Most of our clients operate in the SME market and as such it is common that the owner/shareholder of the business is also the sole director of the business. It is also not uncommon for us to see how the owner of the business does not have clear split between his/her business and personal finances. Indications of this are:
1. Personal & living expenses/debit orders are paid through the business account;
2. Constant cash flow shortage within the business;
3. The director is not paid a monthly salary;
4. The owner/shareholder spends all the funds as he/she sees fit as they operate on the basis that they are the only shareholder and director of the entity thus all the funds/profits are theirs to utilise as they see fit.
The problem then arises that the owner/shareholder has utilised funds during the year of assessment directly out of the entity’s business account without considering/noting that there are tax consequences to this.
As the new 2019 financial year has already started it is advisable you contact your advisor to discuss the items below in detail and decide on the best way forward.
The tax consequences of the 3 most common ways for the shareholder/director of the business to draw funds from his/her business are explained below:
- If the company owes you money on loan account (you funded your business), the business can repay your loan account with additional funds available in the business.
- Salary (Director’s remuneration) – In many cases it is common practice that the owner/shareholder is the main driver of the business, thus remuneration for these services is recommended. The entity is required to be registered for the applicable payroll taxes (PAYE, UIF, SDL etc.). Payroll taxes are payable on the gross remuneration.
- Dividend can be declared to the shareholder of the entity. Dividend withholding tax of 20% is payable on the gross dividend.
- Two of the three options above have a tax consequence, thus the importance for the business owner to understand these consequences as SARS penalties and interest can be an unnecessary burden on the business.
What is the optimal amount of salary or dividend or combination thereof to be declared to the shareholder/director?
a. Example: If the company has R100 profit and distributes all of this to the shareholder
Profit = 100
Company tax at 28% = R28
Profit after tax = R72
Gross Dividend = R72
Dividend withholding tax at 20% = R14.4
Nett Dividend = R57.60 (Nett amount payable to the owner/shareholder)
Thus, the effective tax rate if the profits are declared as dividend is 42.4% (28% + 14.4% or R100 – R57.60)
b. Individuals are taxed on sliding scale between 18% and 45%
i. The 2018/2019 tax table taxes income above R1,500,000 at 45%. Thus, taking into consideration the effective tax rate if a dividend is declared it makes sense to declare a salary up to R1,500,000 and to declare a dividend thereafter.
Thus, the if the owner/shareholder’s taxable income for the year should remain below R1,5 million it would be most optimum to declare a dividend on the balance of company profits after that, but before deciding on a salary to be declared you should consider all other taxable income/deductions for the year of the owner/shareholder i.e. interest, foreign dividends, capital gain transactions and contributions to retirement funds to ensure the taxable income remains below R1,5 million.
If you are uncertain regarding the best way forward, or have any questions, please do not hesitate to contact your trusted Accountant or Tax Practitioner at MMS Group!
This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)