Avoiding expat tax – financial emigration isn’t always the answer

This article was first published in Biznews.

“Expat tax” – the hot topic around most braais outside of South Africa. Polarised views from industry professionals have led to a lot of confusion – particularly amongst South Africans living overseas concerned with facing an ever-growing tax liability in South Africa.

In 2017, the National Treasury announced that the tax exemption on South African expatriates is changing. The legislative amendment, coming into effect on 1 March 2020, states that South African tax residents abroad will be required to pay tax of up to 45% of their foreign employment income, where it exceeds the R1 million threshold. This is again under review with a separate workshop set aside to deal with this issue.

Some tax practitioners and financial advisors are advising that financial emigration is a sufficient or even the only requirement in order to change tax residence status to non-resident. We don’t agree with that view. Here’s why:

What is financial emigration?

The process of changing your tax status from “resident” to “non-resident” is called financial emigration – it’s purely an exchange control matter. It doesn’t affect your citizenship, passport or other interests such as properties and financial services.

People regarded as South African residents (for exchange control purposes) who are leaving South Africa to take up permanent residence in any country outside the Common Monetary Area may make their application through an authorised dealer for emigration facilities.

A South African can only financially emigrate by making an application to the South African Reserve Bank (SARB) and, upon approval, then become classified as a non-resident. South African residents who have been living abroad, but haven’t officially emigrated through the SARB, are still considered residents for exchange control purposes.

The financial emigration process involves:

• Completing an MP336
• Application for an emigration tax clearance certificate through SARS
• Submission to the SARB
• On approval, opening of a blocked Rand account
• Proceeds* from remaining assets in South Africa are deposited
• Funds are then transferred overseas

*For example, surrendering a retirement annuity or selling a property.

From an exchange control point of view, there are three categories of persons:

1. South African residents – living in South Africa
2. South African residents temporarily abroad – a South African living overseas who has not financially emigrated
3. Non-residents – this includes South Africans who have financially emigrated

To determine whether you need to pay the “expat tax”, you first need to know your tax residency status.

The residence system

South Africa has a residence-based system of taxation, meaning that residents are taxed on their worldwide income and gains, subject to certain exclusions. Non-residents remain taxable on their South African actual or deemed source of income.

A non-resident is:

• Not ordinarily resident in South Africa, or
• Not physically present in South Africa for a specified period, or
• Someone who meets either of the above tests but is regarded as exclusively resident in another country by virtue of a tax treaty

Ordinary residence test

The term “ordinarily resident” is not defined in the Income Tax Act, so the interpretation of the courts must be followed. They’ve determined the concept to mean the country to which a person would naturally and as a matter of course return to from his/her wanderings, i.e. the person’s real home.

The question is one of fact, but it isn’t possible to lay down hard and fast rules. A physical presence at all times is not required to be ordinarily resident in South Africa. The following requirements need to be met:

• An intention to become ordinarily resident in a country, and
• Steps indicative of this intention having been or being carried out

It’s up to the taxpayer to discharge the onus that he or she is not ordinarily resident in South Africa.

Physical presence test

The physical presence test is simple and lays down hard rules that need to be complied with. It’s essentially a day-counting exercise.

As far as treaty residence is concerned, this comes into play where a person is regarded as a tax resident in two different countries that now have competing claims to taxing the individual.

< p>Tax treaties do not normally concern themselves with the domestic laws of the countries that lay down the conditions under which a person is fiscally “resident” and fully liable to pay tax. Countries stake their claims entirely on their own domestic laws.

 

In these cases, special provisions must be contained in the treaty to determine which of the two concepts of residence is to be given preference.

John’s situation: an example

John’s permanent home is in country A, where his wife and children live. He has a permanent job in country B on a four months on, two months off basis. His long-term plans are to move the family across to country B once his kids finish school. He lives in Airbnbs while he’s there and he’s taxed as being a resident of that country. Both countries claim that he’s fully liable to pay tax, and this conflict must be resolved by the treaty.

In the case of such a conflict, a choice must be made between the two claims, and here’s where the treaty proposes special rules. In this case, a typical treaty gives preference to the claim of country A. This doesn’t mean that the treaty lays down special rules on “residence” and that the domestic laws of country B are ignored because they are incompatible with the rules.

John now decides he wants to get his retirement funds out of South Africa as he wishes to plan for his eventual retirement in country B. He would rather have his funds there and in the foreign currency. As he is not yet 55, John can only move his retirement funds via financial emigration – which he does.

Even disregarding a debate around whether John is still ordinarily resident in South Africa, he still meets the physical presence test requirements – he spends more than 91 days in South Africa each year. In this case, the treaty will still assign John exclusive tax residence in South Africa.

So, did financial emigration render John automatically non-resident for tax purposes? The answer is no.

Financial emigration doesn’t equal non-residence

Some companies are peddling financial emigration as some sort of panacea, which could not be further from the truth. Financial emigration and becoming a non-resident for tax purposes are two distinct concepts and should not be confused with each other.

A SARS interpretation note on ordinary residence states: “The concept of ordinary residence must not be confused with the terms ‘domicile’, ‘nationality’, ‘citizenship’ and the concept of ‘emigrating’ or ‘immigrating’ for exchange control purposes.”

A further illustration of the difference between the concepts can be found in the Exchange Control Amnesty and Amendment of Taxation Laws Act 12 of 2003, which deals mainly with amnesty in respect of undeclared foreign assets both in terms of exchange control and taxation contraventions.

In terms of the Act, “resident” means:

• For purposes of tax matters, a resident as defined in section 1 of the Income Tax Act, 1962, and
• For purposes of exchange control matters, a person whether of South African or other nationality, who has taken up residence or is domiciled in the Republic, for purposes of the Exchange Control Regulations

I have searched and been unable to find any reported case law which would support the notion that financial emigration equates to non-residence for tax purposes.

Benefits of financial emigration

Financial emigration can be beneficial in certain circumstances. The advantages include:

• Accessing your South African Retirement Annuities before age 55*
• Transferring future South African inheritance funds out of the country without being subjected to the South African resident exchange control process
• Should you have no intention to return to South Africa, financial emigration would tidy up your financial affairs with the SARB
• Should you have no assets in South Africa and have been out of the country for longer than five years, you can financially emigrate with an exemption of needing to obtain tax clearance with SARS

*Until you have financially emigrated, your status, from an exchange control point of view, will be as a South African resident temporarily abroad. You will not be permitted to withdraw your South African retirement annuities out of the country. It is possible for any South African resident to withdraw pension and provident funds prior to retirement; however, accessing retirement annuities requires you to financially emigrate.

Capital gains tax (CGT) also needs to be considered as part of financial emigration. This process is a once-off tax on South African and overseas assets that have been “deemed” to have been disposed of. The amount depends on the gain or loss from your assets (a loss attracting zero tax) and the nature of the assets. In certain cases, it’s possible to “backdate” financial emigration. This would be used to ensure you don’t pay tax on any foreign assets you acquired after leaving South Africa.

Know where your advice is coming from

Every case requires some analysis to determine whether financial emigration is necessary or advantageous – your unique personal and financial circumstances need to be considered. We always recommend getting professional advice to make sure you’re doing the best thing for your situation.

Advice from companies who have a commercial interest in recommending financial emigration should always be taken lightly – there’s a clear conflict of interest. Advice on social media should also be avoided. Misinformation, whether brought about by confusion or design, seems to be the most prevalent and severe on these platforms.

Speak to a suitably qualified and experienced advisor who can give you impartial advice specific to your own circumstances and whose livelihood is not dependent on you financially emigrating.

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Get in touch if you would like to discuss your options and get unbiased advice from a qualified, cross-border financial advisor. Contact our team at wealth@sableinternational.com or by calling +27 (0) 21 657 1540.