In short, it is apparent that this fiscal initiative is essentially a corporate law desire of the regulators and in the following paragraphs discussion will be focused on whether or not such an action can or should be taken under the fiscal regime.
Retrospective effect
The present law is applicable for tax year 2017. Accordingly, companies having December 31, 2016 as their financial year-end would have to bear the incidence of this tax even though they would have closed their accounts, and distributed dividends before the amended statute became part of the law on July 1, 2017. In the Finance Act 2017, it has been conceived that such companies fall within the ambit of this law, as it has been stated in the proviso to Section 5A that for the tax year 2017 dividend distributed in the following six months after July 1, 2017 will also be considered as dividend for the purpose of this section. This action of legislature in writer's view is essentially a legislation with retrospective effect as amended law which came in the statute books on July 1, 2017 cannot decide the incidence of tax on income earned during 2016 for which a dividend has already been distributed before July 1, 2017.
Legal substance
The fundamental question with regard to this legislation is whether or not the whole amount 'accounting profit after tax' can again be taxed by way of Section 5A of the 2001 Ordinance. This refers to the fundamental question about the legal validity of Section 5A. When Section 23A of the 1922 Act was applicable, the amount of 'undistributed income' was first 'deemed' to be income and then taxed under the law. This has not been done under Section 5A of the 2001 Ordinance. There can be an argument that validity of Section 5A in this perspective was not made when the same tax related to undistributed reserves exceeding 100 percent of capital. This argument carries a lot of weight; however, this cannot be a basis for not considering the legal validity of Section 5A of the 2001 Ordinance in the present form. It is possible that when this matter will be tested for legal validity of 'taxes on income' under the Constitution of Islamic Republic of Pakistan then a constructive jurisprudence will develop.
This country and as well as its tax policy is facing the shocks it received on account of the decision of a bench of Supreme Court headed by Ajmal Mian in the case of Elahi Cotton Mills when a very broad ambit/shore of the term 'income' for taxing right was adopted. That case law in writer's view has limited scope and requires reconsideration in a wider perspective. It is now time to re-examine that position. In all countries, there is a continuous review and examination of the past decisions according to need of the time and new rules and principles are consistently developed. What can be taxed as income under the Constitution of the country is a question under consideration. It appears that legislature has decided to fulfil many of its non-tax-related desires, such as equity in distribution of dividend under the corporate law, through such tax legislation. The courts when faced with these situations will look into the matter FROM that perspective and ultimately decide that only 'income' can be taxed or deemed to be income for the purposes of taxation. Constitution has not provided unbridled rights to legislature on that count. In this writer's view, entries in that respect in the Constitution have a restricted application.
Killing the goose that lays the golden egg
If we examine the matter purely from 'tax recovery' viewpoint, it transpires that as a result of this amendment, there is essentially a guaranteed tax recovery over and above the normal tax on companies. The company will pay a 30 percent tax on income. If the income is Rs 100 then there will be an income tax recovery of Rs 30. If the company distributes dividend equal to 40 percent then the government will receive 15 percent guaranteed tax on such dividend. It means that there will be a minimum additional liability of Rs 6 (100x40%=40x15%=Rs 6). Accordingly, the total tax recovery out of the profit for the year will be guaranteed at Rs 36. If there is no distribution then the company will pay 7.5 percent of income being Rs 7.5. This essentially means that there will always be a minimum tax recovery of 36 percent tax under the current system. If the company wants to retain or distribute, the incidence in aggregate with the revenue is almost the same. There is guaranteed return in the form of tax from the listed companies.
Now we have to examine the same in real economic terms. If that amount of 40 percent is retained in the company then in most of the cases the earning of the company from the amount retained, but not distributed, will be part of the profit subject to tax at the rate of 30 percent. In author's view, the earnings from such retained assets will be more than what has been collected in the aforesaid manner being Rs 6 or Rs 7.5 as the case may be. If we see this calculation then it means that by way of this amendment ultimate tax collection will be less than what is expected to be received if the amount is retained in the company. This essentially means that this taxation is in some manner similar to killing the goose that lays the golden egg because investment in the company will provide sustainable tax for the country with a higher rate. In author's opinion, in the past, such provisions were abolished for this very economic reason.
Subversion of the rights of directors and members of a company
If we examine the whole subject of taxing the undistributed reserves then it appears that such provisions are essentially lead to subversion of the rights of directors/members under the Companies Act, 2017. Directors are required to decide the amount of dividend that has to be approved by the members. By way of this legislation in the tax statute it is being provided that a penalty will be payable in the guise of taxation if dividend to a certain extent is not paid. This constitutes a clear conflict of taxing and corporate law statutes. In this free market economic system, there has to be autonomy in undertaking the affairs of business as per the desires of the members. Neither corporate nor tax regulator can override on penalize the company, for an action of the management, of not paying dividend up to certain level. This in writer's view is over-regulation that will ultimately spoil both tax and corporate law cultures. It is the reason that such taxing provision does not appear in any of the developed jurisdictions. If tested on constitutional plaint courts will look into this aspect also.
Conclusion
On the basis of the above discussion, it is suggested that present provisions of Section 5A, tax on undistributed income, be kept in abeyance by way of a notification issued and incorporated in the Second Schedule. This had been done in the past and aforementioned Section 23A of the 1922 Act remained out of operation for a long time. There can be other ways to encourage distribution of dividend. But whatever the reason may be, it is the right of the members where regulators cannot interfere.
The second aspect to be taken into account is that, in real terms distribution of minimum dividend each year is essentially anti-growth and anti-investment. The reserves and profits retained in the company have to be used for business purposes leading to more business and higher taxes. Distribution in the hands of shareholders in almost all the cases leads to consumption by individuals, which essentially leads to anti-growth and anti-investment culture. Thus, from the economic viewpoint, this policy, notwithstanding its legal infirmity, leads to lesser investments for the country. This fundamental economic principle is to be taken into account.
Notwithstanding the action of keeping Section 5A in abeyance, the present law is defective in the sense that it does not cater for actual distribution if it is less than 40 percent of profit for the year. Without prejudice to any other action, a notification be issued to the effect that incidence of tax shall be on that undistributed profit, ie, the amount after deducting profit already distributed. This means that such incidence will take into account the amount actually distributed. In simple words, if a company has distributed 30 percent dividend then incidence of tax will be on the remaining 10 percent of the profit and not on the whole profit as per the present law. This imperfection in writer's view is an omission, which will definitely be taken into account before implementation.
At the end, it can be stated that time has come to reconsider whether this country requires documentation and corporatization, maintaining the sanctity of the rights to the members of the company for business decisions. Furthermore, there is a need to decide that under the Constitution only 'income' can be taxed. I hope government will seriously consider this matter and place the law in abeyance immediately and a better proposition can be developed in consultation with the organised corporate sector.
(Concluded)
Comments
Comments are closed.