ARTICLE 18

Pensions and Annuities

This Article deals with the taxation of private (i.e., non-government service) pensions and annuities, social security benefits, alimony and child support payments, as well as with the tax treatment of contributions to, and earnings by, pension plans.

Paragraph 1 - Distributions

Under paragraph 1, pension distributions (and other similar remuneration) in consideration of past employment from sources within one Contracting State and beneficially owned by a resident of the other Contracting State may be taxed by the source State to a limited extent. The State of residence of the beneficiary may also tax the distribution to the extent allowed by the laws of that State. The Treaty, like the 1996 U.S. Model, makes explicit the fact that the term "pension distributions and other similar remuneration" includes both periodic and single sum payments.

Where the U.S. is the source State, the tax on the distribution is limited to 15 percent of the gross amount of the distribution, as long as the distribution is not subject to the penalty for early withdrawal under section 72(t) of the Code. If the distribution is subject to the early withdrawal penalty, the reduced treaty tax rate does not apply and the normal Code tax rates apply.

Where South Africa is the source State, a pro rata amount of a pension distribution corresponding to the amount of the gross pension distribution from South African sources will be

taxed to a beneficiary who is a U.S. resident. The portion of a pension distribution from an employer's pension plan for which South Africa is the source State is equal to the total pension distribution multiplied by a fraction, the numerator of which is the employee's days of service for the employer in South Africa and the denominator of which is the employee's total days of service for the employer. This rule applies only if the beneficial owner

(i) has been employed in South Africa for a period or periods aggregating two years or more during the ten year period immediately preceding the date on which the pension first became due; and

(ii) was employed in South Africa for a period or periods aggregating ten years or more.

For example, assume that the pension was first due to a U.S. resident from a South African pension plan on July 1, 1997. From July 1, 1987 through June 30, 1992, the beneficiary was employed in the United States, and from July 1, 1992 through June 30, 1997, was employed in South Africa, retiring to the U.S. on July 1, 1997. Although the beneficiary satisfies the two out of the last ten years test, the aggregated ten years of work in South Africa test is not satisfied. In this example only the United States may tax the distributions. If, instead, the beneficiary had worked in the United States from July 1, 1977 through June 30, 1987, and in South Africa from July 1, 1987 through June 30, 1997, retiring in the United States on July 1, 1997, both portions of the test are satisfied. Thus, South Africa may tax half of each distribution to the beneficiary, because the beneficiary has worked in South Africa for ten out of his twenty years of service for the employer. In this example, the United States may also tax the entire distribution under the rules of the Internal Revenue Code. The beneficiary may claim a foreign tax credit for any tax paid to South Africa on the distribution.

For purposes of this rule, the phrase "the date on which the pension first became due" refers to the first date on which the participant or beneficiary received a pension payment or, if earlier, the first date on which the participant or beneficiary could have received a pension payment if the participant or beneficiary had requested to have payment made at that earlier time.

The following examples illustrate the meaning of the phrase "the date on which the pension first became due."

Example (1) Individual A works for company B from 1987 to 1997. The company B pension

plan provides that plan participants who work for the company for at least five years may elect to receive benefits on or after the first day of the month following the month they retire, provided they have reached age 60. In 1997, A attains age 60. He continues to work, however, until December 31, 1998, at which time he retires. The date on which A’s pension first becomes due is January 1, 1999.

Example (2) The facts are the same as in Example (1), except that A makes an election under the company B plan to begin receiving benefits on January 1, 2000. As in Example (1), the date on which the pension first becomes due is January 1, 1999, and is not affected by A ’ s voluntary election.

The phrase ? pension distributions and other similar remuneration ? is intended to

encompass payments made by private retirement plans and arrangements in consideration of past employment, as well as tier 2 railroad retirement benefits (See 45 U.S.C. 231 et seq.). In the United States, the plans encompassed by Paragraph 1 include, under current law: qualified plans under section 401(a), individual retirement plans (including individual retirement plans that are part of a simplified employee pension plan that satisfies section 408(k), section 408(p) accounts, and other individual retirement accounts), non-discriminatory section 457 plans, section 403(a) qualified annuity plans, and section 403(b) plans. In South Africa, qualifying plans are occupational plans which include pension funds and provident funds.

The competent authorities may agree that distributions from plans not listed above, but meeting similar criteria, may also qualify for the benefits of Paragraph 1. These criteria are as follows:

(a) The plan must be written; (b) In the case of an employer-maintained plan, the plan must be nondiscriminatory, i.e., it (alone or in combination with other comparable plans) must cover a wide range of employees, including rank and file employees, and actually provide significant benefits for the entire range of covered employees;

(c) In the case of an employer-maintained plan the plan must contain provisions that severely limit the employees ? ability to use plan assets for purposes other than retirement, and in all cases be subject to tax provisions that discourage participants from using the assets for purposes other than retirement; and

(d) The plan must provide for payment of a reasonable level of benefits at death, a stated age, or an event related to work status, and otherwise require minimum distributions under rules designed to ensure that any death benefits provided to the participants ? survivors are merely incidental to the retirement benefits provided to the participants.

Pensions in respect of government service are not covered by this paragraph. They are covered either by paragraph 2 of this Article, if they are in the form of social security benefits, or by paragraph 2 of Article 19 (Government Service). Thus, Article 19 covers section 457, 401(a) and 403(b) plans established for government employees. If a pension in respect of government service is not covered by Article 19 solely because the service is rendered in connection with any trade or business carried on by either state, the pension is covered by this Article.

Paragraph 2 - Social Security

The treatment of social security benefits is dealt with in paragraph 2. This paragraph provides that, notwithstanding the provisions of paragraph 1, payments made by one of the Contracting States under the provisions of its social security or similar legislation to a resident of the other Contracting State or to a citizen of the United States will be taxable only by the Contracting State making the payment. This paragraph applies to social security beneficiaries whether they have contributed to the system as private sector or government employees.

The phrase "other similar public pensions" is intended to refer to United States tier 1 railroad retirement benefits. The reference to U.S. citizens is necessary to insure that a social security payment by South Africa to a U.S. citizen who is not resident in the United States will

not be taxable by the United States.

Paragraph 3 - Annuities

Under paragraph 3, annuities that are derived and beneficially owned by a resident of a Contracting State are taxable only in that State unless the annuity was purchased in the other Contracting State while such person was a resident of that other State, in which case the annuity may also be taxed in that other State. An annuity, as the term is used in this paragraph, means a stated sum paid periodically at stated times during life or during a specified number of years, under an obligation to make the payments in return for adequate and full consideration (other than for services rendered). An annuity received in consideration for services rendered would be treated as deferred compensation and generally taxable in accordance with Article 14 (Independent Personal Services) or Article 15 (Dependent Personal Services).

Paragraphs 4 and 5 - Alimony and Child Support

Paragraphs 4 and 5 deal with alimony and child support payments. Both alimony, under paragraph 4, and child support payments, under paragraph 5, are defined as periodic payments made pursuant to a written separation agreement or a decree of divorce, separate maintenance, or compulsory support. Paragraph 4 provides that an alimony payment made to a payee who is a resident of one State by a resident of the other State is taxable only by the State of residence of the payor and only if the payor may deduct the payment in the State of residence. If the payment is not deductible by the payor in the State of residence, no tax is levied in either State.

Paragraph 5 provides that support payments on behalf of a minor child made by a resident of one State to a resident of the other State are not covered by paragraph 4. If such payments are not deductible to the payor, they are exempt from tax in both States. In the event that the payor is allowed a deduction for a child support payment in his State of residence, the payment would be taxable to the payee by that State under Article 21 (Other Income).

Paragraph 6 - Contributions, Earnings and Rollovers

Paragraph 6 provides a limited deferral of income where an individual works in one State (work State) and participates in a pension plan in the other State (plan State). Paragraph 6 is intended to prevent certain differences between U.S. and South African law regarding the treatment of pension contributions, earnings, and transfers from one plan to another from inhibiting the flow of personal services between the two States.

Paragraph 6 provides three types of benefits in the work State with respect to pension plans located in the plan State, to the extent such benefits are allowed by the work State with respect to its own tax favored pension plans:

(1) deductions (or exclusions) at the plan participant and employer level for contributions to a pension plan (subparagraph (a));

(2) deferral of tax on undistributed earnings realized by the plan (subparagraph (b)); and (3) deferral of tax on rollovers from the plan State plan to a work State plan (subparagraph (c)).

Subparagraph 6(a) allows the individual a deduction (or exclusion) in computing his taxable income in the work State for contributions made by or on behalf of the individual to a plan in the plan State. Subparagraph 6(a) also provides that any benefits accrued under the plan or payments made to the plan by or on behalf of the individual's plan State employer during that period will not be treated as part of the individual's work State taxable income and will be allowed as a deduction in computing the profits of the employer in the work State.

Where the United States is the work State, the exclusion of the individual's contributions from the individual’s income under this paragraph is limited to elective contributions not in excess of the amount specified in section 402(g). Deduction of employer contributions is subject to the limitations of sections 415 and 404. The section 404 limitation on deductions would be calculated as if the individual were the only individual covered by the plan.

Subparagraph 6(b) provides that income earned by the plan will not be taxable in the work State until and to the extent that the earnings are distributed. At such time, the provisions of paragraph 1 would apply to the distributions.

Subparagraph 6(c) permits the individual to withdraw funds from the plan in the plan State for the purpose of rolling over the amounts to a plan established in the work State without being subjected to tax currently in the work State with respect to such amounts. This benefit is subject to any restrictions on rollovers under the laws of the work State. For instance, in the United States a rollover ordinarily must be made within 60 days of the withdrawal from the first plan under section 408(d)(3)(A)(i) and section 402(c). For purposes of maintaining the taxexempt status of a U.S. pension arrangement receiving rolled-over amounts, the assets received will be treated as assets rolled over from a qualified plan.

The benefits of this paragraph are allowed to an individual who is present in the work State to perform either dependent or independent personal services. Subparagraph 6(d) provides that the individual can receive the benefits of this paragraph only if he was contributing to the plan in the plan State, or to a plan that was replaced by the plan to which he is contributing, before coming to the work State. The allowance of a successor plan would apply if, for example, the employer has been taken over by another corporation that replaces the existing plan with its own plan, rolling membership in the old plan over into the new plan.

In addition, the work State competent authority must determine that the recognized plan to which a contribution is made in the plan State generally corresponds to a pension plan recognized for tax purposes in the work State. It is understood that United States plans eligible for the benefits of paragraph 6 include qualified plans under section 401(a), individual retirement plans (including individual retirement plans that are part of a simplified employee pension plan that satisfies section 408(k), section 408(p) accounts, and other individual retirement accounts), section 403(a) qualified annuity plans, and section 403(b) plans. This list is narrower than the similar list provided under paragraph 1. This is because in the U.S. most non-qualified plans are not eligible for deductions of contributions by the employer and/or the participant.

Finally, the benefits under this paragraph are limited to the benefits that the work State accords to the work State plan most similar to that in the plan State, even if the plan State would

have afforded greater benefits under its law. Thus, for example, if the work State has a cap on contributions equal to, say, five percent of the remuneration, and the plan State has a seven percent cap, the deduction is limited to five percent, even though the individual would have been allowed the larger deduction had he remained in the plan State.

Paragraph 7 - Source

For purposes of the Treaty, the source of pension distributions, including distributions attributable to both contributions and earnings, is determined with reference to the place at which the services creditable under the pension arrangement are performed. For example, if a U.S. citizen works only in South Africa for a U.S. corporation with a U.S. pension plan, the distributions received by the U.S. citizen upon retirement will be completely foreign source, including the portion of the distributions attributable to earnings within the U.S. pension plan.

Relationship to Other Articles

Pensions in respect of government service are generally covered by paragraph 2 of Article 19 (Government Service), and not by this Article. Exceptions to this rule are pensions in respect of government service in the form of social security benefits, which are covered by paragraph 2 of this Article. Thus, Article 19 covers section 457, 401(a) and 403(b) plans established for government employees. However, if a pension in respect of government service is not covered by Article 19 solely because the service is rendered in connection with any trade or business carried on by either State, the pension is covered by this Article.

Paragraphs 1 and 3 of Article 18 are subject to the saving clause of paragraph 4 of Article 1 (General Scope). Thus, for example, a U.S. citizen who is a resident of South Africa, and receives a pension distribution from the United States, may be subject to full U.S. tax at graduated rates on the distribution, notwithstanding the rule in paragraph 1 that limits U.S. taxation of the distribution to 15 percent of the gross amount. Similarly, a U.S. citizen who is a resident of South Africa may be subject to U.S. tax on U.S. source annuities notwithstanding the fact that the annuity was purchased while the U.S. citizen was a resident of South Africa. Paragraphs 2, 4, 5, 6 and 7 are excepted from the saving clause by virtue of paragraph 5(a) of Article 1. Thus, the United States will allow U.S. citizens and residents the benefits of paragraphs 2, 4, 5, 6 and 7.