Author: Jenny Klein – Tax Manager at ENSafrica
Many South Africans spend significant periods of time working outside the country. Due to the fact that South Africa taxes the world-wide income of its residents, payments received by residents for services rendered outside the country are included in their gross income for South African tax purposes, but may subsequently be excluded from their taxable income in terms of any available exemptions. Whilst this may be the case the question is often posed whether any similar exemption may apply to their pension benefits received upon retirement from their South African pension fund in relation to the period of services rendered abroad.
There is a specific exemption contained in section 10(1)(gC) of the Income Tax Act, 1962 (“the Act”) which applies, inter alia, to any pension received by or accrued to any resident from a source outside South Africa as consideration for past employment outside the country.
The statutory source rules are set out in section 9 of the Act. If section 9 of the Act does not apply, then the common law source principles as set out in case law should be applied. In terms of our common law, the source of income from services rendered is regarded as being located where those services were rendered.
In the case of a pension or annuity, section 9(2)(i) of the Act provides that an amount is received by/ accrues to a person, from a source within South Africa if services in respect of that amount is so received or accrues were rendered within South Africa. This is subject to the proviso that if the services were rendered partly within and partly outside South Africa, only so much of that pension/annuity as relates to the period during which services were rendered in South Africa must be regarded as South African sourced income.
Section 10(1)(gC) as it currently reads does not specifically refer to the source rule contained in section 9(2)(i) in relation to pension benefits, although this provision previously referred to the old deemed source rule for pensions, which is no longer applicable.
SARS’ has previously taken the view that, in order for the section 10(1)(gC) exemption to apply, the pension fund must be situated outside South Africa and the services in respect of which the pension is paid must have been rendered outside South Africa. Accordingly, if the pension fund is situated in South Africa, the exemption would not apply and the full monthly pension would be taxable. This was on the basis that, in SARS’ view, the section 9(2)(i) source rule only applies to non-residents who are taxable on their South African sourced income only, thus does not apply to South African residents who are taxable on their worldwide income in terms of the Act. The implication is that a pension is regarded as being from a source outside South Africa if the pension fund is situated outside the country.
However, SARS has now issued a Binding General Ruling (No.25) on 14 November 2014 to provide clarity on the interpretation and application of the words “from a source outside the Republic” contained in section 10(1)(gC) of the Act. According to this binding general ruling, the term “source outside the Republic”, for the purposes of section 10(1)(gC), refers to the originating cause which gives rise to the pension income, namely, where the services have been rendered. The ruling also sets out a formula for calculating the portion of the pension that will be exempt due to services rendered outside South Africa, which is effectively a proportionate amount based on the period of foreign services relative to the total services rendered.
The ruling does not refer to section 9(2)(i) but refers to South African case law regarding the source of income being the originating cause which gave rise to that income. In terms of this ruling, the common law principle regarding the source of income from services rendered should be applied to pension benefits and the source of the pension benefit should be regarded as being located where the services to which the pension benefit relates were rendered. Where the pensionable services were rendered partly in and partly outside South Africa, the source of the pension should be apportioned between the South African services and the foreign services, in order to determine the foreign sourced pension that should be exempt in terms of section 10(1)(gC).
The ruling applies from the date of issue (14 November 2014) and will apply until it is withdrawn or the relevant legislation is amended.
Accordingly, recipients of pension benefits whether from South African or offshore pension funds, should ensure that the correct apportionment of their pension benefit is done on the basis of their services rendered abroad.