Governments should incentivise entrepreneurs to develop and grow businesses in their home country right? However, the punitive tax regimes applying to entrepreneurs may make you think twice!
In most countries with a developed tax system, when a shareholder receives dividends from a local company she is taxed on the receipt, whether by withholding tax or income tax on dividend receipts. This is the case in SA, the UK, and Ireland for example. But generally where she receives dividends from a foreign company in which she holds more than a certain percentage, the receipt is exempt. Similarly if a shareholder sells her business and it’s in her own country, she pays capital gains tax but if she sells shares in a foreign company it’s exempt. This seems strange as it means it can be more tax beneficial for entrepreneurs to run a business outside their borders! Today we look at this anomaly with some examples.
How entrepreneurs are taxed in South Africa
In SA an individual shareholder is taxed at a maximum effective tax rate of 20% on dividends received from her local company. This applies regardless of the shareholding percentage held, i.e. whether she is an entrepreneur who built the business or a passive 1% investor. Together with the 27% corporate tax rate suffered by the local company, this works out to a whopping 41,6% effective tax rate on those business profits!
However, where a SA individual holds shares in a foreign company, and the shareholding is at least 10%, then dividends received from that foreign company usually qualify for the so-called “participation exemption” and would be exempt from tax in the hands of the individual. This also applies to capital gains when the hardworking entrepreneur sells her business – fully taxable if its an SA company, exempt if a foreign company.
So, if an entrepreneur starts a business in SA, they are fully taxable on any profits received from that business, but if the same entrepreneur invests in a foreign business, and holds at least 10% of the shareholding in that foreign business, then the dividends are tax-free. Seems counter-intuitive! It almost seems like government WANTS entrepreneurs to build their businesses offshore! But not so fast… to further complicate matters, in SA at least, exchange control restrictions on the externalisation of cash and assets makes it quite hard for entrepreneurs to get the cash offshore in order to invest offshore. Makes no sense, right?
However, the tax challenges faced by entrepreneurs are not limited to SA. We don’t think it’s deliberate, just shows, again, how the business world and commercial tax regime is skewed towards listed corporates and ignores the double whammy effect when business profits are repatriated to the shareholder or the business is sold.
How does it work in other countries?
In Ireland, the individual shareholder is taxed on local dividend income at her individual tax rates, and of course this is in addition to the corporate tax suffered.
For the UK, the same outcome applies in that local dividends are taxable in the hands of the individual entrepreneur at her marginal rate on dividends exceeding the tax-free dividend allowance (currently GBP 2 000). However, perhaps the UK government is a bit more “fair” in their treatment in that foreign dividends received by individuals will also be taxable in their hands (after claiming any foreign tax credits of course), as the participation exemption (called substantial shareholdings exemption there) only applies for companies.
Some countries do have specific relief measures for entrepreneurs, for example, the UK has Entrepreneurs Relief and Retirement Relief, briefly explained below:
Entrepreneur Relief
Where the entrepreneurs’ relief applies, a reduced UK CGT rate of 10% applies to chargeable gains arising on the disposal of a “chargeable business asset” which:
- is (or is an interest in) an asset which is used for the purposes of a “qualifying business” carried on by an individual; or
- is a shareholding of at least 5% in a company whose business consists wholly or mainly of carrying on a “qualifying business” or a “holding company” of a “qualifying group” which have been owned for a continuous period of not less than 3 years at any time prior to the disposal
The reduced rate of CGT applies up to a lifetime limit of GBP 1 million.
Retirement Relief
In addition to the entrepreneur relief, the UK also has retirement relief, where an individual is at least 55 years of age and disposes of the whole or part of her “qualifying assets”, then, provided the amount of consideration for the disposal of those assets does not exceed GBP 750 000, CGT relief is available in respect of the full amount of CGT arising. The limit is reduced to GBP 500 000 when the individual reaches 66 years of age
Conclusion
In summary, entrepreneurs have a much broader tax framework to consider, as they are subject to both corporate tax on their business and to a secondary tax as shareholders in that business. And it is a weird anomaly that the secondary taxes can be much higher if you’re resident in the same country as your business! Thus entrepreneurs should really think about how best to structure their businesses to safeguard their wealth. At Regan van Rooy, we love supporting entrepreneurs so contact us today for your free assessment.
Meet The Author
Today’s article was written by Vanessa Turnbull-Kemp, our head of SA Outbound Structuring, based in Johannesburg. Contact Vanessa at vturnbullkep@reganvanrooy.com
