Difference between VAT and Income Tax
Let's tackle the big question: What's the difference between VAT and Income Tax?
In simple terms, VAT is a tax on the value added to goods and services during the production and distribution process. It's a consumption tax that's paid by the end consumer of the product or service. So, if you sell a product or service, you'll charge VAT to your customers, and then pay the VAT collected to SARS (South African Revenue Service). In other words, VAT is an indirect tax.
It's important to note that the VAT you collect from your customers is not your money from the start. You're only acting as an agent for SARS, collecting the VAT on their behalf. You need to keep accurate records of the VAT you collect and pay it to SARS on time. If you fail to do so, you'll be liable for penalties and interest.
However, VAT only applies to businesses that are registered for VAT. VAT registration is compulsory if your business exceeds R1,000,000 in turnover over a 12-month period. If your business is not registered for VAT, you can't charge VAT to your customers, and you can't claim input VAT.
But if your business is registered for VAT, you can also claim VAT on certain allowable expenses, such as rent, advertising, and office equipment. This is called input VAT. The difference between the VAT you collect from your customers (output VAT) and the VAT you pay on your expenses (input VAT) is what you owe to SARS. Usually, this amount is paid every two months in what's called a VAT return.
Now let's talk about income tax.
Businesses in South Africa are currently taxed at either 28% on their profit or a more favorable sliding scale if they qualify as a Small Business Corporation (SBC). If your business is registered as an SBC, you'll pay tax on a sliding scale based on your taxable income. This means that the less profit you make, the less tax you'll pay.
Here's an example to help you understand the difference between VAT and Income Tax:
Let's say you run a bakery and you sell a cake for R100. If the VAT rate is 15%, you'll charge your customer R115 (R100 + 15% VAT) for the cake. You'll then pay the R15 collected in VAT to SARS. Now let's say you also paid R10 in VAT when you bought the ingredients to make the cake. You can claim this R10 as input VAT, which reduces the amount of VAT you owe to SARS to R5.
Now, let's say your bakery earned R1,000,000 in revenue last year. After deducting all the allowable expenses, your taxable income is R500,000. Depending on your business's tax status, the business will pay a certain percentage of its taxable income in income tax to SARS. Income tax needs to be paid twice a year by ways of provisional tax based on estimated taxable income.
In a nutshell, VAT is a tax on consumption, while Income Tax is a tax on business profits.