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.

The Bench upheld the lower courts’ judgments, ruling that using retained earnings to pay subscribed capital was not raising capital, but rather offsetting shareholders` earlier commitment. They also rejected the Finance Minister’s letter, claiming it failed to comply with Ethiopia’s administrative procedures.

The ruling was met with surprise by experts.

Wasihun Abate, a tax policy advisor at the Ministry of Finance, argued that equating shareholders` promises to reinvest dividends in unpaid subscriptions with debt offsetting was “far-fetched”. He believes shareholders are invested in their stake in the company.

“The Court’s ruling contradicted the spirit of the law and the intentions of the Ministry’s letter to promote investments rather than distributing dividends,” he told Fortune.

The ramifications of this case have far-reaching implications, notably for the 30 commercial banks operating in Ethiopia, ranging from Tsehay Bank S.S. with its 373 shareholders to Amhara Bank with 169,000 shareholders. After a recent audit by the Ministry of Revenues officials, banks` executives are apprehensive about potential profit taxes on their retained earnings.

Demissew Kassahun, secretary of the Ethiopian Bankers Association, expressed his concern, stating that the ruling could lead to imposing taxes that do not align with financial realities. He pointed out that, unlike the contested industry, banks follow the Ministry of Finance’s directive to depict their capital raises on their trade licenses annually.

The case has also drawn criticism from legal experts.

Menilik Solomon, a lawyer specializing in tax issues, believes that the contentious nature of such rulings stems from the Courts’ lack of expertise. Menelik argued that the judiciary needs to consider not only the letter of the law but also its spirit when delivering rulings that could potentially serve as a precedent and significantly impact financial institutions.

“Judges at the appellate courts, especially in tax cases, need expertise that can at least match the technicalities of the appellate tax commission,” Menelik told Fortune.

His remarks underline the complexity of these cases and the potential consequences of judicial decisions that may inadvertently misinterpret or overlook intricate financial realities. The ruling, which implies that retained earnings utilized to fulfil subscribed capital are not reinvestment, but debt offsetting, has indeed stirred the waters of Ethiopia’s corporate landscape. The concept of reinvestment is interpreted as the infusion of fresh capital into a business rather than utilizing retained earnings for business expansion. This perception can have broad implications for many businesses, especially those banking on retained earnings for capital enlargement.


How useful was this post?

Click on a star to rate it!

Average rating 4 / 5. Vote count: 2

No votes so far! Be the first to rate this post.

Put your comments here

N.B: A submit button will appear once you fill out all the required fields.

Editors' Pick