SA residents face taxation on previously untaxed foreign pension benefits

South Africans who worked abroad, contributed to a foreign pension fund, and then came home to retire have a dark cloud moving over their retirement days.

National Treasury is proposing an amendment to the Income Tax Act that will see their previously untaxed foreign pension fund benefits being taxed in South Africa from next year.

The current tax exemption in the Act on these benefits will be deleted to ensure that the benefits received by South African residents are “appropriately taxed in accordance with the residence basis of taxation”, Treasury proposes in the recently published draft Taxation Laws Amendment Bill (TLAB).

It says this will uphold South Africa’s treaty rights to tax. In last year’s Budget, Treasury emphasised “the need to enhance the rules” that exempt lump sums, pensions, and annuities from foreign pension funds “so that these amounts are taxed fairly and consistently”.

Changing the rules

The proposed changes apply only to taxpayers who are considered tax resident in South Africa, says Jenny Klein, principal associate at ENSafrica. There is also no change to the tax exemption on payments from a foreign social security system (foreign state pensions) to a South African tax resident, she adds.

South Africans who worked abroad planned their retirement in anticipation that their private foreign pension will not be taxed in South Africa. “But unfortunately, Treasury has changed the rules, and now the foreign pensions will also be taxed in South Africa,” says Joon Chong, tax partner at Webber Wentzel.

If the proposal is passed into law, foreign pensions and annuities will become taxable but contributions to them were not deductible in the first place, unlike contributions to South African retirement funds, which are deductible.

South African tax residents who contributed to a foreign pension fund while working abroad made the contributions with income that was either taxed in the foreign country or taxed in South Africa without the benefit of a deduction, because foreign funds are generally not “approved funds” for South African tax purposes.

“This creates a situation of effective double taxation over the lifecycle of the investment in the foreign pension fund. The capital base of the pension (the contributions) was built from after-tax funds, and now the income stream derived from that same capital base (the annuity/pension payout) will be taxed again in South Africa,” explains Chong.

“This places individuals with international work experience and savings at a distinct and arguably unfair disadvantage compared to those who have saved exclusively within the South African system,” she adds.

The issues

Treasury identified two issues of concern relating to the blanket exemption on the taxation of foreign retirement fund benefits. First, the exemption may result in double non-taxation, particularly where the foreign jurisdiction does not tax the retirement income because of domestic law or tax treaty limitations.

In these cases, neither South Africa nor the foreign jurisdiction imposes tax on the retirement benefit. “This undermines South Africa’s residence-based system of taxation and leads to revenue forgone to the fiscus,” Treasury says in its Explanatory Memorandum to the TLAB.

The second issue pertains to double tax agreements (DTAs) where the agreement grants South Africa the exclusive right to tax the benefits based on residence. However, South Africa forfeits this right by maintaining the exemption. As a result, the foreign jurisdiction, despite lacking primary taxing rights under the treaty, may choose to tax the retirement benefits because South Africa does not tax them.

“This misalignment allows the foreign jurisdiction to benefit from taxing rights that South Africa does not exercise. The South African fiscus ultimately forgoes revenue that it is entitled to collect,” Treasury points out.

Double taxation

However, the removal of the exemption may now lead to double taxation. In addition, says Klein, if a pensioner has other taxable income in South Africa, the fact that the foreign pension becomes taxable in South Africa may result in the pensioner moving into a higher marginal tax bracket.

Chong says retirees will face more complex annual tax returns because they will have to navigate provisional taxes and claim tax credits in the case of double taxation.

“I can see why Treasury is changing the law, but someone who has planned for retirement, now suddenly finds that their net amount after tax will be significantly lower,” says Chong.

A fairer outcome, she says, would have been a grandfather clause that allows people who receive untaxed foreign retirement benefits from past employment before the promulgation of the new rules to continue receiving them.

However, the rule will be unavoidable for South Africans who are tax resident after 1 March 2026 and who receive foreign pension benefits.

A critical question when deciding where to retire is how far one’s pension will stretch. “It is not an attractive prospect when you have made that decision and suddenly the rules change, and a large chunk of your retirement provision goes to tax,” says Chong.

“It is a discouraging factor for South Africans who wanted to come home and retire here after working abroad,” she adds.

Amanda Visser is a freelance journalist who specialises in tax and has written about trade law, competition law, and regulatory issues.

Disclaimer: The views expressed in this article are those of the writer and are not necessarily shared by Moonstone Information Refinery or its sister companies. The information in this article is a general guide and should not be used as a substitute for professional tax advice.