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Sole trader vs. Close Corporation/Company – how do I make the right choice? - RKH Accounting CC blog

Sole trader vs. Close Corporation/Company – how do I make the right choice?

You took that GIANT step and have started your own business. For months, or in some cases years, you have been thinking about it and now you finally did it! You are willing to risk it all to do what you love. All your doubts and fears have been overcome and today you are known as, what the rest of population describe as a “lucky few”, a business owner.

Now you are a business owner and with it comes much more responsibility than to deliver, excellent products and services to clients. Delivering those top class products and services is a big responsibility on its own and now, on top of it all you need to think like a business person as you have bills to pay and also need to survive financially. Everyone will agree that living expenses are high and therefore business owners should grab every opportunity to save money. By managing your business finances better, this is possible.

Last time, we spoke about how you can reduce your business taxable income when calculating tax. We discussed that the lower your business taxable income is, the less tax the business will have to pay to SARS. The question now is, “at what % does your business get taxed?” To answer to this question, we first need to answer another question, which is, “as what kind of business entity does your business operate?”

The three most popular business forms that we get in South Africa are:

  1. Sole trader (also called Sole Proprietor)
  2. Close Corporation (CC)
  3. Company

I will start to discuss and point out advantages and disadvantages of these 3 business forms, before I show the tax implications that each business form has.

  1. Sole Trader (Sole Proprietor)

A sole trader is legally classified as a natural person (“living and breathing” human beings). A person running his/her own business (that did not register a CC/company) is a sole trader.

Advantages

  • Easy and cost effective to set up
  • There is no formal registration involved
  • You are not obligated to appoint an accounting officer/ auditor
  • You are not obligated to hand in annual financial statements at the CIPC signed off by the appointed accounting officer/auditor
  • You qualify for tax rebates (not applicable for CC/companies)
  • Conversion to a company is relatively easy

Disadvantages

  • The owners’ personal assets (house/motor vehicle etc.) are not separated from those of the business.  This means that if your business goes bankrupt that any organisation that the business owes money to can claim the owner’s personal assets to pay the debt.
  • The trading name lacks legal protection, although it may be registered as a trademark.  That does not however stop anyone else to register a company with the same name.
  1. Close Corporation (CC) & Companies

Important to mention here is that a new companies act came into effect in South Africa on 1 May 2011. From this date onwards no new CC’s can be registered. All existing CC’s will continue to exist until the members of the CC decide to either de-register the CC or convert the CC into a company. The choice lies with the owners.

Advantages

  • The assets and liabilities of CC’s & Companies are separate from the owners’ personal assets. This means that if the business goes bankrupt, creditors can only claim assets owned by the CC or company and not claim personal assets of the owner. (note however that if the owner signed surety in his/her personal capacity that debt collectors can then come after personal assets)

Disadvantages

  • Expensive and complicated to set up. Best is to use an accountant or auditor to handle the registration process.
  • Financial statements have to be compiled annually and signed off the appointed accounting officer/auditor
  • Depending on the size and shareholding of the company it may need to be audited, which can cost a couple of thousands...
  • When registering a company you might be appointed as a director of the company, which places further legal obligations on your shoulders.

How is tax different from a sole trader and CC/Companies?

Sole Trader

If you are trading as a sole trader, the taxable income of the business for the tax financial year gets added to all your personal taxable income and gets taxed according to tax tables. This means that the more you earn the higher the tax rate (maximum of 40%). Every year the minister of Finance has a budget speech in February and these individual tax tables get adjusted accordingly. The tax tables for individuals are as follow for the tax year 2014 {1 March 2013 – 28 February 2014}:

Should you earn taxable income for the year below a certain amount, you are exempt from paying any tax. The tax thresholds for the 2014 tax year are as follow:

Annual taxable income earned of R 67 111 and below (persons under the age of 65 years)

Annual taxable income earned of R 104 611 and below (persons 65 years and under 75 years)

Annual taxable income earned of R 117 111 and below (persons 75 years and over)

Close Corporations (CC)/Companies

For CCs/Companies, SARS has form 2 main groups:

  • SMEs (Small Medium Entities)
  • Non-SMEs

The main reason for dividing CCs/Companies into these groups is to give some tax relief to SME-business owners. The government wants to encourage entrepreneurs to start businesses and keep doing business in the SME-market as this creates jobs.

For a CC/Company, whose main business is to earn income from photography the following criteria has to be met in order to qualify as an SME:

  • All shareholders or members are natural persons who hold no shares in any other private companies or members’ interest in any other close corporation throughout the year of assessment.
  • Gross income for the year of assessment does not exceed R20 million (In 2013 the gross income was R 14 million)

Should your CC/Company (whose main business is to earn income from photography) meets both the above criteria and therefore qualifies as an SME you will be taxed as follows:

(For years of assessment ending between 1 April 2013 and 31 March 2014)

If your CC/Company does not meet the criteria of an SME, then the total taxable income for the year will be taxed at 28%.

Dividends tax

Currently in South Africa a dividends tax rate of 15% is applicable.  Any CC/Company that declares a dividend to a member/shareholder is obligated to pay over withholding dividend tax.

One tend to only compare the normal tax rates applicable and at a quick glance it might look like that tax rates for CC/Companies are more beneficial than for sole traders (as taxable income increases, maximum tax rate for a sole trader is 40% vs. 28% companies tax rate) but don’t forget that when a CC/Company declares a dividend that there is an additional 15% dividends tax rate applicable on the dividend that gets declared.

To sum up

I know this was a mouth full!  Phew!   There is a lot of technicality involved in deciding whether your business should trade as a sole trader or company.  Every photographer’s business is unique and should be assessed individually to see which business form fits the best (from a legal and tax point of view), thus with the facts on the table, consult your accountant or auditor to make sure you are in fact doing what is best for your business.   Find the right balance between legal protection and saving tax.

My advice:  If you are a one-owner business and is still fairly in the beginning, don’t overkill your admin responsibilities.  When your business starts growing, income is increasing, then only start looking at registering your business.