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Limitation of taxing rights on pension income under the United States / South Africa tax treaty

07 September 2012   (0 Comments)
Posted by: SAIT Technical
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By Ruaan van Eeden and Carmen Moss-Holdstock (DLA Cliffe Dekker Hofmeyr Tax Alert)

Non-resident beneficiaries of a deceased’s South African sourced pension income may still be required to submit an income tax return, even where South Africa’s taxing rights are limited under a relevant Double Tax Agreement (DTA).

The general principle under South African tax law is that non-residents are taxed on income from, or deemed to be from, a local source unless South Africa’s taxing rights have been limited under any relevant DTA. With regard to pension income derived by any person (including non-residents who may have rendered services in South Africa), the deemed source rules under s9(2)(i) of the Income Tax Act, No 58 of 1962 (Act) would likely result in at least a portion of that income falling within the South African tax net.

The scenario becomes more complex where the South African sourced pension is received by a beneficiary of the deceased from a local fund administrator, but that beneficiary has never set foot in South Africa or rendered any services here. The question arises whether the local fund administrator is required to withhold monthly PAYE on that amount and whether the recipient of the pension income is obliged to obtain a tax deduction directive from the South African Revenue Service (SARS). Further, what role would a DTA play in the aforementioned scenario, more specifically the United States/South Africa DTA (US Treaty)?

Article 18 of the US Treaty deals with the taxation of private pensions and annuities as well as the tax treatment of contributions to pension plans. The benefit of the US Treaty is that where it is read in conjunction with the US Treaty Technical Explanation (USTE), it sets out clearly the mode of application of Article 18. The USTE states that, under Article 18(1) of the US Treaty, pension distributions (and other similar remuneration) in consideration of past employment from sources within one Contracting State (in this case South Africa) and beneficially owned by a resident of the other Contracting State (in this case the US), may be taxed by the Source State (in this case South Africa) to a limited extent. The residence state (in this case the US) may also tax the distribution.

Under Article 18(1)(b) of the US Treaty, where South Africa is the source Contracting State, the USTE states that apro rataamount of a pension distribution corresponding to the amount of the gross pension distributions from South African sources will be subject to tax in relation to a beneficiary that is a US resident. However, the aforementionedpro ratarule only applies if the beneficial owner

  • has been employed in South Africa for a period or periods aggregating two years or more during the 10 year period immediately preceding the date on which the pension first became due; and
  • was employed in South Africa for a period or period aggregating 10 years or more.

In relation to a beneficiary of the deceased’s pension, it would in most cases not be difficult to argue that neither of the abovementioned requirements will be met, either in relation to period of service in South Africa and/or the fact that the beneficiary never rendered services in South Africa at all. This means that in most cases dealing with the receipt by a non-resident beneficiary of a deceased’s South African sourced pension income, the sole taxing rights will be given to the US.

Given the fact that the US would likely be allocated full taxing rights on the South African sourced pension income, it follows that no normal tax liability arises for the non-resident beneficiary. Stated differently, the Fourth Schedule to the Act requires PAYE to be deducted in respect of the employees' normal tax liability – if no normal tax liability exists or is sterilised by the application of a DTA, then no deduction is required by the local fund administrator. Further, as there is no obligation to deduct PAYE by operation of law, there would similarly be no obligation to obtain a tax deduction directive from SARS confirming this.

However, even where there is no need to obtain a tax deduction directive or deduct PAYE for that matter, there may still be an obligation on the non-resident beneficiary to submit a tax return on an annual basis. This is on the basis that the non-resident’s pension income would still constitute 'gross income' and more importantly, 'remuneration' for purposes of the Fourth Schedule even though no tax liability exists in South Africa (it is only the taxing provision that is sterilised by the DTA).

To the extent that a non-resident beneficiary receives 'gross income', which is below the required threshold of R120,000 per annum, no obligation arises to submit an annual tax return. However, where the non-resident beneficiary receives 'gross income' in excess of R120,000 per annum, the he would be obliged to submit an annual tax return and would need to claim an exemption from South African tax in respect of the pension income.



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