BUSINESS ENTITIES AND COMPANY LAW – THE BASICS!

“No individual or company, no matter how large or how profitable, is above the law” (quote by Eric Holder).

Company law in South Africa has not been comprehensively arranged in a decree. Accordingly, the two pivotal fundamentals of South African company law are the Companies Act of 2008 (“Act”) and the common law as developed by the courts. South African company law is that body of rules which regulates corporations formed under the Companies Act.

However, there are also numerous other sources of rules related to companies. The Constitution of the Republic of South Africa affords that a company is enabled to the rights in the Bill of Rights to the degree essential by the nature of the company and the nature of the right concerned. More pointedly, the Bill of Rights is binding on a juristic person if and to the degree that it is pertinent considering the nature of the right and the nature of any obligation imposed by it.

Since 1 May 2011, the Companies and Intellectual Property Registration Office (CIPRO) ceased to exist and was replaced by the Companies and Intellectual Property Commission (CIPC). The New Companies Act came into being at the same time, changing the way business owners register their companies.

1.           Companies Act of 2008

The Act is a modern piece of work which is aligned to the South African Constitution.

Below are a few points on the prominent ideologies and distinctive features of the Act.

1.1.   The Act affords for what is basically a gliding measure of directives. As a all-purpose opinion, smaller originalities are subject to smaller directives while more substantial originalities are indebted to fulfil with fairly a number of governing requirements which seem to be intended at safeguarding their societal responsibility.

1.2.   The Act requires companies to commit time and capitals to nursing their amenability with other governmental necessities and intercontinental ideals, also seemingly in an determination to protect the societal responsibility and sustainability of bigger originalities.

1.3.   The Act shortens supremacy for companies, by providing precisely for the holding of board and shareholder conferences by automated communication and for the transient of board and shareholder resolves and the appointment of directors by way of inscribed determination even when undisputed agreement is not attained.

1.4.   The right of access to information is stretched outside the directors and shareholders of the company. Although their rights of access are rooted in the Act, in addition creditors and trade unions on behalf of employees of companies are assumed specific discussion and access to economic reports.

1.5.   The Act requires the complete and itemised exposé of salary remunerated to directors, in reviewed economic reports. Payments paid to directors for presence at conferences and other such amenities may be remunerated solitary in agreement with the sums pre-approved by shareholders.

1.6.   The supremacies of directors are significantly heightened. The right to manage the company and exercise its powers is bestowed in the board, subject only to prohibitions in the Act or the memorandum.

1.7.   The Act is not directly troubled with the conservation of investment progressive by shareholders. Rather it entails that the company calculate its vision of continual creditworthiness and liquidness subsequently the incurrence of specific responsibilities.

“Beware of any enterprise requiring new clothes” (quote by Henry Thoreau). Although above is not exhaustive, one should keep in mind new legislation and amendments that shall inevitably change corporate governance in the future.

2.           The company as a juristic person

Companies are juristic persons. The common law also recognises as juristic persons associations formed for purposes other than that of making a profit such as clubs and societies. “Corporation: An ingenious device for obtaining profit without individual responsibility (quote by Ambrose Bierce).

2.1. Characteristics of Juristic Person

2.1.1.  The company is separate from its employees, shareholders or members. If a company is liquidated, its shareholders will lose their shares and such liquidation would prevent its creditors from chasing the shareholders for fulfilment of the its arrears. It is important to note that in some cases juristic personality may be ignored in terms of the Act while the so-called corporate veil may also sometimes be pierced in accordance with the common law. Piercing the corporate veil would be enforceable when it is evident that the shareholders “used” the resources of the company as a veil to protect themselves from being held personally liable.

2.1.2.  It has continued existence of the person which does not depend on the continued membership of any member.

2.1.3.  It has limited liability. For example, such a person will acquire its own rights and liabilities

2.1.4.   A company exists independently of its members

3.           Different kinds of companies/business entities

The most essential difference in the Act is between profit companies and non-profit companies. Profit companies are unified for the determination of monetary gain for their shareholders.

3.1.       Non-profit companies:

This is a company incorporated for public profit or another object relating to one or more cultural or social activities, or communal or group interests, the income and property of which are not distributable to its incorporators, members, directors, officers or persons related to any of them except as barely tolerable in terms of Schedule 1.

Non-profit companies either have members and directors or just directors. Members may either be voting members and non-voting members. The memorandum of a non-profit company will determine whether the company is one with or without members and if there are to be members it will regulate the credentials for membership, the procedure for applying for membership, the price of membership, the rights and responsibilities of members in voting or non-voting member category as well as the requirements on which membership may or will be lost or deferred.

Since a non-profit company has no share capital, members are not owners of the company as with a profit company. Their rights are as set out in the memorandum of the non-profit company. Given the absence of a share capital, the requirements of the Act dealing with capitalisation of profit companies, securities registration and transfer and public offerings of securities do not apply to non-profit companies at all. Nevertheless, the necessities of the Act amendable to shareholders assemblies apply to non-profit companies with voting members, read with the needed changes.

Possibly the most significant delivery in the memorandum of a non-profit company is the statement of its object. The stated object must be a public benefit object or an object relating to one or more cultural or social activities, or communal or group interests and, if the incorporators wish the company to be approved as a public benefit organisation with tax exemption, the stated object must be a public benefit activity listed in Part I of the Ninth Schedule to the Income Tax Act. If, in addition, the incorporators wish to be able to issue certificates to donors for the reduction of their taxable income in terms of section 18A of the Income Tax Act, the stated object must also be a public benefit activity listed in Part II of the Ninth Schedule to the Income Tax Act.

Schedule 1 to the Act includes provisions to guard the assets of non-profit companies for the stated object. A non-profit company must apply all of its assets and income, however derived, to advance its stated objects. A non-profit company must not pay any portion of its income or transfer any of its assets to any person who is or was an incorporator, member or director of the company, or a person appointing a director of the company, except in the limited instances contemplated in Schedule 1.11.

On the winding up or dissolution of a non-profit company the entire net value of the company must be distributed to one or more non-profit companies, voluntary associations or non-profit trusts with similar objects to the company’s main object.

The memorandum of a non-profit company seeking approval as a public benefit organisation in terms of the Income Tax Act must be aligned to the requirements of section 30 of the Income Tax Act in addition to those of Schedule 1 to the Act.

3.2.       Profit companies:

Profit companies are stated as companies without limitations on the transferability of their shares and that do not forbid offers to the public (such as bigger public companies), and companies that do contain limitations on the transferability of their shares and that forbid offers to the public (such as smaller private companies).

3.2.1.     Types of Profit Companies

3.2.1.1.   Personal Liability Companies

i.   The directors and past directors are jointly accountable with the company for any debts and liabilities arising during their periods in office.

ii.  The company name ends with the word ‘incorporated’.

iii.   Several professional control bodies, such as those for attorneys and auditors, only allow firms of their members to incorporate if those professionals remain personally liable for the debts of the company. 

 iv.   A personal liability company must expressly provide in its memorandum that it is a personal liability company.

 v.   The memorandum should also provide that the directors will be liable jointly and severally with the company for debts and liabilities of the company that are or were contracted by the company during their respective periods of office.

3.2.1.2.        State-Owned Companies

i.   This is a company defined as a ‘state-owned enterprise’ or a company owned by a municipality.

ii.  The names of a state-owned company must end with the expression ‘SOE Ltd’.

iii.   A state-owned company is an initiative that is listed in terms of the Act as a company, and either is listed as a public entity in Schedule 2 or 3 of the Public Finance Management Act, or is maintained by a municipality as intended in the Local Government: Municipal Systems Act and is otherwise parallel to a public entity listed in Schedule 2 or 3 of the Public Finance Management Act.

iv.   State-owned companies are preserved as public companies under the Act and are consequently subject to more rigorous directorial and responsibility necessities.

v.   The credentials to this are that the Minister may exempted a state-owned company from the submission of the Act on request by the relevant cabinet minister and furthermore the Public Finance Management Act and the Local Government: Municipal Finance Management Act will overcome in governing a state-owned company in the event of an discrepancy with the Act which cannot be acquiescent.

3.2.1.3.        Public Companies

i.  The explanation of a public company is principally unaffected. The only alteration is that a public company now only necessitates one member for incorporation compared to seven members in the past.

ii.  Public companies are proposed to be utilised by larger connotations where there is a difference between management and membership whereas private companies are predestined to be used where fewer members are involved and there is no clear difference between the membership and those who manage the company in question.

iii.  Last word(s) of the name of the company for public company is Limited or Ltd.

iv.  Minimum number of members is one and the maximum is unlimited.

3.2.1.4.        Private Companies

i.      While analogous to private companies under the old Act, these are parallel to former close corporations.

ii.     Some of the deviations made to private companies comprise fewer revelation and transparency necessities, no longer being limited to 50 shareholders, and a board that must include at least one director.

iii.   The name of a private company must end with the expression ‘Proprietary Limited’ or ‘(Pty) Ltd’.

iv.      Minimum number of members is one and the maximum is unlimited.

3.3.       Domesticated companies

A foreign company may transfer its registration to South Africa. A company must be deregistered in one country and reregistered in another. The requirements for a foreign company to be eligible to transfer its registration to South Africa is that the company is not allowed to issue and has not issued bearer shares, it is in good financial standing, the majority or all of its assets and undertaking are within South Africa, the majority of its shareholders are resident in South Africa and the majority of its directors are or will be South African citizens.

A foreign company intending to transfer its registration to South Africa must satisfy the necessities of the laws in the jurisdiction of its incorporation for the transfer and pass a resolution equivalent to a special resolution of the shareholders in terms of the Act, if this is not done to satisfy the requirements of the foreign laws.

4.   Formation

4.1.          SOLE PROPRIETORSHIP

A sole proprietorship does not have to be formed; it comes into being when a person begins a business.

4.2.        PARTNERSHIP

A partnership is founded on a agreement between the parties and entails nothing just an agreement.

4.3.          A BUSINESS TRUST

A business trust is also formed by agreement though the trustees may not undertake control of the trust property pending the lodgement of a copy of the trust deed with the Master of the High Court and have attained from him approval of their appointment as trustees in the form of “Letters of Authority”.

4.4.          CLOSE CORPORATION

As of 1 May 2011, it is no longer possible to incorporate a new close corporation,3 although existing close corporations may continue to exist indefinitely.

4.5.          COMPANIES

Persons who propose to integrate a company must lodge numerous documents with the Commission.

           

5.   Legal nature of the business entity

A sole proprietorship, partnership and business trust have no communal personality whereas companies and close corporations are juristic persons.

The veil of juristic personality may be pierced in accord with the common law and legislature. Moreover, creditors often necessitate adherents of juristic persons to give personal security for the arrears of the juristic person.

A partnership is occasionally treated as a distinct entity at liquidation and for the resolve of litigation.

A business entity that does not have juristic personality does not have continuous sequence but a trust deed of a business trust may regulate that the trust will remain notwithstanding variations in trustees or recipients.

           

6.   Management

In a company management and membership are at least tentatively distinct. A prescribed construction for administration is arranged and set down by the law.

Partnerships entitle all partners to share in administration of a partnership and the law does very little to regulate it. However, the parties may modify this by agreement.

In trusts, separation between beneficiaries and trustees exists. The assets of a business trust must be managed by the trustee in accordance with the trust deed.

A sole proprietor may manage his business as he sees fit.

           

7.   Accounting requirements

Companies are obligated by legislature to retain appropriate monetary chronicles.

State-owned Company, Public Company and certain Private Companies, Personal Liability Companies and Non-profit Companies, a complete legislative audit must be essentially be done by an independent auditor.

All other companies, except for Owner-managed Companies, must have their annual financial statements independently reviewed. An independent review does not have to be carried out by a registered auditor.

Companies which are obliged to have their annual financial statements audited must also file a duplicate of their annual financial statements with the Commission with their annual returns.

Partners may agree that certain accounting ethics should be upheld, and they are obligated to account to the partnership for their management of it and formal accounts must be purified annually or at other appropriate intervals even in the absence of agreement.

The Master of the High Court may necessitate a trustee to retain specific records and to account to the Master for his management of trust property.

In any event, each tax-paying business entity is obliged to retain such records, books of account and documents as are needed to enable it to comply with applicable tax legislation and to enable the South African Revenue Service to be satisfied that the person has complied with applicable tax legislation.

            

8.   Income tax

“Most large companies structure their affairs so that they minimize their tax payments. As long as you do it within the law, it's OK" (quote by Chuck Feeney).

A company, close corporation or business trust is a distinct tax entity for income tax purposes but then partnerships and sole proprietorships are not.

Tax will be paid by the partners or sole proprietors. This has several inferences, namely:

8.1.           For tax purposes:

8.1.1. Companies pay tax at a flat rate of 28% (although dividends tax will also be payable in some cases). There are also considerable tax benefits for companies that fall inside the classification of “small business corporation”. It is advised that persons with small businesses ought to conduct their businesses as companies or close corporations if they fall within these provisions.

8.1.2. Sole proprietors pay tax at the rates applicable to natural persons. The applicable tax rate of a partner will depend on whether he is a natural person or not.

8.1.3. Trusts are taxed at a flat rate of 45%.

8.2.          Tax year end

8.2.1. coincides with financial year for company’s tax year.

8.2.2. for a partner who is a natural person, a trust and a sole proprietor is the end of February.

8.3.          Income of

8.3.1. a company may be paid to the members if a dividend is declared. 

i.      Tax is payable on these amounts in the hands of the member.

ii.     The tax is imposed on members at a rate of 15% on receipt of dividends but is withheld from the dividend and paid over to the South African Revenue Service by the company or corporation.

8.3.2.  a business trust will be regarded as having accrued to the beneficiaries of the trust if they have a vested right to it.

i.      Income will then be taxed in their hands and they may subtract all deductions that apply to such income. The income does not have to be distributed.

ii.     It is sufficient if the beneficiary has a right to it. If not, the income will accrue to the trust and will be taxed there.

iii.      Income will be taxed in the hands of the beneficiary if the trustees have a discretion to vest income in a beneficiary and they exercise this discretion in favour of a beneficiary.

iv.      In a trust, tax will only be paid by the person to whom it accrues originally. If the income is taxed in the trust then the beneficiaries will not pay tax on it when it is distributed to them at a later stage.

8.3.3.  in partnerships distribution is irrelevant as income already accrues to partners when it is earned. Income splitting to reduce tax is therefore possible in some partnership and business trust situations.

8.4.      Salaries paid

8.4.1.     by Company may be deducted from income on which tax is paid, providing the salaries are realistic for services rendered in the production of income.

i.      If shareholders are employed by the company this will be the most tax efficient technique for distributing income of the company to the shareholders.

ii.      Such an amount is, of course, taxable in the hands of the person who receives the salary.

iii.      On the whole, it will be only be more tax efficient if the person to whom it is paid pays tax at a relatively lower rate than the company (and the amount of dividends tax payable must also be included in this calculation), which will often not be the case.

8.4.2.  to a partner is merely an advance payment of partnership profits and it cannot be subtracted from tax.

8.4.3.  to beneficiaries of a trust are tax deductible.

8.5.      If there is a loss in a particular year, then that assessed loss normally may be set off against profits in later years.

8.5.1.  Assessed tax losses of a company may only be deducted from trade profits on which tax is paid in the hands of the company and it may only be carried forward to the following tax years if the company does not cease to trade for a whole financial year.

8.5.2.  A natural person, like a sole proprietor, may deduct an assessed loss from any income he receives from whatever source. It will be carried over from one year to the next even if that person ceases trading.

8.5.3.  An assessed loss of a partnership will be deductible by each partner from any income that has accrued to him. If the partner is a natural person, tax losses will be carried forward to the following tax years regardless of whether he is trading.

8.5.4.  If the partner is a company as defined in the Income Tax Act 58 of 1962, losses may only be carried over by that company if it has not ceased trading for an entire financial year.

8.5.5.  An assessed loss of a business trust, which accrues to the business trust, is deductible in the trust, and it will not be lost if the trust does not trade.

i.   If the loss is allocated to a beneficiary then he will be able to deduct it.

“Ideas are easy. Implementation is hard” (quote by Guy Kawasaki). Ensure that once you decide on a business entity that all requirements related to the structure and implementation is done correctly. Ensure you understand which business structure you fall under and which business structure fits your idea best.

(NOTE: this article is for information purposes only. Each case depends on merits of matter and should be consulted with an attorney)