This article will identify five common tax pitfalls that many small businesses, especially newly established ones, overlook. This situation is because the owners of these companies often do not have tax expertise, or they are unwilling to use a professional to ensure that their tax affairs are in place.
Small businesses must manage their accounting and tax functions efficiently and smoothly to avoid unnecessary costs like SARS penalties. Making elementary mistakes with a small company’s tax affairs can have disastrous and costly effects on a company’s ability to survive these difficult times.
There are five common tax pitfalls that owners of small businesses should look out for and avoid.
These pitfalls include three value-added tax (VAT) issues, one provisional tax matter, and the fifth item deals with the tax implications for owners of small businesses when they draw money from their company.
Failing to avoid these pitfalls can cost small businesses a lot of stress, and money, including fines. Unfortunately, the cost of sorting out these pitfalls has destroyed small companies.
Failure to register for VAT
The first issue is that many owners of small businesses do not know when t register for VAT as they do not understand the VAT requirements. Mandatory VAT requirement becomes necessary and important once a business has made taxable supplies exceeding R1 million during twelve consecutive months.
Once a small business reaches this threshold, they need to charge their clients VAT for the goods or services. “When small businesses manage their tax affairs, they often neglect to do this because they are unaware of this requirement.
If it comes to light that a company failed to register for VAT, then SARS could impose penalties, including understatement charges and late payment fines, and interest. These penalties will be backdated to when a small company should have been accounting for VAT.
However, the larger a business grows, the more it would lose the opportunity to deduct input VAT that they pay over to VAT vendors that supply them with goods and services and so miss out on lower costs. Input VAT is the tax that a VAT vendor can claim back as a deduction from SARS.
The output VAT is the tax that a VAT vendor levies on goods and services and then pays over this tax to SARS.
The advantage of registering for VAT is that it gives a company greater access to business opportunities, including tenders and contracts, which usually require a company to have a VAT number.
Failure to obtain valid tax invoices
The second pitfall relating to VAT is that many small businesses often fail to secure valid tax invoices for their VAT input claims.
Input VAT should have a neutral impact on a company, but if SARS disallows specific claims, the input VAT becomes a cost, reducing a company’s profitability.
When a small company claim input VAT from SARS, SARS require it to keep records, including specific invoices from their suppliers.
“If a company’s administration is not up to scratch, they might not have these documents, or these documents may not meet SARS’ requirements as prescribed in the VAT Act. At that point, SARS won’t allow you to claim back your input VAT.
SARS usually focuses on the invoices a company receive from its suppliers when reviewing VAT input claims.
The VAT Act specifies that the following details should appear on an invoice for any amount greater than R5000:
- The word “tax invoice” or “VAT invoice” or “invoice”,
- The name, address, and VAT registration number of the supplier,
- The name, address and, where the recipient is a registered vendor, the VAT registration number of the recipient,
- The unique number of the invoice, and
- An accurate description of the goods or services supplied and the volume or quantity of goods or services provided.
For invoices of less than R5000, only the supplier’s information must be contained, not the recipient’s details. Here the supplier need not specify the number of goods or services supplied.
Trying to claim input VAT for the wrong items
Regarding VAT, small companies often try to claim input VAT on entertainment, petrol, and rental of motor vehicles. But the VAT Act makes it clear that companies must not claim these expenses for VAT purposes.
For example, if a company bought coffee, milk, and sugar to offer to its clients when they visit, they cannot claim VAT on these items because SARS view these as entertainment costs.
If SARS finds that a person or company claimed goods ineligible for VAT purposes, it will reject these claims. In addition, if SARS finds that a person or company has overstated their input VAT, then that means understatement penalties and interest would apply.
Misunderstanding about income received in advance
The fourth common issue is that small business often forget that income received in advance is taxable. For example, an advance payment will be needed in a common area where companies require deposits for significant construction contracts. An advance payment like this will immediately be taxable in the hands of the recipient of that money. This knowledge is vital for small businesses when they need to make their provisional tax submissions. SARS requires taxpayers to make these submissions twice a year in February and August.
Amounts are taxed at the earlier of receipt or accrual, and these advance payments are included in a taxpayer’s taxable income in the year in which they are received.
Companies will have to include income received in advance in their provisional tax disclosure to SARS or face penalties.
Implications of drawing money from the business
The fifth prevalent tax issue of which small business owners are often unaware is the tax implications of withdrawing money from their company through interest-free loans or withdrawals that SARS would deem to be dividends or remuneration.
This situation arises with small companies within a sole director or owner. They make loans from the company without a formal loan agreement between the company and the director.
If a company director takes a loan without charging interest, SARS will view that interest as a dividend in specie paid by the company to the director. Therefore, the company would have to pay dividends tax on that amount.
If SARS does a full audit of a company’s books and they see that in substance, that loan is not an actual loan but a salary, the business owner will need to pay penalties and interest.
Business owners often make withdrawals from their business by paying for personal items. But the problem is that the owner and the company are separate legal entities. Therefore, the most tax-efficient way for a director or owner of a small company to withdraw money from their company is to receive a salary rather than withdrawing money as a dividend or receiving an interest-free loan.
Keep this list of common pitfalls in mind and I highly recommend you hire a reputable accounting firm to help you and significantly save the stress, time, and money you could otherwise incur over time.