By Xolani Jadezweni, Individual Tax Compliance Consultant at BDO
Any foreign pension, whether it is a government pension or a non-government pension, will be included in the gross income of a resident. Section 10(1)(gC) of the Income Tax Act exempts the portion of any pension or annuity received or accrued to any resident from a source outside South Africa.
Prior to 14 November 2014, the South African Revenue Service (SARS) had taken the stance that for the exemption to apply, ‘source outside South Africa’ meant that the services must have been rendered from outside South Africa and that the fund that pays the pension must be located outside of South Africa. In other words, if a person remained a member of a South African registered pension fund while working abroad, none of their pension benefits qualified for the exemption.
A number of pensioners and tax specialists breathed a collective sigh of relief after SARS ruled that any pension South Africans accumulated while working outside the country would generally not be subject to local tax. Uncertainty about the treatment of these pensions and differing opinions between SARS and various tax experts have triggered disputes over the issue during the last few years.
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).
As referred to above, section 10(1)(gC) deals with the exemption of foreign pensions or annuities in relation to foreign services by residents, while section 9(2)(i) is the provision relating to the source of income from lump sums, pensions or annuities. The two provisions apply together as illustrated below.
Section 10(1)(gC) exempts amounts received by or accrued to residents under the social security system of any other country. It also states that they shall be exempt from normal tax on any lump sum, pension or annuity received by or accrued to a resident from a source outside South Africa as consideration of past employment outside South Africa.
One therefore has to determine whether the lump sum, pension or annuity is ‘from a source outside South Africa’. It appears that for this determination, one has to apply section 9(2)(i), which provides that a lump sum, pension or annuity is from a source within South Africa if the services in respect of which the amount relates were rendered within South Africa. Where such an amount relates to services that were rendered partly in South Africa and partly outside South Africa, the portion of the amount that is regarded as from a source within South Africa must be determined on a pro-rata basis using the respective periods in which the services were rendered in South Africa to the total period in which the services were rendered.
SARS issued Binding General Ruling (Income Tax) No. 25 with effect from 14 November 2014. According to the ruling, any portion of a pension that accrues to a person that relates to services rendered by the person outside of South Africa will not be subject to tax in South Africa. This ruling provides clarity on the interpretation and application of the words ‘from a source outside the Republic’ in section 10(1)(gC)(ii) in relation to pension payments that are received by or accrued to a resident.
The following formula is used to calculate the exempt portion of pension that relates to services rendered outside South Africa:
Period during which foreign services were rendered x Total pension received or accrued
Total period during which services rendered
The tax treatment of lump sums, pensions or annuities for services rendered may therefore be summarised as follows:
- The portion of the lump sum, pension or annuity that relates to the services rendered by the South African resident outside of South Africa is exempt.
- 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.
With regard to section 10(1)(gC), the 2016 Budget review states that ‘the question of how contributions to foreign pension funds and the taxation of payments from foreign funds should be dealt with raises a number of issues, which require a review. Sufficient time would be required to determine how to deal with contributions to foreign funds and the taxation of payments from foreign funds, taking into account the tax policy for South African retirement funds.’
This statement is cryptic to say the least. However, it does appear from the wording that changes to the status quo would only be implemented after a review of the issues involved.