How to set up an offshore trust – five key factors to consider

How should South Africans approach their global estate planning and hedge their risks in respect of the country’s unstable political and economic circumstances?

These are among the questions facing many South African taxpayers – and for a growing number, the answer lies in offshore trusts. Although many of the tax benefits that were associated with trusts have been eroded by anti-avoidance legislation in recent years, they still offer great advantages – particularly for individuals who are changing, or planning to change, their domicile, residence or citizenship; those with families resident abroad; those seeking asset protection; and those whose principal motivation is not to avoid taxation but to dispose of their estate on death freely and without recourse to a lengthy and expensive probate procedure.

The term ‘offshore’ has been much in the news recently and generally in a negative way. But the basic premise of an offshore structure – company, partnership, fund or trust – is that it should be resident in, and controlled and managed from, a location that is outside the place of residence of its owner or owners. It is therefore simply a ‘non-resident’ or overseas entity.

There may be tax advantages but, in many cases, tax may not even be a consideration. Non-resident structures may offer a more secure and stable legal platform, facilitate the diversification of investments or provide a means to eliminate forced heirship rules or probate in the country where an asset is based. In other words, non-resident structures can offer a wide range of practical advantages but they do not change the tax or reporting obligations of owners or investors.

So while offshore trusts can be effective vehicles to ensure succession planning, asset protection and to avoid the expense and delays of probate, there are five key factors to consider before establishing one, writes Paul-Joffre Esterhuizen, Business Consultant at Sovereign Trust (SA).

  1. Jurisdiction – Many offshore trusts are based in tax-neutral jurisdictions, but choosing the right jurisdiction is critical because the benefits of the offshore trust and the effective administration of the offshore trust by the trustees will be impacted if the trust is established in a ‘black-listed’ jurisdiction.

    Other important factors to consider when choosing a jurisdiction include a strong tradition of enforcing trusts, an English common law system, effective regulation and supervision, good banking infrastructure, economic and political stability, a wide network of double taxation agreements (DTAs) and good accessibility.

  2. Estate planning – At its simplest, a trust is an arrangement whereby property or assets are transferred from one person (the ‘settlor’) to another person (the ‘trustee’) to hold the property for the benefit of a specified list or class of persons (the ‘beneficiaries’). The practical advantages of a trust are gained from the distinction that is drawn between the formal or legal owner of property, the trustee, and those people that have the use or benefit of the property, the beneficiaries.

    A properly established offshore trust is a sound, legal structure that can be used effectively to help families achieve a wide variety of financial planning goals, while protecting and preserving wealth on an intergenerational basis. An offshore trust a highly effective vehicle for holding various asset classes, including the shares of a company to avoid the controlled foreign company (CFC) rules applicable from a South African tax perspective.

  3. Management – Assets transferred into trust are no longer considered as belonging to the settlor, so the income and capital gains generated by those assets are taxed according to the rules governing the legal owner – the trustee(s). For an offshore trust to qualify for any beneficial tax treatment in a specific jurisdiction, the trust must be managed and controlled from that jurisdiction and the trustee must be a tax resident in the jurisdiction.

    In reputable offshore jurisdictions, professional trustees must be licenced and regulated by the local financial services regulator. A trustee must act prudently in the management of trust property and will be liable for breach of trust if – by failing to exercise proper care – the trust fund suffers loss. In the case of a professional trustee, the standard of care that the law imposes is higher. This duty can extend to supervising the activities of a company in which the trustees hold a controlling shareholding. It’s essential to ensure that your trust management company has appropriate professional liability insurance and can provide proof of this on request.

  4. Funding – Many different kinds of assets can be put in trust, including cash, property, shares and land. Trusts can also be funded by the settlor lending money to the trust rather than making a gift. A loan trust is typically used for individuals who want to start estate planning, but don’t feel comfortable about gifting away capital in case they may need it at some point in the future.

    The trustees then invest this money, typically into an investment bond, for the benefit of the trust beneficiaries. The settlor can demand repayment of the outstanding loan at any time – either in full or in part – but any fund growth must be used for the benefit of the trust beneficiaries. It is essential that a loan must adhere to the provisions of sections 7 and 31 of the Income Tax Act, which stipulates among other that these loans must carry interest at a market-related interest rate and be concluded at ‘arm’s length’.

  5. Distributions – Distributions received by South African resident beneficiaries may be taxed in the hands of the recipient. The treatment of distributions of an income nature and of a capital nature differ and will need to be discussed with your tax consultant. However, South African tax implications only arise where distributions are made from the trust. Income can be retained in the trust and used for foreign investment.

The bottom line is that offshore trusts offer attractive estate planning and risk management benefits to South African tax residents – but you’d be advised to get expert advice to make the right choice.

Sovereign Trust, trust formation
Advantage of trust
Pros and Cons of trust

Contact Sovereign in South Africa
Get in Touch

Please contact us if you have any questions or queries and your local representative will be in touch with you as soon as possible.