Who owes where?

This article was first published in the 2nd quarter 2014 edition of Personal Finance magazine.

Your tax liability in the country in which you live and/or work depends on the tax laws of that particular country. Countries can levy taxes on a residence basis, because you live in the country, or on a source basis, which means you are taxed on income or gains arising from activities carried on in the country.

Residence-based tax systems tend to tax their residents on their worldwide income. Many countries, including South Africa, have a mix of both source- and residence-based taxes. For example, if you are tax-resident in South Africa, your worldwide income is subject to tax in South Africa, with certain exemptions, and is eligible for credits for foreign taxes paid on foreign income. In addition, anyone, regardless of where they reside, is subject to South African tax in respect of income and gains that are regarded as being from a South African source, such as South African immovable property or permanent business activities that take place in South Africa, unless special circumstances prevail (see below).

Double taxation

Owning property, running a business or having a regular physical presence in two countries can give rise to the possibility of being taxed in both countries on the same income. This is known as double taxation and is the reason countries sign treaties, known as double-taxation treaties or double-taxation agreements (DTAs). These DTAs determine which country has the right to tax income, capital gains, estates on death and so on, to prevent doubling up and to reduce the likelihood of tax evasion.

Not all countries have DTAs, however, in which case the possibility of paying additional tax is high. South Africa has an extensive tax treaty network that includes 21 African countries (the most recent addition being the Democratic Republic of Congo, which came into effect in mid-2012) and 52 countries in the rest of the world, from the United Kingdom to South Korea. A full list of the treaties is available on the South African Revenue Service (SARS) website. Go to www.sars.gov.za > Legal & Policy > International Treaties & Agreements.

The test for tax residence is important, because it could affect your tax liability in other countries and also because it determines your rights if there is a DTA between South Africa and another country. The concepts of nationality, citizenship, domicile and permanent residence will not necessarily coincide with your country of residence for tax purposes. The tests are often quite different.

Residence for South African tax

Two tests must be considered when determining residence for South African tax purposes. People are regarded as tax-resident in South Africa if they are either “ordinarily resident” in South Africa, or if they pass a “physical presence” test. The test for residence as set out below is limited to natural persons. Separate rules apply to companies, trusts and other entities.

“Ordinarily resident” is not a defined term. However, it has been the subject of numerous court cases, which have helped to settle the meaning. Essentially, it has been held to mean your usual or principal residence – the place that, compared to other places, would be regarded as your real home. It is the place to which you “return after your wanderings”. Factors to be taken into consideration would be where you spend the most time, where your family is situated, where your children attend school and where you have regular social interaction and community involvement. However, none of these factors is conclusive and each case has to be considered on the specific facts and circumstances.

Note that a person who is regarded as ordinarily resident in South Africa can remain a South African tax resident even if significant amounts of time are spent outside the country, provided that the intention is always to return to South Africa. This could be the case even if the time spent outside South Africa spans a number of tax years.

If you are not ordinarily resident in South Africa, you must consider the amount of time you spend or have spent in South Africa. The physical presence test requires you to be physically present in South Africa for:

* More than 91 days in total during the current tax year (which runs from March 1 to the end of February); and

* More than 91 days in total in each of the five prior tax years; and

* More than 915 days in total over the five prior tax years. The days need not be consecutive.

For example, in respect of the tax year ended February 28, 2014, you would have to have spent:

* More than 91 days in South Africa in the period March 1, 2013 to February 28, 2014; and

* More than 91 days in South Africa in each of the tax years ending on the last day of February 2013, 2012, 2011, 2010 and 2009; and

* More than 915 days in South Africa during the period from March 1, 2008 to February 28, 2013.

If you meet all these requirements, you will be regarded as resident for tax purposes with effect from the beginning of the current tax year. In the example, this would be from March 1, 2013.

There are rules regarding partial days and days in transit:

* Partial days are regarded as full days, so the day of arrival and day of departure each counts as a full day; and

* Days spent in transit in South Africa without formally entering South Africa are excluded.

SARS’s income tax interpretation notes three and four offer guidance and examples in respect of both the “ordinarily resident” and “physical presence” tests. These can be found at www.sars.gov.za > Legal & Policy > Rulings > Interpretation notes. (Note that interpretation note four contains some examples that relate to the previous three-year physical presence test. This was revised to a five-year test with effect from the 2006 tax year.)

Different countries have different rules for qualification as a tax resident. It is therefore possible to be tax-resident in more than one country, depending on the definition that applies in each country. For example, you could be ordinarily resident in South Africa and also meet a physical presence test in another country.

Be aware of the detail. Different countries have different tax years, so the start and end dates of any tax-residency tests must also be considered. For example, South Africa’s tax year starts on March 1 and ends on the last day of February each year. The UK operates from April 6 to April 5 of the following year. Other countries, including Portugal and Mauritius, have a tax year that coincides with the calendar year.

The definition of “resident in South Africa” specifically excludes any person who is deemed to be a resident of another country under a DTA between South Africa and that country. Accordingly, if you could be tax-resident elsewhere, it is important to consider the tax rules for residence in that country and whether there is a DTA in place between South Africa and that country. DTAs contain rules known as “tie-breaker” clauses to determine the country of tax residence if both countries claim residence under their domestic tax legislation.

If there is no DTA, it is possible that you could be regarded as tax-resident in both South Africa and the other country, depending on the tax legislation in the other country.

The holy grail in tax planning is to create a situation where no country can claim you as a tax resident. This requires a form of nomadic existence to escape both the ordinarily resident and the physical presence tests across a number of countries … no mean feat.

Cessation of residence

The physical presence test looks for substantial presence in South Africa over six years and must be performed anew in each tax year. If you are not present in the country for enough days to meet the physical presence requirement in any single tax year – for example, if you spend 91 or fewer days in South Africa in one tax year – you will not qualify as a resident for South African tax purposes for that tax year.

Tax residence under the physical presence test also ends once you spend more than 330 days continuously outside South Africa. These days can fall over two tax years. You are then deemed to be no longer resident as from the first of those 330 days.

If you have been ordinarily resident in South Africa and your circumstances change, so that you are no longer regarded as ordinarily resident, there is no 330-day rule as under the physical presence test. You simply cease being a tax resident from the date you are no longer ordinarily resident. The most common reason for this change of status would be formal emigration, but this is not an absolute requirement. If you leave the country without formally emigrating but with no intention of returning on a permanent basis, you are no longer ordinarily resident; therefore you are no longer a tax resident in South Africa.

Ceasing to be a resident can have some negative consequences. When you cease to be tax-resident in South Africa, you are regarded by SARS as having disposed of your assets at market value. This is likely to give rise to tax – in most cases, capital gains tax. This will apply to all of your assets except:

* Immovable property in South Africa;

* Assets that are part of a permanent establishment in South Africa (“permanent establishment” is a defined term and essentially relates to assets of non-temporary businesses set up in South Africa); and

* Employee share-incentive schemes that have not yet vested.

The above-listed assets are taxable in South Africa regardless of your residency status and are therefore not required to be taxed at the date when residence ceased. All other assets – for example, South African equities and, subject to DTAs, any other assets held outside South Africa – are subject to tax as if you had sold them immediately prior to your change in tax residence.

Even when you cease being tax-resident in South Africa, you can still be subject to South African tax on income arising from a South African source, such as rental income from South African property, gains made on the sale of South African immovable property, and income from a South African permanent establishment.

Should you become tax-resident in South Africa again at some future date, you are regarded as having acquired all of your assets at their market value on that date. This will ensure that any increase in market value, from the date you became a South African tax resident until the date of sale of the assets or of again ceasing to be resident, will be taxed in South Africa.

* Kari Lagler is a registered tax practitioner and an independent tax consultant.