Business Owner and Directors Pay in SA: Drawings vs Management Fees

 

Business Owner or Director in SA: Do you take drawings or management fees?

Business Owner and Directors Pay in SA: Drawings vs Management Fees
Photo by Nadin Sh

As a business owner or director in South Africa, deciding how to pay yourself—whether through drawings, management fees, or a salary—can feel overwhelming. Don’t worry! With the right insights, you can make a smart choice that benefits both you and your business.

There are several ways to pay yourself as a business owner, each with its own tax impact. In this post, we’ll break down the differences between drawings and management fees to help you decide what works best for you and your business.

Drawings are basically when you, as the business owner, take money out of your business for personal use. It's like dipping into your business's piggy bank. Think of it as a way to pay yourself without going through the formal process of salary or dividends.

Advantages of Drawings:

• Flexibility: You can take money out whenever you need it, without a strict schedule.

• Simplicity: It's a relatively straightforward process, especially for sole proprietorships and partnerships.

Disadvantages of Drawings:

• Tax Implications: Depending on your business structure, drawings might not be tax-deductible, which can impact your overall tax burden. Taking drawings doesn’t reduce your taxable income.

 

• Reduced Business Funds: Taking too much money out can leave your business short on cash for operations and growth, especially if you don’t have proper record keeping and financial controls to track your income and expenses.

• Financial Clarity: It can be harder to track your income and expenses, making it difficult to manage your finances effectively.

Management Fees, on the other hand, are payments made to a company director or manager for their services. It's more formal than drawings and often involves a set fee or percentage of the company's profits. A management fee is a payment made to a director, owner, or another individual for their role in overseeing and managing the business. It’s essentially a way to compensate yourself or others for the time, expertise, and effort put into running the company. 

Unlike a salary, it’s not tied to being an employee but is more of a service fee for the managerial responsibilities you take on. This approach can be strategic for business owners, as it often has different tax and accounting implications compared to salaries or drawings.

Advantages of Management Fees:

• Tax Deductible: Management fees are usually tax-deductible as a business expense, reducing your overall tax liability.

• Financial Clarity: It provides a clear record of income and expenses, making it easier to manage your finances.

• Professionalism: It can add a layer of professionalism to your business, especially if you're running a larger company.

Disadvantages of Management Fees:

• Complexity: Setting up a management fee arrangement can be more complex, especially if you're dealing with multiple directors or managers.

• Increased Administrative Burden: It can add to your administrative workload, as you'll need to track payments and ensure they comply with tax regulations.

When to Choose What:

• Drawings: Are best suited for small businesses with simple structures, where the owner is actively involved in the day-to-day operations.

• Management Fees: Are more appropriate for larger businesses with multiple directors or managers, where there's a clear separation between ownership and management roles.

Ultimately, the ideal approach will vary based on your unique business circumstances.
It's always a good idea to consult with an accountant or tax advisor to determine the most suitable approach.

Calculating a management fee can be based on two main methods: a set fee or a percentage of the company's profits.

Set Fee:

• Hourly Rate: You can charge a fixed hourly rate for the time you spend managing the company. This is a good option if your workload fluctuates.

• Flat Fee: You can charge a fixed monthly or annual fee, regardless of the time spent. This is suitable if you have a consistent workload.

Percentage of Profits:

• Percentage of Net Profit: You can agree on a percentage of the company's net profit as your management fee. This aligns your goals with the company's objectives.

• Percentage of Gross Profit: You can also base the fee on a percentage of the gross profit, which is the revenue minus the cost of goods sold.

Factors to Consider:

• Workload: The complexity of your role and the time commitment required.

• Company Performance: If the fee is based on profits, consider the company's expected performance.

• Industry Standards: Research industry standards for management fees to ensure fair compensation.

• Tax Implications: Consult with a tax professional to understand the tax implications of different fee structures.

• Contractual Agreement: Clearly outline the terms of the agreement, including the fee structure, payment schedule, and any performance metrics.

Example:

If you agree on a 5% management fee based on net profit, and your company's net profit for the year is R100,000, your management fee would be R5,000.
It's important to choose a fee structure that aligns with your business goals and provides fair compensation for your services.

Tax implications

Management Fees and Taxes

When you're paid a management fee, it's typically treated as a business expense. This means you can deduct it from your company's taxable income, reducing your overall tax liability. However, it's important to ensure that the fee is reasonable and justified, as excessive fees could be questioned by the tax authorities.

Drawings and Taxes

Drawings, on the other hand, are not tax-deductible. When you take money out of your business through drawings, it's considered a withdrawal of your investment. This means it doesn't reduce your taxable income.

However, it's important to note that the tax implications of drawings can vary depending on your specific business structure. For example, if you're a sole proprietor, drawings might not have direct tax consequences. But if you're part of a partnership or a company, the distribution of profits and dividends can have tax implications.

To ensure you're handling taxes correctly, it's always a good idea to consult with a tax professional. They can provide specific advice based on your unique circumstances and help you optimise your tax strategy.

The Best Option: A Balancing Act

The best option between drawings and management fees often depends on your specific business structure, financial situation, and long-term goals. However, in most cases, taking a salary is the most advantageous approach.

Why Salary is Often Best:

• Clear Financial Structure: It provides a predictable income stream, making it easier to budget and plan for the future.

• Tax Efficiency: Taxes are automatically deducted, ensuring compliance and minimising tax liabilities.

• Professionalism: It presents a professional image of your business, especially when dealing with investors, lenders, and employees.

• Long-Term Planning: A regular salary can help you save for the future, whether it's retirement, business expansion, or personal goals.

When Might Drawings or Management Fees Be Considered?

• Early-Stage Businesses: In the initial stages, when profits are uncertain, drawings can provide flexibility to cover personal expenses.

• Simple Business Structures: For sole proprietorships and partnerships, drawings can be a straightforward way to access funds.

• Specific Services: If you're performing specific services for your company, like consulting or management, a management fee can be a legitimate way to compensate yourself.

However, it's crucial to consult with an accountant or tax advisor to determine the most suitable approach for your specific circumstances. They can help you understand the tax implications of each method and recommend the best strategy to optimise your financial situation.

How are director fees taxed in South Africa?

Director fees in South Africa are subject to income tax, but the specific tax treatment depends on the nature of the director's role and the company's structure.

Executive Directors: If a director is actively involved in the company's day-to-day operations and is subject to the company's control and supervision, they are considered an employee. In this case, their director's fees are treated as salary or wages and are subject to Pay-As-You-Earn (PAYE) tax, as well as other deductions like Unemployment Insurance Fund (UIF) and Skills Development Levy (SDL).

Non-Executive Directors (NEDs): NEDs who are not members of the company's executive management team and are not subject to the company's direct authority are not classified as employees. Their director's fees are treated as income from a trade and are therefore subject to income tax but exempt from PAYE, UIF, and SDL.

Key Points to Consider:

• Tax Residency: The tax residency of the director will determine the specific tax implications. Resident directors are taxed on their global income, regardless of its source, while non-resident directors are usually only taxed on income earned within South Africa.

• Double Taxation Agreement (DTA): If the director is a tax resident of a country that has a Double Taxation Agreement (DTA) with South Africa, the specific provisions of that DTA may affect how their director's fees are taxed in both countries.

• Tax Planning: It's important to consult with a tax advisor to understand the specific tax implications of director's fees and to implement effective tax planning strategies.

By understanding these factors, directors can ensure that they are complying with South African tax laws and minimising their tax liability.