Getting a new business venture off the ground is an equally exciting and stressful time. You’re enthusiastic about getting your new product or service out into the market, but you face quite an administrative process to get it off the ground legally.
A decision that often stumps many small business owners is whether to operate as a sole proprietor or as private company, a PTY Ltd. We receive many questions about this from entrepreneurs wanting to know the tax implications of each route.
So let’s first have a look at an overall comparison of the two entities.
|
Legal Entity |
Sole Proprietor
Owner and business are the same legal entity |
PTY Ltd / Company
Company is a separate legal entity |
| Number of owners |
One owner (that will be you) |
May have one or more owners |
|
Start-up capital |
Small start-up capital |
Higher start-up capital (for legal and administrative compliance) |
|
Controlling Body |
The owner has full control over the business |
All the directors have shared control over the business |
|
Legal and Compliance |
Basic |
Complex |
|
Liability |
The sole proprietor is personally liable for all the business’s debts |
Shareholders have limited liability i.e should the company become insolvent, creditors can’t claim from the shareholders in their personal capacity |
|
Business Registration |
No legal requirement to register the business. |
Company needs to be registered with CIPC (Companies and Intellectual Property Commission). Annual returns need to be filed with CIPC together with annual fee for continued registration. |
|
Income Tax Implications |
The owner is personally responsible for all business taxes. Business income and expenses are declared in the owner’s personal tax return under the “Local Business, Trade and Professional Income” section. |
Business income and expenses are declared in the Company’s tax return. |
|
Income Tax Registration |
The owner must register as a individual taxpayer and provisional taxpayer on SARS eFiling. |
A Company Income Tax number is automatically generated when you register your company on CIPC. The Company representative must register the company for income tax and provisional tax on SARS eFiling. |
|
Tax Returns |
The owner must submit two provisional returns (IRP6) during the tax year and the annual tax return (ITR12) after the tax year. |
The company must submit two provisional returns (IRP6) during the tax year and the annual tax return (ITR14) after the tax year. |
|
Tax Rate |
Owner is taxed on the business profits at the applicable personal income tax rate. |
Company profits are taxed at flat rate of 27% from 31 March 2023 (previously 28%) unless the company qualifies as a SBC or Micro Business registered for Turnover Tax. |
|
Dividends Tax |
Not subject to dividends tax. |
Dividends tax is paid by the company and levied at 20% on distributions to shareholders. |
|
Financial Statements |
Not required |
Financial statements need to be compiled by an Accounting Officer and submitted to SARS when the ITR14 is filed. |
|
PAYE |
Sole proprietor’s drawings not subject to PAYE. Must be registered for PAYE if there are employees. |
Company must register as an “employer” with SARS and a director’s salary is subject to PAYE deductions. |
|
VAT Registration |
Requirement to register for VAT when turnover for a twelve-month period is R1m or more. |
Requirement to register for VAT when turnover for a twelve-month period is R1m or more. |
As you can see from the above, the sole proprietor route is less administrative-intensive to start, but you do take on much more personal risk than that of a company director. But let’s hone in on the tax element, shall we? After all, you’d want to select the best way to structure your business in order to be the most tax efficient, wouldn’t you?
The answer boils down to the level of earnings you expect from your business.
Individuals are taxed on a sliding scale, which means that the rate of tax you pay increases as your earnings increase. This is called a progressive rate of tax and applies to any individuals earning more than R95,750 per tax year 2024.
As an individual, you benefit from the general tax rebate, which brings down the amount of tax you owe by a flat amount, depending on your age. If you’re under 65 years, this is called the primary rebate. There’s a secondary rebate for those over 65 years and a tertiary rebate for those over 75 years.
In a company, profits are taxed at a rate of 27%, irrespective of value. In addition, dividends tax is levied at 20% on profits retained in the company and distributed as a dividend in the future.
Let’s do a worked example of the difference this makes on R100,000 profit between a registered company and a sole proprietor’s tax position.
We’ll assume that ABC PTY Ltd didn’t pay out any profit in the year, and distributes a dividend the following year.
PTY Ltd / Company
Company is a separate legal entitiy
|
2020 |
2021 |
|
|
ABC PTY Ltd annual taxable income |
R100,000 |
R100,000 |
|
Company tax at 27% |
(R27,000) |
(R27,000) |
|
Net profit |
R73,000 |
R73,000 |
|
Dividends tax at 20% (20% x R73,000) |
R14,600 |
R14,600 |
|
Effective rate of tax (R27,000+R14,600) / R100,000 |
42.4% |
42.4% |
Now, let’s look at the same situation for Lerato, a sole proprietor.
|
2020 |
2021 |
|
|
Lerato’s annual taxable income |
R100,000 |
R100,000 |
|
Individual tax at 18% (SARS table for R100,000 per annum) |
R18,000 |
R18,000 |
|
Less Primary rebate |
(R14,220) |
(R14,958) |
|
Total tax |
R3,780 |
R3,042 |
|
Effective tax rate |
3.78% |
3.04% |
While we showed the full worked example above, you can take a short cut by using TaxTim’s Income Tax calculator!
In our example above, Lerato’s effective tax rate of 3.78% (2021: 3.04%) is significantly lower than ABC PTY Ltd’s at 42.4%. What we must remember though is that as Lerato’s business grows and becomes more profitable, she’ll move into higher tax bracket, increasing her effective rate of tax.
Let’s do another example, but this time where the taxable income is R1,000,000 for the tax year. How does the tax situation change for Lerato?
Our company this time, XYZ PTY Ltd, has a sole Director, Billy, who draws an annual salary of R360,000 (or R30,000 per month). This amount is deducted before corporate tax is applied.
|
2020 |
2021 |
|
|
XYZ PTY Ltd income before Director’s salary |
R1,000,000 |
R1,000,000 |
|
Director’s salary |
(R360,000) |
(R360,000) |
|
XYZ PTY Ltd’s annual taxable income |
R640,000 |
R640,000 |
|
Less corporate tax of 28% |
(R179,200) |
(R179,200) |
|
Retained earnings |
R460,800 |
R460,800 |
|
Dividend Tax on future pay out at 20% |
R92,160 |
R92,160 |
As Billy is drawing a salary of R360,000, he’ll be liable for individual tax on this amount.
|
2020 |
2021 |
|
|
Tax on salary as per TaxTim’s Income Tax Calculator |
R66,419.50 |
R64,090.00 |
Therefore, the total tax paid:
|
2020 |
2021 |
|
|
XYZ PTY Ltd corporate and dividends tax (R179,200 + R92,160) |
R66,419.50 |
R64,090.00 |
|
Billy’s individual tax |
42.4% |
42.4% |
|
Total tax |
R337,779.50 |
R64,090.00 |
Now let’s have a look at Lerato’s tax for an income of R1,000,000 for the year. This amount puts Lerato into the 41% tax bracket, as per SARS tax tables for individuals.
|
2020 |
2021 |
|
|
Total tax as per TaxTim’s Income Tax Calculator |
R312,821.90 |
R307,813.00 |
As there are numerous other deductions and allowances to consider for both an individual and a company, we’d have to perform detailed calculations for both scenarios to determine which is truly more tax efficient.
Lerato is paying R24,957.60 (i.e. R337,779.50 -R312,821.90) (2021: R27,637.00) less tax in her own capacity than if she was operating through a company and drawing a salary of R30,000 per month.
What is evident though, is that as an individual earns more and moves into the highest tax bracket, the difference in tax between a company and a sole proprietor decreases. At lower levels of taxable income, it’s far more tax efficient to operate as a sole proprietor and enjoy the benefits of sliding tax tables and rebates available to individuals. At higher income brackets, it’s likely that company registration would be more beneficial.
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