South African tax residents working abroad currently qualify for an exemption on their foreign earnings, subject to the proviso that they must be outside South Africa for at least 183 days during any 12-month period, and this period must include a continuous period of more than 60 days.

The exemption was originally introduced in 2000 to avoid the scenario where an individual’s earnings is taxed both in South Africa and in a foreign jurisdiction. At the time, National Treasury cautioned that the exemption would need to be monitored as it may potentially create opportunities for double non-taxation. 

It is important to note that the exemption is not dependent on whether or not the South African tax resident has any tax liability in the foreign country in respect of such income.  Accordingly, currently, where the remuneration is not subject to income tax in the foreign jurisdiction, the remuneration could be earned tax-free.

However, those happy days are almost over! From 1 March 2020, the foreign earnings exemption will apply only to the first ZAR 1-million of foreign earnings, with the excess portion being subject to income tax in South Africa.  With just four months to go until 1 March 2020, employers and employees are now trying to come to grips with the practical considerations in this regard, some of which we deal with below.

First, and very importantly, how much tax will the employee actually pay in South Africa?

This depends on the specific circumstances.  For example, if the South African employee’s only income for the year was qualifying foreign earnings of ZAR 1.5-million, he or she would currently not pay any South African income tax in respect of such earnings.  From 1 March 2020, the employee’s South African income tax liability in respect of the ZAR 1.5-million will be ZAR 113 655.  If no exemption applied, the South African income tax liability would have been ZAR 517 821. 

For an employee receiving foreign earnings of ZAR 3-million per year, the South African income tax liability would be ZAR 742 821.  In the absence of the ZAR 1-million foreign earnings exemption, this liability would be ZAR 1 192  821.  (These calculations all take into account the primary rebate.)

What about the possibility of double tax?

If the foreign earnings are subject to income tax in both South Africa and the foreign jurisdiction, double tax should be avoided by the South African Revenue Service (SARS) granting foreign tax credits in terms of section 6quat of the Income Tax Act, 1962 (ITA).  As a result, the employee’s liability to pay income tax in South Africa is reduced by foreign taxes paid.  The credit must be claimed in the individual’s income tax return.

If the employee earning ZAR 1.5-million in the above example has been subject to ZAR 100 000 in tax in the foreign jurisdiction, his or her South African income tax liability would be reduced from ZAR 113 655 to ZAR 13 655.

Where the employee works for a foreign employer who does not have an obligation to withhold employees’ tax (PAYE), the employee would be obliged to submit provisional tax returns at the end of August and February each year.  

The employee could reduce the provisional tax payments taking into account the foreign tax credits.  The application of foreign tax credits can be somewhat tricky. The failure to calculate and pay provisional tax correctly, could result in the imposition of understatement penalties and interest. It is thus important that the employee ensures that he or she applies the foreign tax credits correctly, or that he or she obtains assistance in this regard.  

However, relying on foreign tax credits is even more complex if the employee has a resident employer who is obliged to withhold PAYE.  The ITA does not, as a general rule, permit an employer to take into account foreign tax credits in order to reduce PAYE. 

While the ultimate income tax liability is that of the employee, an employer is personally liable for the failure to withhold the correct amounts of employees’ tax. It would be very negative from a cashflow perspective if the employee’s remuneration is subject to tax in both jurisdictions and if the employee has to wait until assessment (at the earliest in about July of the next tax year) in order to receive a refund from SARS.

SARS recently released two publications regarding the revised foreign earnings exemption which aim to provide guidance on how to deal with some of the practical issues, including the application of foreign tax credits.  

These two documents indicate that the employer will have to apply for a directive from SARS to take into account foreign tax credits to reduce PAYE withholding on a monthly basis. SARS will apparently make a dedicated channel available to the public to apply for these directives.

The directive would not constitute the actual granting of the section 6quat credit but it permits a reduced PAYE withholding.  The section 6quat credit will only be granted on submission of the employee’s income tax return, subject to the requirements of section 6quat.

What is the tax position if the employee ceases to be tax resident in South Africa?

The short answer is that a person who is tax non-resident, is subject to South African income tax only on his or her income from South African sources.  Remuneration received for services rendered in South Africa would potentially be subject to income tax in South Africa. However, foreign sourced income should not be taxable in South Africa.

In order to determine whether ‘tax emigration’ is an option, the person should first consider (a) whether it would be possible to cease to be tax resident and (b) the tax ‘cost’ of ceasing to be tax resident:

Most South African tax residents are probably what is referred to as ‘ordinarily resident’ in South Africa.  Such a person will cease to be tax resident in South Africa if he or she no longer regards South Africa as his or her home (subjective intention), and if this subjective intention is supported by objective facts. This could include working overseas for most of the year, emigrating from an exchange control perspective, selling South African assets and living overseas with his or her family. However, if the individual’s home and immediate family (spouse and minor children) are in South Africa and if he or she returns to South Africa on a regular basis, it would be much more difficult to persuade SARS that he or she is not ordinarily resident in South Africa. 

It is important to keep in mind that there is a tax ‘exit charge’ should a person cease be to tax resident in South Africa. The taxpayer will be deemed to dispose of his or her worldwide assets, excluding certain assets such as South African immovable property. For example, should he or she have investments in South Africa and/ or overseas, he or she will be subject to capital gains tax on any gain (the difference between their market value at the time that he or she ceases to be tax resident, and what he or she paid for them) at the time when he or she ceases to be tax resident.

There are therefore lots of practicalities for both employers and employees to consider before 1 March 2020.  It is important that they obtain advice to ensure that they do not pay too much tax or fail to meet their South African income tax obligations (which could result in a hefty tax burden).

Written By Aneria Bouwer, partner and Sduduzo Mhlongo, associate at Bowmans.