Parliament Draws Dividend Dispute to a Close

Jul 13 , 2025. By NAHOM AYELE ( FORTUNE STAFF WRITER )

Federal lawmakers have finally brought closure to a protracted and contentious tax debate that has haunted financial institutions for over a year.

In a move widely welcomed by banks and insurers, but not without controversy, Parliament amended the Income Tax Proclamation this month to exempt reinvested dividends used to settle unpaid subscribed capital from income taxation.

The legislative fix ends an interpretive disagreement that had pitted tax officials against 25 banks and insurance companies, leading half of the 5.7 billion Br in tax arrears claims to be locked in escrow. Whether such reinvested earnings constituted taxable income or should be treated as equity contributions has been the crux of the debate.

The confrontation originated in late 2023, when the Federal Large Taxpayers Office (FLTO), relying on a strict interpretation of the 2016 income tax law and a 2023 Cassation Bench ruling, deemed dividend allocations, even when not paid out, as settled liabilities. These were thus taxable at the standard 10pc dividend rate, regardless of whether the funds ever left company coffers.

Financial institutions, however, argued they were not distributing income, but merely converting retained earnings into equity to meet regulatory thresholds. This practice was especially critical when regulators at the National Bank of Ethiopia (NBE) imposed higher capital adequacy demands.

"This was taxation without extraction," said a bank executive, echoing the frustration many felt at being penalised for beefing up capital buffers.

The new amendment, passed after animated debate in Parliament, reclassifies reinvested dividends used to pay up subscribed capital as non-taxable equity injections. Experts see it aligning the tax regime with international standards and the prudential requirements of financial regulators.

"This correction ends a period of legal ambiguity that created financial and legal distortions," said Abdulmenan Mohammed (PhD), a financial analyst based in London.

He believes the change promotes clarity and predictability, factors critical for a country that recently launched its first capital market, the Ethiopian Securities Exchange (ESX).

However, Abdulmenan also offered a contrasting perspective on the industry's grievances. He argued that the earlier tax on dividends used to cover subscribed capital was not inherently unreasonable, as the payments originated from company profits.

"The banks' complaints aren't appropriate," he said, suggesting that taxation of such distributions aligned with basic financial principles.

He acknowledged, nonetheless, that the issue had been subject to competing legal interpretations.

"The government's decision to revise the law and clarify its position was both necessary and timely," he said.

For the Ministry of Finance, the revision marks a strategic, if incomplete, recalibration.

"We wanted to encourage reinvestment and ease capital formation," said Abraham Rega, the Ministry's legal adviser.

He praised the amendment's forward-looking nature. However, Abraham disclosed that assessments issued under the previous regime remain enforceable, with no provision for refunding taxes already collected.

The caveat has drawn sharp rebukes from the banking and insurance industries.

"It would have been better if the new law had ordered a refund of the payments already made," argued Demissew Kassa, secretary general of the Ethiopian Bankers' Association (EBA).

Companies that had paid under protest remain burdened by what they see as a misapplied levy, affecting capital expansion plans and liquidity positions.

Insurers, such as Zufan Abebe, CEO of Nib Insurance, which faces around 90 million Br in disputed taxes, echoed the sentiment. She believes previous tax treatment conflicted with the law's spirit, which had sought to incentivise reinvestment.

"Since shareholders are already being taxed, instead of putting their profits back into the business, they are choosing to keep the earnings for themselves," she said, recalling how the misapplication discouraged reinvestment.

Zufan argued that the amendment should have gone further by explicitly exempting share companies, particularly banks and insurance firms, from the 10pc tax. She stated the importance of correcting the prior misapplication.

"If this issue is not properly addressed," she warned, "then the amendment will fail to bring about any meaningful change."

This concern was echoed by Haddush Hintsay, company secretary of Wegagen Bank, who contended that the previous law was misinterpreted and never intended to impose tax on dividends allocated to subscribed capital.

"That interpretation has hurt share companies, as it discouraged shareholders from reinvesting in their institutions," he said.

Still, Hadush acknowledged the positive trajectory of the reform. By eliminating the tax under the new proclamation, he noted, companies face fewer barriers to raising capital and can better encourage long-term investment.

However, some within the government appear unconvinced. A senior official at the Ministry of Revenue, speaking on condition of anonymity, labelled the amendment "a concession to elite pressure," criticising it as a politically driven retreat that undermines efforts to widen the federal tax base.

"This wasn't about sound tax policy," the official said. "The influence of individuals with access to decision-makers drove it."

The official also warned of a potential revenue shortfall, citing concerns that removing the tax could set a precedent for further erosion of the tax revenues. The federal government, earmarking close to two trillion Birr budget for the fiscal year 2025/26, aspires to mobilise no less than 1.2 trillion Br in taxes.

The amendment arrives at a time when public finances are under pressure. With escalating debt-service obligations, subsidies, and military expenditures, federal officials find it difficult to afford to forgo major revenue streams. The billions of Birr held in escrow represent a substantial sum in a budgetary situation already strained by competing priorities.

Fiscal experts worry that the lost revenue may push the state to consider alternative tax hikes, such as on interest earnings or consultancy payments, thereby spreading the burden to other sectors. Others suggest that the long-term benefits of stronger financial institutions and deeper capital markets could outweigh the short-term revenue hit.

The decision also sends a powerful signal as Ethiopia's Securities Exchange begins trading. By removing taxation on reinvested dividends, officials say the government signals a commitment to investor-friendly policy, crucial for attracting private capital and ensuring the credibility of the nascent bourse.

"The rationale for amending the law is to promote reinvestment and business expansion," said Abraham of the Ministry.

According to him, the new tax exemption is intended to encourage shareholders to support their companies' growth trajectories rather than extract profits.

PUBLISHED ON Jul 13,2025 [ VOL 26 , NO 1315]