A look at what the proposed change to the long-standing tax exemption for South African expats may entail
The Budget Review 2017 proposed that South African residents who work in a foreign country for more than 183 days a year will now be taxed in South Africa, if they are not subject to tax in the foreign country. This proposed overhaul of the private sector offshore employment income tax exemption sent shock-waves among the South African expatriate population across the world.
Why the proposes change?
Little is said about the reasons for this proposal, except that the current exemption of such foreign employment income is overly generous. The argument is that South Africa taxes residents on worldwide income, while the current exemption only benefits private sector employees and the exemption provides an unfair advantage of double non-taxation. It is unclear, at the moment, whether the proposal will also affect South African officers and crew members of foreign-going passenger or cargo ships who are currently also exempt in terms of the 183-days rule.
Who will be affected?
The proposed change affects every South African who works overseas and who does not pay tax on the income earned in those countries. A classic example would be individuals employed in Dubai, as the UAE does not levy employees’ tax on salaries.
Currently, such individuals, whether on secondment or individually employed, are also exempt from South African tax on their salaries if certain conditions are met. Firstly, the individual must be working outside South Africa for more than 183 days in aggregate during a 12-months period. The 12-months period is not limited to a calendar year. Secondly, the individual must be outside South Africa for a “continuous period” of at least 60 days during the measured 12-months period. The individuals are, however, still required to file tax returns in South Africa to declare the foreign income earned.
How will the proposed change affect you?
Going forward, depending on the wording of the proposed change in the legislation, such individuals will also be liable for income tax in South Africa on a sliding scale of 18% to 45%. The 45% rate applies to those in the salary band of more than R1.5 million (about USD 115 000) per annum.
There is no adjustment for the cost of living overseas relative to South Africa. Private or domestic expenses are also not deductible for tax purposes. In addition, the income will not be able to be shielded by any applicable tax treaty between South Africa and the foreign country of employment. This is because South Africa mainly follows the Organisation for Economic Co-operation and Development (OECD) Model Tax Convention in its treaty articles which affects employment income.
In terms of Article 15 of the Model, remuneration received by a South African resident in respect of employment services will only be taxable in South Africa. That is, the residence state has the primary right to levy tax on its residents. The only other time that the other treaty country is also allowed to tax that remuneration is if the employment is exercised in that other country. In such instance, the residence state would then grant a tax credit or exemption in respect of the income to avert double taxation.
South Africa’s right to tax its residents
Article 15 does not cover instances where the employment state does not impose tax, nor does it take away the right of the residence state to impose tax. In fact, it reaffirms the right of the residence state to always be able to tax its residents and, if certain conditions are met, such right is exclusive.
The exclusive right to tax employment income is allocated if the employee concerned was present in the foreign country for a period of less than 184 days, the remuneration is paid by or on behalf of an employer who is not a resident of the foreign country and such remuneration is not borne by a permanent establishment of such an employer in that foreign state. These requirements are self-explanatory. The main object of the exclusivity is that short-term employees should not be taxed in the source state where their employer is not entitled to a tax deduction of their salaries. This would be the case where the employer is not subject to tax because it is not a resident of that state or does not have a permanent establishment therein.
What if I cease to be a tax resident?
You might be wondering about what would happen if the employee concerned ceases to be a tax resident of South Africa. Would South Africa still have the primary right to tax the income? The answer is no.
But then, how does one cease to be a South African tax resident? What about exit charges that may be triggered by a resident ceasing to be a resident? To establish how an individual ceases to be a tax resident, one needs to first establish the mode of the tax residency.
There are two ways in which an individual becomes a South African tax resident:
Based on the number of years (about six years) during which an individual is physically present in South Africa
Based on the individual being regarded as an “ordinary resident” of South Africa
An individual who became a resident through the physical presence test can cease to be a resident if he or she stays outside South Africa for a continuous period of 330 full days.
There are no prescribed guidelines on how an individual, who is an ordinary resident, can cease to be a South African tax resident. It all depends on the facts and circumstances primarily governed by common law. The cutting criterion is whether the individual will naturally, and as a matter of course, return to South Africa from his or her wanderings. The various factors, taken into account include, but are not limited to, physical presence, the taxpayer’s actions, the mode of life and the possession of establishment. It must be noted that ordinary residence is not the same as a country of domicile or nationality, even though these may be taken into account as a factor.
Given that most South African expats retain strong family ties and economic interests in South Africa, it may be a very difficult call to cease South African tax residency to avert the new proposed tax measures. An individual who assumes tax residency of a treaty country may also find that he or she is still being regarded as a South African tax resident based on the treaty tie breaker. The tie breaker looks at factors, such as where the permanent home is located (centre of vital interest), habitual abode and nationality. If none of these criteria break the tie, then competent authorities of the two countries would decide where the individual is a resident.
Ceasing to be a tax resident can be expensive
It must also be noted that ceasing to be a tax resident may be an expensive exercise if the individual has accumulated significant gain assets. When you cease to be a resident, you are deemed to have disposed of all your assets which triggers capital gains tax (or income tax) at a rate of 18%, if you fall under the 45% personal income tax rate, or 28%, if the assets concerned are held for trade.
Other solutions will surely be considered, particularly in relation to secondments. The most common of which is grossing up the employees’ salaries by the amount of tax payable in South Africa. This would effectively push the tax costs to the employer, adding to the costs of offshore expansion.
Administratively, SARS will move from auditing days of absence from South Africa, which is relatively easy to monitor, to, among others, determining whether the South African expat is still a South African tax resident. In other words, SARS will now do the common law and treaty residency tests. This is quite a stretch of SARS’ limited resources and the cost of negative carry are likely to be high. Engagements with National Treasury on the issue are likely to unfold.
Source: Charles Makola, TaxTalk Magazine
Please note that the information provided in this article is based on generic scenarios and should not be taken as tax or financial advice. The circumstances of each individual and employer are different, requiring tailored advice and, where required, customized financial planning. Please contact us should you need any advice on this topic.