Issuing Bonus Shares in Uganda: An overview of the Tax Implications

By Denis Yekoyasi Kakembo, Bill Page, John Teira, Dickens Asiimwe Katta, Francis Tumwesige Ateenyi

What are bonus shares?

Sometimes, companies opt to give out bonus shares instead of declaring dividends. Bonus shares are free
additional shares given to the existing shareholders in proportion of their current holding.

A number of companies listed on Uganda’s Securities Exchange have over the years issued bonus shares to their shareholders. As a company makes profits, its retained earnings increase building up substantial surpluses over the years.

As such, the company is in position, if it so wishes to distribute some of these accumulated profits as free shares to the current shareholders.

The issue of bonus shares is merely a reclassification of the reserves causing an increase in the issued share capital of a company and a proportionate decrease in retained earnings but keeping the net worth of the company intact.

In this publication, we discuss the income tax consequences when bonus shares are issued by a company.

Pre 1st July 2013
The question of whether the bonus issue of shares to shareholders amounted to distribution of dividends under
section 2(w) of the Income Tax Act (“ITA”) and therefore subject to withholding tax ( “WHT”) was a contested one until 11th November 2011 when the High Court of Uganda pronounced itself on the matter.

Prior to the High Court determination, the Uganda Revenue Authority (“URA”) took the position that the issue of bonus shares to shareholders was a distribution of dividends subject to WHT under the ITA.

In the case of Standard Chartered Bank (U) Limited and 6 others versus the URA, Justice Geoffrey Kiryabwire held that the issue of bonus shares was not a distribution of dividends. The genesis of this legal duel was that on 20th December 2010, the Uganda Bankers Association (“UBA”) wrote to the URA seeking for a private ruling on the tax treatment of the bonus issue of shares. It was UBA’s position that by issuing bonus shares, the banks did not give away any of their assets to their shareholders.

As such, the banks argued that the issue of bonus shares was not a distribution of profits to qualify as dividends under the ITA. In its response, the URA contended that the issue of bonus shares was a distribution of dividends from reserves.

URA premised its viewpoint on the argument that the bonus shares issued are assets with an ascertained value in the company’s books giving the shareholder the right to an enduring entitlement to dividends. It is against this background that the foregoing suit was instituted.

The key issue was whether bonus shares were dividends and therefore subject to WHT. The High Court found that the ITA was silent on whether bonus shares were dividends. As such, the issue of bonus
shares did not amount to a distribution of profits to shareholders.

Consequently, there was no applicable WHT as was demanded by the URA.

Post 1st July 2013
Intent on clearly placing the issue of bonus shares within the taxable bracket, the government introduced the
Income Tax (Amendment) Bill of 2013 (“Bill”) for deliberation by Parliament.

The initial text of the Bill extended the definition of a dividend to include the issuance of bonus shares to
shareholders. The implication of this was that issued bonus shares would be taxable as dividends and thus subject to WHT.

The Report of the Parliamentary Committee on Finance, Planning and Economic Development on the Bill
stated the following on the proposed amendment to include the issuance of bonus shares as dividends:
Clause 2 extends the definition of dividends to include the issue of bonus shares. Bonus shares issued to a
shareholder will fall within the realm of dividends and thus be taxable.

However, when the Bill was presented before Parliament on 18th September 2013 for the final reading, the
discussion amongst Members of Parliament was whether there was policy justification to subject the issue of bonus shares to WHT.

The majority view was that taxing the issue of bonus shares would discourage capital creation via
the option of capitalizing profits. The minority view was that the issuance of bonus shares was some form of tax avoidance scheme by companies that needed to be sealed with the proposed WHT imposition.

The recommendation of Parliament that went on to form the final text of the law was that the issue of bonus shares would only be taxable upon disposal. The definition of dividends in section 2 (w) (vi) of the ITA was thus expanded in 2013 to include the issuance of bonus shares to shareholders. However, the same section further guided that the issue of bonus shares would only be taxable upon disposal.

Contradictions
The amendment of the law notwithstanding, there are practical challenges regarding how taxpayers can comply
with the arising tax obligations. The obligation to withhold tax would lie on the party that declares and pays out the
dividends. At the time the bonus shares are being disposed which is the point at which the obligation to withhold
tax would arise, the issuer of the bonus shares no longer has any control over those shares because the same were
ceded to the shareholder at the time of allotment of the bonus shares. It is therefore unclear who would withhold
the tax for the dividend pay-out that the law deems to arise at the time the bonus shares are being disposed of.

It is therefore prudent to deduce that the URA is only likely to collect capital gains tax of which the obligation to
account would lie on the selling shareholder.

The writers are with Cristal Advocates