The South African government has consistently expressed its support for small business. This support includes tax incentives. However, the point consistently missed is the critical need for the government not to disrupt cash flow, which is far more important than any of the so-called tax incentives to date.
Most small businesses are involved in the service sector with human services being the key value-add. Companies of this nature often make small-margins and must pay their employees monthly (or even weekly) to maintain business activity. Third-party inputs (e.g. small product purchases and third-party services) must also be paid within tight time-frames (e.g. at point of purchase or within 30 days).
On the other hand, receipts are often delayed due to the lack of economic power. Small businesses simply lack the resources and the uniqueness of product to enforce prompt payment, especially when dealing with organisations larger than themselves. It is not unknown for the South African government and its public entities to make payment from six months to a year after small business services are performed. Larger companies typically pay small business last in queue with payments being delayed as much as 90 days. Even transactions between small businesses can be problematic if the small business client delays payments due to cash flow difficulties.
It is against this background that the longstanding VAT invoice method for small business companies is so problematic. Under the bi-monthly system, VAT will often become due to SARS even though cash receipts are delayed or lacking. The net result is an inevitable cash short-fall. The small business owner is then left with three difficult choices:
- delay payment to employees and watch their business disintegrate;
- delay payment to SARS at significant cost (e.g. penalties, interest and administrative hassle); or
- obtain expensive short-term bridge financing from lender subject to high-interest charges.
Each of these options come at high long-term cost that narrows business viability. More formalised businesses with better financials and bank relationships can choose bridge financing. Smaller business typically fall mercy to SARS rather than risk employees.
It should be noted that small business companies can admittedly utilise the cash method for VAT as long as these businesses operate as sole proprietors instead of companies. However, the loss of limited liability offered by company status is no small sacrifice; small businesses are risky ventures and limited liability is key. Company status has also become a tool for business legitimacy in respect of the government and larger private clientele. Indeed, small business companies can even opt out of VAT entirely in theory if annual turnover does not exceed R1 million; but again, many larger private business and governmental organisational clients informally require VAT registration as a condition for entry to prove business legitimacy.
At a policy level, the refusal to allow the cash method for VAT in respect of small business companies is out of sync with international norms. Most advanced VAT systems fully allow for the cash method in the case of small business regardless of whether the business operates as a sole proprietor or as a company (e.g. New Zealand, Australia, France and the United Kingdom). National Treasury had promised in Annexure C of the 2015 Budget Review to revisit the issue but nothing was forthcoming.
So what is the hold up in South Africa? Concerns over avoidance of course. More specifically, SARS is concerned that a mix of connected (i.e. related) small companies can be formed – some on a cash basis and others on an invoice basis. This mix could then be used to obtain input credits (e.g. refunds) on the invoice basis for connected person purchases while having a delayed VAT charge for connected person sellers using the cash basis.
While the above anti-avoidance concerns are no doubt legitimate, tax policy always requires balance between efficiency and revenue protection. The majority of small businesses are legitimate commercial affairs and should not subject to harsher conditions merely because of the problematic few (and indeed, artificial refunds in the small business arena cannot be discounted, but the bigger danger often relates to the invoice method as opposed to cash method).
Small businesses should accordingly be allowed to use VAT on a cash basis subject to anti-avoidance rules to protect the government coffers. Small businesses need all the help they can get during these harsh economic times. Respect for cash invoices is not an incentive – merely a recognition of small business reality.
Keith Engel is deputy chief executive of the SA Institute of Tax Professionals (Sait).