Many South Africans earning income abroad often find themselves caught off guard by their tax obligations back home. This confusion largely stems from South Africa’s shift from a source-based to a residence-based tax system, effective from 1 March 2001. Under the residence-based tax system, South African tax residents are required to declare and pay tax on their worldwide income, rather than just income earned locally. This means that even if you are working and earning abroad, SARS still expects you to meet your tax obligations.
The 2020 amendment to Section 10(1)(o)(ii) of the Income Tax Act further tightened the rules for expats and foreign workers, particularly regarding the foreign employment income exemption. Now, only R1.25 million of foreign income is exempt from tax, with anything above this threshold subject to South African tax rates. This change has made it more important than ever for South Africans working internationally to fully understand and comply with their tax duties.
What is Tax Residency in South Africa?
How Does One Qualify as a South African Tax Resident?
An individual may qualify as a South African tax resident under one of two tests established by legislation, the “ordinarily resident” test or the “physical presence” test.
The “Ordinarily Resident” Test
The term “ordinarily resident” is not explicitly defined in South African tax law and is assessed on a case-by-case basis, as outlined in SARS Interpretation Note 3. Factors typically considered include where an individual has their permanent home, their family and social ties, and the location of their habitual abode. Essentially, if South Africa is considered the place to which a person naturally returns, even after being abroad for extended periods, they are likely to be deemed “ordinarily resident.”
The Physical Presence Test
An individual may also qualify as a tax resident if they meet the criteria of the physical presence test. This test requires an individual to spend a certain number of days in South Africa over a five-year period:
- 91 days or more in the current tax year;
- 91 days or more in each of the preceding five tax years; and
- A total of at least 915 days in the preceding five tax years.
If all these conditions are met, the person becomes a South African tax resident under this test. For a detailed breakdown of this test, refer to SARS Interpretation Note 4.
Nuances and Misconceptions
It is crucial to understand that if an individual is exclusively regarded as a resident of another country under a tax treaty, they are not considered a South African tax resident, even if they meet the criteria of the “ordinarily resident” or physical presence test. This provides critical relief from double taxation in cases where a tax treaty applies.
Additionally, it is a common misconception that financial emigration automatically terminates tax residency. Financial emigration is merely one factor considered by SARS, but on its own, it does not conclusively break an individual’s South African tax residency status. Careful evaluation of all relevant circumstances is necessary.
Understanding the Section 10(1)(o)(ii) Foreign Employment Income Exemption
The Section 10(1)(o)(ii) foreign employment income exemption serves as the primary mechanism for qualifying South African tax residents to reduce their foreign income tax liability. To qualify for this exemption, a tax resident must meet the 183/60-day rule. This rule stipulates that the individual must spend more than 183 full days outside South Africa during any 12-month period, with at least 60 of those days being continuous. It is important to note that this 12-month period is not tied to the calendar year or the South African tax year; it can be any continuous period of 12 successive months.
The exemption applies exclusively to employees, meaning that independent contractors are excluded. Both resident and non-resident employers may qualify under this rule, provided the other conditions are met. The types of remuneration covered under the exemption include a wide range of earnings such as salary, bonuses, leave pay, overtime, commission, allowances, share vestings, and more.
However, there are exclusions to consider. Public sector employees and individuals employed in roles appointed under an Act of Parliament, such as Members of Parliament or judges, do not qualify for this exemption.
This provision provides significant relief for South African tax residents working temporarily or extensively abroad, making it a critical factor in international tax planning.
The R1.25 Million Cap: What Changed on 1 March 2020
Prior to 1 March 2020, qualifying South African tax residents were able to exempt their entire foreign employment income from local tax, provided they met the 183/60-day rule. This rule required individuals to be outside of South Africa for more than 183 days in total, including at least one continuous period of 60 days, during a 12-month period. However, an amendment to the law came into effect on 1 March 2020, which introduced a cap on the exemption. Now, only the first R1.25 million of foreign employment income is exempt from South African income tax. Any income earned above this threshold is taxable at the individual’s marginal rate.
For example, consider a South African tax resident earning R1.5 million abroad. Under the amended law, the first R1.25 million is exempt from South African income tax. However, the remaining R250,000 is subject to taxation at the individual’s applicable marginal rate. This change has increased the tax obligations for many expatriates, and careful financial planning is now essential to manage these additional liabilities effectively.
It is also important to note that foreign income must still be declared in a South African tax return, even if the total earnings fall within the exempt threshold. Failing to report foreign employment income is a common area of non-compliance, which taxpayers must address to avoid penalties.
Avoiding Double Taxation: Section 6quat Relief
When foreign employment income exceeds R1.25 million, there is a risk of double taxation as both South Africa and the host country may have the right to tax the excess amount. To address this, Section 6quat serves as South Africa’s domestic mechanism for providing relief through a foreign tax credit. If tax has already been paid in the foreign country on income that is also subject to South African tax, taxpayers can claim this foreign tax credit upon assessment via their income tax return.
Furthermore, employers can apply for a directive from SARS under paragraph 10 of the Fourth Schedule to account for the Section 6quat credit on a monthly basis. This approach helps to reduce the employee’s monthly tax withholding in real time, alleviating the financial burden throughout the tax year. It is important to note that the availability of double tax relief is also governed by applicable double tax agreements (DTAs) between South Africa and the foreign country in question, which play a critical role in determining taxing rights and potential exemptions.
Ceasing Tax Residency: The Section 9H Exit Charge
Some individuals opt to formally cease their South African tax residency to completely avoid the implications of the 2020 amendment. However, this process comes with its own complexities, primarily the Section 9H exit charge. Under this provision, upon ceasing tax residency, a person is deemed to have disposed of their worldwide assets at market value, with the exception of immovable property in South Africa held personally. This deemed disposal triggers a capital gains tax liability, which can reach a maximum effective rate of 18%.
A major practical challenge arises here, as the exit charge often creates a significant tax liability without any corresponding cash inflow to settle it, placing taxpayers in a difficult position. Furthermore, individuals who suspect they have already ceased their South African tax residency without formalising the process are advised to consider approaching SARS through the Voluntary Disclosure Programme (VDP). The VDP provides an avenue for regularising any past non-compliance and avoiding additional penalties.
Supporting Documents SARS Will Expect
Key Documents for Claiming the Foreign Income Exemption
When claiming the foreign income exemption, taxpayers must ensure they maintain proper documentation to substantiate their claims. SARS frequently requests these documents, and inadequate record-keeping can result in the exemption being disallowed. Below are the key documents taxpayers should retain:
- A detailed travel spreadsheet: This should meticulously track all days spent in and out of South Africa to demonstrate compliance with the required time-based exemptions.
- Passport copies: These must show clear evidence of entry and exit dates to corroborate the travel spreadsheet and verify periods spent abroad.
- Employer letter: The letter should confirm the nature of the work performed overseas, the duration of the assignment, and the remuneration earned during that period.
- Foreign assignment employment contract: This document serves as proof of the contractual agreement governing the overseas assignment.
- Relevant IRP5: The IRP5 must reflect the correct foreign income source codes (such as 3651, 3653, or 3655). If local codes are mistakenly used, taxpayers must ensure the employer re-issues the IRP5 with the correct codes.
Proper preparation and meticulous record-keeping play a vital role in successfully claiming the foreign income exemption and avoiding unnecessary disputes with SARS.
South Africa’s residence-based tax system generally subjects foreign income to taxation. However, the Section 10(1)(o)(ii) exemption provides significant relief, allowing qualifying employees to exclude up to R1.25 million of their foreign income. For those potentially facing double taxation, Section 6quat offers a mechanism for relief, helping to offset foreign taxes paid. Additionally, ceasing tax residency may be an option for some, but it comes with its own financial implications, particularly the Section 9H exit charge.
It is essential to note that these tax rules are both complex and fact-specific. What may apply to one taxpayer might not apply to another, depending on their unique circumstances. Taxpayers earning above the R1.25 million threshold or considering a change in their tax residency status should seek personalised advice to make informed decisions and remain compliant with SARS regulations.