The legal structure of your business is of critical importance. It can either be a hindrance or an advantage.
The legal entities you can choose from are:
Structuring your business in a tax efficient way is very important. But be careful – you should never structure your business in a particular way for tax reasons only. The following aspects should also play a role in selecting the optimal legal structure for your business.
A sole proprietorship as a legal entity, may only be used by one business owner. However, if your business has no other owners you may also use a private company, closed corporation, an incorporated professional practice (if you are a professional whose professional association allows the use of this legal entity), a business trust, or a combination of legal structures. The legal limits on minimum and maximum numbers of business owners for the different legal entities are as follows:
Partnership: Minimum 2 – Maximum 20
Private Company: Minimum 1 – No Maximum
Closed Corporation: Minimum 1 – Maximum 10
Business Trust: No limits
If it is important to you that your business should continue after your death, you should choose a legal entity that will allow this. A sole proprietorship as a legal entity is not separate from your personal estate. A business operating as a sole proprietorship will, therefore, die with the owner. Only the assets may be transferred to the heir(s) after all debts have been paid.
A partnership dissolves upon the death of any one of the partners. A private company and a closed corporation are legal entities separate from the personal estates of their owners. These two legal entities, therefore, offer you continuity of your business after your death. This means that the business can continue even if you die. Only the ownership of the business will change hands, but the business itself will not be affected by your death.
Although an inter vivos trust was never meant to be used as a legal entity for a business, it can be used as such. The assets will be owned by the trustees in their capacity as trustees and, therefore, it will be separate from the personal estates of the trustees. The trustees can incur debt on behalf of the trust and not in their personal capacity and in this way it is possible to separate the debts of the trust from the personal estate of the trustee. However, if you want to use a business trust as legal entity, please obtain legal advice as this can be a minefield if you are not a legal specialist.
If you want to sell your business, the legal entities and continuity will also be an issue. Only a private company, closed corporation and a business trust, as structures, will allow you to sell your business as an entity. With the sole proprietorships and partnerships you will only be able to sell the business assets. The new owner(s) will have to negotiate their own debt relationships with the creditors.
Running your business as a sole proprietorship will cost you nothing extra because of the nature of the legal entity, whereas using a private company as legal entity will be on the other end of the cost scale. If, however, the benefits you derive from the particular structure you choose, outweighs the cost, it would be worth your while to incur the extra cost of the administration.
The different legal entities are taxed differently. A sole proprietorship and a partnership are taxed according to the individual income tax scales – currently between 18% and 41%. A private company and a closed corporation are taxed at a flat rate of 28%. On any amount declared as a dividend, 15% dividend tax will be levied. A business trust is taxed at a flat rate of 41%.
The owner of a private company or closed corporation may also be an employee of that particular legal entity. He/She could therefore be paid a salary, as well as receive employee benefits like a car allowance, etc. This situation opens the way to the optimal tax structure for a business owner.
The different legal entities are also treated differently for capital gains tax purposes. Any capital gain by a sole proprietorship or partnership is included at a rate of 40%. For closed corporations, private companies and trusts, the inclusion rate is 80%.
All legal entities will pay transfer duty on the purchase price of an immovable property according to a scale of between 0% and 13% of the value of the property.
Estate duty will not affect the business entity in the case of a trust, closed corporation or private company. However, the estate of the owner of a member’s interest in a closed corporation, or the estate of an owner of shares in a private company, will pay estate duty on the value of the member’s interest or shares. A sole proprietor’s estate will pay estate duty on the nett value of the business. The estate of a partner will pay estate duty on that percentage of the nett value of the business that the partner had owned.
A question every business owner must ask, is what would happen to his/her personal assets if his/her business goes insolvent. In the case of a sole proprietorship, or partnership, the business owner’s personal estate is always at risk. In other words, if the business goes insolvent his/her personal assets will be sold to pay his/her business creditors.
If you trade as a closed corporation, private company or trust, your business and your personal assets are separated. In the event of your business going insolvent your personal assets will be protected, provided that you did not sign surety for the debts of your business in your personal capacity.
A sole proprietorship, a partnership and a trust may only raise finance from outside the business in the form of a loan. A closed corporation may sell an interest in the business to a financier and in the same way a private company may sell shares in the company to a financier. The latter two business entities, therefore, provide more options for financing the business.
It is possible to structure your business in a way that allows you to use the benefits of the different legal entities. You may, for instance, run your business as a private company and set up a family trust that owns the shares in the company.
By doing this you can save huge amounts of money in estate duty, because the value of the shares in the company appreciates in the hands of the trust and not in your own. This is just one example of how you could benefit from using a combination of different structures.
But beware – if you want to get involved in this kind of financial engineering you need the help of professionals.
Article written by Adv. Kobus Engelbrecht, Marketing Head: Sanlam Business Market