A small masterstroke

The tax reforms announced in the latest budget are like the prophet taking a few resigned steps towards the mountain. The South African Revenue Service (Sars) was never going to win the paperwork battle with South Africa’s substantial informal sector without completely destroying it.

By introducing a radical new tax on turnover (as opposed to the usual tax on profit) for businesses with turnover of less than R1-million a year and lifting the value-added tax (VAT) threshold to R1-million, the Treasury has probably become the first government department to accept that informal businesses do not become formal in a single generation.

The challenges

To appreciate fully what a masterstroke the proposed reforms are, one has to understand the predicament faced by Sars up till now.

Enforcing tax laws on millions of township businesses, including the substantial ones, would cause havoc in the township economy, even if a business was given a year to get its books in order.

Few township shops, including large ones, keep accounting books or use a stock-control system. Usually stock is kept behind a counter to stop clients from pilfering. Yet as soon as a shop makes a turnover of more than R300 000 a year — the current VAT threshold — the business is required to become a VAT vendor. Registering is one thing. Doing the VAT paperwork is virtually impossible for a business owner who has never done any books before.

The VAT paperwork means setting up a system in the business that splits the amount of VAT charged to customers on each of the thousands of transactions, making sure that no VAT is charged on zero-rated items, adding it all up, keeping all the slips of purchases, adding the VAT paid on them and subtracting it from the VAT collected from the customers.

The record-keeping requirements for VAT are so fundamentally different from informal business practice that offers by Sars of simplified VAT systems have largely been ignored by business owners.

Income tax is no less complicated. Working out the exact profit a shop makes in a year requires an intricate, abstract system that is extremely difficult to set up and maintain by somebody with an average South African education.

Effective record-keeping is not only an educational outcome, but also a deeply ingrained cultural approach to business that seems to take generations to instil.

The taxman knows that if he presses ahead with informal business-tax compliance, he will only make accountants rich and hurt the pillars of the township communities. So, over the past decade and a half, Sars has turned a blindish eye.

But that is also unfair, not only to those who do pay tax, but also to informal entrepreneurs themselves. The sheer paperwork cliff face presented by VAT and income tax keeps them from any economic activity demanding a tax-clearance certificate — liquor licences, maintenance of the local school or painting the magistrate’s office, local road-works or street-sweeping tenders and other ideal contracts for informal operators.

The crunch probably came when Sars got involved in the taxi-recapitalisation programme. Tax-clearance certificates had to be issued to the taxi industry en masse if the subsidised programme for the replacement of old taxis was to be successful.

Even among mountains, the taxi industry is a particularly reluctant mover, no matter who the prophet is. The thousands of new-order taxi operating licences issued so far and small-business-tax amnesty applications that are still being processed are most probably based on wild estimates of the taxi owners’ real taxable income.

Sars has three choices:

The reforms

Sars seems to have opted for the third option. A business with a turnover of less than R1-million will soon not have to bother with VAT paperwork. With the turnover tax a business does not have to prove how much profit it makes. It simply pays the taxman as follows:

This compares favourably with a formal sole proprietor who pays tax on profit. For example, a sole proprietor who does a turnover of R750 000 and makes a decent 20% profit will pay R29 625-worth of tax, compared with R25 750 if he pays turnover tax. At R1-million, the turnover tax becomes slightly more expensive — R44 500 as opposed to R43 125 if tax is paid on a profit of 20%. But add at least R15 000-worth of bookkeeping expenses per year, and the formal business still pays more.

Sars does dangle a carrot in front of all businesses not only to formalise but also to incorporate, in the form of the small business corporation tax break. A qualifying CC with a R1-million turnover only has to pay about R35 000 tax on 20% profit, for example. At higher profit levels, the tax break can save a business up to R60 000 in taxes, easily paying for bookkeeping expenses.

The implications

The proposed turnover tax, which is expected to kick in next year after a consultation and legislative process this year, presents quite a few ifs and buts for business owners.

If you choose the turnover tax option, you will still pay tax even if you don’t make a profit. A start-up choosing the system won’t be able to offset its initial losses against profit made in later years.

If you choose turnover tax, you have to stick to the system for three years. Once you opt out of turnover tax, you may not return to it for five years. This is to prevent businesses from jumping between the two systems to minimise tax.

Freelance one-man shows, with their low turnover, low overheads and high profit structure, will probably be disqualified from the turnover tax under the classification of ”personal services”. The idea is to stop employees from pretending to be businesses just to pay lower tax.

Then there is the question of how you prove turnover. Surely not by presenting a full set of books? Franz Tomasek, Sars head of legislative policy, says ”the thinking at this stage” is that a simple record of daily takings would be sufficient.

The least the mountain can do is to roll a boulder or two in the direction of the prophet.

Get by with little angel help

After more than a decade of barking up the banking tree for more small business finance, the government has finally come around to the real source of start-up finance — family and friends.

Soon you will be better able to persuade a rich uncle to buy shares in your business with the introduction of a tax incentive for ”angel” investment announced in the latest budget.

Internationally recognised as the most important source of business start-up finance, ”business angels” are individuals with spare cash who are willing to invest in businesses so risky that no bank or formal institution would touch it; in other words, businesses started by owners with few assets to serve as loan-finance collateral. Usually, the investment is made on the basis of trust and close relationship.

The treasury has taken its first tentative steps towards incentivising angel investment by proposing that an individual who buys shares in certain businesses will be able to deduct a third of the value of the investment from their taxable income, up to a maximum of R500 000. So if you were planning on asking your uncle for a million, make it R1,5-million.

Corporations may deduct up to R750 000 and venture capital funds up to R7,5-million a year through the tax break, but given the reliance of small businesses on finance from family and friends, it is likely to have the most impact on individual investors.

Details are sketchy, but the incentive will at first only apply to ”high growth and high-tech companies with an annual turnover of up to R14-million or gross assets of up to R7-million”. The Treasury usually starts new tax incentives with limited scope, and if it works without too much abuse, it can be scaled up, as it did with the small business corporation tax break.

Jo Schwenke, MD of small-business finance house Business Partners, says the incentive is unlikely to have a major impact on his company, which ”invests close to a billion rand a year” in owner-managed businesses, but ”it does mean our main competitors [angel investors] will now get a tax incentive, so they might do it a little more vigorously”.

He says a beneficial effect of the incentive is its push towards equity finance, as opposed to loan finance. He explains that equity finance is ”patient capital” that a small business needs to see it through its first few rocky years. Loan finance, on the other hand, tends to be called up at the first signs of trouble, leading to business collapse.