Until some one comes up with a better idea, taxation is the only practical means of raising the revenue to finance government spending on the goods and services that most of us demand [1] . In order to achieve this objective most developing countries prefer to use classical system of corporate taxation than imputation system of corporate taxation. Since the management and productivity of the revenue of the former is much easier than the latter and ignoring, tax neutrality, and equity issues. This assignment work attempts to address the advantages and disadvantages of both classical and dividend imputation corporate taxation.
Objective
To demonstrate the understanding of classical system of corporate taxation and dividend imputation system of corporate taxation, as well as understanding of tax neutrality, efficiency, simplicity, and equity under each system.
Methodology
Evaluating two systems of corporate taxation.
Source of Information
Teaching materials of direct taxation principles
Different websites
Literature Review of Classical and Imputation System of Corporate Taxation.
Classical System of Corporate Taxation System
Classical system of corporate taxation is a system in which companies and their owners are liable for corporation tax as separate entities. A company's taxed income is therefore paid out to stockholders, who are turn taxed [2] as dividend tax at different tax rate.
Taxing companies as separate entities is also justified as a withholding tax, which may be useful means of ensuring that income flowing through the conduct is taxed in a comprehensive and timely manner and that the base of the individual income tax is protected. Many economists including some, who have not advocated full integration, have argued that this withholding function is indeed the main argument for the imposition of a tax on corporate income. In addition to this a separate tax on the profits of companies is considered reasonable also on the ground that incorporation confers substantial benefits such as limited liability of shareholders, right to sue and be sued. What is more corporate taxation is an administratively simple device for taxing an appropriate type of income from capital [3] .
A classical corporation tax which taxes the equity income of companies at a positive rate may distort incentives in four main ways.
Discourage business from incorporating and hence from taking advantage of benefits which are associated with the corporate form of organization such as benefits of limited liability which reduces the cost of companies of raising outside capital for expansion,
Encourages companies to finance their projects by using debt rather than equity finance,
Encourages a company to retain its equity earnings rather than distributing them to its shareholders, and
Reduces the incentive to invest, and may therefore inhibit growth [4] .
Dividend Imputation System
The dividend imputation system was introduced by the Hawke/Keating government in 1987 [5] and is defined as a form of equalization tax, since the tax paid by the corporation is credited against the tax liability of the shareholders. Thus, imputation system eliminates double taxation of distributed profits of a corporation unlike the classical tax system which taxes profits of a company and then taxes dividends the company distributes out of those profits [6] .
Introduction of Dividend Imputation
As per my opinion, dividend imputation must emanate from already existed tax policy of a given country. Even though, the setting up of efficient and fair tax systems is, however, far from simple, particularly for developing countries [7] , it is obvious that almost all countries do have their own tax policy. On their tax policies these countries in corporate taxation system. Therefore, when one wants to introduce dividend imputation or any other types of taxation system, first he/she has to check the corporate taxation issues on the tax policy of that country. Accordingly the introduction of dividend imputation should based on the evaluation of the following points:
Defining the existing corporate taxation system of a given country,
Defining classical system of corporate taxation,
Defining the newly introduced taxation system (dividend imputation),
Analysing the business nature of the country (tax base of the country, i.e. corporated or uncorporated),
Balancing competing interest,
Implement expected or dividend imputation system, and
Amendment of existing tax policy.
Defining the existing corporate taxation system
Defining the existing corporate taxation system is used to know more about that taxation system of that country. Based on this analysis, one can distinguish that the existed corporate taxation is efficient, neutral, simple and equitable.
The existing corporate taxation system of Ethiopia is typically categorized under classical system of corporate taxation. Because, in Income Tax Proclamation no. 286/2002 of the country under its Article 19 sub 1, taxable business income of bodies is taxable at the rate of 30% and under Article 34 sub 1 regarding dividend taxation, every person deriving income from dividends from a share company or withdrawals of profits from a private limited company shall be subjected to tax at the rate of 30% [8] . This is good indicator of double taxation regime.
Defining the Classical System of Corporate Taxation
Classical system of corporate taxation is a system that companies paid company tax on their earnings and after tax earnings were then available for dividend declarations. On this declared dividend shareholders paid personal income tax on any dividends received by them, despite the fact that the companies paying them had already paid tax on the underling profits [9] . Normally under classical corporate taxation taxes are imposed according to a person's ability to pay the tax (maintaining equity), but classical taxation system favour one tax payer sole proprietor over corporated tax payers, and it is an efficient tax system, and easy to manage and harvest substantial amount of revenue.
However, there are some short comings of classical corporate taxation system, of which the following are listed as follows:
Discourage business from incorporating and hence from taking advantages of benefits,
Encourage companies to finance their projects by using debt rather than equity finance,
Encourage company to retain as equity earnings rather than distributing them to its shareholders,
Reduce incentive to invest and may therefore inhibit grow, and
Reduce foreign direct capital investment (when dividend rate is relatively high).
Defining the newly introduced (dividend imputation) corporate taxation system and its merits and demerits
As defined in literature review of dividend imputation, it is a form of equalization tax, since the tax paid by the corporation is credited against the tax liability of the shareholders. As a result of this it eliminates double taxation of distributed profits of a corporation.
Major merits of dividend imputation system
It avoids double taxation
It promotes foreign direct capital investment
It maintains horizontal equity
Major demerits of dividend imputation system
It minimizes revenue
Analysing the business nature of the country (tax base of the country i.e corporated or uncorporated)
This stage helps to choose and implement classical or dividend imputation system. If the tax base of a given country is mainly based on non corporated individual income tax, for the time being the issue of choosing classical or imputation system is not valid. Where as, if the country's tax base is dominantly based on corporated firms, the issue of choosing classical or dividend imputation system will be mandatory. Since, classical and/or dividend imputations are applying only on corporate firms.
At this stage one has to analyse critically advantages and disadvantages of both classical and dividend imputation based on tangible and sufficient statistical data. Based on this analysis one can say application of classical system of corporate taxation system is good or bad and, at the same time application of dividend imputation favours the country than classical corporate taxation. As a result, if the tax base of the country is mainly based on corporated firms and at the same time relay on foreign direct investment no doubt that introduction of dividend imputation is valid. Where as if the country's tax base is dominantly depend on uncorporated individual tax payers, except that favouring foreign direct investment introduction of dividend imputation system is not as such important issue.
Balancing competing interest
Once the analysis under stage 4 shows that the existing corporate taxation has to be changed or replaced by new taxation (dividend imputation), the government or tax authority should communicate the concerned parties about the change and its importance.
This stage helps to collect valuable comments about the change and shows the tax authority's transparency on any tax change issues. In addition to this, it gives chance for tax authority to announce the introduction of dividend imputation and its importance.
Implement expected or dividend imputation system
This stage is the stage where all the necessary procedures and manuals are prepared as how to administered the newly introduced dividend imputation system. It could include communicating the tax administrative staffs giving trainings, etc. and finally implementing the dividend imputation.
Amend the tax policy (if necessary)
When we implement new taxation system in a given country's taxation system no doubt that the existing policy of the taxation system has to be changed accordingly.
Conclusion
As per my opinion Ethiopian classical corporate taxation system seems ideal due to three reasons:
The tax base of the country is not based on corporated firms,
Existing tax rate (company 30% and dividend 10%) is not higher rate as compared to other countries, and
Government is favouring foreign direct investment by giving tax holidays up to 6 years. As a result, country should not introduce dividend imputation.
