How to avoid a 10% penalty from SARS this 2020 tax season
By Emanuel Gerson|
August 13, 2020
Debt and taxes in the time of Corona
Benjamin Franklin is often quoted as saying that there are only two things certain in life: death and taxes. Some say that the quote originated in the book written by famous author Daniel Defoe, The Political History of the Devil. Regardless of who coined the phrase, two things are certain in life: death and taxes (there is a debate as to a possible third, being Rand depreciation – but that’s a lengthy discussion for another day).
Along with earlier sunrises and warmer days, August brings the provisional tax season for most businesses. The thought of this, even more so during the Covid pandemic, is enough to make any business owner break out in a cold sweat. . While the South African Revenue Service has granted relief across the various direct and indirect taxes (see here for detail), there still remains a tax burden on business owners to meet their tax obligations.
While provisional tax is currently topical, the objective of this article is not to specifically address the payment of a provisional tax obligation with debt, but rather aims generally to address the question of whether it’s worth taking on debt to make tax payments. and covers all types of direct and indirect taxes including but not limited to Income Tax and provisional payments, Value Added Tax, and Pay As You Earn.
It could be said that paying tax is for the fortunate, i.e., if you’re paying tax you must be making money. But this doesn’t mean you necessarily have the cash flow to pay the liability (another topic for another day – Profit vs. Cash Flow). Furthermore, in the current economic environment, the average South African SME may find itself in a serious cash flow crunch. From slow-paying debtors to decreased sales, it’s safe to assume that many will grapple with the looming provisional payments. For some businesses, this may be the first provisional for 2021, in which case this likely means there could also be a top up for 2020 required – or possibly just their VAT bill or PAYE due.
The thought probably crosses a business owner’s mind at some point as to whether or not they should deprioritise tax payments and focus on getting the rent paid, staff salaries taken care of or paying nagging creditors. An option available to many businesses is the use of debt to manage or bridge themselves through these times. As such, the question arises, should I be using debt to pay my taxes? In order to assess whether or not it’s worthwhile taking on debt to satisfy your tax obligations, you need to answer two key questions and weigh up the answers against each other:
- What are the implications of not paying my tax on time or not paying at all?
- What is the cost of the debt?
Implications of missing a tax payment
Let’s start by analysing the implications of short or non-payment of a tax bill. With the current state of the fiscus and under collections of tax revenue against targets, coupled with the rise of technology and data, the South African Revenue Service is becoming a lot more aggressive and adept at identifying and enforcing tax collection. South Africa has first world tax law in both the Income Tax Act and the Tax Administration Act, and you can bet your bottom Dollar (currently at an exchange rate of R17.20) that if you step out of line there will be consequences.
Missing a tax payment, by even one day, can incur an instantaneous penalty of up to 10% of the amount unpaid, never mind the interest charges that may follow. There are business owners that may consider understating revenue, profit or taking other measures to try and alleviate their tax pressures – this is not recommended as the “slap on the wrist” for doing so could be a hefty 50% of the under-stated amount.
In summary, the answer to question one is that a missed payment can incur a penalty of up to 10%.
The cost of debt
The answer to the second question depends on the type and flexibility of debt you have . Long term secured debt such as a mortgage will be priced very differently to an overdraft, which will be priced differently to an invoice discount. Each business will have their own cost of debt, so in order to answer the question let’s rather reverse the conversation. Knowing that you will incur a tax penalty of 10% for even one day logically results in a business owner being prepared to pay anything less than 10% for one day to avoid this. But maybe we are not talking about one day; the business may require a few months to accumulate sufficient reserves to make the tax payment. So let’s rather use an example to illustrate the equation:
No Money (Pty) Ltd has a tax bill due of R100,000 on 31 August 2020. Their cash flow is under severe pressure and they have no money to pay the obligation. Should they not pay on the 31st of August they will immediately incur a penalty of R10,000 (note – the interest charges are still to follow).
They are able to apply for finance that will cost them 2% per month and it’s likely that it will take them three months to repay the debt (assume for ease of calculation that they accrue the funds and make a bullet payment on the debt at the end of three months, and that the rate is simple interest per month). The total cost of the debt would therefore be R6,000 – a full R4,000 cheaper than the penalty. You can use Bridgement’s business loan calculator to test other scenarios with different tax bill amounts and durations.
It makes sense (possibly even Rands, but not Dollars) to use debt to pay tax
Using this example we can conclude that as long as the cost of the debt over the term is cheaper than the penalty incurred, it would make sense to use debt to pay your tax obligations. Never mind the headache factor and administration involved in missing a payment and having to engage the tax authorities, the pure economics itself are advantageous. Businesses should definitely consider the options available to them when their tax obligations arise as a reasonably priced debt line can very well be cheaper than an expensive tax penalty.
Footnote – for those that want to get technical, interest and penalties paid to SARS are not deductible for tax purposes whereas the interest on the debt is. This means that a cost of debt over the entire term of anything less than circa 13.9% would be better for a business than incurring the tax penalty.
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