As Benjamin Franklin was so rightly quoted saying, “‘In this world nothing can be said to be certain, except death and taxes.” Tax is something that everyone has to pay and is levied on income and profit received by a taxpayer. Taxes are the government’s main source of income and to that end, individuals and companies that do not comply with tax regulations are severely dealt with.
Business entities and tax
Once you have decided to start a business, you must also decide what type of business entity to use. There are legal, tax and other considerations that can influence this decision. There are several different types of business entities in South Africa – sole proprietorship, partnership, close corporation and a private company. Each of these has different tax responsibilities.
A sole proprietorship is a business owned and operated by an individual and is the simplest form of business entity. The business has no existence separate from the owner who is the proprietor.
The owner must include the income from the business in their own income tax return and is responsible for paying taxes, which are levied at progressive rates ranging from 18% to 40%.
Advantages to this type of business are that it is simple to establish and operate; the owner is free to make decisions with minimal legal requirements. The owner receives all the profits and it is also easy to discontinue the business should this be necessary.
Disadvantages to this type of business are that there is unlimited liability of the owner who becomes legally liable for all the debts of the business. There is a limited ability to raise capital as it is directly linked to whatever the owner can personally secure. This in turn limits the expansion of a business when new capital is required.
A partnership is the relationship between two or more people who join together to form a business. It is also not a separate legal person or taxpayer. Each partner shares equal responsibility for the partnership’s profits and losses and its debts and liabilities.
The partnership itself does not pay income taxes, but each partner has to report their share (as agreed at the onset and noted in their partnership agreement) of business profits and losses on their individual tax return. Partners are taxed on their share of the partnership profits.
Each partner is subject to income tax levied at progressive rates ranging from 18% to 40%. It is similar to a sole proprietorship except that a group of owners replaces the sole proprietor. The number of persons who may form a partnership agreement is limited to 20.
Advantages to this kind of business are that they are easy to establish and operate and offer greater financial strength in terms of safety in numbers. It also combines the different skills of the partners who each have a personal interest in the business.
Disadvantages are that there is unlimited liability of the partners. Each partner may be held liable for all the debts of the business. Therefore, one partner who is not exercising sound judgment could cause the loss of the assets of the partnership as well as the personal assets of all the partners. Authority for decision-making is shared and differences of opinion could slow the process down.
Close corporations (CC)
A CC is a company, similar to a private company. It is a legal entity with its own legal personality and succession and must register as a taxpayer in its own right. A CC has no share capital and no shareholders. The owners are the members of the CC and their initial interest in Rands (which often reflect their ownership percentages) are called membership contributions. For income tax purposes a CC is regarded to be a company.
It is important to note that following the new Companies Act that came into force on 1 April 2011, no new CCs can be incorporated. All existing, registered CCs will continue to exist. Current CCs can choose to either convert to a company or continue to exist until deregistration or dissolution.
No automatic conversion or dissolution is provided for. CCs that continue to exist will have to compile financial statements, as is currently the case, but will not be subject to audit on the same terms and conditions as companies.
CCs are taxed at a rate of 28% on taxable income for the tax year, unless they qualify as a Small Business Corporation (SBC), in which case they are taxed at a different, lower scale.
A private company is treated as a separate legal entity and must also register as a taxpayer in its own right. The owners of a private company are the shareholders and the company name ends with the suffix “(Pty) Ltd”.
The new Companies Act only requires public companies, State-owned companies and certain others to audit their yearly financial statements. The Act also no longer limits the number of shareholders in a private company, which means that more companies will opt to take on the status of a private company and, therefore, will not be subject to auditing.
Private and Public Pty Ltd.’s are taxed at a rate of 28% on taxable income for the tax year, unless they qualify as a Small Business Corporation (SBC), in which case they are taxed at a different, lower scale.
The advantages of a Private Company are that the life of the business is perpetual and continues uninterrupted as shareholders change. The transfer of ownership is easy and this type of business is adaptable to small medium and large business.
Disadvantages to this type of business are that it is subject to many legal requirements. Every shareholder and director who is involved in the management of the company’s overall financial affairs is personally liable for tax payable and for any debts of the private company if it is found that they have acted negligently. Also, Directors who choose to opt out of having the company’s financial statements audited, place the company at risk of being refused funding in the future, should financial institutions require audited financial statements to be submitted before granting a loan. A Private Company is more difficult and expensive to establish and operate than other forms of ownership such as a sole proprietorship or partnership.
- a) Compulsory registration
Any person who owns or manages a small business and whose total value of taxable supplies (taxable turnover) exceeds, or is likely to exceed, the compulsory VAT registration threshold, must register for VAT. The threshold is currently R1 million in any consecutive 12-month period.
1. b) Voluntary registration
A person can register as a vendor if that person runs a business in which the total value of taxable supplies (taxable turnover) exceeds R50 000 (but does not exceed R1 million) in the preceding 12-month period.
- c) Refusal of registration
You will not qualify to register as a vendor if you do not fall within these categories. In all other instances, no VAT registration will be allowed if the annual turnover is below the minimum voluntary registration threshold.
How to register
Application for registration as a vendor must be made within 21 days of becoming liable to register.
This is a simplified tax system for micro businesses and serves as an alternative to the current income tax, provisional tax, capital gains tax and secondary tax on companies and VAT systems.
A person qualifies as a micro business if that person is a natural person or company where the qualifying turnover of that person for the year exceeds R150 000 but is less than R1 million. From 1 March 2012, qualifying micro businesses are allowed to be registered for VAT and turnover tax.
As soon as you commence business, you will become a provisional taxpayer and will be required to register with your local SARS office as a provisional taxpayer within 30 days after the date upon which you become a provisional taxpayer. Companies are automatically regarded, and often automatically registered as provisional taxpayers.
The payment of provisional tax is intended to assist taxpayers in meeting their normal tax liabilities. This occurs by the payment of two installments in respect of estimated taxable income that will be received or accrued during the relevant tax year and an optional third payment after the end of the tax year, thus obviating, as far as possible, the need to make provision for a single substantial normal tax payment on assessment after the end of the tax year.
The first provisional tax payment must be made within six months after the commencement of the tax year and the second payment not later than the last day of the tax year.
The optional third payment is voluntary and may be made within six months after the end of the tax year if your accounts close on a date other than the last day of February. For a tax year ending on the last day of February, the optional third payment must be made within seven months after the end of the tax year.
You must keep records that will enable you to prepare complete and accurate tax returns if you are involved in a business.
You may choose a system of record-keeping that is suited to the purpose and nature of your business. These records must clearly reflect your income and expenditure.
This means that, in addition to your permanent books of account or records, you must maintain all other information that may be required to support the entries in your records and tax returns.
It is advisable to open a separate bank account for your business so that you do not mix your private and business expenses, and is one of the minimum requirements if you trade as a company, or as a close corporation, especially if your company needs to be audited.
The records should include:
- Records showing the assets, liabilities, undrawn profits, revaluation of fixed assets and various loans
- A register of fixed assets
- Detailed daily records of cash receipts and payments reflecting the nature of the transactions and the names of the parties to the transactions (except for cash sales)
- Detailed records of credit purchases (goods and services) and sales reflecting the nature of the transactions and the names of the parties to the transactions
- Statements of annual stocktaking
- Supporting vouchers (which in QuickBooks 2014 can be attached using the document centre)
Please note that different documents have varying periods for which they have to be retained, ranging from 5 years, to 15 years, to indefinitely.
This is a basic outline of the different types of companies that can be registered in South Africa and the tax implications that come with each of them. So when you are starting a new business, make sure that you choose the right company type so that you can keep tax to a minimum.