Interpretation Note 16 (Issue 3) – Exemption from income tax: Foreign employment income

Interpretation Note 16 (Issue 3) – Exemption from income tax: Foreign employment income

• 31 January 2020
• SARS

Important:

This article is based on tax law for the tax year ending 28 February 2021.

The exemption under section 10(1)(o)(ii) was introduced in 2000 to prevent double taxation of an individual’s income between South Africa and a host country. The exemption creates opportunities for double non-taxation in instances where the host country imposes little or no tax on employment income. This outcome is contrary to the purpose for which the exemption was introduced. It was originally indicated that the impact of the exemption would be monitored with specific focus on whether the exemption is unduly exploited resulting in no foreign tax on foreign employment income.

From 1 March 2020 and in respect of years of assessment commencing on or after that date, foreign employment income earned by a tax resident of South Africa will no longer be fully exempt as the exemption under section 10(1)(o)(ii) will be limited to R1 million. Any foreign employment income earned over and above R1 million will be subject to normal tax in South Africa, applying the normal tax rates for the particular year of assessment. All requirements to qualify for the exemption under section 10(1)(o)(ii) remain the same.

The Note discusses the requirements to qualify for the exemption under section 10(1)(o)(ii). The impact of the limitation of the exemption and the correct method of apportionment is also examined, as well as how the exemption affects gains included in income upon the vesting of any equity instrument under section 8C.

In order to qualify for the exemption, a taxpayer must be a tax resident of South Africa who earns certain types of remuneration for employment services rendered outside the Republic. The exemption will only be available provided the specified qualifying periods are met and none of the exclusions apply. These requirements are analysed and interpreted below.

Remuneration

Not all remuneration qualifies for exemption under section 10(1)(o)(ii). The remuneration that qualifies is remuneration received by or accrued to an employee “by way of” the following amounts, namely, salary, leave pay, wage, overtime pay, bonus, gratuity, commission, fee, emolument or allowance, for services rendered. Amounts contemplated in paragraph (i) of the definition of “gross income” in section 1(1) are also included, as too are amounts referred to in sections 8, 8B or 8C. The exemption relates to remuneration received or accrued for services that were rendered outside the Republic (see below) during the qualifying periods (see below). Periods outside the Republic where no remuneration was earned fall outside the ambit of section 10(1)(o)(ii).  Remuneration received subsequent to a qualifying period, but in respect of such qualifying period, will qualify for the exemption, but subject to any applicable apportionment (see below).

Remuneration received by or accrued during a qualifying period for services rendered within the Republic does not qualify for exemption. Remuneration earned during a qualifying period in respect of services that were rendered both inside and outside the Republic must be apportioned (see below) so that only the income relating to foreign services is exempt.

Employment relationship

The exemption under section 10(1)(o)(ii) only applies if an employment relationship exists. The services that are rendered for or on behalf of the employer must be rendered under an employment contract. The term “any employer” means that services rendered to resident or non-resident employers could qualify for exemption. The term “employee” is not defined in the main body of the Act, and so must be given its ordinary meaning. An “employee” under the common law excludes an independent contractor or self-employed person. Directors in their capacity as directors are holders of an office, not employees, and to the extent that they earn director’s fees, such fees do not qualify for exemption under section 10(1)(o)(ii).

Services rendered The remuneration must be received in respect of services rendered. Amounts payable by an employer to an employee, but which do not relate to services rendered, are not included in the scope of the exemption. Payments for the relinquishment, termination, loss, repudiation, cancellation or variation of any office or employment or of any appointment (or right to be appointed) to an office or employment are received by virtue of such termination, loss, repudiation, cancellation or variation, not in respect of services rendered, and are accordingly not exempt under section 10(1)(o)(ii).

Outside the Republic In order to qualify for exemption, the services must be rendered “outside the Republic”. The “Republic” is defined in section 1(1). The definition encompasses the landmass of South Africa as well as its territorial waters, which is a belt of sea adjacent to the landmass but not exceeding 12 nautical miles (roughly 22,2 km) beyond the baselines of the country.

In certain circumstances, the Republic may extend beyond the geographical limits of its landmass and territorial waters. The definition of the “Republic” specifically includes those areas beyond the territorial sea which have been designated under international or domestic law as areas where South Africa may exercise sovereign rights in respect of the exploration or exploitation of natural resources. This definition is aligned with domestic law and international law, which provide for South Africa’s right to explore and exploit natural resources in the exclusive economic zone and on the continental shelf. The exclusive economic zone extends to 200 nautical miles (roughly 370,6 km) from the baselines. The continental shelf extends to the outer edge of the continental margin, or 200 nautical miles from the baselines, whichever is the greater. These are factors that must be considered when determining whether a person renders services in the Republic or outside the Republic, for purposes of section 10(1)(o)(ii). Remuneration for services rendered beyond South Africa’s territorial seas but within the exclusive economic zone or on the continental shelf will not qualify for exemption under this section if the person’s employment services relate to the exploration or exploitation of natural resources.

Days test

Period or periods exceeding 183 full days in aggregate

In order to qualify for the exemption, a person must be in employment, outside the Republic, for at least 183 full days during any 12-month period. A “full day” means 24 hours (from 0h00 to 24h00). The 183 full days do not have to be consecutive or continuous but, in order to meet the exemption requirements, a total of 183 full days in any 12-month period must be exceeded. It is not necessary to exceed this period by a full day. Any amount of time in excess of 183 full days, such as a few hours, will be sufficient. Calendar days must be looked at, not only work days, when calculating whether a person has been outside the Republic for 183 full days. Weekends, public holidays, annual leave days, sick leave days and rest periods (as required under the specific terms of a contract of employment) that are spent outside the Republic are taken into account for purposes of calculating the period or periods outside the Republic.

Note: the rules applicable to qualifying days for apportionment of income are different to the rules to calculate whether the 183-day or 60-continuous-day tests have been met (on apportionment, see above). A distinction must be made between a situation where a person is in employment and is actually outside the Republic but is not physically rendering services, and a situation where a person is physically present outside the Republic but is not in employment. Section 10(1)(o)(ii) clearly links the days test to the person’s employment. Days spent outside the Republic when a person is not in employment do not qualify as days outside the Republic under section 10(1)(o)(ii), and are thus not taken into account in the determination of the 183 days for purposes of the exemption. Such broken periods of employment may arise if an employee is employed at intervals. An employee may, for example, be employed on a contract basis and enter into separate employment contracts for each broken period of employment. The time in-between the contracts where the employee is unemployed and where no services are rendered do not qualify under section 10(1)(o)(ii) as days outside the Republic. Conversely, employees who remain in employment whilst outside the Republic, but only render services for specified periods and then have rest periods, will be able to claim the rest period days as days outside the Republic for purposes of the days test. A common example is where employees work rotational shift periods, such as a specified number of days rendering services followed by an equal number of days of rest. Such rest periods are often required by local health and safety legislation. The rest periods do not interrupt continuous employment, and such days are accepted as falling within the scope of the days test.

Continuous period exceeding 60 full days

In addition to the requirement that services must have been rendered outside the Republic for a period or periods exceeding 183 full days in aggregate during any period of 12 months, a person must also have rendered services outside the Republic for a continuous period exceeding 60 full days in the same period of 12 months. For example, if a period of 12 months from 1 April 2013 to 31 March 2014 is used to calculate whether the person spent a period or periods exceeding 183 full days in aggregate outside the Republic, that same period of 12 months must be used to determine whether the person spent a continuous period exceeding 60 full days outside the Republic. To exceed a continuous period of 60 full days does not mean that it must be exceeded by a full day, but by any amount of time, even if this amounts to, for example, a few minutes or hours. Taxpayers must be in a position to substantiate their absences from the Republic and that the absences were under an employment contract and to render services, and may thus be required to provide some form of documentation when claiming the exemption. This documentation may include, without limiting the scope of what could be requested by SARS, letters of secondment, employment contracts for foreign services, travel schedules and copies of passports. This documentary proof will assist in the verification of the period or periods worked outside the Republic.

During any period of 12 months

The remuneration that is exempted by this provision relates to amounts earned from services rendered outside the Republic, if the days tests were met during “any period of 12 months”. The word “month” is not defined in the main body of the Act. Section 2 of the Interpretation Act provides that, unless the context otherwise requires, the word “month” in any law means a “calendar month”. Under dictionary meanings, a calendar month could mean either one of the twelve named portions into which a calendar year is divided, or it could mean a period of time which is calculated from a date in one month to the same date in a successive month. 

In Subbulutchmi v Minister of Police and Another,  James JP stated the following: “According to the Interpretation Act 33 of 1957 a month means a calendar month. In the absence of any clear indication to the contrary to be found in the words used in any particular legislation a calendar month running from an arbitrary date expires with the day in the succeeding month immediately preceding the day corresponding to the date upon which the period starts. Thus, if a calendar month commences on the 10th of one month it will expire at the end of the 9th day of the succeeding month.” There are no clear indications in the context of section 10(1)(o)(ii) that the more restrictive meaning of a named calendar month was intended. The contextual factors in fact point the other way – the use of the word “any” prior to the words “period of 12 months” indicates that the meaning should be extended rather that restricted. The period of 12 months referred to in section 10(1)(o)(ii) must therefore be given the more extended meaning and does not need to commence on the first day of a named calendar month or end on the last day of a named calendar month. The period or periods exceeding 183 full days mentioned above must fall within a period of 12 consecutive months. The period of 12 months is not necessarily a year of assessment, a financial year, or a calendar year; it is any period of 12 consecutive months.

Practical application In identifying a period of 12 months that may be used, the period during which the services were rendered to the employer should first be identified. A useful point to commence the enquiry would be by looking from the first day of the month in which remuneration from foreign services was received or accrued, and then working forward 12 months to determine whether the 183-day and 60-continuous-day tests were met. If so, that is the end of the enquiry and the foreign remuneration will be exempt. If the days tests are not met, the last day of the month in which foreign remuneration was earned can be looked to, and then by working backwards 12 months.

This is not an either/or approach. A person is entitled to look both forwards and backwards over any period of 12 months, meaning that some periods may overlap. If the first month in this test does not meet the requirement of the 183-full-days and 60- continuous-full-days, the following month can be looked to, and worked forward or backwards – meaning that the prior month that was looked at first, will be taken into account again in assessing whether the days test was met for the second month. The multiple use of any specified period is permitted due to the wording of the section that permits the test to be conducted over “any” period of twelve months. Although the first or last day of a month, and a full month, is used in the explanation above, that is simply for illustrative purposes. Because a 12-month period can commence or end on any day in the month, the 12-month period could commence, for example, on the 12th of a month and end on the 11th of that month in the following year. The test could therefore also be applied on a daily basis, which means that a person can consider a 365- or 366-day period looking both forwards and backwards from any specific day.

Persons in transit through the Republic 

A person is deemed to be outside the Republic where such a person is in transit between two places outside the Republic and –

• the person does not formally enter the Republic through a port of entry as contemplated in section 9(1) of the Immigration Act 13 of 2002; or
• the person does not formally enter the Republic at any other place as may be permitted by the Director General of the Department of Home Affairs or the Minister of Home Affairs under the Immigration Act.

This means that the point of departure and the point of destination of the journey that is being undertaken must be outside the borders of the Republic (see above).

Exceptions

The following two categories of employees are expressly excluded from the exemption: • A public office holder, as contemplated in section 9(2)(g), who must be appointed or deemed to be appointed under an Act of Parliament.27 • Employees of employers, as contemplated under section 9(2)(h), in the national, provincial or local sphere of government, certain constitutional institutions, national and provincial public entities listed in Schedules 2 and 3 of the Public Finance Management Act,28 and municipal entities. 29

This article first appeared on sars.gov.za.

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