Your small business is doomed to fail without proper tax compliance

South Africa

Starting a business can be a daunting task for anyone, especially first time owners. For the youth month and Micro-, Small and Medium-sized Enterprises Day, we'd like to put together an article for young entrepreneurs advising them about legal requirements one needs to meet in order to set up a company in South Africa, and how to put all the necessary legal requirements to preempt potential issues that may arise in the future ie. keeping your tax issues up to date, ensuring all necessary steps are followed and adhered to when employing people and when entering trade contracts with other companies etc.

SMMEs – the hope of our youth

Every year, June marks as a very important month in the lives of South African young people. June 16 is a reminder of the sacrifices made by the youth in 1976 during the Soweto uprising protesting against the use of Afrikaans as a medium of instruction under the Apartheid Regime.

South Africa’s youth remain vital and integral part in growing  South Africa’s economy. Almost 25 years later, and South Africa’s youth still face many challenges including unemployment. Recently, Statistics SA published South Africa’s unemployment figures, which recorded a staggering unemployment rate of 32,6%. Added to this is of course the challenges that COVID-19 has brought alongside it to our youth.

But it's not all doom and gloom for all. Many young people have embraced their entrepreneurial thinking and ideas and have chosen to embark on opening their own businesses and entrepreneurial pursuits in the form of companies and small, micro, and medium enterprises (SMMEs).

 Starting a new business comes with its tax requirements as prescribed by the various tax laws. One of the biggest challenges that our youth faces when setting up their own business is taxpayer education and compliance, which can negatively impact the cost of doing business.  

For most businesses, getting to a fully tax compliant status can be time-consuming and burdensome. However, this is vital for SMMEs as non-compliance may lead to loss of revenue, penalties, and interest being imposed by the South African Revenue Services (SARS).  

Tax compliance is important for a number of reasons especially when dealing with government and business entities that require a Tax Compliance Certificate for purposes of letters of good standing for tenders in the private and public sector.

Being tax compliant shows to potential clients and customers that the SMME :

  • Has no outstanding tax returns

  • does not owe any money to SARS

  • is registered for all taxes and

  • understands the importance of compliance with the country's laws.

To be tax compliant, SMME’s must ensure that there is proper accounting in the business relating to:

  • Expenses and disbursements

  • Income and receipts

  • Preparation and submission of tax returns

Each type of business is subject to different tax requirements and understanding each tax type is important to understand the underlying compliance requirements. 

Where a person under his or her own name as a sole proprietor, his/her income is included in his/her own personal income tax returns. As such, a sole proprietor must register for his/her personal income tax with SARS, and the business income will form part of the individual's income tax return.

Similarly, in the case of a partnership, each partner is taxed separately based on their contribution and income from the partnership and their income will be reflected in their personal income tax returns. Sole proprietorship and partnerships are taxed on the Individual tax tables.

Interestingly, according to the 2020 Tax Statistics published by SARS in December 2020, personal income tax is the main source of tax revenue in South Africa, making up 39% of the tax revenue in South Africa.  Corporate tax, however, is the third-largest contributor to tax after Value Added Tax (VAT), with over 2 million companies registered as of March 2019.

A company will automatically be registered for corporate income tax with SARS and will have to declare corporate income tax annually. In addition, and where applicable, the company may also be required to register for VAT and Pay as you earn (PAYE) and will be liable for these taxes.

There are a number of tax incentives available to qualifying small businesses. These include Turnover Tax, Small Business Corporation (SBC) Tax, and Employment Tax Incentives (ETI’s).

Turnover tax is a  tax incentive that was introduced for micro-businesses with a qualifying annual turnover of R1 million or less which includes sole proprietors, partnerships, close corporations, and companies.

The turnover tax incentive for micro-businesses not only reduces the record-keeping requirements but also simplifies the tax obligations for new business owners and SMME’s. Turnover tax incentive enables a micro business to pay a single tax to SARS, instead of paying separate taxes such as income tax, VAT, provisional tax, capital gains tax, and dividends tax.

Small businesses with an annual turnover of less than R1 million can register for Turnover Tax for a single tax system, which replaces Income Tax, VAT, Provisional Tax, Capital Gains Tax, and Dividends Tax reduces the administrative burden which enables taxpayers to pay a single tax. The qualifying businesses will declare and pay a single tax and will have a tax liability when the annual turnover exceeds R335 000. For other businesses, the tax liability is based on the flat corporate income tax rate of 28% due at the end of their year of assessment. 

Companies are liable for tax at a rate of 28%.  As an added measure of relief, it was announced in the 2021 Budget Speech that the corporate income tax rate will be lowered to 27% for the years of assessment commencing on or after 1 April 2022.

The second type of incentive for SMME’s is SBCs, which allows qualifying businesses to pay reduced favourable tax rates.

The following requirements must be met by companies in order to qualify as SBC’s:

  • The business must be a qualifying business which includes close corporations, co-operatives, private companies, and personal liability companies

  • The gross annual income of business must be less than R20 million in the relevant tax period

  • The member or shareholder of the business do not hold any shares or have any interest in another company (subject to certain exclusions)

  • The business is not a “personal service provider”

  • The business receipts or accruals  are limited to 20% of “investment income” and the income derived from the provision of a “personal service.”

SBC’s with annual turnovers of not exceeding R20 million may qualify for reduced tax rates depending on a sliding scale. For the period 1 April 2021 and 31 March 2022, SBC’s will pay 0% tax if their taxable income is less than R87 300. Thereafter, there are reduced tax rates on a sliding scale of 7% and 21% on taxable income up to R550 000.  Reduced rates for SBC’s will automatically apply when completing the income tax return provided that all the requirements are met. For example, to qualify for this reduced tax rate, the shareholders of the SBC must be natural persons throughout the year of assessment.

VAT compliance can be challenging for many SMMEs. Not only does VAT have increased administrative requirements, but is it is also burdensome on the business' books. This is due to the fact that the business has a VAT liability based on its sales before it can be recovered. This is particularly true for companies who rely on the government as clients to run their business operations as their invoices often get paid late. This in turn delays VAT credit refunds from SARS which negatively impacts the business's cash flow.

Businesses with a turnover of over R1 million must register for VAT with SARS. Businesses with an annual turnover of less than R1 million may voluntarily register for VAT. A business registered for VAT will be required to charge 15% VAT on the taxable supplies of goods and services.

Companies with one or more employees will be required to also register for PAYE and will also be liable for Skills Development Levy (SDL) and Unemployment Insurance Fund (UIF)contributions to SARS.

PAYE is a tax that is deducted by an employer from an employee’s salary on a monthly basis. SDL is a tax imposed to encourage learning and developing skills of employees and is levied at 1% of the total amount paid in salaries to employees. An employer must also register for UIF contributions with SARS and withhold 1% of the remuneration paid to an employee, while the employer must contribute another 1%.

A business is liable to deduct or withhold PAYE, SDL, and UIF on a monthly basis which must be paid over to SARS. Employers must also complete a monthly employer declaration (EMP201) based on the above-mentioned tax allocations.

Due to the challenges brought upon by COVID-19, additional tax relief was introduced to assist employers to provide financial stability to their employees. This included a 35% deferral on the PAYE liability for the period April to August 2020. Furthermore, government provided a tax holiday on SDL payments for the same period.

SMMEs are encouraged to ensure that all their returns are prepared and submitted timeously and in an accurate manner, failing which SARS may levy interest and penalties on late and inaccurate income tax returns. In addition, it may be difficult for these SMMEs to tender for new work and expand their client base if their tax affairs are not in order as they will not be able to obtain tax clearance certificates from SARS. As such, being tax compliant is rather an important key factor in determining the business' success.

While the lockdown has negatively impacted our youth, it has also encouraged our youth to step of their comfort zones and start their own businesses. This has resulted in new goods and services, production methods, productivity, and competition in South Africa and various global developments. The government has also devoted its efforts into assisting SMMEs during the lockdown by launching the COVID-19 Business Rescue Initiative.

ETIs is another tax incentive introduced encouraging employers to hire young work seekers and reduce the unemployment rate in South Africa. ETI’s which enables taxpayers to pay a reduced amount of PAYE by claiming a deduction on the PAYE amount. ETI’s apply to every employer that is registered for PAYE, provided that the followed  

As an added advantage for new SMME owners will be allowed to claim a deduction on the PAYE, provided that the following requirements are met:

  • The employer is registered for PAYE or must be eligible to register for PAYE

  • The employer is not in the national, provincial or local sphere of government

  • The employer is not a public entity listed in Schedule 2 or 3 of the Public Finance Management Act (other than those public entities designated by the Minister of Finance by Notice in the Gazette)

  • The employer is not a municipal entity

  • The employer is not disqualified by the Minister of Finance due to the displacement of an employee or by not meeting the conditions as may be prescribed by the Minister by regulation.

SMMEs and young entrepreneurs play a crucial role in South Africa as a developing nation and contributions 27 June is celebrated internationally as Micro, Small, and Medium-sized Enterprises Day by the United Nations to raise awareness and celebrate among others SMMES’s in their contribution towards sustainable development and the global economy.

SMME’s can ensure that they are tax compliant by seeking advice from professionals to understand their tax obligations, and to assist with the submission of their tax returns. Investing in a good accounting system appropriate for the size and type of business ensures that all invoices, payments, and expenses are recorded and tracked in an automated manner. Lastly, taxpayer awareness is important, especially the understanding when each tax return is due.

More information about setting up a business may be obtained on the SARS and CIPC websites.