Leading financial institutions have found themselves embroiled in a legal battle with federal tax authorities over a contentious dividend tax issue.

A landmark ruling by the Federal Supreme against Tsehay Industries S.C. has opened the floodgates for a broader interpretation of tax laws, with consequential implications for the financial sector. The issue came to light after the acquisition of the former Quality Steel Industries by Tsehay Industries, a process that dates back over a decade.

The Tax Appellate Commission in the Mexico Square area has become the arena for this unfolding drama. Close to 10 private commercial banks, including Awash and Abyssinia, along with insurance giants like Nyala and Nib, have deployed their legal teams, mounting defenses against what they perceive as a direct threat to their liquidity.

Central to the controversy is how shareholders of Tsehay Industries used net profits of 48.9 million Br to increase their paid shares in the company to 439.5 million Br. The increase was made without the shareholders paying dividend taxes, a decision that stood unchallenged until a recent ruling by the Cassation Bench of the Supreme Court. The interpretation of Article 61 of the income tax proclamation, which stipulates that undistributed dividends not immediately reinvested are subject to taxation, remains at the core of the litigations.

In a recent hearing, federal tax authorities successfully argued this point before the Justices of the Cassation Bench, setting a precedent that has now alerted the entire financial sector. Banks and insurance companies are undergoing rigorous five-year audits, facing the prospect of paying billions in taxes.

Abere Asfaw, the legal directorate head at the Ministry of Revenues, has been aware of the contentious nature of dividend taxation for years. However, the Cassation Bench ruling against Tsehay Industries has acted as a catalyst, bringing this issue to the fore. Abere argued that while the income tax law allows for dividend taxation, the practical challenges of conducting extensive audits had previously led to a lax enforcement of this provision.

"Trade license should reflect the raised capital status," he told Fortune.

The shift in tax policy comes when the federal government is looking to significantly increase its tax revenue. This year, the tax collection target has expanded by 35 billion Br to 440 billion Br, a jump partly attributed to the government's reliance on tax revenues for about 60pc of its annual budget.

Mulugeta Ayalew, head of the Tax Appellate Commission, acknowledged the landmark nature of the Supreme Court ruling. He recalled several previous rulings on the payment of dividend taxes and noted that the requirements to present the recapitalised amount on trade licenses have historically been more relaxed. According to Mulugeta, renewals of these licenses often did not occur, leading to the current disputes.

"Renewals had not occurred immediately after capital growth," he told Fortune.

The situation has prompted intense debate among legal professionals and experts who closely examine the country's commercial and income tax laws.

Yohannes W. Gebriel, a legal expert, pointed out the critical need to distinguish between shareholders as individuals and as part of share companies.

"These are two entities," he said.

He argued that while the general assembly makes the decision to fulfil unpaid subscribed capital obligations, the responsibility ultimately rests with individual shareholders. He believes that the payment in cash of authorised capital should not be conflated with the capitalisation of a share company.

"The final ruling by the courts appears valid from a legal perspective," Yohannes told Fortune. "Authorised capital must be paid within five years of a company’s registration."

Despite the legal backing, the ruling has not been without its detractors. A notable dissent came from Finance Minister Ahmed Shide, who suggested that shareholders could use their dividends to meet subscribed capital requirements, a move intended to aid the industry. However, his views were quickly sidelined due to their "incongruity" with the established hierarchy of law. This has led officials at the Ministry of Finance to draft a new directive, currently awaiting approval from the Ministry of Justice.

According to Wasihun Belay, a tax advisor at the Ministry, the directive is a response to the evolving situation, ensuring that the Ministry's actions are in line with legal expectations.

"We've done what is expected from us," said Wasihun.

The insurance industry, represented by figures like Yared Molla, president of the Association of Ethiopian Insurers, is particularly hard hit.

Yared described the situation as a "tax storm" sweeping the industry, with insurance companies facing back taxes from 20 million to 130 million Br each.

"We are being sacrificed due to miscommunication between authorities," he said.

He pinned his hopes on a previous letter by the National Bank of Ethiopia (NBE), which argued for an exemption from tax obligations for insurance companies in certain contexts. Despite this, insurers are compelled to appeal before the Commission, even though the central bank’s regulations offer a different type of oversight.

The situation is equally dire for commercial banks. Neither the Finance Ministry's pending directive nor the recollection of the Commission has given the commercial banks any relief as they juggle credit caps and diminishing liquidity. The tax tidal wave has been the subject of several general assemblies over the past few months, with banks, including the veteran ones, telling shareholders to prepare if the appeal falters.

These financial institutions, struggling with credit caps and diminishing liquidity, view the tax demands as a significant threat. Bank leaders, some from long-established institutions, have expressed their determination to take the case to the highest court. The process, however, is costly, as an appeal before the Commission requires payment of half the demanded tax amount, with an additional 25pc required for cases taken to a higher court. A private bank has deposited 250 million Br, half the tax demanded, for going to appeal before the Commission.

Demsew Kasshun, secretary of the Bankers' Association, voiced the frustration of many in the financial sector. He recounted several unsuccessful attempts to engage with key government figures like Finance Minister and Minister of Revenues, Aynalem Nigussie, seeking recognition of the disproportionate impact of the tax levy.

"The banks will be on the brink of a crisis," he told Fortune. "Billions are on the table."

The ruling against Tsehay Industries has further emboldened the tax authorities, leaving the banks to confront the possibility of a financial crisis. The dispute has escalated to the point where Tsehay Industries has taken its grievances to the constitutional inquiry of the House of Federation.

Workeneh Tesfaye, the general manager of Tsehay Industries, asserted that the issue has transcended its initial scope, becoming a matter of national significance.

PUBLISHED ON Dec 16,2023 [ VOL 24 , NO 1233]

How useful was this post?

Click on a star to rate it!

Average rating 4 / 5. Vote count: 1

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