On 19 July 2017, the South African National Treasury released the 2017 Draft Taxation Laws Amendment Bill (“draft TLAB”) for public comment. One of the proposals contained in the draft TLAB is the deletion of the exemption for foreign employment income contained in section 10(1)(o)(ii) of the Income Tax Act, 1962 with effect from 1 March 2019.
In terms of this exemption, any remuneration received by or accrued to a South African resident in respect of services rendered outside South Africa for or on behalf of any employer, is exempt from income tax provided that the employee was outside South Africa for more than 183 full days, and for a continuous period exceeding 60 full days, during any period of 12 months and where such services were rendered during those periods outside South Africa. If these requirements are met, the foreign remuneration of the South African resident will be exempt from tax in South Africa. This exemption applies irrespective of whether the remuneration is taxed in another jurisdiction.
The foreign remuneration exemption was introduced in 2001 when South African tax residents became subject to tax on their worldwide income, in order to ensure that South African tax residents were not subject to double taxation of the same employment income in South Africa and the country of source where the services were rendered.
The 2017 Budget Review stated that the foreign employment income exemption applies only to private sector employees and “appears excessively generous”. It was further stated that if a resident works in a foreign country for more than 183 days with no tax payable in the foreign country, that foreign employment income will benefit from double non-taxation. It was accordingly proposed in the Budget Review that the exemption be adjusted so that foreign employment income would only be exempt from tax if it was subject to tax in the foreign country.
However, the draft TLAB proposes to delete the exemption in its entirety with effect from 1 March 2019 and tax years commencing on or after that date (ie from the 2020 tax year). According to the Draft Explanatory Memorandum on the draft TLAB, this exemption was never intended to create situations where employment income is taxed neither in South Africa nor in the foreign country, and the exemption creates unequal tax treatment between South African residents employed by the private sector and government employees.
The effect of the removal of the exemption would be that South African residents who earn remuneration from working abroad will be subject to tax on all such remuneration in South Africa in the same way that they are taxed on their remuneration for services rendered in South Africa, but will be entitled to claim a foreign tax rebate against their South African income tax for any foreign taxes paid in any other country in respect of that remuneration.
One of the issues that arise in relation to claiming foreign tax rebates, is that this may only be done in the employee’s annual tax return. There is currently no mechanism for taking foreign tax rebates into account for purposes of employees’ tax (pay-as-you-earn (“PAYE”)) withholding. This may result in an employee who is on a South African payroll being subject to PAYE in South Africa and foreign withholding tax in the country of source (ie where the services are rendered), without being able to offset the foreign tax against the PAYE, unless a tax directive is obtained from SARS to allow for this. Any refunds due by SARS in respect of the foreign tax rebate claimed in the employee’s tax return may also take some time to be processed and paid. As a result, there would be cash flow implications for the employee or for the employer if the employer pays the taxes due on behalf of the employee in terms of a tax equalisation policy.
In addition, it is not always easy to obtain adequate documentary proof of the taxes paid in a foreign country for purposes of claiming a foreign tax rebate and additional complexity results from the fact that the foreign country’s tax year is typically not aligned with the South African tax year.
If the employee renders services in a jurisdiction that has a lower income tax rate than South Africa, the removal of the exemption would result in a higher overall tax liability for the employee than is currently the case. If the employee is tax equalised, this could result in a significantly higher tax cost of the assignment for the employer, particularly taking into account the fact that any taxes borne by the employer on behalf of the employee are required to be grossed up for fringe benefit tax purposes.
The above proposal is contained in draft legislation which is subject to change. Public comments on the draft proposals must be submitted by 18 August 2017.