Foreign employment exemption: Key considerations of offshore assignments for South African employers

A South African employer administering the payroll for employees working outside South Africa, need to be mindful of the detailed reporting on the IRP5 tax certificates and understanding the relevance of tax treaties to ensure compliance in the withholding of the correct PAYE. Employers bear the responsibility of knowing their employees’ tax residency status and travel calendar to ensure their compliance. 

Understanding the foreign employment exemption 

Up until 1 March 2020, in qualifying for the foreign employment exemption set out in section 10(1)(o)(ii) of the Income Tax Act No. 58 of 1956 (“IT Act”), as amended., the full remuneration earned by an employee for services rendered outside of South Africa would be exempt from tax in South Africa. 

With effect from 1 March 2020 the same requirements needed to be met to qualify for the exemption, but only R1,25m of the foreign remuneration would be exempt from tax. 

To meet the requirements of the exemption an employee had to:  

• Be a tax resident in South Africa, 
• Be in employment (not an independent contractor), 
• Render the services while physically outside of South Africa for more than 183 days in any 12-month period, beginning or ending in a tax year of assessment; and  
• Be outside of South Africa for a continuous period exceeding 60 days during the same 12-month period. 

Employers with employees on assignments outside of South Africa, need to manage their employees’ movements to determine if the exemption does or does not apply as this may affect the PAYE to be withheld from their remuneration. 

Employers play an essential role in verifying the eligibility of their employees for the exemption and ensuring accurate reporting is done on their IRP5 tax certificates and the correct tax is withheld. 

IRP5 certificate requirements for foreign income  

When preparing an annual IRP5 tax certificate for their employees; an employer must make a clear distinction between remuneration being received from services rendered in and out of South Africa, as well as what portion of this income would be regarded as exempt on the IRP5. This classification is crucial because SARS use IRP5 data to populate an employee’s income tax return for that year. When employers correctly classify remuneration source codes on the IRP5, SARS can more readily assess compliance and apply the exemption where it is valid. 

Only a maximum amount of R1,25 m can be reflected as exempt on an IRP5 during a year of assessment in the case of an employee working outside South Africa.  Any amount in excess of this amount needs to be reported as taxable remuneration. 

Separate income source codes need to be used on the IRP5 for the taxable remuneration and the exempt remuneration. 

If the income is not correctly identified on the employees’ IRP5 certificate, SARS may request that amendments be made after the fact by the employer to align with the correct treatment. 

This level of detail in IRP5 reporting helps facilitate SARS assessments, ensuring employers and employees remain compliant with income disclosure requirements under the correct source codes, and the disclosed income has a clear correlation between both party inputs.  

Payroll related issues 

When preparing the payroll for employees working outside of South Africa, the R 1,25m exemption should be applied during a tax year on a cumulative basis to all qualifying remuneration. When the first R1,25m is reached, only then does remuneration in excess of this amount become subject to normal tax. The R1,25m exemption cannot be smoothed or averaged over the year of assessment. 

The obligation to withhold PAYE from an employee’s remuneration rests with the employer. Should the employer therefore not be satisfied that the employee will meet the requirements of the foreign employment exemption, the employer must withhold PAYE on the full remuneration paid to an employee. Should the employee then meet the requirements of the exemption, they will be able to claim a refund of any PAYE on assessment of their personal annual income tax return, provided that the employer has made the correct disclosure on the IRP5 certificate issued to the employee separately identifying the remuneration received from foreign and local services rendered where applicable.  

Where the amount paid to an employee is exempt as a result of the requirements of section 10(1)(o)(ii), this amount paid to the employee no longer constitutes remuneration and will not be subject to unemployment insurance fund contributions and skills development levy. 

Where the monthly remuneration is paid in foreign currency, the remuneration should be converted to ZAR at the spot rate applicable to the monthly payment being made to the employee. 

What employers need to consider when sending employees offshore 

Employers sending employees offshore must consider several key factors to remain compliant: 

1. Tax Residency Status: Employers should monitor the tax residency status of employees working abroad. As the foreign employment exemption only applies to South African tax residents, where an employee becomes a tax resident in the country in which they are rendering services in terms of that country’s domestic tax laws, an analysis needs to be done as to whether the employee has ceased to be tax resident in South Africa as the foreign employment exemption is only applicable to South African tax resident employees. 
2. Duration of Assignment: To not withhold PAYE from an employee, employers should be confident that the employee will qualify for the exemption and be outside of South Africa for at least 183-days, including one continuous period exceeding 60 days, within a 12-month timeframe. The 12-month period does not need to be aligned to a tax year but can begin or end during a particular tax year. It is recommended that employees maintain accurate records of travel dates to support these claims, providing same to their employers, should SARS request such evidence.  
3. Remuneration Structure: Where an employee is to render services both in and out of South Africa, employers may structure remuneration in a way that distinguishes between local and foreign remuneration minimising potential misunderstandings and audit risks. 
4. Documentation Requirements: SARS mandates comprehensive supporting documentation for employees claiming the foreign employment  exemption. Employers are advised to retain copies of employment contracts, travel logs, and proof of tax withholding in the foreign country, should foreign taxes be paid by the employee is.  

Obtaining a tax directive from SARS 

Where the foreign remuneration earned by an employee exceeds the R1,25m exempt amount, the taxable remuneration in excess of the exempt amount may be subject to tax in both South Africa and the country in which the services are being rendered. This will result in payroll tax being withheld on the same remuneration in both countries. An employer may apply for a directive from SARS, in order to reduce the PAYE to be withheld in South Africa. 

The application for the directive submitted to SARS should take the potential foreign tax credit into account, when calculating the monthly PAYE due to SARS. 

In order for the employee to be able to claim the foreign tax credit as a rebate, the employee will be required to submit evidence of the actual foreign tax credit being paid on assessment. 

If an employee does not meet the requirements of the foreign employment exemption, with tax being withheld in the country in which the services are being rendered, a directive can also be applied for to the extent that tax is being paid twice on the same remuneration and to alleviate any hardship. 

For employees who qualify for the exemption but their foreign remuneration exceed the R1.25 million limit, a directive allows the employer to withhold tax on the taxable amount only. 

There are certain circumstances under which SARS will not consider an application for a tax directive: 

• The employee’s remuneration is below the tax threshold. 
• The employee’s total remuneration is fully exempt (less than R1.25 million). 
• The employee is not subject to tax in the foreign country. 

Employers should seek directives in appropriate cases to ensure compliance, minimise underpayment risk, and support employees in submitting accurate tax returns aligned with SARS’ expectations. 

The takeaway 

By understanding the foreign employment exemption criteria and with effective planning, employers can better navigate the complexities of managing employees working outside of South Africa’s borders. With SARS’ expanded compliance expectations, these practices can help employers protect their organisations and employees from unexpected tax liabilities. 

Authors: 

Jessica Brown, Tax Consultant & Sharon MacHutchon, Manager