Thursday, November 13, 2014

TO BE OR NOT TO BE A COMPANY?



It’s the question we are all grappling with, should we or should we not form a company?
In a recent discussion among friends, landlords are fretting because Uganda Revenue Authority (URA) is moving in more aggressively to tax their rental incomes. The law has always been there but URA has not be able or willing to enforce it across the board – I suspect partly because there are many landlords in URA.


"But as the demand for locally generated revenues build up, look to the taxman to get more aggressive in going after every cent that is due to him...


Everybody should pay taxes (please reinstate graduated tax), but if we are to get ahead it would be wise to pay only those taxes due to ourselves.

One way of doing that is keeping verifiable records, so if there is a tax dispute you have a basis on which to stand, but more importantly we really should incorporate or do all our business under a company, even those hobby farms we have on Hoima road.

To illustrate.
Assuming there is a rental property which earns about sh10m annually in rent. But also the landlord has done some repairs and shoulders the security, garbage expenses and other expenses, which in total amount to three million shillings a year.

Mr Magezi -- Landlord
INCOME
EXPENSES
Rental income                                 10,000,000
Repairs, security etc                          3,000,000
                                                        10,000,000
                                                           3,000,000

Mr Magezi tax liability will be sh10,000,000 X 30% or about sh3,000,000. URA allows some expenses as tax deductible if you are trading as an individual, up to 20% . So let us say they will allow Mr Magezi sh600,000 deduction so his tax bill will be (sh10,000,000 – sh600,000)X30% = sh2,820,000.

[Since this article was published in the New Vision i have been corrected on my computation on taxes paid on properties ownd by an individual.


Tax computation of an Individual;

Gross Rental tax                          10,000,000
Less: 20% of (10,000,000)=       (2,000,000)
                                                      8,000,000
Less: Annual thresh hold            (2,820,000)
                                                      5,180,000

Tax rate @ 20%                          (1,036,000)
rental income net of tax                4,144,000

NB: The expenses the land lord incurs like repairs and maintenance, security etc. for an individual are assumed to be 20% of the gross rental income.
Annual thresh hold is provided for in the current Income Tax Act.

This may suggest that its advantageous to own property in individual names but other expenses a company is allowed include depreciation and finance costs that may still bring the tax liability down even further]



But if Magezi had incorporated his real estate business the situation changes quite dramatically.

Magezi & Sons Ltd – Landlord
INCOME
EXPENSES
Rental Income                                 10,000,000
Repairs, security etc                         3,000,000
                                                         10,000,000
                                                          3,000,000

To get the tax liability of the company Magezi & sons first they deduct the expenses so sh10,000,000 – sh3,000,000 = 7,000,000, which is profit. Then they tax the profit say 7,000,000 X 30% = sh2,100,000.

Of course the calculation has been oversimplified, but the principle remains that in taxing individual income they do not deduct expenses before they lay on the tax, while in a company they first deduct the expenses and tax the profit. Technically if you are making losses you pay no tax.
An expert near you can advise you, but incorporating sooner rather than later is in all our best interests.

For starters it formalises your operations. All incomes and expenses are documented to start with, which gives you a more accurate picture of the state of your business. If you were under any illusions that you were making money keeping records can disabuse you of the notion before you have thrown too much money down the hole.


"How many of us are subsidising our business from our salaries with no end in sight but if we knew better would close the business and look somewhere else?..


Secondly a formalised business is more likely to attract serious partners – clients, suppliers, investors and banks, than an informal one, making ones chances of survival and expansion much better.

The story is told of some serious monied investors coming to Uganda looking for opportunity. There first choice was to partner or buy out an existing business as a way to enter the market. When they looked around they found that the so-called market leader was such a shambolic operation, they could not even come up with a fair value for the business. Not only that, they realised they could come into the market from scratch and actually put the “market leader” out of business. And that’s what they did within 18 months they are the market leader and the previous local businessman’s enterprise is sliding down into collapse.

And finally. If you are not paying tax now when URA comes knocking they will attempt to recoup all the taxes you have been dodging. Now if your books are well kept you might be able to negotiate, but if not it will really be up to the discretion of the tax agents what you are liable for. Many a businessman has collapsed in trying to pay their tax arrears.

Incorporate your chicken coop, your vegetable patch, your make believe consultancy as soon as is possible, being informal is a luxury you cannot afford if your intention is to build your business into a sustainable going enterprise that will feed your family for generations to come.

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