I was recently asked an interesting question by someone who, due to circumstances beyond her control, found herself without her employment just after the start of the Covid 19 pandemic and, like many other brave people, she formed a company to start a new business. The business is finally starting to reap the benefits of her dedication and hard work over the last (almost) two years and she asked me if, without having invested any time, energy or risk capital, the South African Revenue Service (“SARS”) will now be entitled to take 28% of the company’s profits as its ‘share’ of the business.
Put that way, the concept of SARS jumping in and grabbing 28% of the hard-earned cash anyone has generated in a new business, without it having had to go through any of the hard work and stress it takes to get a new business up and running and also without having put in any seed capital, seems rather obscene. However, perhaps we are judging the position a little too harshly.
Since the company in question now has an annual turnover of over R1mn (and is correctly registered for VAT) and it, thus, doesn’t qualify the Turnover Tax regime, this article won’t discuss that regime.
Firstly, it has to be remembered that, provided a company is trading with a view to and is, preferably, earning some income, tax legislation allows it to deduct qualifying expenses incurred to generate that income. If these exceed the income then the losses may be carried forward to be used against the taxable income of future trading years – thus SARS doesn’t “plunder” the business until there are ongoing profits to take a share of. (It should be noted that, aligned with a reduction in tax rate to 27%, the claim of the assessed loss against the full income is to be limited at some, currently unknown, point in the future…but we’ll cross that bridge when we get there).
Secondly, once it has started making some profits, a company is able to pay its founder a salary for their hard work. Assuming the company has to pay tax at a rate of 28% i.e. it doesn’t qualify for the small business corporation (“SBC”) regime (see below), it may be wise for the company to pay its founder – you – a salary which, provided it is not excessive for the work you are performing, is tax deductible for the company but, potentially, taxed at a rate lower than 28% in your hands:
Individuals are taxed on a sliding scale and, assuming there is no other income, an average effective tax rate of 28% is only reached at a salary of just over R800 000 – below this the effective rate is less. (This is based on the 2022 tax year tables and rebate and assumes you have no other income and do not claim deductions for, for example, retirement contributions, donations to qualifying public benefit organisations or medical costs or the medical rebate).
Thus, assuming you have no other income, you can manage the tax rate to an extent.
But before doing that you also need to consider whether the SBC tax provisions (section 12E of the tax legislation) apply. This regime is far more favourable than for non- qualifying companies. First of all, an SBC will, like an individual, be taxed on a sliding tax scale: 0% up to taxable income of R87 300; 7% and 21% for taxable incomes of up to R365000 and R550 000, respectively, such that the 28% rate is only paid on each rand of taxable income that exceeds R550 000 (again for the 2022 tax year). If this regime does apply, you will need to reconsider what salary you should draw so as not to end up paying too much tax in your own name when the company is paying tax at a lower effective rate…a SBC’s effective rate is always lower than 28%.
A SBC also benefits from more favourable deductions than those that apply to a company taxed at the full 28%. For example, it may deduct the full cost of plant and machinery used for the first time in the business for the purposes of manufacture or a similar process, in the year it is purchased. In addition, the cost of other assets may be claimed over a period of three years (50% in year 1; 30% in year 2 and 20% in year 3). The ‘cost’ referred to is the lower of actual cost or market value (if not acquired in an arm’s length arrangement).
Clearly this SBC regime can be hugely beneficial. So, how will you know if your company qualifies for this regime?
There are a number of important requirements that still need to be satisfied:
- As its name suggests, the regime only applies to businesses conducted through a registered company;
- The company must be owned by a natural person and that shareholder must not hold the shares of other trading companies unless they are, for example, listed shares, unit trusts etc (there is a list of entities that qualify as ‘ok’);
- The turnover (‘gross income’) of the company must be less than R20mn (if the company traded for less than a year this is apportioned down to the relevant period);
- If your company doesn’t employ 3 or more employees who are not connected to you, you need to determine if the nature of your business qualifies. The SBC regime does not apply if:
- the company can be classified as a ‘personal service provider’ per the employees’ tax provisions (in short this is a company where the owner/employee essentially provides the services an employee would ordinarily provide, under the supervision of the ‘client’ and more than 80% of the income comes from one ‘client’). Even if it isn’t classified as a personal services provider-
- 20% or more of the receipts and accruals (excludes capital) and all capital gains of the company come from “personal services” and investment income:
- “Personal services” comprise: accounting, auditing, actuarial science, architecture, auctioneering, broadcasting, consulting, draftsmanship, health, IT, journalism, education, engineering, financial services broking, law, management, real estate broking, research, sport, surveying, translation, valuation or veterinary science.
- “Investment income” is the income that comes from dividends, interest, trading in financial instruments (including shares), annuities, royalties and fixed property rental etc.
Thus, it seems that SARS does ‘come to the party’ to some extent to make sure it doesn’t take its risk-free share of a young business’s profits before it has given that business the chance to become established. However, it is selective in that the company’s business must be ‘small’ (less than R20mn turnover) and not an investment company – seems fair enough; and it either employs at least three unconnected people or be a non-service type business – also seems fair enough in the context of encouraging employment.