An analysis of the accounting treatment of a tax on company distributions in South Africa

Abstract

South Africa adopted a dual corporate income tax system in 1993 by reducing the normal company tax rate and introducing a second-stage tax on distributions known as secondary tax on companies (STC) that was imposed on the company and not on the shareholder. The local consensus was that STC must be recognised as an expense as part of the company tax charge. This consensus appeared to contradict the definition of an expense in the Conceptual Framework for Financial Reporting. STC was subsequently replaced with dividends tax which, in the case of cash distributions, is a withholding tax imposed on the shareholder while it remains a tax on the company in the case of non-cash distributions. The objective of this study is to evaluate the accounting treatment of taxes on distributions, both formerly and currently imposed in South Africa, to determine which treatment approach is appropriate. The appropriateness of the different accounting treatment approaches to a tax imposed on company treatments is assessed based on the relevant fundamental principles of accounting practices (standards) and the decisionusefulness theory. The study includes a reflection on the differences and similarities, both legal and in substance, between STC dividends tax in order to determine whether a differential accounting treatment approach is warranted. The study observed that there are significant legal and administrative differences between STC and dividends tax but that the economic substance of the two taxes is similar in that both taxes diminish the ultimate return derived by shareholders. It was further observed that the differentiator applied by accounting standards in determining the treatment approach, favours the legal form rather than the economic effect (substance) of the taxes. The study found that a country-specific pronouncement on whether dividends tax is an income tax would be useful. Preparers of financial statements would also benefit from specific guidance on determining whether dividends tax is linked to past transactions or events that generated distributable profits.