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 simply a ‘non-resident’ or overseas entity.
Non-resident trusts can offer a wide range of practical advantages, but they do not change the tax liabilities or reporting obligations of owners or investors. There are five key factors to consider before establishing one:
- 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 large network of tax treaties and good accessibility.
- Estate planning – 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 is a highly effective vehicle for holding various asset classes, including the shares of a company to avoid the controlled foreign company (CFC) rules.
- 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.
- Funding – Many different kinds of assets can be transferred into a trust, including cash, property and shares. Trusts can also be funded by the settlor lending money to the trust rather than making a donation. A loan made to a trust is typically used by individuals who want to start estate planning but don’t feel comfortable about giving away their capital irrevocably in case they may need it at some point in the future. This is also a preferred route in funding a trust, taking into account tax planning considerations.The trustees can 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 the loan adheres to the provisions of sections 7 and 31 of the Income Tax Act, which stipulate that such loans must carry interest at a market-related interest rate and be concluded at ‘arm’s length’.
- 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 financial adviser. However, South African tax implications only arise where distributions are made from the trust. Income that is retained in the trust can be used for foreign investment.
The bottom line is that offshore trusts offer attractive estate planning and risk management benefits to South Africans.
Working with your financial advisers, Sovereign offers a personalised service to meet your needs. You’ll benefit from efficient, compliant asset administration and we adapt quickly to changing individual circumstances and regulatory conditions.
We are also able to assist clients who are interested in second residency, tax residency or citizenship by investment programmes in various jurisdictions and help determine which would be the most suitable route.