Author: Amanda Visser (Business Live)
Tax experts say small business owners have three options; a salary, dividends paid from after-tax profits and borrowing from the company.
Many people are under the impression that owning a business makes life easier. The harsh reality they tend to forget is that bosses have to finance themselves and everyone else working for them.
The decision on how to reward a business owner can be quite tricky, mainly because of the tax implications if the wrong choice is made. It could affect not only the bosses, but also those who are dependent on them for a living.
Tax experts say small business owners have three options; a salary, dividends paid from after-tax profits and borrowing from the company.
Chris Herbst, team leader at CH Consulting, says the option of using a loan account without paying a salary or a dividend “is almost never a good option. Some directors are under the impression that this option does not attract tax. They are wrong.”
The first factor to consider is the interest rate the company charges for the loan. In most cases, the company does not charge any interest.
Herbst says this implies that the owner is receiving a benefit due to the connection with the company. This equates to remuneration and, like everybody else, the owner must pay tax on the remuneration.
The Income Tax Act deems interest free or low-interest loans as a dividend. If the boss wants to take all the annual taxable profits, of say R400,000 as a loan, the company will pay 28% on the profits (R112,000).
If no interest was charged, the deemed dividend on R400,000 at 7.5% (the official rate of interest) will be R30,000. At 20% dividends, the withholding tax amounts to R6,000. The owner will be left with R282,000 and the South African Revenue Service (SARS) will get R118,000. The total effective tax rate will be 29.5%. But, says Herbst, the loan account for the following year will still be R400,000 if the owner does not repay it and the R6,000 dividend tax will again be liable.
Rodney Smith, director at Liandor Financial Accountants and board member of the South African Institute of Tax Professionals, says he also does not advocate loan accounts as a debit loan attracts an ongoing tax as a deemed dividend.
“The value of this deemed divided tax is currently quite low, but nothing prevents SARS from increasing this deemed tax in the future. I see this as a risk.
“Of greater concern is that a debit loan negates the separation between the estate of the firm and the estate of the owner,” he says.
In the case of insolvency, civil claims and employee claims, loans could effectively suck the personal estate of the owner into the pot available to the creditors, as the company will have a loan claim against the owner.
Herbst says his first option for business owners would be to extract a salary as an employee of the company. If the salary is R400,000 (the taxable profits of the company) it is important to remember that the first R195,850 will be taxed at 18%; the second portion of up to R305,850 will be taxed at 26%; and the third portion up to R400,00 will be taxed at 31%. However, the effective tax rate on the R400,000 is 23.24% and the tax payable on the salary of R400,000 will be R92,960.
If rebates or tax credits are ignored, the business owner will earn R307,040, SARS will receive R92,960 from the owner but no tax from the company because all the profits were paid as a salary.
“The main advantage for extracting the profit by way of salary is that the salary decreases the taxable income of the company by the amount of the salary,” Herbst says.
Bowmans tax partner Patricia Williams says the owner’s salary must be market related. If it is not, SARS may consider it to be excessive and disallow the deduction claimed by the company for the salary paid. “Also, a salary that is viewed by SARS as being too low, could give rise to SARS viewing the dividends paid by the company as being for services rendered, and not as a return to shareholders.
“In this case SARS may attempt to subject these dividends to income tax instead of dividends tax,” says Williams.
Another option for paying business owners is the deemed dividend. If it is R400,000, it will attract tax of R169,600 at a total effective tax rate of 42.4%. The company will pay 28% on the R400,000 leaving R288,000, which attracts dividend tax of 20% (R57,600).
Tax Audit Solutions head of global employment, expatriate tax advisory Shohana Mohan says there is no hard and fast rule when selecting a payment option. However, given the difference in tax rates for personal income taxpayers against the rate at which dividend withholding tax is applied, the most common extraction of income happens in the form of declaring dividends.
Mohan says each case is different and the choice made often depends on the business and personal circumstances.
Smith says he too would recommend a salary for business owners, who can maximise their contributions to pension funds and medical aid to reduce their taxable income.
He warns against buying a vehicle through the business accounts for personal use. Many have found the fringe benefit tax attributable to the vehicle to be “shocking and unaffordable”.
Williams says taxpayers often do not keep a proper record of their real business expenses, which are tax deductible, and include travel, entertainment, cellphone or internet expenditure.
This article first appeared on businesslive.co.za.
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