Taxonomy of Dividend under Income Tax Ordinance, 2001

Taxation of dividend in Pakistan is quite unique in its treatment compared to similar statutes of the rest of the world. There are two different taxation treatments applicable under the Income Tax Ordinance, 2001, one which is meant for companies and other is for persons other than companies. This article is an endeavor to understand the taxonomy of tax regime applicable on dividend income, problems related thereto and suggestion for improvement in tax regime to reap full benefit.

TAXONOMY OF DIVIDEND INCOME

The term “income” includes dividend income received from a company or trust; however, bonus shares are specifically excluded from the term dividend. The term company means

1. A company [as defined in Companies' Ordinance, 1984],

2. A small company

3. A body corporate formed by or under any law in force in Pakistan,

4. A modarba,

5. A body incorporated by or under any law of a country outside Pakistan relating to incorporation of companies,

6. A trust,

7. A co-operative society,

8. A finance society,

9. Any other society [constituted by or under any law for the time being in force],

10. A foreign association [whether incorporated or not and Central Board of Revenue has declared it to be a company for the purpose of Income Tax Ordinance, 2001, by general or special order],

11. A provincial government and

12. A local authority.

The term trust includes unit trust and means an obligation annexed to the ownership of property and arising out of the confidence reposed in and accepted by the owner, or declared and accepted by the owner for the benefit of another, or of another and the owner. In furtherance, the term unit trust means any trust under which beneficial interests are divided into units such that the entitlements of the beneficiaries to income or capital are determined by the number of units held.

The term dividend is normally understood as distribution of profit; however, distributions and payments are specifically included in the term dividend. The term Distribution in turn means the release, by the company; of all or any part of its assets including the money to the extent it possesses accumulated profits to its shareholder. The term shareholder encompasses modarba certificate holders, unit holders of a unit trust and beneficiaries of a trust. Following payments are specifically included in the term dividend.

1. Distribution to shareholder

• From accumulated profit

• At the time of liquidation from accumulated profit

• On reduction of share capital from accumulated profit

• From debenture, debenture stock or deposit certificate

2. Payment by a private company by way of advance, loan or any payment for individual benefit to the extent of accumulated profit

The term “accumulated profit”, apart from keeping its general accounting definition, has been defined in relation to distribution or payment of dividend and includes any reserve made up of any allowance, deduction or exemption admissible under this ordinance either wholly or in part. This entails the fact that such exemption, allowance or deduction is only restricted to original recipient and such benefits cannot be forwarded to the shareholders. For the purpose of 1(a), 1(b) and 2 above, the term “accumulated profit” means all profits of the company including income and gains of a trust up to the date of such distribution or such payment. However, for the purpose of 1(b), “accumulated profit” includes all profits of the company including income and gains of a trust up to the date of its liquidation.

As stated earlier in 1(a) above in the definition of dividend, any distribution of accumulated profits by a company to its shareholders shall be treated as dividend. However, such distribution must entail the release of all or any part of the assets including money of the company, by the company, to its shareholders. In furtherance, it is immaterial, whether such accumulated profits are capitalised or not,

In furtherance, as stated earlier in 1(b) above in the definition of dividend, if a company is in liquidation and made any distribution to the shareholders to the extent that such distribution is attributable to the accumulated profits of the company immediately before its liquidation shall be treated as dividend. It is immaterial that whether such profits are capitalised or not.

Moreover, as stated in 1(c), if a company is reducing its capital and made any distribution to its shareholders to the extent that such company possesses accumulated profits, which shall be treated as dividend. It is immaterial whether such accumulated profits have been capitalised or not

The above-referred three scenarios of the definition can be illustrated in the following examples.