Banks and insurance firms are battling tax authorities over whether dividends used to pay for unpaid subscribed capital should be taxed. Nearly 25 financial institutions have already paid 5.7 billion Br, half the assessed amount, to contest the claims before the tax appellate body. Many now await decisions from appellate courts, worried that potential rulings against them could jeopardise their ability to raise capital and discourage much-needed investment in the financial sector.

Federal Large Taxpayers Office officials insist that 10pc tax should be applied to dividends directed toward covering shareholders’ subscribed shares yet to be paid. They classify such dividends as liabilities, subject to tax obligations under Article 61 of a tax law passed in 2016. However, shareholders invested in the financial institutions argue that the dividends amount to reinvested earnings and, hence, should be exempt. They contend their interpretation falls within the scope of existing law.

The Ethiopian Bankers' Association (EBA), led by Abie Sano, also president of the Commercial Bank of Ethiopia (CBE), has taken the issue directly to the Prime Minister's Office. In a letter sent two weeks ago, the Association argued that undistributed dividends intended for recapitalisation lack legal grounds for taxation. The Association further warned of far-reaching consequences for the financial sector, which could face financial strain if forced to pay billions in taxes on what they consider reinvested funds.

“It undermines the banks’ capital-raising efforts,” said Demissew Kassah, the Association's secretary general. "The legal basis for the tax claims is shaky at best."

Insisting on reinvestment status, the Association's leaders contended that dividends shareholders choose to reinvest have traditionally been excluded from tax. Many in the financial sector share this view, noting that the Large Taxpayers Office historically did not seek such payments.

The Ministry of Revenues initially pressed its case at its Tax Appeals Tribunal. Several banks deposited 50pc of the disputed amount to lodge their claims before Federal Tax Appellate Commission judges. Some of the cases now appear on a path that has led some to the Federal Supreme Court's Cassation Bench.

Awash Bank, one of the country’s largest private banks, is among the plaintiffs. Its Chief Financial Officer (CFO), Berhanu Balcha, confirmed that Awash Bank had paid half the tax officials demanded and is bracing for what justices of the Cassation Bench might rule. He anticipated that if the ruling goes against the Bank, the resulting tax bill could severely constrain its capital base.

Tax authorities cited precedent dating back to a ruling in April 2023, which emerged from a six-year legal battle between federal tax authorities and Tsehay Industries. Lawyers representing Tsehay Industries argued that dividends paid for subscribed capital are reinvestments. Justices disagreed. They ruled that undistributed dividends face tax unless they are demonstrably reinvested rather than used to cover prior obligations. The Court's decision that retained earnings covering subscribed capital are taxable as dividends triggered a chain reaction of further audits of financial institutions.

With oversight responsibilities for about 700 businesses accounting for more than 70pc of the country’s tax revenues, officials of the Large Taxpayers Office have become more assertive. They plan to audit 19 banks this fiscal year for possible claims of back taxes.

According to its Deputy Head of Law Enforcement, Zeleke Jambo, once dividends are determined as existing liability, they cannot be deemed fresh investments. He argued that the ruling against Tsehay Industries serves as an unequivocal precedent. The federal government targets 1.5 trillion Br in domestic taxes in the current fiscal year, causing anxiety in the business community about how assertively tax authorities might pursue collection to meet this ambitious goal.