As part of the review, Treasury outlined only minor administrative amendments for the previously announced overhaul of the foreign employment income tax exemption for South African residents overseas – also known as the ‘expat tax’.
So, what does it mean for those impacted by the changes?
In 2002, SA moved from a source based system of taxation to a worldwide basis of taxation, meaning that foreign earnings, income and gains from 1/3/2002 would be liable to tax in SA, even if not remitted in to SA, for those who are either classified as ‘physically present’ or ‘ordinarily resident’ SA tax residents.
Although SA citizens overseas will often break the first test, the latter is a common law principle, very similar to the UK concept of domicile, both of which are particularly difficult to lose.
For this reason, when the tax system changed, the foreign earnings exemption was put in place to protect those people with earned income overseas from taxation in SA, subsequently known as section 10(1)(o)(ii) of the Income Tax Act 1962.
To qualify for this exemption, an employee needs to have spent more than 183 full days (including a continuous period of more than 60 full days) outside of the country working, in any 12-month period. If this requirement isn’t met, then the individual is taxed on worldwide income.
The story so far
In the Feb 2017 budget, SA’s finance minister, Pravin Gordhan, announced the removal of the exemption, intended for the tax year starting March 2019. As a way increasing tax revenue for the National Treasury, the same budget extended a tax amnesty for those with undisclosed wealth and for exchange control contraventions, to bring wealth within the tax net, as well as confirming how the common reporting standard (CRS) would help in boosting tax collection.
Given strong public opinion, in the subsequent 2018 budget the new finance minister Malusi Gigaba agreed to maintain the exemption, not on an unlimited basis, but with a ZAR1m (£53,234m, $69,514, €61,838) allowance, so that only overseas earnings in excess would become chargeable, from a delayed start date of March 2020.
This year’s budget, introduced by finance minister Tito Mboweni, confirmed that, before implementation, the National Treasury will hold a workshop to consult taxpayers on their practical and administrative concerns.
High on the agenda for the taxpayer will be the impact of a volatile rand versus the currency overseas workers are paid in. The National Treasury confirmed that any resulting amendments would be processed during the 2019 legislative cycle, ahead of 1 March 2020. However, the change remains set to become effective from that date.
This workshop was subsequently held on 6 March and did not change the planned implementation of the expat tax.
Breaking tax residency – Physical presence
The South Africa Revenue Service (Sars) physical presence test determines whether a South African is tax resident, based on physical presence in the country.
The day count test considers whether the tax payer spends in SA:
- 91 days in total during the year of assessment under consideration
- 91 days in total during each of the five years of assessment preceding the year of assessment under consideration, and
- 915 days in total during those five preceding years of assessment.
An individual who fails to meet any one of these three requirements will not satisfy the physical presence test. In addition, any individual who meets the physical presence test, but is outside South Africa for a continuous period of at least 330 full days, is not be regarded as a resident from the day on which that individual ceased to be physically present, according to Sars.
However, if an individual passes the physical presence test, they will be taxed on their worldwide income and gains in South Africa.
Breaking tax residency – Ordinary residence
Ordinary residence is judged not by a day count (a quantative test) but by an actions, connections and intentions test (a qualitative test) where precedent has been built up by the SA courts over many years, with guidance available provided by the Sars Interpretation Note No. 3, Issue 2, 2018.
This indicates that the purpose, nature and intention of the taxpayer’s absence beyond the period in question must be established to determine whether a taxpayer is still ordinarily resident. It is therefore this test that most are caught by.
Famously, in the Cohen case (1946) Schreiner JA held that “… ordinary residence would be the country to which [a man] would naturally and as a matter of course return from his wanderings”.
For those living in two countries
In situations where South Africans are split between two nations – working overseas for extended periods of time but remaining connected to South Africa – Sars has double taxation agreements (DTAs) with certain countries to determine who has exclusive taxation rights.
Sars indicates that South Africa has DTAs with a number of other countries with a view to, among other things, preventing double taxation of income accruing to South African taxpayers from foreign sources, or of income accruing to foreign taxpayers from South African sources.
However, Sars also state that DTAs should not assist ‘double non-taxation’, such as the situation where 10s of 10,000s citizens work in the Middle East countries, such as the UAE.
Frustratingly, many SA DTAs are new and unproven in this sense, as the exemption has meant DTAs have rarely needed to be relied upon.
Financial emigration and DTAs
Much has been said about financial emigration – the formal legal process of cutting ties with South Africa –for someone who fully intends to remain overseas. Estimates indicate more than 900,000 SA citizens reside overseas, with only 103,000 having formally financially emigrated between 2006 and 2015, according to Statistics South Africa (StatsSA).
Surprisingly, this may not be necessary to avoid the expat tax, provided the individual meets the right requirements. If non-residents (South Africans living abroad) can prove to Sars they are ordinarily resident in the country they’re living in, then the tax should not apply.
Formal financial emigration can make it easier for inheritances and retirement annuities in SA to be brought out of the country as lump sums. Also, and importantly, this removes the spectre of donations tax and estate duty (maximum rates of 30%).
However, should someone return within five years, ‘failed emigration’ means that financial penalties normally apply.
Through either of these routes, (emigration or financial emigration) or if relying on the DTA tiebreaker clauses, often overlooked is a deemed disposal of world-wide wealth for capital gains tax (CGT) purpose (with the exception of residential property in SA), often referred to as an ‘exit tax’.
It is what is known as a ‘dry tax’, meaning nothing is actually sold, which can lead to difficulties in paying the liability.
Advice here is certainly needed, given various traps for the unwary. For example, sale of what was a principle residence in SA after immigration will give rise to a CGT charge there, most likely without the ability to claim the generous allowance on own homes in SA sold before individuals leave.
Who is affected?
The proposed changes will affect many South Africans ordinary residents with eared income overseas, making over ZAR1m in the year of assessment.
This includes those who pay taxes where they are present overseas, if taxes there are lower than what would be paid to Sars. It will also impact companies that send employees overseas for work, who will have to deal with the new tax implications financially and practically.
South Africans who have permanently left the country, who have not settled their tax affairs, may also be subject to tax and penalties, depending on their individual circumstances, and Sars has encouraged them to formalise their tax status and ensure their affairs are up to date.
Young people, or anyone who is travelling and working abroad, who qualify for exemption under section 10(1)(o)(ii) will remain exempt, provided they earn less than ZAR1m in the year.
Savings income, dividends and capital gains
To the surprise of many South Africans abroad, the foreign employment income tax exemption has only ever applied to earnings, not to other sources of income, dividends, interest and capital gains overseas.
Given the widespread uproar with respect to the changes focusing on earnings, this suggests citizens abroad have been unaware of these obligations, with reporting of profits potentially overlooked.
This has hit hard those financially emigrating, the process for which requires Sars clearance including fully up to date tax affairs, not just on earned income.
This has led to many having significant unexpected tax bills, while others, quite rightly, have been looking for the most legitimate tax efficient structures for their investments, in so far as SA tax is concerned.
International pensions can have a part to play, as can offshore investment bonds that can defer tax for as long as is required, and are ultimately chargeable to CGT at a maximum effective rate of 18% on profits, rather than income tax at up to 45%. This is another area where quality advice is needed.
The expat tax will have a major impact on the competitiveness of South African businesses sending professionals abroad if they are unable to modify their remuneration policy.
Those employed by foreign business may have less sympathy, with those ‘employed’ through personal services companies having no-where to turn.
For some individuals whose earned income is in excess of the ZAR1m exemption, the options will be to except the reduction in post-tax income, return to SA, or formally exit if remaining overseas is their legitimate intention.
Though one further budget in Feb 2020 will happen immediately before implementation, most financial professionals consider these changes, given the economic status of SA, inevitable.
David Denton is an international tax expert at Old Mutual International