The bold move by Finance Minister Tito Mboweni to phase out the “administratively burdensome” process of emigration through the South African Reserve Bank (Sarb), announced in his budget speech on Wednesday, received wide applause.
Government is sending out a clear message that the abuse of financial regulations to create a tax industry that cross-sells banking solutions as a tax process or a “tax status change” will no longer be tolerated, says Hugo van Zyl, cross-border tax and exchange control specialist.
“It is of great interest to note that it is clearly only the Reserve Bank formal emigration process and not the tax emigrations that are being given a sunset death knell.”
Van Zyl says it was a bold move to bring to an end the incorrect use of a bank process as a tax compliance process.
Henry Hollingdrake, director at Falcon Marine Consulting, says the phasing out of the emigration process through Sarb will bring to an end the concept of “financial emigration”.
“It created confusion for South African expats, and in fact has resulted in incorrect advice being given,” says Hollingdrake.
“Expats were advised that once they have ‘financially emigrated’ then they are no longer tax resident in South Africa.”
The catalyst for the ‘financial emigration’ solution was the change to the tax exemption provision in the Income Tax Act on foreign earnings of South African tax residents abroad.
Tax-free limit raised
Initially the tax-free amount was limited to R1 million per annum, but Mboweni announced an increase to R1.25 million in his budget this week. The change will be effective from March 1.
Hollingdrake says people who “financially emigrated” were under the impression that they escaped the SA tax net and that their foreign income would not be taxable in SA.
“This was incorrect, as financial emigration is merely an indicator that someone may be non-resident [for tax purposes]. In fact, certain SA expats who have financially emigrated are still tax resident since they are still considered to be ordinarily resident in South Africa,” says Hollingdrake.
Shift to Sars
The emigration process will now shift to the South African Revenue Service (Sars), and there will be a validation confirmation process to see when the Section 10 foreign income exemption is applicable or not. For this the ordinary resident test and the physical presence test will still be used to determine the tax status of people living and working abroad.
“What remains now for SA expats will simply be, and it is actually not that simple, to prove that they are [tax] non-resident,” says Hollingdrake.
“There will be no single formal application process that one must go through. There will be a validation confirmation, however, which will be predicated on not being ordinarily resident in SA.”
Bernie Herberg, director at Stonehage Fleming, says the rules for emigrants withdrawing funds from retirement funds will be amended as these presently require proof of Sarb emigration.
Restrictions applicable to emigrants such as not being able to have SA bank accounts, or to borrow or invest freely in SA, have been repealed.
“Under the new system, natural person emigrants and natural person residents will be treated identically,” says Herberg.
Keith Engel, CEO of the South African Institute of Tax Professionals, says that while the devil is indeed in the details, the proposed changes appear to be one of the most significant changes to exchange control for both individuals and corporates in the last 20 years.
National Treasury is literally shifting the default to say all is allowed for moving funds offshore “but for” certain relatively narrow restrictions.
“Perhaps the hope is that the South African desire to emigrate will no longer exist if one is free to exit at any time,” says Engel.
“Of special interest is the corporates. Will South African companies be free to enter most cross-border transactions free of interference? If so, South Africa may have a chance of being a regional financial hub after all.”
Herberg notes that the so called anti-loop structure exchange control rule has been very restrictive over the years. “Simply stated, South African residents cannot invest in a foreign entity that then invests back into South Africa.”
It is indicated that the anti-loop rules may be scrapped, but only after relevant income tax amendments are made to address the avoidance of tax on dividends and capital gains tax through loop investments.