FORMS OF DOING BUSINESS IN SOUTH AFRICA

(a) Basic rule

Business may be conducted in South Africa in a number of different forms. Each form has its advantages and disadvantages depending on the rates of tax on normal income, capital gains and distributions as well as compliance costs, regulatory requirements, limitation of liability, audit requirements, nature and form of the owners, ease of operation and ease of selling.

The different forms for normal business operations are:

• company

• close corporation

• trust

• partnership/joint venture

• sole proprietorship

• public benefit organisation

• external company, and

• branch.

All of these business forms, except for external companies, are available for the use of both residents and non-residents. An external company is only available for non-residents. The sole proprietorship and the close corporation are the most common forms used for small businesses. The company is the most common form used for large businesses.

(b) Description and characteristics of each form

Company

Formation and governance

A company includes any association, corporation or company incorporated under any law in South Africa. A company also includes any corporate body formed or established under South African law and any association, corporation or company incorporated under the law of a country other than South Africa.

A company is a legal entity separate from its owners (shareholders). The liability of the shareholders for the debts and obligations of the company is limited to their respective capital contributions, unless there has been reckless trading or the signing of outside suretyships.

If the business of a company is carried on recklessly or with the intent to defraud creditors of the company or for any fraudulent purpose, the court may declare that any person who was knowingly a party to the carrying on of the business in that manner is personally liable for all or any of the debts of the company, without limitation of liability.

The word “recklessly” is not defined by statute, but numerous cases have dealt with the term. In general, an action is reckless if it involves a risk that, given the particular facts and circumstances, would require gross carelessness on the part of the doer to undertake the action. Actual knowledge of the risk is not required. For example, the business of a company would be reckless if it incurs debts in the course of business at a stage when the directors are aware or should be aware that there is little or no likelihood of the debts being able to be repaid.

A suretyship is a guarantee. If a person acts as a guarantor for the debts of a third party, the guarantor is referred to as a surety and the document signed to evidence the guarantee is referred to as a suretyship. If a company incurs debts and a shareholder acts as a guarantor for those debts (ie signs a suretyship in favour of the creditor), the shareholder is liable to settle those debts regardless of the fact that, if no suretyship had been signed, the shareholder would not normally be liable for the debts of the company (unless the shareholder was aware of and was party to the company trading recklessly as discussed above).

The shareholders of a company can be natural persons, trusts, close corporations, companies or any other association. A private company may have between one and fifty shareholders, but may not offer its shares to the public. A public company must have at least seven shareholders, and it may be listed on a public exchange.

Directors appointed by the shareholders are in charge of managing the company. Directors are not personally liable for the debts and obligations of the company unless there has been reckless trading or the signing of outside suretyships. A private company must have at least one director. Public companies must have at least two directors.

The shareholders and directors of a company are not required to be citizens or residents of South Africa. A company must appoint a public officer who is a resident of South Africa to represent it in its relations with the South African Revenue Service (SARS). A company must have a registered address in South Africa. Additionally, exchange control considerations and tax considerations may apply.

All South African companies must be registered according to the terms of the Companies Act.

All companies must appoint an auditor and present their annual financial statements in accordance with International Financial Reporting Standards (IFRS). Annual financial statements must be audited using the International Standards of Auditing (ISA). Public companies and external companies must lodge their annual financial statements with the Registrar of Companies. These statements are public documents. The cost of audit compliance can be relatively high.

Professional partnerships, particularly partnerships with more than 20 partners, often incorporate as a section 53(b) company. The directors of this type of company are jointly and severally liable for the debts of the company contracted during their term of office. This type of company is a convenient structure for large partnerships to ensure continuity, ease of admission and retirement of partners.

A company may sell its business either through a sale by the company of its business assets or through a sale by the shareholders of their shares in the company.

Ref: ITA s 1; CA s 53(b), 322, 324 and 424; Howard v Herrigel and Another NNO 1991 (2) SA 660 A at 672 E; Philotex (Pty) Ltd and Others v Snyman and Others 1998 (2) SA 138 (SCA) at 142 I to J

Developments

A new Companies Act has been promulgated and is expected to come into force late in 2010.

Taxation

A company is subject to income tax at the entity level. Shareholders are generally not subject to income tax on dividends received from a local company.

Close corporation

Formation and governance

A close corporation is a business entity formed under the Close Corporations Act, 1984. A close corporation is a legal entity separate from its owners (members). Members of a close corporation generally are liable for the debts and obligations of the close corporation only up to their contribution. In certain circumstances (e.g. contravention of certain sections of the Close Corporations Act, reckless trading, deregistration, etc), the members may be personally liable for the debts of the close corporation.

A member of a close corporation must be a natural person; the deceased estate of a natural person; or a trust, the trustees and beneficiaries of which are natural persons. A close corporation may have no more than ten members. Each beneficiary of a trust and the trustee count as members for this purpose (i.e. if a trust has one trustee and nine beneficiaries, the trust can be a member of a close corporation, but there can then be no other members).

Members of a close corporation are not required to be citizens or residents of South Africa. A public officer resident in South Africa must be appointed to represent the entity in its relationship with SARS, and the entity must have a registered address in South Africa.

The members of a close corporation are both its owners and managers. There is no separation between ownership and management of a close corporation.

A close corporation must prepare annual financial statements in accordance with the Close Corporations Act rather than IFRS. The financial statements of a close corporation are not available for inspection by the public. Although a close corporation must appoint an accounting officer, no audit is required. The costs of compliance are therefore far lower than those of company.

A close corporation may sell its business either through a sale of its business assets or through a sale by the members of their membership interest in the close corporation.

It is possible to convert a company into a close corporation and a close corporation into a company.

Developments

In terms of the new Companies Act which will come into force late in 2010, it is effectively proposed that no new close corporations will be able to be formed. The Act contains provisions to allow for the formation of smaller owner-managed companies with no audit requirement. At this stage the tax regime will be the same as for existing companies and close corporations.

Taxation

For tax purposes, a close corporation is treated as a company.

Trust

Formation and governance

No statutory law deals comprehensively with trusts. Generally a trust has a founder (or donor or testator), trustees and beneficiaries. The trustees administer the trust for the benefit of the beneficiaries. There is no restriction on the number of trustees or beneficiaries. Founders, trustees and beneficiaries may be natural persons, incorporated entities or other trusts.

In general, there are two types of trusts, testamentary trusts and inter vivos trusts. A testamentary trust is created under the will of a deceased person. An inter vivos trust is created by living persons or entities. Where a trustee has discretion whether or not to distribute the income or capital of a testamentary or inter vivos trust, or discretion over which beneficiary will receive the income it distributes, the trust is known as a discretionary trust.

A trust is governed by the terms of the will or trust deed. Both must be registered with the Master of the High Court as public documents. Trustees may take no actions until they are issued with letters of appointment by the Master of the High Court. Unless they act negligently, trustees are not liable for the debts of the trust.

A trust must prepare annual financial statements. IFRS does not apply to trusts and, unless the will or trust deed specifically directs, an audit of the financial statements is not required. The costs of compliance are relatively low.

Neither trustees nor beneficiaries are required to be citizens or residents of South Africa. A trust must have a registered address in South Africa and must appoint a representative taxpayer resident in South Africa to represent the trust in its relations with SARS.

Trusts are often used as vehicles for estate planning and for protection against creditors, as the ownership of the assets of a trust vests in the trustees. A trustee owns these assets separately from their personal assets.

Trusts are also used as vehicles for collective investment schemes such as mutual funds or unit trusts which acquire listed shares or interests in immovable property or real estate on behalf of the unit holders.

Although technically possible, it is generally accepted that the ownership of a trust cannot be sold or transferred.

Taxation

In general, the beneficiaries of a trust are subject to tax on income and taxable capital gains distributed to them by the trust. The trust is taxable on undistributed income.

In view of the fact that local taxable capital gains are not taxable in the hands of a non-resident (except in the case of the disposal of immovable property, real estate or assets of a permanent establishment through which a trade is carried on in South Africa), such gains of a local trust, if distributed to a non-resident beneficiary, will be taxed in the hands of the trust rather than in the hands of the non-resident beneficiary.

Losses of a trust cannot be distributed to beneficiaries. The losses are carried forward to be set off against future taxable income of the trust.

Ref: ITA s 7(5) and 25B, Sch 8 para 80

The income of a trust retains its nature in the hands of the beneficiaries, and the trust generally acts as a conduit in this regard. For example, if a trust derives local dividend income and distributes this income to a beneficiary, the beneficiary is deemed to have earned local dividend income, which would be tax free in the beneficiary’s hands.

Ref: Armstrong v CIR (1938) 10 SATC 1

If the income or taxable capital gains of an inter vivos trust arise as a result of a donation, settlement or other disposition from a third party subject to a condition that the beneficiaries will not receive income until the occurrence of some event, the trust is not taxable. For example, if a third party advances funds interest-free to an inter vivos trust, the undistributed income or taxable capital gain, to the extent of a normal interest charge, is taxable in the hands of the third party instead of the trust.

Similarly if a parent makes a donation, settlement or other disposition to an inter vivos trust, and the trustee makes a distribution of income to a beneficiary who is the minor child of the parent, the parent will be taxed on the income arising from the disposition.

Ref: ITA s 7(3) and (5)

If a non-resident trust has taxable income resulting from a donation, settlement or other disposition made by a resident of South Africa, the resident trust founder is subject to tax on that income if:

• the taxable income is distributed to a non-resident beneficiary, or

• the taxable income is not distributed to a resident beneficiary due to a condition that the beneficiary not receive income until the occurrence of an event.

Ref: ITA s 7(5) and (8)

If a resident acquires a vested right to any capital of a non-resident trust (e.g. by way of an award from the trust), such amount is taxable in South Africa, if:

• the capital arose from receipts or accruals of the trust that would have constituted taxable income if the trust had been a resident in any prior year during which the resident had a contingent right to that amount, and

• the amount was not previously subject to tax in South Africa.

Ref: ITA s 25B(2A)

Partnership/joint venture

Formation and governance

South African statutory law does not deal comprehensively with the legal status, formation requirements, or governance of partnerships or joint ventures.

Under common law, an agreement between two or more natural persons, incorporated entities or trusts creates a partnership or joint venture. Such agreements are usually in writing; however, no formation instrument is required and, if a written partnership agreement is made, the document is not public.

There is no legal difference between a partnership and a joint venture. A joint venture is often created for only one project, while a partnership generally has a longer duration: but even this difference is not essential or always applicable.

Formation of a partnership requires few formalities. First, each partner must make a contribution to the partnership (in money, service, etc). Second, the purpose of the partnership must be to make a profit. The partnership itself is not a separate legal entity and is not required to register or file a partnership agreement with a governmental authority.

Except in the case of certain professional partnerships, there cannot be more than twenty partners in a partnership unless the partnership registers as a company under the Companies Act. Partners are not required to be citizens or residents of South Africa.

Ref: CA s 30

A limited partnership is also known as an en commandite partnership. A limited partnership has at least one disclosed partner. A limited partnership is generally managed by the disclosed partner/s only.

A partnership must prepare a financial statement on an annual basis, and must allocate the profits or losses amongst the partners according to pre-determined proportions.

Partners do not enjoy limited liability except in the special case of limited partners. They are jointly and severally liable for all the debts and obligations of the partnership. If any one partner pays such debts, that partner can claim the proportionate share from the other partners. If a partnership is sequestrated or liquidated, the individual estates (assets less liabilities) of all the partners are simultaneously sequestrated or liquidated (unless a partner pays all the partnership debts).

With limited partnerships, all disclosed partners have unlimited liability for the debts of the partnership. The other partners are not disclosed and have no liability beyond the amount they may have already invested in the partnership.

If a partner retires from the partnership, the partnership ends and the remaining partners normally reconstitute themselves as a new partnership. The same occurs when a new partner is admitted. In practice, the new partnership simply steps into the shoes of the old partnership and continues the business as before.

Taxation

A partnership is not an entity for tax purposes and does not file its own tax return. If a partnership carries on a trade or business, the computed taxable income or loss of the partnership is allocated amongst the partners according to an agreed ratio. Each partner is deemed to be carrying on the trade or business of the partnership in their own capacity, and each partner is subject to tax. There is no difference in the formation, operation and taxation of partnerships and joint ventures.

Ref: ITA s 24H

Sole proprietorship

A natural person may engage in business as a sole proprietor in South Africa. No formation or governance formalities exist. A sole proprietorship is not a legal entity separate from the sole proprietor, and the sole proprietor is liable for all the debts and obligations of the sole proprietorship.

A sole proprietor is not required to be a citizen or resident of South Africa.

A sole proprietor must prepare annual financial statements for tax purposes, and all income of the sole proprietorship is treated as the income of the sole proprietor.

Public benefit organisation (PBO)

PBOs are established for non-profit purposes and enjoy a tax exempt status except to the extent that they derive trading income above certain limits. PBOs are defined in s 30 of the Income Tax Act (ITA) as organisations which comply with numerous control provisions and carry out public benefit activities. These activities are listed in the Ninth Schedule to the Income Tax Act, and include the provision of disaster or poverty relief, human rights advocacy and community development for the poor and needy.

Ref: ITA s 30 and Sch 9

External company

An external company is a foreign incorporated company that has established a place of business in South Africa. An external company is required to register in South Africa. If it fails to register in South Africa, it may not acquire the ownership of South African immovable property or real estate.

External companies are otherwise governed under the rules applicable to companies in general.

Ref: ITA s 1; CA s 53(b), 322, 324 and 424

Branch

A branch of a non-resident company must register in South Africa as an external company to establish a place of business in South Africa or to acquire immovable property or real estate in South Africa. It is subject to tax at the rate of 33% on its taxable income from a South African source (other than interest income if the exemption applies).

Ref: CA s 322 to 324

(c) Residence

A physical presence test applies to the determination of South African residency. A taxpayer is a resident of South Africa for tax purposes if:

• the taxpayer is a natural person who is ordinarily a resident of South Africa

• the taxpayer is a natural person who is not at any time during the year of assessment ordinarily resident in South Africa but was physically present in South Africa:

– for a period or periods exceeding 91 days (or part days) during the relevant year of assessment as well as for a period or periods exceeding 91 days in aggregate during each of the preceding 5 years, and

– for a period or periods exceeding 915 days (or part days) in aggregate during those preceding 5 years of assessment (with residency proceeding on the first day of the sixth year)

• the taxpayer is not a natural person and is incorporated, established or formed in South Africa or has its place of effective management in South Africa.

Ref: ITA s 1 definition of “resident”

Where a tax treaty applies, the test of residence in the treaty overrides the basic tests set out above.

The courts have interpreted the term “ordinarily resident” to mean the place a person will naturally return to after their wanderings (i.e. their usual or principal place of residence or real or true home).

Ref: Cohen v CIR (1946) 13 SATC 362

The physical presence test does not apply to any person who is ordinarily resident of South Africa at any time during the relevant year of assessment. An emigrant from South Africa ceases to be a resident for tax purposes from the date of emigration, as long as they do not “break” the physical presence test rules in subsequent years of assessment.

In terms of the physical presence test, as long as a person spends 91 days (or part days) or less in South Africa in any one tax year, the person cannot be deemed a resident until at least another five years have passed in each of which the person has been present in South Africa for more than 91 days (or part days).

(d) Tax year

The tax year for all natural persons and trusts commences on 1 March (or the date of registration for the first tax year of a trust) and lasts until the end of the following February. SARS may approve and accept financial statements drawn up to a date other than the last day of February.

Ref: ITA s 1 definition of “year of assessment”

The tax year of a company or close corporation coincides with the company or close corporation’s financial year. In general, a company or close corporation’s financial year ends on the last day of February. A company or close corporation may apply to SARS to use a different tax year end.

Ref: ITA s 66(13A)

The taxable income of a partnership or joint venture accrues to the partners on the date agreed upon in the partnership financial statements. As the partnership itself is not subject to tax, income is deemed to accrue to the individual partners on the date on which the income accrued to the partners in common.

(e) Liability to tax: jurisdiction

South African resident taxpayers are subject to tax in South Africa on their total taxable income and taxable capital gains on a worldwide basis, depending upon the type and source of the income and subject to certain exceptions and exemptions. Non-residents are subject to tax in South Africa only on income from a source within or deemed to be within South Africa.

Ref: ITA s 1 definition of “gross income”

The source of income derived from services is the place where those services are rendered. A foreign non-resident executive working in South Africa is generally liable for South African tax on remuneration received for services rendered in South Africa at the same rate of tax as is applicable to South African residents. Under some tax treaties, a foreign executive who comes to South Africa to work for short periods (usually not exceeding 183 days in any one tax year) is not liable for tax in South Africa on the remuneration earned during such periods. Tax liability may still arise in the executive’s home country.

A non-resident entity or natural person that does not carry on business in South Africa at any time during the year through a permanent establishment, and a natural person who is not physically present in South Africa for a period exceeding 183 days in aggregate during the relevant tax year, are exempt from South African tax on interest income received or accrued during that year.

Ref: ITA s 10(1)(h)

A non-resident is liable to South African tax on capital gains only if the gains arise from the disposal of immovable property or real estate situated in South Africa (owned directly or indirectly) or from the assets of a permanent establishment through which a trade is carried on in South Africa.

Ref: ITA Sch 8 para 2

Remuneration received by or accrued to any person (resident or non-resident) during any year of assessment for services rendered outside South Africa by that person is exempt from tax in South Africa, if that person was outside South Africa:

• for a period or periods exceeding 183 full days in aggregate during any period of 12 months commencing or ending during that year of assessment, and

• for a continuous period exceeding 60 full days during that period of 12 months.

Ref: ITA s 10(1)(o)

(f) Returns and assessments

Basic rule

Individuals and trusts must file annual tax returns with SARS within approximately nine months of the tax year end (longer if lodged electronically). Companies and close corporations must file annual tax returns within 12 months of the tax year end. On written application, a reasonable extension of time will be granted. Electronic filing of annual tax returns (known as eFiling) was introduced in South Africa in the 2006/07 year of assessment. It is not compulsory to file in this way, but SARS has strongly encouraged it by granting longer periods of time to lodge returns for those who file electronically. This is dealt with administratively by SARS.

Ref: ITA s 66

Provisional tax

All individuals having investment or other income in excess of certain limits as well as all companies, close corporations and trusts must register as provisional taxpayers and are liable to pay provisional tax.

Ref: ITA Sch 4

The first provisional tax payment is due no later than six months into the tax year (ie for February year end taxpayers, not later than the previous 31 August). The amount of the first provisional tax payment must not be less than 50% of the tax payable on estimated taxable income for the year. Without the consent of SARS, the amount of the estimated taxable income must not be less than the amount of taxable income reflected on the most recent annual tax assessment. SARS may request substantiation for lower estimates. SARS may also require any estimates to be justified and can require payment on the basis of higher amounts.

The second provisional tax payment is due not later than the last day of the tax year. This payment may not be based on less than 80% of the actual taxable income for the year. If it is less, the taxpayer must pay penalties at the rate of 20% of the tax deficiency. If the taxable income for that year is below R1 million, the amount of the taxable income reflected on the most recent annual tax assessment may instead be used to avoid penalties.

Unlike the first two payments, the third provisional tax payment is voluntary. It is payable within seven months of the end of the tax year ending in February or six months from the end of the tax year in other cases.

If the total provisional tax paid exceeds the amount of final tax assessed for that year, the taxpayer receives a refund in the amount of the excess. Interest is paid on the refund. If the total provisional tax paid is less than the amount of tax finally assessed for that year, the taxpayer must pay the shortfall on assessment and owes interest from the date the third provisional tax payment was due.

Late payment of the first or second provisional tax payment attracts a penalty of 10% of the amount of tax payable plus interest at the prescribed rate (currently 10.5% per annum). This is in addition to the penalty on any deficiency in respect of the second provisional tax payment.

Late payment of the third provisional tax payment attracts no penalty. Interest is payable at the prescribed rate on the amount of tax deficiency.

SARS may waive all penalties in whole or in part if it is satisfied that the late payment was not intended to evade or delay payment of any tax due. A new comprehensive monetary penalty regime came into effect from 1 January 2009 to cover non-compliance or late compliance with the requirements of the Income Tax Act.

Ref: ITA Sch 4

(g) Registration and licensing

All companies, close corporations, trusts and natural persons are obligated to register as taxpayers as soon as they become liable for tax. In practice, they must register before they earn taxable income. To register, a taxpayer should use the IT77 form. If the entity derives income that is subject to special rules or rates (eg gold mining companies), the registration is standard. Disclosure of the nature of the income is required when the entity files its annual tax return.

Ref: ITA s 67

Laws particular to specific industries require certain industries to obtain special licences (eg those selling liquor require a liquor licence, those transporting goods or passengers for reward require an appropriate licence). Exploration for minerals also requires a special licence.

(h) Business regulation and compliance

Every South African taxpayer is issued a tax number by SARS. A taxpayer can only use this number for normal tax purposes and a few other local taxes. A separate tax number is assigned for value added tax (VAT) purposes and a further number for employers who are obliged to register as an employer, deduct pay-as-you-earn tax (PAYE) from employee remuneration and remit PAYE to SARS.

With permission from the Worldwide Business Tax Guide published by CCH Australia Limited.