You’ve got “THE” idea. You are starting to plan how you are going to put your idea to paper, and even have dreams about going global with your idea. It’s unique, and hopefully going to make you big bucks in the long run. Before you start actually putting those ideas to paper, however, let’s talk about your business being local, going global and the tax implications of both.
If you are going to start your business locally, how you structure your business tax-wise is important, as it is going to define how much tax you pay in the long-run. Many people think that in order to start a business, you need to register a company, which is not the case. You may want to consider a company for liability reasons (for example, your personal assets are separate to the company’s- if someone were to sue the company, your personal assets would usually be safe from being attached). However, a company pays tax at a rate of 28% on taxable income- in your personal capacity, your personal tax bracket might be lower based on your amount of taxable income for the year. As a private company, you may qualify for small business corporation tax, where you could pay tax rates of either 0%, 7%, 21% or 28%, depending what amount your taxable income is. A lot of taxpayers don’t realise that they may qualify for these lower tax rates, and if you don’t claim, you don’t get! Why pay 28% when you could qualify to pay a rate of 7%?
There are two major things you need to think of before you go offshore, namely tax and exchange control regulations. There are two ways you could go offshore, either in your personal capacity or by registering a company offshore. If you go in your personal capacity or via your company (but don’t register a foreign company), you need to be aware of the risk of creating a taxable presence in the foreign company, called a “permanent establishment”. You need to meet certain requirements to become a permanent establishment, but once a permanent establishment is created the foreign country obtains the right to tax some or all of the profits you earn in that country, from your business presence there.
It is understandable if you think that by establishing an offshore company in a low-tax country, you will be free from the taxman in South Africa. This is unfortunately not the case, however. A South African tax resident is taxable on their worldwide income, and in the context of a company, if the company is “effectively managed” (defined by case law) from South Africa, it becomes a tax resident of South Africa, even if it is registered in another country. The risk here is that it may become a tax resident of both South Africa and the other country, which is not ideal if there is not a tax treaty in place between both countries- which means that you could potentially be taxed on the same income in both countries. A tax treaty can help reduce or eliminate this risk, but before you go offshore, you need to carefully examine your reasons for doing so, and what the tax risks will be. Another thing to be aware of is controlled foreign company rules- in a nutshell, if a foreign company is controlled by more than 50% of South African resident shareholders, then a proportionate amount of the net income of that foreign company will be included in the gross income of the shareholders who own more than 10% of the shares or voting rights in the foreign company. For example, if SA Resident shareholder A owns 60% of the foreign company, and the foreign company’s net income is R100,000 for the foreign tax year, then R60,000 of that foreign income would be attributable in the SA resident shareholder’s gross income.
From an exchange control perspective, a company registered in South Africa would be a resident for exchange control purposes. If you set up an offshore company, the company itself won’t be subject to South African exchange control laws, but the South African shareholders always will be. If your foreign company creates and owns IP, it won’t in most instances be subject to the restrictive rules imposed by exchange control. A South African resident company however always needs exchange control approval if any IP or right to IP is “exported” from South Africa. Another definite no-go is having your offshore company re-invest into South Africa or other CMA areas, as the SARB calls these “loop structures” where a South African resident invests in a foreign company which in turn re-invests into South Africa. Where a loop structure exists, penalties can be pretty severe. There are some exceptions to this rule, but it is suggested that you get legal advice before implementing some of your ideas.
There are many more things to think about when going offshore, including the need for business permits, the status of tax treaties with other countries, taxes on the digital economy, VAT and more. Legalese can work with you to structure your business in a tax-efficient manner, whether local or offshore.