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Tax on stock dividend and retained earnings: A brief note

Tofazzul Hussain | Published: July 19, 2019 20:48:41 | Updated: July 24, 2019 20:49:08


As the Bangladesh economy is growing consistently, the country is set to   become one of the top thirty economies of the world by next two decades. Integration with global economy is also increasing and overall development indicators are positive. The national budget for the current fiscal year (FY2019-20) needs to reviewed in this context.

The budget with an outlay of Tk 5.23 trillion (approx US$ 62 billion) was placed in parliament by the finance minister on June 13 and was passed on June 30.

A key feature of the approved budget is that tax rates have remained unchanged except for a very few areas putting significant importance on wider tax net and tax at source. Value Added Tax (VAT) and Supplementary Duty Act 2012 became effective from July 1, 2019 with the aim of widespread application of four-tire VAT rates: 5.0 per cent, 7.5 per cent, 10.0 per cent and 15.0 per cent.

Regarding income tax, the changes were made to facilitate growth and ease of doing business.  Personal tax rates have remained the same with no changes in income threshold.  Corporate tax rates have also remained unchanged. 

With the introducing two new sections 16F and 16G (as a matter of fact section 16 under CHAPTER IV is reserved for Charge of income tax) in the Income Tax Ordinance 1984 (ITO 1984), 10.0 per cent tax is to be charged on full amount of dividend declared if stock dividend is higher than cash dividend to ensure that the ratio of stock dividend and cash dividend will be same. On the retained earnings, listed companies can transfer up to 70.0 per cent of their net profits as reserve or surplus.  From the remaining 30.0 per cent, the companies will have to pay a 10.0 per cent dividend, failure of which will cause the company liable to a 10.0 per cent tax each year.

Therefore, dividend declared by a listed company shall be minimum 5.0 per cent cash dividend and 5.0 per cent stock dividend with a preference to 10.0 per cent cash dividend.  Otherwise, there will be a 10.0 per cent additional tax on the total amount of dividend declared if cash dividend is less than minimum 5.0 per cent. As a result, general investors will hopefully have some cash return on their hard earned investment in the shares of any listed companies.

New tax provision for retained earnings requires a quick review. Retained earning is distributable profit (also known as PAT or profit after all charges and taxes). If it is TK 100 million, Tk 70 million can be reserved for further investment in future. The remaining amount or Tk 30 million has to be distributed as dividend to maximise tax benefit of the company.

Any shortfall in dividend payout as suggested above will be reckoned as elusive and the shortfall will be automatically added to the excess retained earnings, which itself attracts another additional 15.0 per cent tax.  Literally, excess retained earnings' tax is tantamount to thin capitalisation tax, as the finance bill said and there will be a tax of 15.0 per cent on excess reserves including retained earnings.

That means in any income year, of the total of retained earnings, any reserve or other equity except paid-up capital in excess of 50 per cent of the paid-up capital of a Bangladeshi registered and listed company shall be liable to 15.0 per cent tax on such excess amount of the company in the respective income year

For clarity, in fact, as per the Companies Act 1994 paid-up capital is the capital shown as duly paid by the shareholders/ subscribers up to which their liabilities are limited.  Any surplus or reserves are the accumulated profits of the corporations over years on which the shareholders have residual rights. 

Unfortunately, in this country's context, there are plenty of companies with low paid-up capital base, which means company owners'/promoters' liabilities are limited to a very negligible amount.  Paid-up capital is deemed as the real money invested by the promoters of a company.  In this regard, to ensure cash injection by promoters, there is already a tax rule in place to prove that paid-up capital is paid from the bank accounts of the promoters.  Section 19(24) of the ITO 1984 says, "Where a company, not listed with any stock exchange, receives paid-up capital from any shareholder during any income year in any other mode excepting by crossed cheque or bank transfer, the amount so received as paid-up capital shall be deemed to be the income of such company for that income year and be classifiable under the head 'Income from other sources'".

On the other hand, retained earnings and surpluses as shown as shareholders' equity on the face of the statement of financial position (balance sheet) are the seedbeds for earnings manipulation through creative and aggressive accounting. The curse of creative accounting is widespread disbursement of debts by financial institutions that rely heavily on the size of shareholders' equity including the accounting reserves and surpluses because these are recognised by Basel as Tier-1 capital.

Accordingly, most of the companies in Bangladesh are 'thinly capitalised'. Thin capitalisation refers to the situation in which a company is financed through a relatively high level of debt compared to equity. Thinly capitalised companies are usually highly leveraged or highly geared resulting in rampant bad loans.  And it's not a surprise that our banking sector has trillions of taka classified as doubtful.

Therefore, when there is low amount of paid-up capital but higher amount of reserves and surpluses, we will keep on classifying more and more loans as bad and doubtful for recovery. Considering the above analogy and realities, tax authorities' attempt to curb the bad loan culture is promising.  One should, however, wait for the Paripatra to have a clear view to calculate the "Charge of tax on retained earnings" under section 16G of the Income Tax Ordinance 1984.

 

Tofazzul Hussain FCA is lead consultant and chairman of HUSSAINS Business Consultants Ltd, a business, tax and investment advisory firm.

tofazzul@hussainsbd.com

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