Companies are not taking advantage of tax breaks because criteria are too onerous, say analysts.
South Africa might have some of the most generous tax breaks on offer for small and micro businesses, but they remain grossly unused.
Figures from the South African Revenue Service (Sars) show that in the 2012 tax year just 86 354 enterprises were taxed as “small business corporations” (SBCs) and that just 8 493 micro firms registered for “turnover tax for micro firms”. Both options mean smaller enterprises are taxed at a lower rate than the country’s 28% corporate income tax rate.
Although Sars says the figures are subject to a final reconciliation, they are likely to remain worryingly low.
No one seems to know why the uptake has been so poor and Sars isn’t saying — but some speculate that it could be due to poor marketing of the tax breaks and to the onerous criteria one needs to meet to qualify for some of the tax breaks.
Easing the burden
It is hoped that the Minister of Finance Pravin Gordhan’s tax review committee panel, which began work in July, will look into why so few small businesses benefit from these tax breaks.
The committee’s head, Judge Dennis Davis, said in July that he expects the review to take up to two years, but that a report on small business taxes could be out by the end of the year.
In recent years Sars has introduced a number of tax breaks and measures to ease both the tax and compliance burdens for small firms.
These include the introduction of SBC tax in 2001, where businesses with an annual turnover of up to R14-million (R20-million from the 2013/14 tax year) pay less tax, and a turnover tax in 2009, in which firms with just basic accounting records and a turnover of up to R1-million can pay less tax.
In the same year Sars introduced a venture capital tax incentive with tax rebates for investors in small businesses.
A research and development (R&D) tax incentive that came into effect in 2006 also benefits many small firms.
Sars has also carried out a number of other initiatives to ease the tax burden for small firms — such as a tax amnesty in 2006, lifting the turnover threshold for VAT to R1-million and introducing a special concession to allow smaller firms to submit VAT three times a year, instead of bi-monthly (though Sars says only 1 001 firms used the special concession in 2012).
Sars can afford to grant generous tax breaks to small firms (worth over R5.1-billion in the SBC tax alone between 2008 and 2011 tax years) because the bulk of corporate taxes come from large firms. Just 459 companies contributed 57.6% of the company income tax assessed in 2010, according to 2012 tax statistics.
Yet with the tax breaks remaining so undersubscribed, the cost to the fiscus is even less. Take the venture capital tax incentive, contained in section 12J of the Income Tax Act. Four years after it was introduced, only one small business, an IT firm, has benefited from a venture capital investment.
This is despite Sars having overhauled the incentive last year, after a campaign by industry members against the onerous criteria needed to qualify for the incentive. However not all the onerous criteria were removed.
The incentive aims to boost venture capital investments in small businesses by allowing individuals to make upfront tax deductions if they invest in venture capital companies, which in turn invest in certain kinds of small enterprises.
South Africa Venture Capital Association (Savca) chairperson Erika van der Merwe said that the small uptake was due to the incentive not having been widely marketed by Sars and it not being perceived as “sufficiently attractive” by the venture capital market and high-net-worth individuals.
Jeff Miller, director of Grovest, said the provision in the 12J regulations (in which a deduction is recouped if an individual disposes of their shares in a venture capital company) might have put some investors off.
It means that when investors chose to sell shares, Sars would — in one year — recoup the full amount of an investor’s deduction and apply capital gains tax to any profits made from selling of the shares.
Miller pointed out that such a provision does not exist for the UK’s venture capital incentive. Three years ago the recoupment rule was cited by one venture capitalist as the key reason why his fund was unable to raise sufficient money from investors using the incentive.
Olivewood Resources chief executive James Allan, whose fund remains in limbo without having made a single investment since registering in 2009, said he was given no explanation by Sars of why the rule had not been changed.
Investors might also be put off by the high penalties. Sars can issue a fine equal to 125% of the amount contributed by an investor if Sars opts to later withdraw the status of any investment firm as a venture capital company.
Venture capital companies also have to be vetted by Sars first and licensed with the Financial Services Board (FSB) before they can begin operating. Miller said that Grovest’s application to the FSB took nearly a year.
The incentive should be spurring more angel investors to investing in small companies, but Brett Commaille, who runs angel investment network Angel Hub, said unlike in the UK, investors are not given the choice to place investment directly in firms to benefit from tax rebates, but have to do so via a venture capital company.
Commaille points to McKinsey & Company data on venture capital incentives, where 74% of UK angel investors reported that the tax incentives played a highly significant role in their decision to invest in a small business.
Then there’s the SBC tax. Businesses taxed under this dispensation enjoy a potential tax saving of about R60 000 a year and can also write off equipment against taxable income in the year in which it was bought.
Under the current R14-million threshold the number of companies that elected to be assessed as SBCs during the 2009, 2010 and 2011 years of assessment came to only between 107 000 and 110 000, according to Sars. This is despite there being over two million companies registered with Sars by March 2012.
Because firms must select to be taxed as SBC, and Sars then checks that they qualify, in 2011 only about 90 000 businesses got the tax break.
Piet Nel, a project director at the South African Institute of Chartered Accountants (Saica), believes onerous rules that disqualify certain types of businesses and business owners from benefiting from the tax are partly responsible for the low uptake of the SBC tax regime.
One interpretation note currently on the Sars website deals extensively with the SBC incentive and the agency’s spokesman, Adrian Lackay, added that this is being updated.
To qualify for the tax, business owners can’t have shares in more than one business, can’t derive more than 20% of their revenue from investments and the rendering of personal service and can’t be a personal service provider unless they employ three or more people.
Nel wants Sars to do away with the rule that personal service providers can only qualify if they have at least three employees. He said many personal service providers start off with one person before expanding and so the rule discounts many start-ups in the services sector.
Over the years a number of business owners have taken Sars to court after being discounted from qualifying for SBC tax and Nel said he had heard of at least four cases in the last month where business owners had disputes with Sars over whether they qualified for SBC.
Finally, there’s turnover tax on micro businesses. Only 10 000 businesses have registered for turnover tax.
It is not clear how many of these are informal businesses that have been introduced into the tax net, or whether they are businesses that would have paid ordinary tax anyway.
Turnover tax does have one serious drawback: businesses pay tax regardless of whether they make a profit or not, whereas under ordinary income tax they would at least be guaranteed a zero tax rate in the event of a loss. Furthermore, once signed up for turnover tax a business must stay in the system for at least three years.
Brazil’s Micro Entrepreneur Law, introduced in 2009 to bring mainly street traders into the tax net, offers traders the chance of getting onto social welfare if they sign up.
Over 2.7-million Brazilians have to date signed up to the regime, according to Brazil’s Ipea statistics bureau, with 55% reporting higher sales after formalisation according to the country’s small business support agency Sebrae.
No benefit like that exists for turnover tax, so it could be likely that informal sector operators in South Africa steer clear of the tax.
But what kind of tax system will best benefit small businesses and the fiscus? The US uses a graduated tax rate, applicable to any size firm, according to a company’s sales. The tax rate ranges between 15% and 47%, depending on a firm’s sales and the state it is registered in.
Such a system (a similar one also in use in Korea), creates more certainty, simply because there are no barriers or boxes that need to be ticked to enter the system, allowing more companies to qualify. The trade-off, however, is the ability to break larger companies into smaller ones and therefore qualify for lower taxes.
It is also probably why Sars —like its counterpart tax agencies in Russia, Malaysia and Brazil — favour separate tax dispensations for smaller firms; it makes it easier to assess whether a company really is a small business or not.
Sharon Smulders, head of tax technical, policy and research at the South African Institute of Tax Practitioners, tends towards the US’s system, pointing out that one needs to allow business owners easy access into the tax system and then “rather pick up any tax avoidance or restructuring through regular audits”.
South Africa’s SBC tax rate for small firms — between 0% and 28% — makes it difficult to compare the country’s taxes with those of other countries. However, the 2013/14 turnover threshold for SBC of R20-million is higher than that of Russia (firms below R18.2-million are taxed at 15%), Brazil (firms below R15.2-million are taxed at between 4% and 17%), Malaysia (firms below R7.6-million are taxed at 20%) and the UK (firms below R4.7-million are taxed at 20%).
South Africa may have generous tax breaks, but for business owners to benefit, Sars could do with lowering the amount of onerous criteria needed to qualify for them.
Readers can send suggestions on how to improve small business taxes to the tax review committee at [email protected]
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