The National Treasury published the Draft Taxation Laws Amendment Bill, 2020 (Draft Tax Bill) for public comment. One of the more contentious proposals in the Draft Tax Bill relates to the ability of people emigrating from South Africa to access amounts in their pension preservation fund, provident preservation fund and retirement annuity fund (retirement funds) when they leave.
In accordance with the policy decision to phase out "financial emigration" for exchange control purposes, which was announced in the 2020 Budget Speech, National Treasury and the South African Revenue Service (SARS) have proposed to amend the definitions of the terms "pension preservation fund", "provident preservation fund" and "retirement annuity fund".
South Africans emigrating for exchange control purposes are currently able to make pre-retirement lump sum withdrawals from the retirement funds if they financially emigrate for exchange control purposes in accordance with the process prescribed by the South African Reserve Bank.
The proposal in the Draft Tax Bill is for the payment of lump sum benefits from retirement funds to only be permissible when a member of a retirement fund ceases to be a South African resident and such member has remained non-tax resident for at least three consecutive years or longer (3-year rule). The 3-year rule will impact all persons who are members of retirement funds and require immediate access to their retirement funds upon emigration.
The effect of the 3-year rule is that members of retirement funds who emigrate will have to wait for a period of at least three years before they may access their pre-retirement lump sum benefits. This will cause financial hardship for people, who may need these funds to start a new life in the destination country.
The proposed 3-year rule also poses other practical problems, including that it does not consider the position of retirement fund members who financially emigrate shortly before it commences. Those who have started the financial emigration process but have not completed it by 1 March 2021 - the proposed commencement date of the 3-year rule - will also be prejudiced.
A further practical issue is that the 3-year rule makes retirement annuity funds more unattractive as retirement savings vehicles. The reason for this is that members of retirement annuity funds will have to wait three years to access to their retirement benefits, whereas members of pension preservation and provident preservation funds may access certain pre-retirement benefits once prior to retirement and members of pension and provident funds may make a pre-retirement lump-sum withdrawal upon termination of their employment relationships.
The most puzzling feature of the 3-year rule is its arbitrariness. In South Africa, a person is considered to be a South African tax resident where that person is either ordinarily resident in South Africa or is deemed to be tax resident by complying with the threshold requirements of the physical presence test. The 3-year rule does not reconcile to either the ordinary resident test or the physical presence test and is, in fact, at odds with the definition of resident in the Income Tax Act, 1962 (Income Tax Act). The 3-year rule also creates a misalignment with other provisions in the Income Tax Act that give rise to immediate tax consequences when people cease being a tax resident in South Africa.
Although the 3-year rule was proposed to modernise the foreign exchange control process, it is unrefined and raises the above practical issues (amongst others) which must be urgently addressed. If the 3-year rule was intended to create a better reporting arrangement in respect of which SARS may be assured that a person is emigrating from South Africa, and has permission to live somewhere else, we recommend that enhanced administrative processes, similar to a SARS audit process, be undertaken before allowing the retirement funds to be released in whole at the relevant tax rates. This would align with the way that the existing exchange control process administered by the South African Reserve Bank functions.
The 3-year rule is not an equivalent reporting arrangement, and is prejudicial especially bearing in mind that these funds are often needed for beginning a new life in the destination country, and the volatility of the Rand which may lead to a further erosion of the value by the time the funds are received. Furthermore, in our view, the existing exchange control emigration process cannot be abolished within five months to align with the proposed commencement of the 3-year rule on 1 March 2021.
We recommend that National Treasury refrain from promulgating the 3-year rule until all the practical issues regarding its implementation have been resolved.
UPDATE: On 9 September 2020, the National Treasury held a workshop on the Draft Tax Bill. We summarise below the takeaways from this workshop.
- National Treasury confirmed that the financial emigration process would be phased out as part of the new capital flow management process to be put in place by the South African Reserve Bank (SARB). National Treasury also acknowledged comments made on the Draft Tax Bill focused largely on the administrative burden on fund administrators and on individuals emigrating.
- The Budget Review 2020 also referred to the phasing out of the concept of "emigration" for exchange control purposes, to be replaced with a risk management verification process for individuals. When an individual has emigrated, they will need to close most of their South African bank accounts, cancel their credit cards, have no access to online banking, cannot extend loans back to South Africa and all transactions will need to go through an authorised dealer. Once an individual has emigrated, it is difficult for the individual to return to South Africa. By phasing out emigration, National Treasury hopes to make it much easier for individuals to return to South Africa. The financial emigration process was creating a barrier for individuals to return to South Africa. Further, there is no intention by the National Treasury to hold on to retirement funds and there is no link between this proposed amendment and the prescribed assets rule.
- The existing rules of the Income Tax Act permit individuals to have access to retirement funds prior to retirement on emigration or at normal retirement age. If the emigration process is to be phased out, National Treasury will have to find an alternative trigger for individuals to have access to these funds. The MP336(b) process is an administratively intensive process and there are adverse implications triggered for individuals who return to South Africa within five years of emigrating.
- National Treasury thus proposed that the new trigger would be that the individual would have access to those funds afterthree years of ceasing to be tax resident. If the new trigger is ceasing to be tax resident for only a year, National Treasury is concerned that there would be anomalous situations where an individual who has ceased to be tax resident for a year and returns to South Africa in the second year would have had access to those retirement funds, In contrast, individuals who have remained South African tax residents for all the years would have had no access to those funds.
- An alternative proposed by National Treasury is to enable a tax trigger event when the individual ceases to be tax resident, but to have the tax liability deferred until the time when the individual withdraws from the fund.
- Responding to comments that individuals who are relocating require access to the funds to start again in the new country, the purpose of the retirement funds is not to fund an individual's emigration. From a policy perspective, National Treasury's view is that the tax advantages of investing in retirement funds must come with certain conditions.
- On the question of how fund administrators would implement the proposed amendments, National Treasury responded to say that the same directive application process for current lump sum withdrawals would be in use.
- National Treasury also acknowledged that allowing individuals an election whether to withdraw would be useful. As for individuals who have submitted the MP336(b) form but have not completed the process by 1 March 2021, National Treasury would still need to consider how best to accommodate these individuals.
- National Treasury invited further comments on alternatives to the 3-year ceasing to be tax resident rule. Suggestions included that the trigger should be when the individual ceased to be ordinarily resident, or aligning the provisions of emigration with other provisions in the Income Tax Act, such as section 9H. National Treasury was of the view that the 3-year rule is feasible and invited comments on why the rule was not practical.