Recent commentary on the plan to scrap the tax exemption on income earned abroad by South Africans has caused widespread confusion, concern and some scaremongering for many South African (SA) citizens abroad.
Following public comment, Treasury proposed a concession by limiting the annual exemption to the first R1 million of foreign remuneration, as opposed to scrapping the exemption in its entirety.
The truth of the matter is that this change is unlikely to affect most South Africans living outside South Africa. Only a handful of SA citizens rely on the tax exemption. The worst affected will be those temporarily working in low or zero tax jurisdictions (which commonly do not have treaties with South Africa in place) and earning more than R1 million per annum. For them, this change will be a bitter pill to swallow, but nothing is stopping them from emigrating – which is clearly going to be a possible consequence of limiting the exemption.
What is the exemption and how does it work?
In terms of section 10(1)(o)(ii) of the Income Tax Act 58 of 1962 (as amended), SA residents are entitled to an exemption for remuneration received or accrued with respect to services rendered outside South Africa, provided the SA resident was outside South Africa for a total of more than 183 days during any 12 month period, and 60 of these 183 days were consecutive.
Treasury has proposed to limit this exemption to the first R1 million of your foreign remuneration with effect from 1 March 2020.
1.1 When can SARS tax my offshore income?
Before everyone fears the worst, it is important to go back to basics.
Let’s take a step back. The first question one should ask is; when will the SA Revenue Service (SARS) have taxing rights in respect of my income and gains?
South Africa taxes its residents on a worldwide basis, while non-residents are subject to tax in South Africa on SA source income and only certain capital gains from a SA source. Importantly, remuneration from employment outside South Africa is not seen as being from a SA source for non-residents.
SARS can therefore only tax you on a worldwide basis (which includes your foreign earned salary) if you are a SA tax resident.
1.2 Therefore the starting point for your SA tax liability would be your tax residence status.
1.3 A natural person is regarded as tax resident in South Africa if he is:
– ‘ordinarily resident’ in South Africa; or
– not ordinarily resident, but spends a certain amount of time, determined in terms of the ‘physical presence test’, in South Africa,
provided that he is not treaty resident in another country which is party to a double tax agreement (treaty) with South Africa. If he is so treaty resident, the treaty residence would override SA residence rules.
The crux – SA tax residence
Ordinary residence is also known as the ‘pipe and slippers test’. In short, it means the place where a person eats, sleeps and works with some degree of continuity and permanence. Your ordinary residence is the country to which you would naturally and as a matter of course return from your wanderings. Note that ordinary residence is a question of fact, and is not determined solely by the amount of days spent in a jurisdiction (like with the physical presence test).
If you are not ordinarily resident in South Africa, you could still qualify as being a SA tax resident in terms of the ‘physical presence’ test; if you:
– are physically present in South Africa for more than 91 days in aggregate during the current tax year;
– were physically present in South Africa for an aggregate period exceeding 915 days during the preceding five tax years; and
– were physically present in South Africa for more than 91 days in each of those five years.
If you permanently work in a country other than South Africa, the physical presence test would most likely not be applicable. So, effectively only the ordinarily resident test would be applicable to ascertain if you could still be regarded as SA tax resident and thus subject to tax on your worldwide income to SARS.
However, if you are regarded as being tax resident in both South Africa and in another country with which South Africa has a treaty in place (i.e. the country you work in), your tax residence status will depend on in favour of which country the tie-breaker clause in the treaty breaks. If it breaks in favour of South Africa, you would be regarded as tax resident only in South Africa, but if it breaks in favour of the other country (i.e. where you work), your SA tax residence will cease.
Usually the tie-breaker clause provides that a dual resident is deemed to be resident of the country where he has a permanent home available to him. If he has a permanent home available in both countries, he will be deemed to be resident of the country where his personal and economic interests are closer (i.e. ‘his centre of vital interests’). If his centre of vital interests cannot be determined, where he has a habitual abode will be the deciding factor, and if all of the above will be equal in both states, the country of which he is considered to be a national will be his country of residence for purposes of the treaty.
So, even if you are still considered to be ordinarily resident in South Africa, but you live in a country such as the UK which has a double tax treaty with South Africa, you will most likely be treaty resident in the UK if that is where you live, work and reside with your family. In this case South Africa will have no taxing rights whatsoever on your non-SA source income or gains.
For those working in countries which do not have treaties with South Africa there will be no tie-breaker to rely on and South Africa will unfortunately continue to have taxing rights, unless you actually cease to be SA tax resident.
Therefore, in short, the change to the exemption contained in section 10(1)(o)(ii) of the Income Tax Act will have ‘no’ effect on you if:
– you have ceased to be tax resident in South Africa; or
– you are ordinarily resident in South Africa, as well as resident in a treaty country (where you work), but the treaty tie-breaker breaks in favour of the treaty country.
Should I emigrate?
However, there is a catch for those who wish to cease their SA ordinary residence (assuming there is no treaty working in their favour).
A deemed capital gains tax (CGT) exit charge is triggered under section 9H of the Income Tax Act upon ceasing to be a SA tax resident. Or if you hold assets as trading stock (which is quite uncommon) the 9H charge can also be an income tax charge.
This means that you would be deemed to dispose of all your assets for their market value on the date immediately before the day on which you cease to be a SA tax resident and to have reacquired those assets immediately after the date of disposal at the same market value. This will result in a CGT charge of up to a maximum effective tax rate of 18%. It is, however, important to note that the CGT exit charge will not apply to cash, immovable property in South Africa, assets of a SA permanent establishment, and certain equity instruments granted by reason of employment.
Apart from a potential deemed CGT exit charge, emigration could suit many SA residents who already do not spend more than 183 days in South Africa. If, with careful days planning, you ensure that you are not in South Africa for 90 days in the tax year after you cease your SA tax residence, you can spend up to 183 days in South Africa for the following five tax years without being resident under the physical presence test. You will then just have to ensure that you do not ‘revive’ your ordinary residence and/or remain treaty resident outside South Africa.
(Please be aware that exchange control residence is a separate concept to tax residence and has its own formal procedures to comply with upon a financial emigration via the South African Reserve Bank (SARB). This topic is not covered in this article.)
Consequences for the SA resident working abroad
If you still qualify as being ordinarily resident in South Africa whilst being employed abroad, the change to section 10(1)(o)(ii) will only affect you if you work in a jurisdiction with a lower tax rate than South Africa and earn more than R1 million per annum.
You will, however, be able to get a credit for the tax (if any) paid in that lower tax jurisdiction, but will have to pay tax in South Africa on the balance (i.e. up to the tax you would have had to pay if the services were rendered in South Africa). Also, be aware of exchange rate differences.
We appreciate that SA tax residents working in low tax jurisdictions could be left ‘high and dry’, as they will now be required to pay up to the SA income tax rates on the portion of their foreign salaries in excess of R1 million and will, essentially, not be able to receive any form of credit for their high living costs in the low tax jurisdiction.
Therefore there will most likely be an increased desire to emigrate for tax, and as we have pointed out above, that may well be an achievable result, with little downside.
If, however, you are a SA tax resident working abroad, but in a higher tax jurisdiction (like the UK), the change to the section 10(1)(o)(ii) exemption will not really have a financial impact on you, apart from a potential administrative burden. The reason being that you will be able to claim a credit for the tax paid in the country where you are employed, which will often be more or equal to the tax that you would have paid in SA.
Finally, if you live and work in one of the 78 countries with which South Africa has a tax treaty and are deemed resident in that country the change to the section 10(1)(o)(ii) exemption may not affect you at all.
So yes, some people may be negatively affected because they are working in low tax jurisdictions for most of the year, but South Africa has been very generous for a long time and is merely aligning itself with the practice of many other countries. It may therefore be good to consider formal emigration and to take expert advice on your circumstances. However, for most of the SA citizens who are living abroad, this change is unlikely to affect them and they can get on with life without worrying about the proposed change.
Jaco van Zyl is a Senior Associate, and Yvonne Steyn is an Associate at Maitland