It’s that time of the year when many entrepreneurs explore ways to limit their income tax liability before the 28 February deadline.
Rather than focusing on cutting your tax bill, I propose a different strategy to my clients: Focus on growing wealth and use the year-end time to review your financial situation and make changes, if necessary.
Here are a few things to think about to reduce your tax bill and grow your wealth.
Grow wealth by reinvesting your RA tax refund
I am not the biggest fan of Retirement Annuities (RAs), but they serve some people well.
You can claim up to 27.50% of your taxable income as a deduction (up to a maximum of R350,000 per year). In most cases, this will be your total contributions for the year. Rather than spending the refund, I advise my clients to grow their wealth by reinvesting it into their RA.
Let’s say your effective tax rate for the year is 25%. A portion of that will be for tax refunds for your RA contributions. By reinvesting that portion back into your RA, you effectively make an additional 25% growth on your RA per annum.
Getting too creative with tax deductions could end up costing you more
Clients often ask if it’s a good idea to purchase a new vehicle to bring down their tax liability.
The short answer is: no – buying a vehicle to pay less tax only makes sense if it works for you, for example, as a delivery van.
Suppose you need to purchase a vehicle that will make a difference to your business’s bottom line or efficiency. Wonderful! In that case – yes – you will pay less tax but remember that you can’t achieve capital growth without an income tax effect.
Based on an effective tax rate of 25%, you would need to spend R100 to save R25, leaving 75% less in the bank.
But by not spending the R100, you’ll still end up with R70 in the bank after tax.
This is why you shouldn’t use saving tax as your only motivation to purchase a vehicle. But if it’s going to reduce the cost to serve your customers, then it’s a solid investment.
SARS is wary of travel claims
There are various types of travel claims:
- A travel allowance as part of a salary structure
- A fringe benefit on a company car
- The use of vehicles to conduct business and generate income
Whatever your situation, you need to keep a logbook. This is non-negotiable.
Recently, SARS audits have been particularly focused on travel claims, which is understandable with the world shifting to remote work and international travel grinding to a halt.
If you’re audited, these are the documents you’ll need to provide SARS:
- Detailed travel logbook. List each trip separately, even if they were on the same day. Include the opening and closing odometer readings for each trip. You also need to specify the person or company visited and the reason for the meeting. Investing in an electronic logbook might be your best ROI for travel claim purposes.
- Purchase finance agreement for your vehicle: If you paid cash, you’d need to provide the invoice, proof of payment, and RC1 (registration document).
- If you used a vehicle registered in someone else’s name, attach an affidavit by that person confirming that you may use the vehicle.
The above may sound like a mountain, but it’s merely a habit to get used to – one that will save you many taxes annually.
ETI: The most powerful SME tax hack
The Employment Tax Incentive (ETI) is probably the most effective tax hack for small business owners – it’s often one of the first conversations I have with my clients.
Your business qualifies for the ETI if you employ people under the following requirements:
- Monthly salary between R2,000 and R6,500
- Ages between 18 and 29
- Valid South African ID
Speak to your accountant for guidance on how to claim the ETI.
Use Tax-Free Savings Accounts (TFSA) benefits
Tax-Free Savings Accounts (TFSAs) offer tax benefits to investors because you don’t pay tax on dividends, interest, or capital gains.
This investment scheme requires after-tax money to be invested, with no deduction on your deposits.
Currently, you can invest R36,000 per year, tax-free, with a total lifetime limit of R500,000.
Capital gains tax consideration: Stretch the sale
Individuals receive an annual capital gains tax exemption of R40,000. If you are considering selling your business, try to structure the transaction over two income tax periods. In doing so, you can use the capital gains tax exemption over two years for one transaction.
When selling shares or property during this period, consider making the sale date from 1 March and not before 28 February. Doing this will postpone capital gains exposure and the impact on your cash flow. This tactic also allows you to generate additional income with the capital on hand before you need to declare provisional tax.
Pro bono work for charities
If you do pro bono work for a Public Benefit Organisation (PBO) approved charity, you might be able to obtain an annual Section 18A certificate for your services.
Compile a spreadsheet of all pro bono services delivered between 1 March 2021 and 28 February 2022, including your market-related fee. The PBO may issue a Section 18A certificate to you for this amount. You will be able to deduct 10% of your taxable income on all donations to PBOs.
A few things to note about this:
- Not all PBOs may issue Section 18A certificates; they must be separately approved by the SARS Tax Exemption Unit. Confirm this status with the charity you are working with.
- The Section 18A certificate must include the PBO’s reference number, date of receipt of the donation, name and address of the donor, and the amount or nature of the donation.
Keep your submissions simple this Tax Year-End
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Net losses from part-time businesses
Many part-time entrepreneurs (employees who also have side businesses) tend not to declare their secondary income for tax purposes, either because they think it’s irrelevant or are scared about the potential consequences on their income tax return.
To be clear: it is compulsory to declare any additional income from any business source.
My experience is that most of these businesses have a net loss in the first one to three years. This is mainly because the company is constantly evolving and growing, which requires input capital.
The first few years of running at a loss will actually benefit you exceptionally well. Since the loss is deducted from your salary (as an employee), your income tax liability will be smaller. This means that you will receive income tax back from the overpayment of PAYE from your employer.
This is a massive and often overlooked benefit for start-up businesses.
Note: In certain circumstances, SARS might ringfence the losses; this needs to be discussed with your tax consultant.
Conduct a financial health assessment
Whenever my team meets with a new monthly accounting client, we do a financial health assessment with SARS and the Companies and Intellectual Property Commission (CIPC).
These are some of the things I look out for:
- Have the CIPC annual returns been submitted, and are they up to date?
- Are there any outstanding tax returns for the company or its directors?
- Is there any debt owed by the company or its directors?
- Does the company qualify for small business corporation status? This alone results in a massive saving in corporate tax.
- Can we use the Employment Tax Incentive on the payroll?
Preparing for and complying with tax year-end can be stressful for small business owners.
But it’s a good time to zoom out and take stock of your finances and look for opportunities to not only reduce your tax burden but also grow your wealth.