned returns, earned income from foreign services, as well as distributions made by an offshore trust in favour of individuals who are South African tax and exchange control residents. As will be unpacked in this article, a material level of FSD subjectivity on repatriation of offshore funds creeps in, as it relates to South African tax and exchange control resident beneficiaries of an offshore trust.
Individuals investing offshore
Individuals over the age of 18 and in good standing with SARS are allowed to externalise funds from South Africa utilising their respective foreign investment allowances, up to R10 million per annum and special allowances, excess of R10 million. Individuals may further utilise their respective discretionary allowances of up to R1 million per year, without the need to obtain a tax clearance certificate from SARS.
Important to understand, and a common theme in relation to these allowances, is that no FSD obligation exists to repatriate active or passive income, as well as capital gains generated through legitimately externalised funds, back to South Africa. It is not necessary to provide an overly technical analysis of the aforementioned FSD policy save to state that, in order to enjoy the dispensation to retain funds offshore, the initial investment must have been made through the utilisation of legitimate processes laid down by the FSD and authorised dealers.
Having regard to the above, an individual utilising his or her foreign investment allowances, special allowances or discretionary allowances may legitimately retain funds offshore. The question that arises is, should they? Notwithstanding the tax consequences, which will be discussed below, there are various non-tax benefits of retaining funds offshore, including but not limited to an effective ZAR-hedge and the ability to freely deploy capital offshore without having to go through a potentially cumbersome FSD process.
From a tax perspective various matters need to be considered, which are distinct from the concept of physical repatriation of offshore funds. On the assumption that the relevant individuals are “resident’’, as defined in section 1 of the Income Tax Act, he or she will be subject to tax In South Africa, on a worldwide basis, on the earlier of receipt or accrual. Physical repatriation of funds is therefore not prerequisite to taxation In South Africa.
As the amounts would in most cases have already ‘accrued’ to the relevant individual. The individual could therefore end up in a position of having to settle the attendant South African tax liabilities with domestic ZAR-based funds, where a decision is taken to retain funds offshore.
It follows that, depending on the nature of the offshore returns (and the list below is not exhaustive), the individual would need to consider the following potential tax consequences:
- Gains from the disposal of the individual’s investments held on capital account will likely be subject to a maximum effective rate of 18%, whereas investments disposed of with a profit motive will attract a South African tax liability at the individuals marginal tax rates. The individual could potentially rely on the so-called ‘’participation exemption’ where he or she held at least 10% of the equity shares in a foreign company and the disposal is at market value and to an un-connected non-resident. In that case the capital gain is excluded for South African tax purposes.
- Foreign dividends will be taxed at a maximum effective rate of 20%, unless the individual is able to rely on the so-called `participation exemption’, by holding at least 10% of the equity shares and voting rights in a foreign company, in which case the foreign dividends will be exempt from normal tax in South Africa.
- Other types of income, such as foreign interest, rental income and profits from a permanent establishment offshore, would generally be taxable at the individual’s marginal tax rate.
Individuals rendering services offshore
With effect from 1 July 1997, South African tax exchange control residents physically rendering services abroad are not obliged to repatriate income earned in respect of those services back to South Africa.
From a South African tax perspective, the individual may have been able to claim an exemption under section 10(1 )(o)(ii) of the Act, a provision which is not dependent on the physical repatriation of funds from offshore.
With effect from 1 March 2020. the physical repatriation of funds from offshore may become more relevant, particularly where South African tax residents physically rendering services offshore are not able to avoid the potential ‘top up’ of South African taxation where their remuneration exceeds the first R1 million exemption threshold.
The affected taxpayer would need to utilise domestic funds or repatriate foreign earnings back to South Africa in order to settle the potential South African tax liabilities. which is not ideal.
Distributions from an offshore trust
The repatriation of offshore funds becomes more complicated as it relates to the exercise of an offshore trustee’s discretion in favour of South African exchange control resident beneficiaries, in the case of beneficiaries who have not formally emigrates from South Africa.
It Is quite common In practice for trustees of offshore trusts to ascertain from the South African exchange control resident beneficiary where distributions should be deposited, A common misconception Is that South African exchange control resident beneficiaries of offshore trusts are automatically allowed to retain such distributed funds offshore.
Current FSD policy only allows a South African exchange control resident beneficiary to retain the distributed funds offshore if that beneficiary is also the original settlor or funder of the offshore trust and externalised funds legitimately through his or her foreign investment allowance or discretionary allowance, to settle or fund the offshore trust. As stated above, a certain level of subjectivity creeps in for the balance of South African exchange control resident beneficiaries, due to the fact that they are not permitted to automatically retain the distributions offshore. Instead, upfront approval must be obtained from the FSD to retain any distributions offshore, based on subjective policy applicable at that point in time.
In general, the FSD currently allows for so-called ‘third generation planning’ whereby distribution to South African resident beneficiaries, other than the settlor, are allowed to be retained offshore subject to upfront approval being obtained. In essence, upon upfront FSD approval being obtained, the South African exchange control resident beneficiaries are availed similar treatment to that of the original settlor of the offshore trust and will be allowed to retain their respective distributions offshore. Similar to individuals investing directly abroad, retaining funds offshore provides an effective ZAR-hedge far the South African beneficiaries.
From a South African Tax perspective, various and in many cases complex issues arise. Assuming the beneficiaries of the offshore trust are South African tax residents, it is important for beneficiaries to be able to distinguish between the different types of income or capital that a particular distribution is made up of. Offshore trustees generally segregate the different ‘sources’ or ‘pots’ from which a particular distribution is made, which is important, as it has a direct bearing on the disclosures required to be made to SARS and the rates at which a distribution should be taxed, if at all.
Again, the taxation principles are based on worldwide income and the earlier of receipt or accrual. This means that where a trustee exercises discretion in favour of a South African tax resident beneficiary to distribute trust income or capital, an accrual arises and, barring any further suspensive conditions attaching to that distribution, a declaration must be made to SARS. By applying the provisions of the Income Tax Act, the distribution will then either be subject to or potentiality exempt from normal tax.
Although the scope of this article excludes an in-depth analysis on the taxation of offshore trust distributions in general, the following considerations should be taken into account by South African tax resident beneficiaries:
- Segregation of income sources is important given that, in its absence, SARS would invariably argue that the relevant distribution should be taxed at the beneficiary’s marginal tax rate.
- Whereas the distribution of trust corpus would likely not be subject to tax in South Africa, the distribution of amounts sourced from the foreign dividend ‘pot’ or the capital gains ‘pot’ , will likely be subject to tax at a rate of 20% and a maximum effective rate of 18%, respectively. The ability to utilise the foreign dividend and capital gain participation exemptions has largely been sterilised by the way of recent amendments to the Income Tax Act.
It is important for South African tax and exchange control residents to be aware of the various FSD and SARS regulations affecting offshore funds, as it pertains to the repatriation and taxation of these funds. They should ensure that repatriation and taxation is each dealt with on mutually exclusive basis.
This does not constitute advice. Although every effort is made to ensure the accuracy of the information provided, we are reliant on external information.
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