In a landmark ruling that could reshape Ethiopia’s business landscape, justices at the Federal Supreme Court Cassation Bench have passed a judgment on the taxability of retained earnings used to pay up subscribed capital. The ruling, delivered in April this year, has stoked a lively debate among legal and financial experts about the interpretation and application of income tax laws.

As Ethiopia’s economy grows and businesses evolve, the legal precedents the justices set will play a critical role in shaping tomorrow’s business environment. Justices at the Cassation Bench - Teferi Gebru, Endeshaw Adane, Teshome Shiferaw, Melaku Kassaye and Nestanet Tegegn - unanimously entrusted with setting a binding precedent for all subsequent cases of similar nature. The Court addresses cases that claim a consequential legal misinterpretation that requires rectification and uniform application across all other courts.

Several companies, particularly in the financial sector, will be subjected to paying tax on dividends used to pay subscribed capital.

The legal standoff began six years ago when lawyers representing Tsehay Industries S.C. (TISC) petitioned the Appellate Tax Commission, challenging the profit tax levied by the Ministry of Revenues on retained earnings. According to Tsehay Industries, these earnings were earmarked for reinvestment into the company as paid-up capital.

Tsehay Industries acquired the 1.2 million Br capital Qality Metal from the state in 2012. Subsequently, its shareholders resolved to grow the company’s capital to 439.5 million Br, with several shares remaining subscribed. Four years later, shareholders agreed to use part of the 48.9 million Br net profit to pay for the subscribed capital of some of the shareholders, while others took dividends. The company passed the year without paying dividend tax on the amount used to cover the subscribed capital.

It was a decision challenged by federal tax officials in a court of law.

The fulcrum of the case was the interpretation of Article 61 of the income tax proclamation, which states that undistributed profits are subject to a tax rate of up to 10pc, provided they are not reinvested. The Appellate Commission, siding with the Ministry, maintained that these profits were indeed taxable.

Unpleased with the verdict, TISC’s lawyers embarked on an all-out journey through the appellate hierarchy, persisting all the way to the Supreme Court’s appeal bench. The company finally presented its case to the Federal Supreme Court Cassation Bench, claiming that lower courts had fundamentally misunderstood the definition of reinvestment under the income tax proclamation.

Tsehay’s Industries lawyers argued to the Bench’s five justices that lower courts had violated both the spirit and the letter of the non-taxability law of undistributed dividends used to raise paid-up capital. They submitted a letter signed by Finance Minister Ahmed Shide the previous year, stating that retained earnings used for paying up subscribed capital should not be taxed, as doing so would incentivize savings and investment.

However, Wendmu Adisse, the Revenue Ministry’s legal representative, countered that this letter violated the country’s administrative procedure, as a letter should not have precedence over existing laws and regulations.