How Much Does It Cost to Distribute Dividends for Income Tax Purposes, and Why Can the Tax Cost Reach 40%?
Dividend distributions have a tax cost that is not limited to the 7% tax applicable to certain dividends. In fact, determining the overall tax burden also requires considering the Income Tax paid by the company on its profits.
In a recent article published by iProfesional, journalist Dolores Olveira explains, based on comments from Carlos Fernández, Tax Director at Fidem Partners, how this cost is calculated and what effective tax rates may result from combining both levels of taxation.
How Much Income Tax Is Paid on Dividends?
The Argentine Income Tax Law establishes a 7% tax rate on certain dividends, including those distributed to individuals who are residents of Argentina and to certain nonresident beneficiaries.
However, this 7% rate does not, by itself, represent the total tax cost of distributing profits.
Before reaching the shareholder, the profits were earned by a company that is also subject to Income Tax.
Therefore, to calculate the overall impact, it is necessary to consider:
- The Income Tax assessed on the company.
- The tax applicable to the dividends distributed.
- The corporate tax rate applicable in each case.
How Is the Total Tax Cost Calculated?
For corporations, the general Income Tax rates established under the applicable regime are 25%, 30%, and 35%, depending on the level of taxable income.
When these rates are combined with the 7% rate applicable to dividends, the resulting combined effective tax rates are:
| Corporate Tax Rate | Dividend Tax Rate | Combined Effective Tax Rate |
|---|---|---|
|
25%
|
7% |
30,25% |
|
30% |
7%
|
34,90%
|
|
35%
|
7%
|
39,55% |
These percentages result from taking into account the corporate tax and, subsequently, the 7% tax applied to the amount remaining available for distribution.
A Simple Example
- If a company earns $100 in profit before taxes and is subject to a 35% tax rate, it will owe: $100 × 35% = $35
- After Income Tax, the amount remaining is: $100 – $35 = $65
- If those $65 are distributed as dividends and the 7% withholding tax applies: $65 × 7% = $4.55
- The total tax burden will therefore be: $35 + $4.55 = $39.55
- On the initial $100, the combined tax burden represents 39.55%.
What Happens When Shareholders Want to Receive the Dividend Net of Taxes?
There is also a situation that can increase the tax cost.
In certain cases, shareholders may seek to receive an amount net of taxes, meaning that the amount agreed upon as a dividend reaches the shareholder in full.
In that scenario, the company must take the effect of the withholding tax into account when determining how much it must distribute so that the shareholder receives the intended net amount.
As Carlos Fernández explains in iProfesional, in these cases the effective tax rate on dividends may increase to 7.53%, thereby increasing the total tax cost of the distribution.
How Are Dividends Treated Under the RIGI?
The Incentive Regime for Large Investments (RIGI) establishes specific tax treatment.
According to Fernández, companies that have joined the regime are subject to a single 25% Income Tax rate.
With respect to dividends, the rate is 7% during the first years and, seven years after joining the RIGI, is reduced to 3.5%.
In this way, the regime establishes a tax structure that differs from the general regime for companies and projects that meet the requirements to join the RIGI.
Why Is It Important to Consider the Total Tax Cost?
The analysis of a dividend distribution should not be limited to considering the 7% withholding tax.
The tax cost should be analyzed on an integrated basis, considering first the company’s taxation and then the taxation applicable to the distribution.
As Carlos Fernández points out, with corporate tax rates of 25%, 30%, and 35%, the combined tax burden may range from 30.25% to 39.55%.
Consequently, the amount ultimately received by the shareholder may be significantly lower than the profit originally generated by the company, depending on the applicable tax rate and the conditions of the distribution.
Conclusion
The tax cost of distributing dividends in Argentina requires jointly analyzing the company’s Income Tax and the taxation applicable to dividends.
With a corporate tax rate of 25%, 30%, or 35% and a 7% tax rate on dividends, the combined effective tax rates are 30.25%, 34.90%, and 39.55%, respectively.
Companies subject to the RIGI have specific tax treatment, with a 25% Income Tax rate and a reduction in the dividend tax rate to 3.5% after seven years from joining the regime, subject to the conditions established under the applicable rules.
Therefore, before approving and making dividends available for distribution, it is necessary to consider the total tax cost of the distribution and not only the withholding tax applicable to the shareholder.
Article Information and Sources
Original source: iProfesional
Journalist: Dolores Olveira
Specialist consulted: Carlos Fernández, Tax Director at Fidem Partners.
At Fidem, we work alongside companies throughout their growth, financial planning, and strategic structuring processes.
