If you’re facing the decision of running your business as a sole proprietor or registering a company, this is aimed at you!
There are a couple of main areas I would consider:
– a tax comparison
– brand appeal
– debt and liability
– bookkeeping and accounting costs
THE TAX COMPARISON
A sole proprietorship is a business that is owned and operated by a natural person (individual). This is the simplest form of business entity. The sole proprietorship is not a legal entity. The business has no existence separate from the owner who is called the proprietor.
How are they taxed:
– The owner must include the income from such business in his or her own income tax return and is responsible for the payment of taxes thereon.
– Individuals are taxed on a sliding scale – have a look here, but generally it ranges from 18% – 45%
– As an individual, you benefit from the general tax rebate, which brings down the amount of tax you owe by a flat amount, depending on your age. If you’re under 65 years, this is called the primary rebate. There’s a secondary rebate for those over 65 years and a tertiary rebate for those over 75 years.
REGISTERED BUSINESS – PRIVATE COMPANY
A private company is a separate legal entity registered through CIPC (www.cipc.co.za) of which you can be the registered director and or shareholder.
How are they taxed:
– A private company is treated by law as a separate legal entity and must also register as a taxpayer in its own right.
– A private company pays income tax at a flat rate of 28%.
COMPARISON OF TAXES
The decision to move from a sole proprietor to a company in terms of where you will be paying the least amount of tax is a complicated calculation which is best to do with an accountant, but here are a few facts to take into account:
Alternatives to the traditional 28% income tax payable by private companies:
– If your company qualifies as a ‘Small Business Corporation’ you are looking at a greatly reduced tax sliding scale – have a look here.
– Your company could qualify for ‘Turnover Tax’ which is also a greatly reduced income tax system – have a look here.
Could I not just compare the 28% to my individual tax bracket:
– You are not simply able to help yourself to any cash in your business without it having tax implications.
– One way of accessing the cash from your business is to declare a salary to yourself.
– This is done by registering your company for payroll taxes (PAYE), running a payroll system which produces a payslip and an EMP201 report which is then submitted to SARS monthly and the amount of tax deducted from your salary must be paid over to SARS by your company.
– This means you’re paying tax in your individual capacity on the SARS individual tax scales just like a sole proprietor would.
– Your company then claims this salary paid to you as an expense in it’s profit and loss statement meaning it reduces it’s profits before paying tax at 28% on the profit.
– If you are not declaring a monthly salary to yourself, and using business funds in your personal capacity this will go to a loan account on the balance sheet as if though you owe your business that money.
– This means that the payouts to you are not expensed in the income statement and your company will be paying income tax on its profits which will not be reduced by the amounts paid to you.
– The only way of reducing your profits with the amounts paid over to yourself is by declaring a salary and paying the payroll taxes over to SARS.
– If you are in a position where your company owes you money (you have put in more than what you have drawn from your company), then you are able to reduce this balance owed to you personally without any tax implications, it is simply a loan being paid back, unless you’ve structured it as an interest bearing loan.
– Once this loan is fully paid up it, any payment to you (other than a salary) will start building a balance due by you to your company.
– SARS doesn’t like that you are taking funds from your business without paying tax on it.
– So what they do is they can make you pay what they call a deemed dividend.
– Best is to either declare a salary or a dividend to not have a loan owed by you to your business at year end.
– The other way of paying out money to yourself is by declaring a dividend in your company.
– After a company has paid it’s income tax on it’s profits it can declare a dividend from that after tax money left over in the company.
– The company needs to withhold 20% dividends tax from the payment to you and the balance is paid to you personally.
– This money is not taxable in your personal capacity as the company has paid the dividends tax on it already.
– But take into account before any amount hits your personal bank account, your company has paid 28% income tax on it’s profit, and withheld 20% dividends tax on the amount, which is a large sum of tax before you get the balance.
This is a mouth full.
What I would suggest is to take your specific facts to your accountant and talk it through to know exactly what amounts you’re looking at paying in each instance.
Let’s look at a simple calculation where your business has a profit of R100,000:
XYX (Pty) Ltd annual taxable income (profit): R100,000
Income tax (28% flat rate): ( R28,000)
After tax profit: R72,000
Dividends tax at 20% (20% x R72,000): R14,400
Effective rate of tax (R28,000+R14,400) / R100,000: 42.4%
Individual’s annual taxable income (profit): R100,000
Individual tax at 18% (check the sliding scale first!) R18,000
Less primary rebate (check first – changes every year) (R13,500)
Total tax payable R4,500
Effective tax rate (R4,500 / R100,000) 4.5%
It’s simple to see that for relatively smaller businesses, sticking to being a sole proprietor usually is the best tax option.
Once you start making bags full of money, the situation might look very different:
Let’s assume the profit for the business is R 1,000,000 and a salary expense equal to R30,000 per month (R360,000 per year) has been applied to you:
XYX (Pty) Ltd annual taxable income (profit): R1,000,000
Director’s salary (R360,000)
Profit/Taxable Income R640,000
Income tax at 28% (R179,200)
Profit after tax R460,800
Dividends tax to pay that balance out to you: (R92,160)
On top of these taxes your company pays, you will be liable for individual income tax according to the sliding scale which totals R68,380.
XYZ PTY Ltd corporate and dividends tax (R179,200 + R92,160) = R271,360
Your individual tax R68,380
Total tax R339,740
Individual’s annual taxable income (profit): R 1,000,000
Individual tax at 41% (check the sliding scale first!) R 315,931
You will be paying R23,809 (R339,740-R315,931) less tax in your own capacity than if you were operating through a company and drawing a salary of R30,000 per month.
As there are numerous other deductions and allowances to consider for both an individual and a company, I’d have to perform detailed calculations for both scenarios to determine which is truly more tax efficient.
What is evident though, is that as an individual earns more and moves into the highest tax bracket, the difference in tax between a company and a sole proprietor decreases. At lower levels of taxable income, it’s far more tax efficient to operate as a sole proprietor and enjoy the benefits of sliding tax tables and rebates available to individuals. At higher income brackets, it’s likely that company registration would be more beneficial.
If you find yourself in a position where clients are requesting your organisation’s particulars and you not being a registered business becomes a problem, then it may be time to register an entity for the sole purpose of brand appeal. I am not talking about a once-off sale, I am talking about continued sales which will be greater and materially more if your potential clients would trust you more if you operate a formally registered company.
This is very rare. Usually they simply ask, you say you’re a sole proprietor, and they continue doing business with you. But if for some reason you are missing out on business because of it, consider the move across.
DEBTS AND LIABILITY
If you need to obtain large loans for whatever reason, I would very much consider forming a company and obtaining the loans in the company’s name. As a company is a separate legal entity this could hold a large advantage in terms of personal liability.
BOOKKEEPING AND ACCOUNTING COSTS
There are multiple additional costs involved in running a company and it is worth your while adding these up and comparing that to any possible tax benefit you calculated.
Registering a company on CIPC costs money, mandatory annual returns for a private company costs money.
Accounting fees are much higher – compare my packages here.
Lawyers fees to get a memorandum of incorporation formalised and other legal issues sorted will cost money.
While I’ve researched this subject extensively, this is just meant to start a conversation and I am happy to work through all of these with my clients individually.