This article was first published in the first-quarter 2015 edition of Personal Finance magazine.
Being your own boss – and potentially being boss to others – has many advantages, but unless you are a stickler for detail, you might not welcome the increased burden of administration – tax-related and otherwise. This will come just when you are likely to be busy with more urgent activities for your new business, such as marketing, sales, bookkeeping, credit control, operations and management.
So be prepared, and try to tackle the admin in small increments, so that it doesn’t overwhelm you. Consider roping in friends and family with the requisite skills to assist. Alternatively, before you start your business, look around for bookkeepers, accountants and/or tax practitioners to lift some of the load. You should feel comfortable with your advisers and be able to rely on them to respond to your requirements quickly and within your budget. If you leave it to the last minute, you may not find people with the best fit.
Expect to keep additional records to support business expenses – for example, the cost of rent or of maintaining an office at home, and your expenditure on business travel and marketing. Ideally, you should keep a complete set of accounts for your business, even if you operate as a sole trader (that is, operate in your personal capacity).
Provisional tax
If you do not already pay provisional tax, you are likely to have to register as a provisional taxpayer. Provisional tax is the payment in advance of your annual income tax, and late payment can result in a hefty penalty.
Find out early on what your obligations are regarding registration, calculation and payment. Try to forecast your expected cash flows, and take the advance payments of tax into account in your forecasts.
Even if you are already a provisional taxpayer, be aware that a move to non-salaried employment often means uncertainty of cash flows, and your provisional tax computation, particularly the second payment on February 28, is likely to be more complex. Take care not to underestimate your provisional tax, so that you avoid penalties when you can least afford the extra cash outflow.
If you employ staff in your business, you will probably be required to deduct employees’ tax (SITE and PAYE) and other levies, such as for the Unemployment Insurance Fund and skills development, and you will have to provide the South African Revenue Service (SARS) with reconciliations. A decent payroll system should cover most of these requirements, or you can outsource these functions. Non-compliance with your responsibilities as an employer – tax- and non-tax-related – can result in serious penalties.
If you exceed the threshold for VAT (annual turnover in excess of R1 million), you will have to register for VAT. Again, investigate this in advance so that you can register in good time and comply with your statutory obligations from the start.
Do not be surprised if the change in the make-up of your income and expenses raises a flag on SARS’s system. You may be required to submit proof of your expenditure, so keep your records in good order and easily available. I know of an objection that is still outstanding from the 2010 tax year, when a salaried attorney started his own business. SARS taxed the revenue in full, but disallowed all the attendant business expenses. A change of tax office and tax practitioner and the absence of supporting documents have compounded the problem.
Company business
If you decide to operate your business in another legal entity, such as a company, you will have to submit tax returns for the company, as well as your own personal tax returns. So you can expect to double up on submissions, at least.
As has been said in “Small business, big challenge” on page 26, it is important that you do not treat the company as an extension of yourself, and this is particularly so in the tax arena.
If you pay yourself a salary from the company, you are an employee in relation to the company, with the attendant employees’ tax and other payroll deductions. Spending the cash generated by the company amounts to a loan, which may have fringe benefits or dividend withholding tax implications. If you declare a dividend from the company, dividend withholding tax of 15 percent must be applied.
If you use assets you own in your personal capacity in your business, make sure you keep records of what it cost to acquire them. You may be able to claim a wear-and-tear allowance in respect of these assets. If you operate your business as a separate legal entity, you may wish to transfer the assets to the new entity through a loan account. This will help with future cash flows, because the company can repay your loan account without attracting fringe benefits tax or dividend withholding tax. If your business is registered for VAT, you may be able to claim an input VAT deduction in respect of the assets, so if they are valuable, it may be worth obtaining expert advice.
However, before you embark on a scheme of selling your assets on a loan account to your business at vastly inflated prices, be warned: ensure that all transactions between you and your company are at arm’s length, because you will, in all likelihood, be regarded as connected persons. Manipulation of prices above or below what an unrelated third party would pay can give rise to other adverse tax consequences, such as donations tax.
Personal service companies
Another aspect to consider is whether your company qualifies as a small business corporation, as set out in section 12E of the Income Tax Act. If so, you may enjoy beneficial tax rates and accelerated depreciation allowances in respect of plant and machinery used in your business.
There are a number of qualifying criteria, but the most important one is that companies that provide personal services are generally excluded. Personal services are defined as services in the fields of accounting, actuarial science, architecture, auctioneering, auditing, broadcasting, consulting, draftsmanship, education, engineering, financial service broking, health, information technology, journalism, law, management, real estate broking, research, sport, surveying, translation, valuation or veterinary science, if the person performing the service holds an interest in the company.
Another beneficial tax-rate regime exists for micro businesses that earn less than R1 million in annual turnover. Once again, businesses that provide personal services are disqualified.
The reason for excluding personal service providers from the beneficial tax rates was to discourage employees from incorporating and offering their services in incorporated form to their former employer to avoid the deduction of employees’ tax. Your company or trust is a personal service provider if services are rendered to clients of the company or trust personally by you and more than 80 percent of the income of the company or trust comes from one client, or if you are required to perform the services at the client’s premises under the client’s supervision. However, there is an out if the company or trust employs at least three full-time employees who are unconnected to the company, trust and/or owners of the entity.
The consequence of categorisation as a personal service provider is that clients are required to deduct employees’ tax from the amounts they owe your company or trust, which will have an adverse impact on the cash flow of your business. In addition, the expenses allowed as a deduction in the company or trust are limited – for example, wear and tear is not allowed, which could be significant, depending on the type of business you operate.
* Kari Lagler is an independent tax consultant and registered tax practitioner.