The Ministry of Finance and Economic Development (MoFED) has issued a final directive forcing private businesses to pay tax on retained earnings, the Ethiopian Revenue and Customs Authority (ERCA) announced.
ERCA officials met with representatives of the private sector on Monday August 19 to provide the final clarification regarding the controversial tax issue.
ERCA officials said the Ministry, which issues directives and regulations relating to revenue and customs, has issued the approved directive paving the way for a 10 percent tax to be collected on dividends, either distributed or transferred to retained earnings.
Since ERCA requested companies to pay tax on retained earnings last October, several business community members challenged the new scheme on the basis that the request did not have any legal framework.
Some had planned to go to court to contest the issue.
However, in June 2013, at a private-public partnership conference chaired by Prime Minister Hailemariam Desalegn, MoFED Minister, Sufian Ahmed, said companies should not be required to pay tax on retained earnings.
Officials from MoFED and ERCA told Capital after the meeting that tax revenue from retained earnings will not be dropped and companies had to pay up to expedite government development projects. At the meeting on Monday, organized by the Addis Ababa Chamber of Commerce and Sectoral Associations (AACCSA) in collaboration with ERCA, officials said MoFED sent a directive in early August which ordered companies to pay tax on their retained earnings.
Nebiyu Samuel, Advisor to the Director General of ERCA on tax issues, told Capital that the government has made a decision to implement the directive, but companies who want to go to court to find a solution can go ahead and try it.
According to the directive, companies have to disclose whether they have invested or distributed dividends within the coming 12 months of the end of a fiscal year.
“If companies do not disclose their report within the specific period, it will be considered as if they have distributed dividends for shareholders and therefore they will be required to pay the necessary 10 percent tax,” ERCA Director General Beker Shale explained at Monday’s meeting.
The private sector has continued its opposition to the government’s new scheme, although some participants at the meeting said they accepted the decision and called for the reporting period to be extended.
“12 months is not a sufficient period of time for company shareholders to decide whether to reinvest in the company, other investments or to take their dividends, so it will be better to give companies more time for reporting their shareholders decision,” said one participant.
Others suggested that the government should give upto three years for reporting.
But ERCA officials rejected the business community’s view.
“Government money will accrue or remain in the hands of the private sector for too long if we change the reporting period. The tax is needed to subsidise government mega projects on time. Due to that pertinent fact, it is not acceptable to extend the reporting time by more than 12 months,” an ERCA official explained.
According to information obtained from ERCA, the Authority has identified almost 1,500 companies who are required to pay the levied tax and currently one-third of them have settled.
Even though on several occasions ERCA said there is no gap in the law to implement the collection of this tax, experts on the sector and the business community have blamed government offices for its implementation without the backing of the law. But the government argued that MoFED has a right to provide clarification on tax-related laws and other financial issues.
Some experts who spoke to Capital said it was better if MoFED had clarified and issued the directive which would allow the government to collect tax from retained earnings rather than allow ERCA to push the private sector into paying the tax without explaining the controversial law (the 2002 Income Tax proclamation, section 5, article 34).
Although the tax claimed by the Authority is 10 percent of the accumulated net profit that will be divided between shareholders or owners, ERCA has also claimed interest as well as penalties on unpaid tax since the 2004/05 fiscal year, when it launched its accrued dividend tax collection campaign in December 2012.
It later agreed to drop its claim for the payment of interest and penalties for those who agree to fully pay the amount claimed by ERCA.
ERCA officials explained that private companies refused to pay the imposed tax on their retained earnings and took their case to court but the cassation bench ruled in ERCA’s favour.
“There is a confusion between retained earnings and dividend profit, and due to that fact, we have taken the necessary steps to clear up the grey area,” said Beker Shale, Director General of ERCA.
He also said that the retained earning controversy has existed for some time, but insisted ERCA’s stand is not wrong.
“We have a responsibility to implement it, and those subject to such requirements have to start paying the necessary tax immediately,” he said.
He advised the business community to pay their tax promptly rather than confront the Authority.
“It would be a waste of time to have disputes with ERCA’s officers,” he said, repeating the government’s position.
“There are still some cases in court about the issue but I’m advising the private sector to duly pay the tax,” he added.
The new Director General noted that the Authority would work hard to collect all types of taxes to finance development projects.
ERCA has offered a tax settlement scheme for specific accrued tax, according to the directive from MoFED.
According to the plan, companies shall pay 25 percent of the accrued tax initially, and the balance within three years.
Based on the plan, companies have to pay five-year dividend tax in arrears from undistributed dividend profit.
“We have conceded that the Authority should have asked relevant companies to pay tax from retained earnings on time. Even though this was not done, it doesn’t exempt private limited companies and share companies from paying the accrued tax,” he noted.
“Our sense of urgency is to resolve the country’s backwardness; due to that we should collect all taxes and support developmental projects,” he added.
The 2002 Income Tax proclamation, section 5, article 34 indicates that:
1) Every person deriving income from dividends of a share company or withdrawals of profit from a private limited company shall be subject to tax at the rate of ten percent (10%).
2) The withholding Agent shall withhold or collect the tax and account to the Tax Authority.
3) This tax is a final tax in lieu of income tax.
Capital was unable to obtain the new directive issued by MoFED on August 6, 2013 even though
ERCA officials had stated that it was available to interested parties.