Death and taxes, the idiom goes, are the only certainties in life. But we would all love to reduce the tax we pay. Thus, it would be helpful to learn some basics about taxes.
Taxes can be classified in various ways, the most common being direct versus indirect taxes. Other classifications are: income tax, transactional taxes, duties and levies. This article focuses on the first classification.
Direct taxes
Direct taxes are usually charged on what you earn (income), or what you own (capital) and the burden of tax cannot be shifted to other parties. 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 one’s tax liabilities depending on the tax laws of your jurisdiction.
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, if the government is trying to incentivise certain behaviours like savings, it may give certain reliefs to be deducted against your tax liability such as insurance relief, but you must claim them to benefit.
Indirect taxes
Think of indirect taxes as taxes charged on your expenditure. Examples of indirect taxes are value added taxes and excise duty. With indirect taxes, you can shift the burden down the supply chain since the tax is tied to goods and services.
Finally, the ultimate consumer, unable to shift the tax to anyone else, bears the final tax burden. 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
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 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 order to manage your taxes (hence your cash flows), you must understand the nature of taxes. You cannot reduce your tax liabilities arbitrarily. It would be worse for your business to attempt to reduce its liability by evading its obligations.
The taxman eventually catches up with those who think they can dodge their tax obligation and the penalty of up to double the tax evaded is quite stiff.
This is not meant to scare you but to motivate you to create a plan that complies yet optimises your tax liability. Do not be caught in a trap!
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. 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.
Basic understanding
Nevertheless, a basic understanding of how tax works will better equip you to identify key tax issues and find a good practitioner who can guide your business. It will also enable you to have meaningful discussions with them about your business’s specific strategy.
Kananu Imathiu is the Finance and Strategy Lead at Red Beryl Consulting
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