In good company: deciding how to structure your business
Derick14 Oct, 2020
Starting a new business is an exciting and daunting task. Other than getting your product or service going there is a myriad of decisions that need to be made to ensure that your operations run smoothly for many years to come. One of these important decisions is deciding whether you want to run the business in your own name, as a sole proprietorship, or register it as a separate entity, a company.
Disclosure: The following info is by no means exhaustive and should only be used as a basic guide. For advanced business planning, always seek the advice of a qualified business consultant or tax advisor.
Understanding the difference between a company and a sole proprietorship
In short, a company is considered a separate legal entity that generates income and incurs expenses. Ultimately, a company gets taxed in its own name. Because it operates outside of your personal finances, a company is a great and clean way to get multiple individuals involved, either through shareholding or salary.
On the other hand, a sole proprietorship is a business that is essentially owned and run by a single individual, therefore there is no legal distinction between the business and the individual.
When deciding which entity type is best for your business, the following points are important to consider.
Keep a neat house
It’s important to note that, regardless of your decision of company structure, you should always strive to keep good accounting records of your business. This will serve you well when doing your taxes and will save you lots of headaches in the long run. Even the most basic of side-hustles can benefit from a simple “cash-in, cash-out” ledger that tracks the movements of your money, using receipts and invoices as supporting documents.
Contrary to popular belief, sole proprietorships can have employees other than the business owner. Regardless of how the business is structured, a sole prop or company will need to be registered for PAYE for its full-time employees and pay over the relevant taxes to SARS every month.
However, if you are running a small enough business that does not require full-time staff, you can opt to pay part-time staff in cash as independent contractors. The onus is on them to declare their income and pay the relevant taxes to SARS. As a small sole proprietor, this is a more common practice as opposed to companies that have many full-time employees and, as a result, need to be registered for PAYE.
Life, death and taxes
It’s important to note that companies are taxed differently than individuals and sole proprietorships.
As an individual who operates as a sole proprietor, all your taxable income from your business will be added together with any other income earned from other jobs in any given tax year. You will also be able to deduct allowable business expenses from this income which will essentially leave you with a tax “profit or loss”. Should you have a “profit”, SARS will tax you on that amount according to the sliding tax scale for individuals, ranging from 18% to 45%. After these taxes are paid, any remaining profits are yours to keep.
Because a company is considered a separate legal entity, it pays its own taxes at 28% of profits. Now, while 28% might seem lower than what you would pay as a sole proprietor, its important to note that those after-tax profits do not belong to you as a business owner yet.
As the owner of a company, you can either draw a salary from the company, of which you will then be taxed in your own capacity, similar to a sole proprietorship, or you can declare dividends from your company’s profits. It’s important to remember that dividends are taxed at 20% and need to be paid to SARS by the company issuing the dividends. Therefore, by the time the company has paid 28% on profits and an additional 20% Dividends Withholding Tax, the effective tax on dividends is a whopping 42.4%.
When deciding which structure suits your new business best, you need to have a good idea of the intended size of your business. If you plan on just having a side-hustle, operating as a sole proprietorship is the most tax-efficient and easiest way to operate. However, if you plan on having multiple business partners, plan to employ many full-time employees, a company is the safest and cleanest way to go.
Also, remember that the decision is never final and your business can transition from a sole proprietorship to a company once it reaches a certain size, if you want to get more partners on board, or even take up investment. Keeping good accounts is important in such cases and it is recommended to get a qualified accountant to assist with the transition.
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