Retirement fund benefits for employees who worked abroad: the apportionment rules

The application of the apportionment rules to South African retirement fund benefits due to South African residents who contributed to these funds while they worked abroad, is currently not clear. The South African Revenue Service (“SARS”) holds the view that lumps sum benefits should be treated differently from annuity payments. This view impacts on the tax treatment of provident fund payments and the lump sum portion of pension fund payments.

The apportionment rules as they applied to December 2011

The Income Tax Act (“the Act”) contained specific statutory source rules that applied to the apportionment of pension fund benefits. Previously, section 9(1)(g)(ii) in principle, provided that a portion of a pension granted to an individual would be deemed to be from a source within South Africa, if the services were rendered in South Africa for at least 2 years during the 10 years immediately preceding the date on which the pension first became due. The application of this statutory rule meant that a resident who worked outside of South Africa for more than 2 out of the 10 years prior to his retirement would be able to apply the apportionment rules and exempt all or a portion of his/her pension benefit, depending on the amount of time he/she spent working outside of South Africa.

The apportionment rules applicable from January 2012

Section 9 of the Act has been amended with effect from 1 January 2012. This also affects the source rules applicable to retirement fund payments and consequently, the apportionment of these benefits.

In terms of section 9(2)(i) of the Act, an amount is deemed to have been received by or accrued to a person from a source in South Africa if that amount constitutes a pension and the services in respect of which that amount is so received or accrues were rendered in South Africa. However, in terms of the proviso to section 9(2)(i), if the amount is received for services which were rendered partly within and partly outside South Africa, the portion of the amount to be included in the individual’s taxable income must be calculated pro rata to the time spent rendering services in South Africa, e.g. if 4 out of any 10 years’ of services were rendered in South Africa, 40% of the pension will be sourced here.

The portion of the pension which is sourced outside South Africa in terms of this provision and is received as consideration for past employment outside South Africa will be exempt from South African tax in terms of section 10(1)(gC) of the Act.

Concern with lump sum payments

The apportionment of retirement fund benefits have been simplified through the amendment of the source rules and certainly provide some clarity going forward for individuals working abroad.

The issue we have encountered with SARS is, however, that they only apply the apportionment rules to annuity payments and not to the lump sum component of retirement fund payments. This appears to be because of their strict interpretation of the meaning of a pension payment.

We do not agree with this view because retirement fund lump sum benefits are specifically included in the gross income of a taxpayer in paragraph 2(1) of the Second Schedule to the Act.

SARS’ current view of the treatment of lump sum benefits unfairly prejudices individuals who have participated in a provident fund. The effect of their view is that individuals who retire from a provident fund and receive a lump sum benefit are not able to claim a tax exemption in respect of the portion that relates to their services rendered outside South Africa. It is unclear, why in principle, the apportionment rules relating to lump sum payments should be any different from those applicable to annuity payments. This view also does not correspond with international guidelines set out in the OECD commentary.

We understand that the issue is currently being addressed by National Treasury and SARS and hope for clarification and confirmation of the uniform treatment in the next set of legislation.