Most business operators endeavour to embrace tax efficient strategies in order to reduce the cost of doing business and increase retains for the shareholders.
In this regard, business operators need to understand the ramifications of some of the transactions undertaken by an enterprise, particularly transactions with related parties. Transactions with a related party can bring about tax complexities with far reaching implications on an enterprise. Today, we aim to reveal and highlight one of the key tax implications arising from gratuity payments made to shareholders i.e., dividends withholding tax (WHT). In this article, words importing the masculine shall be deemed to include the feminine.
Generally, a gratuity is paid by an employer to employees in appreciation for services rendered during the tenure of employment. Ordinarily, a gratuity is subject to Pay As You Earn (PAYE) to the extent of two thirds whereas the remainder is free from tax. However, transactions become convoluted and interesting when a person entitled to the gratuity is a shareholder of the paying company. For tax purposes, it is imperative to note that a shareholder who controls at least 5 percent of a company’s shares is technically referred to as a participator of that company. Consequently, a company’s transactions with such a participator are required to comply with specific regulations in terms of the Income Tax laws. Let us briefly have a look at the regulatory requirement of participators.
Enter participator rules
As alluded to above, related party transactions are subject to regulations meant to inhibit loss of revenue to the fiscus as well as a deterrent for tax avoidance schemes. In this respect, the Income Tax laws provide that a gratuity payment to a participator i.e., a shareholder who holds at least 5 percent equity shares, is deemed to be a dividend payment. Further, the Act states that such amount i.e., deemed dividend, triggers WHT which shall be due and payable to BURS.
Literally, the unvarnished extract of the law states that, ‘where any amount paid by a close company in any tax year to or for a participator is a gratuity in respect of employment such amount shall, notwithstanding any provision to the contrary in this Act, be treated as dividend income for that tax year accrued and shall form part of the taxable income of such a participator and be charged to tax at the prevailing dividend withholding tax rate to the participator.’ We must state that a close company is just but a technical term which refers to the paying private company in which the recipient shareholder is a participator i.e., holds at least 5 percent of equity shares.
Enter withholding tax
It is apparent that the legislature is not convinced that a shareholder, being an employee, can be entitled to a gratuity as any other ordinary employee. It is prudent to state that these rules seem to be inclined towards owner managed businesses wherein shareholders are the working directors of their company and who are entitled to gratuities, where one third of The said payments is exempt from PAYE. Technically, this means that the gratuity paid will be deemed to be net of tax. Therefore, any gratuity paid will be grossed up and dividends withholding tax at 10 percent determined thereon.
To sum it up, it is imperative that business operators take cognizance of the regulatory provisions regarding emoluments to working directors/shareholders. Tax planning is advisable to avoid incurring additional taxes and in worst case scenarios incurring penalties and interest in case of a tax audit.
Well folks, we hope that was insightful. As us the two Yours Truly say goodbye, remember to pay to Caesar what belongs to him. If you want to consult, join our free Tax WhatsApp group or to know about our 9 Tax e-books, send us a text on the cell number below. You can read more tax articles on our website, www.aupracontax.co.bw under the ‘Tax articles’ tab.