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In the previous article we looked at how a South African can get offshore exposure, either directly or indirectly, in their investment portfolio. In this article we will take a closer look at further considerations that need to be taken before diversifying a portfolio into international markets.
As with any investment, understanding the risks and determining if you are comfortable with such risks should be a first consideration. Not only must you consider the investment risk of the underlying investment, but you must understand the risks associated with the country in which the funds will be invested and what factors may impact the markets in such a country or region. Furthermore, you may be dealing with third parties such as forex brokers and investment houses and it is important that they have a good reputation.
An important consideration with offshore investments is that if the funds need to be withdrawn and converted back to rands you are also exposed to currency risk. Considering that the rand is a relatively volatile currency, as most other emerging market currencies, this risk needs to be well understood as a depreciating rand will diminish the investment’s returns.
Given the high risk associated with offshore investments, funds invested in such investments must, if possible, be invested for a minimum of five years. Although this restriction is not placed on the investor by regulators, it is a responsible strategy for investing in higher volatility investments.
Direct offshore investing, meaning rands have been converted to another currency, is usually an appropriate investment if the investor plans on accessing that offshore capital by way of emigration, education or even holidays. Given the effort and costs of getting the funds offshore it is not sensible to bring back such funds for living expenses in South Africa.
As a South African tax resident, you will be taxed on your worldwide assets and income and it is therefore important that you also declare your offshore investments when filing your tax returns. Also keep in mind that you will pay income tax on the interest and dividends earned from your offshore investments in the same manner as you would with locally held investments.
You will also be liable to pay Capital Gains Taxes (CGT) on the disposal of any offshore assets. This means that you will calculate your capital gain or loss which must then be translated to rands, using the exchange rate at the date of the sale, which must then be included in your taxable income.
As such, it is important to determine the extent of any CGT liability before disposing of any offshore assets to ensure that you avoid paying unnecessary tax. Remember, death is a capital gains event and, in the event of your passing, your foreign assets will be deemed to have been sold at market value which, in turn, can trigger CGT.
In South Africa we enjoy freedom of testation but it must be considered that there are many law jurisdictions that have what is referred to as mandatory succession rights or forced heirship. You may therefore want to ensure that your offshore investment is not impacted by these laws as it can add additional complications for winding up your estate. In the event of your death, your foreign-domiciled investments will form part of your South African estate and will therefore be estate dutiable. South Africa has however entered into double-taxation agreements with a number of countries, with the goal of avoiding a double taxation situation. Therefore, be sure to understand whether your chosen offshore investment jurisdiction has a double taxation agreement with South Africa, and what the implications are for your estate planning.
When deciding to invest funds offshore investors need to look beyond the potential investment returns that can be achieved. Other considerations such as risk appetite, income needs, investment horizon, and investment objectives must all be factored in before making a decision of how and where an investment will be placed. There is no doubt that international investment markets offer a diversity of opportunities that are not locally available, but it is important to be clear on what one hopes an offshore investment will achieve and to externalise appropriately.