The commercial banking industry finds itself ensnared in a contentious tax dispute, rooted in a recent ruling by the Federal Supreme Court in favour of the government. This has left the country’s banks poised for a financial faceoff with senior officials of the high-income taxpayers' bureau under the Ministry of Revenues.

An unprecedented demand for back-taxes, along with interest and penalties, on previously untaxed shareholder earnings, shocked the industry leaders. They warn that this tax claim not only reaches back four years but also foreshadows a potential financial earthquake that could upset the financial sector.

The move by the tax bureau takes advantage of a ruling made by justices of the Federal Supreme Court Cassation Bench, upholding a lower court decision on a case between Tsehay Industries and the Federal Tax Appeal Commission.

A legal standoff six years ago between lawyers representing Tsehay Industries S. C. (TISC) and the Appellate Tax Commission over profit tax levied on retained earnings earmarked for reinvestment into the company as paid-up capital set the fire on.

Tsehay Industries’ shareholders increased the company’s capital to 439.5 million Br after they acquired the 1.2 million Br capital Qality Metal from the state in 2012. However, several shares remained subscribed four years later, when shareholders agreed to use part of a 48.9 million Br net profit to pay for the subscribed capital of some of the shareholders.

The company passed that 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, on the ground that Article 61 of the income tax proclamation subjects undistributed dividends to 10pc tax, provided they are not reinvested. The Appellate Commission, siding with the Ministry, maintained that these profits were indeed taxable.

Justices at the Supreme Court agreed. Shareholder earnings, used to pay for subscribed capital commitments, were liable to a dividend tax.

The Ethiopian Bankers Association, chaired by Abie Sano, also president of the state-owned Commercial Bank of Ethiopia (CBE), has spent the past two months exploring ways with bankers to respond to this development. Its leaders have filed their appeal before the Ministry of Finance and the National Bank of Ethiopia (NBE), challenging the tax bureau’s demands.

“The commercial banks have been pleading with the tax officials to recognise the implications of this obligation,” said Demisew Kassahun, secretary of the Association.

The implications he referred to include a potential industry-wide shock that could undermine the banks' capacities to compete within the sector. This financial stress comes at a particularly delicate time, with foreign banks poised to make an entry into the Ethiopian financial market. The Association’s leaders argued that the demanded taxes could dramatically diminish their financial strength.

There is a fear that this financial pressure might be too much for some banks to bear.

“Some of the banks may collapse,” reads the letter signed by Abie.

It also predicts a fierce dispute set to rise between shareholders, the government, as well as the banks’ directors and executives, highlighting that shareholders could potentially bear the ultimate brunt of this tax burden.

Almost all the commercial banks have made public offering to raise their capital base in response to a directive the central bank issued two years ago. It instructed all the banks to increase their paid-up capital to five billion Birr by 2026. However, only a few titans in the industry have managed to reach this benchmark as the deadline steadily approaches. Several are banks inching towards this goal by issuing new shares and offering existing shareholders.