Dividend tax to hit smaller companies hard

The minister of finance announced that the dividend withholding tax will be increased from 15% to 20% with effect from February 22.

Motivation for this increase appears to be to close the gap between the effective tax rate for individual shareholders who earn more than R1.5 million per year, as their top marginal tax rate has now been increased to 45%. Before the budget, the top marginal tax rate for local individuals was 41%. The effective tax rate on dividends to local shareholders has increased from 39.8% to 42.4%.

This will mainly affect smaller companies whose shareholders can substitute between salaries and dividends. Listed and widely held larger companies have a variety of shareholders and the treatment of dividends differs for various categories of shareholders.

Retirement funds are exempt, unit trusts are taxable while reduced withholding rates apply, where applicable, to nonresidents in treaty countries.

Tax on retirement fund distributions are deferred until members exit or receive pensions and unit trusts rely mainly on capital growth, so the increase in withholding tax may not be a big disincentive for investors.

The effective tax rate affects shareholders of smaller companies disproportionately compared to other investors. The increase may limit tax arbitrage between salaries and dividends.

However, small businesses owners may now be at a disadvantage compared to institutional investors and foreign investors.

The negative effect of this on small businesses may have been underestimated.

Owen Murphy is Head of Africa Desk at BDO SA