Farming business structure: Company or sole trader?

Business advisory

They say the quickest way to become a millionaire is to start as a billionaire and invest in an airline. They also say if you want to lose money – become a farmer. Now, the latter is not necessarily true, but the former could be debated at length over a beer or three.In this series of discussions, I will attempt to explain accounting and taxes as simply as possible. Not implying that farmers are simpletons, but just enough to keep such practical folks awake.

In the 2014 budget, the government made an explicit statement in support of farmers by reducing farming income tax from 15% to 10%. A one-third cut in farming income taxes. That is massive!

How has this impacted farm businesses and how have farmers reacted to this over the year? Well, a client of ours from north of Lusaka came and asked me why he should carry on business as a limited company farm when he could become a sole trader and benefit from this saving directly. Being the mathematician that he is – it makes perfect sense, but let’s consider the options.

The scenario is as follows:

Farmer Moonga owns 99.99% of Moonga Farms Ltd[1]. His wife, Chibo, owns the other 00.01%. They are successful and have indeed gone forth and multiplied their crop.

On the other hand, Farmer Musonda wholly owns Musonda Farm, a sole trader registered business and his success matches that of Moonga.

Their respective trading positions before they see their accountant are as follows:

Comparison of taxes payable for company vs. sole trader

[1] According to the Zambian Companies Act, a person cannot own 100% of a limited company

Comparison of tax position – limited company vs. sole proprietor

Both have similar profits and one could say similar net worth. However, Farmer Musonda draws K900,000 profits and spends it on his son’s university fees. There are no further taxes for him and his business to pay. His taxes are fully paid and he sleeps well at night.

Farmer Moonga, on the other hand, is not entitled to take money out of the company without tax. He needs K100,000 to pay school fees at a private boarding school and Chibo’s vehicle is due for replacement at a cost of K800,000. So he is quite stressed. His accountant recommends that he pay himself a dividend of K900,000 to help meet his pressing family matters. Unfortunately for Farmer Moonga, he has additional taxes to pay as the dividends are taxed at 15% as shown above.

Farmer Musonda retains more money for his household and would personally have a higher personal net worth and disposable income because of the way he is structured. Farmer Moonga pays 135%more in taxes to Zambia Revenue Authority.

Allow me to summarize the pros and cons of being incorporated vs. a sole trader in the table below.

sole trader vs company - pros and cons

A first glance at the overall tax position suggests that the farmer is better off conducting business as sole trader due to the substantial tax savings to be made. In reality, most commercial farms take at least ten years to make a return on their investment.

During that period they would have provided their land as loan collateral.

Banks are always happy to lend money to commercial farmers since they take land and all growing crops, receivables and moveable assets as security, resulting in banks earning more income from the farms than the farmers themselves.

To correct this anomaly, I  suggest that the farmer incorporate and do the following:

1.     List all the assets being “given” to the farm – in the form of a fixed asset listing with estimated discounted market values. For example, if the farmer has a desk and chair being given as a business asset –this should be documented at cost first, or failing that at market value (replacement), and because this is a related sale – I would knock the value down by say 50%. So, the chair and desk are replaceable at K1,000 but would be sold to the business for K500.

2.     Document the sale of assets in the form of Minutes of a Directors Meeting establishing what the company owes the shareholders (farmer) and have this lodged with Patents and Companies Registration Agency (PACRA).

3.     If the land is held in the farmer’s name, I  recommend that the portion being used for business be evaluated by a professional valuer to ascertain what the rental charge would be if the farmer charged the business for land use, etc. Having arrived at a rental figure, the farmer should document a lease agreement with the help of a lawyer and commence to charge the business a rental.  

The most important part of running a business is perpetual succession or business continuity. Several of our farmer clients are running successful businesses that depend on the farmer being there. Banks have requested expensive key man insurance on some of our clients to protect themselves from default in the event of the farmer’s death.

Most farmers have a committed spouse who manages the finances and ensures debts are collected and bills paid timeously. In most cases, however, the farmers’ children are disinterested in farming and so the traditional business continuity or growth model is at real risk. There is a need to look into the crystal ball and mitigate risk on the part of the farmer’s family and business. This is where you need to engage your accountant in a hard talk about the if’s and when’s.

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