When starting a business, it is important to consider the type of business entity you plan to operate in as these each have different implications for the business. There are four main options:
- a sole trader or proprietor
- a partnership
- a company
- a trust
Each has advantages, disadvantages and tax implications. It is recommended that you consult a professional adviser before committing yourself.
1. A sole trader
This is the simplest type of entity and means that you trade in your own name and through your own bank account, although you may have a separate designated bank account for your business so that your personal expenses, which are not tax deductible, do not get entangled with business transactions.
Unlike a company or trust, there is no separate legal entity which means that you will be personally liable for all debts incurred. This can lead to your sequestration if the business fails. As the business grows and you employ people you will have to register for PAYE in your own name and once your turnover seems set to exceed R1m per annum you need to register for VAT in your own name as well. This means that you will also be personally liable for any PAYE or VAT that is found to be short paid to SARS.
2. A partnership
This is another simple form of enterprise whereby two or more sole traders work together. Added to the disadvantages set out above, in a partnership you are liable for the debts of your partner as well, unless you structure an en commandite partnership whereby liability is limited. A detailed, written and signed partnership agreement is essential.
3. A company
The Companies Act of 2008 saw the simplification of certain companies and did away with Close Corporations. Close Corporations which were already in existence could continue but they have no real advantage over a company anymore.
A company is a separate legal entity and a shareholder or director will not have liability for the debts of the company unless they have signed surety or have breached the provisions of the Companies Act. The company is owned by its shareholders who can number up to 20 and is managed by directors who are appointed by the shareholders. If all the shareholders are directors and the Public Interest Score is less than 350 then no audit is required by law and only a compilation report is required. This report gives no assurance but is prepared by a suitably qualified person and is akin to the report that would accompany a sole trader or close corporation report.
If all shareholders are not directors and or a juristic person e.g. if a trust is a shareholder, then an independent review is required. This is a type of ‘light’ audit report. An audit report states that the annual financial statements ‘fairly present’ whereas a review contains more review and analytic procedures and gives a negative or lesser assurance, however we have no reason to believe that the financial statements do not ‘present’.
The Public Interest Score or PIS score is calculated by taking what is deemed the public interest into account:
- Each completed R1m of turnover equals 1 point
- Each staff member equals 1 point
- Each R1m of debt equals 1 point
- Each shareholder equals 1 point
These points are totalled so a business with a turnover of R350m, with 350 staff or with debt of R350m or with 350 shareholders (or a combination of the above which exceeds 350 points) requires an audit. If the score is less than 350, but not all shareholders are directors, an independent review is required - which is cheaper than an audit.
4. A Trust
Trusts evolve from Roman Dutch law. In essence a founder or donor sets up a trust. It is managed by trustees who are akin to directors and need to be suitably qualified as they manage assets placed in trust by the donor/founder for the beneficiaries who are entitled to the income and or assets of the trust. There are normally three trustees and at least one needs to be independent. All the provisions are set out in a trust deed, which is lodged with the local Master of the Supreme Court who administers trusts. Trusts also need to be registered for tax with SARS and can be registered for VAT and PAYE as well.
Trusts may require an audit if prescribed by the trust deed otherwise they just need a compilation report. Because they are used to pass wealth from generation to generation, SARS has enacted various pieces of legislature to make them less attractive including higher income and capital gains tax rates and section seven which stipulates that interest free loans need to attract donations tax at the rate of 8% deemed interest per annum. However, due to the conduit principle, whereby the profits of a trust can be distributed to a beneficiary, they nevertheless remain widely used.
1) Sole Traders and Partnerships
Income tax - You are taxed at your marginal rate of tax which varies in bands from 0% (up to R R79 000 pa if under 65 years old) to 45% on amounts over R1.5m.
Capital gains tax (CGT) - up to 18% dependent on your income (40% inclusion rates times 45 % tax). Remember that at date of death CGT is triggered on all assets at market value.
Estate Duty - normally 20% on assets in estate at market value exceeding R3.5m on date of death but 25 % on assets over R30m.
Donations tax is 20% on assets donated with the first R100 000 pa donations tax-free.
The rate of tax for normal companies is 28% of taxable income.
If the after-tax profit is paid out as a dividend, then dividends tax of 20% is payable.
CGT is 22.4% (80% of the capital gain times 28%)
Small Business Corporations where the shareholders are natural persons and have no other business interests and turnover does not exceed R20m are exempt on the first R79 000 taxable income, 7% to R365 000, 21% up to R550 000 and 28% above R550 000.
Micro businesses need to be registered as such with a turnover of up to R1m pa. Tax is paid on turnover as follows:
- up to R335 000 at 0%,
- R335 001 to R500 000 at 1%
- R500 001 to R750 000 at R 1650 plus 2%
- R75 001 and above - R6 650 plus 3% of turnover over R750 000
Because trusts are not subject to dividends, tax and assets in a trust will not fall part of an estate for estate duty they are taxed at a flat rate of 45%, which is equal to the highest individual tax rate.
CGT is at 36% (80% inclusion times 45% tax)
Using the conduit principle, profits and capital gains in a trust can be distributed to beneficiaries thus reducing the rates of income tax and CGT to individual rates applicable.
When starting a business, banks and creditors request sureties. Try where ever you can to avoid signing them. If you start a business in a company and you do not breach the provisions of the Companies Act your liability can be limited to the share capital you introduced which is normally nominal, as well as loan funds you introduced which may be lost. When you sign surety for the business your personal assets are pulled into the company - your house., car etc.
Structures cost money but typically a financial adviser will recommend the following structure:
A company to trade through
A separate property company to own the company’s building or equipment. A lease agreement is then entered into and the trading company rents the building.
A trust to own the growth assets. This may include the shares in both the trading company and the property company and possibly the owners house and a share portfolio.
In an ideal situation if the trading company gets into difficulty, it goes into business rescue from where it either recovers or is liquidated. The property company and trust containing the assets continue and the owner is fine however, if she has signed personal surety she would be sequestrated.
This article does not constitute professional advice. A qualified and experienced professional such as a business adviser or chartered accountant should be consulted before making any financial decisions.
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