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Sole Proprietor or Company: What's Best for Tax?

Posted 31 May 2016 under Tax


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Getting a new business venture off the ground is an equally exciting and stressful time. You’re enthusiastic about getting your new product or service out into the market, but you face quite an administrative process to get it off the ground legally.

A decision that often stumps many small business owners is whether to operate as a sole proprietor or as private company, a PTY Ltd. We receive many questions about this from entrepreneurs wanting to know the tax implications of each route. 

So let’s first have a look at an overall comparison of the two entities.

Key Differences Between a Sole Proprietor and PTY Ltd

 

Sole Proprietor

PTY Ltd / Company

Legal Entity

Owner and business are the same legal entity.

Company is a separate legal entity.

Liability

The sole proprietor is personally liable for all the business’s debts.

Shareholders have limited liability meaning that should the company become insolvent, creditors can’t claim from the shareholders in their personal capacity.

Business Registration

No legal requirement to register business.

Company needs to be registered with CIPC (Companies and Intellectual Property Commission).

Annual returns need to be filed with CIPC together with annual fee for continued registration.

Tax Registration

Owner to be registered with SARS as a provisional taxpayer and pay tax twice a year on estimated business profit.

Company must be registered with SARS as a provisional taxpayer and pay tax twice a year on estimated business profit.

Tax Rate

Owner is taxed on the profits at the applicable personal income tax rate.

Company profits are taxed at flat rate of 28% (unless the company qualifies as a SBC or Micro Business registered for Turnover Tax).

Tax Returns

Business profits are included in the owner’s individual tax return (ITR12) under the “Local Business, Trade and Professional Income” section.

Company needs to file a Company Tax Return (ITR14).

Dividends Tax

Not subject to dividends tax.

Dividends tax is paid by the company and levied at 15% on distributions to shareholders.

Financial Statements

Not required.

Financial statements need to be compiled by an Accounting Officer and submitted to SARS when ITR14 is filed.

PAYE

Sole proprietor’s drawings not subject to PAYE.

Must be registered for PAYE if there are employees.

Company must register as an “employer” with SARS and a director’s salary is subject to PAYE deductions.

VAT Registration

Requirement to register for VAT when turnover for a twelve-month period is R1m or more.

Requirement to register for VAT when turnover for a twelve-month period is R1m or more.


As you can see from the above, the sole proprietor route is less administrative-intensive to start, but you do take on much more personal risk than that of a company director. But let’s hone in on the tax element, shall we? After all, you’d want to select the best way to structure your business in order to be the most tax efficient, wouldn’t you?

How Do I Run My Business in The Most Tax Efficient Way?

The answer boils down to the level of earnings you expect from your business.

Individuals are taxed on a sliding scale, which means that the rate of tax you pay increases as your earnings increase. This is called a progressive rate of tax and applies to any individuals earning more than R75,000 per year.

As an individual, you benefit from the general tax rebate, which brings down the amount of tax you owe by a flat amount, depending on your age. If you’re under 65 years, this is called the primary rebate. There’s a secondary rebate for those over 65 years and a tertiary rebate for those over 75 years.

In a company, profits are taxed at a rate of 28%, irrespective of value. In addition, dividends tax is levied at 15% on profits retained in the company and distributed as a dividend in the future.

Let’s do a worked example of the difference this makes on R100,000 profit between a registered company and a sole proprietor’s tax position.

We’ll assume that ABC PTY Ltd didn’t pay out any profit in the year, and distributes a dividend the following year.

ABC PTY Ltd annual taxable income R100,000
Company tax at 28% (R 28,000)
Net profit R72,000
Dividends tax at 15% (15% x R72,000) R10,800
Effective rate of tax (R28,000+R10,800) / R100,000 38.8%


Now, let’s look at the same situation for Lerato, a sole proprietor.

Lerato’s annual taxable income R100,000
Individual tax at 18% (SARS table for R100,000 per annum) R18,000
Less Primary rebate (R13,500)
Total tax (R18,000 – R13,500) R4,500
Effective tax rate (R4,500 / R100,000) 4.5%

While we showed the full worked example above, you can take a short cut by using TaxTim’s Income Tax calculator!


In our example above, Lerato’s effective tax rate of 4.5% is significantly lower than ABC PTY Ltd’s at 38.8%. What we must remember though is that as Lerato’s business grows and becomes more profitable, she’ll move into higher tax bracket, increasing her effective rate of tax.


Let’s do another example, but this time where the taxable income is R1,000,000 for the tax year. How does the tax situation change for Lerato?


Our company this time, XYZ PTY Ltd, has a sole Director, Billy, who draws an annual salary of R360,000 (or R30,000 per month). This amount is deducted before corporate tax is applied.

XYZ PTY Ltd income before Director’s salary R1,000,000
Director’s salary (R360,000)
XYZ PTY Ltd’s annual taxable income R640,000
Less corporate tax of 28% (R179,200)
Retained earnings R460,800
Dividend Tax on future pay out at 15% R69,120


As Billy is drawing a salary of R360,000, he’ll be liable for individual tax on this amount.

Tax on salary as per TaxTim’s Income Tax Calculator
R68,380

Therefore, the total tax paid:

XYZ PTY Ltd corporate and dividends tax (R179,200 + R69,120) R248,320
Billy’s individual tax R68,380
Total tax R316,700

Now let’s have a look at Lerato’s tax for an income of R1,000,000 for the year. This amount puts Lerato into the 41% tax bracket, as per SARS tax tables for individuals.

Total tax as per TaxTim’s Income Tax Calculator
R315,931


Lerato is paying R69 (R316,700-R315,931) less tax in her own capacity than if she was operating through a company and drawing a salary of R30,000 per month.

As there are numerous other deductions and allowances to consider for both an individual and a company, we’d have to perform detailed calculations for both scenarios to determine which is truly more tax efficient.

What is evident though, is that as an individual earns more and moves into the highest tax bracket, the difference in tax between a company and a sole proprietor decreases. At lower levels of taxable income, it’s far more tax efficient to operate as a sole proprietor and enjoy the benefits of sliding tax tables and rebates available to individuals. At higher income brackets, it’s likely that company registration would be more beneficial.



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Hi, I'm Tim!
I'll help you do your Tax Return with Confidence
Quickly, Easily
And Correctly
Do your Tax Online with Expert Help from Me, Step-by-Step.
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