Tax Guide for Small Businesses

Provided by the South African Revenue Service for more information visit the SARS webpage at www.sars.gov.za

Contents:

Introduction

Part I - Initial considerations when Organising a business

Introduction
Types of business organisations
Comparative tax structures
Registering with the appropriate authorities

Part II Record keeping

Introduction
Importance of accurate records
Availability and retention of records
How to determine net profit or loss
Comparative tax structures

Part III You and the Receiver of Revenue

Introduction
Income Tax - Sole proprietorships and partnerships
Income Tax Close Corporations & Companies
Value Added Tax (VAT)
Employees Tax (PAYE)

Introduction

This guide contains in formation about the tax laws that apply to businesses. It describes the four major forms of business organisations - sole proprietorship, partnership, close corporation and private company - and explains the tax responsibilities of each.
  
This first edition of "Tax Guide for Small Business" is divided into three parts, The first part contains general information on business organisation and registration. Part II discusses various aspects of record keeping, including an explanation of net profit or loss. This helps to illustrate the specific tax considerations for each of the flour different business Organisations Part III contains an explanation of income tax and some of the other taxes you may have to pay in addition to income tax.
       
The information in this publication applies to many different kinds of businesses. However this guide does not discuss insurance companies, banks, investment companies, trusts, fishing or farming enterprises. This guide is only a general guide and does not try to deal with every aspect that can arise. If it does not give the answer to your own tax problem, your local Receiver of Revenue will be pleased to help you.

• Part I

Initial considerations when organising the business

• Introduction

Once you have decided to start a business you must decide what type of business entity to use.There are legal and tax considerations that will enter into this decision The legal considerations are beyond the scope of this guide. However an important element in your decision will be the tax consequences of each type of entity.

• Types of business organisations

Sole Proprietorship

A sole proprietorship is a business that is owned by one person.This is the simplest form of business organisation.The business has no existence apart from the owner who is called the proprietor. Only the proprietor has the authority to make decisions for the business. The proprietor assumes the risks of the business to the extent of all his or her assets whether used in the business or personally owned.

Some advantages of a sole proprietorship are:

• The business is simple to organise.
• The owner is free to make decisions.
• The business has a minimum of legal requirements
• The owner receives all the profits.

• The business is easy to discontinue.

Some disadvantages of a sole proprietorship are:

• Unlimited liability for the owner The individual owner is legally liable for all the debts of the business. Not only the investment, but any personal and real property may be attached by creditors.
• Limited ability to raise capital.The business capital is limited to whatever the owner can personally secure. This limits the expansion of a business when new capital is required. A common cause of failure of this form of business organisation is lack of funds. This restricts the ability of a sole proprietor to operate the business effectively and survive at an initial low profit level, or to get through an economic "rough spot".
• Limited skills. One individual has limited skills, although the owner may be able to hire employees with other skills.

Partnerships

A partnership is the relationship existing between two or more persons who join together to carry on a trade, business or profession. Each person contributes money, property, labour or skills, and each expects to share in the profits and losses of the business. It is like a sole proprietorship except that a group of owners replaces the individual owner. The number of persons who may join in a partnership agreement is limited to twenty. Like the sole proprietorship the partnership has advantages and disadvantages.

Some advantages are:

• It is easy to organise.
• It has greater financial strength.
• It combines managerial skills of the partners.
• It has a definite legal status.
• Each partner has a personal interest in the business.

Some disadvantages of a partnership are:

Unlimited liability of the partners. Each partner may be held liable for all the debts of the business.Therefore, one partner not exercising good judgement can cause the loss of the assets of the partnership as well as the personal assets of the remaining partners.

• The authority for decisions is divided.

Close Corporation:

A close corporation is much the same as a private company. It is a legal entity with its own legal personality and perpetual succession. The owners of the close corporation are the members. Members do not hold shares but have an interest in the close corporation. The interest is expressed as a percentage. Memberships generally speaking restricted to natural persons. The maximum number of members is 10.
        
Some advantages of a close corporation are:

• It is relatively easy to organise.
• The life of the business is perpetual (i.e. continues after members die).
• The members have limited liability (i.e. they are not personally liable for the business debt).
• The transfer of ownership is easy.
• Fewer legal requirements than a private company.

Some disadvantages of a close corporation are:

• It is subject to special taxation rates.
• The maximum number of members is restricted to ten.
• More legal requirements than a sole proprietorship or partnership.

Private Company:

A company is treated by law as a single legal entity. It has a life separate and apart from its owners with rights and duties of its own. The owners of a private company are the shareholders. The managers of a private company may or may not be shareholders. The maximum number of shareholders is restricted to fifty.
                
Some advantages of a private company are:

• The life of the business is perpetual.
• The shareholders have limited liability.
• The transfer of ownership is easy
• It is easier to raise capital and to expand.
• Efficiency of management is maintained.
• It is adaptable to both small and large business.

Some disadvantages of a private company are:

• It is subject to special taxation rates.
• It is more difficult and expensive to organise than other forms of ownership.
• It is subject to many legal requirements.

Some Advantages and Disadvantages of the Four Types of Business Organisations

• Comparative tax structures of each of the four forms of business organisation

In order to understand the tax consequences of each of the four business organisations, you will need to understand the basic steps for determining your business' profit or loss. This is explained in Part II of this guide. A diagram comparing the different tax consequences is also given.

• Registering with the appropriate authorities

Before you actually commence with your business activities it may be necessary for you to register with certain authorities in order to comply with the laws or regulations pertaining to your area of operation. It will be in your own interest to make enquiries in this regard and to comply with all the requirements that might be set. Some of the requirements that might be applicable to you are mentioned below the purpose of this section is merely to bring to your attention some of the authorities that might require your registration. Kindly note that the list below is not comprehensive.

  
Receiver of Revenue - You may have to register for one or more of the following:

• Income Tax: As soon as you commence business, you are required to register with your local Receiver of Revenue in order to obtain an income tax reference number.
• Employees tax (PAYE):A system of Employees Tax collection is in force in South Africa. Under normal circumstances, amounts that you pay to employees for services rendered by them are taxable. In these cases you must deduct tax from their salaries or wages and pay such amounts over to your local Receiver of Revenue. Registration in this regard is necessary.
• Value-Added Tax (VAT): VAT is a tax that must be included in the price of every taxable supply (i.e. the sale of goods and/or the supply of services).

When your taxable supplies exceed, or likely will exceed R150 000 per annum, you are obliged to register for VAT at your local Receiver of Revenue.

Unemployment Insurance Fund (U.I.F.): This fund provides for the insurance of employees against the risk of loss of earnings arising from unemployment due to the termination of their employment illness, maternity etc. An employer is required within 14 days of commencing business, to submit to the Unemployment Insurance Fund a notification on form U.I.F which can be obtained from the fund on application.This fund is administered by the Department of manpower, and all correspondence must be addressed accordingly

Regional Services Council (R.S.C.): R.S.C's are statutory autonomous bodies, similar to local authorities, and have been established to render services on a regional basis. Any person within the region who has other persons in his employ or who owns a business in the region must register with the R.S.C. Inquiries in this regard must be directed to your local Regional Authority.

Other authorities with which registration may be necessary include:

• Local licensing authorities.
• Health authorities.
• Customs and excise authorities.

- Part II

Record keeping

- Introduction

If you are involved in a business you must keep records that will enable you to prepare complete and accurate tax returns. You may choose a system of record keeping that is suited to the purpose and nature of your business. The records must clearly establish what your income and expenses are.This means that, in addition to your permanent books of account or records, you must maintain all other information that may be required to support the entries on your records and tax returns.

Paid accounts, cancelled cheques, etc. that support entries in your records should be filed in an orderly manner and stored in a safe place. For most small businesses, the business chequebook is the prime source for entries in the business records. Be sure to open a separate bank account for your business so that you do not mix your private and business expenses.

- Importance of accurate records

Accurate records are essential for efficient management. The following reasons demonstrate the need for accurate records.

a) Identity source of receipt

You may receive cash or property from many sources. Unless you have records showing the source of your receipts, you may be unable to prove that some are from sources that would make them non-taxable.

b) Prevent omission of deductible expenses

Expenses may be overlooked or forgotten when you prepare your tax return, unless you record them at the time they are incurred or paid.

c) Establish amounts paid out as salaries or wages

Under normal circumstances amounts paid to employees for services rendered are taxable. In these cases employees' tax must be deducted from salaries or wages by the person paying such salaries or wages.

d) Explain items reported on your income tax return

If your income tax return is examined by the Receiver of Revenue, you may be asked to explain the items reported. Adequate and complete records are always supported by sales slips, invoices, receipts, bank deposit slips, cancelled cheques and other documents.

- Availability and retention of records

 
You are required to keep the books and records of your business available at all times for examination by the Receiver of Revenue. A brief list of the retention periods for documents, records and books is given in the diagram below.The retention period commences from the date of the last entry in the particular document, record or book.

- How to determine net profit or loss

In order to prepare your income tax return, you will need to understand the basic steps for determining your business' profit or loss.This procedure is fairly simple and is much the same for each type of business organisation. Basically, profit or loss is determined as follows:

Income - Expenses = Profit (Loss).

You will use this formula with some slight changes in determining your profit or loss the diagram 1 & diagram 2 explain the determination of profit or loss and the distribution of income for the different types of business organisations.

- Definitions of the various terms used are given below.

         
Gross sales is the income a business receives. For example ABC Furniture Store sold R7 800 worth of furniture. Therefore ABC Furniture Store had gross sales of R7 800. Cost of goods sold or cost of sales is the cost of the business to buy or make the product that is sold to the consumer. It would be simple to determine the cost of sales if you sold all your merchandise during the year. However this seldom happens. Some of your sales during the year will probably be from stock that was bought in the previous year, and some of the goods that were bought in the current year will not have been sold.

To determine the cost of sales under these circumstances, you add the cost of goods bought during the current year to the value of stock on hand at the beginning of the year. From this total you subtract the value of your stock on hand at the end of the year. For example, ABC Furniture Store had R1 000 worth of furniture in the store at the beginning of the year during the current year R1 000 worth of furniture was bought from a manufacturer. At the end of the current year the store had R2 000 worth of furniture left. The cost of goods sold for the current year would therefore be:

R1 000 + R6 000 - R2 000 = R5 000.

Beginning stock + Purchases - Ending stock = Cost of sales.

Gross profit is the gross sales less the cost of goods sold. ABC Furniture Store had gross sales of R7 800. The cost to the store for the furniture sold was R5 000.The gross profit is therefore R2 8OO. Business expenses or operating expenses are the ordinary and necessary expenses incurred in the operation of the business. ABC Furniture Store incurred R1 200 worth of expenses for the salesperson's salary commission, telephone, stationery etc.

Net profit is the amount by which the gross profit of a period exceeds the expenses of the same period. Net loss is the amount by which the expenses exceed the gross profit. ABC Furniture Store had a gross profit of R2 800; the business expenses were R1 200 leaving ABC Furniture Store with a net profit of R1 600.

In the case of a business that provides a service, i.e. physical goods are kept or sold, the procedure to determine your business profit or loss is the same as mentioned above with the exception of cost of goods sold. A business that provides only a service will not have to calculate cost of goods sold. Business or operating expenses will be deducted from gross sales (e.g. professional fees, taxi fares, services rendered, etc.) to give net profit or net loss. After you have determined your business' net profit or loss there are differences in the way it is taxed, depending on your type of organisation.

• Comparative Tax Structures

Comparative Tax Structures

- Part III


You and the Receiver of Revenue
 
- Introduction

Now that you are beginning a business, it will be helpful if you have a general understanding of the various activities of your Receiver of Revenue, as well as your duties and obligations in terms of the tax laws. The tax laws are administered by the Commissioner for SARS, Pretoria, acting through the Receivers of Revenue who are stationed in 32 major centres throughout the country. The Receiver of Revenue is obligated by the law to determine and collect from each taxpayer only the correct amount of tax that is due.

The Receiver's office is that of representatives of the Commissioner for SARS, and in that capacity he must ensure that the tax laws are administered correctly and fairly so that no-one is favoured or prejudiced above the rest. The first section of this chapter deals with the income tax position of sole proprietors and partnerships after which close corporations and private companies are discussed. Lastly a short explanation of VAT and PAYE is given.

- Income Tax - Sole Proprietorships and Partnerships:

Soleproprietorships and partnerships do not have separate legal personalities as is the case with close corporations and companies. With a sole proprietorship, the owner or proprietor must include the income from his business in his own gross income as he is responsible for the payment of taxes thereon in his individual or personal capacity. This is also the case with partnerships. A partnership is not a taxpayer but each partner is taxed on his share of the partnership profits. Sole proprietors and partners must register as provisional taxpayers with their local Receiver of Revenue.

The payment of provisional tax is intended to assist taxpayers in meeting their tax liabilities continually and by way of installments out of taxable income received during the relevant tax year thus obviating, as far as possible, the need to make provision for substantial tax payments on assessment after the end of the tax year. For more information regarding the payment of provisional tax, see the guide for Provisional Taxpayers; (IRP 12), obtainable from your local Receiver of Revenue.

- Income tax - Close Corporations and Private Companies:

Close corporations and private companies are legal entities and have separate legal personalities of their own.They must therefore register as taxpayers in their own right as opposed to a partnership or sole trader/proprietor where the only taxpayers are the owners or partners of the business.

Basically the taxable income of the company or close corporation is determined in the same way as that of a sole proprietorship or partnership(see diagram 1 & diagram 2). Unlike natural persons, a company or close corporation pays tax at flat rate (35% tax 12.5% STC) on its taxable income for the year of assessment. The year of assessment of a company or close corporation coincides with its financial year if the financial year end is 30 June, its tax year or year of assessment will run from 1 July to 30 June.

A company is required by law to appoint an auditor who will audit and sign its financial statements. Similarly a close corporation is required to appoint an accounting officer. Normally the auditor or accounting officer will provide assistance in determining the taxable income and the amount of tax to be paid.

You will probably have to register for one of the following at the Receiver of Revenue:

- Value-Added Tax

Value Added Tax (VAT) is an indirect tax levied under the Value-Added Tax Ad 89 of 1991 (the VAT Act). VAT is levied on the supply of goods or services by a registered vendor in the course or furtherance of his enterprise. VAT is also levied on the importation of goods and certain services into South Africa by any person, whether or not a vendor; as it is in effect a tax on the consumption of goods or services in South Africa.

Registration

Application for registration as a vendor under the Act must be made on form VAT 101 (which is obtainable from your local Receiver of Revenue), within 21 days of becoming liable to register

Two categories of registration

• Compulsory registration - any person who on or after 30 September 1991 carries on any enterprise and whose total value of taxable supplies (taxable turnover) exceeds or is likely to exceed R150 000 in any 12 month period.
• Voluntary registration - any persons who on or after 30 September 1991 carries on any enterprise and whose total value of taxable supplies (taxable turnover) does not exceed R150 000 in any 12 month period.

Every registered vendor is obliged to furnish the Receiver of Revenue with a VAT 201 return which must be submitted within the period ending on the 25th day of the month, following the month in which the tax period ends together with any payment due.

The VAT 201 return is used to calculate the VAT payable by or refundable to the vendor. Where a vendor's output tax (i.e. VAT charged on supplies of goods or services) exceeds his input tax (i.e. VAT paid or payable by a vendor on goods or services which are acquired for the purpose of making taxable supplies) the difference is the VAT payable by the vendor.Where the input tax exceeds output tax for any period a refund will be paid to the vendor

An input tax credit may only be claimed as a deduction against output tax, if the following conditions are met:

• The input tax was paid and invoiced by a registered vendor.
• A tax invoice/agreement is in the vendor's possession.

Because every vendor within the production and distribution chain is liable for VAT but claims the amount of tax paid in respect of inputs by setting it off against its output tax, the total amount of tax is collected by the Receiver of Revenue at the final stage of consumption. The end consumer is therefore actually paying on the value added hence the term Value-Added Tax.

Supplies:

• Taxable supply
• Exempt supply.

Taxable supply is any supply of goods or services in the course or furtherance of an enterprise subject to tax at one of the two rates:

• Standard rate, currently 14% (10% prior to 7 April 1993).
• Zero-rate (i.e. 0%).

Zero-rated supplies

Zero-rated supplies are certain taxable supplies, taxed at a rate of 0%. These supplies relate mainly to the exportation of goods or services and also to certain basic foodstuffs sold locally.

Goods at zero-rate:

• Movable goods exported.
• Goods supplied in the course of repairing goods temporarily imported into the Republic.
• Goods supplied under a rental agreement for use in an export country.
• Supply of an enterprise as a going concern.
• Supply of unwrought gold to registered banks.
• Certain goods supplied for pastoral, agricultural or other farming purposes.
• Fuel levy goods (e.g petrol, diesel but not paraffin).
• Crude petroleum oil, oils to be refined and anti-knock preparations added.
• Certain foodstuffs.
• Goods transferred to a branch situated in an export country.
• Gold coins issued by the Reserve Bank but excluding any form of jewelry.

Services at zero-rate:

• Transport of passenger or goods if:
  • service is rendered outside SA
  • inside SA to an export country
  • outside SA to SA
• Air travel within SA forming part of an international journey (international carriage).
• The supply of transport within SA and ancillary transport services supplied as part of the international transportation of goods.
• The insuring and arranging of the above.
• Services comprising the transport of goods or any ancillary transport services supplied directly in connection with the exportation/importation of goods or the movement of goods through SA if the person to whom the services are supplied is:
  • not a resident of SA, and not a vendor
• Services in connection with land situated in an export country.
• Services in respect of movable goods situated in an export country or temporarily admitted into SA.
• Certain services rendered to foreign-going ships/aircraft containers if person is not a resident of SA, and not a vendor.
• Arranging of certain activities for a non-resident, not registered as a vendor.
• Repairs to trains operated by non-residents.
• Services physically performed outside SA.
• Services supplied for the benefit of and contractually to a person who is a non-resident of SA and is outside SA at the time the Services are rendered.
• Use of rights outside SA.
• Services supplied by a welfare organisation to a public or local authority.
• Services rendered to a branch situated abroad.
• Payment received from public authorities.

Any vendor applying rates of zero percent must obtain and retain documentary proof of his entitlement to apply the zero rate.
         
Exempt supplies

Exempt supplies are supplies of goods or services on which VAT is not chargeable at either the standard or zero rate. Exempt supplies are not taxable supplies and do not form part of your taxable turnover. If a person only makes exempt supplies, the person may not be registered as a vendor for VAT purposes. VAT incurred on any goods or services acquired in order to make exempt supplies may not be claimed as an input tax credit.
                 
Exempt supplies are:

• Financial services.
• Donated goods or services supplied by an association not for gain or any other goods made/manufactured by such association if at least 80% of the value of the materials used in making/manufacturing such other goods consists of donated goods.
• The letting of a dwelling for use as private resident but excluding commercial rented establishment.
• The supply of leasehold land by way of letting to the extent that the land is used principally for accommodation in a dwelling on that land.
• The supply of fixed property situated outside South Africa.
• The services of sectional title body corporates and share block companies.
• The transportation of fare-paying passengers and their personal effects by road or rail.
• Educational services when supplied by the State including any provincial administration or any institution of a public character.
• Services rendered by employee organisation to the extent that the consideration for such supply consists of membership contribution.

Employees Tax:
 
Employees Tax is a system of tax collection whereby employers are obliged by law to deduct tax from the salaries or wages that they pay to their employees. The tax so deducted is paid by the employer to the Receiver of Revenue on behalf of his employees. The object of the Employees Tax system is the deduction of tax from salaries or wages on a regular basis so that the income tax payable on such income is set aside while it is being earned.

The advantage of this system to employees is that payment of tax is spread over the whole year so that it will not be necessary for them to pay a lump sum to settle their tax indebtedness at the end of each year of assessment It is your duty as an employer to register with your local Receiver of Revenue as soon as you take persons into your employ. Upon registration the Receiver of Revenue will provide you with a set of tables according to which tax must be deducted the tax thus deducted is known as Employees Tax.

You as an employer however require certain information from your employees to enable you to determine according to which deduction table Employees Tax should be deducted from each employee. In this regard it is important that you obtain the relevant personal information from your employees.

At the end of each year of assessment you must issue an IRP5 certificate to each employee from which Employees Tax (PAYE) has been deducted. The IRP5 certificate is proof that tax was in fact deducted from the salaries and wages of your employees. Your employees will require this certificate when completing their annual income tax returns. If during the course of the year of assessment an employee leaves your service, you must immediately issue him with an IRP5 certificate on termination of service.