Structuring a business as a company is often seen as a fashion without considering the tax and commercial implications that may arise from such a choice. To many, being in business is synonymous with running a company, when in fact a company is one among many ways of structuring a business. Choosing a structure that reflects your financial, tax and administrative needs is of paramount importance. Traditionally, limited companies have been selected as a way to secure the protection of limited liability and capital raising. However, if you are simply providing consultancy services, then a limited company might be unnecessarily complex and tax inefficient. This article demonstrates why partnerships may be better than companies when it comes to tax efficiency.
A partnership is similar to a sole trader – only it has more than one owner who lawfully carries on business. It is not itself a separate legal entity from its owners as with limited companies. For tax purposes, partnerships are viewed as a conduit pipe of the profits or losses of the partners. They are also excluded from the definition of a person by virtue of s 2 of the Income Tax Act (ITA) and because only persons are subject to income tax, it means that a partnership per se is not liable to income tax. Despite section 37(15) of the ITA requiring partners to submit a joint income tax return, each partner is separately and individually liable for the rendering of the joint return.
In practice, the taxable income of partners is first determined on the assumption that a partnership is a separate taxable person and then split between or amongst partners according to their agreed profit or loss sharing ratio, and each partner then becomes liable to tax on his share.
A partnership is tax efficient than a company when it comes to assessed losses. Section 15(3) of the ITA makes provisions for the deduction of assessed loss. Any assessed loss which cannot be immediately deducted is carried forward and offset against future profits from the same trade. If it remains unutilised for a period of 6 years (except in the case of mining where carry forward is indefinitely), the assessed loss falls off. The assessed loss stays within the company and shall not be attributed to shareholders. The position is different with a partnership. In such cases the losses are attributed to the partners and can be offset against their other incomes.
Another distinction between a company and a partnership is in relation to tax on dividend. The profits left after paying corporation tax are stuck in the company. When such profits are distributed to shareholders a secondary tax in the form of dividend tax becomes payable. In a partnership the tax liability is at the partner level at the same tax rate applied on profits of the company with no further tax applied, effectively avoiding dividend tax.
Additionally, a partnership is unique in its tax treatment of remuneration paid to the partners. According to paragraph 1(1) of the 13th Schedule to the ITA, salary and other benefits of a partner do not constitute remuneration. This stems from a principle that a man cannot be his own employer. A shareholder who is an employee in his company is taxed on his remuneration based on employees’ tax tables. The same earnings are also subject to National Social Security Authority (NSSA) rules. In contrast, partners are subject to income tax on the full amount of their profits regardless of how much money they draw out of the business as ‘salaries’ each year. This is achieved by deducting the remuneration in the joint statement of taxable income of partners and bringing it back in the taxable income of the partner. The same principle is applied to other private expenses of a partner such as medical insurance. Private expenses for owners of a company may be taxed under remuneration if these are employed in their companies or non-executive director’s fees if they are not employed in their companies. Nonexecutive directors’ fees are also subject to a withholding tax of 15%.
While partners in a partnership can make drawings from their business without further tax consequences, for shareholders in a company there are transfer pricing provisions which need to be considered. In line with the new transfer pricing rules in section 98A and B of the Act, the Commissioner can deem any loans and other payments made to shareholders, directors or an associate of a shareholder or director as dividend distributions by the company to its shareholder if such loans or payments were made free of interest or at concessionary rates or terms. Dividend tax thus arises.
There are other differences in tax treatment between companies and partnerships in respect of motor vehicles used wholly or partly for business purposes. Shareholders are assessed on the private use of company vehicles based on the engine capacity of the motor vehicle provided. In the case of a partner, use of partnership motor vehicle results in an arm’s length cost of running the motor vehicle multiplied by the percentage of private use being taxed to the partner but such costs are fully deductible to the partnership
While setting a business is synonymous with registering a company. if one is simply providing consultancy services, a limited company might be unnecessarily complex and tax inefficient. It may be necessary for owners to structure their business as a partnership. However, there are no hard and fast rules in choosing a business structure, a simple comparison of the tax efficiency of the two is only one of the many factors that should influence this key business decision.
Add a Comment