A few months ago I wrote on the topic of investing offshore and the provisions of the Income Tax Act that deems interest, rentals, royalties and certain annuities received to be taxable in South Africa, notwithstanding that they may have been derived from offshore investments.
However, I have come across a number of situations recently which are of great concern to me. Consequently, I am going to cover certain aspects of the topic again.
The situation to which I refer relates to a potential "double" taxation that could arise if you decide to invest in an offshore trust or company in which South Africans hold more than 50 percent of the participation rights or are entitled to exercise more than 50 percent of the votes or control of the entity.
If, say, you are the only shareholder, or you and your South African resident family are the beneficiaries or shareholders, this would clearly be the case. Your trust or company will then invest the funds in the offshore investments of your, or the designated trustees', choice.
In order to provide the funds to the trust or company, you may either donate or lend them. (If you are providing the funds to a company, you may invest in the share capital, in which case the "double" taxation scenario which I will present below will not arise).
If you donate the funds to the trust or company you will pay donations tax on the excess of the funds donated over and above R25 000.
There will be no transfer pricing implications arising directly from the donation, as there is with a loan (see below).
If, however, you lend the funds to the trust or company, and you do not charge a market related interest rate on the loaned funds, which would probably be the case since you would not want the trust or company to have to pay money back to South Africa, you may find yourself with a bigger tax bill than you bargained for.
This is because of the transfer pricing rules contained in the tax legislation.
These rules basically say that, if there is an international agreement (in this case an offshore loan) between connected persons (in this case you and your trust or company would be connected) and the South African Revenue Services (SARS) is satisfied that the price charged (here the interest) between the parties under the agreement is not market related (if no interest is charged it is clearly not market related), the SARS may deem your taxable income to include a market related rate of interest.
In short, this section applies a notional interest rate to your loan for tax purposes.
That's all very well. But if your trust or company has invested the borrowed funds in investments that derive interest, royalties, rentals or certain annuities, then the deemed source provisions may automatically include that income in our South African taxable income notwithstanding that it was earned by your non-resident South African trust or company.
So, as a consequence of your investment offshore you may end up being highly taxed as a consequence of the two deeming provisions. I have used the term "double" taxation since the taxes both arise in respect of the funds you have placed offshore.
In practice, SARS has informally indicated that it would probably not apply both provisions.
But why give SARS the option, when, if you are aware of this problem, you can make sure you don't open up the potential to be taxed in this manner simply by ordering your affairs differently?