Your primary concern when you invest offshore may be finding a suitable and safe fund manager (read How can I invest safely offshore?). But there are a number of other things you need to consider when you invest offshore in a fund domiciled in another country and in a foreign currency.
These include the fact that your investment may require some estate planning, the tax implications and the investment risk that come with investing in foreign currencies and in foreign countries.
Estate planning
If you own assets in another country, you may need to consider drawing up an offshore will.
If you only have a bank account and a unit trust investment offshore, you may not have to go to the expense of having a separate will drawn up for that account and investment.
If your offshore fund is held on an offshore platform managed by a South African provider operating in this country’s tax jurisdiction, it is possible that your estate may be wound up by a South African executor. Check with your investment platform if this is the case.
However, if you have other assets such as property, you should probably get some advice.
In some European countries, the law provides for forced heirship which means your assets pass to your spouse and children in fixed percentages, and a foreign will expert can help you work within the law to draft a suitable will. Such an expert can also assist if you own physical property in an offshore country.
If you plan to use your local will for your offshore investment, then make sure you have two copies as the Master of the high court in South Africa will require an original will and the offshore authorities may also need one. If you only have one copy, it could result in a delay in winding up your estate.
Problems with wills and offshore estates, as well as estate duty, can also be minimised by investing through a South African offshore endowment. However, the 30% tax rate and additional costs may make them unsuitable for those paying lower tax rates and with smaller amounts to invest.
Tax issues
Like South African funds, distributions paid from offshore funds attract tax. Foreign dividends are taxed at 20% and interest paid from offshore funds is taxable at your marginal rate. The interest exemption cannot be used against this interest.
If your offshore fund is one managed by a company operating in South Africa or on a South African offshore investment platform, the company will withhold dividends tax on the foreign dividends before these are paid to you.
If your offshore fund or investment platform does not withhold dividends tax, you must declare the dividends on your tax return and pay dividends tax. You can declare any dividend tax paid in the country from which they were paid and this may offset the local dividends tax.
Your dividends and interest can be converted to rands at the spot currency rate that applied on the day it was paid or at the average exchange rate for the year which is published by SARS here.
When you sell your offshore fund, you may be liable for capital gains tax on any capital gains you have made and any gains on the currency movement.
The capital gain or loss you have made must be calculated first using the amount you invested in a foreign currency when you first invested and the amount you realised when you sold your investment.
This must then be converted into rands using either the average exchange rate for the tax year or the exchange rate on the date of sale. Then apply the annual exclusion of R40 000 - or the balance of the exclusion if you have already used it against any other investment.
Currency risks
When you invest in a foreign currency, you take on a new investment risk by way of movements in the currencies you are dealing in.
A big risk that many South Africans expose themselves to when they react to bad news about the country’s socio-political and economic situation, is that it often coincides with a time of weakness in the rand.
Taking your money out when the rand is weak, means you can buy less in a foreign currency investment than you could when the rand is stronger against other leading currencies. Your investment needs to work harder to show a return in rands.
In addition, if you plan to spend the money in South Africa – for example, if you are saving for your retirement and will need the money here, you are at risk of having to convert it back into rands when the rand is strong, and the currency again works against you rather than for you.
The exchange rate between the rand and other currencies depends on a variety of intricately related factors, not only locally but also in other countries, as well as how the market views those factors. It is difficult – some say impossible - to make any predictions on how the currency will perform in the short term.
Asset managers and economists, do, however, often tell investors that over the long-term the currency will perform in line with the differences in inflation in order to keep the purchasing power of the currency relative to another.
When you invest, it is important to consider currency movements and your investment horizon. The more time you give your offshore investments, the less you have to worry about currency fluctuations.
Fluctuations in currencies can create investment opportunities when you are investing into offshore markets, but they also create risks when you need to draw on your investment, especially if your investment term or horizon has been short.
The currency risks should not put you off investing offshore as you may also benefit from diversifying away from the rand especially when it is depreciating.
Country and geographical risks
Investing offshore also introduces the risks that come with the decision on where to invest. There may be political, economic or exchange rate risks to investing in a particular country. When it comes to interest-bearing funds, country risk may be the risk that the government will default on repaying its bonds.
If you invest in a global fund, the fund manager may make the decision about where to invest on your behalf but check the fund’s mandate and its investment universe.
A global fund may have an investment universe of developed markets only or developed and emerging markets. It may follow the allocations of a global market benchmark, like the Morgan Stanley Capital World Index All Countries, or the manager may be mandated to be what is known as benchmark agnostic and choose country or regional exposure without taking cognisance of the benchmark allocation.
A professional global fund manager will be aware of the risks to investment markets in each country or region and should also be able to make an informed decision on how much to invest in each. He or she will also know which country’s markets rise and fall at more or less the same time – they are correlated – or if they respond differently to global events.
While you can make your own calls on countries and regions – such as Asia, Europe, Latin America or Africa - in which to invest and these calls can be rewarding especially at times when a country or region is doing well, the more concentrated and less diversified your investments, the greater the risk that you could incur losses, especially over shorter terms.
