Are you a citizen of the United States of America? If so, you have US tax obligations… even if you’ve never set foot in the country.
Part of my preparations for relocating to the UK in 2017 was to ensure that my South African tax affairs are in order. Apart from the obvious legal requirements of the Income Tax Act and other tax legislation, tax clearance is also required if one is to apply for the repatriation of one’s financial assets to one’s new country of residence. This is known as a ‘financial emigration’, and is a formal process involving the South African Reserve Bank, which includes an application by one’s bank in terms of the Exchange Control regulations.
It is different to ‘tax residency’, which is how many countries around the world determine who is liable for tax to that particular country.
Residence-based taxation systems normally seek to subject a resident’s worldwide income, profits, capital gains, etc. to tax in the country in which the person is considered to be tax resident. The principle applied is that if someone lives in a particular country for an extended period of time, they are considered to be enjoying the benefits of doing so—and it is thus regarded as appropriate that such person contributes to that country’s coffers in the form of taxation.
While no-one particularly enjoys paying tax, the principle of tax residency can (for the most part) be considered to be a fair and reasonable one.
Uncle Sam has to be different
Below, under the subheading, How tax residency is normally determined, is an example of how tax residency is determined in South Africa and the UK. Note that there is no reference to nationality or citizenship in this example—the reason is that one’s nationality or citizenship is usually irrelevant when it comes to tax.
While one does need to meet a particular country’s criteria when it comes to the right to be resident in the ordinary sense in such country (which can be by means of citizenship or any other criteria that such country may determine), tax residency assumes that such criteria have been met and thus determines residency based on the premise that one is legally permitted to be resident in a country in the ordinary sense.
For example, a British citizen would not automatically have a right to become a resident of South Africa in the ordinary sense, but once such right has been granted (e.g. by the issuance of the appropriate visa or permanent residence permit by the Department of Home Affairs), such person will become a tax resident of South Africa once they have met the relevant residency provisions contained in the Income Tax Act.
It’s different with citizens of the United States of America.
A cursory glance at the provisions of the Double Tax Agreement (DTA) between the United States and South Africa indicates similar provisions to what one finds in most DTAs between two contracting states that have residence-based taxation systems, i.e. it determines which income stream is taxed in which state, provides relief in cases where one state has taxed income that a resident of the other state may have a tax liability to such other state, indicates how income derived from the state in which the taxpayer is not ordinarily resident, and contains provisions for settling disputes, amongst others.
The United States does base their taxation system largely on residency, following the same principle that someone living in a particular country (in this case, the US) is considered to be enjoying the benefits of doing so and should therefore contribute to the US’s tax coffers. However, where the US differs from (say) South Africa or the UK is that for those who have the right to be domiciled in the US, the obligation for complying with US tax requirements is not extinguished when such person ceases to be a resident of the US in the ordinary sense.
There is also a significant difference in how the United States determines ‘tax residency’ compared to (say) South Africa or the United Kingdom. This is evident in Article 4, paragraph 1(a)(i) of the US / SA DTA, which reads as follows: “For the purposes of this Convention the term ‘resident of a Contracting State’ means: a) in the case of the United States, i) any person who, under the laws of the United States, is liable to tax therein by reason of his (sic) domicile, residence, citizenship [author’s emphasis], place of incorporation, or any other criterion of a similar nature, …”.
One can thus see that anyone who is a US citizen would be considered a US tax resident—even if such person has never set foot on US soil in their entire lives! However, this presumption of US tax residency extends beyond US citizenship to non-US citizens who may have acquired the right to be ordinarily resident in the US.
Andrew Grossman, a retired US Foreign Service Officer now resident in Switzerland who has written numerous articles on private international tax law, wrote in his 2008 article entitled FATCA: Citizenship-Based Taxation, Foreign Asset Reporting Requirements and American Citizens Abroad that “US nationality is only one of the criteria by which an individual may become subject to US taxation. Deemed residence (‘Green card’ status), physical presence, and certain cases of former nationality at least since 2008 give rise to indefinite tax obligations in the absence of particular administrative demarches having been effected: and this is true whether the individual has any right to enter or work in the United States, and can be true even if he or she has been deported.”
This practice of including citizenship as a determinant of tax residency is specific only to the United States and to Eritrea—no other country in the world imposes such an onerous definition.
Reporting requirements by US tax residents
What this essentially means is that not only US citizens who are currently not (or, in fact, may never have been) resident in the US, but also those who may have at some point held a US work permit (‘Green Card’) would be subject to US tax legislation and would need to make regular filings to the United States Internal Revenue Service (IRS).
According to the website of London-based chartered accountants Warrener Stewart, US tax residents worldwide have the following reporting requirements to the IRS (adapted by the author in accordance with the United States / South Africa DTA):
- Foreign Earned Income Exclusion: US taxpayers living outside of the US are entitled to exclude up to $102,100 (2017 rate) of earned income from tax in the US. This is subject to meeting certain criteria and is only available on general earnings, such as employment income or profits from self-employment. Note that this does not include dividends—even if they are received from a company in relation to services performed.
- Foreign Tax Credit: Income from South Africa may have been subject to South African taxation, whether deducted at source or paid over to SARS by means of a provisional tax payment or upon final assessment. In this situation, it is possible to claim a deduction from your US tax liability for the amount of tax already paid on the income in South Africa. This also applies for other countries, depending on the double taxation treaty in place.
- Pensions: The US / SA tax treaty allows for individuals to make a claim for pension income to be taxed solely in one jurisdiction, either the US or South Africa, depending on the individual situation. This avoids being taxed twice on your retirement income.
In addition, it is a legal requirement for all US tax residents to file a ‘Report of Foreign Bank and Financial Accounts’ (FBAR) by 15 April each year. This must be filed online to the IRS. FBAR covers all foreign accounts held by US tax residents (including bank accounts, insurances, pensions, trusts—whether the US tax resident is the main beneficiary or a signatory for the account) where the total balance held in the accounts is in excess of $10 000 in aggregate at any given time during the US tax year.
The penalty for failing to correctly file a FBAR report is $10,000 per account.
Severing ties with the United States
In theory, the provisions of the DTA between the United States and South Africa are not much different to those found in (say) the UK / SA DTA. As already mentioned, most of the clauses in the US / SA agreement are fairly standard to most DTAs between countries where residence-based taxation systems are in place.
However, according to Grossman, “The US Congress has as a matter of practice overridden tax treaty provisions and doubtless will continue to do so”, and cites firstly the example of the US tax liability that arises from the Alternative Minimum Tax and the Net Investment Income 3.8% surtax (to fund ‘Obamacare’) levied on unearned income of individuals with adjusted gross income exceeding $200,000 ($250,000 in the case of married couples filing jointly), as determined in Haver v. Commissioner, 444 F.3d 656 (DC Circuit Court, 2006) (AMT).
Grossman goes on to state that “FATCA [the Foreign Account Tax Compliance Act] is no less [than] a tax treaty override.” FATCA provides for a mechanism of information-sharing on accounts held by US tax residents by financial institutions worldwide. Many countries, including South Africa, have signed on to the International General Agreement (IGA) to provide such information.
According to the SARS website, “Financial Institutions in South Africa meeting the prescribed due diligence requirements to find reportable accounts and report the prescribed information (referred to in the FATCA IGA as Foreign Financial Institutions or FFIs), include South African banks and custodians, brokers, asset managers, private equity funds, certain investment vehicles, long-term insurers, and other participants in the financial system” are required to provide information to the IRS relating to accounts held by a ‘US Person’ (which includes a US citizen or ‘resident individual’, e.g. a ‘Green Card’ holder).
Many such institutions, having determined that complying with such reporting requirements are considered too onerous, have simply taken the decision not to provide financial services to persons who are US citizens or US tax residents. One notable example is when opening a Vanguard UK investment account (Vanguard UK being the largest UK provider of exchange-traded funds), the applicant must declare that “By clicking the ‘Proceed’ button below, you are confirming that … You are a UK resident. You are not a US tax resident or US citizen”.
An option to be considered, albeit a drastic one, is to renounce one’s US citizenship. However, this comes with significant exit and tax charges, and would also depend on whether one has citizenship of another country in order to do this (since international human rights conventions determine that a person cannot be left ‘stateless’).
Appropriate professional advice is critical
The requirement to comply with reporting requirements in more than one country is complicated enough to warrant seeking appropriate professional advice.
However, the United States’ extended definition of what it means to be a ‘tax resident’, the particular reporting requirements of the IRS, the ongoing obligations even once a taxpayer has ceased to be ordinarily resident in the US, and the onerous provisions relating to the renunciation of US citizenship (not to mention the potential implications thereof), means that not seeking professional assistance could be financially suicidal for those with US connections—no matter how tenuous these may be.
How tax residency is normally determined
Each has its own rules to determine tax residency. South Africa, for instance, applies two tests to determine whether one is a ‘resident’ for tax purposes.
The first is the ‘ordinarily resident’ test, which covers situations where (for example) someone is seconded overseas on (say) a three-year contract, but still maintains their residence in South Africa and intends to return to such residence once they’ve completed their secondment.
The second is the ‘physical presence’ and is applicable when the requirements of the ‘ordinarily resident’ test are not met. If a person is not physically present in South Africa for a period or periods exceeding
- 91 days in aggregate during the tax year under consideration;
- 91 days in aggregate during each of the five tax years preceding the tax year under consideration; and
- 915 days in aggregate during the above five preceding tax years,
they will be automatically considered not to be tax resident in South Africa once these time periods have been exceeded.
The United Kingdom’s method of determining residency is even simpler—once you have lived in the country for longer than 12 months, you are automatically considered to be a tax resident in the UK and become liable to be taxed under the UK’s tax laws.
This can lead to a situation whereby the different residency periods can mean that a person relocating from South Africa can be considered to be simultaneously a tax resident of both South Africa and the United Kingdom. Both HM Revenue & Customs and the South African Revenue Service can thus lay claim to taxation rights on the same income.
Situations such as these are normally resolved with reference to a Double Tax Treaty / Agreement (DTA) concluded between countries where such a situation is likely to arise. A DTA will provide a mechanism for determining tax residency, as well as containing provisions covering which income streams are liable to tax in which country.
WRITTEN BY STEVEN JONES
Steven Jones is a registered SARS tax practitioner.
While every reasonable effort is taken to ensure the accuracy and soundness of the contents of this publication, neither writers of articles nor the publisher will bear any responsibility for the consequences of any actions based on information or recommendations contained herein. Our material is for informational purposes.