A step in the right direction: small business corporations regime extended to personal liability companies
Authors: Gigi Nyanin and Mark Morgan.
On 8 July 2016, National Treasury (Treasury) released a draft Taxation Laws Amendment Bill (TLAB) and specific draft regulations related thereto, all of which aim to give effect to the various tax proposals announced in the 2016 National Budget Speech. One of these proposals relates to the extension of the small business corporations (SBCs) tax regime to personal liability companies (PLCs).
By way of background, the SBC tax regime, which was introduced in 2001 to stimulate development and encourage fixed capital formation, allows for certain concessions to entities which comply with the definition of a SBC as set out in s12E(4)(a) of the Income Tax Act, No 58 of 1962 (Act). The concessions are in the form of progressive tax rates applicable to entities qualifying as SBCs (ie 0%, 7%, 21% or 28%) and the granting of special allowances for the manufacturing assets used by SBCs. These allowances include a 100% tax deduction for the costs of new and unused manufacturing plant and machinery brought in to use by the SBC as well as a three-year accelerated write-off for other types of assets.
As mentioned above, for an entity to qualify as a SBC, the entity must meet certain requirements which comprise four key areas, namely (i) a legal entity requirement, (ii) a holder of shares requirement; (iii) a gross income limitation requirement, and (iv) a business activity requirement. For purposes of this article, we will only discuss the legal entity requirement.
Legal entity requirement
When the SBC tax regime was introduced in 2001, one of the requirements for qualifying as a SBC was that the taxpayer had to be a juristic person in the form of a close corporation or a company registered as a private company in terms of the then applicable Companies Act, No 61 of 1973 (Old Companies Act). According to the Explanatory Memorandum to the TLAB, the scope of the definition of SBC was “intentionally limited to curb the disguise of passive income and remuneration as business earnings”. The reasoning for such limitation was that such a disguise would have allowed persons rendering professional services to take advantage of the progressive tax rates that apply to SBCs instead of having the disguised passive income and remuneration taxed at 28%.
As a result of the abovementioned limitation, an entity could not qualify as a SBC, if more than 20% of its income and capital gains was made up of passive income and income earned by the entity as a result of rendering certain professional services which were performed by a person who held an interest in the entity.
The abovementioned limitation was relaxed in 2005 and entities that rendered personal services could qualify as SBCs (provided that they employed at least three full-time employees who did not have an interest in the entity and were not “connected persons” (as defined) in relation to those that have an interest in the entity).
Under the Old Companies Act, a PLC fell within the definition of a private company. Historically therefore, PLCs could have qualified as SBCs. This situation, however, no longer prevails due to the fact that when the new Companies Act, No 71 of 2008 came into effect, PLCs were expressly excluded from the definition of a private company. Consequently, PLCs, which in most cases render personal services, cannot qualify as SBCs for tax purposes and as a result cannot benefit from the SBC tax regime.
In order to rectify this anomaly, Treasury proposed that PLCs be expressly included in the definition of SBC in s12E(4) of the Act. However, PLCs will be subject to the requirement of employing at least three full-time employees who do not have an interest in the entity nor are related to any person who has an interest in the entity.
The TLAB proposed that the abovementioned proposal would take effect as of 1 March 2016. Pursuant to the public consultation process regarding the amendments proposed by Treasury, the Standing Committee on Finance indicated in its Draft Response Document dated 21 September 2016, that PLCs will benefit from the SBC regime in respect of the years of assessment commencing from the 2013 year of assessment, as the years of assessment prior to that would have prescribed.
In conclusion, it is quite clear that the move to include PLCs in the SBC tax regime will be welcomed by qualifying PLCs as such inclusion is in line with the objectives of the SBC tax regime, namely the development and fixed capital formation of SBCs.