Income Tax: What employees receiving foreign income should know
26 Sep 2018
Employees might attempt to escape a tax liability on a portion of their income received in another country, however in a recent Court decision it was confirmed that the foreign income shall nevertheless be subject to tax consequences where such income was paid by a South African based employer, irrespective of the fact that the income was derived in a foreign country.
On 9 March 2018, the Tax Court, Western Cape Division, had to consider a case before it dealing with foreign income and when such income will be subject to tax consequences. In delivering judgment in the matter of Mr X v the Commissioner for the South African Revenue Service the Court turned the spotlight to the actual “source” of Mr X’s employment income.
Mr X (“Appellant”) appealed against the Commissioner’s (“Respondent”) disallowance of R4 million claimed by the Appellant as non-taxable foreign income earned as a result of services he rendered to his employer outside the parameters of South Africa. On 31 March 2011 Mr X entered into a contract of employment with his employer, of which the terms were as follows:
- the contract of employment was entered into in Johannesburg, thus in South Africa;
- the Appellant was employed by the Johannesburg branch of ABC Inc. United States (“Employer”), having been registered in South Africa as an external company; and
- the Appellant would be remunerated by way of receiving an annual salary, net of any taxes and payable in monthly instalment.
The total income of the Appellant for his employment amounted to R10 million and as a result hereof the Employer issued an IRP5 certificate reflecting the annual income for the 2014 year of assessment as R10 million against which it paid pay-as-you-earn-tax. The Appellant argued that the certificate incorrectly included a surplus amount of R4 million as taxable gross income as this amount was received by the Appellant for services rendered outside of South Africa.
The Court was faced with the following two questions as a point of departure in resolving the above dispute concerning the taxable income:
- whether the Appellant was ordinarily resident in South Africa during the relevant tax period or whether he fell in the exclusionary provisions of section 1(b) of the Income Tax Act No. 52 of 1962 (“ITA”); and
- whether the disputed income can be regarded as having been received by the Appellant from “a source within the Republic”.
Consideration of the law applicable:
The residency element was correctly abandoned by the Court however in determining and interpreting the meaning of “source” the Court referred to several precedents and the ITA respectively. Gross Income is defined in the ITA as –
“(ii) in the case of any person other than a resident, the total amount, in cash or otherwise, received by or accrued to or in favour of such person, from a source within the Republic.”
Counsel for the Respondent argued that the originating cause of the Appellant’s income was the contract of employment which was entered into South Africa and experienced in South Africa for all the days that he worked in South Africa and that the Appellant performed his contractual obligations to his Employer and not to each of the individual recipients in the other countries. The Respondent further argued that the source of the income is the employment itself and not the actual services rendered. The Respondent relied on various case law in support of its argument and held that in First National Bank of SA (Pty) Ltd v CLR the legislature intended the use of the words “source within the Republic” to be determined by the Courts and the Court cited the decision in Lever Bros and Another, where it was held that there is a need to consider the factual matrix and in order to ascertain the actual source of a given income is a practical hard matter of facts.
The Respondent raised a further point that a company registered in South Africa, although being registered as an external company which is a branch of a company registered outside South Africa, exists as a separate and individual legal entity within South Africa. The Appellant, in contrast, argued that the South African branch was not in fact a separate legal entity for this purpose and accordingly could not have been the originating cause of the remuneration received.
The Court’s judgment
The entire dispute revolved around the definition of where the employment is exercised and the source of the accompanying income of such employment. The Court considered a portion of the Vienna Convention on the Law of Treaties of 1969 (“VCLT”) which serves as a general guide on how a treaty should be interpreted and the Court ruled parts thereof to be applicable to South African law.
The Court referred to Article 31 of the VCLT which contain general rules of interpretation and it states that –
“A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in light of its object and purpose.”
As a result of the above consideration of interpretation, the Court held that the use of the wording “employment is exercised” would ordinarily mean the place where the employment agreement is implemented. The contract of employment was entered into by the Appellant in South Africa and the Appellant furthermore chose a South African address as his domicilium as did the Employer. In determining where the employment is exercised the following factors were also taken into account:
- what the contract itself stipulates;
- where the contract was concluded;
- who is paying the employee;
- who the services are being rendered to; and
- where the services are being rendered.
The Court held that the Appellant rendered the services in the fulfilment of his obligations to his Employer and not as an independent contractor. In the Lever Bros and Another case, it was held that two problems arose when deciding whether or not money, received by a taxpayer is gross income for the purposes of the ITA. The source of income should be determined, together with the obstacle of locating the source. The Court held that the source of the taxpayer’s income is directly linked to the work done by the taxpayer in order to receive the income.
Section 9(2) of the ITA stipulates –
“An amount received by or accrues to a person from a source within the Republic if that Amount –
(h) is received or accrues in respect of services rendered or work or labour performed for or on behalf of any employer –
(i) in the national, provincial or local sphere of government of the Republic;
(ii) that is constitutional institution listed in Schedule 1 to the Public Finance Management Act;
(iii) that is a public entity listed in Schedule 2 or 3 to the Act; or
(iv) that is a municipal entity as defined in section 1 of the Local Government: Municipal Systems Act, 2000 (Act No.32 of 2000).”
The above section of the ITA confirms a determinate factor as being the performance of work or rendering services by an employee for or on behalf of an employer. The source of the Appellant’s remunerations received for the services rendered to the Employer outside South Africa is the same source from which remuneration was derived in the remaining days that the services were rendered to the Employer within South Africa.
The dispute was settled by the Court’s ruling that the employee’s actual source of income is where the contract of employment is implemented and therefore the Appellant’s entire income in casu was fully taxable. Therefore regardless of whether the employee has earned a portion of his/her salary outside the borders of South Africa, the determinate factor for purposes of a tax liability will be the actual source of the employee’s remuneration and not where the employee rendered the services.
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