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Articles in Category: General

Provisional Tax Estimate - The Risk of using the Basic Amount

on Sunday, 06 August 2017. Posted in General, Tax

Provisional Tax Estimate - The Risk of using the Basic Amount

Many tax practitioners have reverted to the easy option of using the basic amount as an estimate for the first-period provisional tax estimate. Many tax professionals are also under the incorrect impression that this is within the ambit of the income tax act to use the basic amount as a first period estimate.

The actual purpose of the basic amount is twofold:
1. It serves as the minimum estimate.
2. It is used as a limit to calculate underestimation penalties if the taxpayer's assessed income it below R1 million.

A brief examination of the income tax law will substantiate statements one and two above:

Paragraph 19 of the Fourth Schedule of the Income Tax Act 58 of 1962:

19. (1)(a) Every provisional taxpayer (other than a company) shall, during every period within which provisional tax is or may be payable by that provisional taxpayer as provided in this Part, submit to the Commisioner (unless the Commissioner direct otherwise) a return of an estimate of the total taxable income which will be derived by the taxpayer in respect of the year of assessment in respect of which provisional tax is or may be payable by the taxpayer: Provided that such estimate will not include any retirement fund lump sum benefit, retirement fund lump sum withdrawal benefit or any severance benefit received by or accrued to or to be received by or accrue to the taxpayer during the relevant year of assessment.

(b) Every company which is a provisional taxpayer shall, during every period within which provisional tax is or may be payable by it as provided in this Part submit to the Commissioner (unless the Commission directs otherwise) a return of an estimate of the total taxable income which will be derived by the company in respect of the year of assessment in respect of which provisional tax is or may be payable by the company.

(c) The amount of any estimate so submitted by a provisional taxpayer (other than a company) during the period referred to in paragraph 21(1)(a), or by a company (as a provisional taxpayer) during the period referred to in paragraph 23(a), shall not be less than the basic amount applicable to the estimate in question, as contemplated in item (d), unless the circumstances of the case justify the submission of an estimate of a lower amount.

It is clear that the basic amount serves as a minimum estimate when
paragraph (a), (b) and (c) are read together.

An important point to note is that paragraph (c) does not absolve the taxpayer of the obligation to estimate the taxable income and instead fall back on the basic amount.

Paragraph 20 of the Fourth Schedule of the Income Tax Act 58 of 1962:

20. (1) If the actual taxable income, as finally determined under this Act, for the year of assessment in respect of which the final or last estimate of his or her taxable income is submitted in terms of paragraph 19(1)(a) by a provisional taxpayer other than a company, or the estimate of its taxable income in respect of the period contemplated in paragraph 23 (b) is submitted in terms of paragraph 19(1)(b) by a company which is a provisional taxpayer, in respect of any year of assessment is--

(a) more than R1 million and such estimate is less than 80 per cent of the amount of the actual taxable income for such year of assessment, a penalty, which is deemed to be a percentage based penalty imposed under Chapter 15 of the Tax Administration Act, equal to 20 per cent of the difference between--

(i) the amount of normal tax, calculated at the rates applicable in respect of such year of assessment and after taking into account any amount of a rebate deductible in terms of this Act in the determination of normal tax payable, in respect of a taxable income equal to 80 per cent of such actual taxable income; and

(ii) the amount of employees' tax and provisional tax in respect of such year of assessment paid by the end of the year of assessment;

(b) R1 million or less and the estimate is less than 90 per cent of the amount of such actual taxable income and is also less than the basic amount applicable to the estimate in question, as contemplated in paragraph 19(1)(d), the taxpayer shall, subject to the provisions of subparagraphs (2), (2B) and (2C), be liable to pay to the Commissioner, in addition to the normal tax payable in respect of his or her taxable income for such year of assessment, a penalty, which is deemed to be a percentage based penalty imposed under Chapter 15 of the Tax Administration Act, equal to 20 per cent of the difference between--

(i) the lesser of--

(a)(a) the amount of normal tax, calculated at the rates applicable in respect of such year of assessment and after taking into account any amount of a rebate deductible in terms of this Act in the determination of normal tax payable, in respect of a taxable income equal to 90 per cent of such actual taxable income; and

(b)(b) the amount of normal tax calculated in respect of taxable income equal to such basic amount, at the rates applicable in respect of such year of assessment and after taking into account any amount of a rebate deductible in terms of this Act in the determination of normal tax payable; and

(ii) the amount of employees' tax and provisional tax in respect of such year of assessment paid by the end of the year of assessment...

It is evident from paragraph 20 that the basic amount is used as a limit when calculating the understatement penalty for taxpayers where the assessed taxable income was below R1 million.

It is tempting to use the basic amount as a default estimate for the first-period provisional tax estimate. However, risk is involved in doing so.

Let us take a situation where the taxpayer had a basic amount of R900 000 and thus based his / her taxable income estimate for the first provisional tax period on this amount. If the actual assessed income is R1 200 000 paragraph 20(a) will apply (since actual taxable income above R1 000 000). Thus the basic amount will not be used as a limit to calculate an underestimation penalty.

The taxpayer's estimate was less than R960 000 (80% of R1 200 000) and therefore according to paragraph 20(a), an understatement penalty will be issued. The fact that the taxpayer's basic amount was used will not be a justification to avoid the penalty, however, if the taxpayer can provide another legitimate reason SARS may remit the penalty.

The conclusion is that the taxpayer should estimate taxable income and not rely on the basic amount as a default. The basic amount was not intended for this purpose and SARS does not accept it as such.

 Author: Chris Herbst - CH Consulting

Contact us for tax consulting: https://www.chconsulting.co.za/contact

 

Tax and small business owner remuneration

on Saturday, 08 April 2017. Posted in General, Consulting, Tax

The tax consequences of profit extraction by directors of owner managed companies.

Tax and small business owner remuneration

 

Introduction

A question that we often receive from directors is how to compensate yourself if the company is owner managed. In other words a business where the owners are the directors and have discretion in how they are going to structure their own remuneration, or how they are going to extract the profit from the company.  Let us explore three possible scenarios.

1. Building up a loan account

We often find that the owners draw money at will and build up a loan account with the company. Some directors are under the impression that this method attracts no tax. They are wrong. 

The first factor to consider here is the interest rate that the company is charging the director. In most cases this is 0%. In normal circumstances a company would charge an interest rate to someone it lends money to. Thus in this case the 0% or lower than market related interest rate is directly attributed to the fact that the director is a connected person to the company. In other words the director is receiving a benefit due to his / her employment or connection with the company. This  equates to remuneration and as you know remuneration is taxable. 

The way the income tax act deals with this situation is by a concept called a deemed dividend. The logic behind this is that the interest free \ low interest loan to the director is (substance over form) the same as a dividend. At the tax year end the balance of the director’s debit (owing to the company) loan account is used to calculated the deemed dividend. The difference between the interest rate that the company charged the director and the official interest rate (repo rate plus 1%) is used to calculated the amount of interest that “should” have been charged were the director not  a connected person. The balance times the interest rate that “should” have been charged is now deemed a dividend and off course dividend tax (currently 20%) is payable on this amount.

Let me illustrate by way of an example:

Director A of company ABC has a loan account debit balance with the company at year end of R100 000. The company did not charge any interest to the director. The current repo rate is 7% and thus the official interest rate is 8% (7% + 1%). 

Thus the deemed dividend is R8 000.00 (R100 000 x 8%) and the dividend witholding tax on that is  R1 600.00 (R8 000.00 x 20%).

Some directors might think that this is not a bad deal R1 600.00 on R100 000 cash withdrawn from the company. They are again wrong. Remember since the loan is of a capital nature it does not get deducted on the income statement as for example a salary, thus it does not decrease your taxable income. So in effect you can argue that the company pays 28% income tax on the R100 000 (since this would have been deductible if it was a salary. Already you are at R28 000 (R100 000 x 28%) plus R1 600.00 deemed dividend which is R29 600. Again the director might think that this is better than a normal dividend of R72 000 (the after tax profit R100 000 - R28 000) which would have resulted in R14 400 witholding tax (R100 000 x 20%) plus the R28 000 income tax which would which would have resulted in a total of R42 400.

In the loan account situation your total tax was R29 600 at an effective tax rate of 29.6% (R29 600 / R100 000) and in the dividend situation your total tax was R42 400 at an effective tax rate of 42.4% (R42 400 / R100 000). Well that might seem that the loan account is the better option, but the differentiating factor is that the same deemed dividend will be charged on the same R100 000 (plus interest from previous year) in the next year. In other words your effective tax rate in the loan account situation keeps on growing each year that the loan has its balance outstanding. Effectively the director is being taxed multiple times on the same initial R100 000.

2. Paying a dividend

This was basically covered in the previous section. If the director declares a dividend to him / herself the effective tax rate is 42.4%. Simply due to the fact that the company pays 28% tax on the profit and the director pays 20% dividend tax on the dividend allocated from after tax profit.  

An example:

The company has R100 000 taxable income (which the director would like to allocate to him \ herself. Thus the company pays R28 000 income tax and the after tax profit is R72 000 (R100 000 - R28 000). The company can declare a dividend on the after tax profit to the director which results in R14 400 dividend witholding tax (R72 000 x 20%). In other words the company and director paid a total tax of R42 400 (R28 000 plus R14 400) which is an effective percentage of 42.4 (R42 400 / R100 000).

3. Paying a salary

The director can also pay him \ herself a salary. For some reason many directors are under the impression that this is the least tax efficient. In many cases this is actually the most tax efficient.

The tax rate off course varies based on the total salary that the director receives from the company. However the effective tax rate is less than 42.4% (as with the dividend) for a total annual salary of up to R5 961 949 (based on the 2018 individual tax rate table, a corporate income tax rate of 28% and a dividend witholding tax rate of 20%).

Conclusion

Many factors have been left out for simplification in the discussion above. My advice would be to always contact a tax professional to evaluate your specific situation. If I had to make a rule of thumb, I would say it is simple, if your company’s taxable profit that you would like to extract is less than R5 961 950 (for 2018 tax year) extract the profit by way of a salary, if it is more than R5 961 950 (for 2018 tax year), extract the R5 961 950 as a salary and the amount above that as a dividend. What about loan accounts? I would say, stay away!

Contact us for assistance: https://www.chconsulting.co.za/contact

 Author: Chris Herbst

Business Valuations

on Wednesday, 08 April 2015. Posted in General, Consulting

Business valuations: The art of the science - Part 1

Business Valuations

Image license: https://creativecommons.org/licenses/by/2.0/

Image title: Plan and Valuation of Pews

Business valuations are a combination between well-developed financial principles (science) and professional judgement (art). From the onset there is one principle that needs highlighting:

The best form of a business or any other valuation is the price that a willing buyer will pay to a willing seller in an arm’s length transaction. Please keep this principle in the back of your mind while reading the rest of this article.

It does not really matter what a business is worth on paper if no-one is willing to pay that amount. The danger of business valuations are that one can easily inflate the value of the business with ambitious future projections. Before we explore this statement, the discussion of some of the popular business valuation approaches will lay a foundation.

The Discounted Cash flow (DCF) and Net Present Value (NPV) methods.

These two methods are discussed together as they are closely connected. The basis of the DCF method is the calculation of the present value of future income. The backbone of these two methods is to take the future profits/cash flows that the business will generate and then determine what these profits/cash flows are worth today.

To illustrate by example:

Company A will generate profit of R10 in year 1, R20 in year 2 and R30 in year three. To determine the NPV of these profits you need to discount the profits to today’s value. All that this means is that you should look at what these profits are worth in today’s money. To simplify, say investor X had two options (ignore inflation for simplicity):

  1. Invest her money in a risk free fixed deposit at Big Bank that earns 10% interest per annum
  2. Invest her money by buying 100% shares in Company A

If she were to choose option 1 and invest R100, her investment after year one would be worth R110 (R100 x 10% = R10, add the R10 to the original investment of R100). After year two her investment would be worth R121 (R110 x 10% = R11, add the R11 to the value of the investment at the end of year one). Following the same logic the investment would be worth R133.10 at the end of year three. Thus she could increase her capital by R33.10 without taking any risk (not that a risk free investment is really possible, but that that is a topic for another day). Based on this, one can safely say that she would want to earn at least 10% on the investment in Company A. However by investing in Big Bank she does not take on any risk, with Company A she could lose all her money. Thus naturally she would expect additional return for the increased risk (higher risk = higher return). To determine the additional return for the additional risk, one would look at the Beta, Systematic and Unsystematic risky premium for the investment. I will return to this at a later stage. For now assume the additional reward for the additional risk is 5%. Thus a fair rate of return for investing in Company A would be 15% per annum.

You will recall that in order to get from the initial value of the investment in Big Bank to the value after year one, the calculation was ((R100 x 10%) + R100) = R110. An easier way to write this is simply R100 x 1.1 = R110. Thus to now discount the investment from year 1 to today, one needs to do the reverse of the above. That is R110 / 1.1 = R100.00.

Now you know how to discount the future profits of Company A:

Year 1: R10 / 1.15 = R8.69

Year 2: R20 / 1.15 = R17.39, but now we have only moved from year 2 to 1. Thus we must also move from year 1 to year 0. R17.39 / 1.15 = R15.12 (you can also write this as R20 / (1.15)^2, where ^ is “to the power of”)

Year 3: R30 / (1.15)^3 = R19.72

Thus the total value of all three year’s profits discounted to today is R43.53 (R8.69 + R15.12 + R19.72).

If we assume the company will only exist for three years then we can say that the value of the company to this investor is R43.53. Thus if the investor offer R30.00 for the company there will be intrinsic (built-in) value of R13.53. If the seller is willing to accept a price below R43.53 it will be a worthwhile investment for the investor.

At this stage there should be two things bothering you:

  1. The influence of our fair rate of return/discount rate ( 15% in example )has on the valuation, or how we determine the correct rate
  2. How long we assume the company will exist (three years in the example)

These points will be address in a follow up to this blog.

Author: Chris Herbst

Contact: https://www.chconsulting.co.za/contact

A quick view on the tax consequences of the Budget 2015

on Thursday, 05 March 2015. Posted in General, Tax

A quick view on the tax consequences of the Budget 2015

Photo title: And another business day is almost over... 

License: https://creativecommons.org/licenses/by-nc-nd/2.0/

This speech of Minister Nene was highly anticipated and perhaps feared by some. 

There are varying opinions on the tax changes that have been implemented. It seems as if the main opinion of tax experts is that it was reasonable. I must agree, I do not see major problems in how they have distributed the tax collection burden.

Firstly the increase in sin taxes is one that in my opinion is always a good measure. An interesting one is that they have increased the rate at which individuals are taxed. This is a first since 1995. An important aspect to note here is that if you earn below a certain point you are still better off than the previous year (excluding inflation). For an individual below the age of 65:

  • earning R150 000 per year will pay R44.25 less tax per month in the 2016 tax year compared to the 2015 tax year
  • earning R250 000 per year will pay R30.37 less tax per month in the 2016 tax year compared to the 2015 tax year
  • earning R380 000 per year will pay R19.79 more tax per month in the 2016 tax year compared to the 2015 tax year
  • earning R600 000 per year will pay R92.91 more tax per month in the 2016 tax year compared to the 2015 tax year
  • earning R1 700 000 per year will pay R962.58 more tax per month in the 2016 tax year compared to the 2015 tax year

Thus it is clear that the higher income earning individuals are targeted for the increased tax revenue. For centuries there have been lengthy debates on how fair this approach is. The high net worth individuals makes out roughly 11% of this taxpayer base and they are responsible for roughly 60% of the income from this class. The tax rate of trusts has also increased from 40% to 41%. This will also have the biggest effect on high net worth individuals.

However the lower income earners must not feel that they have escaped the burden as the fuel levy has been used to collect taxes from them. The fuel levy has increased by 30.5 cents per litre. The road accident fund levy was also increased by 50 cents per litre. Almost all people irrespective of your income will be affected by this increase, whether you travel with public transport or your own vehicle. A knock on effect on the food prices will increase the burden.

It was anticipated that the broad based collection of taxes will increase, but it was not clear how. It could have been an increase in the VAT rate, which has remained unchanged at 14%. The recent decrease in oil prices has made an increase in the fuel levy an easy choice for Minister Nene. The possible problem is that the oil prices will rise again (in my opinion that can be soon) and then the man on the street will feel the burden even more.

Another option was to increase corporate taxes; however it remained unchanged on 28%.

There will be greater relief for Micro businesses where the tax free portion has increased from R150 000 to R335 000. However the requirements to be a micro business eliminate the majority of small businesses. The revenue cap of R1000 000 is understandable; however the main eliminator comes with the exclusion of personal service providers, which is defined by the fourth schedule as:

‘Personal service’ means: Any service in the field of accounting, actuarial science, architecture, auctioneering, auditing, broadcasting, broking, commercial arts, consulting, draftsmanship, education, engineering, entertainment, health, information technology, journalism, law, management, performing arts, real estate, research, secretarial services, sport, surveying, translation, valuation or veterinary science if that service is performed personally by any person who holds an interest in that company or close corporation. However, the services will not count as personal services if the company or close corporation also employs at least three other full-time employees throughout the year of assessment in its business of rendering services and none of those employees is a shareholder or member or its connected person.

In my opinion this discourages persons that have obtained a professional qualification.

Other points to note are:

  • The tax exemption on interest earned has remained the same at R23 800 for persons below the age of 65 and R34 500 for persons above the age of 65
  • The monthly medical aid tax credit has increased from R257 to R270 for the main member and the first dependant and from R172 to R181 for each additional dependent
  • The primary rebate has increased from R12 726 to R13 257 (4.17%, below inflation) and the secondary rebate has increase from R7 110 to R7 407 (4.17%, below inflation). This was taken into account with the tax calculation for the various salaries for individuals above

I conclude by saying that although it does not look to rosy, in my opinion, given the circumstances Minister Nene did an acceptable job.

Author: Chris Herbst

https://www.chconsulting.co.za/contact

Who should register for provisional tax?

on Tuesday, 14 January 2014. Posted in General, Tax

Who should register for provisional tax?

Who should register for provisional tax?

Let’s start with why provisional tax exists. It is simply a way to spread the tax amount due by the person or company over a period of time. This is to ensure that a large amount of tax is not due when the relevant assessment has been completed. Basically it is similar to Pay As You Earn (PAYE), except it is less frequent. Where PAYE is due monthly, provisional tax is due every 6 months. Straight to the point, SARS wants to ensure that they get their money while it is most likely that you still have cash.

To answer the question of who should register for provisional tax, it is any person that derives any income other than a salary. In other words any income on which PAYE is not paid. Thus if you earn a salary and for example earn rental income you should register. From the SARS website:

“Any person who receives income (or to whom income accrues) other than a salary, is a provisional taxpayer. A provisional taxpayer is defined in paragraph 1 of the Fourth Schedule of the Income Tax Act, No.58 of 1962, as any –

  • person (other than a company) who derives income, other than remuneration or an allowance or advance as mentioned in section 8(1);
  • company; or
  • person who is told by the Commissioner that he or she is a provisional taxpayer.

Excluded from being a provisional taxpayer as defined are any –

  • approved public benefit organisations or recreational clubs;
  • body corporates, share block companies or certain associations of persons; and
  • persons who are exempt from paying provisional tax, namely:
    • Non-resident owners or charterers of ships or aircraft;
    • Any natural person who is under the age of 65 and who does not earn any income from carrying on a business – provided that person’s taxable income will not be more than the threshold (R63 556 for 2013 and R67 111 for 2014); or the taxable income of that person (earned from interest, foreign dividends and rental) will not be more than R20 000;
    • Any natural person who is 65 years or older – provided that person’s taxable income will not be derived in any way from carrying on any business; will not be more than R120 000; and will not be derived otherwise than from remuneration (such as salary), interest, foreign dividends or property rental.
      Examples of income that will make you a provisional taxpayer include rental income, interest income or other income from the carrying on of any trade. 
      Companies automatically fall into the provisional tax system. There is no formal registration or deregistration needed to be a provisional taxpayer. If a taxpayer is liable for provisional tax, he or she merely needs to request and submit an IRP6 return.”

The timeline for provisional tax is as follows:

There are three provisional tax payments; the first is due within six months from the start of the relevant tax year, the second within twelve months and the third within nineteen months if the taxpayer’s year end is 28 February or within eighteen months in any other case.  Note that the third return is voluntary and not compulsory. Thus if you are an individual or company with a 28 February year end;

  1. Your first return is due 31 August
  2. Your second return is due 28 February
  3. Your third voluntary return is due 30 September

Visual timeline (example 2014 tax year):

01 March 2013 Start of 2014 tax year

31 August 2013 First provisional tax return (201401) due

28 February 2014 Second provisional tax return (201402) due

30 September 2014 Third voluntary provisional tax return (201403) due

31 January 2015 Income tax return (2014) due                             

Please contact us if you have any queries or would like us to handle your provisional tax

http://www.chconsulting.co.za/contact