We all wish for success and security, prosperity and peace of mind. In fact we do not know of many people, if any, who wish or seek to fail.
Yet on a regular basis we note the failures of the most passionate, well intended, sometimes well-funded business people, and on the flip side we aspire to the mega successes that we see splashed in media around the world.
So, why we ask, does this happen? What is the recipe for success? How do we avoid failure? In short there is no magic formula. As the cliché goes, success has many fathers and failure is an orphan.
What we are certain of is how to structure a business so that if you are prosperous you ensure proper and speedy wealth creation through tax efficient structures, and if you fail, your wealth, assets and family will be secure from your business failure.
To demonstrate the biggest open secret on how to keep your wealth safe and turbo boost your financial goals, we are going to follow the lives of Mr A and Mrs B, two entrepreneurs.
Mr A commenced a business, and did not set up the correct structures. He carries on his business as a sole proprietor. Mr A initially does very well and in fact becomes a victim of his success in that he pays too much tax. His tax rate is 41% (max rate for individuals, excluding the abatement and marginal rates).
Mrs B starts her business and she sets up a (Pty) Ltd. Initially she qualifies for the small business corporation (SBC) tax regime and her company only pays between zero and 21%* tax (excluding dividends tax and salary she may draw but she will still be better off than Mr A).
As Mrs B’s business grows she no longer qualifies for the SBC, she then structures the shareholding of the (Pty) Ltd, so that she does not own the shares. As Mrs B no longer owns the shares of the Company she is able to keep her Company tax rate to 28%. The structure allows her to avoid, defer or delay the dividends tax thus saving a further 15% in tax.
This simple exercise puts her way ahead of the game compared to Mr B. Further she has considerably more after tax funds to invest than Mr B. Accordingly her returns are going to skyrocket compared to Mr A, who is investing considerably less after having to pay 41% tax.
We have covered the positive aspects of business and investing; we now focus on the downside.
The economy crashes and burns. To boot, Mr A’s business products have become obsolete and he cannot pay his suppliers, staff, rent, loan and overdrafts. In a nutshell, he is bankrupt. The fact that he carries on his business as a sole proprietorship means that he has no limited liability so his creditors will sue him personally and he will lose all of his assets – his home, investments, vehicles, toys, jewellery, cash, furniture and all other movables! He may even be sequestrated which is tantamount to a financial death. That is a pretty grim picture!
Let’s now contrast Mrs B’s position. She structured her company, and simultaneously also set up a personal structure. She owns nothing! When the economy crashes and burns, and her products become obsolete for whatever reason, she will enjoy limited liability! The debt is the debt of the business. What about sureties, the liability to SARS or the directors’ liability in terms of the Companies Act? As Mrs B owns nothing she has options. Further, one will never misrepresent, so being on the right side of the law, Mrs B has got nothing to lose except for a bruised ego, and she gets to play another day compared to Mr A who is financially deceased.
Now that taxes and failure are out of the way what about death?
Mr A being a sole proprietor has really created a mess for his family and estate! Assuming he has rebounded from his financial ruin and has accumulated assets on the event of his death his estate is frozen! His dependants can not access any funds or assets.
On his demise, any of his assets that have appreciated in value will be taxed at 16.4% (maximum Capital Gains Tax rate, subject to a R300k exemption). Any of his assets in excess of R3.5 million net will be subject to estate duty of 20%. Mr A’s gross estate, yes, that means before taxes, debt, costs etc., will be subject to an executors fee of 3.5% plus VAT (effectively 3.99%), and a 6% fee on any income that flows to the deceased estate! The values for CGT and Estate Duty are calculated as at the date of his death not what they are sold for! This is crazy.
In contrast, Mrs B owns nothing, so when she dies there are no assets, cash etc. that will be frozen in her estate. As she does not own anything there will be no Capital Gains Tax due, there will be zero Estate Duty payable and she will have succeeded in her estate not paying any executors fees!
We trust that we have managed to briefly highlight the importance of structures from an asset protection, tax and estate planning perspective.
Now you have a choice, do you want to be Mr A or Mrs B?