Introduction
1.1 Overview
This study attempts to explore the impact of taxes on the dividend policy of banks in the Nigerian financial system. Dividend policy is the exchange between retaining earnings and paying out cash or issuing new shares to shareholders; it varies from one corporate organization to the other depending on various factors. One of such factors that have been identified is taxation- taxes the corporate organization must pay over to government from their profitability either directly (as tax on the corporation itself − corporate tax) or indirectly (as withholding tax on dividends paid out to shareholders).
Corporate tax is paid directly on profit made, whether or not the company pays dividends to its shareholders and, in Nigeria, it is at the rate of 30% on taxable profits. Another such tax paid by the corporation in Nigeria, on profit made, is Education tax, which is 2% of taxable profits. Since such taxes are paid before profit available for possible dividend payment is known they reduce the amount of profit available for dividend payment.
The indirect (withholding or dividend tax) is that levied by government on the proportion of profit paid out to shareholders as dividends; it is levied at the rate of 10% of the amount so paid out. This is normally in addition to the taxes on profit and is therefore sometimes referred to as a phenomenon of “double taxation”; intending to mean that company owners have paid tax twice on their earnings from the business − first, through tax on profit made and secondly, through dividend tax. Consequently, it becomes obvious that taxes are important to investors and may impact on the dividend policy to be adopted. This study attempts to study the level of such impact.
Debates have been carried out by scholars on the impact of taxes on dividends and corporate financial policies for decades and many of these debates have generated a lot of controversies regarding the actual relationship between taxes and dividend policies. This, in turn, has attracted much of academic interests, consequent upon the need to settle the related controversies. The debate over the importance of dividend policy was first started by Miller and Modigliani (1961), who suggested that both firm financing and dividend policy were irrelevant for firm investment decisions and independent of the value of the firm.
Financial theorists such as Brennan(1970), Masulis and Trueman (1988) have stipulated that taxes affect organizational corporate dividend policy. If this theory were true, then changes in dividend payout of the company would be anticipated every time the government changes its income tax policy. However, this does not always happen, especially in the banking business. Lintner (1956) asserted that the major determinants of dividend policy are the anticipated level of future earnings and the pattern of past dividends. This discrepancy may have underpinned M & M (1961) theory, which consequently provided a platform for the enormous debates and researches on dividend policy. It is worthy to mention that attention has been seriously focused on tax in these debates.
Tax is a compulsory levy imposed by government on the incomes of individuals and corporate organizations for the performance of its duties of social welfare. It is a levy imposed by the government against the income, profit or wealth of the individual, partnership and corporate organization (Ochiogu, 2001). Every corporate organization is therefore expected to pay taxes as one of its responsibilities to the society.
Dividend policy, on the other hand, forms a major financial decision often faced by management of corporate organizations in their pursuit of maximizing the value of their organization. It allocates the company’s earnings between payment to shareholders and reinvestment in the firm. Dividends are usually paid to owners or shareholders of a business at specific periods and it depends largely on the declared earnings of the firm and the recommendations of the directors. Therefore, if no profit is made dividends will not be declared. But when profits are made the company is obligated to pay corporate tax and other statutory taxes to the government; the taxes reduce profit available for distribution/allocation by the organization.
For several years, many postulations and assumptions have been made regarding whether such taxes paid by organizations actually affect a firm’s pattern of dividend policy, as already pointed out earlier. Although dividends affect the shareholders’ tax liability, it does not in general alter the taxes that must be paid regardless of whether or not the company distributes or retains its profit (Brealey, Myers and Marcus, 1999). Conscious of these postulations and assumptions surrounding dividend policy and all the associated controversies, this study is directed at evaluating the impact of taxes on the dividend policy of banks in Nigeria. The banking sector is of interest in this research because of the structure of its dividends. A couple of similar studies have been carried out in Nigeria but with approach different from what will be adopted in this study.
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