Irma Lategan, Senior Associate based in Cape Town, takes us through the maze of the foreign earnings exemption, and points out that “financial emigration” does not necessarily exempt a taxpayer from paying tax in South Africa.
There is a lot of conflicting information in the media regarding the taxation of South Africans on their foreign earnings and the effect of the implementation of the amendments to the tax law.
Currently, remuneration earned by South African tax residents for services rendered abroad is exempt from SA tax, if that resident spent more than 183 full days (including a continuous period of more than 60 full days) outside SA in any 12-month period during which those services were rendered (“foreign earnings exemption”).
With effect from 1 March 2020, the foreign earnings exemption will only apply to up to R1 million of foreign income earned in a tax year. Income earned abroad exceeding R1 million will not be exempt under the foreign earnings exemption.
We are being contacted on a weekly basis by South Africans who work and/or live abroad and want to “financially” emigrate by placing their emigration on record with the Reserve Bank. They think that by taking this measure, their foreign income will not be taxed in South Africa. What they fail to understand is that this will not necessarily exempt them from paying tax in SA.
Who will be affected by the changes in the law?
It is important to understand the difference between becoming non-resident for tax purposes and non-resident for exchange control purposes.
The foreign earnings exemption, and its new cap, only applies to SA tax residents. If you are not a SA resident for tax purposes, you will not be affected by this amendment. People who have placed their emigration on record with the Reserve Bank may still be tax resident in SA.
SA tax residency
SA has a residence-based tax system. Residents are taxed on their world-wide income, except if it is specifically exempt, as is the case with the foreign earnings exemption.
A resident is defined in section 1 of the Income Tax Act 58 of 1962 (“ITA”) as a person who is either:
- ordinarily resident in SA (the “ordinary residence test”); or
- who qualifies as a resident in terms of his or her physical presence in SA (the “days test”).
Note that in order to be non-tax resident in SA in terms of the ITA, you must be non-resident in terms of both tests.
Even if you are regarded as a SA tax resident in terms of the tests under the ITA, you may however still be regarded as a non-resident for tax purposes under the applicable Double Tax Agreement (“DTA”) which was entered into between SA and the country where you are working or living.
The ordinary residence test
The ordinary residence test serves as the point of departure i.e. the first step in determining tax residency.
According to the South African Revenue Service, the following requirements need to be satisfied in order for a person to qualify as ordinarily resident:
- an intention to be ordinarily resident in SA, and
- steps indicative of this intention being taken.
SARS may challenge a person’s intention to be ordinarily resident, or not, by looking at objective facts which might disprove such a subjective intention.
It is important to note that a person can be ordinarily resident in SA regardless of the number of days spent in, or absent from, SA.
The following are helpful questions to ask to determine whether you might be ordinarily resident in SA. These questions are based upon factors provided by SARS which they take into account to determine whether a person is ordinarily resident in SA:
- Is SA the country to which I return to from my wanderings?
- Is my primary residence within SA?
- Where is my most settled place of residence?
- How many days do I spend in SA compared to other jurisdictions?
- What nationality am I?
- Do my family members reside in SA?
- Where is my immovable property located?
- Where are my assets or personal belongings located?
- Is there any documentary evidence on file (e.g. emails, correspondence etc.) which may imply an intention to permanently live in SA?
- Where are my business and economic interests primarily located?
- Do I have any political, social and religious ties to SA?
If a person has no intention to be resident in SA and this intention is objectively evidenced by steps taken to give effect to that intention, that person will not be ordinarily resident in SA.
The days test
The next step in determining if a person is resident in SA, is to apply the days test.
If you are not ordinarily resident in SA, you may still qualify as a ‘resident’ on the basis of the amount of days spent in SA over a period of six years. Intention is irrelevant under this test.
In terms of the days test, you will become resident in the following circumstances:
- if you are physically present in SA for more than 91 days in aggregate during the current year of assessment; and
- if you have been physically present in SA for more than 91 days per year during each of the previous five years of assessment; and
- if you have been physically present in SA for a period(s) exceeding 915 days in aggregate during the previous five years of assessment.
In calculating the number of days, a day includes a part of a day but excludes any day spent in transit through and without formally entering SA.
In the first year of assessment in which you fulfil the days test requirements, you are deemed to be a resident from the first day of that year of assessment.
If you are deemed a SA resident because of the days test, residency can be broken by leaving SA and remaining outside the Republic for a continuous period of at least 330 full days.
Should you be regarded as a SA tax resident as a result of either the ordinarily resident or days tests, the applicable DTA entered into between SA and the country in which you are living and/or working might regard you as non-resident in SA, and as resident in the other country. It is therefore essential that the terms of the DTA be checked.
Section 6 Quat
Should you be regarded as a SA tax resident, and are taxed in another country on the same income on which you are taxed in SA, section 6quat of the ITA provides for a rebate of the foreign tax paid against SA taxes. The rebate is limited to the SA tax payable on the foreign income.
The effect of the 6quat rebate on the newly introduced cap on the foreign earnings exemption is therefore that, for SA tax residents, all taxes paid abroad on income in excess of R1 million will be rebated against the SA taxes payable on that same income. The earnings exceeding R1 million, will therefore not be taxed twice, but at the higher rate of SA or the foreign country.
Financial emigration through the reserve bank
The main reason for financial emigration is to break exchange control residence.
In order to financially emigrate, application is made to the Financial Surveillance Department of the Reserve Bank with proof of the right, either by foreign passport or an appropriate visa, to live in another country.
Through the application the person must show his or her intent to no longer be permanently resident in SA.
By financially emigrating, a person is strongly demonstrating the intent to have a primary residence outside of SA and not to be ordinarily resident in SA.
Financial emigration is only a strong indication that a person is not ordinarily resident in SA, and not a definitive factor. SARS takes various factors into account, and a person’s residency status at the Reserve Bank is only one of them.
Even if you can show that you are no longer ordinarily resident, you may still be tax resident as a result of the number of days spent in SA, or as a result of the applicable DTA entered into between SA and the country where you are working.
Non-residents for tax purposes in SA do not pay tax on foreign sourced income. The amendments to the foreign earnings exemption would therefore not be applicable to non-residents as the foreign earnings are never taxable.
If you are tax resident in SA, from 1 March 2020 the first R1 million of foreign earnings will be exempt in terms of the foreign earnings exemption if you are outside of SA for more than 183 full days (including a continuous period of more than 60 full days) in any 12 months period. The amount exceeding R1 million will be taxable in SA.
If you are taxed in SA on the amount earned exceeding R1 million, you may get relief in terms of section 6quat of the ITA.