South Africans are increasingly mobile, either working abroad, staying abroad for extended periods, or opting to retire outside of South Africa. This has increased the focus on foreign pension products because South African retirement funds are limited in terms of their access to offshore markets.
However, a recent binding class ruling by the South African Revenue Service (Sars) has highlighted the importance of understanding the product and its rules, and the potential tax implications.
The application for the ruling was made by a South African company, the founder of a foreign pension trust. The trust is a non-resident pension scheme constituted by way of a trust deed. The class is South African resident investors who make contributions to the trusts and become beneficiaries of the trust.
Sars ruled that the foreign pension trust was not a pension fund, provident fund or a retirement annuity fund as defined in the Income Tax Act and therefore the benefits associated with a pension product would not apply.
A binding class ruling is issued in response to an application and clarifies how the Sars commissioner would interpret and apply the provisions of the tax laws relating to a specific proposed transaction.
Hybrid products
Hanneke Farrand, director of Farrand Global, says many South Africans have invested in foreign pension trusts over the years. It is typically a hybrid product where a trust structure is combined with a pension scheme.
The contributions to these products were not treated as a donation, and payments by the trust to the beneficiary were often regarded as exempt.
“The two structures could cause confusion, as it was a combination of trust rules and pension rules in one animal,” she says.
Farrand adds that the Sars ruling is based on a specific pension trust deed, and it does not necessarily apply to all foreign pension trusts.
“People need to carefully look at the pension fund rules of the product that they acquired. This ruling deals with a hybrid structure and should not be confused with typical pension products,” says Farrand.
Tax treatment
In this case, Sars ruled that investors in the trust would not qualify for a tax deduction on their annual contributions, that the investors (contributors) acquired a vested personal right to the income and capital of the foreign pension trust, and any annuity received or accrued by an investor would form part of their taxable income in South Africa.
The impact of this ruling is that when investors die before retirement age, they will be subject to capital gains tax (CGT) on the deemed disposal of their vested right. If they die after retirement age, the right to the annuity will attract estate duty and CGT on the deemed disposal of the annuity.
The annuities paid by the pension trust will form part of the investor’s taxable income. The right to the annuity after retirement will be part of their estate.
This is an unenviable position. There is no deduction on contributions, and there are potentially CGT, estate duty and personal income tax liabilities.
Investment considerations
There are two options when people want to contribute to a foreign pension fund. They either invest their foreign earnings in a foreign pension fund while working abroad or they obtain exchange control approval to invest their foreign allowance in an offshore pension product.
The contributions to the foreign pension fund are often not tax-deductible, but lump sums or annuities paid to South Africans could benefit from a favourable tax rate. Generally, when making contributions to a retirement fund with after-tax income, the lump-sum or annuity payments are exempt from tax.
“I do not think it is the end of the world when you do not get a deduction on the contributions, because the lump-sum or annuity payment will be tax-free. There is always a balance in tax,” says Farrand.
She emphasises that the binding class ruling relates to a specific product, but notes that similar products have been sold to South Africans over the years.
It is important for taxpayers to ensure that their tax return disclosures are accurate and up to date to allow them to rely on prescription defences if necessary.
Trust structures are transparent in terms of international disclosure requirements as set out in the Common Reporting Standards and the Automatic Exchange of Information requirements.
“The beneficial ownership in trusts is open to public record. Proper disclosure of ownership in these structures is made in any event.
“My advice is to ensure you understand the product or offshore structure you are investing in. In my experience, it is always better to use known structures that have been around for many years because that is where the tax treatment more is certain,” says Farrand.
Amanda Visser is a freelance journalist who specialises in tax and has written about trade law, competition law and regulatory issues.
Disclaimer: The information in this article does not constitute legal or financial advice.
