16 September 2021 by Tax & Exchange Control Alert

Exit charge on retirement fund interests when ceasing residency

On 28 July 2021, National Treasury and the South African Revenue Service (SARS) published the 2021 draft Taxation Laws Amendment Bill (2021 Draft TLAB), which includes proposed changes to the Income Tax Act 58 of 1962 (ITA), in relation to the tax treatment of an individual’s interest in a pension fund, pension preservation fund, provident fund, provident preservation fund or retirement annuity fund (retirement fund) upon that individual’s cessation of residency.

In terms of section 9H(2) of the ITA, when an individual ceases to be South African tax resident during any year of assessment, there is an automatic capital gains tax charge which is calculated on certain assets held by that individual. In terms of this section, that individual will be treated as:

  • having disposed of their qualifying assets to a resident person;
  • on the date immediately before the day on which that individual ceases residency;
  • for an amount equal to the market value of those assets on that date; and
  • having reacquired each of those assets on the day on which that individual ceases residency, at an expenditure equal to that market value.

Typically, the exit charge applies to a range of assets, but does not apply in respect of assets specified under section 9H(4) of the ITA. Currently, and in terms of the Explanatory Memorandum to the 2021 Draft TLAB (Memo), when an individual ceases to be a South African tax resident, their membership interest in a retirement fund may not be subject to South African tax due to the provisions of certain double tax agreements concluded between South Africa and foreign jurisdictions.

National Treasury has proposed the insertion of wording in section 9H to clarify that the deemed disposal rule in 9H(2) will not apply in respect of an asset of a person ceasing residency where that asset constitutes any amount representing the value of the interest in any retirement fund, as well as the insertion of a new proposed section 9HC in the ITA to provide for the “disposal of retirement fund interest[s] on change of residence”. In terms of the new proposed section 9HC, an individual ceasing South African tax residency will be subject to South African tax on the value of their retirement fund interest(s) irrespective of whether that individual withdraws or retains their interest in a South African retirement fund upon ceasing residency. In either scenario, as outlined in the Memo, the treatment of that individual’s retirement fund interest will be as follows:

  1. If that individual, upon ceasing residency, withdraws their interest prior to retirement or death:
  • The individual will be deemed to have withdrawn from the retirement fund on the day before they cease to be a South African tax resident.
  • The interest in the retirement fund will form part of the assets of the individual subject to tax applicable to withdrawal benefits, however, the tax payment, including associated interest, will be deferred until a withdrawal payment is receivable by that individual from the retirement fund.
  • When the individual receives a payment from the retirement fund, the tax on the withdrawal benefit will be calculated based on the prevailing withdrawal tax tables.
  • A tax credit will be provided for the deemed tax as calculated when the individual ceased to be a South African tax resident.
  1. If that individual, upon ceasing residency, retains their interest and only withdraws upon retirement or death:
  • The individual will be deemed to have withdrawn from the retirement fund on the day before he or she ceases to be a South African tax resident.
  • The interest in that retirement fund will form part of the assets of the individual subject to tax applicable to withdrawal benefits, however, the tax payment, including associated interest, will be deferred until payments are receivable by that individual from the retirement fund.
  • When the individual ultimately receives payments from the retirement fund, the tax on those payments will be calculated based on the prevailing retirement fund lump sum tax tables or in the form of an annuity.
  • A tax credit will be provided for the deemed tax as calculated when the individual ceased to be a South African tax resident.

As indicated in the Memo, the responsibility of the individual ceasing South African tax residency will be to firstly, ensure that a valuation of the interest in the retirement fund is obtained on the day preceding that individual’s cessation of residency and secondly, notify SARS that they have ceased South African tax residency.

The deferral of the tax payment to when payment is receivable from the retirement fund is in line with the recent changes to the ITA, which allow individuals ceasing residency to withdraw lump sum amounts from their retirement funds if they have remained non-tax resident for at least three years on or after 1 March 2021 (discussed in our Tax Alert on 23 October 2020).

The proposed amendments are intended to come into operation on 1 March 2022 and will apply in respect of any year of assessment commencing on or after that date.

Comment

The due date for public comments on the proposal was 28 August 2021 and as expected, a number of submissions were received from the public. These submissions were considered and discussed during the National Treasury workshop on the 2021 Draft TLAB on 9 September 2021.

The submissions made seem to suggest that many are against the proposal. One of the issues raised was, for example, that the proposed amendment would contravene South Africa’s obligations under international law, in that it would be inconsistent with some of South Africa’s double tax agreements with other countries.

It remains to be seen how National Treasury will respond to the submissions received. It is likely that in the coming weeks, National Treasury will release a response document, summarising its responses to the submissions received. This will give some idea as to whether the proposed amendment will be implemented or not.

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