THOUGHT OF THE WEEK Reduction of exempt foreign earned income and the ever widening tax net
As a general rule, South African tax residents are taxed in South Africa on their worldwide income. Relief is however provided through an exemption introduced in 2000 aimed at preventing double taxation by exempting foreign earned income provided that certain requirements are met. These requirements can be summarised as follows:
The taxpayer must:
– be a tax resident of South Africa; – earn qualifying remuneration income; – through an employment relationship; – for services rendered outside the Republic; and – the services must be rendered outside of Republic for at least 183 full days (24 hour days) during any 12 month period and for a continuous period of at least 60 full days during the same 12 month period.
This exemption contained in section 10(1)(o)(ii) the Income Tax Act No. 58 of 1962 (“the Act”) will remain applicable until 29 February 2019 exempting foreign employment income in full.
Effective from 1 March 2020 an amendment to this provision tempers the provision by only exempting the first R1 million of remuneration income earned, whilst the remuneration exceeding this threshold will generally be fully taxable in South Africa.
The reason behind the limitation of the exemption is quite clear from SARS’ interpretation note (Interpretation Note 16) (“IN16”) which states that it aims to address the opportunity created for double non-taxation. This would be the position where the host country imposes little or no tax on employment income, whilst SA exempts the same income with effect that the income is not taxed in either jurisdiction.
Double Tax Agreement The amendment may lead to double taxation as the income would be taxable in the source state as well as in SA unless a Double Tax Agreement (“DTA”) entered into between SA and the relevant state specifically award taxing rights to the income to a particular state. Should the DTA not provide specific relief one would most likely have to rely on Foreign Tax Credits.
Foreign tax Credits To the extent that tax is paid in the foreign jurisdiction, the tax paid can be used as credit to the extent that foreign taxes are “paid or proved to be payable”. Unless the SA payroll can take foreign tax paid/payable into consideration there will be an out of pocket scenario for the taxpayer having to pay tax in both jurisdictions with a tax credit being claimed through a tax return in future.
Implication for employers Under the current (old) system, employers who pay employees via local payroll did not have to deduct PAYE on foreign qualifying remuneration. This will change on 1 March 2020 and will introduce a significant complicating factor as employers may have to deduct PAYE whilst taking into account foreign tax credits and navigate information and documentation sourced from foreign tax jurisdictions as would be the requirement for applying for a directive from SARS in terms of paragraph 10 of the Fourth Schedule to the Income Tax Act.
Will formal emigration remove me from the SA tax net?
This aspect is touched on in the FAQ available on the SARS website and IN16 which seem to suggest that SARS may dispute whether a person remains a tax resident following their formal emigration as it is not connected to an individual’s tax residence. Care should be taken when considering to formally emigrate and we suggest that specific advice be sought before acting.
What is important to note is that South African tax residents are taxed on their world-wide income. Conversely it means that if you are not a tax resident of SA, that you will not be liable in SA on foreign earned income.
A person is regarded as a tax resident of SA if they are “ordinarily resident” in SA. Whilst there is a vast amount of case law on the subject, the test to determine whether an individual ordinarily resides is one of intention being the “place to which a person naturally returns”. Failing the “ordinary resident” test, one can still be regarded as a tax resident of SA on term of the “physical presence test” which regards a person as tax resident in SA if they are physically present for more than 91 days on aggregate during a year of assessment as well as more than 91 days in aggregate during each of the 5 preceding years of assessment and for a period of more than 915 days in aggregate during those 5 preceding years of assessment.
What is important to note that a change to a person’s financial residency status does not necessarily affect a person tax residency status and vice versa. It is for example possible to emigrate as a tax resident whilst retaining exchange control residency. Although tax emigration may from an administrative perspective be fairly straight forward, it could be quite costly when taking the “exit charge” into account at a maximum of 18% levied on one world wide assets (excluding immovable property in SA).
It is essential that specific advice be sought as the facts in every case must be carefully considered to ensure that an optimal result is obtained as the cost of getting it wrong could be quite substantial from a tax and exchange control perspective.