Why pay yourself a Salary as a Business Owner in South Africa

 

Business Owner In South Africa: Why Paying Yourself salary is a Better Option

Why pay yourself a Salary as a Business Owner in South Africa
Photo by Anna Frolova

Paying yourself a salary as a business owner in South Africa will give you peace of mind and potentially reduce your tax liabilities.

Deciding how to take money out of your business is an important choice in South Africa, with meaningful tax implications to consider.

Let’s explore the options in a way that’s easy to understand, so you can make the best decision for your situation.

Even though it might be nice to take extra cash as compensation or drawings, sticking to a regular salary is the smartest move. A thorough understanding of SARS regulations and tax incentives can help you maximise your income and reduce your tax burden.

What does paying yourself means?

Paying yourself, as a business owner, is essentially withdrawing money from your business for your personal use. It's how you compensate yourself for the work you've done and the risks you've taken. The method you choose to do this can have significant tax implications, so it's important to understand the different options and their consequences.

The most common methods of paying yourself are:

1. Salary: This involves treating yourself like an employee, paying yourself a regular salary, and deducting PAYE and other relevant taxes. This method offers several benefits, including pension fund contributions, medical aid tax credits, and unemployment insurance contributions.

Paying yourself a salary is a great option for tax purposes, but it does come with a bit of extra paperwork. First, you’ll need to register for PAYE(Pay As You Earn) and UIF (Unemployment Insurance Fund). These payments must be made on or before the 7th of the following month—so timely payments are key. If you're late, pay less than required, or fail to submit your returns, you could face penalties and interest from SARS.

Once you're registered for PAYE and UIF, you'll need to make monthly contributions for as long as your business is running—whether or not the business is profitable. You’ll also need to withhold and pay medical aid and pension fund contributions every month.

While managing a salary adds some administrative work and costs to the business, it offers peace of mind. It creates clear, official records of your income, which can be really helpful if you need to apply for loans or credit.

Overall, paying yourself a salary is a good option if you own a registered business and want to keep everything in order for both tax and financial planning. It’s a smart move, but it does require some ongoing effort to stay on top of the admin!

2. Owner's Drawings: This is a more informal method where you simply withdraw money from the business account as needed. While it's a straightforward approach, it doesn't offer the same tax benefits as a salary and can be less structured. 

Drawings are more practical for sole traders or self employed individuals, because as business owners they can't register for UIF and PAYE.

3. Dividends: If your business is a company, you can pay yourself dividends. However, dividends are taxed at a higher rate than salaries, and there are additional tax implications to consider.

It's crucial to consult with a payroll specialist, accountant or tax advisor to determine the most suitable method for your specific circumstances. They can help you understand the tax implications of each option and recommend the best approach to maximise your after-tax income.

Reasons why a salary is the optimal choice and the tax implications associated with each method.

While South African business owners have several options for drawing funds from their businesses, paying yourself a salary is often the smartest choice. It not only offers clear financial benefits but also helps you manage your taxes more effectively, making it a highly advantageous approach in the long run.
This option offers several benefits, particularly when considering tax implications and financial management.

Firstly, paying a salary allows for a clearer separation between business and personal finances. By establishing a formal salary structure, business owners can accurately track income and expenses, simplifying bookkeeping and financial planning. This clarity is crucial for maintaining sound financial records and complying with tax regulations.

Secondly, a salary structure offers significant tax advantages. When a company pays a salary to its owner-director, the salary expense becomes a tax-deductible expense for the business. This reduces the company's taxable income, resulting in lower corporate tax liabilities. Conversely, the owner-director is liable for personal income tax on the salary received.

You’ll be paying personal income tax on the salary you take, the overall tax impact might still be more favourable compared to the tax savings you get at the corporate level. In many cases, the corporate tax rate is higher than personal tax rates, so structuring your compensation in a way that takes advantage of the corporate tax benefits can actually result in significant savings for the business.

By paying yourself a salary, the company can reduce its taxable income, which lowers the overall corporate tax bill. At the same time, you’re still paying personal tax, but it’s often less than what the company would have paid in corporate tax if profits were kept within the business and taxed at the higher corporate rate. This makes it a financially advantageous strategy, especially if managed correctly.

To break it down even more:
When you run a business, there are two types of taxes to consider: corporate tax (paid by the company) and personal income tax (paid by you, the individual).

• Corporate tax is the tax the company pays on its profits. In South Africa, this is typically 27% for companies.

• Personal income tax is what you pay on the salary you receive from your business. Personal tax rates are generally lower than corporate tax rates, depending on your income level.

Now, when you decide how to take money from your business—whether as a salary or through dividends—you’re essentially deciding between these two tax systems.

Your salary can be deducted as a business expense, lowering the company's taxable income. This lowers the company’s profits, and therefore its corporate tax liability. So this reduces taxes the company has to pay.

Although you’ll pay personal income tax on the salary you draw, the overall tax impact can still be more beneficial than if the company kept all the profits and paid corporate tax on them. That’s because your personal tax rate could be lower than the corporate tax rate, depending on how much you earn.

In contrast, withdrawing funds through management compensation or owner's drawings can lead to less favourable tax outcomes. Management compensation, while tax-deductible, is subject to closer scrutiny by the South African Revenue Service (SARS). If the compensation is deemed excessive or unreasonable, SARS may disallow the deduction, increasing the company's tax burden. 

Owner's drawings are treated as personal income and are not tax-deductible for the business.

When you run a business, the company has taxable income—this is essentially the money the business makes after accounting for all expenses (like operating costs, salaries, etc.).

If you choose not to pay yourself a salary or take drawings, the company keeps its full taxable income. In simple terms, the company has more money left on paper, and it will be taxed on that full amount.

So, if your business has more taxable income (because you're not paying yourself a salary), the company will end up paying more in corporate taxes.

To put it simply, when the business keeps its full income, it doesn't get any tax relief for salaries or other deductions, which means the company could face a higher tax bill.

Furthermore, paying a salary ensures regular income for the business owner, providing financial stability and security. This regular income stream can be used to meet personal financial obligations, such as mortgage payments, education fees, and retirement savings. In contrast, owner's drawings can be unpredictable and may not provide a consistent income flow, potentially leading to financial difficulties.

In conclusion, while various methods exist for taking funds from a South African business, paying oneself a salary remains the most advantageous approach. It offers tax benefits, financial clarity, and income stability. By understanding the tax implications and financial advantages of a salary structure, business owners can make informed decisions to optimise their financial well-being and business growth.

Advantages of Taking a Salary as a Business Owner in South Africa

• Clear Financial Structure: A salary provides a predictable income stream, making budgeting and financial planning easier.

• Tax Efficiency: Taxes are automatically deducted, ensuring compliance with SARS regulations and minimizing 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.

• Employee Benefits: Depending on your business structure, you might be eligible for employee benefits like medical aid and retirement funds.

• Clear Record-Keeping: A salary ensures accurate financial records, making it easier to track income and expenses.

Disadvantages of Taking a Salary as a Business Owner in South Africa

• Increased Administrative Burden: You'll need to register for PAYE and UIF, which can be time-consuming and requires additional administrative tasks.

• Higher Tax Liability: Taking a salary can increase your personal income tax liability, especially if you're in a higher tax bracket.

• Reduced Business Profit: Paying yourself a salary reduces your business's net profit, which can impact your ability to reinvest in the business or pay off debts.

Ultimately, the decision to take a salary depends on your specific business situation and financial goals. It's advisable to consult with a tax advisor or accountant to understand the implications and make an informed decision.

If you're finding it difficult to manage your payroll as a business owner, then reach out to us.