16 December 2012

Ethiopia: Revenue Service Goes After Dividend Taxes

The Ethiopian Revenues & Customs Authority (ERCA) is going after share companies and Private Limited Companies that have not yet paid their dividend taxes.

Dividend tax is a 10pc tax levied on the income that a person derives from dividends from a share company, or withdrawals from a private limited company, as stated in the income tax law of 2002. The law also considers 80pc to 95pc of the net profit after tax to be a dividend, whether the companies have dispatched that much or not.

The tax authority and the individual companies seem, however, to interpret the law differently. The companies claim that they are not obliged to pay the tax unless their shareholders have actually shared the profits.

"It is like expecting an employee to pay income tax while they did not yet received salary," an auditor at an import company argued.

The ERCA, on the other hand, argues that companies should collect the tax on account of the Authority, whether profit is shared or not, arguing that income includes all sorts of gains that a person acquires, whether it is paid, credited or received, according to the proclamation.

According to the Tax Authority, companies may reserve five to ten per cent of their net profit as retained earnings. The remaining amount then has to be split between shareholders, and each of those is obligated to pay a divided tax on the payout. If the shareholders choose to reinvest the capital into the company they will still have to pay the divided tax and reinvest the amount remaining, unless the company is one of those excepted by the Ministry of Finance & Economic Development (MoFED), such as those in the manufacturing industry.

"The question that should be answered here is whether or not the company has made a profit," a legal advisor at the Authority said.

If the company actually made a profit, the shareholders have the right to share profits as per the share amount that they bought, thus the amount of income that a shareholder will receive is known. Hence, 10pc should be paid right away, even though it has not yet been distributed.

The Authority claims that it has conducted an investigative survey of numerous companies and found that most did not pay the tax, whilst simultaneously declaring huge profits to the Authority.

Some companies surveyed have avoided reporting dividends, by keeping everything in the retained earnings account, according to the ERCA, whilst others have used untaxed revenue to compensate for their losses. The MoFED has also endorsed the ERCA's survey and its plan to collect the back taxes in this fiscal year.

A private limited company, engaged in medical imports, which Fortune talked to, is among such companies. The company, which was established by two people, four years ago, was told to pay 85 million Br in back taxes when it requested a tax clearance from the Authority, in order to replace one of its shareholders.

The company did not share the dividend for the past four years, but rather has kept the amount in a retained earnings account.

Although the company has recorded profits, the main reason why the profit has not been shared is because there is a working capital shortage and hence the money is being accumulated under such an account, according to the auditor of the firm.

The company also did not agree with the ERCA's calculation of the tax, as it added interest and penalties for not paying the tax on time.

The ERCA, however, has only collected dividend taxes, thus far, from companies that have distributed the profits to their shareholders.

"It was because of a misinterpretation of the law," a legal expert at the ERCA told Fortune.

This reason, however, did not hold water with the import company that Fortune talked to, which is currently preparing to file a complaint to the Tax Review Committee, objecting to the decision of the Authority.

"It makes no sense to penalise and demand interest since it is the ERCA itself that has made the initial mistake and led us to do the same," the auditor argued.

ERCA claims that it has forgone dividend tax from companies.

ERCA, which plans to collect 101.6 billion Br, in the 2011/12 fiscal year, has collected 22.2 billion Br in the first quarter, to which business profit tax contributed 4.5 billionBr.

The survey was triggered after the tax authority investigated Libya Oil Ltd and discovered that the company had not paid the 91 million Br it owed in dividend tax..

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