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| By the time high tide arrives, your money is gone. |
So I had a look to see if it was something worth pursuing.
I am of course not a financial adviser or a tax expert, so the usual this is not investment or tax advice type disclaimer applies.
In this post I will briefly look at how CGT works, and then how it is applied to a local versus offshore investment, and if it is worth it for you to go offshore. I also made a spreadsheet which you can use to evaluate the Tax payable when investing your money directly offshore versus putting it into a locally available offshore product.
How Does Capital Gains Tax Work?
First up a quick refresher on CGT.
In a nutshell, and to try keep things simple, CGT works a little something like this – best explained with an example...
Anything more than R40k, SARS will start taxing you. In this example they want some of the remaining R10k profit (50k gain – 40k annual exclusion = R10k). SARS take 40% of the rest of the gain (in this case 40% of R10k = R4000) and add it to your income for the year. This means that you will pay your top income tax rate on that R4000.
So in this example, if you are in the 39% income tax bracket, you will pay 39% of R4000 = R1560.
As you can see, Capital Gains Tax is one of the more gentle taxes. In this example you only pay 39% of 40% of your profits after you have deducted R40k. From a R50k gain you pay tax of R1560 or around 3% of the total. Of course paying 0 would be the best, but 3% is not a bad second place.
In truth CGT is not a very taxing tax (see what I did there!) You will never pay a rate more than 40% of your income tax rate.The table below shows the worst case CGT rate you will pay according to the income tax bracket you are in. Even the high income earners will never pay more than 18% CGT.
| Marginal Tax Rate |
Worst Case CGT Rate |
18%
|
7.20%
|
26%
|
10.40%
|
31%
|
12.40%
|
36%
|
14.40%
|
39%
|
15.60%
|
41%
|
16.40%
|
45%
|
18.00%
|
(Disclaimer the above is how it currently stands for the 2019 Tax year – of course the annual exclusion, and other rates are subject to change. So if you are reading this sometime in the future it may no longer be accurate).
Okay so with the Intro to Capital Gains Tax out the way (and your certificate in the mail), it’s time to see how this plays out with regards to investing offshore versus onshore.
Local Is Lekker
Let’s assume I have R50 000 available and I would like to invest it in the US stock market with a time-frame of 15 years. I decide on an S&P 500 tracker ETF.
The easiest way for me to make such an investment would be to buy one of the locally listed S&P500 ETF’s (the Sygnia Itrix S&P 500 is currently the cheapest). In this situation, basically what happens, is I buy the locally listed ETF, and the ETF issuer invests in the S&P 500, in dollars, for me.
After 15 years, the value of my investment would be roughly equal to the starting Rand amount, multiplied by the growth of the S&P500, and multiplied by any Rand/Dollar currency gains (ignoring fees, spreads etc.)
For this example, let’s assume that the S&P500 index averages 7% a year over the 15 years. This will give total cummulative growth of 175%.
And what of the Rand Dollar exchange rate? Well, in theory, over the long term, every year, the Rand Dollar exchange rate will move by the difference in inflation between South Africa and the USA (don’t stress the why, think of it as a feature of the black art of economics). Over the last 10 years, the difference in inflation between SA and the USA has been around 4.2%. If we assume that this continues in future, then it means that over 15 years, the Rand Dollar exchange rate would increase by around 85% and move from it’s current levels of around R11.90 to the Dollar, to R22.00 to the dollar (yes that’s right, R22 to the dollar is probably coming, and it will be pretty normal and totally expected).
15 years pass, and I am now ready to sell my investment. In this scenario, my investment would have grown as follows:
R50k in, R250k out - not bad.
After selling, the Capital Gain is pretty easy to work out. R254 200 – R50 000 = R204 200
And, assuming an income tax rate of 39%, the CGT calculation would look something like this
Total tax payable will be R25 600 and I will walk away with around R228 600.
Over The Seas And Far Away
Let’s say instead of investing in a locally listed S&P 500 ETF, I convert my money to dollars and then buy an offshore listed S&P500 tracker. Some paperwork involved, but it definitely can be done (check this Just One Lap article for some pointers on how to set it up. )
I would then proceed as follows:
- Take my R50k and convert it to dollars at the exchange rate of R11.90 to the dollar. I end up with $4201.68.
- Then I use those dollars to invest in a Dollar denominated S&P500 index tracker (e.g. the Vanguard one (at a TER of only 0.04% - beautiful!)
- The investment grows at the same 175% as in the previous example
- After 15 years the investment is worth $11554.62
- I then sell the S&P500 index tracker and convert those dollars back to Rands at the exchange rate of R22.00 to the dollar.
As expected the ending Rand amount is exactly the same. But the difference lies in the way the Capital Gain is calculated.
In the previous locally listed ETF example the Capital Gain calculation was simple:
Capital Gain = Ending Rand Value – Starting Rand Value
In this example however, the Capital Gain is equal to the dollar ending amount, less the dollar starting amount, converted into Rands at the exchange rate at the time of sale.
=> Capital Gain = (Ending Dollar Value – Starting Dollar Value) x Ending R/$ Exchange
=> Capital Gain = ($11 555 - $4202) x 22
= R161 766
As you can see, by going offshore, although the final investment Rand value is the same, the Capital Gain is less (R161 766 versus R204 200) because it ignores the currency move.
The same CGT rules now apply and R40 000 can be deducted from the Capital Gain before 40% of the remaining amount (R48 706) is taxed at my marginal rate of 39%. I will pay total tax of R18 995, and walk away with around R235 200.
Saving Tax By Going Offshore
The result is summarised below:
As you can see, going offshore would have left me 2.54% better off, or R7 000. Of course R7 000 extra is better than 0 extra, but for the amount of paperwork involved, you got to wonder if it's worth it? Especially when you consider that R7 000 in 15 years time is only worth around R2900 in today's money. That works out to around R193 a year, or just R16 a month.
And then of course there is a pretty good probability that the CGT exemption will be a lot higher in 15 years time (SARS should, in theory, increase the exemption amount by inflation each year). So the Tax saving will be even less.
When I consider all that, and the amount of admin involved, it hardly seems worth it...
Okay, I can hear some people with larger amounts and in higher tax brackets shouting at me. Let’s run the same scenario using R200k and a tax bracket of 45%. The results are summarised below:
Ok, and now I can hear all the South African perma-bears shouting at me. There is no hope for South Africa, the rand is going to tank, taxes are going to rise, I want to take all my investments offshore.
So let’s consider a bit of a “worse case” scenario.
Because this is a "doom and gloom all hope is lost" -type investment, it makes sense to move your maximum annual discretionary allowance of R1 Milllion offshore. And of course, because South Africa is royally screwed, Taxes will be going up and there will be a newly created 50% tax bracket. But that’s not all, the Rand is going to totally tank as well – to R50 to the dollar. And just for good measure there is no growth in the S&P500 (which is of course still better than the -80% returns the JSE is going to get).
This concoction is about as bad as I could cook up for the local versus offshore scenario. Let’s see what happens:
If you believe something like the above could happen, it may be worthwhile to go directly offshore.
So in conclusion, for scenarios where the Rand depreciates significantly (may be within our politicians skill set), and where there is little to no underlying asset growth (very unlikely to happen over a long period of time) and where you are in one of the higher tax brackets (something you hope will happen!) then maybe there is a case to be made for going directly offshore.
Your Turn
If you are considering whether or not to move your money offshore in the interest of saving Tax, I have created a spreadsheet which you can use to compare the outcomes. You can download it on the Spreadsheets PageYou can run your own numbers through it using a few scenarios and see what comes out the other side.
Some Other Thoughts
Other Costs
On the flip-side there are costs involved in moving your money offshore and bringing it back again. Exchanging between Rands and Dollars is not cheap.
Then there is also platform fees, brokerage fees, spreads etc. which may all be different and should be considered.
What Is Your Time Worth?
I can’t imagine filling out Tax returns to be quick and painless if you hold an offshore bank and brokerage account. Then of course, depending on where you invest, you may also want to claim tax back (example Dividend Withholding Tax) from a foreign country - that could be fun too!Consider if the time and admin is worth it. Of course you could hire someone to do all this for you – but then that’s an additional cost.
Why Are You Investing Offshore?
It must be said that saving Tax is never a good reason to make a particular investment. So don’t decide to invest offshore just because you want to go one up on SARS.If you have already decided that you want to allocate some funds offshore, then you can look at the pros and cons of going direct.
How Much Money Do You Really Have To Invest?
There are other Tax efficient ways which you should probably consider before investing offshore. For example, have you maxed out your (and your wife/partners) TFSA(s)?If not, there is only one thing better than reduced Capital Gains Tax, and that is 0 capital Gains Tax – something which a TFSA can give you. You may also want to consider additional RA contributions – which although not for everyone (and only maximum 40% offshore, and not totally Tax free) may be something worthwhile.
Any remaining money after that (lucky you!) can be considered for the onshore versus offshore debate.
Other Implications
Going offshore can put you in the cross-hairs of some legislation and rules which you may not even be aware of. This is a risk not to be taken lightly.For example, in the US, there can be some pretty hefty estate duty implications if you pass away while you have money directly invested there. Best to do some reading up on all the ins and outs before you decide to take the plunge – who knows what other funnies are out there…
Long Term Predictions
With regards to equity investments, the holding period is usually many years, even decades. Of course predicting the Rands movement and market returns over such a long time period is unlikely to be what plays out in reality. What if the Rand strengthens? (Hey don’t laugh, stranger things have happened). In that scenario, there will be 0 CGT benefit to going offshore.
Till next time, Stay Stealthy!
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