Before you assume that as the owner of a small business you qualify for special tax concessions, make sure you understand the Receiver of Revenue's definition of a "small business".
In his Budget speech this year, Minister of Finance Trevor Manuel announced that further special tax concessions would be granted to small businesses. In the past, the special treatment accorded to small businesses was limited and only applied to certain types of small businesses.
The draft legislation for the new rules provides for more benefits to small businesses. However, before taking comfort in the assumption that your small business will benefit from the new rules, it is important you are sure that your business qualifies as a "small business" as defined in the draft legislation.
Your business has to satisfy all the following criteria for it to be classified as a "small business":
- The small business must be operated in a company or close corporation (CC). Thus, the benefits will not apply if the business is carried on in the name of an individual.
- 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 Securities Exchange, or held through a unit trust fund.
- The gross income of the company or CC must not be more than R6 million for the relevant tax year. If the company or CC operates for less than a year, the R6 million must be apportioned accordingly.
- The company or CC must not be an employment company (that is, a personal service company or certain types of labour brokers - these are defined in the draft legislation).
- No more than 20 percent of the income and capital gains of the company or CC may be in the form of interest, rental, dividends or any other form of investment income.
- Where 20 percent or more of the income and capital gains of the company or CC are derived from income from rendering personal services (see below), the company must have at least four full-time employees (not related to the shareholder or member), who work directly in the principal business of the company or CC. Thus, the gardener and the domestic worker cannot be put on the payroll to fulfil this requirement.
This latter requirement is significant in that, previously, companies or CCs that rendered the personal services set out did not qualify for the benefits at all. However, the requirement that the company or CC have "at least four full-time employees" could still be quite onerous for a small business, particularly when you consider that this requirement does not apply to non-personal-service-rendering businesses.
The list of "personal services" is quite extensive, but in essence it 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, for example, the list includes a wide range of businesses from accountants, architects, brokers, journalists and estate agents to sportspeople.
The benefits
So, once you've established that your small business does, in fact, qualify, what are the benefits?
Firstly, the first R35 000 of taxable income is not taxed at all. Any income earned thereafter, up to R250 000, is taxed at 15 percent, and only any income over R250 000 is taxed at the rate at which other companies are taxed (29 percent).
Secondary tax on companies (the tax imposed on a company or CC when it declares a dividend or makes a distribution) still applies, as with any other company. This tax is 12.5 percent of the dividend declared.
Then, when you buy capital assets used in the process of manufacturing (for example, machinery), you may deduct 100 percent of the cost against your taxable income in the year you acquire the asset. The cost of all other assets (such as computers, furniture and so on) may be claimed as a deduction over three years: 50 percent in the first year, 30 percent in the second year and 20 percent thereafter.
If your small business pays total remuneration of less than R500 000 a year, it will be exempt from contributing to the Skills Development Levy Fund.
In addition, your small business may apply to submit a VAT return only every four months, instead of every two months.
The South African Revenue Service has also indicated that it will set up dedicated help desks to assist small businesses to comply with all the relevant tax requirements, and that it will provide special computer programs to help small businesses maintain proper accounting systems.
Clearly, the tax benefits of owning a small business are significant, provided your business in fact does qualify as a small business.
Definitions
Labour broker:
Any person, company or close corporation who, in return for a reward, provides clients with other people who render a service or perform work for those clients. The workers perform the services for the client, but are remunerated by the labour broker, who is their employer.
Personal service company:
A company is regarded as a "personal service company" if a connected person (shareholder), in that company renders the services on behalf of the company to clients, and:
- The person rendering the service would be regarded as an employee of the client if the service was rendered by that person directly to the client without the company being involved; or
- That person or the company is subject to the control or supervision of the client insofar as the manner in which, or hours during which, the duties are performed in rendering such service; or
- The amounts paid or payable in respect of the service consist of, or include, earnings which are payable at regular daily, weekly, monthly or other intervals; or
- Where more than 80 percent of the total income the company earns by rendering services consists of amounts received directly or indirectly from any one client, during the tax year.
However, a company will not be regarded as a personal service company if it employs more than three full-time employees who are engaged in the business of rendering the services.
However, these three employees cannot include any employee who is a shareholder, a member of the company or a connected person in the company. Thus, the three employees cannot include, for example, your relatives, the gardener and the tea lady, who do not directly perform the functions of the business.
Deborah Tickle is a partner in tax services at KPMG.
This article was first published in Personal Finance magazine, 3rd Quarter 2005. See what's in our latest issue