Tax treatment of small businesses

Starting a business can be an overwhelming process, as there are many factors to consider. One of these is the tax treatment of your business, which depends on the structure of your business and the type of entity you establish.

In this article, Lana Visser, certified financial planner at Fiscal Private Client Services, looks at these different types of entities, how they are taxed, and the qualifying criteria for the tax treatment of small businesses.

Sole proprietor

A sole proprietor is the simplest form of ownership. It is simple to establish, there are very few legal requirements to get started, and the owner has the freedom to make all business decisions without needing to consider any other stakeholders. In this case, there is no separate legal entity, and all business income is declared in the owner’s personal tax return. The owner therefore enjoys all of the profits of the business, but is also liable for all business debts.

Partnership

A partnership is similar to a sole proprietorship in that it is not a separate legal entity, but rather an agreement between two or more parties to carry on a trade. Each partner has a personal interest in the business and all income, debts and profits are shared between the partners in this same proportion. From a tax point of view, each partner’s portion of the income is declared in their own personal tax returns. For example, Sarah and Thandi own a business together. Sarah has a 40% interest in the business and Thandi 60%. For the 2023 tax year, the business taxable income was R500 000. Sarah will declare business income of R200 000 in her tax return and Thandi will declare business income of R300 000. Each of them will be taxed on this income at their own marginal tax rate.

Private companies

A private company is a registered business and is treated as a separate legal entity. It has its own company registration number and also needs to be registered with the South African Revenue Service (SARS) in order to obtain its own tax registration number. A tax return must be submitted in the name of the business, and income is not included in the personal tax returns of the owners. In general, companies are taxed at a flat rate of 27% on its taxable income for the tax year. This is for income tax purposes, and other tax rates apply for dividends or value added tax, for example. There are, however, some exceptions for how income tax is treated in smaller businesses that meet specific criteria.

Small business corporation (SBC)

The taxable income of a SBC is taxed according to a sliding scale in which the first R91 250 is tax-free, and the next brackets are taxed at 7%, 21% and 27%. In order to qualify as a SBC, the following criteria must be met in each tax year:

• All shareholders must be natural persons, i.e. no shares can be owned by a trust or another company.
• No shareholders should hold any shares or business interest in any other businesses.
• The gross income of the business may not exceed R20 million in a tax year.
• The investment income and income derived from the rendering of a ‘personal service’ may not exceed 20% of total income within a tax year.
• The company may not be a ‘personal service provider’.

This list is quite lengthy and can be found in the Income Tax Act. It is best, however, to consult a tax practitioner for assistance and advice.

Let’s consider Sam, Sheldon and Susan, who are shareholders of a small business that operates as a boutique fashion store, Triple S. For the 2023 tax year, the gross income was R500 000, of which R75 000 was interest income from fixed deposits (i.e. investment income). As each of the shareholders are natural persons and do not own shares in any other businesses, Triple S qualifies as a SBC. Their taxable income for the 2023 tax year was R320 000, of which the first R91 250 is tax-free, and the balance is taxed at 7% – resulting in tax of R16 012.50.

Besides income tax being levied according to a sliding scale, there are other tax advantages for being a SBC, such as the write-off of assets directly involved in the manufacturing process and accelerated write-off allowances for other various assets, etc.

Micro businesses

This business type, which is based on turnover tax, is not only applicable to companies but also to sole proprietors and partnerships. It is a simplified tax system for businesses with a ‘qualifying turnover’ of R1 million or less for the tax year. Income tax is then calculated on the turnover of the business rather than profits, and is based on a sliding scale where the first R335 000 of taxable turnover is tax-free.

Qualifying turnover is the total amount that a business receives within a tax year for the carrying on of business activities. Receipts of a capital nature, such as the sale of an asset, as well as certain government grants are excluded from qualifying turnover. So if the business turnover for the tax year is R850 000, but an asset is sold for R300 000, the qualifying turnover still falls below the R1 million threshold. Note that qualifying turnover is used to determine if your business is eligible for turnover tax, but the tax payable is still calculated on the taxable turnover.

In addition to the qualifying turnover requirement, there are several other qualifying criteria that must be met. This includes the need for the business to not be a ‘personal service provider’, income from personal services and investments combined should not exceed 20% of total income for the tax year, and the business should not have sold assets where the total sale proceeds exceed R1.5 million over the last two years, etc.

It is important to note that once you determine if your business qualifies for these tax treatments, that you register with SARS to ensure your business is taxed correctly. As always, it is important to consult an accountant and a tax practitioner to assist and provide advice regarding the taxation of your small business and to find out what deductions and allowances are available to your business.

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