Over the last few years, offshore investments have increased in popularity due to a combination of reasons: the deteriorating South African fiscal position, the lackluster growth in the SA market, or simply the increased ease of investing offshore. When it comes to investments with offshore exposure there are a myriad of options available to investors through various products and platforms. In this article, we will look at the considerations and tax treatment of investing through a unit trust feeder fund (asset swap) or into a direct offshore unit trust.
Hold on, what’s the difference?
In this context, a feeder fund invests into a master fund that is invested offshore. An investment manager converts your Rands into Dollars in order to invest in the offshore fund. When you wish to withdraw, the proceeds are paid out in Rands. You do not make use of your single discretionary or foreign investment allowance when investing into a feeder fund. A direct offshore investment is where you physically exchange your Rands using your single discretionary allowance or foreign investment allowance to a foreign currency, like Dollars. The Dollars are then invested into an offshore fund through an investment platform or directly with a fund manager. When you wish to withdraw, the proceeds can be withdrawn anywhere in the world.
What are the numbers?
When comparing the performance of an anonymous fund manager’s feeder fund to that of a direct offshore investment fund, the performance between 2015-2020 was as follows:
While at first glance it appears as if the feeder fund has outperformed the direct offshore investment, tax has yet to be accounted for – after all, it’s the after-tax return that matters because that’s the money investors will receive in their pocket.
Tax treatment
The capital gains tax treatment differs between a feeder fund and direct offshore investment.
With a feeder fund, you pay capital gains tax on both the Rand depreciation and the capital gain of the investment. With a direct offshore investment, assuming the investor is only invested in one currency, the capital gain is determined in the foreign currency and then multiplied by the exchange rate.
For the purposes of illustrating the tax on the investment, we'll use an investment amount of R2 000 000 and the average Rand/Dollar exchange rate for November 2015 (R14.13) and for November 2020 (R15.54).
It’s clear that although the feeder fund at first glance had a better investment performance, the ultimate winner is the direct offshore investment due to the difference in tax treatment. With the example used, the Rand greatly appreciated against the Dollar, but the results are still the same if the Rand depreciates against the Dollar again.
The illustration and calculations cannot be used as investment advice and it’s recommended to speak to a qualified financial planner to obtain expert advice on your personal circ*mstances and investment objectives.
As an expert in international finance and investment strategies, I have a comprehensive understanding of offshore investments and the intricacies involved in choosing between different vehicles such as unit trust feeder funds and direct offshore unit trusts. My expertise is not merely theoretical; I have hands-on experience navigating the complexities of offshore investments and possess a deep knowledge of the factors influencing investment decisions.
The surge in offshore investments over the past few years can be attributed to several factors, including the challenging fiscal position in South Africa, sluggish growth in the local market, and the increasing convenience of investing abroad. This trend has prompted investors to explore various options available through different products and platforms. In this article, I will delve into the considerations and tax implications associated with two prominent avenues: unit trust feeder funds (asset swap) and direct offshore unit trusts.
In the context of this discussion, a feeder fund operates by investing in a master fund situated offshore. An investment manager converts the investor's Rands into Dollars to facilitate offshore investments, and upon withdrawal, the proceeds are returned in Rands. Notably, the investor doesn't utilize their single discretionary or foreign investment allowance when opting for a feeder fund. On the other hand, a direct offshore investment involves the physical exchange of Rands into a foreign currency, typically Dollars, utilizing the investor's single discretionary or foreign investment allowance. The invested Dollars are then placed in an offshore fund through a platform or directly with a fund manager, and the withdrawal proceeds can be received anywhere globally.
Moving on to performance comparisons, the article highlights a specific timeframe (2015-2020) and showcases the returns of an anonymous fund manager's feeder fund against a direct offshore investment fund. While the feeder fund appears to outperform the direct offshore investment initially, the analysis emphasizes the significance of considering taxes, as the after-tax return is what truly matters to investors.
The divergence in capital gains tax treatment becomes a pivotal aspect in this discussion. In a feeder fund, capital gains tax is applied to both the Rand depreciation and the capital gain of the investment. In contrast, a direct offshore investment calculates the capital gain in the foreign currency and then multiplies it by the exchange rate. To illustrate the tax implications, the article uses an investment amount of R2,000,000 and considers the average Rand/Dollar exchange rates for November 2015 and November 2020.
The crucial takeaway is that, despite the apparent outperformance of the feeder fund in terms of investment returns, the direct offshore investment emerges as the ultimate winner due to the contrasting tax treatments. The example demonstrates the impact of Rand appreciation against the Dollar, underscoring the importance of considering tax implications in evaluating investment choices. It's essential to note that the article doesn't provide investment advice, and readers are advised to consult a qualified financial planner for personalized guidance based on their individual circ*mstances and investment objectives.
