Taxation of Dividends and Deemed Dividends under the Finance Act 2018

 

NO DIVIDENDS

By gatuyu t.j

Section 3 (2) (b) of the Income Tax Act brings to tax income in respect of dividends and interests. The details on the forms of dividends subject to tax is provided for under Section 7, which enumerates events that lead to dividends or deemed dividends. The Finance Act 2018, assented by President Kenyatta on September, has repealed and replaced these provisions.

The general rule on taxation of dividend has been retained. A dividend paid by a resident company is deemed to be income of the year of income it was payable. Therefore, the year of income in relation to dividends is the year the dividend was declared, and not necessarily the year it was paid.

However, Finance Act introduces five circumstances when an amount would be deemed to be a dividend distributed by a company to a shareholder, irrespective of whether there was a declaration to that effect. In that case, dividends would be deemed where:

(a)   any cash or asset is distributed or transferred by that company to or for the benefit of that shareholder or any person related to that shareholder;

(b)  the shareholder or any person related to that shareholder is discharged from any obligation measurable in money which is owed to that company by that shareholder or related person;

(c)    the amount is used by that company in any other manner for the benefit of the shareholder or any person related to that shareholder;

(d)  any debt owed by the shareholder or any person related to that shareholder to any third party is paid or settled by that company;

(e)  the amount represents additional taxable income or reduced assessed loss of that company by virtue of any transaction with the shareholder or related person to such shareholder, resulting from an adjustment.

Indicatively, for tax purposes, notional definition of dividend to be only share of the after-tax profit of a company, distributed to its shareholders, is abandoned. Other distributions to shareholders for their benefit, apart from being dis-allowable expenses in computation of taxable income, they will further be subject to the withholding tax chargeable to dividends.

The repealed provisions on deeming dividends in the ITA were ambiguous and out of touch on the corporate law developments. They provided that distribution of assets or cash would only be deemed to be dividends where a company was being wound up voluntarily.

The repealed provisions also provided for deeming of dividends where a company would issue debentures or redeemable preference shares for free. In such a case, the higher value between the nominal or redeemable value of the issue would be deemed to be dividends.

Lastly, the repealed provisions provided where a company would issue shares or rights to acquire shares, to any of its shareholders in a ratio not proportionate to their existing equity, the excess issue would be treated as a dividend to the recipient shareholders.

These were narrow dividend deeming provisions, hence the cause of their replacement. Now, it does not matter whether the benefit to shareholders is in the context of winding up or preference given in context of financing.

There will be deemed dividends where cash or assets is distributed to a shareholder for their benefit; where obligations due to a shareholder is discharged; where a company uses money for personal benefit of a shareholder; where debt for shareholder is settled by the company (for whatever purpose); or in transactions a company deals with shareholders in non arm’s length basis.

The development aligns the tax treatment of dividends in Kenya with what is provided for under Article 10, paragraph 3, of both the UN and the OECD Model Conventions . These Conventions include income from other corporate rights, such as money or money’s worth, as forms of dividends.

The change brought by the Finance Act will have deep practical implications in the corporate world. It will also be a festival for KRA officers in the audit department. Going forward, a company that gifts cars (and the like) to shareholders, sells goods to shareholders at a preferential price (less than market value), pays loans on behalf of the directors, sponsors chairman’s holiday in Bahamas! All these will be deemed to be dividends, and taxed accordingly.

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