Taxing dividends twice

Imagine a business group that has built profitable companies, paid corporate tax, listed a subsidiary and generated earnings for reinvestment. Yet when those earnings move from one company in the group to another, the taxman appears again, as if the same rupee has become new income merely by changing hands.

In a country starved of investment and desperate for deeper capital markets, that is a self-inflicted wound.

The issue is simple in concept but serious in its consequences. A subsidiary earns profits and pays corporate tax. It then distributes part of those after-tax profits to its parent company, where dividend tax is imposed.

When the parent later passes that income on to shareholders, there may be yet another dividend levy. Thus, the same stream of earnings is taxed repeatedly before it reaches its final destination. This raises the cost of moving capital to where it is most useful, discourages internal allocation of resources and turns the tax system into an obstacle to investment rather than a neutral collector of revenue.

In practice, it penalises groups that want to reinvest profits efficiently across businesses, even when that reinvestment would support growth, jobs and productivity.

That is why the tax relief for inter-corporate dividends introduced in 2007, and which remained in force for nine years, made economic sense.

When holding companies can receive dividends from subsidiaries without another tax bite, they can channel capital into expansion, acquisitions and new ventures with less friction. This is not a loophole; it is recognition that the underlying profits have already been taxed at the operating-company level.

Pakistan does not merely need more investment; it needs larger, better-governed businesses, deeper pools of patient capital and broader public participation in growth. Most mature tax systems recognise this principle in one form or another: income should not be taxed repeatedly inside the same corporate chain before it reaches the ultimate owner.

Yet in Pakistan this sensible treatment was withdrawn, restored and then withdrawn again, leaving policy uncertain and investors guessing. That stop-start approach carries a cost of its own.

Businesses make long-term decisions about structure, listing, financing and expansion. If tax treatment changes unpredictably, firms become more conservative, groups hold excess cash, and potentially productive investment is delayed.

The case for reform, however, cannot be made in a vacuum. Critics worry that a blanket concession for intra-group dividends could concentrate economic power in a few hands without broadening public participation or improving governance.

In an economy where ownership is often narrow and capital markets remain shallow, any tax preference that simply reinforces closed corporate pyramids would be hard to defend.

However, real that concern may be, it does not justify bad tax policy. Distortionary taxation is a poor substitute for competition policy, securities regulation and disclosure rules. If the state wants more competition, more transparency and more participation by outside investors, it should design rules to achieve those aims directly rather than taxing the same income again and again and hoping for a better result.

Good policy should separate two questions that are often muddled together: whether inter-corporate dividends should be neutral within a group, and under what conditions a group should qualify for that neutrality.

The sensible course is therefore not a blanket giveaway, but a carefully targeted restoration of tax neutrality for eligible corporate groups under strict conditions. If a parent company is to receive dividends from a subsidiary without another layer of tax, both entities should be listed and both should maintain a meaningful free float in the hands of independent public investors.

The thresholds should be clear, measurable and difficult to manipulate. Related-party holdings should not be counted toward public float, disclosure should be robust, and any structure created merely to game the rules should be disqualified outright.

Regulators could also require a minimum holding period and full transparency on intra-group flows so that the concession supports genuine capital allocation rather than short-term tax arbitrage. Such an approach would align the tax benefit with broader policy goals: firms that accept market discipline, publish better information, and share ownership more widely would receive neutral tax treatment on internal dividend flows. Reform, if it is to endure, must come with guardrails.

Pakistan should not make it harder for businesses to deploy capital efficiently at a time when investment is scarce, confidence is fragile and formal markets need to deepen rather than shrink. Nor should it grant tax concessions without asking what the public receives in return.

The right answer is a conditional exemption for intra-group dividends, one that rewards listing, strengthens public ownership, improves disclosure and deepens market discipline.

Properly designed, such a reform would do more than remove a technical flaw in the tax code and align it with global practice. It would encourage firms to organise capital more efficiently, support expansion into productive sectors and create stronger incentives for businesses to come to the market rather than remain private and opaque. This may seem a narrow matter of tax law, but it speaks to a larger choice about the kind of economy Pakistan wants to build.

A country that needs investment should not tax reinvestment into submission, and a state that wants broader, more transparent capitalism should use the tax code to encourage that outcome, not frustrate it.

Copyright Business Recorder, 2026