# General Business Category > Entrepreneurship and Business Management Forum > [Question] Close Corporation Questions Relating to Member Salaries and Company Vehicles

## JohnK

Hi 

I have recently bought into an existing close corporation which has been around for about 18 years. There were originally four members, now there are only two remaining. I was offered a 10% ownership within this entity at a specific amount. Based upon the fact that I was employed within this entity for a long period, I rushed into the deal without understanding the workings around the administration of the entity. 

One year has passed since I have joined, now there are items cropping up which I have questions about.. 

1. Members Salaries - I was informed that members salaries are not seen as expenses within the financial statements, therefore they are not tax deductible. It was further explained to me that the Expenses (excluding Member Salaries) will be deducted from the Revenue to give the Profit of the CC before Tax. Then, tax will be taken out, leaving the Net Profit which will be shared amongst the members according to their shareholding. In my case this will be 10%, my salary will then be deducted from this amount and the remainder can be paid to me as a dividend. So,

E.g. Revenue R10 000 000 - Expenses R5 000 000 = Profit R5 000 000 - Tax (28%) R1 400 000 = Net Profit R3 600 000

My 10% = R360 000 - (Member Salary R25 000pm * 12 = R300 000) = Dividend Pay-out of RR60 000

2. Company Vehicles - When I came into the company the majority shareholder (75%) had a company vehicle. I was informed that based upon my 10% shareholding it would not be worth my while purchasing a vehicle since the value of the vehicle would be linked to the 10% ownership. This is base don the fact that the value of the vehicle (repayments) would be deducted from my R60 000 dividend which would not work out. 

Any advise on the above?

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## CLIVE-TRIANGLE

Hi Johnk
Based on your point 1, it sounds like there is an association agreement in place, or at least common agreement on the mechanisms to appropriate profit. What they are saying is that:
1. Members salaries are in fact drawings and therefore not expenses.
2. All after tax profits profit are declared as dividends.
3. Drawings are deducted from the payment of dividends.

The advantage to you is that you would have no tax liability because the dividends comprise after-tax profits and are themselves net of the withholding tax on dividends.

What is unusual is that in most cc's members also perform jobs as it were, and receive remuneration for that work and that remuneration is a normal operating expense as compensation for work done. Dividends are then paid on the remaining profit, which comprises the return on investment.

If your "salary" is subject to PAYE then the above does not quite make sense; it only make sense if the monthly payments are regarded as drawings.

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## Dave A

Isn't there going to be a problem with taxation on the paid dividends (which doesn't seem to be provided for in the example)?

The other question to ask - assuming the majority owner stops working in/on the business, what happens then?

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## JohnK

Hi Clive

Yes, in this case I do perform duties/functions within the CC for which I receive remuneration. The remuneration is taxed as per a normal salary, not structured to that of monthly withdrawals. I also know that my salary has PAYE deducted form it.

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## JohnK

Hi Dave

Yes, my example did not cater for the tax portion on the dividend, which would be 10% from what I can gather. 

Also, I would assume that if the majority owner stops working, he would expect to be bought out by the remaining shareholders..

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## Mike Simmonds

Hi JohnK

How do you account for Income Tax on your Member's Salary?  The whole agreement seems strange and I am just trying to understand a little more before assessing the tax inefficiencies of it.

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## CLIVE-TRIANGLE

John



> 1. Members Salaries - I was informed that members salaries are not seen as expenses within the financial statements, therefore they are not tax deductible. It was further explained to me that the Expenses (excluding Member Salaries) will be deducted from the Revenue to give the Profit of the CC before Tax. Then, tax will be taken out, leaving the Net Profit which will be shared amongst the members according to their shareholding. In my case this will be 10%, my salary will then be deducted from this amount and the remainder can be paid to me as a dividend. So,


This statement is then incorrect. If members' salaries are taxed, then they are not drawings, and if they are salaries then they are a deductible expense both in the Income Statement of the financial statements, and in the Income Statement of tax return. Nor is there an add-back anywhere.

The profit is then taxed at 28%.

The remaining profit can then be distributed as a dividend, according to the % holding. The cc is obliged to withhold 15% as dividend tax and the members are paid the net thereof. The dividend tax is a tax that the members pay, but the cc is bound by the tax provisions to deduct it and pay it to SARS within 21 days.

Ignore the tax issue for the moment. 

The cc may use any method it wishes to arrive at a dividend, provided the cc satisfies liquidity requirements'.

However if I understand correctly, the method in use does not satisfy the requirement that dividends are shared according to the equity ratio.

The excel attachment is an example. Change the numbers and see what comes up.

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Dave A (03-Dec-13)

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## JohnK

Hi Mike, well I pay income tax as an individual monthly as per my payslip..

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## JohnK

Hi Clive should line C14 be "Profit before Remuneration" or after?

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## CLIVE-TRIANGLE

Before deducting it from Revenue - "Profit before deducting Remuneration" (or else deduct it, but then add it back?)

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## JohnK

Thanks Clive.. 

I have always assumed that my salary was based upon my output and role/job within the CC. From what I can deduce my salary gets withdrawn from my dividends.. Which means I was better off getting a salary from the company and not buying in as a director. 

At the moment, based on my salary and the profit after tax, I would be owing the CC money!!

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## sterne.law@gmail.com

I think Clive has covered the mechanics of salary vs drawings.
It may be worth your while to try and find the original partners and how they were treated and/or the association agreements.

There is no logic to the so called calculate profits and then take out 'salary' and then distribute policy. In that case you may be better off 'quitting' and just getting your dividends. If the partners did this, then the company would have to employ people and that would gobble up the so called dividends anyway. 

It sounds to me as if the major shareholder is trying to mislead you or really believes that that is the way it is done, hence my suggestion to try and make some discreet enquiries with the previous shareholders.

Re the company car (not allowance?). If it is a company car, then it belongs to the company and you own about 2 of the wheels, at least. If it is a car allowance (and the car is in his personal name) then the payment should be dealt with as with salary (get your profits then from that your salary etc, ect)

This raises a common issue - distinguishing between the equity relationship and the employee relationship, two different issues although often intertwined.

As I read the initial post, you effectively gave up your salary in that you get 10% of the profit (revenue less expenses). From the profit (your own share) you deduct the 'salary' to get what your profit is. Still the same nett some, just with two differnet names.
Whereas what should happen, and what you envisaged, I presume, is get salary, then of the profit, calculated as Turnover less expenses less salaries, you would get 10%. Thereby increasing your monthly income.

The difficulty is how do you resolve the issue given that this is your employment and not merely an investment, hence the need to be more diplomatic and careful in comparision to an outside entity type  dispute.

The delicacies of dispute resolution aside, the issue is contractual in nature, what info was at your disposal, what did you think you agreeing to etc. You mentioned buying in, which would raise the question f valuation and the finaancials used to support that valuation which brings due diligence into the picture. Your post at thi sjuncture, though, seems to be aimed at ascertaining iif your understanding of the calculations is correct/flawed.

You mention keep cropping up which raises the point of when did this calculation method come to your knowledge?

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## CLIVE-TRIANGLE

Well put Anthony.

The thing is, there is no fixed way to determine the aggregate dividends; they are entirely discretionary and must simply satisfy the solvency test that actually applies to all payments to members, as per Section 51(1), including financial assistance to members. So, any method can be used to arrive at aggregate dividends, or no method at all.

Section 46 (f) however requires that any payments to members, made to members solely due to their membership (this is important; it therefore covers distributions styled as anything else, including disproportionate fringe benefits!) must be in proportion to their share of members interest.

The excel example I posted shows how this posted method of payment distorts the share of dividend and as a result it does not comply with the Act.

As a member you are entitled to have access to all previous financial statements. These must reflect all transactions with members and an analysis of members net investment. So it should be a simple matter to check these calculations and payments for compliance.

It is of course not a simple matter for a minority partner to resolve it if they don't. Normally I would suggest discussing it in private with the Accounting Officer, who is also tasked with ensuring compliance with the Act, however if he is "cosy" with the other members this can be difficult and in that case I would approach the members directly.

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Dave A (04-Dec-13)

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## wynn

One of the first things you will need to do and I hope it is not too late, is to isolate yourself from any debts that accrued to the 'cc' before you become/became a member.
There is nothing more disheartening than being held jointly responsible for the failed lease repayments for the big car of the 'Big Cahuna'

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## JohnK

Hi Anthony, Thanks for the advise. 

When I bought in there was an issue raised by myself as to how the value of the 10% shares were arrived at. I then questioned the fair value of the company, to which it was explained that it was based upon the value that the previous Partner was bought out at.. I presented a case of the real fair value of the company and we agreed to a fair amount for the 10% shareholding. 

I have reviewed my association agreement and it is not clear on how the dividends get split with regard to the salary (included or not). 

As to when this calculation came to my knowledge.. Well two weeks ago!!

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## JohnK

Hi Clive, 

I guess all of the above apply, the members are quite cosy with the financial officer and when I have approached the majority member directly it became quite tense..

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## JohnK

Hi Wynn, 

That's where this whole issue started, I queried why I should sign as surety for the purchase of an expensive vehicle. To which I have excluded myself from..

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## Dave A

> I have reviewed my association agreement and it is not clear on how the dividends get split with regard to the salary (included or not).


If it is silent on the inclusion of salaries in the calculation of dividend pay outs, the default position would surely be that salaries are separate from dividends.

You're still stuck negotiating though - the members would set and agree the salaries of the members, and they do not have to be the same for all members.

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