HOW CRAZY IS IT for a company to allow nearly two-thirds of shareholders’ profits to be wiped out in tax? Surely a tax bill for more than double the ideal corporate tax rate can be avoided? Attracting a tax bill equivalent to 63,2% of a company’s profit before tax “sounds a bit dangerous and the planning is irresponsible,” says Boris Pelegrin, tax lawyer and adviser at professional services firm Maitland in Johannesburg. “If so much of your bottom line is wiped out by tax it’s dangerous.”
According to the 2006 annual report of JSE-listed industrial machinery group Howden Africa Holdings, the company attracted a tax liability of R35,3m – 63,2% of its R55,9m profit before tax. That whittled down its net profit to R16,5m. To further add to its tax bill, Howden declared a special dividend of 241c plus a final dividend of 6c/share – a total of R162,3m.
If all the above sounds puzzling, try this one: Howden used its R71m cash resource and borrowed R100m from Standard Bank to pay the special dividend. While the special dividend might have been paid for unknown corporate reasons, Pelegrin says to borrow money to pay dividends “sounds very inappropriate and at best irresponsible. It’s like creating debt to settle debt. It’s quite dangerous to borrow money to pay a dividend, as it creates a long-term liability for the company.”
Pelegrin suggests another motive for declaring a dividend in money that isn’t in the bag: to pull funds out of the country if offshore shareholders control the company. “There are always two ways to pull money out of SA – interest on (shareholder) loans and dividends.”
Doug Gaul, tax manager at Grant Thorn- ton, bemoans the planning that would attract such a high tax liability in one year, noting that the company had a 5,3% prior year tax adjustment. “The prior year tax adjustment is very high. They could have underprovided for tax in prior years, which is bad for tax planning.” Gaul says the company could have been sitting on capital reserves for a long time and had decided to pay dividends that attracted the tax for all the years.
Gaul also criticised the debt incurred by the company to pay dividends. “It’s not a sound commercial practice. They should have paid dividends from their own resources. Interest on borrowed money isn’t tax deductible if the money is to be used to pay dividends, among others.”
If anything, it really sounds like a waste of shareholders’ money.