It is a myth that it is more tax efficient to trade as a close corporation or company rather than a sole proprietor or partnership.
Colin Wolfsohn, tax partner at Grant Thornton Kessel Feinstein, says business owners often believe they can claim more expenses against income tax as a close corporation or company than if they were trading as a sole proprietor or partnership.
However, a sole proprietor or partnership can claim all normal business expenses.
Wolfsohn says you should not just consider income tax when you plan how to operate your business. You also need to look at the legal and practical implications.
Trading as a company or close corporation affords the directors or members protection of their personal assets, which is not the case when you trade as a sole proprietor or a partnership.
However, directors or closed corporation members also have to provide personal surety for business operations.
Wolfsohn says the nature of the business must also be considered, as often potential customers or clients prefer to deal with a company or close corporation, because of the perceived protection.
"Some business people also feel that they require the status of being called a member of a close corporation or a director of a company."
Wolfsohn says close corporations were introduced to allow businesses to incorporate without the stringent rules that apply to companies.
It is, however, more costly to operate as a close corporation than as sole proprietor or partnership. A company requires a statutory annual audit which is even more costly.
Wolfsohn says an important consideration is the different tax treatment of corporations as opposed to individuals. A company or close corporation pays a flat rate of 35 percent tax on taxable income. An individual pays on a sliding scale depending on the level of income.
Wolfsohn says you need to differentiate between the marginal rate of tax and the average rate.
"According to the tax tables for the year ending on February 28, 1999, you will have to pay a marginal tax of 45 percent on any taxable income in excess of R120 000.
"However, the average (or actual overall) rate of tax on a taxable income of R120 000 is 32,2 percent. The magical breakeven figure is attained at a taxable income of R155 000."
This means that if your taxable income is more than R155 000 and you are trading as a close corporation or company, any income over the R155 000 should be left in the company or close corporation and taxed at 35 percent, instead of it being distributed to you.
If the money comes to you it will attract a marginal tax of 45 percent and an average tax rate of 35 percent.
Wolfsohn says businesses operating as a close corporation or company are not, necessarily, able to claim more vehicle costs.
As a sole proprietor you are entitled to claim full motor vehicle expenses including depreciation, licences, insurance, fuel, services, repairs and finance charges.
However, part of the expenses are deemed to be for private use and are not deductible. This amount is calculated at 1,8 percent a month of the original cost of the vehicle, excluding VAT.
If the vehicle is owned by the company or close corporation, private use of the vehicle is regarded as a fringe benefit. The value of this benefit for tax purposes is also based on 1,8 percent of the vehicle cost a month.
Wolfsohn says calculating whether it is more beneficial to have the use of a company car or to receive a travel allowance for the use of a privately owned vehicle is quite complicated and depends on the kilometres travelled in each year and on the cost of the motor vehicle.
As a very rough guide, if less than 26 700 kilometres are travelled in a tax year, it could be more beneficial to have the use of a company owned vehicle. If more than 26 700 kilometres are travelled, a travel allowance is more beneficial.