Corporation Income Tax Structure in Developing Countries
Author: George E. Lent

The basic approaches to the taxation of corporate profits by developing countries are modeled on those of developed countries, and are subject to evaluation on similar grounds. As is true of industrial countries, the issues involved have never been satisfactorily resolved, and shifts continue to be made from one system to another. There is, therefore, an abundance of experience with different forms of corporation tax, even within particular countries, and a voluminous literature exists on the comparative merits and limitations of each.1 Differences in the economic environment and in the relationships between shareholders and corporations in different stages of economic development, however, call for a re-examination of the tax treatment of corporations that is most appropriate for developing countries.


The basic approaches to the taxation of corporate profits by developing countries are modeled on those of developed countries, and are subject to evaluation on similar grounds. As is true of industrial countries, the issues involved have never been satisfactorily resolved, and shifts continue to be made from one system to another. There is, therefore, an abundance of experience with different forms of corporation tax, even within particular countries, and a voluminous literature exists on the comparative merits and limitations of each.1 Differences in the economic environment and in the relationships between shareholders and corporations in different stages of economic development, however, call for a re-examination of the tax treatment of corporations that is most appropriate for developing countries.

The basic approaches to the taxation of corporate profits by developing countries are modeled on those of developed countries, and are subject to evaluation on similar grounds. As is true of industrial countries, the issues involved have never been satisfactorily resolved, and shifts continue to be made from one system to another. There is, therefore, an abundance of experience with different forms of corporation tax, even within particular countries, and a voluminous literature exists on the comparative merits and limitations of each.1 Differences in the economic environment and in the relationships between shareholders and corporations in different stages of economic development, however, call for a re-examination of the tax treatment of corporations that is most appropriate for developing countries.

This paper appraises the variety of approaches to the taxation of corporations in developing countries from the standpoints of their effects on resource allocation, equity, and administration. It considers not only the modalities of the corporation tax and the treatment of dividend income but also the tax rate structure, the discrimination between different forms of business organization, and the discrimination between foreign and domestic shareholders.2

I. Factors Influencing Corporation Tax Policy

The formulation of corporation tax policy for developing countries must take into account their essential differences from industrial countries in economic, legal, and social structures. Among developing countries, there are wide differences that reflect their relative stages of economic and social development.

From the standpoint of corporation tax policy, perhaps the most striking distinctions are the relative scarcity of capital that characterizes most developing countries and the critical role played by the corporation in mobilizing capital for investment. As a result, most of these countries depend on the attraction of capital from abroad. As capital importing countries, their corporation tax policy is greatly influenced by the tax treatment of earnings by the creditor countries to which they are remitted.

The internal capital markets of developing countries are either nonexistent or relatively unorganized, so that the mobility of capital is limited.3 The corporations themselves are a major source of capital for new investment, and cash flow attributable to depreciation allowances and earnings provides substantial funds for new development. These factors also influence the form of the corporation tax, as well as that of special provisions to promote domestic savings and wider public ownership of corporations.

Although the corporate sectors of developing countries are often characterized by foreign ownership and control, resident companies generally are small-scale enterprises controlled by local family interests. The tax treatment of locally-owned resident companies may be shaped by considerations that do not apply to foreign-owned or publicly-owned corporations; this sometimes leads to various forms of discrimination based on size and ownership.

The taxation of corporate income cannot be considered apart from the entire income tax complex of a country—taxation of shareholders at home and abroad; taxation of proprietorships and partnerships; tax treatment of capital gains and other forms of income (such as interest); and, indeed, taxation of capital (especially net wealth). In a neutral tax system, income from all these sources would be treated equally. Such an idealized system, however, has never been instituted.4 Recognition of the corporation as a taxable entity separate from its shareholders poses practical and political obstacles to the realization of such an objective. As a result, the problems of reconciling the corporation tax with the taxation of dividends and other sources of income that have challenged tax experts for decades remain unsettled.

II. Variations in Corporation Tax Structure

The basic problems of taxing the corporation stem from its recognition as a juridical person, separate from its shareholders. Corporation tax structures vary basically according to their treatment of distributions to shareholders—that is, according to whether, and by what method, the tax on dividends is integrated with that on corporate income. The Appendix classifies the corporation tax structure and summarizes the tax rates of 80 representative developing countries.

separate entity systems

As in the case of other taxes, the corporation tax structure originally adopted by most developing countries replicated that of the colonial power under whose influence they came. Perhaps the most commonly accepted form employed in continental Europe had its origins in the schedular system of taxing different classes of income at different proportional rates.5 This is the prototype of the so-called classical system of treating the corporation as a separate entity according to the business income schedule; shareholders are taxed independently on their income from “movable property,” that is, from shares. This system was introduced early, not only in the French colonies of West Africa, Equatorial Africa, North Africa, and Indochina but also in Belgian and Dutch colonies throughout the world (for example, the Congo—now Zaire—and Indonesia). With few exceptions, this system has been preserved in francophone countries, notwithstanding France’s income tax reforms of 1948 and 1966 that substantially modified the traditional form of the corporation tax. In addition, a number of countries in South America (for example, Argentina, Brazil, Chile, Colombia, Peru, and Venezuela) apparently have followed the continental precedent.

Through a succession of reforms, the United States has departed from its original concept of the corporation tax, adopted in 1913, that provided for coordination with the personal income tax. Its basically “classical” system has served as a model for several developing countries (for example, Bolivia and the Philippines). More recently, other developing countries, such as Kenya, Tanzania, Uganda, and Zambia, have converted from integrated tax systems that originally followed the British colonial model to systems that treat the corporation as a separate taxable entity.6

In the classical model, shareholders are taxed separately on dividends received, and usually no provision is made to reduce the individual income tax on earnings distributed. Many countries, however, treat the juridical person (that is, the corporation) as they do the natural person, and do not levy a separate tax on dividends. The graduated tax scales of Central American and Middle Eastern countries are the best-known examples of this practice. A few countries, including Colombia and Thailand, provide for partial exemption of dividends, while others, such as Oman and Saudi Arabia, do not have a conventional personal income tax. Uruguay has abolished the personal income tax, but it does withhold tax on distributions of earnings to residents and nonresidents.

integrated systems

As distinguished from the classical system that follows the original continental model, there are two accepted systems that integrate the corporation tax with the personal income tax on dividends. Integration may be accomplished at either the corporate or the shareholder level. The former, known as a split-rate system, taxes distributed earnings at a lower rate than retained earnings.7 Integration at the shareholder level is accomplished by what is known as the imputation method. An undistributed profits tax is the ultimate form of the split-rate system; it provides a deduction from corporate earnings for dividends paid, leaving only retained earnings chargeable to tax. Shareholders are taxed on dividends received, with distributions abroad subject to a withholding tax; nonresident corporations, including foreign branches, usually are subject to the standard corporation tax rate on their declared earnings. This system is now in effect in only a few countries: Afghanistan, Ecuador, Egypt, Greece, and Mauritius. Iraq also has an undistributed profits tax, although resident shareholders are not subject to tax on dividends. Other countries (for example, Rhodesia and Uruguay) that once employed undistributed profits taxes have converted to other forms.

The imputation system, similar to the traditional form employed by the United Kingdom prior to 1965,8 provides for a basic tax rate on corporate income that is credited, in whole or in part, to shareholders on dividends received; resident shareholders are required to include in their taxable income cash dividends received, grossed up by the amount of corporation tax applicable, and are entitled to deduct the tax withheld from their income tax liability. This system, known as the withholding method, was incorporated in the British colonial Model Income Tax Ordinance of 1922 and was introduced in many colonies, several of which have retained it with little or no modification after gaining independence (for example, Cyprus, Ghana, Malaysia, Nigeria, Sierra Leone, and Singapore). Other countries have either replaced this form with a separate corporation tax (for example, India, Kenya, Zambia, Tanzania, and Uganda) or have supplemented it by a separate profits tax (for example, Barbados, Guyana, Jamaica, Malaysia, and Trinidad and Tobago). Such a hybrid corporation tax structure is referred to as a partial imputation system.9

III. Discrimination Between Distributed and Undistributed Earnings

The central issue in the taxation of corporations arises over the tax treatment of corporate distributions. If the corporation is taxed as a separate (juridical) person, it is held that further taxation of dividends results in double taxation, unless this is avoided by providing for integration of the two separate taxes. Because such double taxation of dividends discriminates against this source of income and is claimed to have undesirable effects, both on the grounds of equity and economic efficiency, it is necessary to assess the alternative corporation tax structures from these points of view in formulating tax policy.

equity considerations

Both the full imputation and the undistributed profits tax (split-rate) are intended to improve the horizontal and vertical equity of the tax system. By avoiding so-called economic double taxation of distributed earnings, the tax on dividends is brought into alignment with the tax on other returns to capital such as interest, and the tax is distributed progressively, in accordance with ability to pay. These systems make it possible, by full distribution of earnings, to attain complete neutrality in the taxation of corporate earnings.

Table 1 illustrates the comparative marginal tax burden on companies and shareholders under the three different systems, assuming a corporation tax rate of 40 per cent and marginal personal income tax rates ranging from 15 per cent to 65 per cent. It is clear that the combined marginal tax rate on companies and shareholders in different tax brackets varies with the proportion of earnings distributed: with no distribution, the rate remains the same on shareholders in all three systems; with 50 per cent distribution, the combined marginal rate ranges from 44.5 per cent to 59.5 per cent under the separate entity system, as against 27.5 per cent to 52.5 per cent under both the imputation and undistributed profits tax systems. With full distribution, it can be seen that the marginal tax rates under the integrated systems correspond to the personal income tax rate schedule, as against a much higher double tax on the company and its shareholders under a separate entity system. The differential is greatest—34 percentage points—in the lower tax brackets; it declines—to a minimum of 14 percentage points—as the size of personal taxable income increases. Because of the 40 per cent corporate rate, the effective tax burden of the separate entity system, assuming full distribution of earnings, ranges from more than 200 per cent higher for a shareholder in the low-income brackets, to only 21 per cent higher in the highest income bracket, than it would be under integrated systems.

Table 1.

Combined Effective Tax Rates on Companies and Individuals Under Separate Entity, Full Imputation, and Undistributed Profits Tax Systems, with Different Distribution and Marginal Personal Tax Rates

(Percentage of taxable earnings)

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It may be neither feasible nor advantageous to distribute corporate earnings so as to realize the neutrality objective. If the corporation tax rate is below the marginal tax rate of the controlling shareholders, they would be subject to additional tax on distributed income. This situation might inhibit dividend payments, and the corporation tax burden would approach that existing under a separate system of corporation tax. However, because integrated systems eliminate so-called economic double taxation of dividends, the corporation tax rate would have to be somewhat higher than the rate prevailing under a separate entity system if the same total revenue is to be realized. (See the remarks on incentive effects at the end of Section III.) The opportunity for avoiding the personal income tax would thereby be reduced under either the full imputation system or the undistributed profits tax, and equity would be improved.

On the other hand, the economic double taxation of dividends is rationalized by some who believe that “unearned” income is properly more heavily taxable than “earned” income, such as wages and salaries. This view, traditionally held in Colombia, was one consideration that militated against reform of its separate corporation tax.10 Some support for heavier taxation on returns to capital can also be found in the inducement that may thereby be given to more labor-intensive methods of production in order to promote employment.11 However, such policy runs the risk of deterring new investment.

implications of incidence of corporation tax

The above observations must be qualified by the assumptions that the incidence of the corporation tax rests on the shareholders—that is, on capital—and that it is shifted neither backward to labor through lower wages nor forward to consumers through higher prices. The opportunities for short-run shifting in developing countries are somewhat circumscribed. In most developing countries there is a limited market, with manufacturers usually protected by tariff rates that tend to set a ceiling on prices; moreover, government price controls are frequently operative. Firms producing for export markets are constrained in their pricing by world prices. Still other local industries—banks, service companies, marketing companies, hotels, etc.—may operate under competitive conditions. Therefore, if a corporation tax were introduced, the tax would tend to rest on the corporation in the short run. But the diversity of economic conditions and institutional factors in developing countries makes it impossible to generalize about the final resting place of the corporation tax.

In promoting new enterprises and planning for expansion, the corporation tax is taken into account as a factor of cost, so that the target rate of return on capital, after tax, equals at least the opportunity cost of capital. This would be true especially of open economies, where foreign investors seek a return on investment comparable with that available in alternative situations. In the long run, therefore, the corporation tax tends to be shifted either to labor through lower wages or to consumers through higher prices of goods, or to both. If this, indeed, is the case, there is no economic double taxation of dividends, and provision for shareholder relief from the tax on dividends is not warranted on equity grounds. Because of the lack of empirical evidence, and because of likely variations in the experience of different industries in different countries, this hypothesis provides a rather uncertain basis for corporation tax policy.

As in industrial countries, the weight of expert opinion on the incidence of the corporation tax in developing countries is inconclusive. Bird believes that oligopolistic conditions favor the shifting of corporation taxes in Colombia.12 The Colombian Commission on Tax Reform, in rejecting integration of corporation and personal taxes, concluded that there was too much uncertainty about the incidence of the corporation tax to justify this step.13 Several statistical analyses of the corporation tax in India have yielded conflicting results.14 Lall concluded that the corporation tax was shifted back to labor; Ambirajan’s study indicated that it may not have been shifted at all since 1951; Laumas’ analysis showed that the tax was more than fully shifted to consumers between 1951 and 1962; and Gandhi concluded that the corporation tax was not shifted during the same period, but fell essentially on capital, reducing either dividends or retained earnings.

If the corporation tax in developing countries does not rest on capital in the long run, equity purposes are not served by its integration with the individual income tax. If it is shifted forward to consumers through higher prices—the most likely outcome—the tax is equivalent to an indirect tax on consumption, and there is equity justification for separate taxation of dividends. A serious question of tax equity might therefore be raised about the exclusion of dividends from the individual income tax, as practiced by many countries. (See Appendix, section II.) Discrimination is not so evident in countries with no personal income taxes; however, some of these countries have a corporation income tax (for example, Oman and Saudi Arabia) but do not tax the income of unincorporated businesses.

allocative considerations

Corporation tax policy plays an important role in the savings and investment decisions of shareholders. Not only does the rate of corporation tax (and the conceptual basis of taxable earnings) determine the availability of earnings for new investment, but the tax treatment of dividends may also influence the amount of earnings retained for investment. In this respect the separate (double) taxation of dividends is generally believed to encourage the retention of earnings and thereby to enhance savings and investment, while an integrated tax system—whether of the imputation or the split-rate form—tends to encourage distribution.

Separate taxation of dividends places a premium on retention of earnings that varies directly with the (marginal) rate of personal income tax that is applicable to shareholders. Under integrated systems, however, there is a tax advantage in retaining earnings only if the corporation tax rate is lower than the marginal personal income tax rate. To minimize the taxes of a closely held corporation, distributions would be made only to the level at which these two rates are equivalent for the major shareholders.

Needless to say, the minimization of income taxes is only one of many factors influencing dividend policy, and it is substantially limited to companies whose ownership is closely identified with control. Cash distributions also depend on corporate liquidity and access to alternative sources of financing working capital and new investment. On the other hand, especially for publicly held companies, it may be necessary to satisfy shareholders’ expectations of a reasonable yield on their investment, and thereby attract capital for expansion by means of new stock issues. In order to maximize shareholders’ after-tax income, management has a greater obligation under integrated systems to distribute, rather than to retain, earnings.

There is virtually no empirical evidence on the effects of different corporation tax regimes on dividend policy in developing countries.15 These effects would be extremely difficult to establish on an aggregate basis because of the different tax treatment of dividends paid to non-resident and domestic shareholders, especially when there is substantial foreign ownership. Imputation does not normally apply to nonresidents, and special withholding taxes are usually levied on distributions abroad under both separate entity systems and undistributed profits taxes. Mauritius, for example, taxes only the undistributed income of resident companies, while it taxes the entire income of foreign companies (that is, companies whose control and management is exercised outside Mauritius), both at a standard 45 per cent rate.

Neither the imputation system of Malaysia nor that of Singapore appears to have discouraged the retention of profits. In 1964, dividends and interest payments amounted to only about 17 per cent of corporate profits assessed in the former, and about 25 per cent in the latter.16 If accurate, this rate of distribution is comparable to the 17 per cent of earnings distributed in cash by 658 nonfinancial corporations in 1959 under Argentina’s (then) separate entity system,17 and is even less than the 26-28 per cent payout ratio estimated under Kenya’s former imputation system.18 These data are in sharp contrast to Colombia’s experience with its separate corporate tax over the period 1956-59, when between 45 per cent and 50 per cent of all corporate after-tax profits was distributed.19 The distribution rate of 54 nonfinancial corporations listed on the stock exchange was even higher, averaging over 70 per cent.20 Although the above data are fragmentary, they raise doubts about claims that separate taxation of corporations and shareholders encourages the retention of earnings. One possible explanation is the comparative importance of foreign ownership: because of political uncertainties and the lack of viable domestic investment opportunities, earnings may be repatriated rather than reinvested.

It should be observed that retention of earnings by no means assures their optimum investment. Expansion of an existing business may, in fact, divert resources from other more urgent investment requirements for new industries promising higher rates of return. If there is an efficient capital market, shareholders may seek out investment opportunities (for distributed earnings) that are more profitable than those provided by the corporation. However, relatively few developing countries have organized stock markets to facilitate the mobilization of capital. Many, indeed, have few local investors; corporations, including subsidiaries of multinational corporations, are owned and controlled predominantly by foreign residents.21

On the other hand, it may be argued that corporate retention of earnings maximizes the total savings of the country. Dividends to resident investors are spent partly on consumption and, if they are saved, may be invested abroad. Distributions to nonresident investors are a net loss to the economy. Since investment in an open economy is influenced principally by the comparative profitability of economic opportunities in that country and abroad, differences in corporate tax structure would appear to have only a marginal effect on domestic savings. The effects would be somewhat greater in a closed economy. If the capital market is sufficiently well developed and the economy is expanding, much can be said for a tax policy that encourages distribution, rather than reinvestment, of earnings.

incentive effects

The rate of income tax paid by the corporation probably is more important to the investment decision than the combined tax burden of the corporation and its shareholders. Whether or not the corporation tax is creditable, in whole or in part, to shareholders, the prospective return on capital after the payment of corporation income taxes is a decisive factor in evaluating investment in a new venture or expansion of an existing enterprise; the lower the tax rate is, the shorter the capital recovery period will be, and the lower will be the risk of undertaking the investment. From the standpoint of the foreign investor—other factors being the same—a country with a low corporate tax rate offers a more attractive long-range prospect for investment than a country with a high rate.

In this respect, a separate corporation tax structure normally has an advantage over an integrated tax structure that yields an equivalent amount of revenue. Since the tax collected from its shareholders is additional to that charged the corporation, a lower corporate rate is indicated. The corporation tax rate for a separate entity system that will yield the same amount of revenue as an imputation system in a particular country depends on the proportion of earnings distributed under each system and the comparative tax rates on earnings distributed abroad. Assuming that the same amount of earnings is retained under each system, it can be seen that the separate entity system tax rate would be substantially below that called for by an imputation system. If, for example, a typical 40 per cent rate applied by developing countries under an imputation system were replaced by a separate corporation tax, and the same amount of earnings were retained under both systems, the rate could be reduced to, say, 24 per cent.22 If greater earnings were retained as a result of separate taxation, the corporate tax rate would have to be higher to compensate for the loss of personal income tax revenue. These rates assume that all shareholders are resident individuals. If corporations were owned by nonresidents who were not entitled to a tax credit, withholding rates would have to be 40 per cent to yield the same revenues as an imputation system with a 40 per cent rate.23

Notwithstanding these revenue implications, Barbados and Zambia retained the same corporation tax rate—40 per cent—when they eliminated the credit for corporation tax; the 45 per cent corporation tax rates in Kenya and Uganda and the 50 per cent rate in Tanzania are now higher than the rate (40 per cent) under their previous imputation systems. These shifts in corporation tax policy appear to have been decided principally on revenue grounds.

The dilemma of the corporation tax has been resolved in several industrial countries by a compromise system of partial integration. Both Belgium and France allow a tax credit to resident shareholders, the former at 45 per cent of the net dividend and the latter at one half of the corporate rate; the United Kingdom provides a credit equal to three sevenths of the corporate tax; and Canada allows a credit of one third of the corporate tax.24 The Federal Republic of Germany, which has long followed a split-rate approach, has recently (1977) carried it to the limits of an undistributed profits tax by crediting resident shareholders with the tax on dividends. Japan’s tax rate on distributed earnings is three quarters of the rate on retained earnings. Other industrial countries, however, continue with the classical system, with various modifications. It is possible that the recent declaration by the Commission of the European Communities in favor of the partial imputation system will induce other countries to follow. The directive proposed for adoption by the Communities provides for a tax credit for dividends ranging between 45 and 55 per cent of the normal corporation tax.25

IV. Discrimination Between Small (Private) and Large (Public) Companies

compensating tax measures

As was indicated above, shareholders of closely held companies may control the distribution of earnings so as to minimize their tax liabilities. Many countries have enacted supplementary taxes on earnings that are retained by private companies seeking to avoid personal income taxes. Different standards and techniques have been adopted, some depending on whether the earnings were retained for necessary business reasons, and others depending on the ratio of retained earnings to earnings after tax or on the ratio of earnings to business capital. A favorite device is that found in the British Model Income Tax Ordinance of 1922, which empowered the Commissioner of Revenue to assess additional tax on the incomes of closely held corporations that he determined were retained to avoid personal income tax. Because of the difficulty of ascertaining the financial requirements of a business for working capital and expansion, and of proving the owners’ motives for retaining income, such a determination is subject to taxpayers’ disputes and litigation.

Some countries set an arbitrary limit on the proportion of earnings that can be retained without a tax penalty. In East Africa, for example, companies that distributed less than a specified percentage of earnings were assessable unless they showed a need to retain a greater proportion for working capital or expansion needs.26 These rules were not codified but were agreed with the Association of Accountants in East Africa. A similar device was used to supplement Malawi’s imputation taxes until 1968. Malawi’s maximum personal income tax rate of 60 per cent took effect at a chargeable income level of only 6,500 kwacha, so that many shareholders gained considerable advantage by retaining earnings rather than taking the benefit of the credit for the company tax of 37.5 per cent on dividends. A penalty rate of 22.5 per cent on retained earnings in excess of one third of net profits after tax was intended to equalize these rates. Partly because of the authority of the Finance Minister to adjust undistributed profits for approved investment, however, the penalty tax appears to have had little effect on corporate distributions.27 Even so, by setting standards for retained earnings, however arbitrary they may be, the burden of proof of retention for legitimate business needs is placed on the company and the administrative burden is eased.

Other countries have imposed a surtax on all undistributed earnings of closely held companies, whether or not these earnings are reinvested. Following the Australian example, Papua New Guinea’s income tax law provides for such a tax on retained earnings of “private” companies (companies owned by not more than 20 persons, or controlled by not more than 7 persons). But because virtually all companies have been owned by nonresidents, who are not subject to Papua New Guinea’s personal income tax, no purpose would be served by such a tax, and it has not been implemented.

Another form of penalty tax on retained earnings was introduced in 1962 by the Republic of China. This imposes an additional tax, at the corporation tax rate, on the amount of earnings retained if the accumulated amount of retained earnings (earned surplus) exceeds 25 per cent of the book value of the capital stock, after providing for income tax and certain legal reserves amounting to 10 per cent of income. The tax is payable by the shareholders. In lieu of cash dividends, corporations may declare dividends in stock that are taxable in the hands of the shareholders, and in this way avoid the penalty tax on the earnings retained. In practice, cash dividends declared are usually sufficient to cover the shareholders’ tax liabilities on stock dividends. This technique more fully exposes shareholders to tax on corporate earnings “excessively” retained without unduly sacrificing corporate funds that may be needed for investment.

graduated tax rates

Many developing countries with separate entity systems graduate their corporation tax rates according to the size of the firm’s taxable income. The principal exceptions appear to be the francophone countries, the countries of East and Central Africa, Argentina, Brazil, Chile, and Colombia. Several countries with imputation systems also provide reduced tax rates for low-income companies.

Because companies are generally owned by more than one person, and since the shareholders are in different income groups, graduated corporation tax rates cannot be justified on the same grounds (i.e., ability to pay) as graduated personal income tax rates. Many countries, nevertheless, have adopted rate schedules that parallel those applicable to personal incomes. This is especially true of countries that do not include dividends in personal taxable income—for example, Costa Rica, Honduras, Guatemala, Iraq, Jordan, Nepal, Nicaragua, Panama, and Sudan.

Graduated income tax rates on companies are designed in part to improve the neutrality of income taxes among different forms of business—corporations, partnerships, and proprietorships—and thereby provide tax relief to small businesses. While discrimination cannot be avoided, undue tax disparities will influence the form of organization adopted, taking into account the comparative nontax benefits of the corporate form, such as limited liability, transferability of ownership, and delegation of management. In many countries it would appear that the maximum rate is aimed at large, foreign-owned companies; indeed, special high rates are often imposed on mining and petroleum companies and on other extractive industries. The lower rates generally favor locally-owned businesses.

There is less need for graduated rates under a full imputation system than under a separate entity system. This is because of the opportunity afforded shareholders to recoup income tax assessed on the corporation by distributing its earnings. A few countries, however, provide tax relief for small businesses, including Cyprus, Ghana, and Nigeria. As was noted above, cash distributions may be constrained by a lack of liquidity. For this reason, it might be feasible to provide for a system of deemed distributions under which shareholders of small companies could claim a tax credit for dividends declared by unanimous consent but evidenced only by scrip. Alternatively, when there is a tax advantage, small corporations could declare cash dividends and subscriptions to new shares of stock simultaneously.

One objection raised to graduated company rates is the opportunity these provide for avoidance of income tax through multiple incorporation. Rather than operate as a single consolidated business, it may be expedient to incorporate separate branches, each of which enjoys the benefit of lower rates. While separate incorporation of distinctly different businesses operated by a family or individual can be justified where it is important to insulate the risks, safeguards should be erected against tax avoidance. This could be accomplished by requiring the consolidation of tax returns for all related businesses controlled by the same shareholders.28

preferential rates for public companies

Several developing countries have sought to promote the development of capital markets through public ownership of businesses by granting preferential tax treatment to public, or open, companies. Rate reductions are offered generally under two conditions: (1) that the stock of the company is widely distributed, and (2) that the shares are quoted on the stock exchange and/or their turnover during the year is above a specified minimum.

One of the more interesting examples is found in Korea, which has the following rate schedules for closely held companies and for open companies meeting certain requirements:

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In order to qualify as an open company, a firm’s shares must be listed on the stock exchange; at least 30 per cent of the shares must be held by 200 or more minority shareholders, no one of which holds more than 3 per cent; the two major shareholders combined may not own more than 51 per cent of the outstanding stock; and transfers over the year must amount to at least 0.2 per cent of the average monthly shares issued. In addition to the benefit of a lower corporate tax rate, minority shareholders are exempt from dividends tax, while major shareholders are subject to a withholding rate of 5 per cent instead of the standard 20 per cent.

Argentina, Brazil, Colombia, Cyprus, and Thailand also provide tax incentives to encourage the development of capital markets. Brazil exempts qualified open companies from the 5 per cent tax on distributed income; Cyprus taxes certain open companies at a reduced rate of 25 per cent, as against 42.5 per cent for close companies, for a period of seven years from the date they are registered (effective after January 1, 1975). Thailand provides a higher exemption for taxable dividends of open companies—B (baht) 10,000 and 30 per cent of the balance, as against the standard exemption of B 5,000 and 20 per cent of the balance.

Whether these tax concessions can be justified by the benefits to be derived from the development of a capital market depends largely on the revenue costs and the sacrifice of tax equity involved. Stock markets have evolved in a number of developing countries without such inducements (for example, in Malaysia/Singapore, in Hong Kong, and in several Latin American countries) because of the growth of wealth and investment opportunities; indeed, Brazil’s active stock market would seem to make any tax inducement redundant. The magnitude of the tax relief provided in Cyprus and Korea, however, implies potentially heavy costs in exchange for uncertain benefits, most of which are realized by those retaining a major interest in particular companies—up to 70 per cent in Korea and up to 80 per cent in Cyprus. By 1973, 79 open corporations had been formed in Korea; they accounted for about 13 per cent of adjusted corporate profits, but, because they were subject to lower tax rates, these firms contributed only 10 per cent of corporate tax revenue.29 Without taking into account the reduced tax on dividends, the revenue loss in 1973 is estimated at about 3 billion won, or 5 per cent of total corporation tax revenue.

V. Discrimination Between Corporations and Other Forms of Business30

Corporation tax policy should take into account the tax treatment of other forms of business enterprise. Sharp differences in the level of taxes between corporations and partnerships, for example, create inequities and encourage the adoption of the less efficient of the two business forms. Within practical limits, taxation should be neutral toward different forms of business organization.

the separate entity approach

The most serious problems of discrimination tend to arise with the separate entity approach. Discrimination is avoided, of course, if partnerships and corporations are treated comparably. This is usually the situation in countries that follow the schedular approach of taxing different sources of income at separate rates; in such cases, all business profits, regardless of the form of business in which they originate, are subject to the same rate schedule. Some countries that do not follow the schedular tradition also make no distinction between corporations and partnerships. This uniform treatment is found among the francophone countries of Africa and Indochina; in Indonesia, Korea, and (for registered partnerships) in Thailand; and in a number of Latin American countries including Bolivia, Costa Rica, Brazil, Mexico, Panama, and Venezuela.31 Partnership and corporation income that is distributed may or may not be subject to personal income tax; if this income is taxable, no credit is given for the income tax on the business.

Many developing countries do not levy a tax on partnerships as such; rather, partnership income is allocated to the partners and their income is made subject to personal income tax. This is the system generally followed by countries with a tradition of integrated taxes, such as the Commonwealth countries, Greece, and Turkey; it is also employed by many countries that have adopted separate corporation tax systems. When corporation tax rates are high and are not graduated, there is usually a tax advantage in using the partnership form of business, especially for small and medium-sized firms. One means of obtaining better parity between the two forms of business is the graduation of corporation tax rates, which was discussed earlier. While it is not possible to match corporation rates with those on individuals in comparable income classes, the rate disparities can be sufficiently mitigated under a graduated rate system to permit retention of the corporate form without the imposition of an undue tax penalty.

Greater neutrality in the taxation of corporations and partnerships can be achieved by giving corporations the option of being treated as partnerships. The United States has provided such an option for many years to business corporations with ten or fewer shareholders, provided that all shareholders consent and that less than 20 per cent of the firm’s gross income is passive (investment) income.32 Jamaica is one of the few developing countries that give a similar treatment to corporations, but the option is limited to low-income companies owned by five or fewer shareholders—so-called controlled companies. El Salvador has a similar provision for certain small companies.

A partnership option for corporations makes it possible for small businesses to enjoy the advantages of the corporate form without paying a tax penalty. However, such options may cause administrative problems, and there may be abuses arising from the dual treatment of an enterprise. This is especially true when a corporation changes its mode of treatment; among other problems, it changes the taxability of dividends and the basis for computing capital gains on the sale of stock. Moreover, unless minimum time limitations are imposed on the election, it would be possible for companies to manipulate taxes by shifting from one business form to the other, depending on their changing income and tax considerations.

integrated systems

The problems of reconciling integrated corporation tax systems with the taxation of partnerships are less serious than they are under separate entity systems because double taxation can be avoided by fully distributing earnings. Earnings are then taxable in the hands of the shareholders, as is true in the typical partnership situation. Lack of corporate liquidity, however, may preclude the distribution of earnings necessary for companies to realize any such tax advantage. One solution, suggested earlier, would be to permit dividends to be issued in scrip for tax purposes to enable the shareholders to be treated as partners without impairing corporate liquidity.

This latter suggestion bears a resemblance to the proposal of the Canadian Royal Commission on Taxation.33 The Royal Commission’s plan was intended to achieve neutrality between the tax on corporate income and taxes on all other sources of income, including partnership income. As is done under the full imputation method, shareholders would receive a credit for corporation tax allocable to dividends; in addition, they would be taxed on earnings deemed to be distributed, for which they would also receive a credit for the corporation tax. Shareholders would have the option of being taxed on all corporate earnings, whether distributed or not; but, unlike the option for small companies discussed above, this one would be available to all corporations regardless of size and would operate under a tax credit system, rather than a partnership method, with corporations paying the basic tax currently. In its original concept, the Canadian plan was envisaged as optional rather than mandatory. Its efficacy would depend on a corporation tax rate equivalent to the top personal income tax rate, so that it would generally be advantageous to shareholders for corporations to select the option. It could, however, be made mandatory.

Despite the attractions of such a system and its advocacy by many experts, no country has adopted it. One obstacle may be the drastic realignment of personal income tax rates that would be required in countries with highly progressive rates; these could be reduced only at the cost of revenue. Other objections can be raised on the grounds of equity and administration. If personal tax rates were not reduced to the level of corporation tax rates, an equity problem might arise with switches in ownership of stock being made during the year for the purpose of exploiting tax advantages; if undistributed earnings and allocable taxes were apportioned as of the end of the accounting period, low-income persons would benefit from tax refunds on stock purchased, and high-income individuals would avoid higher income taxes by selling stock. This situation would create great uncertainties in the stock market. There would be similar problems in the tax treatment of losses, including the possibility of tax refunds. Administrative difficulties would arise in dealing with additional assessments or refunds arising from the audit of tax returns, as shareholders affected would have to file amended returns—often several years after the original filing date.

VI. Discrimination Between Domestic and Foreign Shareholders

When dividends are subject to personal income taxation, a serious policy question arises over the tax treatment of earnings distributed to nonresidents. The problem requires examination not only of tax equity between foreign and domestic shareholders but also of the possible effects on economic development of the cumulative taxes on corporate profits and dividends. This question is closely involved with the tax treatment of dividends by the foreign shareholder’s country of residence, including measures for the avoidance of international double taxation of earnings.

distributions of resident companies

It is generally recognized that both the country of source and the shareholder’s country of residence have a jurisdictional right to tax dividends.34 The source country, of course, has the advantage in exercising this right, with the result that countries of residence are obliged either to waive the right to tax dividends or to provide for a credit or deduction of the foreign tax paid in the interest of avoiding excessive taxation. Indeed, some developing countries hold that, in principle, dividends should be taxed only by the source country; if, however, both groups of countries claim the right to tax, these developing countries insist that the shareholder’s home country should grant a full tax credit, regardless of the amount of foreign tax to be absorbed.35 While this is an extreme view, at least one industrial country—the Federal Republic of Germany—has departed from its general rule by exempting dividend income from companies in developing countries received by corporations owning 25 per cent or more of such a company’s equity investment. Other industrial countries, including France and the Netherlands, tax only income derived within the country.

Virtually all developing countries that tax dividends under a separate entity system levy a fixed rate of tax on the dividends paid abroad by resident corporations. This is withheld at the source at rates ranging between 10 per cent and 40 per cent; in most developing countries (about two thirds), withholding rates range between 10 and 20 per cent. Colombia and Mexico graduate the rate according to the size of the dividend paid—an unusual policy. Many countries reduce their withholding rates under double taxation treaties.

Most countries with a separate entity tax withhold tax on dividends paid to residents at the same rate they withhold tax on dividends paid to foreign shareholders. The tax withheld may either be credited against the resident shareholder’s personal income tax liability, or it may be the final tax liability, as in Costa Rica and Panama. A few countries, where dividends are subject to personal income tax, withhold tax on nonresidents, but not on residents (for example, Argentina, Bolivia, Chile, the Philippines, and Thailand).

On the other hand, a number of nations that do not tax dividends paid to residents nevertheless withhold tax on dividends paid to nonresidents (for example, Guatemala, Honduras, and Paraguay). This practice raises a question of discrimination that might be resolved by tax treaties with the capital exporting countries.

In contrast to countries with separate entity systems, those with full imputation systems do not impose a separate tax on dividends paid to nonresidents. Rather, the corporate tax itself is treated as a withholding tax and is creditable against the personal income tax payable by resident shareholders.36 This tax becomes the final tax liability of nonresident shareholders not subject to the source country’s personal income tax. In some Commonwealth countries, however, nonresident individuals have traditionally been permitted to file personal income tax returns limited to their dividend income from the source country, and to claim credit for the company tax that is allocable. There is no reciprocity under the recently adopted British imputation system, and some developing countries (for example, Barbados and Malawi) have rescinded their tax credit to nonresidents.

On the other hand, developing countries with an undistributed profits tax impose a compensatory tax on distributions to nonresidents. Otherwise, the source country might unduly sacrifice revenue that would, instead, accrue to the shareholder’s home country. Mauritius, for example, taxes the undistributed earnings of companies owned and controlled in Mauritius, but taxes the entire earnings of all “foreign” companies. Ecuador taxes the total income of nonresident companies at 44.4 per cent, as against a 33.3 per cent rate for the undistributed income of resident companies.

tax treatment of foreign branches

When a company doing business in a developing country is chartered and controlled abroad, it is not generally subject to the same tax rules that govern distributions of a resident company. While its income derived in the source country is fully taxable, remittances of that income to the home office do not legally represent dividends, and no attempt may be made to tax them as such. Indeed, the OECD Model Convention does not provide for a tax on distributions of branch profits.37

When branch earnings are remitted to the home office, it is difficult to enforce a tax on their distribution because of the problem of identifying the nature of the transfer. Such remittances may be disguised as repayments of home office advances or other payments. No similar problem arises under the full imputation system, since no separate tax on dividends is imposed.

Under a separate entity system, failure to tax distributions of branch earnings on a comparable basis with corporate dividends may unduly encourage the use of branches, rather than resident companies, to do business in developing countries. Many countries deal with the problem by imposing a presumptive dividend tax. According to this technique, the withholding tax rate is applied to a standard presumed distribution of branch earnings. This policy is commonly followed by the francophone countries in Africa. Benin, for example, in the absence of a tax treaty, presumes that 90 per cent of after-tax earnings is distributed; Zaire presumes a 50 per cent distribution. Other countries, including Brazil and Mexico, presume a distribution of 100 per cent. Panama imposes a dividend tax (10 per cent) on a presumed 100 per cent distribution of foreign branch income, as against a presumed 40 per cent minimum distribution by resident companies.38

Rather than impose a separate tax on distributions of foreign branches, many countries incorporate a compensating rate in the basic income tax—for example, Honduras, India, Peru, Tanzania, and Uganda. This consolidated rate generally presumes 100 per cent distribution of earnings.

equity and economic considerations

Dividend tax policy should be guided by considerations of equity as well as by its effects on investment in the source country. Tax equity calls for a tax on distributions that does not discriminate between foreign and domestic investors. This criterion is satisfied by a uniform withholding rate that is the final tax. But the criterion is not so easily satisfied when resident individuals are subject to tax on dividends at graduated personal income tax rates, against which the withholding rate may be credited. If, as is generally true, the tax on nonresidents does not exceed the average marginal rate paid by residents on their dividend income, there is no discrimination against foreign investors. But, as noted above, when tax is withheld on distributions abroad in the absence of a tax on dividends received by resident shareholders, a question of discrimination might arise.

A special question arises over the tax treatment of intercorporate distributions. Since resident companies generally are not subject to tax on dividends received from other domestic companies, it is sometimes argued that the country of source should not tax distributions to affiliated and other companies abroad. Indeed, the OECD Draft Double Taxation Convention on Income and Capital (Article 10) makes some concession to this principle in calling for a lower 5 per cent rate on distributions to foreign companies owning 25 per cent or more of a domestic company’s stock, as against a 15 per cent rate on all other dividends. Trinidad and Tobago, for example, observes this rule by withholding tax at 15 per cent on distributions to nonresident parent companies, as against 30 per cent on other dividends. On the other hand, it would seem to be the responsibility of the country of residence, rather than the source country, to exempt such income. This would be consistent with the generally observed principle of taxing dividends originating in the country of residence only when they are ultimately paid out to individual shareholders.39 Since the source country cannot expect to realize such future tax benefits from distributions made to foreign affiliated companies, it would appear appropriate for the source country to tax these earnings at the time they are remitted.

The major capital exporting countries unilaterally mitigate the double taxation of earnings remitted from abroad by allowing either a deduction of the tax or a tax credit.40 The tax credit may be limited to the tax on dividends (direct credit) or it may cover an indirect credit for corporation tax as well. Industrial countries usually negotiate special double taxation agreements with developing countries in which they have an important investment stake. These agreements generally reduce the developing country’s withholding tax rates applicable to dividends, interest, royalties, and other contractual payments in consideration of reciprocal tax concessions. They are an important instrument for achieving intercountry tax equity as well as relief from the burden of taxes on international capital flows.

In these circumstances, developing countries’ tax rates on corporate income and dividends are frequently influenced by corporation tax rates in the principal capital exporting countries, which set a ceiling on the size of the tax credit allowed, either unilaterally or by means of double taxation agreements. If the income taxes allocable to distributions abroad fall short of foreign residents’ income taxes allowable as a credit, an upward adjustment of the source country’s taxes to this limit would enable it to capture greater revenue without increasing the total tax burden on the enterprise. The higher tax rates on dividends paid abroad that are imposed by Argentina, Guatemala, and Honduras, and El Salvador’s high rate on foreign branches, might be explained by this strategy; nondiscriminatory rate adjustments in other countries are, of course, less obvious but are nevertheless implicit in the corporation tax adjustments of some developing countries.

Because of differences among industrial countries in their rates and in their techniques for eliminating or reducing double taxation, it is not possible to match the rates of more than one capital exporting country. But, because of commercial ties based on colonial experience or proximity, one country usually dominates trade: France in West Africa, the United Kingdom in parts of Africa and the Caribbean, the United States in Latin America, and Japan in Southeast Asia. Even so, tax rates and related tax provisions of industrial countries do change, and it is not feasible for the source country to achieve more than a rough equivalence in rates with these countries.

If a developing country desires to exploit the revenue potential implicit in the foreign tax credit of its principal supplier of capital, it has the option of adjusting either the corporate rate or the dividend withholding rate (including the tax on branch profits). Assuming the separate taxation of dividends, the most common situation, the best choice is to adjust the withholding rate on dividends rather than the corporate rate.41 A low corporate rate is more conducive to domestic investment, which might further benefit from whatever inducements a higher dividend tax provides for the retention of earnings. Moreover, some industrial countries provide for only a direct tax credit—that is, a credit for the tax on dividends—and do not credit the underlying corporation tax. This is especially true for individuals and for portfolio investments of corporations.

VII. Summary and Conclusions

The differences in economic and social conditions among developing countries call for a separate appraisal by each country of the comparative merits of the various corporation tax structures in terms of equity, economic efficiency, and administrative convenience. Tax policy in this respect tends to reflect the general scarcity of capital in developing countries and their dependence on foreign investment. Tax neutrality between different forms and sizes of business is also a consideration.

discrimination against dividend income

Basic corporation tax structures in developing countries take a variety of forms. Although the separate taxation of corporations and shareholders predominates, many countries either do not include dividends under the personal income tax or tax them at low withholding rates. A large number of countries avoid the economic double taxation of dividends, either at the shareholder level, by providing a credit for the corporation tax against personal income tax, or at the corporate level, by allowing a deduction from taxable income for dividends paid to resident shareholders. Unlike industrial countries, developing countries appear to be moving away from such integrated systems and toward mixed, or separate, tax systems.

For developing countries, there is no clear advantage of one system over another. Although equity considerations appear to favor methods that avoid economic double taxation of dividends, this would be true only if the incidence of the corporation tax were on capital; theory and the results of empirical studies are too uncertain, however, to provide a firm basis for a decision based on the incidence of the tax.

It is also frequently assumed that separate taxation of dividends causes corporations to minimize their distributions of earnings so as to enable their shareholders to avoid personal income taxes. There is, however, no clear evidence that retention of earnings under this system is any greater than it is under imputation or split-rate systems. Retention will largely depend on the extent of foreign ownership in a company, since nonresidents are usually unaffected by such differences in the treatment of dividends. Whether there is an economic advantage to the country in the distribution of earnings depends on the development of a capital market that will assist in channeling corporate savings into the most profitable fields of investment.

A separate entity system tax may have some desirable incentive effects in attracting new investment because the tax rate may be much lower than that of alternative integrated systems that raise an equivalent amount of revenue. However, if foreign ownership dominates, tax rate increases may be needed to compensate for taxes on earnings distributed abroad.

discrimination between small and large companies

A problem common to both developed and developing economies is the avoidance of personal income taxes through retention of corporate earnings. This is especially true of the separate taxation of corporations and shareholders. Different techniques have been employed to deal with this problem, but they encounter difficulties in penalizing tax avoidance without reducing legitimate reinvestment.

Graduated rates may serve a useful purpose in encouraging the development of small businesses. But they are inherently inequitable because they do not allocate taxes in accordance with the shareholder’s ability to pay; they also are subject to abuse and can lead to the splitting up of businesses into multiple corporations for purposes of tax avoidance. Such avoidance can be curbed, however, by requiring controlled companies to file consolidated returns.

Many developing countries provide tax incentives to encourage wider public ownership of corporations. Such discrimination between public and private companies may stimulate the development of a capital market in shares, but the public benefits must be carefully weighed against the private gains of corporate promoters, who generally enjoy the major tax benefits of these incentives without sacrificing control.

discrimination between the corporation and other forms of business

Tax neutrality between the corporation and other forms of business is difficult to achieve when different modalities are employed. It is not uncommon, however, to treat both corporations and partnerships as separate entities. While graduated corporate rates may be designed to achieve rough equivalence with individual income taxes on the separate shares of partners—a common approach—sharp tax differentials inevitably arise in many different circumstances. One partial solution, which is attempted in a few developing countries, is a partnership option for certain closely held companies.

Because of the possibility of avoiding economic double taxation under both the imputation and split-rate forms (undistributed profits tax) by distributing earnings, these systems are more compatible with the taxation of partnership shares. Even here, however, distribution of earnings might be inhibited by a lack of liquidity; scrip might be authorized in lieu of cash as a basis for assessing tax.

discrimination between resident and nonresident shareholders

Foreign branches and domestic firms are usually subject to the same corporation income taxes; discrimination might arise, however, between resident and nonresident shareholders because of different tax treatment of dividends. Although the right of the source country to tax distributions to nonresidents is generally accepted, it might be difficult, if not impossible, to achieve parity of treatment unless a flat withholding tax is imposed as the final tax liability. A problem arises in taxing the foreign branch earnings that are remitted abroad. Because such distributions are not legally dividends, and since the amount of earnings remitted can be concealed, many countries presume that an arbitrary percentage of earnings—frequently 100 per cent—is remitted.

When countries tax dividends received from abroad, double taxation of earnings is usually mitigated unilaterally by allowing shareholders either a deduction of the foreign tax or a tax credit. Double taxation treaties between industrial and developing countries further limit tax impediments to the flow of capital. When a developing country’s income taxes on earnings remitted abroad fall short of the credit allowable by the principal capital exporting country, it is possible for the developing country to exploit the tax revenue potential by an upward adjustment of rates. This can be done better through an adjustment of withholding taxes on dividends than through a higher corporate rate.


Table 2.

Taxes on Corporate Income and Distributions in Developing Countries

(In per cent)

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Sources: United Kingdom, Board of Inland Revenue, Overseas Tax Developments, Issue No. 4 (June 15, 1976); United Kingdom, Board of Inland Revenue, Income Taxes outside the United Kingdom (London, 1966-); African Tax Systems (Amsterdam, International Bureau of Fiscal Documentation, 1971-); Corporate Taxation in Latin America (Amsterdam, International Bureau of Fiscal Documentation, 1971-); Walter H. Diamond, Foreign Tax and Trade Briefs (New York, 1965-); and various government documents.

Mr. Lent recently retired from the Fund as Senior Advisor in the Fiscal Affairs Department. He has been on the faculties of the University of North Carolina and Dartmouth College. He has served as an assistant director of the tax analysis staff, U. S. Treasury Department, and as Consultant to the Organization of American States.


See, for example, Richard Goode, The Corporation Income Tax (New York, 1951); Charles E. McLure, Jr., “Integration of the Personal and Corporate Income Taxes,” Harvard Law Review, Vol. 88 (January 1975), pp. 532-82; Mitsuo Sato and Richard M. Bird, “International Aspects of the Taxation of Corporations and Shareholders,” Staff Papers, Vol. 22 (July 1975), pp. 384-455; William J. Byrne and Mitsuo Sato, “The Domestic Consequences of Alternative Systems of Corporate Taxation,” Public Finance Quarterly, Vol. 4 (July 1976), pp. 259-84.


The various forms of tax relief to promote investment are discussed elsewhere. See George E. Lent, ‘Tax Incentives for Investment in Developing Countries,” Staff Papers, Vol. 14 (July 1967), pp. 249-323.


See U Tun Wai and Hugh T. Patrick, “Stock and Bond Issues and Capital Markets in Less Developed Countries,” Staff Papers, Vol. 20 (July 1973), pp. 253-302.


Perhaps its best approximation is the model proposed by the Canadian Royal Commission on Taxation, which, however, has not been adopted by the Canadian Government. The proposed system is basically structured on the partnership principle. The corporation would be taxed at the maximum rate applicable to individuals, say 50 per cent, and shareholders taxed both on actual dividends and retained earnings allocated to them. Both actual and deemed dividends would be grossed up by the amount of the corporation tax and a credit would be given to shareholders against their income tax liabilities, with refunds of credits in excess of their liabilities. Canada, Report of the Royal Commission on Taxation, Vol. 4 (Ottawa, 1966), pp. 3-98.


The basic schedules (cédules) in France covered income from (1) real property, (2) dividends and interest, (3) business, (4) farming, (5) wages and salaries, and (6) noncommercial activity. Each schedule had its own rate and special rules for determining income. Harvard University Law School, Taxation in France (Chicago, 1966), p. 88. Some developing countries have elaborated the schedules; Venezuela, for example, has employed as many as nine different schedules.


Barbados (1975) and Trinidad and Tobago (1966) also abandoned similar integrated systems in favor of the separate entity approach, but, after a brief experience with it, they both adopted partial integration (imputation) systems.


Prior to 1977, for example, the Federal Republic of Germany taxed undistributed income at 52.23 per cent and distributed income at 15.45 per cent. If a German company distributed its entire income, the effective tax rate was 24.55 per cent because the income retained to pay tax was taxed at the retention rate. Germany has combined a split-rate system with a partial imputation system. Undistributed profits are taxed at 56 per cent and dividends at 36 per cent, the latter tax being allowed as a credit to domestic shareholders.


It remained in a pure form until 1937, when it was supplemented by a separate corporation tax; imputation was repealed in 1965 and reintroduced in 1972. In its original concept, the corporation tax was equivalent to the standard rate charged individuals; accordingly, dividends were subject only to surtax.


Guyana, for example, has company tax rates of 45 per cent to 55 per cent, of which 20 percentage points are creditable against tax paid on dividends. Malaysia has a corporation tax rate of 40 per cent which is fully creditable, plus a noncreditable corporation rate of 5 per cent.


Colombian Commission on Tax Reform, Fiscal Reform for Colombia, ed. by Malcolm Gillis (Cambridge, Massachusetts, Harvard University Law School, 1971), p. 81.


See George E. Lent, “Tax Policy for the Utilization of Labor and Capital in Latin America,” Rivista di Diritto Finanziario e Scienza delle Finanze, Vol. 33 (March 1974), pp. 3-23.


Richard M. Bird, Taxation and Development: Lessons from Colombian Experience (Harvard University Press, 1970), p. 82.


Colombian Commission on Tax Reform, Fiscal Reform for Colombia (cited in footnote 10), p. 81. Richard Slitor, in a staff report, was of the opinion that the economic situation in Colombia with respect to incidence was too confused to warrant integration on equity grounds; see p. 499.


For a summary of the conclusions of these analyses, see Ved P. Gandhi, Some Aspects of India’s Tax Structure (Bombay, 1970), pp. 68-89.


Nor has econometric analysis reached any firm conclusions in the industrial countries. See Byrne and Sato (cited in footnote 1), p. 267.


Clive T. Edwards, Public Finances in Malaysia and Singapore (Australian National University Press, 1970), p. 100.


Banco Central de la República Argentina, Inversiones y Fuentes de Recursos Balances Agregados y Resultados de un Conjunto de Sociedades Anónimas Nacionales, años 1955-59 (Buenos Aires, 1961).


Data supplied by East African Statistical Department, plus data contained in East African Community, East African Income Tax Department, Report, 1967/68, 1970/71.


Joint Tax Program of the Organization of American States and the Inter-American Development Bank, Fiscal Survey of Colombia (Johns Hopkins University Press, 1965), p. 246.


Ibid., p. 256.


Over 95 per cent of Papua New Guinea’s corporate equity is owned abroad, mostly by Australian investors.


This assumes the following: (1) retained earnings, and therefore taxable dividends (including the grossed-up dividends under the imputation system) are the same under each system; and (2) all shareholders are residents in the country. Assuming an average marginal personal income tax rate of 50 per cent and a dividend of 40 cents per share, the separate tax system with a 24 per cent rate would yield 44 cents on a dollar of corporate income, equivalent to that yielded under imputation: 40 cents plus 20 cents tax on dividends ($0.40 × 0.50) less 16 cents tax credit ($0.40 × 0.40). In other terms, the rate of a separate corporation tax yielding the same total income tax revenue as an imputation system is equal to the tax rate of the latter multiplied by the percentage of earnings retained.


Forty cents in dividends at a rate of 40 per cent equals 16 cents personal income tax on the dollar, plus 24 cents corporation tax equals 40 cents—the same amount yielded by a 40 per cent imputation tax with no separate dividend withholding.


Organization for Economic Cooperation and Development, Company Tax Systems in OECD Member Countries (Paris, 1973), pp. 9-11.


Commission of the European Communities, Proposal for a Directive of the Council Concerning the Harmonization of Systems of Company Taxation and of Withholding Taxes on Dividends (Brussels, July 23, 1975). Also see European Taxation, Vol. 15 (July 1975), p. 251.


Companies with small incomes and companies that distributed at least 70 per cent of trading income, 89 per cent of professional earnings, and 100 per cent of investment income were excluded from review.


Nineteen companies were charged penalty tax amounting to MK (Malawi kwacha) 13,851 in 1965, against MK 617,514 corporation tax. Malawi, Department of Taxes, Income Tax Statistics (Blantyre, 1967).


Section 1562 of the U. S. Internal Revenue Code allows only one $25,000 surtax exemption to each group of controlled companies; control is evidenced by 80 per cent ownership of the voting stock.


Republic of Korea, Office of National Tax Administration, Statistical Yearbook of National Tax, 1974, pp. 70-73.


It would go beyond the scope of this study to discuss the minimum taxes on corporations that are levied by all former French West African countries and a few other countries, including Sierra Leone. There are several varieties: (I) fixed amounts (Ivory Coast, Senegal), (2) low percentage rates on turnover (mostly 1 per cent), or (3) the greater of (1) and (2). This tax is generally credited against income tax based on accounting net income but frequently exceeds that, and is chargeable even if there is a statutory net deficit. Since similar taxes are rarely imposed on unincorporated businesses, these minimum taxes are inherently discriminatory.


See Mitsuo Sato, “The Tax Treatment of Partnerships” (unpublished, International Monetary Fund, May 1, 1973), pp. 34-40.


In 1971 these small (Subchapter s) corporations filed 15.6 per cent of all corporations’ returns but accounted for only 3.4 per cent of all corporate taxable income. Internal Revenue Service, Statistics of Income—1971, Corporation Income Tax Returns (U. S. Government Printing Office, Washington, D.C., 1976), pp. 108-109.


See footnote 4. The U. S. Treasury Department recently proposed a plan that would extend the effect of Subchapter S (Partnership Treatment of Closely Held Corporations) to all corporations. U. S. Treasury Department, Blueprints for Basic Tax Reform (Washington, 1977).


United Nations, Department of Economic and Social Affairs, Tax Treaties Between Developed and Developing Countries, Fourth Report (New York, 1973), pp. 16-17. See also Richard A. Musgrave and Peggy B. Musgrave, “Inter-nation Equity,” in Modern Fiscal Issues: Essays in Honor of Carl S. Shoup, ed. by Richard M. Bird and John G. Head (University of Toronto Press, 1972), pp. 68-69.


United Nations, Department of Economic and Social Affairs (cited in footnote 34), First Report (New York, 1969), p. 21.


Where there is a mixed system, however, as in Barbados, Jamaica, and Trinidad and Tobago, a separate withholding tax may be imposed.


Organization for Economic Cooperation and Development, Fiscal Committee, Draft Double Taxation Convention on Income and Capital (Paris, 1963). It is of interest that, in the absence of a treaty, the United States withholds tax at a 30 per cent rate on dividends paid abroad, but does not tax distributions of foreign branch profits.


This 40 per cent presumed distribution rate conforms to the average percentage of earnings distributed by U. S. manufacturing subsidiaries in developing countries between 1963 and 1967. United Nations, Department of Economic and Social Affairs, United States Income Taxation of Private Investments in Developing Countries (New York, 1970), p. 130.


This principle is only partially observed by the United States, which grants corporations a deduction equal to 85 per cent of dividends received from domestic corporations which were subject to income tax. See U. S. Internal Revenue Code, Sections 243-46.


Industrial countries generally tax branch profits currently, but defer tax on subsidiaries’ profits until the income is received. The Federal Republic of Germany, Japan, Sweden, the United Kingdom, and the United States allow resident corporations a credit for foreign income taxes, limited to the tax otherwise payable in the country of residence on the foreign income, before tax. The Federal Republic of Germany exempts dividends received from developing countries by firms owning 25 per cent or more of the equity. France exempts foreign branch income and substantially exempts (95 per cent) dividend income. The Netherlands also exempts foreign income derived from foreign branches and subsidiaries. Belgium and Italy provide partial exemptions and deductions, and Switzerland also allows a partial exemption.


Peggy B. Musgrave, “International Tax Differentials for Multinational Corporations: Equity and Efficiency Considerations,” in The Impact of Multinational Corporations on Development and on International Relations (United Nations, 1974), p. 55.

IMF Staff papers: Volume 24 No. 3
Author: International Monetary Fund. Research Dept.