A corporation is a legal entity created under a state

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Corporations may be taxed on their incomes, property, or existence by various jurisdictions. Many jurisdictions impose a tax based on the existence or equity structure of the corporation. Many jurisdictions instead impose a tax based on stated or computed capital, often including retained profits. To point out the various models of corporate taxation i.e. full integrated, classical system of corporate taxation and partial integration.2

In Ethiopia, a corporation may be organized under either Federal or provincial laws. Most jurisdictions recognize as corporations entities organized under the corporate or company laws of other jurisdictions. Under many tax systems, any entity providing limitations on the liability of all members for the actions of the entity is considered a corporation. Characterization as a corporation for tax purposes is based on the form of organization in most taxing jurisdictions.3

1 http://www.lexisnexis.com/documents/pdf/20080710094611_large.pdf

2 http://en.wikipedia.org/wiki/Corporate_tax

3Ethiopian income Tax Proclamation No. 286/2002: Article 6

Business Profit Tax is the tax imposed on the taxable business income /net profit realized from entrepreneurial activity. Taxable business income would be determined per tax period on the basis of the profit and loss account or income statement, which shall be drawn in compliance with the generally accepted accounting standards.

In Ethiopia Corporate businesses are required to pay 30% flat rate of business income tax. For unincorporated or individual businesses the business income tax ranges from 0% - 35%.Unincorporated or individual businesses are taxed in accordance with the following schedule below: 4

And In Proclamation No. 286/2002 Article 34 (1) stated that, every person deriving income from dividends from a share company or withdrawals of profits from a private limited company shall be subject to tax at the rate of 10%.5

Having this information about my country's tax policy, it is very vital to gauge the impact of this tax policy on corporate and unincorporated business. When I compare corporate ABC plc and unincorporated (sole proprietor) business XYZ having annual profit of Birr 70,000 each during one budget year, the total amount of taxes needed from both businesses ABC&XYZ should be as follows.

Taxes needed from corporate business(ABC)is(70000*30%=21000)

Dividend (70,000-21,000=49,000*10%=4,900)

Total amount 21, 000+4900= birr25, 900.00

Taxes needed from unincorporated (XYZ)

Total amount=birr16, 550.00 as calculated in table 1 below.

4 Taxation in Ethiopia, Addis Ababa 1/2005, www.bds-ethiopia.net/taxation.html

5 Ethiopian incomes Tax Proclamation No. 286/2002: Article 6

Example- for Taxable income of 70,000 birr the calculation will look like this:-

Table 1

Income per year(a)

Tax Rate(b)

Tax revenue in Birr


Exempt threshold




(6000*10%)= 600.00



(9000*15%)= 1,350.00



(11400*20%)= 2,280.00



(14400*25%)= 3,600.00



(17400*30%)= 5,220.00

Over 60,000


(10000*35%)= 3,500.00



Source: Tax Rate for Individual Business income based on the proclamation Article 19, Schedule "C"

According to the above table the amount of tax should be collected from xyz is Birr16, 550.00.So based on the above reasons an unincorporated (sole) business has obliged to pay less amount of tax than operating in corporate level. So this shows unincorporated business got tax advantage than corporate business. Here there is a reflection of split rate systems occur in a classical system of corporate taxation (it distorts to markets by creating a disadvantageous treatment of corporate profits by comparison to the profits of other legal forms).6

This type of tax treatment may guide tax payers to hide their tax liabilities. Companies Prefer not to distribute their profits to their shareholders because of the unfair tax rate (double taxation) and this may discourage investment.

Before stating the feasibility of introducing a dividend imputation system to increase equity in the tax system and to encourage investment in corporations, I should elaborate briefly about the options for taxing corporate profits. So generally this difficulty may became from the interest of achieving maximum revenue, but it should be also think how to manage investment, equity & so on.

6 Centre for Customs & Excise Studies University of Canberra ACT 2601, Australia

To have a full knowledge about classical system of corporation taxation it is helpful to asses the three models of corporate taxation, namely; full integration, classical system and the partial integration system.

To begin with Full integrated system it treats a personal services entity such as a company as fiscally transparent with respect to a particular category of income. That is, the corporate form is effectively ignored for the purposes of identifying the relevant tax entity(s). As a result the shareholders are attributed with their respective shares of the corporate profits, losses, tax credits etc in the year that they arise.7

Though full integration model would perhaps be the most appropriate because it would allow income tax to be imposed upon those who at least possess the legal power to control corporate profits it has flows/limitations/ like: shareholders would require complete information regarding the financial affairs of the company, it reduces the number of payers that must be monitored by government in order to assure the proper collection and payment of tax revenue to the government, Corporate tax rates often exceed this withholding tax rate, the removal of corporate profits tax would diminish the revenue, individual shareholders may not be in a position to know what their share of the corporate profits may be for some considerable time, there is no capacity for the retention of profits in a no tax or lower tax form, require the shareholder to second guess the decision of the board should the decision be made to retain profits for reinvestment.

Unlike fully integrated corporate taxation, which effectively ignores the corporate form for the purposes of identifying the relevant tax entity(s), in classical system of corporate taxation the company is recognised as a separate taxable entity. And to impose income tax upon corporate profits, there are a number of options for how corporate distributions are treated.

7 Center for Customs & Excise Studies University of Canberra ACT 2601, Australia

One is a Deductible dividend which allows a tax deduction with respect to dividends paid to shareholders in the relevant income year. This approach would ensure that corporate profits would not be subject to double taxation. It would also achieve neutrality between resident and non-resident shareholders, but this neutrality might be considered disadvantageous to the country in which the company is a resident. 8

The Second one is Exempt Dividends which is another approach to treating corporate profits to impose tax at the corporate level only, with dividends paid to shareholders being exempt. This would overcome the non-discrimination issue noted above, but entails shortcomings like high income earners might be subjected effectively to tax at a rate lower than their marginal rate of tax. As it is mentioned earlier In Ethiopia Corporate businesses are required to pay 30% flat rate of business income tax and 10% on dividend. And in such a case where shareholder's marginal rate of tax (10%) is lower than the corporate tax rate (30%) it is better to impose tax at the corporate level only to avoid discrimination.

Third Split rate systems a classical system of corporate taxation where income tax is imposed at both the company level and upon any profits distributed to shareholders in the form of dividends. But it distorts private markets by creating a disadvantageous treatment of corporate profits by comparison to the profits of other legal forms.

However Double taxation of corporate profits creates a bias in the tax system favouring debt over equity as companies are allowed a deduction for interest incurred on borrowings. This double taxation can be avoided using 1st the retention of profits within the company, corporate profit retention, thereby ensuring that corporate profits are only taxed once.

8 Centre for Customs & Excise Studies University of Canberra ACT 2601, Australia

2nd by Corporate Chains to defer tax which entails the creation of multi-tiered private company structures whereby income passed through a chain of companies before being derived by the natural person who controlled the company. 3rd dividend strip which represents a means by which a shareholder, who expects to receive a distribution of corporate profits by way of a dividend, might access the economic value of those profits in a manner which produces a lower tax liability than if the dividend distribution were made to that shareholder.

A third option for taxing corporate profits which adopts elements of both the full integration and classical models of corporate taxation is called 'partial integration' model. It strikes a compromise between fiscal necessity, compliance with double tax conventions, neutrality and equity.

Partial integration entails taxation at the corporate level with respect to gross corporate profits and also taxation at the shareholder level. However, resident shareholders receiving dividends out of profits that have been subject to tax at the corporate level receive a credit for that corporate tax paid. If the shareholder is a non-resident, no credit is allowed but nor is any withholding tax imposed with respect to the dividend paid to the shareholder. Such partial integration is also known as the 'dividend imputation' system of corporate taxation.9

Dividend imputation is a corporate tax system in which some or all of the tax paid by a company may be attributed, or imputed, to the shareholders by way of a tax credit to reduce the income tax payable on a distribution. It reduces or eliminates the tax disadvantages of operating a business in a country.10

9 Centre for Customs & Excise Studies University of Canberra ACT 2601, Australia

10 http://en.wikipedia.org/wiki/Dividend_imputation

Dividend imputation is designed to avoid double taxation on dividends. Corporations obtain franking credits for company tax paid on profits that the Dividend Imputation has a significant impact on the income generated from equity investments.

Tax policy analysts typically measure any tax change against three criteria: efficiency, equity, and simplicity. The dividend imputation system substantially meets these criteria as a means of integrating the corporate and individual tax systems. 11

It also reduces the bias toward debt financing rather than equity financing; the bias toward retention of earnings; and the bias against the corporate form. The double taxation of dividend income violates equity because the tax burden on investors varies with the source of the income (e.g., dividends versus interest). In contrast, dividend imputation eliminates this distinction by ensuring that distributed corporate income is taxed at the shareholder's marginal rate. When a system is overly complex, compliance costs escalate and taxpayers and their advisors have more incentive to "beat the system." In contrast, dividend imputation reduces the incentives to artificially lower taxable income at the corporate level because distributed corporate income is ultimately taxed at the shareholder's marginal rate regardless of the corporate rate.

Hence, in my opinion it is relatively feasible to introduce a dividend imputation system to increase the equity in the tax system and to encourage corporate capital investment which intern will have a positive impact for growth and development a country.

11 http://www.nysscpa.org/cpajournal/2004/804/perspectives/p15.htm