The perils of dividend tax

One of the most noteworthy aspects of Finance Minister Pravin Gordhan’s recent budget was the thumping increase in dividend tax by a buttocks-clenching 25%. The Treasury is hoping to bring in an additional R6.8bn in revenue through the increase.

No tax increase is welcome, but it’s worth asking whether — apart from increasing the government’s revenue — this kind of tax hike is a good idea. It should be noted that the two are often intertwined, for the simple reason that the higher tax rates become, the less effective they become because high taxes incentivise avoidance. But leaving that issue aside, what are the likely consequences, good and bad, of this tax?

Two important caveats should be mentioned. Dividend tax is not applicable to companies receiving dividends from another company. This is to avoid the same lump of cash being taxed twice. The tax is also not applicable to foreigners or foreign companies from countries with which SA has a tax agreement in place. The tax is essentially an increased burden on domestic, individual taxpayers.

The Treasury’s argument in favour of the tax is twofold. First, it argues that SA’s rate of dividend tax is low by international standards. Because the tax is paid on profit on which corporates have already paid company tax, the effective tax rate consists of the corporate tax rate combined with the dividend tax. That, says the Budget Review, amounts to a total rate of 38.8%. SA’s rate was previously just below the average rate for Organisation for Economic Co-operation and Development (OECD) countries and the new level will be marginally higher than the average. The problem with this argument is that most of the developing OECD countries are below the average. At the new rate, SA’s combined level will be just less than Norway and Sweden’s. That would be fine if South Africans got Scandinavian-level services, but we don’t.

The Treasury’s second argument is that it was effectively obliged to increase dividend tax after it increased the maximum marginal rate; if it did not, there would then be an arbitrage opportunity between the two rates. This is a good argument, assuming you agree with the idea of increasing the top marginal rate.

One of the noteworthy complaints about the tax has come from black business, with the Black Business Council saying the measure would hurt black economic empowerment (BEE) schemes and so would not contribute to “radical economic transformation”. The objection provides a rare and happy issue on which all business groups agree. However, because the tax does not apply to dividends paid to corporations, it’s unlikely to be seriously debilitating. Most BEE schemes are housed in special purpose vehicles that are themselves companies, so they are likely to avoid the effect of the tax.

The tax might, however, affect individuals within companies who are part of BEE schemes. Often the best aspect of BEE schemes is their effect on employees since if workers are included, the scheme helps align the interests of employees with those of shareholders. This is potentially a problem not only for BEE participants, but also ordinary employees and particularly executives whose remuneration partly consists of shares.

The key question, however, is whether the tax will affect capital formation. The broad answer is that there is a significant danger of tax leakage. Dividend taxes are often imposed to encourage companies to expand rather than just disgorge cash. Often, however, it doesn’t work out that way, because the issues involved in the expansion are wider and more complicated. In short, the Treasury should be thinking much more aggressively about cost containment than how to squeeze more tax out of already overtaxed South Africans.

THE KEY QUESTION IS WHETHER THE TAX WILL AFFECT CAPITAL FORMATION