Draft tax law has pitfalls

Two weeks ago government took a step closer to introducing changes to tax on small businesses when they passed the draft Revenue Laws Amendment Act. In the February budget Finance Minister Trevor Manuel recommended tax relief measures for small businesses which increased the threshold for value-added tax (VAT) registration from an annual turnover of R300 000 to R1-million.

He also recommended a turnover tax on certain companies with turnover of less than R1-million. The final Act will still need to be passed and this is expected to be finalised by January next year. However, the draft legislation has brought clarity to the process allowing small businesses to carefully consider their options.

Presumptive tax based on turnover

Johan Troskie, director at Deneys Reitz Tax, says a small business, including individuals, will be able to elect a more simplified tax system through a tax on turnover.

However, certain businesses may not qualify, for example a business (or person), that provides professional services such as accounting, broking, engineering, law, management, real estate surveying or veterinary science. The payment of the tax will be done on a similar basis as that of the existing provisional tax system.

The rates applicable to the various turnover levels are proposed as follows:

TurnoverTax rate

  • On the first R100 000 …….. tax free
  • R100 000 to R300 000 …. 1% of each rand above R100 000
  • R300 000 to R500 000 …… R2 000 plus 3% of the amount above R300 000
  • R500 000 to R750 000 …… R8 000 plus 5% of the amount above R500 000
  • R750 000 and above ……… R20 500 plus 7% of the amount above R750 000

VAT registration
The VAT threshold for compulsory registration will be increased from the current R300 000 per annum of turnover to R1-million. When any vendor deregisters from the VAT system, it is required to pay VAT (sometimes referred to as a “self charge” or exit VAT) on the value of the assets held before deregistering.

This is because when these assets were purchased, the business was able to deduct the VAT on the assets and this now has to be repaid. Troskie says the new legislation will allow the exit VAT to be paid over a period of six months. If the vendor deregisters from the VAT system in order to register for the turnover tax, they will be able to deduct up to R100 000 of the value of the assets held.

Do you or don’t you?
The new legislation is aimed at encouraging the formation of new small businesses and is not necessarily a benefit to existing businesses whose turnover is less than R1-million. Before you opt out of your current tax system, there are many questions you need to consider:

Will you really pay less tax?
Johan Troskie, director at Deneys Reitz Tax, says you need to calculate your current tax paid to see if the turnover tax is beneficial. For example, if your turnover is R1-million, your effective rate would be 3,8% or R38 000 under the new system. If your net profit margin is only 20%, then based on existing tax rates for small businesses, you would pay 10% on your profit, which is R20 000. “This turnover tax is designed for much smaller businesses with annual turnover less than R600 000,” says Troskie.

Can you pay the exit VAT?
Although the new legislation will allow you to pay off the exit VAT over six months, it is still a cost to consider when deregistering from VAT. The South African Revenue Service will also undertake a full audit to calculate the exit tax due.

Do you have many expenses?
If your business has substantial expenditure needs, it may be worth staying in the VAT system. Troskie says that while it may save you administration, it could cost you more as you are unable to deduct 14% as an input expense. For example, for a builder who buys the materials for the job, the input costs may make up a bigger percentage of the final invoice in comparison to labour. The ability to reclaim the VAT could save the business 14%. If you decide to remain as a VAT vendor, then you cannot apply for the turnover tax.

Who is your client?
If your client is the final user like an individual or a household, which will not be able to pass on the VAT cost, then by deregistering you can cut your costs by 14%to undercut competitors. However, if your client is another corporate, it is able to claim back the VAT costs.

What to do as a new business?
With the draft legislation in place, Troskie recommends that new businesses take a wait-and-see approach. Troskie says it is important for business owners to realise that once you have opted out of the tax system you cannot re-enter for five years. Therefore any decision made now should not be taken lightly and professional advice should be undertaken.

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Maya Fisher French
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