Summary of the article:
- This article gives talks about a useful way to classify taxes for business owners
- It describes the differences between direct and indirect taxes and how one can lower these taxes
- It mentions how tax is administered and the importance of this
- It gives some thoughts on tax consultants and their role in businesses
Classifying taxes: a helpful criterion
None of us likes to pay taxes even though in essence we understand the logic behind taxation; yet, we have no say in the matter. Death and taxes, the idiom goes, are the only certainties in life. All of us would love to reduce the amount of tax we pay, but one cannot challenge what one does not understand. To reduce our taxes, we would have to understand what provisions the law makes for reduction of our tax liabilities. Thus, it would be helpful to learn some basics about taxes.
Taxes can be classified in various ways. A common classification method is in terms of direct versus indirect taxes. The distinguishing characteristic of these two classes is that direct taxes are levied on persons (individuals or organisations) whilst indirect taxes are levied on goods and services. Other classifications of tax include income tax, transactional taxes, duties and levies. This article focuses on the direct versus indirect tax classification.
Direct taxes
Direct taxes are usually charged on what you earn (that is, income), or what you own (your wealth, or capital). The burden of tax for direct taxes cannot be shifted to other parties. This means that the amount of tax charged will be drawn from your pocket in the case of individual direct taxes, or the coffers of your business in the case of companies. Examples of direct taxes include income taxes on both individuals and companies, and capital gains taxes.
There are provisions for deductions to be made against your direct tax liabilities depending on the tax laws of your jurisdiction. The law allows persons to reduce the amount assessed for income tax in an effort to ensure equity or as a relief to lessen the burden on taxpayers. The rule of thumb is that you can deduct amounts that have already been taxed (principle of double taxation), or amounts that are exempt for various reasons. For example, the government in trying to incentivise certain behaviours such as saving among its citizens, may give certain reliefs such as insurance reliefs or pension reliefs to be deducted against your tax liability, but you must claim these reliefs to benefit.
Indirect taxes
You can think of indirect taxes as taxes charged on your expenditure. This is why we say indirect taxes are tied to goods and services, because they are based on the value of goods and services purchased. Examples of indirect taxes are value added taxes (VAT) and excise duties.
With indirect taxes, you can shift the burden of tax down the supply chain since the tax is tied to goods and services. What this means is that you purchase an item from a supplier with indirect taxes loaded onto it, and when you sell the item, you transfer that indirect tax to your customer, and this goes on along the value chain. Finally, the ultimate consumer, unable to shift the liability to anyone else, bears the final tax burden. They cannot charge anyone else the indirect tax. Think of the “pass-the-parcel” game we played as children where the one who ended up with the parcel when the music stopped claimed the prize, except in this case the “prize” is payment of the indirect tax.
Tax administration/ collection
Taxes are collected in a number of ways. They may be withheld at source, paid in instalments, paid in advance or in arrears. All these are dictated by the law and are worth noting because they affect your (or your business’s) cash flows. Breaching these terms could attract hefty penalties which, coupled with interest on delayed payment, could accumulate to crippling amounts that in many cases kill small and medium businesses.
In some cases, the revenue authority entrusts businesses or organisations as withholding agents for different taxes to help them with monitoring of the flow of funds in the economy and ensure compliance among taxpayers. A very basic example is the pay as you earn obligation (PAYE) which is typically withheld by the employer and remitted directly to KRA, leaving the employees with the obligation to file their returns at the specified filing deadline. Thus, any organisation with taxable employees therefore automatically becomes a collection agent for the revenue authority.
Taxes and business cash flows
For any business, but especially for small and medium sized businesses, cash flows are vital for the continuity of the business. If cash flow is not appropriately managed and planned for, the business struggles to make payments when they fall due, and this causes strain on the business as well as increases the risk of collapse. Taxes are an important yet often ignored contributor to the flow of cash for any business and must therefore be taken into account when budgeting for cash flow needs for the year.
The importance of a basic understanding
In order to manage your taxes (hence your cash flows), you must understand the nature of taxes, the timing of their incidence, and when they become due for payment. You cannot reduce your tax liabilities arbitrarily. Worse still would it be for your business to attempt to reduce its liability by evading its tax obligations.
Remember the idiom: death and taxes! The taxman eventually catches up with delinquents who think they can dodge their tax obligation. Penalties incurred from tax evasion could add to up to double the amount of tax evaded, which is quite stiff. In the end the risk of being caught in default is not worth the apparent reward of temporary improved cash flows. The law allows the revenue authority to go back in time to re-calculate your tax obligation if they have reason to believe that you have been dishonest in your declarations and payments.
This is not meant to scare you but to motivate you to create a plan that complies with the law yet optimizes your tax liability. Do not be caught in a trap! There is a difference between avoidance and evasion: the former is provided for by the law, the latter is unlawful and therefore a disaster waiting to unravel.
Minimising your business expenses
Small business owners are often careful on their spend. This is sensible, considering the business is often at its early stages and wants to plough back as much money as possible into growth. Perhaps the business is not so young, but cash flows are limited and the owner wants to ensure they are maximising their profitability. Minimising expenditure is usually a reasonable thing to do, but business owners must be careful to distinguish between costs that are worth saving on and those that are worth incurring.
There is a Swahili proverb that says that if you do not seal a crack, you will build a wall. The English equivalent is the proverb a stitch in time saves nine. It makes no sense to save on the cost of a tax professional and gain a little profit in the short run, only to default on your tax obligations and be fined hefty amounts in the future. Better to mind the cents and the shillings will take care of themselves.
Tax consultants: to hire them or not?
Tax laws are continuously being updated, depending on government needs. This is what the Finance Act is about, among other things. The sheer amount of factors you need to consider with regard to taxes is a lot, and being on top of your tax compliance is pertinent.
Nevertheless, as a business owner you use your time poorly by trying to keep abreast of every single tax development rather than getting a general understanding of the tax environment. This is the ambit of a good consultant, whose focus is the workings of taxes in your jurisdiction and how your business can take advantage of tax laws to reduce your tax liability legally.
Still, a basic understanding of how tax works will better equip you to identify a good practitioner who can guide your business in matters tax. It will also enable you to have meaningful discussions with them about your business’s specific strategy. Hence, a tax consultant is definitely a worthy investment for any serious business.
Do you need help with your taxes?
Red Beryl professionals have gained experience from large established corporates and who have likewise worked with small budding businesses. We are well versed with handling tax compliance matters as well as handling tax controversy resolutions. We have worked with various small businesses to ensure that their tax accounts are clean and compliant. We also help businesses in planning their business strategy to optimise their tax liability legally. If you need support with your business taxes, please email us on ask@rbconsulting-ltd.com or call +254723673615.
