The South African Revenue Service (SARS) has just released two publications regarding the revised foreign earnings exemption, namely a draft version of Interpretation Note 16 (Issue 3) (Draft IN16) and a SARS guide with frequently asked questions (FAQs).
South African employers with employees who qualify for the exemption, and South African residents working offshore must take note of these two publications.
The two publications deal with the revised foreign earnings exemption as provided for in section 10(1)(o)(ii) of the Income Tax Act, 1962 (the ITA).
The exemption was originally introduced in 2000 to avoid the scenario where an individual's earnings is taxed both in South Africa and in a foreign jurisdiction. It provides for qualifying foreign earnings to be exempt from income tax in South Africa.
There is no requirement that the remuneration has to be taxed offshore in order to qualify for the exemption. Accordingly, where the remuneration is not subject to income tax in a foreign jurisdiction, it is currently possible that no income tax is paid in respect of such earnings.
In those instances where the employee works both in South Africa and offshore, the income has to be apportioned in order to determine the exempt amount, as only the offshore portion qualifies for the exemption.
In terms of the revised exemption, from 1 March 2020 only the first ZAR1 million of qualifying foreign earnings will be exempt in South Africa. To the extent that such earnings is taxed both in South Africa and in the foreign jurisdiction, South Africa will in terms of section 6quat be obliged to allow applicable foreign taxes as a credit in respect of the employee's South African income tax liability.
The partial exemption creates lots of complexities, including:
- how the exemption should be applied in the context of the apportionment of income and/or where the employee receives salary and specific benefits, such as a travel allowance or accommodation benefit;
- how foreign tax credits must be applied in respect of the taxable portion of an employee's remuneration;
- the tax treatment of amounts paid by a foreign employer, in those instances where remuneration is paid by both a resident and a non-resident employer;
- the potential application of a double tax treaty; and
- how a resident employer must / may take into account foreign tax credits in order to determine the amount of employees' tax (PAYE) to be withheld.
The obligation of a resident employer to withhold PAYE is of particular concern, as the ITA requires an employer to withhold PAYE based on an employee's liability for normal tax. It does not permit an employer to take into account foreign tax credits in order to reduce the amount of PAYE to be withheld.
Draft IN16 and the FAQ document both indicate that an employer will have to apply for a directive from SARS in order to reduce the amount of PAYE to take into account foreign tax credits. SARS has indicated that a dedicated channel will be made available in relation to these directives.
It is disappointing that there is not an automatic ability to reduce PAYE where proof of foreign taxes is available (for example where the employer is aware of the withholding of foreign employees' tax by itself or a related party).
It is further important to note that the directive will not constitute the actual granting of the foreign tax credit, but that the directive simply allows the employer to withhold a reduced amount of PAYE.
The obligation placed on resident employers to obtain individual directives in all circumstances is a heavy administrative burden. Non-resident employers on the other hand should as a general rule not be obliged to withhold PAYE in South Africa. The employees will however be obliged to make provisional tax payments in respect of their South African income tax liability on amounts in excess of ZAR1 million.
While the two SARS publications provide some guidance regarding the practical implementation of the revised exemption, it is anticipated that there will be lots of teething problems, especially in the context of PAYE withholding by resident employers and the obligation to apply for a directive before taking into account foreign tax credits.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.