South Africa’s “expat tax” and its potential implications have caused a great deal of hype (largely based on inaccurate information), resulting in many clients looking to financial emigration as a means of resolving their issues around paying tax in South Africa on income earned offshore.
Financial emigration is the application, as part of a formal emigration process, to the South African Reserve Bank to change from a resident of South Africa to a non-resident for exchange control purposes. It does not by itself impact one’s tax residency, but can be seen as a related process.
Formal emigration and changing tax residency are complex processes and may well be the desired outcome for individuals seeking to live permanently in another country, but it is certainly not a quick-fix solution for tax relief. Furthermore, changing tax residency status could result in immediate tax consequences in the form of exit charges.
Revised legislation
The revised Income Tax Act (effective 1 March 2020) will result in South African tax residents working abroad temporarily being exempted from paying tax on the first R1.25 million they earn abroad. Thereafter they will be required to pay tax on any foreign earnings.
Previously, the foreign employment income earned by South African tax residents was fully exempt from tax in South Africa, provided certain requirements were met. Importantly, the amendment only affects income received from employment and does not affect those earning foreign investment income (which is already taxed) or individuals who are no longer residents of South Africa for tax purposes.
Much of the misunderstanding around this topic stems from the fact that financial emigration is a colloquial term that does not exist in any legislation.
Rather, the key issues are formal emigration and tax residency, which are two separate (often linked) processes. Formal emigration entails physically relocating from one country to another country.
Formal emigration will typically also involve financial emigration, i.e. changing one’s status to non- resident for exchange control and tax purposes.
The entire process is lengthy and includes rigorous audit, and upon South African Reserve Bank (SARB) and South African Revenue Service (SARS) approval, the individual will be issued with an Emigration Tax Clearance Certificate.
Sometimes, financial emigration needs to be done retrospectively when people physically emigrate and only subsequently recognise the requirement to regularise their status as non-resident for exchange control and tax purposes.
Substantial exit charges
Changing your tax status to non-resident could have significant capital gains tax consequences, as your worldwide assets (with the exception of fixed property situated in South Africa) are deemed as being disposed of at market values. Therefore, 40% of any gain would be included in your income and you will be taxed at your marginal tax rate. This “exit charge” can be quite substantial and you may need to raise liquidity to settle your affairs with SARS.
It is important to ensure that your intention to relocate and your affairs are fully disclosed in your tax returns in the year of your emigration, as well as in the proceeding five years. These disclosures could be key if, at a later stage, your tax residency or ability to exit funds were to be examined.
Complex residency tests
South Africa’s tax regime is a residence-based system and one’s tax residency status is determined by how much time you spend in the country, where your assets are based, where your family resides most of the time, and the location of your primary residence. In order to become non-resident, individuals must prove their intention to become ordinarily resident in another country and demonstrate the steps they have taken (or are taking) to carry out this intention.
Finally, they will then need to meet requirements of the physical presence test by being in South Africa for no more than 91 days in total during the current assessment year; 91 days in total during each of the five years of assessment preceding the current assessment year; and 915 days in total during those five preceding years of assessment. Contravening any of these periods will result in an individual’s tax status being reverted to South African resident. So, one could have formally emigrated, changed your tax residency status and then subsequently be classified as a SA tax resident again.
Be clear about your objectives; seek professional advice
In conclusion, it is clear that financial emigration is a
highly complex, costly and long-term decision and pursuing this path solely to avoid tax is ill advised. Investors should bear in mind that all South Africans have an annual R1 million single discretionary allowance and R10 million foreign investment allowance – both of which can be used for foreign investment and asset transfer without having to change tax residency.
While everyone’s circumstances are different, there are numerous factors to consider and it is important to understand the real cost and lifestyle implications before deciding to financially emigrate. As with any major financial decision, it is always advisable to seek professional, expert advice to ensure that your actions and objectives remain aligned and that your investment plan is optimally structured.
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