What are your tax options if you're self-employed

Maya Fisher-French
2017-04-23 13:43
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As a freelancer, should you form a company or remain a sole proprietor? Maya Fisher-French looks at the pros and cons.

During periods of weaker economic growth, companies are more open to using freelancers or contractors so that they can reduce their cost-to-company spend.

It also creates employment in an economic environment where employers are less likely to hire full-time staff because it allows them to be more flexible in terms of employing the skills they need when they need them.

Freelancers, in turn, have the flexibility to adapt their work hours to suit their lifestyles.

Whether you are a freelancer by choice or necessity, understanding your tax obligations is important because far too many freelancers land up in financial trouble after not making provision for their tax.

City Press spoke to Lesedi Seforo, tax project manager at the SA Institute of Chartered Accountants, about the best tax practices for freelancers.

Should you form a company or register as a sole proprietor?

Seforo says the decision over what legal form you should use should not only be determined by tax, but also by other commercial concerns such as limitations of personal liability.

In the case of a sole proprietor, you are the legal entity; in the case of a company, the company would be the legal entity and would hold the liability.

From a tax perspective, however, it may not make sense for a one-person consultancy to register as a company.

Seforo says the main consideration as far as income tax is concerned has to do with the rate of tax levied on a company versus a sole trader.

Most freelancers use the fees they charge as their income and do not necessarily reinvest in the business because the nature of their business does not require capital.

In this case, Seforo says the tax effect is neutral as no income tax will be paid in the company on this amount because the full salary will be a tax deduction.

The scenario is different if the individual wishes to reinvest money into the business.

For example, a consultant registered as a sole proprietor with a profit of R1.5 million that they want to reinvest in the business will pay about R520 000 in income tax.

If the owner-manager forms a company and keeps the money in the company, the company will pay a lower company tax rate of 28% – about R420 000 income tax would be payable.

You also need to take into consideration special anti-avoidance provisions that apply to companies that have a single person rendering services.

Seforo says this scenario will limit the tax deductions the company can claim, making this kind of small company unviable.

“From a tax perspective, it is therefore usually less favourable to have a company where a consultant as the owner-manager is solely rendering services, but rather usually advisable to wait until the business has three or more unconnected employees to fall outside this anti-avoidance provision,” says Seforo, who adds that the company will only be able to access the more favourable small business tax rates when it has several employees because personal services are excluded unless it meets the three or more employee threshold.

In addition, the payment of VAT is more favourable for a sole proprietor than a company because a company has to pay VAT on an invoice basis, while a sole proprietor works on a payment basis.

As Seforo explains, the standard rule is that VAT vendors are subject to VAT on an invoice basis, which means that they must pay VAT to the SA Revenue Service (Sars) based on invoices issued during a particular period, even if those invoices have not yet been paid by the client.

This can become a risk for a freelancer who has formed a company because the longer a client takes to pay the freelancer, the more likely the freelancer will experience cash flow problems.

The alternative is the payments basis, where VAT is payable to Sars only once payments have been received from clients.

This is available to sole traders who make less than R2.5 million a year, but it is not accessible to freelancers trading through companies.

When should you apply for a tax directive?

As a freelancer or consultant, you can apply for a tax directive so that you will not pay more income tax during the year than what your final tax determination will be.

In other words, this will equal out your monthly tax payments so that you are not overpaying your tax.

This is usually a result of variable income payments, such as commission or project payments.

A tax directive can be applied for if you are not deemed to be fully independent.

If you get more than 80% of your work from one client, work at the client’s premises or under their supervision and have less than three full-time employees, you will be classified as a personal service provider, and pay-as-you-earn (PAYE) tax will have to be deducted.

If you earn commission or a variable fee, you can apply for a tax directive and your client/employer will be instructed by Sars to deduct a specific rate or amount of PAYE.

If you are not an employee because no client makes up 80% of your income and you are not under their supervision, no PAYE will be deducted and you will pay tax in your biannual provisional tax return.

In this case, it is important to make sure that, at the end of each month, you put your estimated tax away in a savings account so that the provisional tax bill does not come as a shock.

If you use a home office, what are legitimate expense claims?

For a home office, one must remember that the office must be specifically used as such.

“A person cannot work in their living room or from a desk in their bedroom and claim office expenses from Sars,” says Seforo, who adds that, for a legitimate home office, most of the household expenses can be claimed from Sars, but only the portion that relates to the home office.

This apportionment can be done on a square metre basis – you divide your office’s square metreage by the total home square metreage and multiply that by legitimate house expense claims.

Examples of legitimate expense claims would be rent (if renting), interest on your bond (if you own the property), electricity, levies, water, other municipal charges and your domestic worker’s wages.

You will also be able to claim repair expenses incurred on the home office.

Money spent at coffee shops or other spaces where you work will have to meet the tax requirements, which include that these expenses are in the production of your income and in the course of your trade, and not for your personal maintenance.

Generally, such expenses incurred during client engagements qualify under such requirements.

Do you have to fill in a logbook or can you work on deemed kilometres?

Keeping a logbook is important for a freelancer as they do not receive a travel allowance from an employee.

Historically, one used to be able to work with deemed kilometres, but now one has to keep a logbook of all business-related travel to claim petrol and car maintenance expenses.

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