By: Christine Bornman, Fiduciary and Tax Specialist at Sanlam Private Wealth
With amendments to tax laws targeting the foreign earnings of South Africans coming into effect on 1 March 2020, the number of local residents seeking to cease their South African tax residency and formalise their resident status for exchange control purposes has increased significantly.
Leaving the country could have significant implications for estate planning, however – here’s what you need to know
AMENDMENT FROM MARCH 2020
South Africans working abroad for more than 183 days during any 12-month period, which includes a continuous period exceeding 60 full days during that 12-month period, have until now not been taxed in South Africa on their foreign employment income. Section 10(1)(o)(ii) of the Income Tax Act 58 of 1962 (ITA) provided a specific exemption for this income.
This has now changed, however. Treasury was of the view that the exemption was creating opportunities for double non-taxation in cases where the foreign host country either doesn’t impose income tax on employment income, or taxes such income at a significantly lower rate. With effect from 1 March 2020, Section 10(1)(o)(ii) has been amended to allow the first R1.25 million of foreign remuneration to be exempt from tax in South Africa.
As a result of this amendment, all South African tax residents working abroad will from March be subject to tax in South Africa on all foreign employment income earned exceeding R1.25 million. However, if tax has been paid on these earnings in the foreign host country, they’ll be able to claim this as a credit in South Africa, limited to the amount of local tax payable on the foreign earnings.
CESSATION OF SA TAX RESIDENCY
Many South Africans who have already left the country are now rushing to ‘officially’ cease their South African tax residency to avoid unnecessary complications as a result of the amendment. However, there are several potential stumbling blocks to consider before taking this step.
It’s important to realise that ceasing tax residency isn’t the same thing as formal emigration. If you’ve ceased your South African tax residency and have paid the necessary taxes, you’ll be seen as a non-SA taxpayer. Formal emigration, however, means taking all your assets out of the country, which involves a South African Reserve Bank (SARB) process resulting in a change of your residency status for exchange control purposes. This process is known as ‘formalising’ your emigration.
IMPACT ON ESTATE PLANNING
If you haven’t formally emigrated, but have ceased your South African tax residency, how will it impact your estate plan, especially the intergenerational transfer of wealth? What do you need to think about?
Many South Africans are either trustees or beneficiaries of a local trust. If you’re a trustee, complications may arise if you wish to relocate. You may in fact need to resign as trustee. The Master of the High Court may require that you furnish security, unless there are grounds for exemption. If no security can be provided, the Master may request that you be removed as a foreign trustee.
What if you don’t know that you’re the beneficiary of a trust? In cases where a trust has been set up by parents or grandparents for the purposes of intergenerational planning and preservation of wealth, beneficiaries may not even be aware of their status as such. We can’t emphasise enough the importance of honest and open communication between generations – the financial impact can be significant if decisions are made without full knowledge by relevant family members of wealth transfer plans.
Then there are also implications if beneficiaries living abroad are in need of financial assistance, and the trustees authorise trust distributions to these beneficiaries. When a capital gain is distributed to a non-SA resident trust beneficiary, the conduit principle (shifting the tax burden to the beneficiary) will not apply and the trust will pay the taxes at a higher effective rate of 36%.
If you as a beneficiary are still a South African resident for exchange control purposes, you can’t receive the funds freely – exchange control regulations will need to be taken into account. You’ll have to use your discretionary allowance (R1 million per calendar year) or your foreign investment allowance (FIA) (R10 million per calendar year) to receive the funds offshore. If you make use of your FIA, you’ll first need to obtain a SARS tax clearance certificate – which means your South African tax affairs have to be up to date.
Punitive taxes imposed by some other jurisdictions present a further potential challenge. If you as a beneficiary are living in the US, UK or Australia and receive distributions from foreign trusts, including South African trusts, then those countries may hit you with punitive taxes. If a local or an offshore trust has beneficiaries in these jurisdictions, it’s crucial to obtain expert advice before any distributions are considered.
In broad terms:
When an Australian resident beneficiary receives a capital distribution consisting of current or historic capital gains from a South African trust, the capital distribution has to be included in assessable income in Australia.
In the case of a US tax-resident beneficiary (typically a US citizen or green card holder) the entire distribution could become payable to the US Internal Revenue Service (IRS) as tax.
In the UK, the rules pertaining to the nature and composition of distributions are extremely complex. This may result in additional taxes arising in the hands of UK beneficiaries if the trustees have not kept a careful record of historical income and gains, and kept income and gains separate.
To complicate matters further, the US Foreign Accounts Tax Compliance Act (FATCA) requires trustees or the relevant financial institution managing the trust assets to report to SARS that a US resident or green card holder is a beneficiary of a trust, and SARS will report the same to the IRS. Similarly, resident beneficiaries may be subject to certain Foreign Bank Account Report (FBAR) requirements directing them to declare to the IRS if they have funds available outside the US.
In terms of the Common Reporting Standards (CRS), the details of settlors and beneficiaries of trusts must be recorded, and this information is available to all CRS-member countries, including South Africa, Mauritius, the Channel Islands, Australia and the UK.
Besides setting up a trust, another option for transferring wealth to the next generation is simply to bequeath assets directly by way of a last will and testament. Again, it’s important to understand all the implications. If your children haven’t placed their emigration on record with the SARB, they’ll only be allowed to transfer their inheritance offshore by making use of their discretionary allowance and/or FIA, provided that their South African tax affairs are up to date.
It should be clear that ceasing your tax residency doesn’t mean an end to all problems. It’s critical to consider the impact on your estate plan (whether it’s your own or an intergeneration plan) when you leave South Africa. There is no one-size-fits-all solution. Everyone’s personal circumstances, and therefore estate plan, is unique and it’s crucial to seek professional advice – whether it’s you who is relocating, or your grandchild.
Expat Tax: Top 5 Questions
Comments by Stanley Broun, Head of Fiduciary and Tax at Sanlam Private Wealth
Much has been written in the media of late on the new ‘expat tax’ – from 1 March 2020, South Africans employed abroad will be subject to income tax on their foreign earnings above R1.25 million. There’s still considerable confusion and uncertainty over the impact of the new laws. Here are the top five concerns our clients have raised.
- How will the existing tax laws be amended?
With effect from 1 March 2020, Section 10(1)(o)(ii) of the Income Tax Act 58 of 1962 (ITA) has been amended to allow only the first R1.25 million of foreign remuneration to be exempt from tax in South Africa. This effectively means that all South African tax residents working abroad are now subject to tax in South Africa on any foreign employment income above the R1.25 million threshold. If tax has been paid on these earnings in the foreign host country, South Africa will allow a tax credit, limited to the amount of local tax payable on the foreign earnings.
- Who will be affected by the new laws?
There’s been much media hype around the tax law amendments, with headlines often referring to ‘SA expats working abroad’. It’s important to note that the change in legislation won’t necessarily impact all South Africans working abroad. In broad terms, it will only be applicable if you’re still a South African tax resident, and:
- receive remuneration for employment services rendered outside South Africa, including salary, share options, leave pay and wage overtime pay
- are outside South Africa for more than 183 days in aggregate during a 12-month period, and for a continuous period exceeding 60 full days during that 12-month period
- are employed by a resident or non-resident employer.
If this applies to you, it may be beneficial to consider the cessation of your South African tax residency, or rely on an available double tax treaty. See our article on the implications for estate planning if you decide to cease your South African tax residency. It’s crucial to consult a fiduciary and tax expert, however, as your current circumstances might result in you falling outside the scope of the new Section 10(1)(o)(ii), for example, if you’re:
- an officer or a crew member of a ship (not an independent contractor or self-employed person), engaged in the transportation of goods and services for reward during a year of assessment and
- outside South Africa for a period or periods exceeding 183 days on aggregate during a year of assessment.
- If I cease my tax residency, will the exit charge apply only to my SA assets?
There is a misperception that if you cease to be a tax resident, the exit charge will apply only to your South African assets and not to those held abroad. This can’t be further from the truth. As a local tax resident you’re subject to tax on a worldwide basis. When you cease to be a South African tax resident, you’ll therefore trigger an exit charge on your worldwide assets, and not only your local assets.
The Income Tax Act 58 of 1962 includes a provision under Section 9H that should a person cease their residency, they must be treated as having disposed of all their worldwide assets on the day immediately before cessation. A note of caution: the provision states that the market value to be used is not the value on the day you cease your residency, but the value on the preceding day.
- Are there any assets excluded from the exit charge when I cease to be a tax resident?
The exit charge will be applicable on your worldwide assets – excluding any fixed property you own in South Africa. However, as a non-tax resident, you’ll still be liable for capital gains tax when you sell the property.
- Will I be taxed at the 45% marginal tax rate?
If your foreign employment income is equal to or greater than R1 577 301 for the tax year, it doesn’t necessarily mean you’ll be taxed at 45%. It’s important to remember that you’re taxed on a worldwide basis and not only on your foreign employment income. Once you’ve included all your income in your tax return (including foreign employment income and interest) the South African Revenue Service (SARS) will first apply the relevant exemptions. It will then deduct any qualifying deductions and add any taxable capital gains. Only then you will derive at your taxable income.
For example, on an income of R1 577 301 that is derived solely from foreign employment, after the R1.25 million exemption – and assuming you have no deductions and taxable capital gains – only R327 301 will be taxable income. If your employer deducted the relevant employees’ tax in the foreign jurisdiction, any taxes levied on the R327 301 portion may be used as a credit to ensure you’re not double taxed. Also, as a tax resident, you’re still entitled to a primary rebate.
The idea that you’ll be taxed at the marginal rate of 45% on your total foreign employment income is therefore incorrect. You’ll have to take into account the relevant exemptions as well as deductions, not forgetting your rebates and credits for taxes already paid abroad.