Per definition, a sole proprietor is a business that legally has no separate existence from its owner (the individual). Income and losses are taxed on the individual's personal income tax return, and the owner is liable for the business debt. The sole proprietorship is the simplest business form under which one can operate a business. Many times, the advantages of trading as a sole proprietor is overlooked.
Assuming R1 000 000 taxable income in a financial year.
For the business operated as a sole proprietor, normal tax rates for individuals apply, thus per tax tables the highest tax rate of 41% is applied and the calculation is as follow:
|Tax payable per tax table||R331 054|
|Minus Tax Rebate (person under 65)||R13 257|
|Total Tax||R317 797|
|Effective Tax Rate||31,78%|
For a business owned by a private company, the company tax rate will be 28%. Thus, the company will pay R280 000 tax to SARS, leaving it with R720 000 profit after tax. However, if this is then paid over to the shareholders (owners) as a dividend, a further 15% tax is imposed as dividend tax with the following calculation:
|Dividend Distributed||R720 000|
|Dividend Tax at 15%||R108 000|
|Total Tax||R388 000|
|Effective Tax Rate||38,8%|
Conclusion – You save 7% income tax in operating your business as sole proprietor versus a private company.
Capital Gains Tax
Assuming all other variables are the same and the business generates capital gain on selling an asset, the capital gains tax calculation will be as follows:
|Sole Proprietor||Inclusion rate of 33% on the capital gain|
|Capital Gain||R1 000 000|
|Included in Income Tax Calculation||R330 000|
|Tax Payable||R135 300 (41% the highest rate for individuals)|
|(Plus there are many exemptions, exclusions and rebates)|
Inclusion rate of 66% on the capital gain
|Capital Gain||R1 000 000|
|Included in Income Tax Calculation||R660 000|
|Tax Payable – Company Tax||R184 800 (28% company tax)|
Conclusion – Sole proprietor effectively pays less tax on capital gains.
There are no setup costs for a sole proprietorship, and you merely start trading in your name. To operate as a private company, one needs to register the legal entity with the Registrar of Companies (CIPC). Obviously, there is a cost associated with the registration.
Apart from the initial setup costs, the costs of operating your business as a private company increase over time (versus a sole proprietor), because you will now have to operate two bank accounts, complete two sets of tax returns, two sets of financial statements and the like.
The sole proprietorship is not a legal entity. It simply refers to a person who owns the business and is personally responsible for its debts. This is also the main reason why bankers, accountants, attorneys and other advisors will recommend the establishment of a company in order to limit the liability of the business owner.
In general, landlords, suppliers, service providers or any other creditors of a small or medium business that require the owner or shareholder of a private company to sign personal surety for the debts of his or her company. In so doing, the business owner finds himself in the same position and liable for the company’s debt. Next time you want to sign the lease agreement with the corporate landlord, or the franchise agreement or want to finance equipment with your bank, read the small print of surety document.
Also note that the Companies Act 71 of 2008 creates a scenario where directors and prescribed officers of a private company can be held liable in accordance with the principles of common law, not only for the company’s debt but also due to breach of fiduciary duty or delict (Section 77).
With the advent of the Consumer Protection Act, there are more protection for the private individual (even if he trades as a sole proprietor) than for an SME operating as a private company. For example, you will find that most corporate landlords will insist that the lease agreement is signed in the name of a legal entity (company or close corporation). The reason for this is, that the individual (sole proprietor) enjoys the protection of the CPA, whereas the company (given certain criteria) is excluded from this protection. When one trades as a company, it is deemed that you are not a “consumer” as defined by the CPA.
It is also easier and straight forward to produce your personal information when required in terms of FICA regulation. The same cannot be said for a private company, where one often needs to struggle through the red tape to comply with the requests from financiers with regards to the FICA documentation for a private company. This only creates more paperwork.
The administrative burden of handing in annual returns to CIPC is only applicable to companies. Sole proprietors do not need to submit a document to any regulatory body to confirm that they are still trading.
There are many advantages of trading as a private company depending on the nature and size of your business. This brief overview is but a small example of some of the advantages of trading as a sole proprietor. When buying a business, always seek professional advice for the most suitable format.
According to SARS, a sole proprietorship is a business that is owned and operated by a natural person (individual). This is the simplest form of a business entity. The sole proprietorship is not a legal entity. The business has no existence separate from the owner, who is called the proprietor. The owner must include the income from such a business in his or her own income tax return and is responsible for the payment of taxes thereon. A sole proprietorship can operate under the name of its owner or it can do business under a fictitious name. The fictitious name is simply a trade name, it does not create a legal entity separate from the sole proprietor owner. Only the proprietor has the authority to make decisions for the business and assumes the risks of the business to the extent of all of his or her assets whether used in the business or not.
- Simple to establish and operate.
- The owner is free to make decisions.
- Minimum of legal requirements.
- Owner receives all the profits.
- Easy to discontinue the business.
- Unlimited liability of the owner. The owner is legally liable for all the debts of the business. Not only the investment or business property but any personal and fixed property may be attached by creditors. The owner signs contracts in his or her name, because the sole proprietorship has no separate identity under the law.
- Limited ability to raise capital. The business capital is limited to whatever the owner can personally secure. This limits the expansion of business when new capital is required. A common cause for failure of this form of business organisation is a lack of funds. This restricts the ability of a sole proprietor to operate the business effectively and survive at an initial low-profit level, or to get through an economic “rough spot”.
- Limited skills. One owner alone has limited skills, although he or she may be able to hire employees with sought-after skills.