There are five common tax pitfalls that owners of small businesses should look out for and avoid.
These hazards include three value added tax (VAT) issues, one provisional tax matter, and the fifth item deals with the tax implications for owners of small businesses when they draw money from their company.
Failing to avoid these pitfalls can cost small businesses dearly in terms of time, stress, and money, including fines. The cost of sorting out these hazards can even destroy small businesses.
- Failure to register for VAT
The first issue is that many owners of small businesses fail to realise that the VAT Act requires that they register for VAT. This requirement becomes necessary once a business has made taxable supplies exceeding R1 million during twelve consecutive months.
Once a small business reaches this threshold, then they need to charge their clients VAT for the goods or services sold. “When small businesses manage their tax affairs, they often neglect to do this because they are not aware of this requirement,” Jean du Toit, head of tax technical for Tax Consulting South Africa.
If it comes to light that a company failed to register for VAT, then SARS could impose penalties, including understatement charges and late payment fines and interest. These penalties will be back dated to when a small company should have been accounting for VAT.
Small businesses can register for VAT with SARS by applying online, and the process is reasonably straightforward and quick but ask for professional help in any doubt.
For micro businesses, it may not initially be viable to register for VAT, as they may be mainly dealing with suppliers and clients of a similar size.
However, the larger a business grows, the more it would lose out on the opportunity to deduct input VAT that they pay over to VAT vendors that supply them with goods and services and so miss out on lower costs. Input VAT is the tax that a VAT vendor can claim back as a deduction from SARS. The output VAT is the tax that a VAT vendor levies on the supply of goods and services and then pays over this tax to SARS.
The advantage of registering for VAT is that it gives a company greater access to business opportunities, including tenders and contract, which usually require a company to have a VAT number.
The only way to rectify the lack of the required VAT registration was to apply for SARS’ Voluntary Disclosure Programme (VDP), Du Toit said. Such a VDP application could see SARS waive any penalties, but it would require the company to pay over the VAT due and interest on late payment of this tax. Ask your accountant to help with any VDP application.
A business can voluntarily register for VAT if over twelve months its income exceeded R50,000. Tertius Troost, a Mazars senior tax consultant, said it might benefit a small business to register voluntarily for VAT if they have many suppliers. But companies must know that there was a cost that went with complying with the VAT Act, he added.
- Failure to obtain valid tax invoices
The second pitfall relating to VAT was that small business owners often fail to secure valid tax invoices for their VAT input claims, Troost said. Input VAT should have a neutral impact on a company, but if SARS disallows specific claims, then the input VAT becomes a cost, and that will reduce a company’s profitability.
When a small company claimed input VAT from SARS, it was required to keep records, including specific invoices from their suppliers. “If a company’s administration is not up to scratch, they might not have these documents, or these documents may not meet SARS’ requirements as prescribed in the VAT Act. At that point, SARS won’t allow you to claim back your input VAT,” Du Toit added.
Ettiene Retief, FTR Tax and Corporate Administration partner, said that SARS usually focussed on the invoices a company received from its suppliers when reviewing VAT input claims.
The VAT Act specifies that the following details should appear on an invoice for any amount greater than R5000:
- The word “tax invoice” or “VAT invoice” or “invoice”,
- The name, address, and VAT registration number of the supplier,
- The name, address and, where the recipient is a registered vendor, the VAT registration number of the recipient,
- The unique number of the invoice, and
- An accurate description of the goods or services supplied, and the volume or quantity of goods or services provided.
For invoices of less than R5000, only the supplier’s information needs to be included on the invoice and not the recipient’s details. Here the supplier need not specify the quantity of goods or services supplied.
- Trying to claim input VAT for the wrong items
The third issue regarding VAT is that small companies often try to claim input VAT on entertainment, petrol, and rental of motor vehicles. But the VAT Act makes it clear that companies cannot claim these expenses for VAT purposes.
If a company bought milk, coffee, and sugar to offer to its clients when they visited, the company could not claim VAT on these items because SARS viewed these as entertainment costs, Retief said. “When I’m in my boardroom, I’m selling my time and the coffee is not part of what I’m selling,” he added. “However, if I own a coffee shop, then I can claim VAT on the coffee beans that I buy,” he added.
If SARS finds that a person or company claimed goods ineligible for VAT purposes, it will reject these claims. In addition, if SARS finds that a person or company has overstated their input VAT, then that means understatement penalties and interest would apply.
- Misunderstanding about income received in advance
The fourth common issue was that small businesses often forgot that income received in advance was taxable, Du Toit said.
A common area where companies required deposits was for major construction contracts, he added. An advance payment like this was immediately taxable in the hands of the recipient of that money. Retief said that an exception to this rule was when a company was paid a deposit as security.
This knowledge is vital for small businesses when they need to make their provisional tax submissions. SARS requires taxpayers to make these submissions twice a year in February and August.
Small companies had to include income received in advance in their provisional tax disclosure to SARS or face penalties.
- Implications of drawing money from the business
The fifth prevalent tax issue of which small businesses are often unaware is the tax implications of drawing money from their company through interest-free loans or withdrawals that SARS would deem to be dividends or remuneration. This situation arises with small companies which have a sole director or owner, and he or she makes loans from the company to themselves.
Another problem is that small companies rarely establish a formal loan agreement between the company and the director.
If a company director takes a loan from the company without charging interest, then SARS would view that interest as a dividend in specie paid by the company to the director and the company would have to pay dividends tax on that amount.
Another way that directors of small companies try to avoid paying tax on their remuneration is to have their company issue them with a loan, instead of being paid a salary. “The company should classify the loan as a salary. What often happens is that the director never pays back the loan, or they pay it back slowly over many years to avoid paying income tax,” Du Toit said. “If SARS does a full audit of a company’s books and they see that in substance that loan is not a real loan but a salary, then the agency can reclassify that item, and there will be tax consequences such as penalties and interest,” he added.
Troost said that usually, the most tax-efficient way for a director or owner of a small company to withdraw money from their company was to receive a salary rather than to withdraw money as a dividend or to receive an interest-free loan.
Retief said that owners of small businesses often make withdrawals from their business by paying for personal items. But the problem was that the owner and the company are separate legal entities. Directors of small companies often used this means of withdrawing money from the business to avoid paying tax, he added. “With small businesses, the temptation is not to show a big salary because of the tax is payable on that money,” Retief said.
At the end of the financial year, the company puts payments for personal items through the director’s loan accounts. But it is often difficult to untangle all the transactions and split the personal items from the company transactions, Retief said.
Keep this list of common pitfalls in mind and ask your accountant for advice on your specific circumstances in any doubt.