The taxation of South African expatriate employees: Dispelling the myth of financial emigration
Introduction The emigration of skilled individuals from South Africa (SA) increased significantly in the 1990s and still continues.1 Reliable statistics on the number of individuals that leave SA are scarce and admittedly underestimated by the South African government.2 Statistics SA confirmed in 2019 that: “Detailed information on the departure of travellers is not available in the movement control system. Data on the purpose of travel and the number of days South African residents intend to spend or spent abroad are not collected by the DHA. Hence, it is not possible to categorise South African residents as tourists or non-tourists.”3 A significant loss of skilled individual taxpayers could lead to erosion of the South African tax base. In the 2017/2018 year of assessment, personal income tax constituted the largest percentage (38%) of the total tax revenue collected.4 The South African Revenue Service (SARS) collected an amount of R321.4 billion during this tax year from only 4.9 million individual taxpayers.5 This relatively small amount of individuals carry the brunt of the tax burden, in spite of 20 million
individuals being registered for tax6 and a current population count of approximately 58.78 million.7 An estimated 900 000 individuals that were born in SA currently live and work abroad.8 This estimate is believed to be conservative and the true number is considered to be three times as high.9 Most of the individuals that leave SA are skilled, high-income earners that contribute to the tax base.10 Besides emigrating, many other South-African-born individuals work in other states, without relinquishing all ties with SA. From a tax perspective, this benefits those expatriates as they need not wind up their affairs and either qualify for unilateral relief from international double taxation11 in terms of the South African Income Tax Act,12 or relief in terms of a double tax agreement (DTA).
This affects the South African tax base negatively as expatriates often pay very little South African income tax while working abroad, although they may return to SA from time to time and still consider SA their home country. To address this potential tax base erosion, National Treasury announced in 2017 that the exemption from South African income tax for certain expatriate employees will be amended with effect from 1 March 2020.13 This proposed amendment was widely reported in the press where the impression was created by certain reports that this change will affect all expatriates.14 Many tax advisors also advocate that all expatriates should financially emigrate to avoid tax liability in SA.15
This chapter analyses the taxation of expatriates in terms of South African domestic tax law and examines the concept of “financial emigration” to determine its relevance from an income tax perspective. It further explains the tests to determine tax residency in South African domestic tax law, the current and proposed exemption from South African income tax for expatriate employees, and the interaction of the residence requirements in tax treaties with the relief from double taxation granted in domestic law. It also provides a very brief overview of the role of the commercial banks, the South African Reserve Bank (SARB) and the SARS upon “financial emigration” within the current legislative and policy framework. The contribution concludes by clarifying the law, pointing out problematic aspects and making a few final remarks concerning financial emigration and the liability of expatriates for income tax in SA
2 The tax liability of individuals in South Africa The starting point to determine whether an individual is liable for income tax in SA is the domestic law as contained in the Income Tax Act. Section 5 of the Income Tax Act (the charging section) levies income tax on the taxable income of any person during a year of assessment consisting of 12 months and ending on the last day of February every year.16 The taxable income of an individual is calculated by determining the gross income of a taxpayer and subtracting certain exempt amounts from it.17 The result of this computation is defined as income.18 From this income, allowable deductions and allowances,19 as well as assessed losses,20 are subtracted, any capital gain or loss is added or subtracted,21 and the result is classified as taxable income.22 The starting point of the income tax calculation for individuals is thus “gross income”.
This definition distinguishes between residents who are taxed on all amounts received from all worldwide sources and non-residents who are taxed in SA if the source of their income is located in the Republic.23 Many of the terms in the definition of “gross income” are not defined further, and reliance is placed on case law to determine the meaning of such concepts.24 As the taxation of expatriates centres on the question of residence, this concept requires further analysis.
3 The tax residence of an expatriate An expatriate is generally described as an individual who is a citizen or resident of one country but is living in another country.25 The term “expatriate” is not used in South African tax legislation. When someone moves across borders it can be challenging to ascertain in which state that person is liable for income tax at a specific moment in time. A nexus is required with the state that levies income tax on this individual.26 As many states levy income tax on a residence or source basis, the individual working abroad has to consider the domestic law of the state from where he or she originates, the state where he or she is resident, and the state or states where he or she is working.27 If a double tax agreement (DTA) was concluded between the two states concerned, the expatriate must also consider the provisions of that treaty.28 A DTA, however, cannot found tax liability and the domestic legislation concerned must contain a charging provision which imposes tax liability on the person working or living in that particular state.29 Although an expatriate might work outside SA, he or she could be liable for income tax in SA if he or she is “resident” in the Republic as defined in the Income Tax Act.30 The meaning of this term is unique to the application of tax legislation.
It is not the same as domicile or citizenship and differs from the meaning of resident used in the exchange control regulations.31 Two tests determine whether an individual is tax resident in SA, namely the “ordinarily resident” and “physical presence” tests.32 In addition, the definition of “resident” determines when residency ceases and ensures that an individual who is resident in another state in terms of a DTA is not classified as a resident of SA.
3.1 The meaning of “ordinarily resident” An individual is resident in SA if he or she is “ordinarily resident” within the Republic.34 The phrase “ordinarily resident” is not defined in the Income Tax Act and the guidelines found in case law is considered to establish its meaning in each specific situation.35 In 1946, the Appellate Division, as it then was, confirmed in Cohen v CIR36 that a person is resident in the state to which he
The South African courts have confirmed the Cohen decision and in addition found that a person may be ordinarily resident in SA, despite being temporarily absent during a specific tax year.38 Similarly, the House of Lords in the English case of Shah v Barnet London Borough Council39 referred to habitual and normal residence as a test “apart from temporary or occasional absences of long or short duration”.40 Olivier and Honiball are of the view that an individual can be ordinarily resident in SA in spite of being physically absent during a specific year of assessment or even several years.41 If an individual has the intention to return to SA as his or
her true home, such an individual is still regarded as ordinarily resident in SA.42 This interpretation of the phrase “ordinary residence” is in line with the courts’ interpretation and can cause an expatriate to be liable for tax in SA, despite not being physically present in this tax jurisdiction. SARS is of the view that two requirements must met for an individual to be ordinarily resident in SA: first, the intention to be ordinarily resident and, secondly, the taking of steps that indicate the practical implementation of this intention.43 In determining this intention, the actions of the person are examined based on several factors and the circumstances as whole.44 These non-exhaustive factors include the location of a fixed residence, habitual abode, business or personal interests, personal belongings, nationality, family and social ties, political cultural involvement, a person’s status in the country and the question whether such a person applied for permanent residence elsewhere.45 These factors indicate that SARS considers more than the mere place of employment or location of work activities when determining the place of ordinary residence of an expatriate. SARS further opines that it is not possible to add a specific time limit to ascertain ordinary residence.46 If a person was physically absent, the intention, purpose, nature and duration of such absence should be investigated.47 In the modern economy an individual could have many multinational economic opportunities causing a person to be constantly on the move and without a permanent home.48 The expatriate bears the onus of proof to show that he or she is a non-resident of SA, or that an amount, transaction, event or item is not taxable or is exempt.
3.2 The physical presence test The physical presence test is based on an objective approach, which considers the time an individual spends in SA and disregards the intention of the taxpayer. Th.
is test imposes tax resident status on individuals who are not ordinarily resident in terms of the common law, but are sufficiently physically present in SA.50 If a person is ordinarily resident in SA, this expatriate is tax resident, in spite of the person possibly not complying with the amount of days required to be resident based on physical presence. A person who is physically present in SA for more than 91 days in aggregate in the year of assessment and each of the preceding five years, as well as an aggregate of more than 915 days in total during the five years preceding.
the year of assessment, is resident in SA.51 The days need not be continuous.52 Practically, a person can only become a resident of SA for tax purposes based on this test in the sixth year of assessment that the person was sufficiently present.53 This test was introduced to encourage foreign skilled workers to work temporarily in SA to address the skill shortage.54 From an expatriate’s perspective, an individual who is or was resident based on this test should carefully monitor the amount of days spent in SA to determine whether he or she is classified as resident in SA.
3.3 The exclusion of individuals that are exclusively resident outside SA in terms of a DTA
Individuals who are resident in another country might be excluded from the South African definition of resident in domestic law. The proviso to the definition of resident in the Income Tax Act excludes an individual from South African tax residence if the person is exclusively resident in another state due to the application of the provisions of a DTA concluded between SA and such other state.55 This treaty override applies to the definition of a resident irrespective of whether the individual was a South African tax resident based on ordinary residence or physical presence. It is a useful clarification for expatriates who find themselves in jurisdictions that have treaties with SA. It was necessary to include this specific treaty override in legislation, as normally the provisions of a DTA have the same effect and status as national legislation.56 This equal status was confirmed in 1975 by the Supreme Court of Appeal in Secretary for Inland Revenue v Downing, 57 and by the Western Cape High Court in Commissioner South African Revenue Service v Van Kets58 in 2012. The latter case further confirmed that the correct application of section 231 of the Constitution requires that any conflict between a provision in a DTA and the South African domestic law must be solved by allowing the provisions in the treaty to prevail.59 This approach was also applied by the Supreme Court of Appeal in CSARS v Tradehold.
For treaty purposes, the residence of an individual is in the state where a person is liable to tax based on a nexus of either citizenship, domicile, residence or a similar criterion, but excluding the source criterion.61 In terms of the South African domestic law, the question whether a person can be resident in more than one location at the same time (dual residence) was not expressly decided by the court in Cohen, but one could argue that a person cannot have more than one “ordinary” residence. It is, however, possible for an expatriate to be a dual resident and be connected to two different states. For example, the person could be physically present and working in another state and considered tax resident there but could also have a home and family in SA, resulting in classification as ordinarily resident in SA, based on the common law. This dual residency is caused by differing resident tests and definitions in the domestic laws of both states.62 This dual residency of expatriates must be addressed and/or eliminated to allocate taxing rights to the appropriate state. The proviso to the definition of resident in South African domestic law also requires exclusive residence in another state for an individual not to be resident in SA.
Dual residence and the tie-breaker provisions in the OECD Model Tax Convention
If an individual is a dual resident, the application of tie-breaker rules may classify this person as exclusively resident in one of these specific states. The DTAs concluded between SA and other states all make use of the Organisation for Economic Cooperation and Development (OECD) Model Tax Convention’s tie-breaker rules to determine the state in which an individual is exclusively resident for tax purposes.63 Article 4(2) of the OECD Model Tax Convention contains a four-step procedure to determine the residency of individuals. First, an individual is deemed resident in the state where that person has a permanent home.64 Secondly, if a permanent home is found in both states, or the individual has no permanent home, the state where the individual’s personal and economic interests are closer – his or her “centre of vital interests” – is considered his or her country of residence.65 Thirdly, if no dominant state is identified based on the vital interests of the individual, the state where his or her “habitual abode” is situated, will be his or her ordinary place of residence.66 Fourthly, if the “habitual abode” cannot be determined or is in both states, the state of which the person is a national is his or her state of ordinary residence.67 If the matter cannot be resolved by applying the four steps in this article, a person who is a national of both contracting states, or of neither of the two states, may contact the authorities of both the contracting states to settle the issue via a mutual agreement
procedure.68 From the perspective of the expatriate, it is clear that more than the mere location of his or her work activities is considered when tax residence is allocated to a specific state. For an expatriate to be tax resident in another state, the factual breaking of ties with SA is required for both the ordinary residence test and the application of the tax treaty override in the definition of resident. The English court in Sheperd v Revenue and Customs Commissioners69 found that evidence of a “distinct break” with the previous jurisdiction is required for a person to be treated as non-resident, even if that person’s intention was to reduce his or her tax liability.70 When an individual works in many different jurisdictions, or is possibly tax resident in three different states, bilateral tax treaties cannot offer a solution.71 The OECD developed a Multilateral Instrument to serve as a guideline in cases where more than two jurisdictions are involved.72 Although SA is a signatory of the OECD Multilateral Instrument,73 SA has not entered into any multilateral tax treaties yet. The treaty override in the proviso to the definition of resident also does not contain a reference to the OECD Multilateral Instrument.74 In this scenario, I submit that the normal ordinary residence test will apply and one would have to determine residency based on the provisions of the DTAs that are applicable (if any) through a process of elimination. The dominant factual ties and/or citizenship should be decisive, and if not, unilateral relief in SA tax legislation or the domestic law of the other state could reduce double taxation. From a revenue collector’s perspective, a risk of double (or triple) non-taxation remains prevalent in this scenario.
Unilateral tax relief granted to expatriate employees
The South African Income Tax Act grants relief from international double taxation to specific categories of individuals that work outside the Republic. Expatriates who have not ended their SA tax residency (either expressly or via the operation of a DTA) remain liable for income tax, but may subtract the amount of foreign tax paid from their South African income tax liability as a credit,75 or may claim a specific exemption76 unilaterally regulated in the Income Tax Act. The same relief is available to expatriates who have not broken all ties with SA but are unsure of their intention to return to SA. Contrary to the impression created in the media,
section 10(1)(o) of the Income Tax Act does not apply to all expatriates.78 This section only exempts certain expatriate employees and individuals involved in the shipping industry under specific circumstances.79 In addition, an exemption is also granted to certain government employees.
Members of crew ships, mining operations at sea, international shipping and fishing
The remuneration of an officer or crew member of a ship which transports passengers or goods for reward, performs certain mining operations on the sea bed, or is involved in international shipping or fishing outside SA is exempt from income tax, if the person performing such activities was outside SA for an aggregate of more than 183 full days during a year of assessment.81 This exemption only applies to remuneration as defined in paragraph 1 of the Fourth Schedule to the Income Tax Act, which regulates provisional tax that is paid in advance by employers on behalf of employees, also known as “pay as you earn” (PAYE).82 This remuneration includes salary, wages, leave pay, overtime pay, commission, fees, emolument, gratuity, bonus, superannuation, pension and allowances received by any person, whether it is received for services rendered or not.83 It further includes certain identified amounts that are classified as specific inclusions in gross income.84 The term “remuneration”, as defined in the Fourth Schedule to the Income Tax Act, also includes allowances in respect of meals, accommodation, business expenses, other specific travel allowances, gains and benefits that accrue to employees that participate in specific share incentive schemes, as well as certain dividends.85 Save for the specific requirements contained in the detailed sections that regulate the nature of remuneration received or accrued, the nature of the employment relationship is not decisive in determining whether individuals qualify for an exemption in terms of section 10(1)(o)(i) of the Income Tax Act. The emphasis is on the nature of the activities that an individual is involved in. This exemption applies to “any person” that was outside SA for the requisite number of days, namely 183 full days.8
Services rendered outside SA by expatriate employees
The remuneration of an employee for services rendered outside SA for or on behalf of any employer is exempt if that employee was outside SA for more than 183 days in aggregate during the year of assessment and for a period exceeding 60 consecutive full days during the 12 months of that specific tax year.87 The type of remuneration is listed in the section itself and includes salary, wages, leave pay, overtime, bonus, commission, fees, emolument or allowance, amounts in terms of paragraph (i) of the definition of gross income,88 or amounts referred to in sections 8, 8B and 8C of the Income Tax Act. 89 Section 8 includes a wide variety of expenses (fringe benefits) that an employer pays on behalf of its employee, section 8B taxes certain amounts that employees receive in terms of broad-based employee share schemes, and section 8C regulates the taxation of the vesting of equity instruments that employees might receive by virtue of their employment. To qualify for this exemption the services must be rendered outside SA by the employee for or on behalf of the employer.90 When determining whether a person was outside SA, employees who are in transit between two states via a South African airport and who do not formally enter SA through a port of entry, are not considered to enter SA.91 If the services of the employee were rendered over two different years of assessment, the remuneration is deemed to accrue evenly/equally over the period of the service.92 This exemption does not apply to holders of a public office,93 or to independent services, work or labour.94 A person who is self-employed is not entitled to the exemption. Income for professional services rendered is taxed in accordance with the normal residence rules,95 and included in gross income in the worldwide income of the expatriate if he or she is resident. The term “employee” is not defined in section 1 of the Income Tax Act for purposes of the general application of this Act, but is defined for purposes of the application of the PAYE rules in the Fourth Schedule to the Income Tax Act.96 Here, an employee is defined (for purposes of the application of this schedule only) as a person that is not a company to whom remuneration is paid or accrues, certain labour brokers, persons declared to be employees by the Minister of Finance and any director of a private company.97 In section 10(1)(o)(ii), however, the type of remuneration is not defined with reference to the Fourth Schedule. Olivier and Honiball opine that the normal meaning of employment would require a form of control by the employer over the employee.98 This accords with ITC 117499 where the Tax Court found that independent contractors are not included in the meaning of the term employee.100 In BMW South Africa (Pty) Ltd v The Commissioner for the South African Revenue Service101 the Supreme Court of Appeal found that amounts paid by an employer to tax advisors who advised their expatriate employee constituted a taxable benefit which should be included in the gross income of the expatriate employee.102 This decision indicates that all possible benefits will be taxable in terms of South African domestic law. In spite of this, and unlike the wide exemption in respect of remuneration in the shipping industry, the scope of the exemption in respect of employees is still more limited, as, for example, dividends, certain pension payments, and payments received on the termination of services are not exempt.
3 The suggested amendment of the taxation of expatriate employees (from March 2020)
On 22 February 2017, National Treasury announced that it would repeal the exemption from income tax in section 10(1)(o)(ii) of the Income Tax Act which currently applies to expatriate employees.104 SARS stated that the reason for the repeal is that the current exemption creates opportunities for abuse, as expatriates could qualify for double non-taxation where foreign host countries do not levy income tax on employment income or taxes it at a reduced rate.105 It is also possible to avoid tax through the manipulation of the days of absence of both jurisdictions. Initially, in 2017, it was proposed that the exemption in section 10(1)(o)(ii) of the Income Tax Act be repealed and that expatriate employees claim a tax credit for foreign taxes paid under section 6quat of the Income Tax Act.106 This amendment, at the time, would have applied with effect from 1 March 2019 for years of assessment that commenced after this date.107 The final amendment kept this exemption in the Income Tax Act, yet changed it to only exempt the first R1 million earned outside SA from income tax for all years of assessment commencing from 1 March 2020.108 All resident expatriate individuals must report and pay South African income tax on an amount earned outside SA that exceeds R1million, if they were absent from the Republic for the requisite amount of days. This amendment only affects expatriate employees as the suggestion amends only section 10(1)(o)(ii) and not section 10(1)(o)(i), which grants an exemption to persons involved in the shipping industry.
The unilateral exemption of government officials
Under certain circumstances, non-resident employees who render services outside SA to an employer in the national or provincial sphere of government or a municipality, or any national or provincial public entity, are exempt from income tax.109 This applies if “not less than 80% of the expenditure of such entity is defrayed directly or indirectly from funds voted by Parliament”.110 The income is only exempt in SA if it is chargeable to tax in the jurisdiction where the employee is ordinarily resident (not SA) and the employee personally paid tax there and this tax was not paid by the employer on behalf of the employee.
The unilateral tax credit for foreign taxes paid
All other South African resident expatriate individuals, who are not employees or members of the shipping industry or government, may claim a tax credit for foreign taxes paid in another state when calculating their South African tax liability.112 This rebate is available to residents who earn any type of income from any source outside SA,113 a proportional amount attributed to an individual in terms of the controlled foreign company (CFC) rules,114 a taxable capital gain from a source outside SA115 or certain deemed accruals in terms of section 7,116 certain capital gains from sources outside SA that are attributed to a resident,117 and certain capital gains of trusts that are attributable to a resident.118 Typically this could apply to an employed person who spends the required amount of time outside SA to qualify for section 10(1)(o) relief but spends the remainder of the tax year in SA or is ordinarily resident in SA.
