Yesterday, we looked at:
• Paying yourself through the shareholder loan and
• Paying yourself a salary.
We looked at the pros and cons of both.
To round up the series, we’re going to talk about paying dividends from profits and paying out of Owner’s drawings
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Declare a dividend
If you’re one of those lucky fish in a registered company that’s making a profit, you have the option to extract profit from the company by declaring a dividend.
But dividends can be expensive.
When you declare a dividend, the profits will taxed at 27% at the corporate income tax rate , and THEN also taxed at 20%. That’s 47% in total. 🤯 before you get money in the bank account.
Now, please note that the 27% is paid by the company and the 20% is a tax withheld and paid by the company but owed by you.
When can dividends be useful?
They become more useful the higher your salary and profits are. And that’s where a good accountant comes in. They can calculate the point at which the combination of employee tax, dividends tax, and income tax is the lowest.
Advantages
- A mechanism for withdrawing profits from the company
- Admin for dividends is not so onerous and only happens once maybe twice a year.
- Can be tax-efficient at very high levels
Disadvantages
- Not tax-efficient at lower profit levels.
- The Company needs to be making a profit.
- Dividends tax needs to be included in the individual shareholder’s tax return
- Can also be subject to individual tax if higher than the individual dividends and interest rebate.
- Only available to companies. Sole proprietors cannot declare dividends
Example of the tax on dividends
I have a business that has made R100 000 profit after taking into account my salary. I have paid myself R30 000 per month for the 12 months, and now I need to know what is the most tax-efficient way to take the last R100 000 out of the business.
Should I declare a dividend or take a higher salary at the end of the last month?
Here’s what it looks like:
If the final salary is zero, and they choose to take all the profit out using dividends, the total tax payable is higher than if they pay it out as a salary.
In this case, a salary is the most tax-efficient way of extracting profits out of the business.
Note: this assumes that the company is not operating as a small business corporation, and the profits are not taxed on a sliding scale.
Take money out of Owner’s drawings
If you’re a sole proprietor, you do not have the option of declaring a dividend. You extract profits from the business using the owner’s drawings.
Owner’s drawings are not taxed because they have already been taxed as profits of the sole proprietor at individual tax rates (sliding scale).
All business profits are included in the owner’s personal income tax return as per Section 1 of the Income Tax Act.
Advantages
- There’s zero tax admin.
- There’s no tax liability
Disadvantages
- Amounts can only be withdrawn after all revenue and expenses are recorded, so it’s important to maintain accurate records of all business income and expenses to ensure correct reporting and compliance with tax obligations.
- Not available to companies, only sole proprietors.
Example
My business has made R100 000 per month and has expenses of R20 000 per month. What is my tax liability? And how much can I extract as Owner’s drawings?
Conclusion
Now that I have covered the advantages and disadvantages of all the options, which is the best option?
For registered companies, where there is a single shareholder who also runs the business and wants to extract all profits from the company.
If all the profits are to be extracted, it’s best to use a salary up until a certain level of profits (around R1 million). After that, you would need a combination of salary and dividends.
What is that combination? That’s a question for your accountant.
And as always:
Disclaimer
This article is not financial advice. It’s for informational purposes only. Tax laws and rules are complicated and can change. Always talk to your accountant or a qualified financial advisor before making any financial decisions. The examples given are just for illustration and may not fit your specific situation. Getting professional advice tailored to your own circumstances is important for following the rules and planning well.
Making decisions based on an email is not wise, but otherwise.
Do you need last-minute tax assistance, let’s chat: https://wa.link/uiabej
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I ran this workshop last week, with Lefika Foundation with some very happy attendees.
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1. I offer financial reviews to help you understand if your finances are under control
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Until next time,
Praneeta
