Accounting for Withholding Tax on Dividends
I was on the SAICA committee that decided that Secondary Tax on Companies was an expense. There was a furious debate at the time as to whether the tax was, in substance, merely part of the normal tax payable by a company or whether it was a tax on the dividend of a company. If it were seen as a tax on dividends, which clearly it was, the charge should not have been an income statement charge but a direct hit to the statement of changes in equity. The accounting framework supported the latter treatment.
So why did our committee decide to treat this as an income statement charge? There were two reasons:
1. The government of the day explained the concept behind STC as an optional tax on profits. If a company wanted to plough back profit for growth, a lesser tax would be payable. If it wanted to pass profits onto its shareholders, a higher tax charge would apply.
2. The users of financial statements had a simple approach to the problem: it’s a tax and a tax is an expense.
In retrospect, I believe that we took the wrong decision. We should have stuck to accounting principles. All sorts of problems arose as a result of this decision, e.g. companies that restructured and paid dividends out of past profits were hit in the current year with a large tax charge, which had nothing to do with the current profitability of the company. I am a shareholder of two companies who postponed the declaration of their dividend thereby penalising their individual shareholders by the higher tax to avoid charging the STC to profits for the year – bonuses based on profits?
Well all of that is now history. Companies thatnow declare dividends are no longer liable for the tax. The tax is an expense of the shareholder and the company withholds the tax and pays it directly to Revenue. This does not apply, for example, where a shareholder is a company as the latter will withhold the tax when it on-pays the dividend to its shareholders, who are not companies. Beware of companies showing lovely growth rates in earnings this year – a large portion of such increase could be due to the change from STC to withholding tax.
I provide a free accounting service to a select number of investors on the JSE. An important measure is to establish whether or not the investor has earned beta (the market return). As we strive to generate alpha (a return over and above the market returns) we need to compare like with like. The JSE’s published dividend yields are, quite correctly, arrived at before deducting tax on dividends. This makes sense as not all shareholders are subject to this tax. Shareholders should, therefore, account for tax on dividends as an expense of earning those dividends and not net the tax against the dividends. Netting in accounting is taboo. So one would expect the Johannesburg Stock Exchange to publish dividends declared per share for each company gross of withholding tax. Agree? They actually publish dividends declared per share net of withholding tax despite that fact that the company declares the gross dividend and not all dividends are subject to withholding tax!
I suppose I should not criticise as we, in my opinion, got the accounting treatment of STC wrong.