Tread carefully when investing directly in listed UK or US stocks
Investing offshore can be an attractive prospect for a number of reasons. It’s always been tricky for South Africans from a tax perspective, however, requiring specialist knowledge in various areas. Last month, we highlighted some of the complexities facing South African residents with offshore assets. In this article, we focus on the estate and inheritance tax implications of holding specifically UK- and US-listed shares.
South Africans invest in equity markets in the UK and the US mainly to protect against political and economic risk or to benefit from growth opportunities not accessible locally. It can be a challenging proposition, however, as investors are required to navigate swiftly between currency swings and exchange control restraints in order to find the perfect stock pick in a global investment arena that could provide for superior returns.
Many investors are well versed in this field and have executed their investment plan close to perfection, believing they’ve given due consideration to estate duty and other tax implications. Unfortunately, investors dabbling on international shores are more often than not unaware that foreign inheritance taxes may be applicable. Neglecting to take cognisance of these taxes may deal your estate plan a deathly blow.
Both the US and the UK levy estate or inheritance taxes at a rate of up to 40% on assets, which are classified as ‘situs’ assets even though these assets are owned by non-residents. As such, due consideration must be given to the effect of foreign taxes in your estate plan – a highly complex area of expertise.
The position in the UK
A share is generally regarded as a UK situs asset if the share register relating to that particular share is held in the UK. For practical purposes, most UK-listed shares will therefore qualify as situs assets.
The UK levies inheritance tax at a rate of 40% on any UK situs asset of a non-resident where the value exceeds the nil rate band (currently £325 000). Most investors are shocked to learn that the UK share portfolio will also be subject to South African estate duty at a rate of 20%, should the dutiable estate exceed the R3 500 000 abatement.
Does this then mean that you will pay 20% estate duty in South Africa and 40% in the UK? Fortunately not! South Africa and the UK have concluded an Estate Duty Agreement (EDA) specifically dealing with estate taxes, which broadly results in South Africa having to give a credit for any UK estate taxes suffered on assets situated in the UK.
So what’s all the fuss about?
Unfortunately, the EDA restricts the credit to the amount of the South African estate duty that would have been payable in South Africa, in other words, 20%. The end result is that South Africa won’t subject the UK-listed shares to estate duty, but the UK will, and at a rate of 40%. This is double the amount of inheritance tax for which most investors will have planned.
South Africa provides for an exemption from estate duty for any assets bequeathed to a surviving spouse. The UK has a similar provision, provided that both spouses are either domiciled in the UK or domiciled outside the UK. The exemption is limited to £325 000 where the deceased is UK-domiciled and the surviving spouse is not.
The position in the US
The US currently levies estate taxes on non-US persons (largely anyone without a US passport or a green card, and living outside the US) at a maximum rate of 40% on the combined value of most US situs assets exceeding US$60 000.
Therefore, if you own US shares in excess of US$60 000 that were issued by a US corporation (irrespective of where the share register is kept), the shares would be subject to federal estate tax at a varying rate ranging from 26% to 40%.
Unlike the UK, no relief is available if the asset is bequeathed to the surviving spouse unless he or she is a US citizen.
Although the US and South Africa also have an EDA in force, this generally doesn’t provide much relief because the provisions dictate that South Africa will not have a taxing right on US situs shares, therefore providing the US with exclusive taxing rights.
Where the owner of US shares is ordinarily resident in South Africa, this will generally result in the shares being subject to US federal estate taxes at a rate of between 26% and 40% provided the value of the shares exceeds US$60 000.
As is the case with the UK, by holding US situs listed shares through a suitable insurance wrapper vehicle, US estate taxes can largely be mitigated.