EXPLAINER: How to plan taxes for small businesses; choosing the type of business

As an entrepreneur or business owner, planning for taxes is a very important aspect of your business.

However, this may come as a daunting task for small business owners as they may not have the requisite modes to execute the task.

In this 2022 article, how to plan properly to file taxes has been highlighted.

Read the full story originally published on July 27, 2022 by Timore Francis

Starting a business is a good thing, but choosing the appropriate type of business can have several other consequences because there are legal, tax and other considerations that should influence the type of business set-up for a potential entrepreneur.

The tax consequences of conducting business through each type of entity is considered below. Because of the different legal and tax obligations that comes with the various types of businesses, it is important to first decide on the type of entity or business that you want to start.

Sole proprietorship

A sole proprietorship is a business that is owned and operated by one person (a natural person as an individual). It is the simplest form of business and the most common form of business ownership in Ghana. Legally, sole proprietorship is not separate from the owner who is called the proprietor. It is therefore not a legal person as in the case of a company. The business is thus the same as the owner.

All the income from the business belongs to the owner. Under the tax laws, the owner is treated as an individual and the business income is included in the owner’s income tax returns and taxed in the hands of the owner. The owner operates on a small scale and the business is run by self-employed individuals. This type of business ownership largely includes informal businesses, such as market women.

The benefits of operating a sole proprietorship business include the fact that it is simple to establish and operate as it does not involve many legal requirements. Registration is very simple. Again, the owner is free to take any decision he likes. He can discontinue the business anytime he wishes, and he alone receives all the profits from the business and does not share the profit with anyone.

The major disadvantage of starting a business as a sole proprietorship is the fact that the owner has unlimited liability. The owner is legally liable for all the debts of the business. Not only the business property but any of his personal and fixed property may be sold by creditors to pay off any debt of the business should the business fail to pay the debts.

Because the owner is a sole or single person, raising capital becomes a challenge. Some banks don’t even want to lend to sole proprietors for fear of no succession should the owner pass away, limiting the ability of sole proprietors to expand their business.

Indeed, most one-man businesses fail because of lack of funds. Also, because the business belongs to one man, when the owner dies, the business also dies; hence, there is no perpetual succession.

Partnership

A partnership is a type of business organisation where two or more persons (but not more than 20 people) come together to carry on a trade, business or profession with the aim of making a profit. Some of the benefits of partnership business include the fact that a partnership is easy to establish and operate.

Again, because it has more members, the financial strength of the members enables the firm to mobilise more money to expand the business. The different people coming together to do business means that there will be different skills-set of the partners that can contribute to the success of the business.

The disadvantages are that a partner’s liability is unlimited just like the sole proprietor in Ghana. The partners are jointly and severally liable, meaning that each partner may be held liable for the debts of the business.

Under the tax law, the partnership firm is not taxed. Rather when the profit is shared among the members, the tax is then levied in the hands of each partner according to the relevant share of the partnership profits.

Company

This is another common form of business ownership. A company is treated by law as a separate legal entity, and must register as a taxpayer in its own name. The owners of a company are the shareholders. The managers may or may not be shareholders. The owners (shareholders) are taxed separate from the business.

Some of the benefits of operating a company as a form of business includes the fact that there is a perpetual existence of the business, meaning the business continues uninterrupted even when a shareholder dies or is changed.

It is easier to raise capital and to expand the business because banks, for instance, prefer to give loans to companies than to sole proprietorship. Companies are mostly managed efficiently than other forms of business, such as sole proprietorship. Shareholders have limited liability – that is, they are generally not responsible for the liabilities of the company.

Some disadvantages of a company include the rigid legal requirement when registering a company and the continuous legal obligation after the registration of the business. This makes companies expensive to operate than other forms of business organisation.

As soon as a person commences a business, whether as a sole proprietor or as a company, the person is required to register as a taxpayer with the Ghana Revenue Authority.

By default, the Registrar General’s Department gives Tax Identification Numbers (TIN) to businesses that are registered, but that is just the beginning of the process. In the case of sole proprietors, their Ghana Card Numbers serve as the TIN.

Section 1 (1) of the Internal Revenue (Registration of Business) Act, 2005 ACT 684 provides that: “A person shall not carry on any business unless that person has registered the business with the Commissioner”. Section 1(2) states that a person who fails to register with the GRA commits an offense and is liable on summary conviction to a fine not exceeding GH¢1,200 or imprisonment for a term not exceeding 3 months.

Income tax implications of establishing various forms of business in Ghana.

Company

Generally, a company is taxed separately from its shareholders. This is provided for under Section 58 (1) of the Income Tax Act, 2015 (Act 896). The general corporate income tax rate is 25 percent.

After the company pays its tax, part or all of the remainder of the retained profit is paid to the shareholders as dividends. Dividends paid by a resident company to its shareholders are subject to withholding taxes at the rate of 8 percent.

There is, therefore, a possible total tax exposure on an investment in a company by approximately 33 percent (i.e. 25 percent at the corporate level and 8 percent at the shareholder level). This creates the problem of double taxation.

This double taxation is usually described as ‘Economic Double Taxation’. From economic point of view, the company and the shareholder who invested the money are ‘one economic unit’, hence, taxing the same income twice in the hands of two different persons is economic double taxation. But why tax companies and shareholders at the same time?

There are a number of reasons why we need to retain a corporate tax despite the double taxation problem. For example, companies benefit from being in a stable legal system. The country provides such a legal system, and therefore, companies should pay for the benefit.

Another reason could be that there would be inequity in not taxing companies because people could leave profits stored up in a company and defer taxation altogether. To ensure fairness, if a tax is to be levied on employment income, there must also be a tax on the profits of a company. Again, a company may have several shareholders, and locating these shareholders could be a problem; hence, it is far easier to locate one company and tax it.

The other option could have been to just tax companies and not the shareholders, but this would create inequity because if shareholders are not taxed on their dividend income, then we will be ignoring the fact that the dividend constitutes a different level of income, and some companies will not even declare dividend at all for it to be taxed.

By taxing the shareholders and the company, fairness prevails. One way to mitigate the effect of double taxation is to tax the dividend at a reduced rate, and currently, dividend is taxed at 8 percent and treated as a final tax. Should Small and Medium (SMEs) companies have special tax rate in Ghana?

Partnership

The general rule is that a partnership is not liable to pay tax on its income and is not entitled to any tax credit with respect to that income, but is liable to tax with respect to final withholding payments. The reason is that partnership firms will share the partnership profit with the partners.

Therefore, it is the individual partners who are taxed as individuals and not the firm. Section 54 of the Income Tax Act provides that the income or loss of the partnership for a year of assessment is allocated to the partners as income or loss in their profit or loss sharing ratio.

Since the profits are allocated to the partners in their profit or loss sharing ratio, the income of the individual partners will be taxed on the graduated scale which starts from 0 to 30 percent if the partners are resident for tax purposes.

However, if a partner is a non-resident for tax purposes, the income will be taxed at the rate of 25 percent. Section 133 of Act 896 defines partnership to mean an association of two or more individuals or corporations carrying on business jointly for the purpose of making a profit, irrespective of whether the association is recorded in writing; hence, it is possible that the partners could be entities and where the partners are entities, the profit allocated to the partners will be taxed at the corporate tax rate which is generally 25 percent.

Sole proprietorship

A sole proprietorship is not different from its individual owner for purposes of income tax.

Income earned by the sole proprietorship is taxed in the hands of the individual. If the owner is a resident for tax purposes, the income will be taxed on the graduated scale up to a maximum of 30 percent. If the owner is a non-resident for tax purposes, the income will be taxed at a flat rate of 25 percent.

Conclusion

The default question is: Which of the above forms of business ownership provides the least tax exposure for an investor? It appears that if the partnership is established by either resident or non-resident entities (instead of individuals), the tax rate on the income will be 25 percent.

If a sole proprietorship is owned by a resident individual, the income will be taxed on the graduated scale up to a maximum of 30 percent. If a partnership is owned by a resident individual, the income will be taxed on the graduated scale up to a maximum of 30 percent.

For companies, they are taxed at the rate of 25 percent, and dividends distributed to the shareholders are taxed at the rate of 8 percent, bringing the total tax exposure of the investment in companies up to a maximum of 33 percent.

It, therefore, means that Sole proprietorship and partnership offers the least tax exposures in Ghana. However, the resident status of the partners can result in tax at the rate of 25%.

In all, sole proprietorship and partnership presents the least tax exposure when compared with company because whiles companies and its shareholders can potentially face 33% overall tax in the form of dividend and corporate tax, partnership and sole proprietorship has a maximum exposure of 30 percent at the graduated scale.

However, the resident status of both sole proprietorship and partnership can also influence the exposure.

It behooves investors to consider the tax implications of the type of business organisation in determining which of the forms of business provides the least tax exposure to the investor. Of course, there are other important considerations aside from taxation.

SSD/NOQ

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