The Minister of Finance in the recently read #budgetspeech for #2025-26 proposed amendments to the definition of capitalisation of profits in the #Income Tax Act 2004 (herein “ITA”) to include retained earnings that remain undistributed for a period of six months after the date of filing of returns of income.
To put it in perspective, #shareholders are normally taxed at the point a company makes a distribution or an entity is deemed to have distributed as far as the ITA is concerned. Before this proposal, an entity would be regarded to have distributed profits to the shareholders at any of the following scenarios: (i) payment made by the entity to its members in any capacity to the extent that the amount of the payment exceeds the amount of any payment made by the member to the entity in return for the entity’s payment (ii) re -investment of dividends which enhances value of shares (iii)capitalisation of profits.
“Capitalisation of profits” is defined in the Act to include a capitalisation by way of issuing bonus, membership interests or increasing the amount paid upon membership interests in the entity or otherwise crediting profits to a capital or premium account of the entity;
But with the proposed change, it would mean that a Company that has undistributed accounting profits for one year or more after the end of the accounting year (six months after the due date of filing the tax return) will regarded or “deemed” to have distributed its profits and hence taxed at 10%, even though no distribution of profits is made to the shareholders. I provide below my views on why this is bad news for Companies and the Government:
Before delving on why this is bad for Corporations and the economy, we need to understand what retained earnings are:
As a tax expert, I refrain from using the term “retained earnings” for obvious reasons as in accounting it is used to simply represent the portion of a Company’s net income that is withheld (not distributed to shareholders) to fund future Company activities. In actual sense, it can mean undistributed accounting net profits which can either be reinvested or distributed to the shareholders. They may change form to “earnings” in my view when they are distributed or declared to be distributed to the shareholders, which based on our #IncomeTaxAct2004, the Company will be required to deduct 10% as final tax and remit to TRA.
Where these retained net profits are withheld for future expansion and the Government opts to tax these undistributed profits, the first question that comes to mind is its tax incidence, or who actually bears this tax liability? Sadly the spirit of the law was not included in #budgetspeech
However, given the fact that a Corporation is a legal entity separate from its owners, by deeming net profits retained for future expansion to have been distributed, you effectively intend to increase the corporate income tax by 10% (mind you these undistributed profits may have already suffered corporate tax at 30%), hence taxing the same tax base twice. Reason being, the profits still remain at the Company’s books and the tax point has not been effected to the point that the Company can shift this burden to the shareholders.
The Second question would be what remedy is available for the Corporation above as the shareholders opted to reinvest the amount by buying additional capital or investment as opposed to distributing the profits. Is the tax incurred by the Company recoverable? If yes, by what means?
In case where only a portion is distributed, can the Corporation apply for refund of the amount reinvested and only account for tax for the distributed portion? What if the profits are used to by a capital asset (shares, land, building), will this tax paid upfront be considered as a credit once the capital item is sold? What if the retained income is for an investment that will earn the Company income? Will the tax be credited against the investment income that is reported in the books?
Another scenario comes about where the Corporation is a Branch of a foreign Company, which is to be subjected to a branch profit tax on the deemed repatriation of profits to the head office. Would the deeming retention of profits be excluded for the Branch? This is since the deemed distribution would mean the effective tax rate for Branches in Tanzania will be 50% (CIT at 30%+10%BPT+10%deemed distribution).
An additional complication would occur in case where the Corporation in question is listed on the stock exchange and for obvious reasons chooses not to distribute profits in a given year of income, implying they have to account for 10% as dividend and remit to TRA despite the fact that that the applicable rate is 5% and 10%.
All in all, there are a lot of considerations that in my view need to be taken into account in order to operationalise this amendment. It is my view that whilst this may have been adopted from another Country, there is a need for the Government to listen to the outcry among the stakeholders regarding this as not only that it brings ambiguity in terms of how it can be applied, but also from an economic sense it discourages re investment which will see not only reduction in terms of capital in businesses but also in the stock exchanges as Companies will be induced to distribute capital to the shareholders at their earliest convenience, thus leading to a shrinkage in investment
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