The 2021 tax bill released proposed to introduce a tax on the retirement interest of those who cease their South African tax residency. This means that a new article will be inserted in the income tax law which will come into force on March 1, 2022. The exit tax may very well lead to the double taxation of pension interest, and this goes to the against the network of double taxation treaties entered into by the South African government.
Countries enter into Double Taxation Agreements (DTAs) to encourage economic activity, prevent tax evasion and, most importantly, prevent double taxation. Double taxation occurs when two countries impose a tax on the same person for the same purpose. DTAs aim to avoid this by assigning taxing rights, which will determine which country has the right to tax the income in question. Where both countries have the right to tax the income, the DTA will require the country of residence to grant a tax credit for foreign taxes paid.
Read: Tax bills propose additional exit tax on emigrant South Africans
In the context of pensions and similar amounts, the CDI would generally give the country of residence the sole right to tax. This is where the problem comes in as the proposed exit tax creates a fiction, where it treats the person as having withdrawn from the applicable fund the day before their cessation of residence, creating a South African tax liability. By conceiving it this way, the exit tax effectively subverts the DTA, which we’ll get to in a moment.
The problem for the taxpayer arises when he actually withdraws his retirement interest at a later date. When that time comes, they will likely have become residents of their new country of residence, which the DTA says will then be able to tax that amount based on their national tax laws. The result is that pension interest is taxed in both countries.
Normally, the DTA will then relieve the taxpayer by requiring the country of residence to grant a tax credit for foreign (South African) taxes incurred. However, since the South African tax did contravene the provisions of the DTA, the new country of residence would not be required to provide such credit.
Does the exit tax prevail over the DTA?
According to the Organization for Economic Co-operation and Development (OECD), a treaty waiver is “the adoption of a law that aims to unilaterally cancel the application of obligations under an international treaty”.
The proposed tax on the deemed withdrawal of South African pension interest from expatriates ceasing their tax residency in South Africa fits this description. This seems to be perfectly understood by the Public Treasury, which in its Explanatory Memorandum on the exit tax brazenly declares that “[t]The application of a tax treaty between South Africa and the new country of tax residence can, in certain cases, lead South Africa to lose its tax rights.
In other words, the new provision appears to be designed specifically to subvert the DTA, thereby overriding the network of DTAs entered into with other countries.
The gravity of this decision cannot be underestimated. It is important to understand that once a DTA has been approved by both Houses of Parliament and published in the Official newspaper, it becomes part of South African law; it is fully binding.
But the DTA is not the only international agreement at risk of being violated. South Africa is bound by the Vienna Convention on the Law of Treaties, which states in article 18 that “[a] The State is bound to refrain from any act which would run counter to the object and purpose of a treaty… ” The purpose of a CDI is to avoid double taxation. If South Africa enacts a provision that results in double taxation, it defeats the purpose of the ITA and, by extension, also violates the Vienna Convention.
The status of treaties in our law is complex and subject to differing opinions, but there are those who believe that treaty obligations have the same force as the Constitution. That is, they occupy the highest possible rank. If this point of view is accepted, disregarding a permanent contract, as proposed by the exit tax, would be unconstitutional.
Either way, the decision of the National Treasury to pass legislation that nullifies its treaty obligations is of great concern.
This is a new measure implemented entirely to the detriment of taxpayers departing from South Africa. It is not clear whether this is intended to serve as an intentional deterrent or simply to raise additional income, but it is an unprecedented political decision.
The Expat Tax Petition Group, along with Tax Consulting South Africa, will submit proposals to Parliament to advocate against the introduction of this amendment.
Jean du Toit, technical tax manager; and Thomas Lobban, legal manager for cross-border taxation.