A small business is defined as an independently owned venture that’s characterised by a few employees, usually between one and 19.
It is an obligation for every registered business to identify its tax liability and remit taxes to the relevant authorities. Governments use tax collections to deliver critical public goods and services, such as roads, electricity, security and law and order.
This week we look at 10 common tax mistakes that can be costly to the growth and survival of a small business.
1. Poor record keeping
Record keeping is a key prerequisite to proper tax filing and compliance. If a business doesn’t keep proper records, then it would be difficult to ascertain the amount of tax it owes the Government.
Further, failing to keep proper records for any business leads to a default penalty of between Sh10,000 and Sh200,000 once detected by the Kenya Revenue Authority (KRA). Such a penalty can, obviously, negatively affect the operations of a small business.
2. Erroneous tax obligation
Entrepreneurs should be familiar with various types of taxes and any changes in rates to ensure that they calculate the correct tax liability for their small businesses. An erroneous tax obligation is an expensive mistake for any small business, as it can lead to hefty penalties and losses.
For example, a business with an annual turnover of more than Sh5 million should register to remit Value-Added Tax (VAT), which is calculated at a rate of 16 per cent of the value of products sold. However, if the firm’s annual turnover is less than Sh5 million, then it should register for turnover tax, which is calculated at a rate of 3 per cent of turnover every three months.
3. Wrong business structure
It is common for small businesses to start out as sole proprietorships or partnerships. However, as the business grows, it may require a change of its legal entity.
Once it gets to this level, as a small business owner, engage an expert for guidance on the structure that would be optimal, as well as the requisite tax implications, including deductibles.
4. Mixing business expenses with personal expenses
If your business is a corporation, it is considered a separate entity and finances must be completely separate to maintain the corporate shield that protects your personal assets.
If you have structured your business as a sole proprietorship, the business is not a separate entity, as you are entitled to all its profits and are also responsible for all its debts, losses and liabilities.
But even then, business and personal finances should be separated because, in the event of an audit, the burden of proof is on you to show the expenses and income that are due to the business.
5. Late submission of taxes
If a business does not pay its taxes on time, it could incur hefty penalties. For instance, if you have registered for VAT, you are expected to pay on or before the 20th of the month that follows the one when sales were made.
Failure to file VAT on time attracts a default penalty of Sh10,000 or 5 per cent of the tax due, whichever is the higher, as well as an additional interest of 2 per cent per month you’re late.
It’s important to avoid the last-minute rush by submitting returns on time. This way, you improve your chances of avoiding being slapped with penalties, and you’re able to maintain healthy business practices. With proper record keeping, filing returns shouldn’t be a burden.
6. Tax evasion
It is common for unethical taxpayers to try to reduce the amount of tax that they have to pay by failing to disclose their full taxable income. This is known as tax evasion and it’s illegal in Kenya.
As a business owner, it is prudent to report all your taxable income and avoid underpayment of tax obligations. Tax evasion attracts a fine not exceeding Sh400,000 or double the tax evaded – whichever is greater – or imprisonment for a term not exceeding three years, or both.
7. Classifying contractors as employees
Since the relationship between employees and contractors is not always clear-cut, business owners have to determine taxable workers and their taxable income, as this will affect the tax payable.
For a contractor, you don’t have to pay any employer taxes, but if you get this wrong it would imply the payroll is wrong. Misclassifying employees also impacts on the amount of deductions you can claim on business taxes.
8. Failure to register as a taxpayer
Several small businesses, in an attempt to remain informal, avoid formal registration, or even registering for taxes. This strategy limits their potential for growth because such enterprises do not benefit from access to loans that can be used for expansion. Informal businesses also fail to tap into the needed human skills to steer their businesses.
9. Underpaying estimated taxes
Self-employed individuals are taxed through a self-assessment system. This means they estimate their taxes and pay on a quarterly basis. If they underpay, interest and penalties can accrue. To avoid underpaying, some of things that a self-employed individual can do is: base tax payments on the previous year’s earnings; ask for professional help; and use a separate bank account for business finances and keep a running tally of your income at the end of each quarter.
10. Relying on unqualified professionals
Most small business may not be able to afford professional support from accountants and legal professionals to comply with the various taxes. While this may be the case, it is advisable to hire individual record keepers that meet minimum qualifications.
A business owner may be tempted to use an expert who suggests that they hide their income or take write-offs. This can be detrimental to the business, especially when the law catches up with these business practices. The revenue authority will hold the owner of the business accountable for tax errors, regardless of who completed the filing.
Starting a business is a costly undertaking, and staying the course is a big hassle for any form of business. But you can make the journey easier through proper book keeping, ensuring accurate tax compliance and working with qualified professionals.
The writer is an investment analyst at Cytonn Investments.