As the year draws to a close, the feeling of joy and festivities is in the air and many will begin to plan for their year-end holidays and celebrations. However, for many businessmen, the end of the year and the beginning of another also signals that the new tax season is drawing near and many will begin to lament as they start to budget for another year of their generous yet grudging ‘annual contributions’ (that’s taxes to you and me!) to the Inland Revenue Board (IRB).
This time of the year is also the best time for small business owners to start planning to mitigate their tax liability for the following year. One of the most overlooked, yet most beneficial, ways to help save on taxes is to incorporate a company. A company is a separate legal entity, which functions just like an individual, but with some compelling advantages.
For a start-up business, it is generally recommended that you start up as a sole-proprietor or partnership (Enterprise) first, due to the following reasons:
- Enterprises are faster and cheaper to set up and they are easier to close if the business fails. You can choose to subsequently convert to a Sdn. Bhd. when your business stabilizes and ready for growth.
- You are bound to make losses in your business at first. The losses from your Enterprise business can be used to offset against your other personal sources of income, for income tax purposes.
So Why Incorporate?
A company, registered under the Companies’ Act 1965 as a Sdn. Bhd, has several advantages over an unincorporated business, which we normally refer to as an “Enterprise”. Table 1 summarises the key differences between an Enterprise and a Sdn. Bhd.:
When Do Small Businesses Incorporate?
It is recommended that small businesses incorporate when one or more of following conditions apply :
- risk with regard to personal liability (a product or service or employees or even your partner could cause harm and leave business open to legal action)
- a large capital investment required to sustain/promote the business
- the admission of a new major investor to the business
- profits are at a level where it is more tax-advantageous to be taxed at corporate level rather than at individual level.
Why Should Incorporate a Company to Run My Business?
A Sdn, Bhd. can be more tax-beneficial compared to unincorporated businesses and below are some of the key benefits:
- Individuals are chargeable to tax at rates ranging from 0% to 26%, while companies with share capital of less than RM2.5 million are subject to a tax rate of 20% on the first RM500,000 of their chargeable income and the remaining amount at a rate of 25%. The income tax bracket for an individual already exceeds 20% when his chargeable income is more than RM70,000.
- A company is a separate legal entity from the individual directors and each party is taxed in his own right. Therefore, you can vary the amount of your personal income you wish to draw as salary or benefits-in-kind and how much you wish to leave in the company which is taxed at only 20% (where the chargeable income is less than RM500,000).
- You can choose to contribute to the Employee’s Provident Fund (EPF) and enjoy the tax deductions for both employer contribution (as a business expense), and employee contribution (as personal reliefs together with life insurance premiums, subject to a maximum of RM6,000).
By putting a business in a Sdn. Bhd. and applying a combination of these factors, the taxpayer could reduce his taxes considerably. Naturally, one must quantify the net annual tax savings achieved from incorporating a Sdn. Bhd. against the incremental annual costs of running one to determine whether if there is any net cashflow advantage of doing so.
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