Many entrepreneurs struggle understanding why they have to pay corporate tax on profit which the business retained and they personally did not enjoy the fruits of their sweat. Currently, corporate tax in Zimbabwe is an effective 25.75% on profit; broken down as 25% income tax and 3% of income tax as AIDS levy. Mind you, our tax authority Zimbabwe Revenue Authority (ZIMRA) adds back what they term non-deductable expenses. These are company expenses such as personal costs, entertainment, teas and lunches, fines, legal fees, tax consultancy etc. This means that entrepreneurs end up paying tax on the taxable profit which is a higher figure than the net profit shown on your income statement (or profit and loss statement).
As an accountant I have had many interesting engagements with my clients to try and explain to them the phenomenon. From an entrepreneurs point of view; if I put back all the excess money that the business made in financial year back into the business to expand the business, then clearly my business must not the penalised by paying taxes on that excess. In non-financial layman terms this sounds about right, doesn’t it…but does it? According to Caesar’s rules, a company pays taxes on the excess that it has made from its economic activities, regardless of how you then use the excess funds. If the entrepreneur so wishes, dividends can be declared from that profit and he can then use that money for his personal needs. By investing the money back into the business, the entrepreneur is either expanding their business or retooling for better efficiency leading to better/higher returns in the future. Therefore, regardless of how the profit is used, the entrepreneur is the ultimate beneficiary of that profit either in immediate benefits by declaring dividends or long term benefits through improved future profitability.
A dividend can only be declared on profit after tax, thus if the business faces a financial loss in a certain reporting period, no dividend can be declared in that period. Regardless of whether the dividend is paid to a company or individual shareholder, all dividends received from locally incorporated companies are exempt from taxation in the hands of the recipient.
Dividend paid to Individuals, Trusts and Partnerships
If you opt to pay dividends to yourself as an individual, your trust or partnership; the taxman expects the operating company to withhold a “resident shareholder dividend tax” of 15% (assuming the company is privately held). The withholding tax has to be remitted to ZIMRA within 10 days of being distributed to shareholders.
Dividend paid to Companies
If you are a smart investor, however, no resident shareholder tax is withheld in the operating company’s books for dividends that are paid to a shareholding company. So the smart way to go around it is to have your shareholding in the operating company held through an incorporated investment vehicle. This can be done by lodging a CR2 with the Registrar of Companies where you nominate your investment vehicle as the shareholder in your operating company. That way, your operating company does not have to withhold and remit to ZIMRA the 15% resident withholding tax on dividends. Effectively, you can then declare a higher dividend to your investment vehicle and you can then use these funds to fund your personal lifestyle buying houses, cars, boats etc and hold them in this vehicle.
If you decide to retain the profit you can either:
- Buy assets for the business and the capital expenditure (CAPEX) qualifies for Special Initial Allowance (SIA) and Wear and Tear (W&T) at a rate of 25% over four years. In the first year, SIA is deducted from your income tax return and over the next three years the W&T is deductible. However, as is standard; depreciation is added back to the profit figure. I always advise my clients to use a deprecation rate of 25% using the straight line method over the useful economic life of the asset so that the deduction is the same as the add-back.
- Keep the profit as current assets such as cash and cash equivalents which you can use to increase trading levels through increased stocking levels, more acreage under farming etc.
So no matter how you decide to use your profit, once your business earns it, you are liable to pay taxes on it. Failure to do so will incur penalties and interest on the taxes that you should have paid and this may ruin your financial planning. Should you need help on filing your tax returns including advice on tax planning please get in touch with Tanaka on landline 08677 130 017, cell 0732 469 712 or email email@example.com