First and foremost,
Let’s make a distinction here:
Tax avoidance is any legal method used by a taxpayer to minimize the amount of income tax owed.
Tax evasion is the illegal non-payment or under-payment of taxes, usually by deliberately making a false declaration or no declaration to tax authorities.
We will look at tax avoidance measures as a way to increase savings in this article because the system isn’t designed for you to win this game if you operate as a sole proprietor.
You’re eventually going to reach all your thresholds and it just won’t be tax efficient anymore. This doesn’t mean abandon ship and change your setup, it simply means understand the levels and thresholds that you go through.
The less tax we can pay allows us to direct monies in the direction of the things we support, rather than leaving it to government to reallocate resources.
Make sure you read to the end, there is some important information you NEED TO KNOW.
Sole Proprietor
As a sole proprietor, you are the exclusive owner of the business and all the responsibility falls on to you. You get to keep all the profits that you generate, however, you are also liable for all the losses, too.
This is what it means when it is an unlimited liability structure. Creditors are free to attach or repossess any of your possessions in your personal name if you operate as a sole propriety and you cannot afford to service your debt obligations.
The risks are all yours (unlimited liability)
Who are these structures designed for:
• Individuals
• One man capital
• Single entities
Setting up this structure is easier than the others as it is the most common form many opt for, not because they don’t want other structures, but because their income generated is usually below the threshold of moving into a PTY Limited. Creating a (PTY Ltd) is futile when your income is below the tax benefits of having one.
Andre Bothma explains in more detail:
As a sole proprietor you don’t need a business set up, there are no tax benefits.
A sole proprietor’s structure could look something like this:
You should only move through different structures as your asset base and cash flow grows. You only need a business set up if you plan to scale, which then will unlock tax benefits.
The rich know NOT to keep all their assets in their personal name
Companies (PTY Ltd)
A PTY Ltd is a registered company that trades for a profit.
Registered companies in South Africa are considered taxpayers in their own right, hence it is considered a limited liability. There is a company and then there is you.
That means they are considered as separate entities to your personal name. It is why you would be taxed twice if you are using a company to pay yourself your own salary. Once as a company (28%), and then again as an individual (18-45%), as Andre explained in the thread above.
Ultimately, if you don’t need to take the money out of your company and you reinvest capital back into the business, then you will experience the full benefit of owning a PTY Ltd.
Key characteristics:
• Limited liability
• Separate entity
• Lower tax rates
• Costly to maintain
• Lifespan is perpetual
• Easier to raise capital.
• Tax payer in its own right
• Consists of shareholders
• Personal asset protection
• Transfer of ownership is easy
The graph below highlights the benefit of using the system to separate personal liabilities. If you are a sole proprietor with assets, you’ll be at risk (unlimited liability)
The rich know this, it’s how they scale, separate assets, and get tax breaks. It’s set up to incentivize this behavior.
If you are adamant and want to set up a company, then here is the process to do that- Easy as ABC
Trusts
A trust is a type of entity that can be set up in two main ways:
1) Testamentary Trust
2) Living Trust
Read more about it in the thread below:
Key characteristics of a trust:
• Do not die - no estate duty
• Income is still distributed
• Offers tax efficiency
• Protection of assets
• Creditor protection
Most people set up trusts once they already have several companies and a large asset base. You won’t just go and set up a trust unless you need to:
Firstly, because it’s costly to maintain. It needs to be worth the amount saved in tax to make it viable, and this comes when you have a high net-worth.
The idea of trusts are to reduce tax liabilities, not to increase your monthly costs. The tax benefit of setting up a trust should outweigh the costs to maintain it
Secondly, tax is steep in a trust (45%)
The wealthy use it as a tool to mitigate tax liabilities. They probably have several companies already that are beneficiaries of their trusts. (Conduit principle)
How do the rich do it?
They use a combination of all three.
• They separate liabilities from their personal name.
• They hide assets in complicated company structures.
• Own companies through companies and trusts.
This is simply how it is done, you won’t win at this game if you don’t know how to play. It is why understanding these structures allows you to plan for the future and progress through them as you scale your business and grow your income.
The more income you get to keep - the better.
What We have done:
Our company, FundUp, set up our structure like this. We started as a stokvel and have slowly progressed to this.
Below, is how we started:
We loan capital to our business (monthly contributions) and then it runs at a loss, as the company is borrowing money from us. These are loans and not revenue.
There is an option of converting one’s loan to equity which is then recorded by issuing share certificates. This share certificate represents your proportional ownership of the underlining assets inside, i.e. your own money + investment gains.
If person A contributes R30k and person B contributes R70k, then ownership would be 30% and 70%, respectively. Any gains from investments (equity) are reinvested back into the business while monthly contributions continue.
We slowly grind upwards like this, increasing our asset base while leaving money within untouched. We try to reduce our tax bill wherever possibly (legally), by holding shares without selling etc, or claiming tax back on the interest part of our loans we’ve taken from the bank.
This is why I am extremely excited for when EasyEquities launches securities lending. We will be able to put our shares up as collateral and take on loans (money). This will give us the ability to scale if we invest the borrowed money prudently.
Side note:
Stokvels usually recruit people and promise them gains on this borrowed money (members contributions). This is because the owners of the holding business (main company) are accessing this capital (other members’ contributions) at a cheaper rate than if they had borrowed money from the bank.
Let me explain, I want to take a loan for R500k from the bank at 11%, but instead I promise members an 8% return on their money if they contribute to our stokvel.
(Remember, the company and the stokvel are two different things here)
Effectively I’m creating the ability to service debt at a cheaper rate for my company by borrowing from members of the stokvel rather than borrowing from the bank directly.
This is why stokvel groups recruit members, to access cheaper capital for their main business. Their main business is where the assets will be held and not in the stokvel.
The risk here, of course, is where you invest that borrowed capital to generate those promised returns for members. Most stokvels promise that the returns will come from property because this is the investment that the general populace understands best, but many haven’t figured out that equity is where you really want to be invested in instead.
Remember this going forward, you don’t want a return on your money. Your money is only being used to reduce the risk for the owners of the business that operates the stokvel you are contributing to. (read that gain)
You are building equity for them while you receive only a % return on your capital. You get no equity ownership of the business that owns the underlining assets, you only get a return on the money you put into the stokvel. You are a means to an end for the main business, which can make this dangerous because you can become susceptible to bad actors.
Stokvels are informal entities, so it cannot enter into a legal agreement to purchase property, this is why you want to own a piece of the business that is running the stokvel.
My advice would be to rather look for stokvels that give equity ownership to the underlining assets inside their main business. Simply put, make sure your contributions are getting you a piece of the business (equity) and not a % return on your money.
Or better yet, start your own stokvel and scale your own business. It’s a long process to get to where you want to be, but it is worth it.
Build your own capital, then use bank financing to leverage.
Then reduce costs by recruiting members and offering them a return on their capital through a stokvel, which should be lower than what it would cost you to borrow from the bank. Then scale gradually using income from the contributions and investment returns.
Also, try not to withdraw for as long as possible.
You’ll go from only having a stokvel account to having a business account and a stokvel account. If used correctly with a trusted group of individuals who are all pursuing a common goal, within the frameworks of the law, you’ll be able to scale a business and create a business empire.
You can also listen to the podcast below where I talk about building capital utilizing stokvels.
Stay safe, everyone
See you next week :)