More and more South Africans from all tax brackets are supplementing their primary income streams with so-called ‘side hustles’ or, as I prefer to call them, ‘part-time businesses’.
Unsurprisingly, the recent increase in part-time businesses is a global trend thanks to the COVID-19 pandemic, increasing people’s financial precarity.
Many of my clients are making extra money in areas such as network marketing, property rental, and cryptocurrency. For the most part, they were either reluctant to reveal their part-time business income or didn’t think they had to. Most people don’t realise that they can use their part-time businesses’ net losses to reduce the tax they pay on their primary income.
Your part-time business is good for your tax
Many people with part-time businesses prefer the term ‘side hustle’ because it sounds less formal. A company is something you register, right? And you only need to declare income if it’s earned through a registered business and hits a certain threshold, right? Wrong and wrong again.
Your part-time business makes you a sole proprietor. Your ID number acts as your registration number, and there is no minimum income threshold, so you need to declare your extra earnings to SARS.
Of course, smaller, newer part-time businesses typically don’t generate a lot of income, which increases their net losses. These losses could apply to costs such as mobile, WIFI, home office equipment, salaries, and so on. This is the time to use those net losses to reduce your overall income tax liability.
SARS is also far more supportive of part-time businesses benefiting from their net losses in their first two years – after that, its assessments get stricter.
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Business growth, legitimacy, and ring-fencing
A necessary conditionality of using your part-time business’s net losses to reduce your primary income tax is that your side hustle needs to demonstrate growth potential. Your motivation needs to include a reasonable prospect of getting taxable income within a reasonable period.
You also must prove to SARS that your part-time business is legitimate. Anything that seems more like a hobby to get tax benefits, such as part-time farming, is automatically ring-fenced. Bear in mind that the list of suspect trades is regularly reviewed and updated, so speak to your tax consultant before you jump on the net losses bandwagon.
Ring-fencing (Section 20a of the Income Tax Act) is when SARS assesses your application to use your part-time business’s net losses as a tax benefit and decides there’s been too much loss and not enough growth.
SARS does not respond kindly to a recurring loss year on year and works on a 3-out-of-5 ratio. If your part-time business shows net losses for three out of five years, SARS rings it with a fence (metaphorically speaking). You don’t lose the loss; once your part-time business starts making a profit, the benefit is retroactively approved. As soon as your part-time business is profitable, though, it’s time to start paying provisional tax!
The net losses tax benefit is worth pursuing if your part-time business is in the start-up phase as it can give you, as the sole proprietor, a helpful reduction on your primary earnings’ income tax.
That said, SARS is getting stricter regarding approving tax benefits, particularly as trends like working from home and building portfolio careers gain traction and challenge the status quo. Your best bet is to get expert advice based on a thorough financial assessment of your specific circumstances – the net losses tax benefit might not be relevant for you, but there are others out there that could be just right.