Treasury takes aim at foreign pensions

David Warneke

In Chapter 4 of the 2025 Budget Review, National Treasury states that ‘the current treatment of cross-border retirement funds may result in double non-taxation, particularly where South Africa is granted the taxing right by treaty. It is proposed that changes be made to the rules that currently exempt lump sums, pensions and annuities received by South African residents from foreign retirement funds for previous employment outside South Africa, with amendments in the current legislative cycle.’

The rather cryptic wording in the Budget review makes it unclear whether the proposal would be merely to change the rules such that the exemption would no longer apply only in cases of double non-taxation. It does not seem correct in principle for South Africa to levy taxation on an amount simply because it had not been subject to tax anywhere else. In any event, it seems more likely that the proposal will be to simply remove the exemption insofar as it applies to lump sums, pensions and annuities, whether or not double non-taxation applies.

Assuming it is the latter, the question arises how wise this proposal would be, given that the exemption regime is certainly one of the benefits offered by South Africa to non-residents who wish to retire here. It would almost certainly have the effect of encouraging such previously non-resident retirees to emigrate and those considering retirement in South Africa to reconsider their options. Most of these retirees are wealthy and contribute positively to the economy, even if their foreign pensions are not subject to taxation here.

The Explanatory Memorandum to the Revenue Laws Amendment Bill of 2000 that introduced section 10(1)(gC) into the Act noted at the time that:

“The issue of the taxation of foreign pensions has raised some controversy. Currently foreign pensions and social security payments are exempt from income tax. It is, however, international practice for a country of residence to tax foreign pensions. Many reasons have been put forward as to why foreign pensions should not be taxable once the Republic moves to a worldwide basis of taxation. It is argued that this may discourage foreigners from retiring in the Republic. Furthermore, it is argued that the income from a pension is static and that any tax imposed thereon will effectively reduce the pensioners’ income. This argument is not necessarily correct as in most instances the country of source in any event taxes the pension if it is not taxed in the country of residence. Various other problems such as the deductibility of contributions to foreign pension funds and the taxation of lump sum payments from these funds will have to be addressed. Foreign funds would also have to be approved by the Commissioner based on whether the rules of the fund comply with the requirements of the Act and this may place a significant administrative burden on SARS. From a practical point of view, it is, therefore, proposed that foreign pensions not be taxed at this stage. It must, however, be noted that this is merely an interim measure and that the issue of the taxation of foreign pensions will be revisited over the next three years. This should provide sufficient time to determine how contributions to these funds and the taxation of payments from foreign funds should be dealt with and to determine what the economic impact of taxing foreign pensions may be. It is proposed that social security payments by foreign governments not be taxed as such an exemption is encountered in comparable jurisdictions.” (emphasis added).

As the above Explanatory Memorandum indicates, the fairness of such an amendment is open to question, given that South Africa would be taxing the withdrawal of amounts from foreign retirement funds under circumstances which, unlike withdrawals from South African retirement funds, no deduction for South African income tax was given when contributions were made to the foreign fund. So, unlike the case of contributions to a South African retirement fund, in the case of a foreign retirement fund there was no direct loss to the fiscus at the point when the contributions were made.

An example of a jurisdiction that would fall into the apparent target of the proposal is the United Kingdom (‘the UK’). Of course, there are many expatriates from the UK who have chosen to retire in South Africa. Article 17 of the double taxation agreement between South Africa and the UK grants the sole taxation rights for pension and similar remuneration to the individual’s jurisdiction of residence. Therefore, a retiree from the UK who receives a UK pension and who has become exclusively South African tax resident is currently not subject to tax on their pension either in the UK or South Africa.

Another issue that arises is that in many cases, at least portion of the foreign pension withdrawals may be capital in nature and would not require the section 10(1)(gC) exemption for non-taxability in South Africa, since amounts that are capital in nature and are not included in a person’s ‘gross income’. Lump sum withdrawals from South African retirement funds, on the other hand, are specifically included in ‘gross income’. However, if the pension is an annuity it would be included in ‘gross income’ even if it is capital in nature, by virtue of a specific inclusion. This is a complex issue that would require careful analysis for the individual retiree concerned, should the proposal become law.

If the above amendment is promulgated, it would likely have a material effect on the financial position of many retirees with foreign pensions who have become exclusively South African tax resident and may well cause them to emigrate to a jurisdiction that does grant a similar exemption. National Treasury needs to tread carefully here – the fairness of such a proposal, given that there was no loss to the fiscus at the point when contributions were made, and the potential loss of such current and potential retirees to the economy, must be carefully considered.