There are significant tax benefits to encourage small businesses, but the size of your business determines which benefits you qualify for, and there are other criteria to keep track of too.
In recent years the government has recognised the need to encourage the development of small businesses by providing special tax rules and methods to help them deal with the heavy administrative burden that all businesses carry but that small businesses, through their lack of size and resources, find difficult to manage.
If you wish to benefit, the question you need to ask is whether, in fact, you qualify as a small business. And the answer to this question may depend on which benefits you would like to take advantage of.
The income tax legislation, for example, has a very specific definition of what it considers a small business to be and provides the tax benefits only to those that satisfy the criteria. These include a requirement that the gross income of the business must not exceed R14 million in the year of assessment.
The small business tax amnesty sets out a definition of "small business" that is less onerous than the income tax legislation one, but it still requires that the turnover of the business must not exceed R10 million during the 2006 tax year.
The value added tax (VAT) legislation, on the other hand, sets out that a smallish business can submit VAT returns every second month, rather than monthly, if its taxable supplies do not exceed R30 million, and that it can submit only three returns a year if its taxable supplies do not exceed R1.2 million.
For employees tax return purposes, a small business is one that has an employees tax bill of less than R500 000. If this is the case, the business does not need to pay any skills development levies.
Furthermore, in his 2005 Budget speech, Finance Minister Trevor Manuel said that small businesses can make use of the advisory services at the South African Revenue Service (SARS) and can apply for free accounting packages. The criteria for these benefits have not been set out, so if you wish to take advantage of them, I suggest you apply because you might just qualify!
Clearly, then, the key to understanding what benefits you qualify for as a small business depends on whether you qualify under that particular benefit.
Criteria for small business
So, let's focus on income tax, which provides the most significant benefits. In order to be a "small business" for this purpose your business will have to satisfy all the following criteria:
- The small business must be operated in a company or close corporation (CC). Thus, if the business is carried on in the name of an individual, the benefits will not apply.
- The company or CC must be owned only by individuals; it cannot be owned by another company, CC or trust.
- The shareholders of the company or the members of the company or CC must not own interests in any other companies or CCs except where those other interests relate to shares quoted on a recognised stock exchange (such as the JSE) or are held through a unit trust.
- The gross income of the company or CC must not be more than R14 million for the relevant tax year. (If the company or CC has operated for less than a year, the R14 million must be apportioned accordingly.)
- The company or CC must not be an employment company (a personal service company or certain types of labour brokers - these are defined in the legislation).
- No more than 20 percent of the income and capital gains of the company or CC can be in the form of interest, rental, dividends or any other investment income, or personal services.
The list of "personal services" is quite extensive but in essence involves the type of service where the owner of the company or CC, himself or herself, personally performs the work that derives the income of the business.
So the list includes a wide range of businesses such as accountants, architects, brokers, journalists, estate agents and sportspeople. However, if the business employs three or more full-time employees who are not related to the shareholder or member and who work directly in the principal business of the company or CC, the income from personal services does not need to be taken into account to determine the 20 percent limit.
Please be aware that because of the full-time and non-connected persons restrictions, a gardener or domestic worker, and your spouse or children cannot be put on the payroll to fulfil this requirement.
The benefits that qualifying small businesses can derive are:
Firstly, based on the 2007 Budget Review for tax years ending after March 1, 2007 and ending before March 31, 2008, the first R43 000 of taxable income is not taxed at all. The next R300 000 is taxed at 10 percent and any further income is taxed at the rate that other companies are taxed at, which is 29 percent.
Secondary tax on companies (the tax imposed on the company or CC when it declares a dividend or makes a distribution) still applies as with any other company. This tax is currently 12.5 percent of the dividend declared. According to the Budget Review, this will be reduced to 10 percent on October 1 this year and in 2008 will change to a withholding tax on the dividend declared to a shareholder. This means it will not be a tax on the company or CC, although the company or CC may have to pay it to SARS on the behalf of shareholders.
When a company or CC buys capital assets that it uses in its process of manufacturing (for example, machinery), it can deduct 100 percent of the cost against its taxable income in the year in which the asset is bought.
The cost of all other assets (such as computers and furniture) can be claimed as a deduction over three years at the rate of 50 percent in the first year, 30 percent in the second and 20 percent thereafter.
The small business tax amnesty is a significant benefit for businesses that qualify. Of interest here is that the business need not be conducted in a company or CC and can be conducted in your own name or even in a trust. (In the Budget Review, the revenue authorities undertake to resolve certain uncertainties relating to how the amnesty applies to founders, trustees and beneficiaries of a trust.)
Essentially, the amnesty allows a small business to "wipe the slate clean" insofar as any taxes (income tax, VAT and employees tax) payable before the 2006 year are concerned.
A qualifying company can make application and must submit a 2006 tax return, together with a levy, which is determined with reference to the taxable income derived in 2006. If the application is approved, SARS undertakes never to look at the past again. The levy is progressive, but amounts to five percent on taxable income exceeding R500 000. Applications can be made up to May 31, 2007. So far, more than 11 000 applications have been made and there have been 43 000 queries about the amnesty.
(For articles on the tax amnesty and personal service companies, see Personal Finance magazine's first quarter 2007 issue.)
Small businesses also benefit from a reduced application fee when applying for a binding private ruling under the new advance tax ruling system (this was introduced on October 1, 2006). Whereas other taxpayers pay R10 000, small businesses whose gross income does not exceed R10 million for the tax year pay only R2 500. In addition, these small businesses will not be charged for the first eight hours spent by SARS to address the ruling requested.
Manuel was surprisingly quiet about small business in his 2007 Budget speech. However, a look at the Budget Review reveals that it was certainly not forgotten. It states: "Government policy remains focused on reducing the tax compliance burden for businesses, especially small businesses, to promote entrepreneurship, the formalisation of informal businesses, economic growth and job creation. The National Treasury and SARS have commissioned a small business tax compliance cost study. The results of this study should also support the development of a more simplified tax regime for very small businesses."
It advises that this simplified tax regime will be introduced in 2008. Thus, we can look forward to a much easier tax system for small businesses in the future but we are going to have to be patient until such measures are introduced.
- Deborah Tickle is a tax partner at KPMG.
This article was first published in Personal Finance magazine, 2nd Quarter 2007. See what's in our latest issue