SOUTH AFRICA: EFFECTS OF THE AMENDMENT TO THE FOREIGN EARNINGS TAX EXEMPTION ON SOUTH AFRICAN EXPATRIATES
Effective from 1 March 2020, the foreign earnings tax exemption currently enjoyed by many South African expatriates will be limited to the first ZAR 1 million of such income. In response, some advisors have been advocating financial emigration as a panacea to no longer having to pay tax to the South African revenue authorities. South African expatriates are advised to have an accurate understanding of the effects of the amendment, to base any course of action on their individual circumstances and intentions, and not to make any rash decision.
Residence-based tax system
South Africa has been operating a residence-based tax system since January 2001. Tax residents of South Africa are generally liable to tax in South Africa on their worldwide income and capital gains, even if those are not remitted to South Africa. Non-tax residents of South Africa are, on the other hand, only taxed on their South African sourced income.
Progressive tax rates apply for individuals. The same rates of tax are applicable to both residents and non-residents. The tax tiers that apply for the 2020 tax year (1 March 2019 to 29 February 2020) are as follows:
|Taxable income (ZAR)||Tax on this income (ZAR)|
|0 – 195 850||18% of taxable income|
|195 851 – 305 850||35 253 + 26% of taxable income above 195 850|
|305 851 – 423 300||63 853 + 31% of taxable income above 305 850|
|423 301 – 555 600||100 263 + 36% of taxable income above 423 300|
|555 601 – 708 310||147 891 + 39% of taxable income above 555 600|
|708 311 – 1 500 000||207 448 + 41% of taxable income above 708 310|
|1 500 001 and above||532 041 + 45% of taxable income above 1 500 000|
Tax exemption on foreign employment income
When the South African tax system was changed from source-based to residence-based in 2001, a foreign earnings tax exemption was introduced to exclude from South African taxation the foreign employment income of individuals who are also tax residents of South Africa. Eligible for the exemption have been employees who have been working outside South Africa for more than 183 days (including a continuous period of 60 days) within any 12-month period. The foreign employment income tax exemption only applied to earnings and not to other sources of overseas income.
Effective as from 1 March 2020, only the first ZAR 1 million of income accruing from employment services outside of South Africa will be exempted in respect of a year of assessment. Included within those emoluments will be any fringe benefits such as travel, housing and security. The foreign employment income earned above the threshold of ZAR 1 million will become taxable in South Africa at the applicable marginal tax rate.
Tax residency by physical presence
The South African Revenue Service uses a physical presence test to determine whether an individual is tax resident in South Africa. To meet the requirements of the physical presence test, an individual must be physically present in South Africa for a period or periods exceeding:
- 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 those 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, will not be regarded as a resident from the day on which that individual ceased to be physically present.
Tax residency by ordinary residence
It is to be stressed that the physical presence test does not apply in cases where an individual is ordinarily resident in South Africa.
Ordinary residence is a common law concept. An individual would be considered to be ordinarily resident in South Africa if South Africa can be described as his or her real home and is the country to which the individual will naturally and as a matter of course return to after his or her wanderings.
In determining ordinary residence, the circumstances of the individual would be examined as a whole and would include factors such as the person’s intentions, the most fixed or settled place of residence, the place of business and personal interests, family ties, employment and economic factors, the residence and citizenship status in South Africa and in other countries, the locations of the individual’s assets, the periods inside and outside of South Africa and the purpose and nature of those visits.
An individual who meets the ordinary residence test or the physical presence test may in some cases be held to be exclusively a resident of a country other than South Africa over specific periods of assessment for the purposes of the application of a tax treaty. The individual could establish whether it is possible to be regarded as exclusively tax resident of another country by applying the tiebreaker clause. Normally, factors to be taken into account are the existence of place(s) of abode, the centre(s) of vital interests (the individual’s personal and economic relations), the place(s) of habitual abode, the nationality or nationalities of the individual.
Individuals residing permanently outside South Africa and outside the Common Monetary Area (South Africa, Namibia, Lesotho and Swaziland) are able to formalise their emigration with the South African Reserve Bank in order for their status to be changed from resident to non-resident for foreign capital allowance purposes.
As part of the process of financial emigration, all assets and liabilities in South Africa, Lesotho, Namibia and Swaziland should be declared, as well as a declaration made that the individual is permanently relinquishing South African residence to take up permanent residence in another specified country, and that there is no plan to return and work in South Africa within 5 years of the date of emigration.
Persons permanently emigrating from South African have the option to withdraw lump sum values from their South African retirement annuity funds, and also transfer future inheritance funds out of South Africa without being subject to South Africa’s resident exchange control process.
It is to be noted that a declaration made to the Reserve Bank of South Africa to no longer being treated as South African resident for exchange control purposes does not automatically equate to emigration for tax purposes. Irrespective of financial emigration, an individual can remain tax resident in South Africa based on a combination of tests. Furthermore, irrespective of tax-residency status, a person is generally liable to pay tax in South Africa on any South African sourced income.
Ceasing tax residence status
Tax residency is a legal status that cannot be changed with a declaration, but is determined independently from a series of circumstances and tests. If, based on those tests and individual circumstances, an individual is not tax resident in South Africa, the cap to the foreign earnings tax exemption would not apply.
The implications of ceasing South African tax residence are as follows:
- A capital gains tax liability may be triggered on some categories of assets located both in South Africa and outside of South Africa as there would have been a deemed disposal of those assets. Furthermore, the cash flow implications would need to be taken into account given that those assets would not have actually been disposed of.
- The individual is no longer taxed in South Africa on worldwide income but on South African sourced income only. However, an individual returning to South Africa permanently within 5 years of emigration may be liable to pay all taxes for that period.
- The individual is not allowed to be in South Africa for more than the number of days set out in the physical presence test to maintain non-residence.
Individuals potentially affected by the tax amendment
The amendment to the foreign earnings tax exemption affects tax resident employees working outside of South Africa for more than 183 days (including a continuous period of 60 days) within any 12-month period and deriving foreign emoluments of over ZAR 1 million. The following are likely to mitigate the impact of the amendment on those affected employees:
- Use of foreign tax credits: It will be possible to claim a credit against South African tax for the foreign tax paid on that income, thus reducing the tax payable to the South African revenue authorities. Individuals deriving earned income from higher tax countries may potentially completely net off and eliminate any tax payable on those income to the South African Revenue Service.
- Tax protection measures from employers: Employers often protect employees posted overseas from any additional tax from employment borne by those employees due to the relocation. However, it is worth noting that, as the individual’s total taxable income may increase as a result of the change, a higher marginal rate of tax may be applied to some other categories of income.
The foreign earnings of South African tax residents amounting to less than ZAR 1m in a year of assessment would continue to be totally exempted provided the conditions for the exemption are met. Individuals who can satisfy the South African Revenue Service that they are not tax-resident in South Africa are also not affected by the amendment.
Seek proper advice
Financial emigration is a serious decision with long term implications that requires careful consideration and should not be implemented as a knee-jerk reaction to the amendment to the foreign earnings tax exemption. Many South African expatriates will not be affected or will only be marginally affected. For those affected, financial emigration may not be the correct or sole approach, and may also not lead to non-tax residence based on the specific set of facts. A lot of misinformation about financial emigration and South African tax residency exists, and it is important to obtain sound advice adapted to one’s set of circumstances and intentions.
DTOS provides valuable insights and value-added services to businesses and individuals with regard to their evolving present and future needs. Should you have any query in relation to the topic covered and require any assistance, please do not hesitate to contact us. We shall be pleased to assist you.
Fred Yeung Sik Yuen CPA FCCA CGMA MBA
Published on 21 January 2020