Entrepreneurs and small businesses play an important role in our economy, particularly to combat unemployment. Government has recognised that is unrealistic to expect small businesses to pay the same level of taxes as more established businesses. This led to the introduction of two favourable tax regimes available to certain small businesses.
Small business corporations
The more well-known of the two regimes is the “small business corporation” (commonly abbreviated as “SBC”) as defined in the Income Tax Act. An SBC benefits from a reduced income tax liability through reduced income tax rates and accelerated depreciation allowance for movable assets.
Most companies pay income tax at a flat tax rate of 28% on their taxable income. SBCs, on the other hand, can benefit from a reduced tax liability if their taxable income does not exceed R550 000 in a year of assessment. For 1 April 2017 to 31 March 2018, qualifying SBCs will not pay tax on the first R75 750 taxable income. Thereafter, the SBC will pay tax at a progressive rate starting at 7%, 21% of taxable income exceeding R365 000 and 28% on taxable income exceeding R550 000. SBCs may also qualify for accelerated depreciation allowances against taxable income.
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If a qualifying SBC owns plant or material and uses it directly in a process of manufacture or similar process, the SBC may reduce its taxable income by the full cost of the plant or machinery in the year of assessment in which it is brought into use for the first time.
An SBC may elect to apply accelerated deprecation rates to other movable assets, which would ordinarily have been regarded as wear and tear or depreciation. An SBC may choose to reduce its taxable income by 50% of the cost of the asset in the first year of assessment during which the asset is first brought into use, 30% of the cost in the second year, and 20% in the third year.
Not all small businesses qualify as SBCs. The following entities may qualify as an SBC: a close corporation, a co-operative, a private company and a personal liability company, if at all times during the year of assessment all of the shareholders or members of that entity were natural persons.
Additional requirements that must all be met to be regarded as a SBC, include:
- The entity’s gross income may not exceed R20 million for the year of assessment
- No member or shareholder of the entity may, at any time during the year of assessment, hold any shares or have any interest in the equity of another company, other than certain specific exceptions which include listed companies, collective investment schemes and others
- Not more than 20% of the total receipts or accruals and capital gains of the entity may consist collectively of “investment income” and income from the rendering of a “personal service”
- The entity may not constitute a “personal service provider” as defined for tax purposes.
The term “personal service”, for purposes of the SBC regime, is defined to include a wide array of professions, including:
- any service in the field of accounting, actuarial science, architecture, auctioneering, auditing, broadcasting, consulting, draftsmanship, education, engineering, financial service broking, health, information technology, journalism, law, management, real estate broking, research, sport, surveying, translation, valuation or veterinary science, if
- that service is performed personally by a person who holds an interest in the entity; and
- that entity does not throughout the year of assessment employ three or more full-time employees (other than a shareholder or member or a connected person in relation to a shareholder or member) who are on a full-time basis involved in the business of the entity of rendering that service.
If an entity (in a year of assessment) employs three or more full-time employees (other than a shareholder or member or a connected person in relation to a shareholder or member) who are on a full-time basis involved in the business of the entity of rendering that service, it will not be regarded as rendering a “personal service” and will not be regarded as a “personal service provider”.
A company, co-operative, close corporation or personal liability company should therefore carefully consider compliance with the requirements and, if so, take advantage of this favourable tax regime.
Turnover tax payable by registered micro businesses
Businesses are not only burdened by their actual income tax liability, but also by their tax compliance obligations in this regard. This led to the introduction of an optional simplified tax system for registered micro businesses in terms of the Income Tax Act, known as the turnover tax regime.
The turnover tax regime allows qualifying micro businesses to register for and pay a single tax known as turnover tax instead of various other taxes. The turnover tax replaces income tax (including provisional taxes and capital gains tax) and to an extent dividends tax. A micro business is still required to withhold payroll taxes and VAT (if voluntarily registered as a VAT vendor).
Turnover tax is calculated by applying the relevant turnover tax rates to the taxable turnover of the micro business as determined. For any year of assessment ending on or within the 12-month period before 28 February 2018, registered micro businesses will pay no turnover tax on a taxable turnover not exceeding R335 000.
A turnover tax will apply to 1% of the taxable turnover exceeding R335 000, 2% of the taxable turnover exceeding R500 000, and 3% of the taxable turnover exceeding R750 000.
Registered micro businesses also benefit from reduced record-keeping requirements and only need to retain information relating to the following:
- Amounts received during a year of assessment;
- Dividends declared during a year of assessment;
- An asset with a cost of more than R10 000 at the end of a year of assessment; and
- A liability that exceeded R10 000 at the end of a year of assessment.
As with SBCs, micro businesses are subject to strict requirements of registration. The turnover tax is available to individuals (sole proprietors or partners in a partnership), close corporations, co-operatives or private companies, if their qualifying turnover (as determined) does not exceed R1 million in a year of assessment.
Certain persons are disqualified as micro businesses, including:
- Persons holding shares or having any interest in the equity of a company, other than certain specific exceptions which include listed companies, collective investment schemes and others;
- If more than 20% of the total receipts during a year of assessment consists of income from the rendering of a “professional service” (for natural persons) or the aggregate of “investment income” and income from the rendering of a “professional service” (for companies);
- If the proceeds from the sale of certain capital assets used mainly for business purposes exceed R1,5 million over a three-year period;
- Companies with a year-end other than the last day of February;
- If any of the partners, members or holders of shares are not natural persons in a year of assessment;
- Personal service providers and certain labour brokers;
- Public benefit organisations, recreational clubs, associations and small business funding entities; and
- Special rules apply to partnerships.
The term “professional service”, for purposes of turnover tax, includes the same array of professions as for the SBC regime, for example a service in the field of accounting, actuarial science, etc. However, for turnover tax, no exception applies for businesses rendering professional services that employ three or more full-time employees.
Businesses rendering professional services, although they will not qualify for turnover tax, may possibly qualify for the SBC regime, provided they employ three or more full-time employees in addition to meeting the other criteria of qualifying as a SBC.
The turnover tax regime does seem to significantly reduce the tax compliance burden of certain small businesses. It may not be the best option for every small business as it imposes tax on a turnover basis as opposed to a taxable income basis – thus affording lower tax rates but without taking into account exemptions or deductions that would otherwise have reduced taxable income.
We understand that very few businesses are registered as micro businesses on the turnover tax system. This could be ascribed to the determination of whether a business meets the registration requirements.
Author: Esther van Schalkwyk