Potential impact of tax levy on undistributed profits

Potential impact of tax levy on undistributed profits

According to analysts at Arif Habib Limited, the government is considering new taxation measures in the upcoming budget, including the imposition of a tax on undistributed profits (reserves) of corporates.

The proposed tax rates are 5% for listed companies and 7.5% for unlisted companies. It is worth noting that this tax will be adjustable for shareholders against future dividends paid by the company.

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The potential impact of this tax levy on the government’s revenue can be analyzed through four scenarios:

Retrospective Taxation: It remains to be seen whether the tax will be imposed retrospectively, penalizing companies that have failed to distribute profits in prior years. This approach may face legal implications, as the decision to utilize reserves for growth or distribution lies within the discretion of shareholders and sponsors.

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Prospective Taxation: Alternatively, the tax may be imposed only on companies that do not distribute profits in the forthcoming year. This approach would be based on the principle that companies should prioritize distribution to shareholders.

Regarding the treatment of reserves, two proposals are likely to be considered in the upcoming budget:

Tax on Non-Distribution: Companies that have not distributed profits in recent years may be subject to a tax if they fail to meet a specified payout threshold (e.g., 20-40% of earnings or paid-up capital). Companies committing to such distributions through dividends or bonuses would be exempt from this tax.

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Tax on Undistributed Reserves: A flat tax on undistributed reserves of all companies, regardless of past or expected payout announcements, could be implemented. However, this approach is more likely to face legal implications.

Companies listed on the Pakistan Stock Exchange (PSX) have already taken proactive measures in response to the potential tax levy. Some have announced an increase in authorized capital, possibly to offer bonus shares to existing shareholders. Others have scheduled extraordinary general meetings (EOGM) or emergent board meetings to address this matter.

In conclusion, the introduction of a tax on undistributed profits aims to encourage companies to prioritize dividend payouts to shareholders. The precise implementation and legal implications of this tax levy are yet to be determined, and companies are taking precautionary measures to mitigate its potential impact.