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“He said that there was death and taxes, and taxes was worse, because at least death didn’t happen to you every year.”
~ Terry Pratchett, Reaper Man

With the advent of electronic technology, the world has seemingly contracted into a single global village, which has had an impact on global tax laws. As such, there is presently an increased focus in South Africa (SA) on global tax compliance with the introduction of the common reporting standards (CRS), as well as the implementation of the United States (US) Foreign Account Tax Compliance Act (FATCA). FATCA is a 2010 US federal law introduced to enforce the requirement for US persons, including those living outside the US, to file annual reports on their non-US assets. In this context, we would like to alert you to some issues relating to the death tax or estate duty implications for South Africans who hold offshore investments.

SA ESTATE DUTY

To begin it is important to remember, SA residents are liable for estate duty on a residence basis of taxation; in other words our worldwide assets are taken into account in determining the value of our dutiable estates. The current exemption from estate duty is R3.5 million per individual, or R7 million per couple, when taking into account the spousal rollover. As a SA resident, you are accordingly liable for estate duty at a rate of 20% on your net estate value over R3.5 million. We remind you, however, that this is presently being reviewed by the Davis Tax Committee (see our previous update regarding the second Davis Tax Committee report).

PRESUMPTION AGAINST DOUBLE TAXATION

However, you must not forget that as a SA resident, with offshore investments, you may also be liable to pay death tax in another jurisdiction. Some countries tax assets situated within their jurisdiction on a source basis even if the owner of the assets is a non-resident in that jurisdiction. Logically, you may conclude that this may result in double taxation if both the SA tax authority and the foreign tax authority attempt to levy estate duty or death tax on the same assets. Fortunately for you, the accepted principles of taxation regard double taxation as inherently unjust. In order to mitigate the negative effects of double taxation, there are double tax agreements (DTAs) in place between SA and many other jurisdictions.

Most of our clients tend to hold shares registered in the United Kingdom (UK) and the US, where death tax or estate duty is known as inheritance tax (IHT) and estate tax respectively. Although there are DTAs in place between both SA and the UK, as well as SA and the US, this does not necessarily mean that you will not be liable for IHT or estate tax. To understand this, it is necessary to go into some of the technical detail.

UK AND US DEATH TAX

In the UK the current threshold, also known as the “nil rate band”, for which no IHT is payable, is £325,000. Subject to the application of certain exemptions and reliefs, any amount over this threshold is subject to IHT at a rate of 40%. A surviving spouse may be able to utilise their predeceased spouse's nil rate band, thus leaving up to £650,000 free of IHT. There is also an unlimited spouse exemption if, for example, a SA domiciled spouse leaves all of the UK shares to his or her spouse.

In the US the rules are less favourable. Tax law considers a SA domiciled individual who is also a non-US citizen as a non-resident alien (NRA). The threshold (estate tax exemption amount) for a NRA is set at only $60,000 with a top estate tax rate of 40%. The SA-US DTA operates so that the US will have the privilege of taxing stocks in companies that are registered in the US. The result is that if a SA resident, who is considered as a NRA, dies owning US stocks valued at over $60,000 a punitive estate tax could be levied. To compound this punitive tax, unlike the unlimited spouse exemption offered in the UK, the US does not necessarily offer the equivalent exemption. If US shares pass to a lawful spouse, there is no spouse exemption unless the surviving spouse is a US citizen.

Regarding your offshore investments, it is important to note that these laws could adversely affect you in two ways:

  1. The death tax rate in the UK and the US is 40%, compared to our rate of 20%. Although the DTAs mitigate against double taxation, you could end up paying death taxes at the higher rate.
  2. Some rollover to the spouse is allowed in the UK but not in the US, unless the spouse is a US citizen.

SHARES, UNIT TRUSTS AND ETFs

We must emphasise that our understanding is that the above considerations around IHT and estate tax apply to holdings of UK and US registered shares. Furthermore, it is also our understanding that any holding in a UK authorised unit trust or a share in a UK open-ended investment company (OEIC) is excluded from IHT, if the investor is not domiciled in the UK. In the UK, these authorised funds are treated very differently to individual UK registered shares. The reason for this special treatment is to encourage non-UK domiciled investors to invest in such funds rather than be put off by the concern about IHT exposure.

For the purposes of IHT, different considerations also apply to investments in exchange traded funds (ETFs). In simple terms, the situs or jurisdiction of an ETF for IHT purposes is determined by where the issuer of the ETF is resident. For example, where a company offering the contract for the ETF is resident outside of the UK, for IHT purposes, the ETF would not be considered as a UK situated asset. The location of the exchange or exchanges used by the ETF does not affect the situs of the fund for IHT purposes.

NOMINEE ACCOUNTS

There has been some suggestion that holding shares in a nominee account administered outside a particular jurisdiction will act as a death tax shield by enabling the beneficial owner of the assets to avoid death tax in that jurisdiction. We have been advised that there is no IHT advantage to be gained by an individual holding UK shares in a nominee account situated outside of the UK. Likewise, there is no estate tax advantage to be gained by an individual holding US stocks in a nominee account situated outside of the US. This is on the basis that the investor, on behalf of whom the nominee holds the investments, is regarded by the respective tax authorities as the ultimate beneficial owner of the investments for tax purposes. The UK and US tax authorities will thus look through the structure to the beneficial owner. On the owner’s death the relevant shares would therefore attract death tax in that jurisdiction.

NOMINEE ACCOUNT MYTH

It would seem that a part of the mythology regarding the avoidance of liability for IHT in the UK, or estate tax in the US, by investing by means of nominee accounts arises, not from a recognised legal principle or tax law, but from the view that the foreign tax authorities will not know about the investment on death of a non-resident of their jurisdiction, and therefore the investments need not be disclosed to such revenue authorities. It begs the question as to why UK IHT or US estate tax would be payable if asset managers do not require IHT clearance or estate tax clearance when dealing with an executor of a SA domiciled estate. The reason is that all foreign taxes that are payable must be paid, regardless of whether the foreign treasury has prompted the investor to pay.

LET’S GET SPECIFIC

At this point you may be thinking, “so what on earth does this mean for me?” Firstly, bear in mind that this death tax issue only affects you if you hold offshore shares in your own name, as opposed to a legal entity such as a trust owning the shares. This is because a trust is a legal person and not a natural person and so is not liable for death tax.

Practically, if you hold shares directly or in a Citadel COS Offshore Personal Equity Portfolio, then your deceased estate may be liable for IHT or estate tax on shares registered in the UK or US. Although there are DTAs in place between SA and these jurisdictions, these may not assist your estate to entirely avoid a tax liability.

SAXO, the Denmark-based share platform administrator for our COS Offshore Portfolios, is of the view that there may be no liability for estate tax, but this seems to be on the basis that the shares are held in nominee accounts outside the UK and the US, and further that the revenue authorities in those jurisdictions may not be aware that the investor is deceased and that death tax may therefore be due and payable.

To obtain clarity on this issue and in order to understand jurisdictional requirements, we have taken offshore legal advice and our understanding is that the location of the nominee does not make a difference, because as mentioned above, the revenue authorities regard the investor on behalf of whom the nominee holds the investments as the ultimate beneficial owner of the investments for tax purposes. We are also of the view that it does not eliminate the requirement for an executor, as representative of the deceased investor, to settle foreign tax owing by the estate.

With the increasing globalisation of tax compliance and other factors, we advise you not to rely on SAXO’s view around lack of knowledge of the investor’s death to avoid death tax in other jurisdictions. And we would like to stress that where Citadel Fiduciary is nominated as the executor in your will, we will do the necessary reporting. Whilst reporting to the revenue authorities may be required, a grant of probate (the legal process whereby a will is "proved" in a court and accepted as a valid public document that is the true last testament of the deceased) is not required to enable the executor to administer the offshore estate.

Certain investments, however, like the Citadel International Plan are not subject to foreign estate tax, as they are unit trust funds rather than a direct share portfolio. Similarly, the Citadel Offshore Plan is an asset swap arrangement which is a SA asset and therefore does not result in exposure to foreign death tax. The same applies if your investments are done through an offshore endowment.

QUALIFIED, JURISDICTIONAL-SPECIFIC ADVICE

Finally, be mindful that death tax may apply in foreign jurisdictions other than the UK and US. We have focused on these two countries for illustrative purposes only. Whilst we do our best to guide you in your estate planning and assist to resolve any potential issues, please bear in mind that we are not legal experts in other jurisdictions but, if necessary, will assist in obtaining the correct jurisdictional-specific advice. In general, whenever we are asked to deal with bespoke legal issues or comment on client-specific offshore legal implications, we always advise that you should also obtain qualified, jurisdictional-specific advice.

We recommend that you speak to your advisor to explore your options with regards to restructuring your investments should you feel it is necessary.

By Citadel Fiduciary Managing Director, Hilary Dudley