Tax considerations for when your hobby becomes a business
24 April 2014
Madeleine Schubert, Citadel
In today’s fast-paced world of juggling careers, partners, children and extended family, only a fortunate few are able to devote attention to a passion or pastime. In certain, often unforeseen, circumstances, such as retrenchment, divorce, or death of a spouse, a hobby can evolve into a fully-fledged business. But, having a creative idea for a business is not enough. Considerations such as the venture’s legal nature, taxation requirements and the impact the business will have on a personal estate should be taken into account when a hobby becomes a business.
Plan the business venture
Failure to plan appropriately upfront may result in increased future tax costs or could expose your estate to risks such as insolvency, divorce or South African Revenue Services (SARS) tax audits.
In an ideal world, these concerns would be addressed before the business venture commences. Unfortunately, identifying the exact point in time when a hobby becomes a business can be difficult. Most important for determining the time of transformation is the time of entering into a scheme for profit-making.
Legally, trading through the correct vehicle for a business from the start is important, as subsequent reorganisation of personal business interests may result in a substantial tax cost. Although there are reorganisation options currently available that provide for tax-free roll-overs, they are limited, particularly if the business interests are incorporated into a greater personal fiduciary plan.
Ensure the business interests are protected
As part of a personal fiduciary plan, two trusts may be set up, one for business interests and the other for personal investments. By transferring the business interests to the business trust at an early stage, personal tax expenses will be relatively low and all future growth of the business will arise in the trust. The direct benefit is that such business interests are not exposed to estate duty upon death, trust assets are protected against insolvency, personal assets are protected from trust creditors and there is protection in the event of divorce.
Crucial to consider is that once the business is sold or donated to the business trust, it is no longer yours. You may be one of the trustees and/or one of the beneficiaries, but if it is a discretionary trust, the assets belong to the trust. If you fail to acknowledge this and act accordingly, you expose yourself to the risk that your creditors (including SARS) or your spouse in the event of a divorce, will seek to obtain access to those assets. One way to manage this risk is to ensure the trust deed is carefully drafted and Trustee meetings are diligently held and minuted.
Comply with tax and labour regulations
From an income tax perspective you become liable for the payment of income tax the moment your hobby becomes a profitmaking scheme. All sales should be included in your, your company or trust’s income tax return and similarly all business expenditure against it. Depending on the legal nature of the business and who owns it, there may be tax friendly allowances and special rates available, especially at the early stages of starting a business.
Consider assessing when you are liable to register as a Value Added Tax (VAT) vendor. Depending on the nature of the expenditure incurred, as well as the type of sales made, you may be in a VAT refund position at the early stages of the venture and being a VAT vendor may be beneficial. Currently, you are legally required to register as a VAT vendor if your taxable supplies are likely to exceed R1 million in a 12 month period. There is the option, however, of voluntarily registering if the taxable turnover will exceed R50,000 in a 12 month period.
When employing staff, ensure that you are registered for unemployment fund contributions, employees’ tax and skill development levies (although there is an exemption if the payroll is below R500,000 per annum). Failure to register for the latter has closed many promising business ventures prematurely, mainly due to SARS tax audits.
Create a legacy plan
Professional advice can assist with turning your hobby into a profitable business venture and help integrate it into a personal legacy plan for your family and their descendants. If selling the business at some point, a professional legacy plan will permit you to reinvest those funds either into a new business or into a well-structured investment plan, enabling optimal income in the form of tax-free dividends and/ or interest. When creating a business from a pastime it is important to ensure your loved ones are left with a comprehensive plan that will benefit them well into the future.
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