Businesses that are not registered for VAT and that have an annual turnover of up to R1 million will be allowed to switch from paying income tax to paying tax on their turnover.
An email poked fun at the tax authorities by depicting a tax return that had just two lines: "How much did you earn?" and "Send us half".
The proposed presumptive turnover tax comes close to making this joke a reality, although the rate will be lower, Franz Tomasek, the general manager for legislation at the South African Revenue Service (SARS), told Parliament's portfolio committee on finance in August when he explained the workings of the proposed new tax.
SARS also pointed out that the aim of presumptive turnover tax is to reduce the tax-compliance burden of small businesses and "not necessarily to reduce the tax liability of these businesses".
In terms of the proposed tax, businesses with a turnover of up to R1 million a year will have the option to pay tax on their turnover, thereby alleviating them of the burden of all the paperwork involved in recording their expenses and calculating their taxable profits.
The rate at which a small business will pay turnover tax will depend on its turnover. The rate is progressive, which means that higher tax rates apply to higher levels of turnover.
In terms of draft legislation that was put before the finance committee in September, the tax starts at one percent of each rand of turnover after the first R100 000. So, the first R100 000 of turnover will be tax-free. Turnover between R300 001 and R500 000 will be taxed at three percent, and turnover between R500 001 and R750 000 will be taxed at five percent. Any turnover that exceeds R750 000 will be taxed at seven percent.
The turnover tax system was announced by Finance Minister Trevor Manuel in his Budget speech in February, but the initial proposals announced in the Budget were tweaked before the draft law was published in August. Tomasek said it was found that the tax rates proposed initially were not as generous as SARS had thought.
Manuel also announced in his Budget that the government would raise the threshold at which a small business has to register for VAT from the current turnover level of R300 000 to R1 million a year.
The draft Revenue Laws Amendment Bills make it clear that you can't use the turnover tax system if your small business is registered for VAT. If your business is registered for VAT, you are keeping the necessary records anyway, Tomasek says, and you don't need the turnover tax system.
Some suggestions were made during public hearings on the turnover tax proposals. But on the whole there wasn't much comment, and the proposals are likely to be approved by Parliament and promulgated in time for a proposed implementation date in March next year.
If the turnover tax system is adopted as proposed, qualifying small business owners may find it easier to comply with the new tax than to pay income tax, because they will need to submit only a record of how much money came into the business - essentially a record of their daily takings.
Hopefully, this won't encourage small business owners to take their eyes off the bottom line, but it could save them the costs of employing an accountant or relieve them of the need to use their own time to keep their books up to date for tax purposes.
The much higher VAT threshold means fewer businesses will face the difficult and potentially costly task of determining how much of their purchase sales are VATable and how much are free of VAT, and therefore how much VAT they owe SARS and how much VAT they have already paid and can claim from SARS.
Some businesses excluded
Personal service businesses and professionals are excluded from using the presumptive turnover tax system. SARS says it doesn't want professionals to set themselves up to benefit from the tax concessions instead of paying income tax.
Personal service businesses are defined in the Income Tax Act. Essentially, they are businesses set up by people who are contracted to work for an employer (see "Tax break for personal service companies", Personal Finance, first quarter 2007).
Professionals are defined in the draft legislation as people who render services in the fields of accounting, actuarial science, architecture, auctioneering, auditing, broadcasting, broking, commercial arts, consulting, draftsmanship, education, engineering, entertainment, health, information technology, journalism, law, management, performing arts, real estate, research, secretarial services, sport, surveying, translation, valuation or veterinary science.
SARS responded to calls for the inclusion of professionals by saying that its single tax rate structure for all types of businesses (manufacturing and services), sole proprietorships and incorporated businesses "was a compromise in an attempt to simplify the proposed system". Tomasek says if professional services businesses with high profit margins are allowed to use the proposed turnover tax, a second tax rate structure would have to be considered.
SARS says the precise mechanism for the exclusion of professional services will be reviewed in future.
The right tax system for you
For some businesses that are not in the habit of keeping formal accounting books, particularly informal traders, the advantages of switching to the new turnover tax are obvious.
For businesses that comply with VAT and income tax accounting requirements, the decision to remain in the current tax system or to opt for turnover tax needs to be weighed more carefully. Your considerations should include a calculation of the effective tax rate your business is paying now and what you would pay under the turnover tax system.
You also need to take into account your profit margin and what you expect it will be in the years ahead. This is because the new system may not improve the bottom line of businesses with a low profit margin.
Personal Finance asked Deloitte Tax to provide an example of how turnover tax will affect small businesses with different profit margins.
The example is of two businesses with the same turnover, but one makes a profit of about 20 percent of its turnover (after VAT), while the other makes a profit of only about 6.25 percent of its turnover (after VAT). Both businesses pay the same turnover tax, but this will result in a lower after-tax profit for the business that turns a smaller proportion of its sales into profits (see
In the example drawn up by Uviwe Mzilikazi and Kristen McClarty of Deloitte Tax, Techco is a technology company with a high profit margin and relatively low expenses, while Industco is a manufacturer with relatively high expenditure and a low profit margin. Both companies have the same turnover, but Industco pays more for its supplies than Techco does. As a result, Techco makes a net profit before tax that is three times higher than Industco's.
Different rates
The rate at which businesses are currently taxed differs depending on whether the business is operated as a sole proprietorship (individual) or in a corporate form, such as a company or a close corporation (CC).
A small business corporation is a company or CC that meets a number of requirements in terms of ownership, type of business and maximum gross income levels. Currently, to qualify as a small business corporation, a business must have a gross income of R14 million or less a year.
A small business corporation that meets the required criteria will pay income tax as follows:
- No tax on the first R46 000 of taxable income;
- Tax at 10 percent on the next R300 000 of taxable income; and
- Tax at 28 percent - the new company tax rate - on any further income.
If a company or CC does not meet the small business corporation criteria, it will be treated as a normal company and subject to the company tax rate of 28 percent on all taxable income (except what are known as employment companies, which pay tax at different rates).
Whichever tax rate applies, a company or CC has to pay secondary tax on companies (STC) in respect of any dividends paid.
An individual or a sole proprietor pays tax on business profits according to the income tax tables, which provide a graduated tax rate up to a maximum marginal rate of 40 percent, and less the applicable primary and possibly secondary rebate.
The tax rates that apply under the proposed turnover system are in this table.
If a business with a low profit margin, such as Industco, elects to pay turnover tax and also deregisters for VAT, based on the assumption that it can raise its sales by half the amount it was collecting in VAT previously, its total tax paid (VAT and income tax) will be lower.
A comparison of the tax paid and the after-tax profits of the two example companies shows that the presumptive turnover tax boosts the after-tax profit of Techco, the company with the higher profit margin, but the tax paid is lower for Techco only if it is paying tax as a company.
The favourable income tax rate that qualifying small business corporations currently enjoy is evident in the example. Even at a R1-million turnover level, the turnover tax would be R38 000, compared with tax of R15 400 if the small business rate applied and the profit was R200 000 (20 percent of R1 million).
If the turnover tax is applied, your tax liability will be R20 500 at a turnover of R750 000, and any rand your business makes in revenue thereafter up to R1 million will attract tax at a rate of seven percent.
At this highest tax bracket, Tomasek told members of Parliament's finance committee, turnover tax is a bit higher than you would pay in income tax (either as an individual or as a small business that qualifies for the small business tax rate and that pays STC). However, you still save on the costs of keeping records for tax purposes. The reason for the high turnover tax rate at the highest bracket, he says, is to encourage you to think of moving out of the system.
Consequences of your choice
You should also be aware that if you choose to use the turnover-based tax system, you will have to continue using this tax system for a minimum of three years, provided your business's turnover remains below R1 million a year. If you, as a small business owner, have elected to use the turnover-based system and thereafter decide to stop using it and rather be taxed according to the traditional tax system, you will not be allowed to switch back to the turnover-based system for three years.
The difference turnover tax makes at a high or a low profit margin and the requirement that you stick with one or the other tax system for three years highlight the importance of choosing the best way to declare your small business's activities to SARS.
A small, start-up business is likely to have a low profit margin, so it may do better by continuing to be taxed according to the current tax system.
A business that is bringing in money but is making a loss will pay tax under the turnover system but not under the existing tax system. Under the existing tax system, losses can be carried forward and offset against profits made in the following tax year.
Not registering for VAT will certainly help small businesses to reduce their paperwork, but, depending on your business, it may be to your advantage to register, even if your business's income is below the limit.
A business that buys a lot of goods for resale to VAT-registered businesses or that needs expensive equipment may benefit from being registered for VAT because it can claim its input costs. On every R100 (including VAT) spent, the business will be able to claim R12.28 in VAT.
Tomasek says you will have to embark on a very detailed exercise if you want to ensure that you get every rand out of the new turnover tax system.
You will have to estimate what profit you expect to make and then work out whether it is worth staying in the current tax system or moving to the turnover tax system. If you operate a company or a CC, Tomasek says, you will also have to make an assumption on what STC or dividend withholding tax you will pay on any drawings you make from the company or CC's profits.
The draft legislation also proposes that businesses that qualify for turnover tax will not be liable for tax on the dividends they declare up to R200 000 in any tax year. The exemption from STC will in future become an exemption from dividend tax.
When dividend tax is introduced, businesses that declare a dividend will in certain circumstances have to withhold and pay the tax to SARS before distributing the dividend.
This article was first published in Personal Finance magazine, 4th Quarter 2008. See what's in our latest issue