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Chapter One Introduction 1.1 Background to the Study Companies Income Tax (CITA) refers to tax payable on profits of a company accruing in, derived from, brought into or received in Nigeria (section 9 of CITA), it also known simply as corporate tax which is tax payable on the profits of incorporated entities in Nigeria. It also includes the tax on the profits of non-resident companies carrying on business in Nigeria. The tax is paid by limited liability companies inclusive of the public limited liability companies. It is therefore commonly referred to as corporate tax. CIT was created by the Companies Income Tax Act (CITA) 1979 and has its root from the Income Tax Management Act of 1961. It is one of the taxes administered and collected by the Federal Inland Revenue Service (‘FIRS’ or ‘the Service’). The tax contributes significantly to the revenue profile of the Service. In 2016, the revenue target for Companies Income Tax is N1.877 trillion representing approximately 40% of the total projected tax revenue of N4.957 trillion for the year. In filing for Companies Income Tax, audited financial statement are statutorily required. This necessitates the engagement of External Auditors to prepare and/or certify the accounts to be submitted. The returns should mandatorily be accompanied by the tax computations and capital allowances computations on qualifying assets of the company. The requirement for filing does not discriminate between small, medium or large taxpayers. The rate of CIT is 30%. This is applied on total profits of the taxpayer. However, minimum tax may be payable by a company making losses depending on the age of the company, industry and equity funding. The Withholding Taxes that were deducted and paid on behalf of the taxpayers are allowed as offset from the computed tax liability. Withholding Taxes in excess of the tax liability is carried forward for future utilisation. However, the taxpayer has the option of refund of the excess Withholding Tax on application to the Service. This study attempts to explore the impact of corporate taxes on the dividend policy of banks in the Nigerian financial system. Dividend policy is the set of guidelines a company uses to decide how much of its retained earnings it will pay out to shareholders or it 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- 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. Dividend policy is the core component of a firm’s overall financial policy. It is comprised of a series of decisions regarding how the firms distribute profits to their shareholders and it mostly includes basic contents about the selection of dividend policy, dividend payout ratio and payout channel etc. Since the dividend policy determines whether distribute the earnings to shareholders or self-finance through retained earnings, so it is an important issue that receives more attention these days from both academics and practitioners. Corporate income tax is one of the major sources of revenue to all governments. In Nigeria, it is a factor to be reckoned with in Federal Government’s budget. The taxes so collected come back to the taxpayers in form of services and to either encourage or discourage some activities in the private sector; though, this depends on whether the policy of the government is towards discouraging or encouraging such companies (Ola, 2016). A lot of controversies regarding taxes and dividend policy have attracted many academic interests. The debate over the importance of dividend policy was first sparked in Miller and Modigliani (2011), which suggested that both firm financing and dividend policy was irrelevant for firm investment decisions and independent of the value of the firm (Elston, 2016). Financial theorists such as Brennan (2012), Masulis and Trueman (2017) have stipulated that taxes affect organizational corporate dividend policy. If this speculation were true, changes in corporate dividend payout would be expected whenever the government changes its income tax policy (Wu, 2016). However, this does not always apply especially in the banking business. Lintner (2015) had asserted that the major determinants of dividend policy are the anticipated level of future earnings and the pattern of past dividend. This discrepancy may have underpinned Modigliani and Miller (2016) theory, which provided a platform for the enormous debates and researches on dividend policy. The financial sector is of interest in this research because of the structure of its dividend as revealed in the study. Dividends are usually paid to owners or shareholders of business at specific periods. This is apparently based on the declared earning of the company and the recommendations made by its directors. Thus, if there are no profits made, dividends are not declared. But when profits are made, the company is obligated to pay corporate tax including other statutory taxes to the government. This is an essential corporate responsibility particularly of profit making companies. The taxes no doubt reduce the profits available at the disposal of the organisations, either to be retained or distributed as a dividend to shareholders of the company. Dividend policy is the trade-off between retaining earning and paying out cash or issuing new shares to shareholders. Some firms may have low dividend payout because management is optimistic about the firm’s future and therefore wishes to retain their earnings for further expansion. Frankfurter and Wood (2017) indicate, dividend pattern of a firm is a cultural phenomenon that changes continuously in relation to environment and time. It is hard to deny that taxes are important to investors. Although, dividend affects the shareholders tax liability, it does not in general alter the taxes that must be paid regardless of whether the company distributes or retains its profit (Brealey, Myers and Marcus, 2011). Taxation is not a new word in Nigeria or the world as a whole. In Nigeria, taxation has been in existence even before the coming of the colonial men or the British. Taxation can be defined as the system of imposing a compulsory levy on all income, goods, services and properties of individuals, partnership, trustees, executorships and companies by the government (Yunusa, 2003). Anyafo (2015) defined taxation as a compulsory payment made by individuals and organization to relevant Inland Revenue authorities at the federal, state or local government level. Tobansi-Ochiogu (2016) sees taxation as a levy imposed by the government against the income, profit or wealth of the individual, partnership, corporate organization. Ola (2016) defined taxation as compulsory levy imposed on a subject or upon his property by the government to provide security, social amenities and create conditions for the economic well-being of the society. Tax is not an assessment of benefits. It is a means of distributing the burden of the cost of government (Jones, 2017). This study shall be directed at evaluating the effects of company income taxes on the dividend policy of financial institutions in Nigeria. 1.2 Statement of the Problem Dividends are typically paid to owners or shareholders of company at specific periods. This appears based on the declared earning of the company and the suggestion made by its management. If the company made no profit, then dividends cannot be declared, but when company makes profit, it is the responsibility of management to pay corporate taxes with other legal taxes to the government. The taxes no doubt decrease the profits of the business; as such, they retain and distribute it as a dividend to shareholders of the company. The objective of this study is to evaluate the effect of company income taxes on dividend policy in the banking sector of Nigeria. 1.3 Objective of the Study The following objectives were developed to guide the study: 1 To examine the impact of company income tax on retention policy of Banks in Nigeria. 2. To examine the effect of company income tax on dividend payout ratio of banks in Nigeria. 3. To examine the effects of company income tax on the bonus issue of banks in Nigeria. 1. Research Questions The following research questions were developed to guide the study 1. What is the impact of company income tax on retention policy of Banks in Nigeria? 2. What is the effect of company income tax on dividend payout ratio of banks in Nigeria? 3. What is the effect of company income tax on the bonus issue of banks in Nigeria? 1.5 Hypothesis The following hypothesis was developed to guide the study: 1. There is no significant impact of company income tax on retention policy of Banks in Nigeria 2. There is no significant impact of company income tax on the dividend payout ratio of banks in Nigeria. 3. There is no significant impact of company income tax on the bonus issue of banks in Nigeria. 1.6 Significance of Study Every research work is expected to be significant in a variety of ways. This one is not an exception. The value attached to decisions involving dividend policy of banks cannot be over emphasized. Therefore, management of banks need this information to harmonise the general direction of the firm with a view to achieving the short and long term objective of the firm with regards to dividend payment. In essence, this study adds to the knowledge of managers on the tax measures and their effect on dividend pay-out (policy), of firms. This study is also significant in the following ways: 1. It helps to determine whether taxes are necessary in the development of dividend policy of a firm. 2. It helps to enhance decision making with regards to how much of the firm’s earning should be distributed or paid out and retained in the firm. 3. It indicates the method to be adopted in computing the dividend payout ratio. Finally, his study contributes to the existing stock of knowledge on the concept of the effect of taxes on dividend policy and will, therefore, serve as a data base for those seeking empirical information on the impact of taxes on dividend pay-out banks in Nigeria. 1.7 Operationalization of the study The study will work with two variable, which are; “Company income tax” and “dividend policies in banks”. In this study, company income tax being the independent variable is considered to be the tax payable by a company according to their annual revenue and the dividend policies of banks maintains the dependent variable, which is the policies implemented by banks for shareholders and subscribers to benefit in some stated percentages or special services from their patronage. Where: Y=f(x) Y=(Y1,Y2,Y3) X=(X1) Y= Dependent variable X=Independent variable Y=Dividend policy Y1=Retention ratio(RR) Y2=Payout ratio(PR) Y3=Bonus issue(BI) X=Companies income tax(CIT) RR=(CIT)………..(1) PR=(CIT)………..(2) BI=(CIT)………….(3) 1.8 Scope of the Study This study has a very wide scope: it is covers all banks in Nigeria but, to carry out a realistic study on all these banks is a difficult task, unrealistic time consuming and would involve enormous resources financially. Thus, this study is restricted to First City Monument Bank of Nigeria (FCMB). All inference and deductions are based on the study of these selected banks and conclusions drawn there from. 1.9 Definition of Terms: