South African tax residents may have to reassess their decision to retire in South Africa in order to avoid a substantial increase in the amount of tax that they are expected to pay during retirement.
Did you work abroad for a South African company? You could be in for a nasty surprise due to changes to the foreign service exemption on retirement benefits from a South African retirement fund.
Changes to the foreign service exemption on retirement benefits from a South African retirement fund could spell disaster for retired South African tax residents who have previously worked abroad, including those on their way to retirement. These individuals will face an increased tax burden in respect of their annuity or lump sum income originating from a South African retirement fund.
This situation has come about due to amendments to the Income Tax Act contained in the Taxation Laws Amendment Act, which was gazetted on 19 January 2017. The amendment act contains changes to Section 10(1)(gC)(ii) of the Income Tax Act which will be implemented on 1 March 2017.
Thus, Section 10(1)(gC)(ii) will only apply to exempt foreign service retirement benefits from foreign retirement funds or foreign service amounts which were transferred from a foreign retirement fund to a local retirement fund.
Unlike the introduction of the “retirement reform legislation”, the legislation does not include any protection for vested rights, other than with respect to foreign retirement benefits that were transferred to a South African retirement fund. In other words, the rule change is retroactive in that it not only affects future retirees or people saving for retirement, but also those who have already retired.
Who is affected?
This amendment affects South African tax residents (retired or not) who have spent a portion of their working life rendering services abroad, while continuing to remain members of and contributing to their employers’ South African retirement fund.
Up until 1 March 2017, these individuals were only required to pay tax in South Africa on the South African sourced portion of their income. (Refer to SARS Binding General Ruling No 25 which will likely be retracted in light of the amendment.)
For illustrative purposes, consider the following hypothetical scenarios
The effect of the amendment on future retirees
Neo was employed by a mining company in 1982. He spent 17 of the last 35 years at the mining company, rendering services abroad. For many of the tax years, Neo was not required to pay tax in South Africa on his foreign sourced income because he met the requirements of Section 10(1)(o)(ii). As part of his conditions of service, Neo continued to contribute to the Mining Pension Fund.
Previously, Neo was advised that, when he retires from the Mining Pension Fund, he will not pay tax in South Africa on a 17/35 portion of the lump sum or the continuing annuity that he receives from the Mining Pension Fund. However, because of the amendment, if Neo retires after 1 March 2017 he will pay tax in South Africa on the entire lump sum which he receives (at the rates applicable in the retirement lump sum tax table) as well as on the entire annuity (at the marginal individual income tax rates) which accrues to him on a monthly basis.
The effect of the amendment on existing retirees
Mercy retired in 2011. She worked for a logistics company and, like Neo, worked abroad for a number of years and continued to contribute to her employer’s South African pension fund. Up until 1 March 2017, Mercy only paid tax in South Africa on 30% of her annuity income because, for seven of the 10 years that she contributed to the logistics company’s pension fund, she was earning foreign sourced income, while rendering services abroad. However, as from 1 March 2017, Mercy will pay tax in South Africa on 100% of her monthly annuity.
Who is not affected by the amendment?
- While Section 10(1)(gC) has been amended, Section 9(2)(i) still applies to non-South African tax residents. Retirement fund pay-outs that relate to services rendered abroad by non-South African tax residents will still be exempt from tax in South Africa in terms of Section 9(2)(i).In short, if Neo was not a South African tax resident or ceases to be a South African tax resident before he retires, he will not have to pay tax in South Africa on the portion of the lump sum or the annuity related to the time he spent working outside of South Africa (17 of the 35 years), which he receives from the Mining Pension Fund when he retires after 1 March 2017.
- Take note, if Neo is currently a South African tax resident, he may want to investigate the consequences of breaking tax and exchange control residency, including the effect of the exit charges applicable.
- Section 10(1)(gC)(ii) still applies to foreign retirement funds. Therefore, if a foreign national settles in South Africa and becomes a South African tax resident, he or she would still be entitled to a tax exemption in respect of his or her retirement benefits that are paid from a foreign pension fund for past employment outside South Africa.
- The amendment contains a caveat that allows South African tax residents who have transferred their retirement savings from abroad into an approved South African pension fund to continue to claim the tax exemption in respect of the amount that was transferred.
It is strongly recommended that South African employers who have a globally mobile workforce reconsider their South African retirement fund structures and those employment policies that require their mobile employees to contribute to South African retirement funds.
South African tax residents with foreign service related retirement income from a South African retirement fund are in trouble. They may have to reassess their decision to retire in South Africa in order to avoid a substantial increase in the amount of tax that they are expected to pay during retirement.
For now, it seems that the position of those tax residents seeking to transfer their foreign retirement savings to a South African retirement vehicle remains unchanged.
The retirement space is currently volatile and all taxpayers are advised to seek professional advice before making decisions that will have a long-lasting impact. Furthermore, the information provided in this article is based on generic scenarios and should not be taken as tax advice. The circumstances of each individual and employer are different, requiring tailored advice and, where required, customized financial planning.
Source: Beatrie Gouws, TaxTalk Magazine