There is some uncertainty regarding the current tax treatment of private sector pension benefits derived by South African tax residents in respect of services which were rendered both inside and outside South Africa, particularly in respect of the source of such benefits. Although there are legislative provisions which may apply, it is not always clear how the relevant provisions in the Income Tax Act, 1962 (“the Act”) interact and how they should apply to lump sum benefits from retirement funds.
It is an established general principle that the source of income from services rendered is located where those services were rendered, because the originating cause of the income is the rendering of the services, which is the quid pro quo in respect of which the income is received (CIR v Lever Brothers & Unilever Ltd, 1946 AD 441).
There are two legislative provisions which apply specifically to pensions and annuities. The first is section 10(1)(gC) of the Act which exempts from tax any pension or annuity received by or accrued to a resident from a source outside South Africa, which is not deemed to be from a source in South Africa in terms of section 9(1)(g), in consideration of past employment outside South Africa.
The second provision is section (9)(1)(g) of the Act, which contains a deemed source rule for pensions and annuities. It provides that an amount shall be deemed to have accrued to any person from a source within South Africa if it has been received by or has accrued to such person by virtue of any pension or annuity granted to such person (wheresoever payment of that pension or annuity is made and wheresoever the funds from which payment is made are situated) by any person, whether residing or carrying on business in the Republic or not, if the services in respect of which that pension or annuity was granted were performed within the Republic for at least two years during the ten years immediately preceding the date from which the pension or annuity first became due.
This is subject to the proviso that if the pension or annuity was granted in respect of services which were rendered partly within and partly outside South Africa, only so much of such pension or annuity as bears to the amount of such pension or annuity the same ratio as the period during which the services were rendered in South Africa bears to the total period during which the services were rendered, shall be deemed to be derived from a source within South Africa.
Therefore, the tax treatment of pensions or annuities for services rendered may be summarized as follows:
- Foreign sourced pensions accrued to South African residents are exempt from tax in South Africa unless they are deemed to be from a South African source.
- A pro rata portion of a pension granted to an individual will be deemed to be from a source within South Africa if the services in respect of which that portion of the pension benefit is granted were performed in South Africa for at least two years during the ten years immediately preceding the date from which the pension first became due. This provision specifically applies wherever payment of that pension is made and wherever the funds from which the payment is made are situated.
Our view is that section 9(1)(g) lays down the legislative basis on which a pension benefit must be apportioned between different sources. If it was argued that the general source rules required the apportionment of pensions between different source locations, and a taxpayer had rendered services both within and outside South Africa in respect of which a pension was paid, then such portion of any pension which was attributable to the South African services would in any event be subject to tax in South Africa under the “normal” source rules. If this were correct, section 9(1)(g) would be redundant and tautologous. There is also currently no authority as to the basis on which such an apportionment should be made in these circumstances, other than section 9(1)(g). A time spent apportionment basis of apportioning a pension benefit may not be appropriate in cases where the fund is a defined benefit fund and the pension benefit is based on the person’s final average salary.
In addition, the meaning of a “pension” for purposes of the tax exemption and the deemed source rule could be widely interpreted to include lump sum benefits derived from retirement funds or narrowly interpreted to refer only to monthly pensions. As lump sum benefits are dealt with under the Second Schedule to the Act, paragraph 2(1) of which states that it is subject to the provisions of section 9(1)(g), it is arguable that lump sum benefits from pension, provident or retirement annuity funds should be included within the section 10(1)(gC) exemption.
The Draft Taxation Laws Amendment Bill, 2011 contains proposals to codify the source rules relating to various types of income, including pensions and annuities. Specifically, the draft proposals provide that the source of pensions or annuities derived from services rendered will be based on the source of the underlying services giving rise to those payments. Therefore, if the underlying services were rendered in South Africa, the associated pension and annuities will be viewed as South African sourced. If the annuities and pensions relate to what are referred to as “mixed services” in the draft Explanatory Memorandum to the Bill, i.e. services rendered within and outside South Africa, the allocation will be based on time spent.
The Explanatory Memorandum states that the doctrine of originating cause (CIR v Lever Brothers & Unilever Ltd, supra) will be incorporated into the source rules as a residual category which will apply to any items of income falling outside the specified categories of income. Items of income that fall outside the South African sourced categories listed in the section will be explicitly treated as foreign sourced income.
However, the Draft Response Document from National Treasury and SARS indicates that a specific source rule will be introduced to deal with pensions and annuities, which would presumably then not fall within the services source rule as originally proposed. The Response Document indicates that the new source rule for pensions and annuities will look at where the services were rendered and maintain the current time apportionment rule, but without the 2/10 years de minimis rule
Should the proposals be accepted, the possible benefits that were available to South African residents who worked outside of South Africa for more than eight years in the last ten years prior to retirement, will no longer be available. The advantage though of the draft proposals is that they will provide certainty to taxpayers in an area that has been the subject of much debate.