Whenever I travel to our fast-growing business in South Africa, I know our marketing team are keen for me to write a blog for our website. However, now after several trips I am conscious that there are only so many blogs you can craft around the themes of political insecurity, South African wine and Table Mountain! So, it was to my relief, that within days of arriving in South Africa it was blindingly obvious that this blog’s subject matter needs to focus on the thorny issue of situs.
For those readers who are not sure what situs is, do not worry because there are loads of people in the industry who are far from certain on the issue and I will try and summarise the detail in a moment.
The first three and a half days of my SA trip were spent busily cramming in 18 meetings alongside my co-director, based locally in Cape Town, David Noon! As we headed to Joburg airport - exhausted - to fly to Cape Town we reflected on the fact that the subject of situs had come up in conversation at least once every day (I can only recall it coming up once in previous trips over many years!). We asked ourselves what had changed all of a sudden because situs has been a thorny issue for South African investors for years. (The issue is not limited of course to South Africans but they will be the focus of this article for obvious reasons).
So what is situs?
In law, the situs of property is where the property is treated as being located for legal purposes. Property is not just physical property but also investments, including shares, collective investment schemes and structured products.
So, investments incorporated in the US, or in the United Kingdom, are considered situs assets and as such will attract inheritance tax (IHT) in the UK and federal estate tax (FET) in the US. This is commonly known as situs tax. (It should be noted that this concept is not just restricted to the UK and the US but it is these locations, which often form the bulk of an offshore investment portfolio for South African investors.)
Situs used to be ignored
While situs has been a potential tax banana skin for many, many years, in my experience some South Africans avoided the issue by investing offshore via non-UK or non-US collective investment schemes and offshore endowment wrappers. In those cases, ownership of the underlying investments was not held in the UK or US.
However, there are also large numbers of South Africans who invested via offshore trusts. Here, the situs issue can become incredibly complicated. It can apply in some circumstances and not in others, heavily dependent on the type of assets held, the domicile and residency of the settlor and/or beneficiaries of the trust. Furthermore, establishing both domicile and residency in itself is extremely complex, particularly in the UK.
Therefore, the situs issue only practically affected a South African investor if death actually occurred and if their assets were held directly in the UK and US. This was because beneficiaries need to go through UK or US probate (and pay the relevant taxes) to release their inherited assets. In contrast, probate was not generally required by beneficiaries to get their hands on their inheritance, where the assets were held via an offshore structure, such as an offshore trust. As a result, it is common for the situs issue to be overlooked by investors (primarily through a general lack of understanding).
So, situs has generally remained a complex issue understood only by tax “nerds” and has been largely ignored by the mainstream offshore investment fraternity.
So what has changed?
HMRC (the tax authorities in the UK) updated its laws in the middle of 2017 to introduce new beneficial ownership reporting requirements for trusts that are subject to UK taxation. The reporting aspects of the regulations have an extraterritorial effect as they purport to apply regardless of where the settlor, trustee and beneficiaries are resident for tax purposes. Affected trustees are required to report a wide range of information to HMRC. Due to the complexity of the UK tax system, reporting obligations may arise in unexpected ways. Furthermore, there are civil and criminal penalties for non-compliance.
Even though the first reporting deadline was 31 January 2018, it is taking time for the implications to be fully understood and felt in the industry. One key element affecting South African investors is that if their offshore trust holds UK assets and/or receives UK income these UK situs assets drag their trust into the reporting obligations. So, this means the situs issue can no longer be ignored.
Trustees are playing catch up but are also increasingly making the holding of UK situs assets an issue for South African investors. Either they simply do not want the UK assets to be held in the trust, or they are increasing their fees to accommodate the new reporting complexity. Neither option is palatable; the first goes against all good investment theory, which holds that tax should not dictate investment strategy, whilst the second is particularly unattractive for Rand-based residents already paying through the nose for hard currency exposure!
The information included in this article is based on our understanding of the current law and taxation practice in the Isle of Man and the UK as at 17th October 2018. This could change in the future, and therefore there is a risk that the tax treatment may change. Tax treatment is subject to individual circumstances and clients should always seek independent tax advice.
So what is the solution?
There are a few different options, but most have a drawback:
1. Place the assets into an offshore endowment life wrapper as this places the ownership of the assets with the domicile of the life company. Drawbacks can include:
a) restricted investment choice
b) additional cost
c) additional layer of communication
d) additional servicing complexity
2. Place the assets into an offshore collective investment scheme or series of offshore collective investment schemes. Drawbacks can include:
a) restricted to limited range offshore collective investment schemes
b) substantial cost of a private collective investment scheme
3. Place the assets into an international pension. Drawbacks can include:
a) restrictions on whether assets can qualify to be transferred in
b) restrictions on how and when assets can be accessed
c) additional cost - particularly if substantial investment flexibility is required
4. Place the assets into a structured investment note.
CIG issues its own structured investment notes (from the Isle of Man) that allows clients, advisers and investment managers to decide their own investment strategy within the note using CIG’s open architecture investment platform. This removes the situs issue, allowing for complete investment flexibility, whilst retaining simplified administration from a single product provider and only at a marginal additional cost. It is tax efficient for South African investors too, whilst the investment strategy is operated within the note. Encashment can also be made at any time, although this will of course create a disposal for CGT purposes if the client is SA resident at the time of encashment.
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So hopefully, this article has helped give you a whistle stop tour of situs. I have also managed to end it with a blatant sales pitch! You are of course free to ignore this and just enjoy the learning.
Disclaimer: The views thoughts and opinions expressed within this article are those of the author, and not those of any company within the Capital International Group (CIG) and as such are neither given nor endorsed by CIG. Information in this article does not constitute investment advice or an offer or an invitation by or on behalf of any company within the Capital International Group of companies to buy or sell any product or security. It cannot and should not be relied upon but may assist advisers and practitioners form their own view. Clients should always seek professional advice before taking any action. The information included in this blog is based on our understanding of the current law and taxation practice in the Isle of Man and the UK as at 17th October 2018. This could change in the future, and therefore there is a risk that the tax treatment may change. Tax treatment is subject to individual circumstances and clients should always seek independent tax advice.