Recent news reports have provided conflicting – and even wholly inaccurate – information around the implications for expats to the scheduled March 2020 change to the Income Tax Act. Alarmingly, a number of tax practitioners and financial advisors have been recommending that people financially emigrate in order to avoid the expat tax the revised Act has implemented. And while financial emigration is a viable option for a small minority of individuals, for the majority it’s likely to be a costly exercise which won’t in the long-term provide significant tax relief.
What exactly is financial emigration? Financial emigration is the process whereby taxpayers change their status with the South African Reserve Bank (SARB) from resident to non-resident. It’s a process conducted purely for exchange control purposes, but which does not affect your citizenship status in any way.
Emigration, on the other hand, is a very different process as it involves physically relocating from one country to another country either in the short or long term. Once emigration has become a permanent status, the process of financially emigrating – during which time the individual’s assets move from their old country of residence to their new country of residence – takes place.
The mistake many people are currently making is that they are expecting financial emigration to resolve their issues around paying tax in South Africa on income earned abroad, a so-called ‘expat tax’. The reality, however, is that financial emigration for most individuals won’t provide material tax savings.
It’s not uncommon in this modern era to find individuals who have primary residence in one country but who work and earn income in at least one other country. The question is, where do they pay tax?
There has been a global acceptance that it’s not fair to expect individuals to pay tax in both their country of residence and in the country in which they earned the income. As a result – and in order to relieve the burden of paying double tax – it became acceptable practice that the country in which the income was earned has the right to charge tax, in which case the income then became exempt from tax in the individual’s country of residence, or the country of residence provided a credit for the tax paid in another country.
Section 10(1) (o) (ii) of the Income Tax Act is the section which provides this particular tax exemption to South African expats on their foreign income. The proviso, however, is that they need to be outside the country for a total of more than 183 days, of which at least 60 days are consecutive days in any 12-month period. Individuals who met these conditions were effectively exempt from paying tax on their income in South Africa.
However, while the exemption clause was intended to protect individuals from being doubly taxed, it was never intended to relieve taxpayers of double non-taxation. The reality, however, is that some individuals are using this clause to avoid paying tax in any jurisdiction. The United Arab Emirates, for example, has no direct tax requirements in place. South African expats working there could, therefore, in theory, avoid paying any tax at all, whilst still retaining their South African residency.
In response to this trend, the South African Revenue Service (SARS) announced that it intended removing this exemption but as a result of public pressure, has agreed to delay its removal until March 2020.
Understanding the changes to the Income Tax Act
Once the amendments to the Income Tax Act come into effect in March 2020, South African tax residents working abroad will only be exempt from paying tax on the first R1 million they earn abroad. Thereafter they will be required to pay tax on any foreign earnings.
The revised Act does, however, make provision for expats working abroad who are registered for tax in those countries. In these instances, the Act allows those individuals to apply for credits in South Africa which are offset against the tax they owe locally, with the tax rate starting at the lowest rate.
The reality, therefore, is that South Africans working abroad will in most instances not be significantly negatively impacted by the changed regulations and will still not be doubly taxed. The only individuals that will be detrimentally impacted are those earning very large amounts offshore and even in these instances, they will still only be paying the same amount of tax they would have been paying in South Africa in any event.
What’s important to understand is that to all intents and purposes the law has not changed but has instead just corrected a loophole.
It would be counter-intuitive to allow South African residents who spend the majority of their time in the country and have the majority of their assets here, to avoid paying tax locally. South Africa’s tax regime is based on a residence-based system and is evaluated according to how much time you spend in the country, where your assets are based, where your family resides most of the time, and where the country in which your primary residence is situated.
South African residents who work abroad permanently and spend the majority of their time living abroad would already be considered non-residents from a tax perspective. Remember that it is possible to change your tax residency without having to financially emigrate.
When is financial emigration a good idea?
While financial emigration is not a means of avoiding the expat tax, there are limited circumstances when it is a viable option. A viable reason for emigrating financially is in order to access your retirement funding earlier or to shift an inheritance offshore. However, what an individual should not forget is that it is possible to make use of the R10 million foreign investment allowance without having to financially emigrate.
Now that foreign income above R1 million is no longer exempt from tax, the authorities are concerned not just with income earned abroad, but also the value of fringe benefits, including accommodation, which the individual has received. The addition of fringe benefits can quickly launch an individual over the R1 million threshold. This is something of a contentious issue, particularly if the taxpayer is working in a developing country and is subjected to very basic, but often fairly costly, accommodation, which you are then taxed on.
A SARS tax compliance certificate is required should an individual decide to emigrate. There are three types of compliance certificates that an individual can apply for.
These are as follows:
- Certificate of Good Standing: This compliance status is issued when a taxpayer wants to confirm that their tax affairs are in order with SARS.
- Foreign Investment Allowance: This compliance status is issued when a taxpayer will be investing funds outside of South Africa. Foreign Investment Allowance applications are only available to individuals older than 18 years of age.
- Emigration: This compliance status is required when a taxpayer will be permanently leaving South Africa to reside in another country and can only be selected if the eFiler is registered for Income Tax and is an individual. Emigrating from South Africa formalises an individual’s exit from South Africa for exchange control purposes. It does not mean that the individual will have to relinquish his/her South African citizenship. The individual may retain his/her South African passport.
There are downsides to financial emigration
What recent news reports encouraging individuals to emigrate financially in order to avoid the expat tax have failed to reveal is that financial emigration is an expensive exercise. There is a huge tax implication involved in changing an individual’s tax residency.
By financially emigrating an individual is deemed to have disposed of all their assets in South Africa, which means that capital gains tax starts applying. Should the individual decide at some future point to financially emigrate back to South Africa, the individual would not get that money back.
To avoid South African taxation rules, an individual would need to first change their tax residency – financial emigration is the very last step and even then, it’s not an essential part of an amended tax residency given that it is only an exchange control provision. Emigration and financial emigration only comfortably overlap when a taxpayer is legitimately emigrating. The latter doesn’t work if the individual intends to continue residing in South Africa.
Before deciding to financially emigrate the individual taxpayer must make sure all the facts are at hand. Understand the cost and long-term implications and carefully consider these before deciding on this route. The individual taxpayer must be certain that it is a permanent move. Does the individual have a long-term visa, a residency permit or is being sponsored to put down roots in a different country? To financially emigrate as a South African resident in order to avoid a small amount of tax is probably not a wise decision.
Even if the taxpayer is legitimately emigrating, they shouldn’t financially emigrate until they are totally convinced that this is a long-term decision. Individuals should also be particularly wary of service providers offering to help with financial emigration who don’t mention the significant cost associated with this. Those individuals that are considering pursuing the financial emigration route should take the time to understand the real cost implications and do their homework thoroughly.