Recent developments in the exemption of foreign pensions

Esther van Schalkwyk, Manager: Tax Consulting at BDO.

Foreign sourced pensions are usually exempt from South African income tax where such pensions constitute consideration for past employment outside South Africa. Taxpayers earning foreign pensions should, however, take note that the application of this exemption has recently been narrowed.

Until recently, the exemption of foreign pensions under section 10(1)(gC) of the Income Tax Act applied to exempt from normal tax any:

• “(i) amount received by or accrued to any resident under the social security system of any other country; or
• (ii) lump sum, pension or annuity received by or accrued to any resident from a source outside the Republic as consideration for past employment outside the Republic”.

This sometimes resulted in the unintended consequence that South African tax residents working outside South Africa could make tax deductible retirement contributions to their local South African retirement funds for the relevant years of assessment, while receiving tax exempt pensions upon retirement.

Effective 1 March 2017, subparagraph (ii) of section 10(1)(gC) was amended to exclude amounts received or accrued from local retirement funds from the application of the exemption. While subparagraph (i) remained intact, subparagraph (ii) now only applies to exempt from normal tax any:

• “(ii) lump sum, pension or annuity received by or accrued to any resident from a source outside the Republic as consideration for past employment outside the Republic other than from any pension fund, pension preservation fund, provident fund, provident preservation fund or retirement annuity fund as defined in section 1(1) excluding any amount transferred to that fund from a source outside the Republic in respect of that member”. (emphasis added)

Binding General Ruling (issue 2), issued on 16 March 2017, deals with the source of income in relation to the foreign pension exemption. The Ruling states that an amount of pension income will be regarded as sourced outside South Africa for purposes of section 10(1)(gC)(ii) if the originating cause giving rise to that amount is located outside South Africa (in other words, if the services that gave rise to the pension were rendered outside South Africa). Only the portion of a pension that relates to services rendered outside South Africa is exempt from South African income tax. The Ruling further confirms that local retirement funds are now excluded from the exemption, irrespective of where those services may have been rendered.

Going forward, the exemption of foreign pensions from South African income tax will therefore only apply to amounts received or accrued from a foreign retirement fund or amounts that were transferred to a local retirement fund from a foreign retirement fund, provided those amounts take the form of a lump sum, pension or annuity and constitute consideration for services rendered outside South Africa in terms of past employment.