The published 2021 Draft Tax Invoices proposed introducing a tax on the retirement interest of those who cease their tax residence in South Africa. It means that a new section will be inserted in the Income Tax Law that will enter into force on March 1, 2022. The exit tax may very well lead to the double taxation of retirement interest, and may contravene the network double tax treaties concluded by the Government of South Africa.
Countries enter into double taxation agreements (DTAs) to promote economic activities, avoid tax evasion and, fundamentally, prevent double taxation. Double taxation occurs when two countries tax the same person for the same matter. DTAs aim to avoid this by assigning tax rights, which will determine which country is entitled to tax the income in question. When both countries are entitled to tax income, the DTA will require the country of residence to provide a tax credit for foreign taxes paid.
Read: Tax Bills propose an additional exit tax for South Africans who emigrate
In the context of pensions and similar amounts, the DTA would generally grant the country of residence the exclusive right to pay taxes. This is where the problem comes in because the proposed exit tax creates a fiction, where it treats the person who has withdrawn from the applicable fund the day before they cease to reside, creating a South African tax liability. By designing it this way, the exit tax effectively subverts the DTA, which we’ll get to in a moment.
The problem for the taxpayer is that they actually withdraw their retirement interest at a future date. By the time this time comes, they will likely have become residents of their new country of residence, which, according to the DTA, can tax that amount in terms of their national tax laws. The result is that retirement interest is taxed in both countries.
Typically, the DTA will provide taxpayer relief by requiring the country of residence to provide a tax credit for foreign (South African) taxes incurred. However, since the South African tax effectively contravened the provisions of the DTA, the new country of residence would not be required to grant such a credit.
Does the departure tax override the DTA?
According to the Organization for Economic Cooperation and Development (OECD), the annulment of a treaty is “the enactment of legislation that aims to unilaterally annul the application of the obligations of international treaties”.
The proposed tax on the alleged withdrawal of South African retirement interest from expatriates who cease tax residence in South Africa fits this description. This seems to be fully understood by the National Treasury, which in its Explanatory Memorandum on the exit tax blatantly states that “[t]The application of a tax treaty between South Africa and the new country of tax residence may, in some cases, result in South Africa losing its tax rights. “
In other words, the new provision appears to be specifically designed to subvert the DTA, thereby nullifying the network of DTAs held with other countries.
The seriousness 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 Government Gazette, becomes part of South African law; it is fully binding.
But the DTA is not the only international agreement that can be violated. South Africa is bound by the Vienna Convention on the Law of Treaties, which determines in Article 18 that “[a] The State is obliged to refrain from acts that would frustrate the object and purpose of a treaty … ” The purpose of a DTA is to avoid double taxation. If South Africa enacts a provision that results in double taxation, it defeats the purpose of the DTA and, by extension, also contravenes the Vienna Convention.
The status of treaties in our law is complex and subject to divergent 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 one accepts this point of view, invalidating a DTA, as proposed by the exit tax, would be unconstitutional.
Either way, the decision of the National Treasury to enact legislation that nullifies its conventional obligations is a matter of great concern.
This is another measure implemented entirely to the detriment of taxpayers departing from South Africa. Whether this is intended to serve as an intentional deterrent or simply a move to raise additional revenue is unclear, but it constitutes an unprecedented political decision.
The Expat Tax Petition Group, with Tax Consulting South Africa, will present proposals to Parliament to advocate against the introduction of this amendment.
Jean du Toit, head of Tax Technique; and Thomas Lobban, legal manager of Cross-Border Taxation.