Nbaa C4 Public Finance and Taxation Ii

C4
PUBLIC FINANCE AND

TAXATION II
STUDY TEXT
NBAA
Edition 1, Version 1
ISBN No 978-9976-78-076-5
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FOREWORD
The National Board of Accountants and Auditors in Tanzania is a professional body in Tanzania, established
under the Auditors and Accountancy Registration Act No 33 of 1972 as amended by Act No 2 of 1995. The
Board has been charged among other things, the responsibility to promote, develop and regulate the accounting
profession in the country.
In fulfilling its role, NBAA has revised its national accountancy examination scheme and syllabi for students
aspiring to sit for Accounting Technician and Professional Examinations. For effective implementation of these
syllabi and improve examination results, the Board has prepared study materials for all subjects to assist both
examination candidates and trainers in the course of learning and teaching respectively.
The study guides have been prepared in the form of text books with examples and questions to enable the user
to have comprehensive understanding of the topics. The study guides cover the wide range of the topics in the
syllabi and adequately cover the most comprehensive and complete knowledge base that is required by a
leaner to pass the examinations.
These study guides for each subject from ATEC I to final Professional Level will ensure that learners
understand all important concepts, know all the workload involved and provide practice they need to do before
examinations. The guides have right amount of information with plain language -easy-to-understand, plenty of
practice exercises and sample examination questions which are set in a competence based approach.
Competency based study guides have been developed aiming at developing a competent workforce. The
guides emphasize on what the individual can do in a workplace after completing a period of training. The
training programme therefore is directly related to the expectations of the employer.
These study guides which have been developed under competence based approach are characterized by the
following features:-
1. Focus on outcome – The outcomes shown in every topic are relevant to employment industry
2. Greater workplace relevance – the guides emphasize on the importance of applying knowledge to the tasks
to be performed at a workplace. This is different from traditional training where the concern has been
expressed that theoretical or book knowledge is often emphasized at the expense of the ability to perform
the job.
3. Assessments as judgments of competence – The assessment will take into consideration the knowledge,
skills and attitudes acquired and the actual performance of the competency.
Study guides are also useful to trainers specifically those who are teaching in the review classes preparing
leaners to sit for the professional examinations. They will make use of these study guides together with their
additional learning materials from other sources in ensuring that the learners are getting sufficient knowledge
and skills not only to enable them pass examinations but make them competent enough to perform effectively in
their respectively workplace.
NBAA believes that these standard study guides are about assisting candidates to acquire skills and knowledge
so they are able to perform a task to a specified standards. The outcomes to be achieved are clearly stated so
that learners know exactly what they have to be able to do, and on the other hand trainers know what training is
to be provided and organizations as well know the skills level acquired by their expected accountants.
The unique approach used in the development of these study guides will inspire the learners especially Board’s
examination candidates to acquire the knowledge and skills they need in their respective examinations and
become competent professional accountants in the labor market thereafter.
Pius A. Maneno
Executive Director
C4 – Public Finance and Taxation II
About the paper i - viii
Section A Public finance

1. Introduction to public finance and the role of the public sector 1 - 12
2. Public sector and the National Economic Accounts 13 - 22
3. Public expenditure policy 23 - 40
4. Government budget 41 - 48
Section B Taxation - theory and policy

1. Theoretical concepts of taxation 49 - 68
2. Theories of tax distribution 69 - 76
3. Approaches to tax equity 77 - 82
4. Tax and expenditure incidence: concepts and principles 83 - 92
5. Taxation and economic efficiency 93 - 100
6. Tax policy concepts 101 - 110
Section C Tax law and practice

1. Basic provisions of the income tax act (an over view) 111 - 172
2. Taxation of non-residents, investment and holding companies 173 - 186
3. Taxation of multinational corporations 187 - 196
4. Double taxation treaties 197 - 202
5. Taxation of specialised industries 203 - 222
6. Settlement of tax disputes 223 - 230
7. Recent reforms in the Tanzanian taxation system 231 - 234
Index 1 - 4
Total Page Count: 246
DETAILED SYLLABUS
STUDY GUIDE
A Public finance
1. Introduction to public finance and the role of the public sector
a) Explain the nature of public finance.

b) Explain nature of the public sector and different levels of government.
c) Discuss the rationale for government intervention in the economy.
d) Discuss the economic functions of the government (allocation function, distribution function and stabilization
function).
2. Public sector and the national economic accounts
a) Describe the role of the public sector in the circular flow of income and expenditure.
b) Analyse the national income accounts.
c) Identify the role of the government in GNP and NI.
3. Public expenditure policy
a) Describe the institutions and instruments involved in implementation of expenditure policy (executive,
parliament audit).
b) Analyse the classification of government expenditure.
c) Identify the principles of assigning expenditure across different levels of government.
d) Examine factors affecting size and growth public expenditure.
e) Apply the decision rules in project evaluation under different budget scenarios (budget size fixed, budget
size variable, lumpy projects).
4. Government budget
a) Compare and contrast the different budget policies (balanced, deficit, surplus budgeting).
b) Discuss the approaches to financing of government budget deficit.
B Taxation - theory and policy
1. Theoretical concepts of taxation
a) Explain the nature and essence of taxation.

b) Identify the factors distinguishing a tax from other sources of government revenue.
c) Discuss the approaches to classification of taxes.
d) Evaluate the requirements of “a good” tax system.
e) Explain “optimal taxation” theory.
2. Theories of tax distribution
a) Explain the benefits theory.

b) Explain the sacrifices theory.
c) Explain the ability to pay theory.
3. Approaches to tax equity
a) Assess the application of the Benefit Principle.

b) Assess application of the ability to pay principle (horizontal equity and vertical equity).
4. Tax and expenditure incidence: concepts and principles
a) Explain the nature of tax burden.

b) Differentiate the concepts of incidence (statutory incidence, economic incidence, tax shifting; and
absolute/differential incidence).
c) Differentiate between specific taxes and ad valorem taxes.
d) Apply principles of incidence in competitive markets.
e) Apply principles of incidence in environment without perfect competition.
5. Taxation and economic efficiency
a) Explain effect of taxes borne by consumers.

b) Explain effects of taxes borne by producers.
c) Explain effect of taxation of savings.
d) Explain effect of taxes on labour.
6. Tax policy concepts
a) Describe the nature of tax policy.

b) Identify objectives of tax policy.
c) Describe the relationship between tax policy, tax law and tax administration.
d) Explain the relationship between tax policy, tax revenue, and tax reform.
C Tax law and practice
1. Basic provisions of the income tax act (an overview)
a) Determine residential status of taxpayers.

b) Calculate total income.
c) Calculate employment income.
d) Calculate business income.
e) Calculate investment income.
f) Prepare tax returns and statement of estimated tax.
2. Taxation of non-resident investment and holding companies
a) Describe the concept of permanent establishments.

b) Calculate tax liability in relation to permanent establishments.
c) Describe the concept of related parties as applied in income taxation.
d) Discuss the approaches to provision of foreign tax relief.
3. Taxation of multinational companies
a) Explain the concept of Multinational Corporation.

b) Differentiate between Tax Avoidance and Tax Planning.
c) Explain the transfer pricing problem.
d) Discuss the standards and methods used in setting transfer prices that are acceptable for taxation
purposes.
4. Double taxation treaties
a) Explain the nature and history of Double Taxation Treaties.

b) Describe the functions of Double Taxation Treaties.
5. Taxation of specialised industries
a) Calculate tax liability for insurance businesses.

b) Calculate tax liability for banks.
c) Calculate tax liability for pension funds.
d) Calculate tax liability for mining companies.
6. Settlement of tax disputes
a) Explain handling of tax objections in Tanzania.

b) Elucidate tax revenue appeals system in Tanzania.
c) Compare and contrast the work of Tax Appeals Board and that of Appeals Tribunal.
7. Recent reforms in the tanzanian taxation system
a) Discuss tax reforms made within 12 months.

Features of the book
‘The book covers the entire syllabus split into various chapters (referred to as Study Guides in the book). Each
chapter discusses the various Learning Outcomes as mentioned in the syllabus.
Contents of each Study Guide
‘Get Through Intro’: explains why the particular Study Guide is important through real life examples.
‘Learning Outcomes’: on completion of a Study Guide, students will be able to understand all the learning
outcomes which are listed under this icon in the Study Guide.
The Learning Outcomes include:
9 ‘Definition’: explains the meaning of important terminologies discussed in the learning Outcome.
9 ‘Example’: makes easy complex concepts.
9 ‘Tip’: helps to understand how to deal with complicated portions.
9 ‘Important’: highlights important concepts, formats, Acts, sections, standards, etc.
9 ‘Summary’: highlights the key points of the Learning Outcomes.
9 ‘Diagram’: facilitates memory retention.
9 ‘Test Yourself’: contains questions on the Learning Outcome. It enables students to check whether they
have assimilated a particular Learning Outcome.
Self Examination Questions’: exam standard questions relating to the learning outcomes given at the end
of each Study Guide.
EXAMINATION STRUCTURE
The syllabus is assessed by a three hour paper based examination.
The examination will consist of two sections.
Section A One compulsory question (covering a range of syllabus content) 40 marks

Section B Three questions out of Five 60 marks
SECTION A
PUBLIC FINANCE
A1
STUDY GUIDE A1: INTRODUCTION TO
PUBLIC FINANCE AND THE ROLE OF THE
PUBLIC SECTOR
Public finance plays a vital role in deciding the fate of development of a country. How a government raises
funds, how those funds are spent and the effect of these activities on the economy and society has, therefore,
been a subject of continuing interest to thinkers since ancient times.
Government needs funds to perform various functions to achieve economic and social objectives. These funds
are referred to as public revenue. The government receives revenue from various sources like taxes, fees,
grants etc; tax revenue is the major source of revenue for any government.
One important aspect that first needs to be understood is why the Government needs to intervene in the running
of the economy. The emergence of public finance as a central discipline in economics has its origin in the
recognition of the fact that all the needs of the public cannot be met by the private market. There is a risk that
the public goods and services will not be provided at all, or may be provided inadequately if left entirely to the
private market. These are goods and services that can be provided only by the government. A simple example
could be national defence.
This Study Guide explains the nature of public finance and explains the rationale behind the need for
intervention of the government in the economy.
a) Explain the nature of public finance.

b) Explain nature of the public sector and different levels of government.
c) Discuss the rationale for government intervention in the economy.
d) Discuss the economic functions of the government (allocation function, distribution function and
stabilization function).
2: Public Finance © GTG
1. Explain the nature of public finance.

[Learning Outcome a]
From your previous study, you would remember that, public finance refers to the monetary resources of the
public, which are managed by public bodies like the central government and state government.
Public finance evaluates the role of the government in the areas of income and expenditure (including
administration and control) of public authorities with a view to benefiting the public.
The government provides goods and services like education, transport services, infrastructure, health care, etc.
to the public at large. The government also pays for the production and distribution of these goods and services
by collecting taxes (from the public) and borrowing from the financial markets (if taxes are not sufficient).
1. Public finance as a science
Public finance is concerned with the study of how the government collects revenue, how the expenditure is
financed and how this procedure is monitored. It includes the study of the principles applied while raising
revenue, and spending of that revenue by the Government. Thus, the various principles which form the basis of
the collection of revenue by the government, maintenance of that revenue and outlay of the expenditure forms
the subject matter of public finance.
Public Finance is considered a science because it requires the application of scientific methods of investigation.
It, however, depends upon two others other sciences - Political Economy and Political Science.
While on the one hand, it draws largely upon the conclusions of these two sciences for its premise, yet on the
other, it contributes a lot to them.
However, the scope of the science of public finance now-a-days is not just limited to the functions of raising
revenue by imposing taxes for covering the cost of administration and defense. It has widened considerably due
to the fact that modern states have to perform manifold functions to promote the welfare of its citizens. In
addition to maintaining law and order within the country and provision of security from external aggression, it
has to perform many economic and commercial functions.
Due to the increased activities of the state, there has taken place a vast increase in the expenditure of the public
authorities. The sources of revenue have also increased. Taxes are levied not for raising the revenue alone but
are used as an important instrument of economic policy. Public finance now includes the study of financial
administration and control as well.
2. Public finance as a branch of economics
Public finance encompasses many theories that have been expounded relating to the efficient collection,
maintenance and expenditure of government funds. Therefore, it has now developed as a branch of economics,
as it deals with the income and expenditure of funds of the government, including financial administration and
control.
3. Public finance as a process
Public finance can also be regarded as a process in view of the following:
¾ It studies and documents the steps followed by the public authorities in order to resolve financial problems.
¾ It is concerned with in the operational issues regarding the laws relating to finance in the economy/country.
¾ It shows the methods of income collection (by way of various types of taxes etc.), the amount of funds
collected, and also how these sources of funds are classified.
¾ It reflects how the funds are branched out to various channels.
4. Public finance as an art
Public finance is also sometimes regarded as an art because it involves finding the best ways of adopting the
laws and policies to better conform to the intended objectives. It also suggests ways in which government
personnel can try to adopt an economical approach with regard to public funds.
© GTG Introduction To Public Finance And The Role Of The Public Sector: 3
2. Explain nature of the public sector and different levels of government.

[Learning Outcome b]
Public sector refers to the government and the services it gives to the people within its geographical
boundary. In simple words, public sector means goods and services provided by the government to the public
for their benefit, irrespective of their caste, creed (the beliefs) colour or affluence.
Services provided by the government are different in different countries; however, most commonly, public sector
includes the police force, defence force, primary education, public transport and health care for the people of the
country.
2.1 Difference between private sector and public sector
1. The Private Sector
The private sector is that part of an economy which is not owned or operated by the government. In other
words, these are the organisations that are privately owned by individuals and companies. The various types of
business organisation in the private sector are sole traders, partnerships and companies. For example, retail
stores, real estate, professional services such as accountants, lawyers etc. usually operate in the private sector.
2. The Public Sector
The public sector, also referred to as the public body or public authority, is composed of industrial or
commercials organisations that are owned and operated by the government. This includes federal, provincial,
state, or municipal governments, depending on the Government structure of each country. Some examples of
public sector in Tanzania are educational bodies, health care bodies, police and prison services, and local and
central government bodies and their departments.
Which of the following statements is true in respect of the public sector?
A Big companies own most of the assets

B Government owns most of the assets
C A group of individuals owns most of the assets
D An individual owns most of the assets
2.2 Role of the public sector
The role of the public sector covers a large spectrum of services for the people living in the country, which
ranges from providing health care, water, electricity, good infrastructure, public transportation and sewage
system to providing and ensuring security, peace and harmony for its citizens. The role of the public sector also
includes responsibilities like taking care of government dealings by raising finance and utilising it for providing
better public services and goods for the people of the country.
The public sector needs to aim at bettering the performance and accountability of the public institution. It is the
role and function of the public sector to make constant efforts for development and improvements in the field of
education, safety, healthcare and other areas of public interest. It is also important that the functions of the
public sector are performed in an utmost ethical manner. Funds rose from the public by way of taxes and duties
must be utilised and disposed of for the benefit of the public and for improvement of the country’s economy.
In Tanzania, the public service is a national institution of excellence that has an important role in the abolition of
poverty and acquiring a sustainable economic growth. In order to ensure economic growth and quality services
of the priority sectors, Public Sector Reforms were implemented in Tanzania. The reform in this sector is an
important initiative by the government in improving the quality of living, bringing stability and unity in the country,
ensuring good governance and building the competitive economy which can respond well to internal and global
development challenges.
In order to guide economic and social development efforts up to the year 2025, the government of Tanzania
have developed the National Development Vision 2025. Consistent with the Vision, by the year 2025, Tanzania
aims to develop into a nation characterised by following key attributes:
¾ High quality livelihood

¾ Peace, stability and unity
¾ Good governance
¾ A well-educated and learning society
¾ A competitive economy capable of producing sustainable growth and shared benefits
2.3 Principles of reform
The main objective of the Public Service Reform Program is to increase performance and accountability of
public institutions. The key principles followed by organisations in the public sector while forming their structures
are as follows:
1. To clearly define the accountability and responsibility for every activity.

2. To describe the work in terms of results to be achieved and not in terms of the work process.
3. To maintain limited reporting lines and to justify the management level in terms of its value addition.
4. To provide maximum operational and managerial self-sufficiency.
5. To provide people who take the responsibility for an activity with the authorization of decision making for
resources and accountability for the outcome for that activity.
The idea is to enable and encourage sustainable economic development which leads to generation of wealth.
For this, a suitable environment that will encourage wealth generation needs to be created, and fair distribution
of this wealth should be ensured such that the society as a whole will benefit from it, rather than a few sections
of society.
Furthermore, policies should be designed and implemented to ensure that the wealth so generated can be
available for use for even the future citizens of the country, i.e. the next generations. All this can be achieved by
laying down a strong framework based on ethical principles and designing a good performance system.
2.4 Different levels of Government in Tanzania
In 1964, the formerly independent countries, Tanganyika and Zanzibar, were united to form a new nation - The
United Republic of Tanzania. The Government of the United Republic of Tanzania is a democratic republic
consisting of Mainland Tanzania and the Zanzibar Revolutionary Government.
The Government of the United Republic of Tanzania has authority over all Union Matters in the United Republic
and over all other matters concerning Mainland Tanzania. The Revolutionary Government of Zanzibar has
authority in Zanzibar over all non-union matters.
For administrative purposes:

¾ The United Republic of Tanzania is divided into 26 regions of which 21 regions are on Mainland Tanzania
and 5 are in Zanzibar.
¾ The regions are divided into districts.
¾ The districts are further sub-divided into divisions.
These districts are also now referred to as local government authorities.
2.5 The local government authority (LGA) in the United Republic of Tanzania
1. The LGA in Mainland Tanzania: the LGA in Mainland Tanzania is divided into:
(a) Urban authorities: mainland Tanzania hosts 22 urban council authorities. The urban council authorities
consist of:
(i) 5 City councils

(ii) 6 Town councils
(iii) 22 Municipal councils
Each of the above three is further divided into wards and Mtaa.
The mtaa is the smallest unit within the ward of an urban authority.
(b) Rural authorities: mainland Tanzania hosts 92 rural council authorities. Rural authorities consist of 97
district councils. The district councils include:
(i) Township council authorities and

(ii) Village council authorities
Each of the above two is further divided into vitongoji.
The vitongoji is the smallest unit of a village of a rural authority.
Diagram 1: The government structure in Mainland Tanzania
2.6 The local government authority (LGA) in the Zanzibar Revolutionary Government
The LGA in Zanzibar: The LGA in Zanzibar is divided into:
1. Urban authorities: mainland Tanzania hosts 22 urban council authorities. The urban council authorities
consist of:
(a) Town councils

(b) Municipal councils
2. Rural authorities: rural authorities comprise district councils.

Diagram 2: The government structure in Zanzibar
Majority of the local government authorities’ revenue comes from transfers from the central government. In
addition, the LGA also have authority to raise revenue by levying fees, property taxes, fines and other charges.
Name the two formerly independent countries which were united to form a new nation - The United Republic of
Tanzania.
3. Discuss the rationale for government intervention in the economy.

[Learning Outcome c]
The idea of government, although then not recognised as government, had been instituted among humans even
before the recorded history. Initially, the societies that were a very small group of individuals would manage
themselves with relatively little government. But when the societies started becoming large, complex and
technologically sophisticated, the need arose for a referee, a rule setter and authority for settling disputes.
The government plays a key role in solving problems in the country. To achieve this, the government needs to
expand its activities through the expansion of the public sector. But the important issue that first needs to be
understood is why does an economy require a public sector at all; why is it not possible for the private sector i.e.
the market to take care of all that the people in the country need for their living and well-being?
The answer to this can be found in the fact that the economic activity of the private sector can never fulfil all the
requirements of a society. Some goods (known as public goods) have certain inherent characteristics due to
which it becomes impossible for the private sector to provide these goods to the society; for instance, the
national defence function cannot be undertaken by the private sector.
Public goods and services are produced by the government sector with a view to satisfying public needs. For
example, national safety, public healthcare, cleans air etc.
Certain other public goods can actually be provided by the private sector, but often, the supply of such goods
falls short of the demand. The main reason for this is that the efficient functioning of the market system requires
certain characteristics such as perfect competition in the entire market, perfect knowledge of the market, perfect
mobility etc. These conditions are hardly ever fulfilled in a market economy. As a result, public goods are
underprovided by the market.
There are two economic rationales for government intervention in the economy: social efficiency and equity.
Social efficiency is achieved at the point where the marginal benefits to society for either production or
consumption are equal to the marginal costs of either production or consumption. Issues of equity are difficult to
judge due to the subjective assessment of what is, and what is not, a fair distribution of resources.
Some of the main reasons for market failure are:

¾ the existence of monopoly in many areas,
¾ the failure of the price to reflect the opportunity cost,
¾ the presence of spill overs, decreasing costs, immobility; and
¾ imperfect knowledge.
The failure of the market system calls for government action. The need for government activity arises due to the
following reasons:
¾ To ensure the production of goods and services that could not be supplied by the private sector. In
a free market there may be inadequate provision for dependants and an inadequate output of merit goods.
Also the activities involving risks and long gestation period are not the preferred choice of the private sector.
Government intervention ensures the smooth supply of the public goods and supply in adequate quantity.
Steel development is believed to be an essential, fundamental component to enhance the economic growth of a
country. However, private sector businesses are motivated only by profit. Therefore, the private sector prefers to
invest in consumer goods where profits are high and the gestation period is short.
The private sector does not show much interest in investing in the capital goods industry such as steel, where
capital requirement is high and the gestation period is long.
¾ To avoid failure of the market mechanism in safe guarding the interest of consumers. Markets may
respond lethargically to fluctuations in demand and supply which may lead to an imbalance and instability in
the economy.
Affordable housing is a key requirement of any economy. However, without government control and regulations,
there is a danger that consumer interests will be ignored in order to earn more profits by the builders. This may
lead to a situation where only the rich can own houses.
¾ To establish the economy by controlling the ups and downs in the economy. To act as a source of initiative
through the public sector by providing a new service or enhancing the quality of existing service. Inadequate
or faulty information provided by the market may lead to unawareness or ambiguity. This results in
preventing people from producing and consuming at levels they would otherwise choose.
¾ To use the appropriate combination of taxes and subsidies as means of correcting market distortions.
Changing the pattern of consumption by providing subsidy to consumers and taxing heavily to reduce the
consumption of harmful commodities plays a major role in correcting the externalities.
Tax subsidies may be provided by the government to set up businesses in economically-backward areas. This
encourages the development of the industry throughout the country.
¾ To set up regulatory bodies to monitor and control activities which are against the public interest.
Cigarettes are injurious to health; therefore, usually there are higher taxes on cigarettes in order to discourage
people from smoking.
Many countries have provision in their constitutions that requires the Government to provide for an adequate
level of education spending. Explain your views on the economic rationale for such a requirement?
4. Discuss the economic functions of the government (allocation function, distribution

function and stabilization function).
[Learning Outcome d]
There are various functions of governments in market economies identified by various economists. These
functions mainly include providing the legal and social framework, maintaining competition in the market,
providing public goods and services, redistributing income, correcting the externalities and stabilizing the
economy.
Richard Musgrave has divided the economic role of government into three major functions:
1. Allocation function
2. Distribution function and
3. Stabilisation function
1. Allocation function
Allocation function deals with the determination of the appropriate process to divide the total resources of the
community between private goods and social goods.
As you have seen in the previous studies, government has to provide for public goods and services, such as
national defense, primary education, public transport, health care, government administration etc. Private goods
are available to only those who can buy them. Therefore these are limited to some individuals of the community.
On the other hand, public goods must be available to all, even to those who can't afford them financially.
Thus, the public goods are essential for consumers but cannot be provided through market mechanism and
therefore government has to provide them. This makes it vital for the government to allocate its resources to
ensure the essential public goods and services can be provided to the people of the country.
The function of determining the funds allocation is closely related to the issues of taxation and spending. The
allocation of funds depends upon the revenue collected by the government in the form of taxes and duties and
then using that revenue for the specified purposes.
The national budget of the country determines the various overheads for which the funds are to be allocated.
The budget specifies the amount of funds set aside for the purposes specifically laid out by the government.
Thus, proper allocation of sufficient funds for appropriate purposes has a direct impact on the economic
development of the country.
A study of expenditures pattern of Tanzania over the period 2006-07 to 2008-09 indicates an increase in
development expenditure from 6.2% of Gross Domestic Product (GDP) in 2006-07 to 7.9% in 2008-09. GDP is
Gross Domestic Product which is the market value of goods and services produced within a country in a given
period of time.
Development expenditure mainly includes allocation of funds to social and economic services and hence it can
be concluded that expenditure towards social and economic objectives has increased over the years.
(Source: MOFEA Budget Execution Reports- Summary of Central Government Operations).

2. Distribution function
Distribution function with reference to public finance refers to activities and policies of the government that affect
the distribution of income and wealth. Distribution simply means the sharing of national income by individuals in
a society. Everything that the government does, such as framing policies to provide primary education or to
make available subsidised food to underprivileged sections of the society etc., affects the distribution of income
and wealth to various sections of the society. The market forces cannot be relied upon to create an equal
society; therefore a budgetary process is required.
Under the allocation function, the fiscal policies set out the various overheads and also set aside funds for each
of the overhead. The distribution function then determines more specifically how those funds will be distributed
through various sections of the economy.
The government might allocate Tshs1 billion towards social welfare programs, but out of this, Tshs200 million
could be distributed to provide subsidised food and another TShs200 million could be distributed to provide low-
cost housing.
3. Stabilisation function
Stable economic growth is the key objective of the budgeting process. The stabilisation function is another
important function of the economic policy to achieve the objective of stable economic growth. Stabilisation refers
to those government actions that influence the overall level of employment, output and prices. The stabilization
function attempts to maintain a reasonable degree of price stability.
The economic instabilities, whether under conditions of inflation or depression, affect the economy of a country.
Every change in the economy will have the effect of benefiting someone in the community and harming others.
In such a situation, the appropriate policy measures applied by the government to avoid the situations of infla-
tion and unemployment help in levelling the aggregate demand in the economy of the country. Such measures
are called stabilisation measures.
It is also important to note that the economic measures are not the only means of achieving economic
stabilisation; the monetary policy, debt policy and income policy also need to be considered. Monetary and
economic policies often complement each other.
The economic growth of the country could become unstable unless appropriate restrictions are put on spending
which ultimately may result in periods of unrestrained growth and contraction. While many economists criticise
the policy of the government to put restraint, the stock market crash of 1929 made it clear that unregulated
growth could have serious consequences.
The market is cyclical in nature i.e. when growth periods end they are followed by contraction in the form of
recessions. Thus, it is evident that unrestrained growth of the market cannot continue for an indefinite period.
Therefore, it is imperative that the economic policies are designed to anticipate and mitigate the effects of such
economic trench.
Answer to Test Yourself
Answer to TY 1
The correct option is B.
Answer to TY 2
The two formerly independent countries which were united to form a new nation - The United Republic of
Tanzania are Tanganyika and Zanzibar.
Answer to TY 3
There are two economic rationales for government provision of a good or service: social efficiency and equity.
Social efficiency is achieved at the point where the marginal benefits to society for either production or
consumption are equal to the marginal costs of either production or consumption. Issues of equity are difficult to
judge due to the subjective assessment of what is, and what is not, a fair distribution of resources.
The importance of education is undisputable in the overall development of the citizens of any country. It has the
following effects:
¾ Personal benefit: educated individuals get better opportunities as regards employment etc.
¾ Positive effect on society: educated individuals make better citizens, which has a positive effect on the
community.
Government spending on providing education is very important, as in the absence of government assistance;
self-interested people would not acquire optimum education if they are compelled to spend entirely from their
own pocket, as they will not consider the positive effect of education on society. Public education enables
redistribution in the society as it increases ‘human capital’, irrespective of the economic level of the students.
Quick Quiz
1. The public sector is composed of organisations that are owned and operated by the government. State
whether this statement is:
A True
B False
2. How does the government pay for production and distribution of goods and services like education,
transport services, healthcare, infrastructure etc. that it provides to society?
A By collecting taxes from the public

B By borrowing from financial markets
C Both A and B
D None of the above
3. The United Republic of Tanzania is made up from two formerly independent countries- Tanganyika and
Zanzibar
A True
B False
4. What are the key economic functions of the government?
Answers to Quick Quiz
1. The correct option is A.
Public sector is composed of organisations that are owned and operated by the government.
2. The correct option is C.
The government pays for production and distribution of goods and services like education/ transport
services/ healthcare, infrastructure etc. which it provides to the society by collecting taxes from the public
and also by borrowing from financial markets (if taxes are insufficient).
The formerly independent countries, Tanganyika and Zanzibar, were united to form a new nation - The
United Republic of Tanzania.
4. The key economic functions of the government are allocation function, distribution function and stabilisation
function.
Self-Examination Questions
Question 1
What is the difference between the public sector and the private sector?
Question 2
There are two common mechanics of public financing. Government provides some goods and services directly
while others are funded publicly but provided privately.
Required:
What is the difference between these two mechanisms of public financing?
Answers to Self Examination Questions
Answer to SEQ 1
The difference between private and public sector is that the public sector is usually composed of organizations
that are owned and operated by the government, while the private sector is usually composed of organizations
that are privately owned and not part of the government. The public sector is not profit-driven, while this is often
the case with the private sector.
Answer to SEQ 2
Goods provided directly by government
Certain public goods and services, for example police force and military, are directly produced and provided by
the government. This is because these are the ‘public’ goods and services needed by the community generally
but would not be efficiently provided by the market, even if the private market is called upon to provide these
goods and services. There may be security issues with regards to the country as a whole if such goods and
services are provided by the private market.
Goods funded publicly but provided privately
Some goods and services can be within the scope of provision of the private sector as regards quantity and
quality, and where no security issues are likely to arise. For such goods, the government may contract with
private entities for their provision. For instance, governments of many countries call upon private companies to
build bridges and flyovers in return for payment.
Moreover, in some cases, the private market may have already become established in certain sectors.
Therefore, the private entities may be better able to provide the goods and services, that too, at a lower rate as
compared to the government. The existence of competition further necessitates the private sector to work out
more efficient methods of production. In such cases, the government prefers to buy these goods and services
from the private sector in view of the competitive prices, and especially as the government may lack discipline in
production that comes from operating in a free market.
SECTION A
PUBLIC FINANCE
A2
STUDY GUIDE A2: PUBLIC SECTOR AND THE
NATIONAL ECONOMIC ACCOUNTS
We all have learned the concept of ‘balance of nature’ in our childhood, which explains how there exists a self
sufficient ecosystem that needs no support from the outside to sustain itself. Nature maintains balance between
all living things as well as the environment - all living things feed off each other to help nature maintain its
balance. There is a circular flow, the plants are grown in the soil, animals like the deer eat the plants, tigers eat
the deer and the cycle continues.
If even one of the elements of nature goes extinct, the balance will be disturbed. So, if all the tigers become
extinct, then the deer will be allowed to flourish and plants will start to diminish. This will cause an imbalance in
nature.
A similar principle applies to the economy. An individual earns salary, he pays money to the shopkeeper to buy
grocery etc. - so this is the income for the shopkeeper, the shopkeeper spends this money to buy clothes from a
retail store, the retail store deposits the money in the bank, the bank uses the money to lend, the borrower uses
this money to produce goods in his factory and pay salary to his staff, the staff gets salary and pay tax to the
government, the government uses the tax to provide facilities and so on. Thus, the expenditure of one sector
becomes the income of another sector and the supply of goods and services by one section of the community
becomes the demand of the other sections.
In this Study Guide, we will understand the various sectors of the economy and the flow of income in the
economy.
a) Describe the role of the public sector in the circular flow of income and expenditure.
b) Analyse the national income accounts.
c) Identify the role of the government in GNP and NI.
1. Describe the role of the public sector in the circular flow of income and expenditure.
A study of the economy reveals that money flows in a circular fashion in the economy; from individuals to
businesses and back to individuals. The expenditure of individuals becomes the income for the businesses and
the expenditure of the businesses becomes the income of the individuals.
An individual spends his income (salary, rent, dividends) for buying consumable goods and services from the
businesses, for paying taxes to the government and for savings in the form of investments. The businesses use
the money (spent by individuals while buying the goods and services and while making investments) to set up
their business, to buy material to manufacture goods and to pay their employees.
Thus, the economy of any country can be divided into five sectors:
¾ Household sector: this includes all individuals and families

¾ Business sector: this includes the firms and organisations
¾ Financial sector: this includes banks and financial institutions
¾ Government sector: this includes the ruling bodies of the state and the central government
¾ International sector: this includes the import and export
Based on the above classification, various models are framed to understand the circular flow process.
The following diagram explains the five sector circular flow model.
Diagram 1: Five sector circular flow model
We will use the above diagrammatical representation to understand how money flows through the economy
through various sectors.
© GTG Public Sector And The National Economic Accounts: 15
Two sector model
The two important sectors that exist in any economy are the household sector and the business sector.
The four flows shown in the diagram are explained as follows:
1. Output (O): the most obvious flow is the provision of goods and services by the business sector to the
household sector.
2. Expenditure (E): the household sector needs to pay for the goods and services supplied by the business
sector.
3. Resources (R): the household sector provides the resources i.e. the factors of production to the business
sector. The factors of production are capital, enterprise, land and labour (CELL).
4. Income (Y): the returns for factors of production are interest or dividend (for capital), profit (for enterprise),
rent (for land) and wages (for labour)
In the two sector model, as the cash keeps flowing in the economy, the state of equilibrium is defined as a
situation in which there no scope for the variations in levels of income (Y) , expenditure (E) and output (O) to
change i.e. Y = E = O
Three sector model
The three sector model expands the simple two sector economy by introducing one more sector – the financial
sector.
With the introduction of one new sector, two new flows arise in the economy (see diagram 1):
5. Savings (S): savings flow from households to the banks.
6. Investments (I): money goes back from banks to the business sector in the form of investments.
Thus, money for investments in the business sector is procured from savings that the household sector puts in
the banks.
Four sector model
Now, let’s go one step further and introduce the fourth sector - the government sector.
As one new sector is introduced, two new flows arise in the economy (see diagram):
7. Taxes (T): taxes are a flow from the household sector to the government.
8. Government spending (G): government then puts the money (collected in the form of taxes) back in the flow
system by way of government spending.
Note that the business sector does not pay tax. Firms are not the final owners; people own all businesses. And
people are part of the household sector. Thus, businesses do not bear the burden of tax, only their suppliers,
owners or customers pay taxes.
Five sector model
We are living in a very globalised world and we deal more and more with the international sector. Therefore the
most realistic representation of the flow system is to include the international sector.
The two new sectors that arise in the economy on inclusion of the international sector are:
9. Import (M): the household sector buys goods and services from overseas
10. Export (X): the businesses sell goods and services to overseas customers
Thus, to summarise:
¾ There are five sectors in an economy (household, business, financial, government, international).
¾ There are four types of flows between the household sector and the business sector (output, expenditure,
resources, and income).
¾ There are three flows going out from the household sector (savings, taxes and imports). Collectively, these
are called ‘leakages’.
¾ There are three flows going into the business sector (investments, government spending and exports).
Collectively these are called ‘injections’.
In a five sector model, the state of equilibrium occurs when the total leakages are equal to the total injections
that occur in the economy.
This can be shown in equation form as:
Savings + taxes + imports = Investments + government spending + exports
S+T+M = I+G+X
In other words,
If injection > leakages; this means the economy is growing

If injection < leakages; this means the economy is diminishing
If injection = leakages; this means the economy is stable
Explain the concepts of leakages and injection from the circular flow of income.
2. Analyse the national income accounts.

2.1 National income accounting
National income is the total value of all goods and services produced in the country in a given time period.
National income accounting is a set of methods and principles used for measuring an economy’s overall
performance, focusing especially on the overall level of production of goods and services.
National income accounting provides the necessary information which is used to assess the health of an
economy and to forecast future growth and development of a country.
2.2 Why is national income accounting important?
National income accounting is important for the following reasons:
1. It studies where the income is being generated and how it is spent.

2. It helps calculate the total production of final goods and services in the country. Thus, it provides useful
insight into how well the economy is functioning.
3. It helps assess the health of the economy by comparing the output per person across countries and across
time periods.
4. It helps in assessing the effectiveness of the economic policies of a country.
2.3 Measures of National Income
The most common measures used in national income accounting are:
¾ Gross domestic product (GDP)

¾ Gross national product (GNP)
1. Gross domestic product (GDP)
Gross Domestic Product, in simple terms, is the total market value of the final goods and services produced
within a country during a specific time period, usually one year.
GDP is a key indicator used to determine the strength of a country's economy. So, when it is said that the GDP
of the country is up by 5% during the year, this means that the economy of the country has grown by 5% as
compared to the previous year.
(a) The key components of the definition of GDP are:
(i) Gross i.e. final goods and services: Only the final products are taken into consideration for calculating the
GDP. To avoid double counting, the intermediate products are not counted.
Consider the calculation of the cost of a shirt.
A farmer produces cotton and sells it to a cotton manufacturer for Tshs12000. The cotton processor processes
the cotton and sells the material to a shirt manufacturer for Tshs18000. The shirt manufacturer makes a shirt
and sells it to a wholesaler for Tshs20000. The wholesaler sells the shirt to a retailer for TSHS25000 and the
retailer sells the shirt to the consumer for TSHS35000.
If all these transactions are counted in calculating the GDP; then we get:
Tshs12000+Tshs18000+Tshs20000+Tshs25000+Tshs35000 = Tshs110000 as the GDP when actually the

value of the shirt is Tshs35000.
Therefore, the intermediate goods are eliminated while calculating the GDP.
(ii) Domestic i.e. produced in the country: the GDP counts only those goods and services that are produced
within the physical boundaries of a country.
(b) Limitations of GDP as a measure of national income
(i) GDP does not account for the non-market activities:
If you yourself drive your car, this activity is not counted in the calculation of GDP. However, if you hire a driver
for your car, then this activity is counted in calculating the GDP, as this is purchase and sale of services. Thus,
even though these are exactly the same activities, they are treated differently.
(ii) GDP does not account for value of leisure
If the average work-week is 60 hours instead of 45 hours, the production would be higher; therefore, the GDP
would be higher. Thus, there is value to leisure, but that value is not counted while calculating GDP.
(iii) GDP does not account for improved product quality
A computer that costs approximately TSHS400000 today is much more advanced than a computer costing
TSHS800000 twenty years ago. However, this quality improvement is not taken into consideration while
calculating the GDP.
(iv) GDP does not account for negative effects on the environment
Although GDP counts the value of every vehicle sold, the negative effects of air pollution that is created during
the manufacturing process are not deducted.
(c) Measuring GDP
There are two approaches for measuring GDP; the income approach and the expenditure approach.
(i) Income approach
According to the income approach, the GDP is the total income earned by the household sector in a year.
As discussed earlier in this chapter, the income of the household sector is the interest received in exchange for
capital, profit received in exchange for enterprise, rent received in exchange for land and wages received in
exchange for labour.
Thus,
Total income of a nation = interest + profit + rent + wages
GDP of a nation = Total income of the nation
(ii) Expenditure approach
According to the expenditure approach, the GDP is the total amount spent on goods and services by the
household sector, business sector, government sector and international sector. Spending by the household
sector is consumption (C), spending by the business sector is investment in capital goods (I), Government
spending is (G) and exports is (X)
Thus,
Total expenditure of a nation = C + I + G + (X – M)

GDP of a nation = total expenditure of the nation
Import
Logically, both approaches should arrive at approximately the same amount.
Therefore, Total income of a nation = Total expenditure of the nation
Tanzania GDP
The Gross Domestic Product (GDP) in Tanzania was worth 28.25 billion US dollars in 2012. The GDP value of
Tanzania represents 0.05 percent of the world economy. GDP in Tanzania is reported by the World Bank. From
1988 until 2012, Tanzania GDP averaged 11.2 USD Billion reaching an all time high of 28.3 USD Billion in
December of 2012 and a record low of 4.3 USD Billion in December of 1990.
The gross domestic product (GDP) measures of national income and output for a given country's economy. The
gross domestic product (GDP) is equal to the total expenditures for all final goods and services produced within
the country in a stipulated period of time. This page contains - Tanzania GDP - actual values, historical data,
forecast, chart, statistics, economic calendar and news. 2013-10-23
Continued on the next page
(Source: http://www.tradingeconomics.com/tanzania/gdp)
2. Gross national product (GNP)
GNP in simple terms is GDP plus net income arising from international trade.
GNP = GDP + Net foreign income
Unlike GDP, GNP is not limited to the value of goods and services produced within the geographical boundaries
of a country. GNP measures the value of goods and services produced by the country's businesses and
workers regardless of their geographical location.
Nissan, a Japanese company, operates in the UK. The profits of Nissan will be counted in the GDP of the UK
(as the goods are produced within the physical boundaries of the UK), but in the GNP of Japan (goods are
produced by a Japanese business at any location).
Differentiate between GDP and GNP.
3. Identify the role of the government in GNP and NI.

As discussed above, GNP represents the total income of the nation. A higher GNP means a higher value of the
economy of a country. Thus, GNP is the indicator of the health of the economy of a country.
All individuals and entities within an economy are influenced by the economic production and growth in a
country, which is the GDP of that country. In a bad economy, businesses would make lower profits, leading to a
bad influence on the stock market. On the other hand, in a good economy, there is a high level of employment
and higher income which results in higher GNP.
Therefore, appropriate measures need to be taken in the country to improve the GNP, which in turn results in
improving the economy of a country. As the economic policies for a country are decided by the government, it
plays a very important role in the growth of a country’s economy.
The government policies influence the GNP and the NI (National Income) of a country in many ways.
Some of these are explained below.
1. Education and health care policies: increased investment in this sector contributes in improving the
quality of human capital of a country which results in increased production. When production increases, the
national income also increases and therefore GNP increases.
It is important that a government aims to increase the quality of its workforce by increasing educational and
professional training opportunities.
2. Institutional infrastructure: improvements in the institutional infrastructure of the country in areas such as
law and order, judiciary system, banking and insurance sector and stable and efficient government
organisations are important to GNP growth.
3. Infrastructure policies: improvement in the physical infrastructure of the country is fundamental to

supporting economic activity and encouraging GNP growth. It includes development of roads, railway lines,
airlines, bridges, dams, power generation plants etc.
4. Social policies: strong policies to reduce unemployment, to control population, to improve social security,
to make better education available, to formulate good environmental policies etc. play a vital role in the
development of a country’s economy and therefore have a significant impact on GNP.
However, there is also a different view that needs to be understood. Although GDP and GNP reflect the overall
health of the economy, an increased GDP does not always mean development.
Economic wealth does not always mean good quality of life. More money within a country does not always
mean better quality of life for everybody.
Natural disasters like floods and earthquakes destroy homes and businesses. The recovery efforts by the
government for disasters mean more government spending (G). Higher G means higher GDP. Therefore,
although the disasters result in improving the GDP, it cannot be considered good for the welfare of the nation.
Answer to Test Yourself
Answer to TY 1
Leakages are the withdrawals from the circular flow of income. The household sector does not put all their
income in business sector, some income is put aside in the form of saving, some is paid to government in the
form of taxes and some is used to buy goods from other countries. Thus, the savings (S), taxes (T) and imports
(M), collectively are called as leakages from the circular flow of income.
Injections into the circular flow are additions to the circular flow from other sectors. This includes investment
from business sector, government spending and income from exports to other countries
An economy is in equilibrium when: injections = leakages
Answer to TY 2
GDP GNP
GDP stands for gross domestic product. GNP stands for gross national product.
GDP is the total value of goods and services GNP is the total value of goods and services
produced within the boundaries of a country in a year produced by citizens of a country in a year within the
by its citizens and foreigners country and also in foreign countries.
GDP = consumption + investments + government GNP = GDP + foreign income
spending + (exports – imports)
Quick Quiz
1. GDP = consumption + investments + government spending + (exports – imports).
A True
B False
2. Honda Motors is incorporated in Japan, but manufactures cars in the United States of America. The cars
produced by Honda Motors are added to the GDP of _____________.
3. Honda Motors is incorporated in Japan, but manufactures cars in the United States of America. The cars
produced by Honda Motors are added to the GNP of ______________.
4. Name the five sectors in the economy.
2. The United States of America
3. Japan
4. The five sectors in the economy are:
(i) Household sector

(ii) Business sector
(iii) Financial sector
(iv) Government sector
(v) International sector
.
Question 1
Explain the meaning of the word ‘gross’ in gross domestic product (GDP).
Question 2
Give two limitations of GDP.
Answer to SEQ 1
GDP is gross i.e. the final value of goods and services produced in a country in a period of one year. The ‘final’
value includes the value of all the intermediate products that have gone into the production of goods and
services in the economy. For example, cotton is sold to the weaver who weaves the cloth.
The cloth is sold to the cloth manufacturer who sells it on to the manufacturer of garments and finally the
garment is sold to the consumer. Therefore, for calculating the GDP, the cost at which the garment is sold
should be taken into consideration and not the values at various stages. Thus, to avoid double counting, the
gross value of the goods is considered in GDP.
Answer to SEQ 2
Limitations of GDP are:
1. GDP does not account for non-market activities. GDP does not include productive activity that does not
have a market transaction. For example, unpaid domestic services such as housework, do-it-yourself home
improvements etc. are not considered while measuring the GDP.
2. GDP does not account for the value of leisure. Leisure contributes to the quality of life.
A country could increase its output (and GDP) if its people worked all seven days of the week. However,
having more products might not mean people are better off if they have no leisure time to enjoy them.
SECTION A
PUBLIC FINANCE
A3
STUDY GUIDE A3: PUBLIC EXPENDITURE
POLICY
Governments are entrusted with not only setting the legal code (“laws of the land”) that organisations must
abide by, but also with shaping the external environment or macro economy that they have to operate in. Public
expenditure is an important facet of macroeconomics as it relates to the spending by public authorities like
central, state and local authorities on various activities for achieving social and economic objectives.
As an accountant, it is important that you understand the various facets of public expenditure which are
discussed in this Study Guide as public expenditure policies shape the economy. This is because changes in a
government’s economic policies will undoubtedly affect your organisation in some way.
This Study Guide will provide you with an understanding of the institutions which implement expenditure
policies, an analysis of the classification of government expenditure, the factors which affect the size and growth
of public expenditure and the project evaluation techniques which can be used by public bodies.
a) Describe the institutions and instruments involved in implementation of expenditure policy (executive,
parliament audit).
b) Analyse the classification of government expenditure.
c) Identify the principles of assigning expenditure across different levels of government.
d) Examine factors affecting size and growth public expenditure.
e) Apply the decision rules in project evaluation under different budget scenarios (budget size fixed,
budget size variable, lumpy projects).
24: Recording Transactions and Events © GTG
1. Describe the institutions and instruments involved in implementation of expenditure policy

(executive, parliament, audit).
Government or public expenditure can be defined as the spending by public authorities like central,
state and local authorities on various activities for achieving social and economic objectives. Therefore
it also includes amounts spent for protecting citizens and amounts incurred to satisfy the general common
needs of the public at large. Thus it brings about social as well as economic development of the state.
1.1 Introduction to public expenditure policy
Public expenditure policy is driven by a range of inter-related issues and sometimes, conflicting objectives.
Long term objectives or strategic objectives will focus on economic growth and alleviation of poverty.
Infrastructure projects are a key enabler of growth.
Short term objectives will relate to fiscal stability and direct social support for the people of Tanzania with
services such as health and education.
Since the Keynesian impact on macroeconomics in the 1930’s, governments and the state executives have
realised that fiscal policy can be a tool which influences aggregate demand, output and employment.
Fiscal policy refers to the actions governments take in setting their level of public expenditure and
determining how this expenditure is to be undertaken. The two main instruments of fiscal policy are government
spending and taxation.
The underlying rationale of the fiscal policy concept is:
Total demand for goods and services in an economy = Consumption + Investment + Government
expenditure + any balance of payments surplus
Therefore in times of low demand for goods and services, governments should spend more. This increased
spending will create additional employment, which in turn will lead to greater spending amongst individuals and
households, thereby creating greater demand for goods and services.
From the above it is clear that Aggregate demand is the effective

¾ budget deficits can stimulate aggregate demand and demand from consumers, firms,
¾ budget surpluses can constrain aggregate demand. overseas players and central and
local government.
Diagram 1: Effect of demand
© GTG Study Guide Name: 25
The budget balance is important in driving demand.
There is a direct relationship between demand and employment, i.e. increase in demand causes increase in
employment and decrease in unemployment.
Limiting factors which affect the direct relationship between demand and employment include:
¾ Availability of spare capacity
¾ Supply side flexibility
¾ Lack of transport or communications capability and lack of skilled labour: this may be an issue in the
Tanzanian environment
Supply side restrictions may also mean that expenditure feeds into inflationary price pressure such as when
wages and salaries have to be increased to recruit workers with key skills. Within the budget balance the level
and nature of spending is important as is geographical distribution and social distribution.
1.2 Factors affecting government expenditure
1. Expansion of spending in total has a positive multiplier effect and the end result will depend on the multiplier
values. The eventual expansion may exceed the initial spend as the spending flows around the economy.
2. The nature of spending is important since capital spending can build infrastructure and a legacy for
future generations. However capital spending can also tend to flow into private sector consumption and
investment.
3. There are of course dangers if government spending feeds into spending on imports since that may
stimulate the economies of others rather than its own.
4. Spending may also create inflationary pressures if it feeds into increased public sector pay that may
encourage private sector pay demands.
5. Geographical issues may be important because spending impacts will be different away from capital cities
and major towns and cities.
6. The social mix is also a major issue since the propensities to consume of different groups may differ.
7. Spending is not, however, totally a matter of choice and discretion since many matters are unavoidable
commitments from past decisions, part of political commitments or built into the structure of government and
the public sector.
(a) Social spending may be unavoidable when unemployment occurs since social security payments
may be a commitment. In Tanzania, the impact will be more limited since the social security safety net for
health and unemployment is quite limited.
(b) Interest payments on past borrowing are a commitment.
(c) Infrastructure projects have long-term flow through requirements.
(d) Much of government is all but committed to spend based on structural issues in departments that have built
spending requirements cumulatively in the past.
All in all governments always have to juggle many balls in the air.
Tanzania also has a particular issue common to many developing countries in requiring a variety of sources in
foreign aid and borrowing to support its budget since local revenues are not sufficient to support required
spending, particularly social spending.
Tanzania also suffers from revenue under-collection and over-estimation meaning that spending plans
may have to be curtailed or cut.
1.3 Issues and challenges relating to government expenditure
Components of government spending in the National Income Accounts
Two key elements of government purchasing are purchases of materials, goods and services and also
spending on wages and salaries. Government purchasing may be seen also as comprising current spending
and capital spending.
Current spending is equivalent to recurring expenditure / revenue expenditure like

maintenance of infrastructure.
1. Issues relating to public expenditure
As already stated in the introduction, the issues can be seen as:
(a) Spending to be in accordance with key strategic government objectives such as the MKUKTA
strategic interventions in Tanzania.
MKUKTA has at its heart the fundamental objectives of economic growth and poverty reduction. The Tanzanian
government has to carefully balance capital spending on infrastructure and current spending on purchases,
wages and salaries and services.
Whilst current spending provides instant social support it does not build infrastructure such as transport,
communications and energy that may be essential in supporting longer-term economic growth.
Current spending may however include vital maintenance work on existing infrastructure to maintain its
effectiveness thereby supporting economic growth.
(b) Making spending decisions as part of overall decisions on budgetary stimulation or restraint using
Keynesian fiscal policy tools.
Remember that in times of unemployment we may seek to use a budget deficit to stimulate demand. The
amount of deficit is as important as the nature of spending in terms of its multiplier effect. For Tanzania, this is
complicated by its reliance on overseas aid. Government spending decisions cannot be entirely separated from
fiscal policy decisions.
After the global banking crisis and ensuing recessionary impact, Tanzania has had to use a fiscal stimulus to
support economic stability and employment. Exiting from the stimulus inevitably means some expenditure
reductions.
(c) Supporting a scale of public sector activity that involves maintenance and expansion of spending
on goods and services or wages and salaries, which in turn will maintain or enhance public sector
service provision.
Many areas of public service provision such as social support, health and education are not easily reversible. In
the context of Tanzania, poverty reduction is a major spending objective and such expenditure is a long term
commitment that may require incremental expansion.
Key sectors in Tanzania are:
¾ Education
¾ Health
¾ Water
¾ Roads
¾ Agriculture
¾ Energy
(d) Continuing to fund subsidies that may be almost committed to support enterprise activity i.e.
essential public spending on the provision of goods and services at a reasonable price.
(e) Having to support agriculture, transport, water and energy.
(f) Having to spend on social security to a greater or lesser extent depending on how economic
fluctuations affect payments to the unemployed and families requiring support. This issue is however
more relevant to advanced economies in which transfer payments of social security support are a
significant part of the budget.
(g) Accepting that an ageing population requires support as does a substantial child population element.
(h) Being burdened by past government deficits that have driven up borrowing and borrowing costs and
payments for interest and repayments of capital
Therefore we can conclude that government spending discretion is limited since much is already
committed and in place.
2. Challenges relating to public expenditure
The challenges can be seen as:
(a) Finding sufficient sources of funding as revenue to support current levels of capital and revenue spending
(b) Making difficult decisions to achieve priorities
(c) Ensuring long-term economic growth is being supported
(d) Making decisions in a challenging environment where election and re-election are important
(e) Making compromises with political alliances, and coalitions being important to maintain
(f) Dealing with sometimes powerful stakeholder groups such as public sector workers who may resist change
and act in self-interest to expand the sector and sector remuneration
(g) The fundamental problem of only being able to make relatively marginal or incremental changes in public
spending
1.4 Institutions and instruments involved
(a) Parliament
In a parliamentary democracy, leaders, parties and candidates for key presidential positions, cabinet
membership, parliamentary seats or local government positions have to present plans in the form of papers,
presentations, and arguments in debate and in published manifestos.
Once elected, these leaders, cabinet ministries, etc. and later communications provide a mandate for the
government in power to operate including many aspects that impact on public spending.
The democratically elected government has to work within parliamentary democracy in putting forward
proposals, papers and ultimately legislation that is worked upon subject to amendment and then voted for to
become law. Once again, this will drive many public spending decisions.
Parliament is often described as the legislature since that is its purpose and function.
Parliament may sometimes delegate matters to parliamentary or cross parliamentary committees who will then
propose legislation and amendments to parliamentary votes.
Government and the cabinet has power, but power within a framework of supervision and approval by the
legislature or parliament to whom they are accountable.
(b) Executives
Whilst governments and parliamentarians may come and go with democratic elections, a permanent executive
exists below them as a structure of largely full-time paid management and staff. Employees do come and go but
their offices and positions are more permanent institutional structural mechanisms and process elements.
Sometimes some are referred to as the civil service.
Civil servants and public sector staff work in a range of different entities with different functions and purposes:
Sometimes called MDAs they are the ministries, departments and agencies of central and local government.
¾ Ministries
¾ Funds
¾ Independent departments
¾ Authorities
¾ Agencies
¾ Boards
¾ Councils
¾ Commissions
¾ Local government etc.
There are also other state entities:
¾ Embassies
¾ Hospitals
¾ Education
And not forgetting the legal bodies and courts:
¾ The judiciary and its courts

Tanzania still has many state enterprises that in developing countries have been privatised out of the public
sector. Ministries will be particularly important in providing policy advice and support to government through
working on proposals given to them and putting proposals forward that support government policy. All MDAs
and state bodies will have budgets with a variety of funding and revenue streams and expenditure plans.
Government can influence, control and use these budgets for policy purposes. However the bodies may have
statutory obligations to fulfil such as defence, policing, law, social or educational provision etc. and have to
provide these by law.
(c) Audit
To support accountability, most of these bodies are subject to independent audit by the state audit function or
National Audit Office of Tanzania. Their audit work is of systems and operations in terms of compliance,
efficiency, economy and effectiveness in process and procedure.
Heads of government bodies are also accountable for their spending to the office (CAG) of the Controller and
Auditor General who then focuses on four key issues:
¾ The account of expenditure

¾ Comparison against appropriated or agreed amounts
¾ Performance against agreed targets in terms of effectiveness
¾ Asset analysis and spend
Audit plays a key part in ensuring spending is properly authorised and reflects decisions made through budgets
laws and regulations as well as statutory obligations.
“Controller and Auditor-General" (CAG) means the person holding the office of Controller and Auditor-General
provided for in section 78 of the Interim Constitution of Tanzania.
In brief, the role of CAG in Tanzania is listed below:
(i) The CAG regulates The National Audit Office of Tanzania (NAOT).
(ii) The CAG is responsible for auditing accounts, appropriations and expenses to ensure their compliance with
Government rules and regulations and comprehensive accounting practices.
(iii) The CAG is responsible for conducting any other audit as provided in this law or other written laws.
(iv) The CAG shall employ, appoint, promote and control categories of officers and employees of such
qualifications as may be considered necessary to assist him in the performance of the functions, carrying on
responsibilities and the exercise of his powers.
(v) S/he prepares an annual audit report in English and Swahili as a part of his/her responsibilities.
Diagram 2: Institutions and instruments involved in implementation of expenditure policy
Explain the relationship between aggregate demand and budget surplus / deficits.
2. Analyse the classification of government expenditure.

2.1 Classification of government expenditure
Government spending can be analysed in three ways:
1. Administratively
This classification is based on the terms of who is responsible for the expenditure and by implication the
activities that drive it.
Responsibility Example of government expenditure Amount incurred

Central government Defence, providing infrastructure relating Total amount incurred by central
to national highways, airways, sea ports, government for providing the
building industrial zones various services (discussed in the
adjacent column
Local government Primary education, local health service, Total amount incurred by local
agriculture extension and livestock government for providing the
development, water supply and local road various services (discussed in the
maintenance. adjacent column)
Total amount Total amount
The above classification will split the entire expenditure of an economy into central government expenditure and
local government expenditure.
In Tanzania, the expenditure is further divided into Ministerial and Local Government Expenditure.
¾ Ministerial expenditure is the expenditure for which the responsibility is on the Ministers of Central
Government and
¾ Local Government Expenditure is incurred by the local authorities like municipalities for the local jurisdiction.
2. Functionally
This classification is based on the terms of what the spending has been upon. Therefore the total public
expenditure of an economy is split up based on the nature of services provided i.e. the total expenditure is split
into defence expenditure, national highways expenditure, total local health services incurred by various local
governments, total local road maintenance expenditure incurred by the various local governments of the
economy, and so on.
Type of expense (examples) Total amount incurred

during a period
Defence expenditure XX
National highways expenditure XX
Total local road maintenance expenditure incurred by the XX
various local governments of the economy
Total local public health expenditure incurred by the various XX
local governments of the economy
Total expenditure of the economy XXXX
3. Economically
This classification is based on the terms of its purpose such as infrastructure, social, health or other policy
purpose. Therefore the total expenditure of the economy will be split up in this way.
Economic Classification of Expenditures in Tanzania (% of GDP)
2006/07 2007/08 2008/09

Total expenditure 23.50 22.80 25.20
Recurrent expenditure 17.30 12.70 17.30
- Wages and salaries 5.10 5.00 6.0
- Interest payments 1.10 1.20 0.90
- Goods and services transfer 11.10 6.60 10.50
Development Expenditure 6.20 7.90 7.90
- Domestically financed 2.60 2.50 3.40
- Foreign- financed 3.60 5.40 4.50
(Source: MOFEA Budget Execution Reports- Summary of Central Government Operations)
2.2 Information on public expenditure
Government spending is published in at least three reports:
¾ Expenditure plans in budget books

¾ Budget estimates
¾ CAG and departmental actual spending
Within these, the Tanzania expenditure budgets follow international conventions such as those issued by the
United Nations for National Accounts.
As we have already seen, the public sector spend can be incorporated at different levels of the National Income
and Expenditure Accounts and can also be pulled out and aggregated as a total spend.
As part of GNP Government purchasing

As part of National Income 1. Surpluses of state entities
2. Subsidies to market players
As part of Personal Income 3. Social security and transfer payments
4. Interest on government borrowing
3. Identify the principles of assigning expenditure across different levels of government.

3.1 Main principles of public expenditure
The main principles of public expenditure are:
1. Maximum Social Benefit: It is necessary that all public expenditure is utilised for general welfare of society
at large and not for the benefit of a particular section of the society.
2. Economy: Public expenditure has to ensure economy that means all wasteful and unprofitable expenditure
has to be avoided and that it has to ensure that the taxpayer is not burdened to the extent that savings are
affected.
3. Approved expenditure: It is necessary to ensure that public expenditure is approved by a competent

authority and that funds are used for the purpose for which they are approved.
4. Flexibility: It is necessary that an element of flexibility exists so that expenditure can be varied according to
needs and circumstances.
3.2 Assigning expenditures across different levels of government
Public expenditure should be incurred bearing in mind the main principles of public expenditure. Therefore at
the most fundamental level government spending decisions could be seen as part of the overall economic
problem of allocating scarce resources amongst competing needs and requirements. However with
government spending the process is not undertaken within a free market pricing system that works
based on the interplay of supply and demand to satisfy those consumers who are able and also willing to
participate to acquire economic goods.
With government spending the allocation of scarce resources is based on decisions in a democratic
process that supports primarily the provision of what most people would see as social goods that they
believe should not command a price like economic goods.
In essence the approach can be seen as a matter of costs and benefits and a framework of competing
priorities. Government ministers and heads of state departments and entities often have to argue their case
and get an agreed budget that includes spending agreements.
It is important to understand the budgetary process since the assignment of spending works within this.
The national process has four key stages:
1. Budget formulation
The members of Parliament and civil servants prepare the budgets for the country. Budgets are prepared by
ministries like railway, finance, etc. The budget aims to ensure optimum utilisation of resources i.e. the
resources are utilised in the best possible manner by producing maximum goods and services at low cost.
2. Debating and approval
Once the budget is formulated it is debated by the parliament members and after obtaining consensus from
elected members of the Parliament, the budget is freezed.
3. Execution of the budget
Once the budget is approved by the Parliament, it is executed i.e. each ministry is sanctioned funds to execute
the budgets.
4. Oversight and control
During the execution of the budget, the auditors like CAG compare the budgets with actuals and monitor
government revenue and expenditures.
4. Examine factors affecting size and growth public expenditure.

Factors affecting the size and growth of public expenditure
The key factors that drive government spending and its growth are:
¾ The extent of past government borrowing: governments indulge in external borrowings in order to fund
development, in times when they face budget deficits. This in turn implies that the government will have to
incur recurrent expenditure towards payment of interest and repayment of principal amount of borrowing.
¾ Existing costs of current public sector institutions and entities: government needs to maintain public sector
institutions like hospitals, educational institutions, railways, etc.
¾ Infrastructure and long-term project costs that continue
¾ Socio-cultural changes in the population total and its mix: increase in population of children will require
increase in the area of public spending relating to children’s education.
¾ Inflationary pressures on wages and salaries
¾ Social, policing, defence and other policy commitments made which need to be maintained.
It is also worth remembering that the scale of the public sector and the extent of the public sector in
particular parts of the social and economic system is clearly connected to political social policy.
In states with a more socialistic history and politics the extent of the public sector expenditure will tend
to be larger due to the following reasons:
¾ State enterprises providing goods and services may be significant compared to total GDP from private
sector enterprises
¾ The state may have banking interests
¾ Utility provision in electricity, gas and water may be largely state provided
¾ Defence production may be entirely within the state system
¾ Social provision in healthcare, education and social services may be naturally greater
Back in the 1880s, German economist Adolph Wagner proposed a ‘law of rising public expenditures’.
A law in economics is a highly plausible hypothesis.
His hypothesis was based on the view that with the development of industrial societies there would be an
inevitable and increasing public pressure and political ‘pressure for social progress’ and an increasing
demand for ‘social considerations’ in business conduct.
He therefore proposed continuing expansion of public expenditure as a natural phenomenon. Evidence in the
late nineteenth and twentieth century supports this view.
However there is a counter demand that is well evidenced in the current century in developed economies for
fiscal restraint to deal with high government borrowings and to allow fiscal flexibility when economies inevitably
go into recession at times.
However the theory requires considerable caution in that it may hold true for public expenditure in absolute
terms but not for public expenditure in real terms or expenditure as a percentage of GDP or public expenditure
in real terms per head. The evidence varies between countries and over time. It is however an interesting
proposition.
Generally the public sector percentage of GDP has risen over time in most states.
Continuing expansion of public expenditure is a natural phenomenon.
Required:
Comment on the appropriateness of the above statement in todays’ world.
5. Apply the decision rules in project evaluation under different budget scenarios (budget
size fixed, budget size variable, lumpy projects).
[Learning Outcome e]
5.1 Expenditure evaluation principles
Expenditure evaluation for many is seen as a way of evaluating competing priorities for spending from
the scarce resources of a revenue budget.
The theories help build a model for evaluating one priority against another.
Many of the theories use a form of financial cost benefit analysis where social and economic benefits and costs
are compared in financial terms assuming that social costs and benefits can be measured in that way.
(a) Let us now look at different types of budgets to evaluate projects:
Fixed budget
The fixed budget approach suggests that the evaluation is first seen in the context of being given a fixed budget
and deciding on the priorities for expenditure. The theory is then similar to that of a household determining its
expenditure with a fixed income and knowledge of utilities and marginal utilities of available goods and services
and their market prices. There is assumed to be a classical rationality in that the state wished the community to
receive the maximum net benefit.
Diagram 3: Variable budgets / marginal
The diagram above shows two potential candidate projects for government expenditure. For each project the
marginal benefits are plotted against expenditure incurred.
The curves are based on a view that the marginal or extra benefit of each Shilling spent falls.
On this basis a state that wished to maximise the net benefit of its spending available will allocate outlays so as
to equate the marginal benefits of the candidate projects for spending.
The objective of the state is to maximise net benefits.
(b) Let us now look at how expenditure evaluation is affected by the nature of projects and the
complexity in objectives before using the marginal theory as a general theory.
(i) Divisible projects
Divisible projects are those where the government can spend any amount of money to finance the project. The
amount of the spending could be anything from one Shillings to a billion and one Shillings. With divisible
projects the marginal theory can be easily applied since any amount can be allocated to a project such that
expenditures can be allocated in proportion to the marginal benefits of the projects.
A proposal to spend hours of caring support in hospital wards could be seen as examples of relatively divisible
projects.
(ii) Lumpy projects
Lumpy projects are quite different. The projects have relatively stepped costs. Road building projects are of this
type since these projects may have outlays that are either spent or not spent. The outlays are indivisible and
cannot be spent shilling by shilling.
Some argue that the projects should be ranked or put in order of their net benefit to cost ratio giving a measure
of return per shilling spent. The projects with the highest return to spend should be undertaken until the budget
has been spent.
Following is the information relating to three projects which are being evaluated by a local government.
Project Cost Benefit

Road A Tshs 80m Tshs 250m
Road B Tshs 100m Tshs 260m
Road C Tshs 120m Tshs 480m
Required:
Using the above information, evaluate the project expenditure and choose the most efficient projects if the local
government follows:
(a) Fixed budget
(b) Variable budget
(c) Divisible projects
(d) Lumpy projects
Answer
(a) Fixed budget
To make the expenditure allocation the state should rank the projects by their benefit to cost ratio and undertake
each project until the budget is spent.
So if the budget was fixed at Tshs200 million only projects A and C would be undertaken. The table below
explains the evaluation made.
Project Cost Benefit Net benefit Benefit to cost Rank

Road A Tshs 80m Tshs 250m Tshs 170m 4.125 1
Road B Tshs 100m Tshs 260m Tshs 160m 2.6 3
Road C Tshs 120m Tshs 480m Tshs 360m 4 2

Variable budget
Where there is a variable budget the state sector and its constituent parts have to extend their view of the
opportunity cost of projects from merely comparing public sector projects against one another to consider the
opportunity cost of increasing the state expenditure budget and creating opportunity costs to the private sector
as a result.
Divisible projects
In theory we need to add private sector projects into the analysis so that the marginal benefits of all projects are
considered.
Lumpy projects
Again in theory we need to add private sector projects into the mix.
Compare and contrast the expenditure evaluation for divisible projects and lumpy projects.
Answers to Test Yourself
Answer to TY 1
The underlying principle of fiscal policy is as follows:
Total demand for goods and services in an economy = Consumption + Investment + Government
expenditure + any balance of payments surplus
Aggregate demand / total demand is the effective demand from consumers, firms, overseas players and central
and local government.
Therefore in times of low demand for goods and services, governments should spend more. This increased
spending will create additional employment which in turn will lead to greater spending amongst individuals and
households thereby creating greater demand for goods and services.
From the above it is clear that
¾ budget deficits can stimulate aggregate demand and

¾ budget surpluses can constrain aggregate demand.
Therefore there is an inverse relationship between budget surpluses and aggregate demand
Answer to TY 2
This statement was made way back in the 1880’s by German economist Adolph Wagner, who proposed a ‘law
of rising public expenditures’. His hypothesis was based on the view that with the development of industrial
societies there would be an inevitable and increasing public pressure and political ‘pressure for social progress’
and an increasing demand for ‘social considerations’ in business conduct. Evidence in the late nineteenth and
twentieth century supports this view as many economies were on the developing stage.
However in the current century this statement does not hold good for developed economies as fiscal restraint is
used to tackle with high government borrowings and also fiscal flexibility is used when economies inevitably turn
down at times.
Answer to TY 3
The difference between the two types of evaluation is as follows:
Divisible projects Lumpy projects

Divisible projects are those where the government These are indivisible projects
can spend any amount of money to finance the
project.
With divisible projects the marginal theory can be The projects which are assessed should be ranked
easily applied since any amount can be allocated to in order of their net benefit to cost ratio giving a
a project such that expenditures can be allocated to measure of return per shilling spent. The projects
equate the marginal benefits of the projects. with the highest return to spend should be
undertaken until the budget has been spent.
Similarities
Both projects need to add private sector projects into the mix, so that the most optimum and efficient projects is
selected.
Quick Quiz
1. What is the relationship between budget deficits and aggregate demand?
A Direct
B Inverse
C No relationship
D Is circumstantial
2. Which option is not a limiting factor that affects the direct relationship between demand and employment?
A Availability of spare capacity

B Supply side flexibility
C Lack of skilled labour
D Social mix
3. Tanzania also suffers from revenue under-collection and over-estimation meaning that spending plans may
have to be curtailed or cut.
The above statement is:
A False
B True
4. Which option does not relate to a type of classification of government expenditure?
A Administrative classification
B Geographic classification
C Functional classification
D Economic classification
5. List the four stages of the budgetary process.
6. Who proposed the law of rising public expenditures?
7. What does public expenditure evaluation mean? Answer in one sentence.

2. The correct option is D.
3. The correct option is B.
5. The four stages of budgetary process are:
¾ Budget formulation
¾ Debating and approval
¾ Execution of the budget
¾ Oversight and control
6. German economist Adolph Wagner proposed the ‘law of rising public expenditures’.
7. Expenditure evaluation is a way of evaluating competing priorities for spending from the scarce resources of
a revenue budget.
Question 1
‘In Tanzania, discretion on government spending is limited’.
Required:
Justify the above statement.
Question 2
The Tanzanian government has a fixed budget of Tshs3.6 million to invest in seven different infrastructure
facilities. The cost of each project is represented by its required investment amount. The benefit assessment
gives the total benefit for each project. Refer to the table below for details:
Project Present value Present value of Net benefits

of benefits investment cost
Tshs Tshs Tshs
A 430,000 140,000 290,000
B 360,000 230,000 130,000
C 600,000 420,000 180,000
D 380,000 340,000 40,000
E 1,130,000 870,000 260,000
F 1,440,000 860,000 580,000
G 1,370,000 570,000 800,000
5,710,000 3,430,000 2,280,000
Required:
Based on the information provided above, determine the projects to be selected and the net benefits from the
projects selected.
Answer to SEQ 1
The main principles of public expenditure are:
i. Maximum Social Benefit: It is necessary that all public expenditure is utilised for general welfare of society
at large and not for the benefit of a particular section of the society.
ii. Economy: Public expenditure has to ensure economy that means all wasteful and unprofitable expenditure
has to be avoided and that it has to ensure that the taxpayer is not burdened to the extent that savings are
affected.
iii. Approved expenditure: It is necessary to ensure that public expenditure is approved by a competent
authority and that funds are used for the purpose for which they are approved.
iv. Flexibility: It is necessary that an element of flexibility exists so that expenditure can be varied according to
needs and circumstances.
Bearing in mind the above mentioned principles, public spending in Tanzania includes the following
committed expenditure:
¾ Spending in accordance with key strategic government objectives such as the MKUKTA strategic
interventions. Therefore the Tanzanian government has to carefully balance capital spending on
infrastructure and current spending on purchases, wages and salaries and services. Current spending
provides instant social support it does not build infrastructure
¾ Making spending decisions as part of overall decisions on budgetary stimulation or restraint using
Keynesian fiscal policy tools. This means that government spending decisions are not independent of fiscal
policy decisions.
¾ Supporting a scale of public sector activity that involves maintenance and expansion of spending on goods
and services or wages and salaries, which in turn will maintain or enhance public sector service provision. In
the context of Tanzania poverty reduction is a major spending objective and such expenditure is a long term
commitment that may require incremental expansion.
¾ Funding subsidies that may be almost committed to incur public spending on the provision of goods and
services at a reasonable price.
¾ Incurring expenditure in the area of agriculture, transport, water , energy, social security expenditure like
health of children and aged
(a) Incurring expenditure on social security based on economic fluctuations affecting payments to the
unemployed and families requiring support.
(b) Incurring expenditure relating to borrowing costs, interest and repayment of capital, borrowed by past
government budget deficits
From the above we can conclude that in Tanzania, discretion on government spending is limited’
Answer to SEQ 2
In dealing with the case above, one can consider those infrastructure projects which will have a higher ranking
in terms of benefits to cost analysis and also will fit into the fixed budget. Refer to the table below to perform the
ranking.
Project Present value Present value of Net benefits B/C B/C

of benefits investment cost Ratio ranking
Tshs Tshs Tshs
A 430,000 140,000 290,000 2.1 1
B 360,000 230,000 130,000 0.6 4
C 600,000 420,000 180,000 0.4 5
D 380,000 340,000 40,000 0.1 7
E 1,130,000 870,000 260,000 0.3 6
F 1,440,000 860,000 580,000 0.7 3
G 1,370,000 570,000 800,000 1.4 2
Based on the rankings determined in the last column of the table, Projects A, G, F and B should be
chosen. The total present value of investment cost in these 4 projects is Tshs1.8 million and the present value
of benefits is Tshs1.8 million.
The net benefit of these four projects is therefore Tshs1.8 million.

SECTION A PUBLIC FINANCE
A4
STUDY GUIDE A4: GOVERNMENT BUDGET
What do you do when you receive your pocket money? Do you spend the entire amount on the same day? No,
you understand that the money that you have received today is to finance your needs for the entire month. So
you make a plan of how you are going to spend the money. You ascertain how much money you need to keep
aside for necessary expenses like purchasing books, travelling cost, canteen bills etc. You also decide how
much you can afford to spend on entertainment like discos and movies. Sometimes, you want to save some
amount from your pocket money each month so that after a few months, you can buy an expensive bike for
yourself.
This process is budget. Budgeting is the process of creating a plan to spend your money. This plan helps you to
determine in advance whether you will have enough money to do the things you need to do or would like to do.
If the money that you have is not sufficient to do everything you would like to do, then you need to prioritise and
spend your money on the things that are most important to you.
This is the process every individual, every family, every organisation and even every country needs to do -
balancing the expenses with the income. This process is important because if you spend more than what you
get, you will slowly sink deeper into debt.
In this chapter, we will learn about government budget – the meaning of government budget, the various types
of budget, how the money collected from the public is allocated to different expenses according to different
priorities etc.
a) Compare and contrast the different budget policies (balanced, deficit, surplus budgeting).
b) Discuss the approaches to financing of government budget deficit.
1. Compare and contrast the different budget policies (balanced, deficit, surplus budgeting).
The word ‘budget’ is derived from the French word ‘baguette’, which means a leather bag. When the British
Chancellor of the Exchequer used to carry the annual financial proposals in a leather bag to the House of
Commons, he is said to “open” his budget i.e. holder of documents.
Government budget, in simple terms, means the economic document which contains the forecast by
a government of its expenditures and revenues for a specific period of time.
A budget usually covers a period of one year, known as a financial or fiscal year, which may or may not
correspond with the calendar year.
The budget in Tanzania is prepared and implemented on an annual basis and it runs according to the financial
year (also called the fiscal year), rather than the calendar year. In Tanzania the financial year goes from 1 July –
30 June. The financial year is typically cited in terms of the year it began as well as the year it ended. For
instance, the financial year that began 1 July 2012 and ended 30 June 2013 is referred to as “FY 2012/13.”
(Source: http://www.policyforum-
tz.org/files/EnglishUnderstandingtheBudgetProcessinTanzaniaCSOGuide_0.pdf)
The two key elements of any budget are the revenue and expenses.
In Tanzania, the Government gets revenue from two main sources – domestic revenue and foreign aid.
Domestic revenue refers to revenue that is raised within the borders of a country – from taxes paid by citizens,
duties on imports, profits from privatization, and various other fees.
The primary sources of domestic revenue are:
1. Tax revenue (main sources)

2. Customs duty
3. Value Added Tax (VAT)
4. Excise duty (imports and local)
5. Income tax
6. Non tax Revenue
7. User charges, e.g. school fees, water, medical charges, rents on government property
8. Dividends
In Tanzania, domestic revenue accounts for about 60% of the total Government budget.
The rest of the budget is mostly funded by foreign aid - grants and concessionary loans made by foreign
governments as well as multilateral institutions such as the World Bank. The other side of the budget is
expenditure - how the Government spends money. Analysing expenditure is critical for understanding
Government’s priorities, or choices. Since the amount of money that can be raised from domestic revenue and
foreign aid is limited, the Government must choose how and where to spend it.
1.1 The budget process
A budget process refers to the process by which governments create and approve a budget.
The budget process comprises stages which feed into one another in a circular process. We can think of four
main phases:
1. Budget formulation (Planning how to spend the money)

2. Debating and Approval of the Budget
3. Budget Execution (Spending the money)
4. Oversight and Control
The below diagram explains the budget process:

© GTG Government Budget: 43
Diagram 1: The budget process
(Source:http://www.policyforumtz.org/files/EnglishUnderstandingtheBudgetProcessinTanzaniaCSOGuid
e_0.pdf)
1.2 Types of budget
Budgets can be broadly divided into three types as:
1. Balanced budget
2. Deficit budget
3. Surplus budget
1. Balanced budget
When the total revenue that a government collects in a year is equal to the amount it plans to spend on
providing public goods and services and debt interest, it is called a balanced budget.
The traditional economists advocated the principle of the balanced budget. Like an individual or a family, the
government is also expected to be prudent and not spend more than its income/revenue.
However, modern economists have a different view. It is argued that a government budget is different from a
private budget both in terms of its objectives and designs. The aim of a government budget is to maximise the
social gain and this objective may not be achieved with a balanced budget.
Also, a balanced budget does not necessarily guarantee the non-existence of uneconomical /unnecessary
expenditure.
For instance, if an on-going project is stopped midway because of the fact that the expenditure expected in the
year on the project is more than what was budgeted for that year, this will result in delaying the overall
completion of the project which will increase the cost of the project. This is detrimental to the economic
development of a country.
2. Deficit budget
A budget deficit is a situation when the expenditure is more than the revenues of the government. Thus, there is
a shortfall of funds to finance the expenses, which needs to be made good by borrowing.
Some economists criticise the deficit budget on the following grounds:
(a) It is likely to result in increasing the money supply which may further result in creating inflationary pressure
in the economy. This causes a fall in the value of money and creates social and economic disturbance in
the country.
(b) There is a threat of increased expenditure by the government when the ideology of deficit budget is
accepted in the country.
However, some economists support the deficit budget policy on the ground that increased government
expenditure helps in creating accelerated income flow in the economy which boosts the demand for the goods
and services of the household sector. This leads to a healthier economy.
Tanzania government budget
Tanzania recorded a Government Budget deficit equal to 10.60 percent of the country's Gross Domestic
Product in 2011. Government Budget in Tanzania is reported by the Bank of Tanzania.
From 1998 until 2011, Tanzania Government Budget averaged -7.3 Percent of GDP reaching an all time high of
-1.7 Percent of GDP in June of 1998 and a record low of -11.9 Percent of GDP in June of 2004.
Government Budget is an itemized accounting of the payments received by government (taxes and other fees)
and the payments made by government (purchases and transfer payments). A budget deficit occurs when a
government spends more money than it takes in. The opposite of a budget deficit is a budget surplus.
This page contains - Tanzania Government Budget - actual values, historical data, forecast, chart, statistics,
economic calendar and news. 2013-10-21
Country Category Dates Actual Highest Lowest Unit Frequency

Tanzania Government budget 1998 - 2011 (10.60) (1.70) (11.90) % of GDP Yearly

(Source: http://www.tradingeconomics.com/tanzania/government-budget)
Explain how a deficit budget may result in increased interest cost.
3. Surplus budget
The opposite of deficit budget is surplus budget. When the revenue generated by the Government is more than
the public expenditure, it is a situation of surplus budget. In simple words, budget surplus is the saving of the
Government.
Some economists praise the surplus budget as a surplus is considered a sign that the government is being run
efficiently. A surplus budget enables the government to use the funds to pay off the national debt or to make
improvements in the public services such as creating more employment opportunities, construction of roads,
good education, affordable healthcare facilities etc.
For example, in the 2002-03 Budget an additional $138 million was provided for highways and roads of national
importance and $1.3 billion over five years to upgrade security in Australia. In 2006 the Future Fund was
established to assist the Government in meeting the cost of public sector superannuation liabilities by delivering
investment returns. The surplus can be used to contribute to this fund. Such action reduces the potential size of
the surplus.
(Source: http://www.hsc.csu.edu.au/economics/policies_mgt/2484/Topic4Tutorial3.html)
The surplus budget also enables the government to reduce taxes
In the 1999–2000 Budget when the government introduced The New Tax System (which replaced the wholesale
sales tax with a broadly based 10% GST, Goods and Services Tax); the reforms also included the largest
personal income tax cuts in Australian history. Most taxpayers (80%) now face a top marginal rate of 30%, down
from the percentage of taxpayers previously facing rates of up to 47%. Company tax rates were also reduced to
30%. Over the 2000s taxpayers received tax cuts in successive budgets. Again, such action reduces the
potential size of the surplus.
(Source: http://www.hsc.csu.edu.au/economics/policies_mgt/2484/Topic4Tutorial3.html)
The difference between what a government collects by way of taxes and what it spends is:
A Net revenue
B Net taxes
C Government budget deficit or surplus
D Government debt
2. Discuss the approaches to financing of government budget deficit.

A budget deficit is when a country's government spends more than what it collects from the public in the form
of taxes and duties.
Individuals, families, companies and other organisations all make budgets. So, sometime or the other, they all
experience situations of surplus and deficit. In situations of deficit, the deficit is financed through short or long
term borrowings. However, although the borrowing fulfils the immediate need for funds, it is costly as interest
needs to be paid on the borrowed funds. Also, the repayment terms need to be strictly observed, otherwise the
creditors will come calling. Also, non repayment of the borrowed funds results in losing the credibility of the
person or the organisation, which makes further borrowing difficult and expensive.
The same philosophy applies to the government, when its budget runs into deficit. Deficit budget is not
uncommon; most governments can run moderate deficits for years. However, there are consequences of
budget deficit even for the government, although the consequences aren't immediate. Therefore, sooner or
later, the government needs to find out ways to finance the budget deficit.
The various methods of financing a deficit budget are discussed as follows:
¾ Financing a deficit through borrowing from the country’s central bank: This form of borrowing from the
central bank basically means that the government prints money to finance the deficit.
¾ Financing a deficit through borrowing from the other sectors of the economy such as household sector,
business sector and financial sector by selling government securities such as treasury bonds.
¾ Financing a deficit by increasing the tax rates. Higher tax rates would earn higher revenue for the
government.
¾ Financing a deficit through borrowing from international financial markets or World Bank.
¾ Financing a deficit by selling government assets. However, this form of financing is not sustainable and can
only be used on a ‘one off’ basis.
As the budget session is scheduled to begin next month instead of June, the first half of the fiscal year 2012/13
has witnessed government budget recording an overall deficit of 943.7bn/-, which was financed by net foreign
loans of 439bn/- and a net domestic borrowing of 504.7bn/-.
The deficit was against the budgeted amount for the first half of this fiscal year. The full year budget was 13.5tr/-
The deficit arose following the government’s shortfall in collection of revenues from taxes on import, local goods
and services and non-taxes revenues against projected amount.
It only managed to surpass the projection on income taxes, other taxes and mobilize grants. The changes in the
period of tabling the budget are expected to spur development and increase efficiency in social services delivery
as it will allow timely allocation of cash to ministries and district authorities, experts have said.
According to the Central Bank monthly economic review for February this year shows that domestic revenue
collected by the central government was 4.12tri/- or 94.5 per cent of the target while tax revenue accounted for
92.0 per cent of total domestic revenue.
During the month under review, total expenditure amounted to 1.27tri/-, out of which recurrent expenditure was
608.1bn/- billion and development expenditure was 599.3bn/-. Domestic revenue amounted to 4.23tri/-,
exceeding the recurrent expenditures of 4.02tri/- .
Similarly, grants received during this period amounted to 1.14tri/- , compared to the projected amount of 1.08tri/-
The total expenditure amounted to 6.02tri/-, which is 87.7 per cent of the estimates. The recurrent expenditure
was 4.03tri or 87.2 per cent of the estimate, while development expenditure was 2tri/- or 88.6 per cent of the
estimates for the period.
Likewise, domestic revenue and grants amounted to 1.25tri/-, revenue collected by the central government was
899.4bn/-and was in line with the target. Tax revenue amounted to 864.9bn/-, 4.4 per cent higher than the
target.
Meanwhile, the Zanzibar government budget operations on cheques issued basis, registered a deficit of 3.2bn/-
after grants, which increased to 6.7bn/- after adjustment to cash.
The deficit was exclusively financed by foreign sources. Total resources amounted to 33bn/-, out of which
24.9bn/- were from domestic sources and the balance was grants. Total expenditure amounted to 36.2bn/-.
Revenue was 24.9bn/- compared to the target of 26.1bn/- in January 2013. Tax revenue was 23bn/-, accounting
for 92.4 per cent of the total revenue collection while non – tax revenue was 1.9bn/-, and was above the target
by 28.8 per cent.
(Source: http://www.24tanzania.com)
Answer to TY 1
A deficit budget situation occurs when a government’s spending exceeds its income. To bridge the shortfall, the
government needs to borrow funds. The increase in borrowing results in increased interest cost. Thus, the
higher the debt, the higher is the interest. This may weaken the economy as government revenue is used to pay
for finance costs rather than being used for productive purposes.
Answer to TY 2
The correct option is C.
Quick Quiz
1. Suppose in 2010, the city of Dar es Salaam collected Tshs500,000 in the form of taxes and spent
Tshs450,000. The city of Dar es Salaam will be said to have :
A Budget surplus of Tshs450,000.

B Budget surplus of Tshs50,000.
C Budget deficit of Tshs50,000.
D Budget surplus of Tshs5,000
2. When the expenditure is more than the revenues of the government, it is called a budget ____________
situation.
3. When the revenue generated by the Government is more than the public expenditure, it is a situation of
__________ budget.
The city of Dar es Salaam will be said to have budget surplus of Tshs5,000.
2. When the expenditure is more than the revenues of the government, it is called a budget deficit situation.
3. When the revenue generated by the Government is more than the public expenditure, it is a situation of
surplus budget.
Self Examination Questions
Question 1
What are the various ways in which the government can use a budget surplus?
Question 2
Explain the risk involved in borrowing money from overseas to finance a deficit budget.
Answer to SEQ 1
The government can use a budget surplus in various ways as follows:
1. The government can use the surplus to repay the debts taken in previous years to finance previous deficits.
This will result in reducing the interest payments. Interest payments saved by the government can then be
used to fund other areas of future expenditure.
2. The surplus can be used to fund government expenditure on infrastructure and the purchase of assets.
3. The surplus can also be used to fund tax cuts.
Answer to SEQ 2
Borrowing money from overseas is a common method of deficit financing. However, if the borrowed money is
not put to productive use, it will not generate sufficient returns. This, in turn, will result in problems in servicing
the debt. And it will ultimately show up in the form of an unstable currency. This will make further borrowing
difficult.
SECTION B
TAXATION - THEORY AND

POLICY
B1
STUDY GUIDE B1: THEORETICAL CONCEPTS
OF TAXATION
Tax is a financial charge imposed by the government. The fundamental purpose of taxation is to finance
government expenditure. Any money the government expends mostly comes from taxation.
You will agree that having to pay tax from your earnings is a painful experience. You must also have wondered
why the government needs to collect taxes. What is the purpose behind collecting a part of our hard-earned
money? Most of the tax payers feel that paying taxes is a waste of their money.
This Study Guide explains the basic theoretical concepts of taxation starting from the nature and essence of
taxation, distinguishing taxes from other sources of government revenue. Various approaches of classifying
taxes will be discussed followed by a discussion on the evaluation of the requirements of a good tax system.
Lastly this Study Guide will explain the optimal taxation theory.
a) Explain the nature and essence of taxation.

b) Identify the factors distinguishing a tax from other sources of government revenue.
c) Discuss the approaches to classification of taxes.
d) Evaluate the requirements of “a good” tax system.
e) Explain “optimal taxation” theory.
50: Taxation - Theory and Policy © GTG
1. Explain the nature and essence of taxation

Taxation traces its origin to the ancient times as a major source of revenue needed for governance. Kingdoms,
monarchies and even dynasties had an elaborate form of taxation imposed on their subjects to source funds
that were used to run affairs of the government. Taxation has had a long and influential history in the shaping of
civilizations throughout the world. All the great ancient civilizations – Egyptian, Romans , Greek, Persians, Zulu,
Oyo, Malian, Songhai, Benin – taxed their people to achieve a collective greatness.
Definitions of Tax
Tax is one of the most important social and economic issue that has kept both the experts and the public
preoccupied throughout the evolution of human civilization.
“Tax is a compulsory contribution to the state revenue, levied by the government on workers’ income and
business profits or added to the cost of some goods, services and transactions”
The Oxford Dictionary
“Tax is a compulsory a contribution imposed by a public authority regardless of the exact amount of service
rendered to the taxpayer in return”
Dalton (1978)
"Tax is any leakage from the circular flow of income into the public sector, excepting loan payments and direct
payments for publicly produced goods and services up to the costs of producing these goods and services."
Charles M. Allan (1971)
According to Allan, this definition is clearly relevant to fiscal economics and is stated in terms of income flows.
"Tax is unrequited, compulsory payments collected primarily by central governments."

The World Bank (1988:79)
However, a more comprehensive definition of tax is that given by Adam Smith which stresses the various
aspects of tax.
"From the standpoint view of the state, a tax is a source of derivative revenue; From the angle of the citizens, a
tax is a coerced payment; From the administrative point of view, it is a demand for money by state in conformity
to established rules; From the point of view of theory, a tax is a contribution from individuals for common
expenditure."
Professor Adam Smith
These definitions shed light not only on the conditions under which people make a contribution to their
government but also reflect a range of attitudes towards tax. In all definitions there is a pursuit to underpin
whether taxation is a civic obligation, a bond between the rulers and the ruled based on reciprocity or just an
unrequited payment to finance government expenditure.
Taxes are the first and foremost sources of public revenue. Taxes collected by Government are used to
provide common benefits to all mostly in form of public welfare services. Taxes do not guarantee any direct
benefit for person who pays the tax. The payment of tax is made by the members of the community without any
assurance given by the tax-levying authority that they will get direct benefit in return for paying the tax. There is
no direct give and take relationship between a taxpayer and the tax-levying public authority. It is worthy
to note that;
¾ Tax is compulsory
¾ It is paid by the taxpayer for the benefit of all
¾ It is not levied in return for any special services
© GTG Theoretical Concepts of Taxation: 51
Tax is a financial charge imposed by the government. The fundamental purpose of taxation is to finance
government expenditure. The imposition of taxation by governments withdraws money from the economy, and
their expenditure returns the money to the economy.
Taxes are the most important source of public revenue and are necessary for the functioning of the government.
Funds collected by way of tax are utilised by the government to provide various infrastructure/ facilities to the
taxpayer; however benefits of such public expenditure by the government is enjoyed even by those people who
are not liable to pay taxes.
Following are the essential elements of any tax:
¾ It is generally payable in money

¾ It is a proportion or a percentage
¾ It is levied on persons
¾ It is levied by the government
¾ It is levied in order to cater to public purpose
1.1 Nature of taxation
Revenue from taxation may be in several forms:
The main taxes employed within Tanzania are as follows:
Tax Suffered by
Revenue taxes
Income tax Individuals, Partnerships
Corporation tax Companies
VAT Final consumer
Capital taxes
Capital gains tax Individuals, Partnerships, Corporates
1. Revenue Tax
(a) Income tax
It is a tax levied on the income of an individual.
Income can be from any sources such as:
(i) income from earnings (e.g. employment income / trade profit)

(ii) income from pensions
(iii) income from other benefits (e.g. rental income)
(iv) income from savings (e.g. interest income)
(v) income from investments (e.g. dividend income)
Income tax is calculated on earned income (i.e. income from employment) as well as on income from savings
etc. Income from various sources is pooled together and tax is charged on the aggregate income after
deducting the relevant personal allowance.
(b) Corporation tax
It is the tax payable by companies on their ‘chargeable profits’.
(c) VAT
VAT is Value Added Tax. It is the tax which is paid on the value added. This tax is levied at each stage of
production. VAT is a consumption tax paid by customers in addition to the price of the product.
2. Capital taxes
(a) Capital Gains Tax
When a person sells an asset that is in his / her possession, the profit arising from such sale is chargeable to
tax as capital gains.
Therefore, capital gains tax liability arises when a ‘chargeable person’ makes a chargeable disposal of a
chargeable asset.
For example, Adam sells his business asset at a profit of £5,000. So, the amount of profit i.e. £5,000 is
chargeable to capital gains tax.
1.2 Purposes of taxation
(a) Economic purpose
Taxes have an economic significance; they are used to promote goals such as full employment, satisfactory
rates of economic growth, and stability of the money supply. The economic goals of taxation are achieved by
raising or lowering tax rates. The imposition of taxation by governments withdraws money from the economy,
and their expenditure returns the money to the economy. Government therefore uses taxation policies to
manage the economy by manoeuvring tax structure. For example, when government need to reduce inflation,
increase employment, protect consumers and society, balance of payment etc. it can simply rise or reduce tax
rate and decide to tax or not to tax some activities.
Taxes provide the money that makes it possible for government to function. Governments require substantial
revenue for expenditure on various public services, such as the provision of health, education, defence,
transport, administration of justice housing and many other services. All governments in the world depend
mostly on tax revenue to achieve their roles to their citizens. Failure to collect enough tax revenue might lead to
government failure or collapse of the government.
Therefore tax revenues are important because of governments need to manage the economy, regulate society,
develop society and provide public goods. Although these goods can be financed through other means, like
loans, even when governments borrow they need tax revenue to repay them.
(b) Social purpose
The government aims to reduce the gap between poor and rich; this has been a political agenda in our country.
Taxes are therefore used as a redistribution of wealth. The purpose of income redistribution is to lessen the
inequalities of wealth in society. In addition to taxing the rich more than the poor government can use cash
transfer system to reduce poverty and promote social equality. The effect of the system is to transfer money
from those who have much of it to those who have very little. Two of the most common examples are social
security payments and welfare payments made to people who, for one reason or another, do not work.
(c) Implementation of government policies
Taxation has been used as a tool of encouraging particular behaviour in a particular society. For instance tax
reduction may encourage an economic activity that perhaps it could not have existed. The introduction of Export
Processing Zone is one of examples which aim at encouraging exports.
(d) Environmental purpose
Taxation can be used as a regulation tool to protect the environment, domestic industries or sectors, consumers
and public in general. Government can enact heavy taxes on harmful products like cigarettes, liquor, etc. hence
making it expensive and discouraging its production.
It is considered unlikely that individuals will contribute voluntarily to protect the environment as they are unlikely
to be affected in their lifetime by the changes taking place. As a result, the government aims to protect the
environment through taxation and spending policies.
Identify two differences between the economic purpose and social purpose of taxation
2. Identify the factors distinguishing a tax from other sources of government revenue.
Government revenue
Government revenue arises from tax and non-tax sources. As discussed in Paper B4, non-tax revenue is
generated through various sources. Some of them are as follows:
1. User Fees
Fees are another important source of revenue for the government. A fee is charged by public authorities for
rendering a service to the citizens. Examples are payment made by users of public services on government cost
sharing in health and education, That is to say the payment made by user of public services i.e. health and
education. It is not the actual cost that they were required to pay rather than contribution on cost already
payable by the government. Other examples include fees charged for issuing of passports, driving licenses, etc.
What makes user fees different from conventional taxes is that there is no compulsion involved in case of fees.
They take the form of a direct payment to government for a specific service rendered to a specific taxpayer by
the state and the payment is usually made at the same time that the service is rendered. A tax-payer does not
receive any service as a direct return for the tax paid by him nor does the government guarantee any specific
benefit to be conferred upon him in return for any particular tax paid by him. A fee is the direct payment for the
service rendered to the payer and the government guarantees the services to the person who pays fees.
Common examples of user fees include:
i. Tuition fees at public universities (you pay when you enroll at a public university).
ii. Hospital fees (payable each time you use the services of a public hospital)
iii. Highway tolls (you pay each time you use a tolled highway);
iv. Car registration and driver’s license fees (you pay each time you register your car);
v. A business license fee
vi. Charge for the passport renewal
In each case, no one has to pay the fee unless they actually use the service. If you don’t drive a car or go to
public school, or public hospital, you don’t pay the user fees mentioned above.
2. Grants and Gifts
Grants and gifts are voluntary contributions by individuals or institutions to the government. Gifts are significant
source of revenue during war and emergency. A grant from one government to another is an important source
of revenue in the modern days. Grants from foreign countries are known as Foreign Aid. Developing countries
receive military aid, food aid, technological aid, etc. from developed countries. Unlike taxes, grants and gifts are
voluntary
3. Surplus from Public Enterprises
The Government also gets revenue by way of surplus from public enterprises. The Tanzania government has
set up several public sector enterprises to provide public goods and services. Some of the public sector
enterprises do make a good amount of profits. The profits or dividends which the government gets can be
utilised for public expenditure. There is some sort of quid-pro-quo in the case of surplus from public enterprises.
This is because, the public gets goods and services, and the government gets prices, and consequently profits
from selling such goods and services. However surpluses are not compulsory
4. Borrowing for Deficit Financing
Deficit means an excess of public expenditure over public revenue. This excess may be met by borrowings from
the market, borrowings from abroad, by the central bank creating currency. In case of borrowing from abroad,
there cannot be compulsion for the lenders, but in case of internal borrowings there may be compulsion. The
government may force various individuals, firms and institutions to lend to it at a much lower rate than the
market would have offered. It is ordinarily presumed that money borrowed will eventually be repaid from funds
raised from other sources of revenue, although in practice this may not always be the case.
Generally speaking, as a source of public revenue taxes is better than borrowing because it is merely
transferring of funds from the private hands to the public treasuries. There is an element of certainty in the
case of a tax. However, in practice, the democratic governments are frequently afraid of taxing people because
if people do not pay taxes and if a government imposes heavy taxes, it becomes unpopular and people may
vote it out of power. Therefore, as a matter of practical expediency, government prefers borrowing to taxing
people beyond the limits of safety.
5. Fines or Penalties
Fines or penalties are imposed as a form of punishment for breach of law or non-fulfilment or certain conditions
or for failure to observe some regulations. Like taxes, fines are compulsory payments without quid pro quo. The
distinction between taxes and penalties lies in the motive. A public authority imposes taxes mainly to obtain
revenue and imposes penalties mainly as a form of punishment or to deter people from doing certain acts. They
are not expected to be a major source of revenue to the government.
Common example of a fine is money paid for violations of traffic laws.
The unique factors which distinguish a tax from the other sources of government revenue are as follows:
(a) Taxes are mandatory charges; they are compulsory payment made to the government. People on whom a
tax is imposed must pay the tax. Taxes are not voluntary contributions, donations or gifts to the state.
Furthermore, refusal to pay the tax is a punishable offence.
(b) Only government or other taxing body has power to levy taxes, therefore other non government bodies like
sports clubs, churches, political parties can not charge taxes.
(c) Depending on tax laws all person regardless of their citizenship pay taxes though non-citizens now get
refunds of VAT paid in Tanzania for goods that will be spent outside of Tanzania. On the other hand, the
non-government revenue are received from either individuals or corporates(depending on the type of
revenue)
(d) A payment of tax, does not involve a “quid pro quo” status i.e. taxpayers cannot expect equal returns for the
tax paid. On the other hand generally the non-tax government revenue like user fees has the characteristic
of ‘quid-pro-quo’.
(e) Though individuals and legal persons pay taxes to government, the government does not have an obligation
to provide an individual account of how tax is utilized; in most cases; however governments account to
parliaments of behalf of taxpayers.
(f) Taxes are usually paid and collected in monetary terms either coins or paper money.
(g) Every tax involves some sacrifice on part of the tax payer.
(h) A tax is not levied as a fine or penalty for breaking law.
Explain three unique features of tax over the other sources of government revenue.
3. Discuss the approaches to classification of taxes

Taxes may be classified into different types according to various criteria like:
¾ tax base,
¾ tax incidence shift ability,
¾ unit or ad-valorem based taxes, and
¾ distribution of tax burden.
Each of the above are explained below.
3.1 Classification according to tax base
Tax base means what is being taxed and what is no. Under this basis we have the following classes:
(a) Income tax: taxed based on the quantum of income earned or received by taxpayers at specific period e.g.
corporate tax, PAYE for employee etc. Income base taxes are most popular taxes all over the world but as
we shall see, what constitutes income is highly debatable.
(b) Wealth tax: taxed based on wealth accumulated by taxpayers. In this category we have capital gain tax,
property taxes, etc. From those two bases we have income tax.
Sometimes wealth taxes can be easily measured and administered, for example land rent taxes which are
based on square metres. Also wealth tax can be used to tackle tax avoidance in the tax system, for
instance, if you buy shares in corporate entity you will only be taxed when you sell or receive dividends. On
the other hand some of wealth taxes are difficult to administer; issue such as inflation, valuation of
properties without being sold for council taxes make the wealth tax complex.
(c) Expenditure tax: taxed based on taxpayers spending their income or wealth accumulated. For example
value added taxes and excise duties on purchase of alcohol and cigarette. Expenditure taxes, unlike income
and wealth taxes relate to taxes on consumption from an economy. Thus, we do not have to worry about
valuation of income in expenditure taxes; and since taxpayers are taxed only if they spend the income or
wealth, they are somehow encouraged to save. However, if we depend only on expenditure tax base, some
income or wealth [savings] will not be taxed so we may end up paying high tax rate.
3.2 Classification according to ability to shift the tax incidence
Tax impact or formal incidence is legal requirement to pay tax. It refers to who is required by tax law to pay
taxes while tax incidence is the actual effect / burden of paying taxes by the one who actually pays taxes.
Building on this basis we have direct and direct taxes.
1. Direct tax
It is a tax levied directly on tax payers (individuals and non individuals) who are required to by tax laws to pay
taxes with no possibility of shifting the incidence to another person. In this case the tax impact and incidence
falls on the same person. Thus the tax is levied on and paid by the same person.
Examples of direct taxes include:
i. Income taxes
¾ Corporate tax - 30% of all companies (whether resident or none resident) carrying on a business in
Tanzania.
¾ Individual Income Tax - non-corporate resident tax payers including sole proprietors and salaried
employees are taxed at progressive individual income tax rates,

ii. estate duty, property tax and capital gain tax
iii. Skills and development levy - a tax on the gross monthly emoluments paid by an employer to employees.
iv. Game of chance and Gambling Tax - charged to casinos, private lotteries and slot machines.
v. Withholding taxes - a scheme, that is basically not a tax source in itself that is operated on a number of
payments made by persons in course of doing businesses/investments. [e.g. investment income, etc].
(a) Benefits of Direct Taxes
The direct taxes are always regarded to be more equitable than indirect taxes because they can be related to
taxpayer’s ability to pay through the progressive rate structure where a change in income automatically pushes
the taxpayer to the next higher or lower tax bracket without altering the tax rates.
Direct taxes also create public consciousness since the taxpayers are made to feel the burden of taxes directly
and hence take keen interest in how public funds are spent. The taxpayers are likely to be more aware about
their rights and responsibilities as citizens of the state.
The direct taxes can help to control inflation. During inflationary periods, the government may increase the tax
rate. With an increase in tax rate, the consumption demand may decline, which in turn may reduce inflation.
The direct taxes are relatively elastic. With an increase in income and wealth of individuals and companies, the
yield from direct taxes will also increase. Elasticity also implies that the government's revenue can be increased
by raising the rates of taxation. An increase in tax rates would increase the tax revenue.
As far as direct taxes are concerned, the tax rates are decided in advance therefore the tax payer is certain as
to how much he is expected to pay. The Government can also estimate the tax revenue from direct taxes with a
fair accuracy.
(b) Criticisms of Direct Taxes
An important criticism of direct taxes is the possibility that highly progressive direct taxes may have serious
disincentive effects. It may reduce people's ability and willingness to work and save and thus have a negative
impact on investment and productive capacity in the economy. If tax burden is high, people's consumption level
gets adversely affected and this has an impact on their ability to work and save. High taxes also discourage
people from working harder in order to earn and save more.
In direct tax burden of tax cannot be shifted. The disadvantages of direct taxation are therefore mainly due to
administrative difficulties and inefficiencies. The extent of direct taxation should depend on the economic state
of the country. A rich country has greater scope for direct taxation than a poor country.
Direct taxes are inconvenient in the sense that they involve several procedures and formalities in filing of
returns. For most people payment of direct tax is not only inconvenient, it is psychologically painful also. When
people are required to pay a sizeable part of their income as a tax to the state, they feel very much hurt and
their propensity to evade tax remains high.
It is also argued that direct taxes are prone to tax evasion. Indeed compared to indirect taxes it is said that direct
taxes are easier to evade. The tax evasion is due to high tax rates, documentation and formalities, and poor and
corrupt tax administration. It is easier for the businessmen to evade direct taxes. They invariable suppress
correct information about their incomes by manipulating their accounts and evade tax on it. In due to high rate of
progressive tax evasion & avoidance are extensive.
The direct taxes tend to be arbitrary. Critics point out that there cannot be any objective basis for determining
tax rates of direct taxes.
2. Indirect tax
It is a tax whose incidence can easily be shifted to another person from a person who is required to pay it by
law. In other words tax incidence in indirect taxes falls on another person than the one paying the tax. For
example VAT is paid by a consumer to a retailer / manufacturer, at the time of purchase of goods. However the
retailer / manufacturer is required to pay this tax (which is collected) to the government.
The ability of taxpayers to shift tax incidence to others depend on a number of factors such as market
structures, industry cost structure, price elasticity of product, and types of tax.
When taxpayers are operating in imperfect market as monopoly, oligopoly, and duopoly where products are
differentiated and there is imperfect communication, tax incidence may easily be shifted. It is difficult to shift tax
burden in perfect market containing many buyers and sellers, full knowledge, no restrictions of exist and entry
as small increase in price lead to significant decrease in sales.
In increasing cost structure any attempt to shift the tax incidence will increase the price of goods that are
probably perceived already high by taxpayers. Therefore a rational taxpayer cannot try to shift tax incidence in
that situation. Taxpayers can possibly shift tax burden in constant cost structure and justify it to his/her
customers, but he/she can easily put the tax burden on customers shoulder in decreasing cost structure simply
by maintaining the price.
The price elasticity of product describes the demand changes due to a change in prices. The product is elastic if
small change in price leads to great change in demand hence less possibility of shifting tax incidence in respect
to that product. If a change in price leads to a very small change in demand the price elasticity is said to be
inelastic, and in this situation there is very high possibility of shifting tax incidence.
Generally if tax is classified as indirect tax there is more possibility of shifting tax incidence while in direct tax it
is not easy to shift tax incidence as tax authority identify and charge tax direct to the tax payer.
Examples of indirect taxes include:
¾ Excise duty on locally manufactured goods - levied on locally manufactured goods which includes beer,
wines, whiskeys, spirits, soft drinks, smoking tobacco, cigarettes, and petroleum products.
¾ Stamp duty - certain legal instruments attract payment of stamp duty for the purpose of authenticating them.
¾ Value Added Tax (VAT) - a consumption tax charged on VAT registered traders for goods and services at a
standard rate of 18%.
¾ Other Internal Taxes such as fees, levies and user charges, which are collected from various sources. For
example. taxes and charges on motor vehicles, port and airport departure services.
¾ Import duty or customs duties. These are tariffs, which are imposed on goods coming into the country.
¾ Excise duty on imports of certain consumer goods into the country.
(a) Advantages of Indirect Tax
¾ Indirect tax is convenient to both the Government and the taxpayer. It is convenient to taxpayer as the
taxpayer do not feel the burden much because they do not pay a lump sum amount for tax and that tax is
paid only when making purchases. Moreover, the tax is "price-coated" i.e it is wrapped in price and
therefore the burden can not be easily felt. It is convenient to the Government as well because the business
owners collects the tax on the Government’s behalf when they charge a price.
¾ There is mass participation. Each and every person getting goods or services has to pay tax. Indirect taxes
are the only means of reaching the poor who are always exempted from paying direct taxes. It is a sound
principle that every individual should pay something, however little, to the Government.
¾ Unlike direct taxes, the indirect taxes have a wide coverage. Majority of the products or services are subject
to indirect taxes. The consumers or users of such products and services have to pay them.
¾ Indirect taxes can be used to influence pattern of production by imposing taxes on certain commodities or
sectors, the government can achieve better allocation of resources. For example by Imposing taxes on
luxury goods and making them more expensive, government can divert resources from these sectors to
sector producing necessary goods.
¾ When imposed on luxuries or goods consumed by the rich, indirect taxes are considered equitable as only
the well-to-do will pay the tax.
¾ Indirect taxes are very elastic in yield, if imposed on necessity goods which have an inelastic demand and
therefore can yield very large revenue, because people must buy these goods. However the dilemma of
indirect taxation is the fact that it is based on consumption and therefore hits the majority of lower income
earners.
¾ There is a less chance of tax evasion as the taxpayers pay the tax collected from consumers. They cannot
be evaded, as they are a part of the price. They can be evaded only when the taxed commodity is not
consumed, and this may not always be possible.
¾ The government can check on the consumption of harmful goods by imposing higher taxes to those goods
such as tobacco, and other intoxicants.
¾ The indirect taxes may not affect the motivation to work and to save. Since, most of the indirect taxes are
not progressive in nature, individuals may not mind to pay them. Therefore, individuals would not be
demotivated to work and to save, which may increase investment
¾ The indirect taxes are more flexible and buoyant. Flexibility is the ability of the tax system to generate
proportionately higher tax revenue with a change in tax base, and buoyancy is a wider concept, as it
involves the ability of the tax system to generate proportionately higher tax revenue with a change in tax
base, as well as tax rates.
(b) Disadvantages of Indirect Tax
¾ The biggest criticism of indirect taxes, is that they do not take into account the taxpayer’s ability to pay Both
the rich and the poor pay exactly the same amount of tax. It is therefore regressive because tax burden to
the rich and poor is the same making the poor spending a greater percentage of their income than the
higher income earners. This may further increase income disparities among the rich and the poor.
¾ Indirect tax is uncertain. As demand fluctuates, tax will also fluctuate. Unless necessecities are taxed (which
is normally not the case) the yield is uncertain. Taxes on commodities with elastic demand are particularly
uncertain, since quantity demanded will greatly be affected as prices go up due to the imposition of tax. In
fact a higher rate of tax on a particular commodity may not bring in more revenue.When the commodity is
not purchased, the question of the tax payment does not arise.
¾ Indirect tax has a direct effect on consumption, production and employment. For instance, a high rate of
duty on certain products such as consumer durables may restrict the use of such products. Consumers
belonging to the middle class group may delay their purchases, or they may not buy at all. The reduction in
consumption affects the investment and production activities, which in turn hampers economic growth.
¾ Most of the taxes are concealed in the price of goods or services. As a consequence, the tax-payer does
not even know that he is paying a tax let alone know the amount of tax he paid to the Government.
¾ They are uneconomical. The cost of collection is quite heavy. Every source of production has to be guarded.
The government has to set up elaborate machinery to administer indirect taxes. Therefore, cost of tax
collection per unit of revenue raised is generally higher in the case of most of the indirect taxes.
¾ The indirect taxes are inflationary in nature. The tax charged on goods and services increase their prices as
taxes are shifted forward.
3.3 Classification according to quantities or values
There are two types of taxes under this category: us unit and ad-valorem taxes.
¾ A unit or specific tax is levied on the physical measures of what is being taxed e.g. volume, weight, square
meters like land and property taxes etc.
¾ Ad-valorem tax is levied on the value of the tax base, for example income tax is charged on the level of
income, VAT on consumer expenditure and import duty.
3.4 Classification for hypothecated taxes
The hypothecation of a tax (also known as the ring fencing or ear marking of a tax) is a tax where the money
obtained, or part of the money obtained, is used for a particular purpose, rather than spent on a number of
things. These are taxes that are raised to pay for specific activities.
Rural energy fund, taxes charged when we buy electricity from TANESCO and skill and development levy paid
by employers to raise fund to the Vocational Education and Training Authority (VETA) for the purposes of
providing the skills to the workforce that employers require the levy is also used to finance the Higher Learning
Students Loan Board [HLSLB].
Another example in many European countries is a television license. There, all users of television sets are
obliged to pay the government an annual fee to use their televisions. The proceeds of the levy are then used to
fund public broadcasting.
Dedicating tax revenues to specific expenditures can however be used by policymakers to mask increases in
total government spending, and it has been shown empirically that hypothecated taxes tend to result in an
increase in total government size but have little effect on the expenditures to which they are tied.
3.5 Classification according to distribution of tax burden fairness
Under this categorization we have progressive, proportion and regressive taxes.
1. Progressive taxes: as income rises so does the proportion of tax i.e. the rate of tax rises as well as the
amount of tax. Furthermore in this case marginal rate of tax is greater than the average rate of tax. This can
be considered as just and fair, as the higher tax payments are made by those with higher incomes. Taxes
which take a higher percentage of the incomes of higher income earners are said to be progressive.
2. In proportional taxes the amount of tax to be paid increases in the same way as the rise in income or any
tax base. It occurs when marginal rate of tax and average rate of tax being equal, good example all tax
payers paying 10% constant of their income.
3. Regressive taxes increase slower than the rise in income and the marginal rate of tax (MRT) is less than
average rate of tax (ART). As income rises, the proportion of tax decreases, e.g. the tax on a packet of
cigarettes remains the same, regardless of the income of the consumer. Regressive taxes can be justified
as smokers are likely to require additional hospital care, which is the reason why they should contribute
towards the cost of it. Taxes which take a higher proportion of the incomes from lower income earners are
said to be regressive.
Most of income and wealth taxes belong to either progressive or proportion taxes which mean that the richer
pay more in progressive tax while they (the rich) suffer the same as poorer in proportional tax.
In progressive tax system taxpayers will end up paying different tax rates depending on their incomes, with the
higher income earner attracting high tax rate.
Assume that Mrs Kanje earns Tshs 1,000,000 per month which is subjected to say 20% tax rate under PAYE
and her friend Mrs. Swabiri gets Tshs 200, 000 per month which is taxed at say 10% under PAYE. You will end
up paying different taxes under progressive tax system, you pay Tshs 100,000 and she/he pays 20,000 to TRA.
If it was proportional tax system they would all be subjected to the same tax rate, for example 20%, Mrs Kanje
would pay Tshs. 200,000 and Mrs. Swabiri would pay 40,000.
In the regressive taxes wealthy taxpayers spend proportionally less of their income than poorer. Consequently,
the poor spend much of their income in paying regressive taxes. In regressive system taking the example, Mrs
Kanje and Mrs. Swabiri buy food at Bestbite for Tshs 10,000 assume it includes Tshs 1,000 as VAT. The richer
(Mrs Kanje) would have spent 1,000/1,000,000=0.1% paying for taxes in this transaction, while poorer (Mrs.
Swabiri) would have spent 1,000/200,000=0.5% paying for VAT significantly above the richer (Mrs Kanje)
burden.
Marginal rate of taxation (MRT) and Average Rates of Taxation (ART)
The marginal and average rates are very important to both government and taxpayers. Marginal rates of
taxation is the rate of tax which is due if taxpayers earn Tshs 1 more than their current income. The average
rate of tax is the total amount of tax paid as a proportion of their total income.
Change in tax paid or amount of tax paid on next Tshs 1 on income

MRT =
Change in income
Total tax due

ART =
Total income
The taxpayers care more about the marginal rate of tax than average rate of tax as it shows how much they are
going to pay as taxes for an increase in income. Take an example of employed taxpayers who want to work
overtime to earn more income, the progressive nature of our payroll taxes mean that the extra income will be
taxed more. Progressive taxes may discourage hardworking individuals, while the government can induce hard
working spirit through decreasing the marginal rate of taxation.
Compute the marginal rate of tax and average rate of tax from following information:
Year Income 'Tshs' Tax paid 'Tshs '

2010 1,500,000 450,000
2011 2,000,000 600,000
2012 2,500,000 750,000
2013 3,000,000 900,000
Answer
Marginal rate of tax is given by change in tax paid over change in income giving the following results.
Year Change in income Change in tax amount Marginal rate of tax %

2010 -
2011 500,00 150,000 30
2012 500,00 150,000 30
2013 500,00 150,000 30
While the average rate of tax is total tax paid/total income.
Year Income 'Tshs' Tax paid 'Tshs ' Average rate of tax
2010 1,500,000 450,000 450,000 / 1500,000 = 30%
2011 2,000,000 600,000 30%
2012 2,500,000 750,000 30%
2013 3,000,000 900,000 30%
Comment: this is a proportion tax system as marginal and average rate of tax are equal.
Explain three advantages of indirect taxes as compared to direct taxes.

4. Evaluate the requirements of “a good” tax system.

It has been provided earlier that taxation has been around in various forms for years, dating back to the Romans
and in deed Africa, all the great emperors and kings demanded and received tax in form of tribute or a
proportion of farm produce or profit from trading goods from their subjects.
However, these taxes were subjective and biased depending on those in power. Advancement in education led
to important studies on the possible forms of taxation that reflected the aspirations and welfare of the people.
Owing to this therefore, Adam Smith, accredited as the “Father of modern political Economy” carried out an
extensive study in Public Finance seeking to give an in-depth analysis of taxation. Smith documented the
findings in his book known as “Wealth of Nations” in 1776. It is in this work that Smith scripted the four maxims
of taxation which were later globally adopted as the Canons of Taxation which are summarized as:
i. equity
ii. certainty
iii. convenience
iv. efficiency
Since Adam Smith’s time there have been a lot of transformations to governments some of which are functional.
Government are expected more to maintain economic stability, fuel employment, reduce income inequality and
promote growth and development. Tax systems should be such that it meets the requirements of growing
government activities. These transformations lead economists to come up with additional canons:
v. Flexibility
vi. Neutrality
vii. Tranparency
viii. Diversity
ix. Elasticity
1. Equity
One of the fundamental criteria for a good tax system is that it should be levied on the important principle of
fairness or equity. The canon of equity states that there should be justice, in the form of equity, when it comes to
paying taxes. Not only does it bring social justice, it is also one of the primary means for reaching the equal
distribution of wealth in an economy. The word equity here does not mean that everyone should pay the exact,
equal amount of tax but the rich people should pay more taxes and the poor pay less. The canon of equity
remains the most important principle of taxation in advancing fairness in government’s revenue collection from
the people. It requires that every taxpayer contributes towards government support based on his ability to pay.
The distributional can either be horizontal equity or vertical equity.
The cannon of equity or fairness are further understood from two scenarios: people with the same ability paying
same taxes (horizontal equity) and people with different abilities paying different taxes (vertical equity). Both
scenarios lay emphasis on the fact that taxes should be paid in manner that is fair to all the involved parties.
Depending on the way these scenarios are understood, horizontal and vertical equity can be seen as
complimentary. However there is a thin line that distinguishes horizontal equity from vertical equity even when
they have a similar basis. The point of divergence between these two forms of equity can clearly be seen when
the benefit principle is incorporated ability to pay principle. Essentially despite people earning the same amount
of income, the level of benefit from public goods and services may vary as the incomes increase. As dictated by
vertical equity, the benefit tax incurred may either be proportionate, progressive or regressive depending on the
proportion of variation benefits in public goods to the increased income. However, horizontal equity maintains
that people with same incomes should pay similar taxes.
2. Administrative efficiency and simplicity
The collection and disbursement of taxes should take place with the lowest possible cost, e.g. tax revenue must
be collected in an efficient way. Efficiency is concerned with neutrality, compliance and administrative efficiency.
Taxes should be levied in an economy friendly manner that spurs a country’s economic development.
Furthermore, compliance of law should be at the lowest possible compliance costs. Compliance costs are cost
paid by taxpayers in fulfilling their obligation for keeping records, buying electronic fiscal devices for VAT, paying
for financial annual audit or tax preparers etc. The more simple and efficient the tax system is, the ‘cheaper’ it
becomes.
The system of taxation should be made as simple as possible. The entire process should be simple, non-
technical and straightforward. Taxpayers should be able to understand the technical, fiscal and spirit of tax laws
in order to comply easily. The tax base should be easy to identify, taxpayers should be able to compute tax
payable with minimum difficulty and make necessary payments on the correct statutory due dates. They have to
know who is supposed to pay what, when and how and the consequences of not paying or not obliging to tax
laws. Unfortunately, most tax laws are not simple; they are full of technical legal jargons not easily understood
by most of taxpayers. This results in increases in compliance costs to taxpayers and high administration costs
on part of tax authority.
A simple taxation system is valuable in promoting voluntary tax compliance and can partly increase the equality
of the system, because then the taxpayer has a better chance of evaluating the effects of taxation. A complex
tax system complicates the evaluation and requires more resources. Basically, when tax system affects
investment decision of taxpayers is not neutral. The efficiency of the taxation decreases when it includes
exceptions and deductions. These also narrow the tax base.
Furthermore, the administrative costs (staff, machine, auditing, taxpayers' surprise visits and inspection) of tax
authority should not be too much. However, the reduction of tax administration costs can be simply shifted to
taxpayers. The introduction of self-assessment for example, shifted the burden from the authority to taxpayers
hence increasing the compliance costs.
3. Certainty
This criterion demands that the quantity, manner and time of payment should be well defined so as there is a
higher degree of certainty concerning tax payment and the budget in its entirety. Everything should be made
clear, simple and absolutely certain for the benefit of the taxpayer. The canon of certainty is considered a very
important guidance rule when it comes to formulating the tax laws and procedures in a country. The canon of
certainty ensures that the taxpayer should have full knowledge about his tax payment, which includes the
amount to be paid, the mode it should be paid in and the due-date. It is believed that if the canon of certainty is
not present, it leads to tax evasion.
In addition it is also important for the taxpayer that the tax system is predictable. This creates a possibility for
future evaluation of the economic behavior of tax treatment since it affects the decisions of households and
corporations at the present. Predictability is especially appreciated when one is making decisions in the long
run. Predictability requires continuity from tax policy, which should be taken into account in tax reforms.
4. Convenience
Canon of convenience can be understood as an extension of canon of certainty. Where canon of certainty
states that the taxpayer should be well-aware of the amount, manner and mode of paying taxes; the canon of
convenience holds that taxes should be collected at the most convenient time to the taxpayer probably at the
end of the month for those who are on a monthly salary. All this should be easy, convenient and taxpayer-
friendly. If the time and manner of the payment is not convenient, then it may lead to tax evasion and corruption.
5. Flexibility
The tax system should be as flexible as possible as the macroeconomic factors change. The ability of tax
system to cope with change in economic conditions such as boom, recession or stagnant is known as flexibility.
Government may need to manage an economy which is growing at an unacceptable rate by taking more tax
revenue from the taxpaying community or may want to reduce inflation by just decrease taxes. This is not
simple job if the tax system is not flexible.
6. Diversity
Canon of diversity refers to diversifying the tax sources in order to be more prudent and flexible. Being heavily
dependent on a single tax source can be detrimental for the economy. Canon of diversity states that it is better
to collect taxes from multiple sources rather than concentrating on a single tax source. Otherwise, the economy
is more likely to be confined, and hence, its growth will be limited as well.
It is also important to emphasize the fairness of the tax system. If the majority of taxpayers regard the tax
system as unjust, the credibility of the tax system and its ability to function suffer. The lack of fairness might
result in emphasized and aggressive tax planning, tax sheltering and in worst-case scenario in tax mutiny. The
qualities pursued for the tax system contain an ecologically secure base. This means that environment-related
taxation must be in unison with the principles of sustainable development. The significance of this criterion is
clearly emphasized.
7. Transparency
Transparency is also essential in a good tax system. The transparency and clarity of the tax system suffer, if
taxation has a lot of exceptions and deductions. These reduce the tax base, in which case taxes per GNP must
be increased in order to gain the same amount of tax revenue. This is regretful, for a rise in taxes per GNP
increases distortions caused by taxation. An extensive tax base and clarity in taxation decrease possibilities for
illegal tax planning and tax sheltering.
8. Canon of Elasticity
An ideal system of taxation should consist of those types of taxes that can easily be adjusted. This means that
taxation must have built-in flexibility.Taxes, which can be increased or decreased, according to the demand of
the revenue, are considered ideal for the system. An example of such a tax is the income tax, which is
considered very much ideal in accordance with the canon of elasticity. Taxation should be elastic in nature in
the sense that more revenue is automatically fetched when income of the people rises.
This example can also be taken in accordance with the canon of equality. Flexible taxes are more suited for
bringing social equality and achieving equal distribution of wealth. Since they are elastic and easily adjustable,
many government objectives can be achieved through them.
Many of the qualities mentioned above can collide with each other, therefore choices and compromises must be
made between them.
Explan any two cannons of taxation
5. Explain “optimal taxation” theory.

One of the main problem of taxation is that of excess burden, Unless they are lump–sum taxes, taxes have an
excess burden. Lump–sum taxation, however is impossible. So the concern has been on how should taxes be
designed so as to minimize the excess burden? Indeed, the appropriate design of a tax system has been a
central issue in public economics. Such a system is required to be able to balance the various desirable
attributes of taxation: taxes must be raised (revenue-yield) in a way that treats individuals fairly (equity), that
minimizes interference in economic decisions (efficiency), and that does not impose undue costs on taxpayers
or tax administrators (simplicity).
Optimal tax theory or the theory of optimal taxation is the study of designing and implementing a tax that
reduces inefficiency and distortion in the market under given economic constraints. Generally, this criterion
consists of individuals' utility and the optimization problem involves minimizing the distortions caused by
taxation.
Optimal tax theory addresses such questions as:
¾ Should the government use income or commodity taxes?
¾ Within commodity taxes, how should tax rates vary across commodities?
¾ How progressive should the tax system be?
Optimal tax theory encompasses a range of models that focus on particular aspects of the tax system. These
different models share three features.
¾ First, each model specifies a set of feasible taxes for the government, such as commodity taxes, and the
government’s revenue needs. In the simplest models, the government’s objective is to minimize the excess
burden generated by the tax system while raising a set amount of revenue.The models typically rule out
lump-sum taxes, which would cause no economic distortion.
¾ Second, each model specifies how individuals and firms respond to taxes. That is, individuals have
preferences about goods and leisure; firms have a given technology for producing goods; and individuals
and firms interact in a given market structure (often perfect competition).
¾ Third, the government has an objective function for evaluating different configurations of taxes. One of the
oldest strands of the optimal tax literature is the optimal configuration of commodity tax rates. The basic
question is whether uniform commodity tax rates—taxing all goods and services at the same rate—are
optimal. This problem is commonly referred to as the Ramsey problem after the solution proposed by
Frank Ramsey in 1927. The short answer is that, abstracting from the collection costs of administering
differentiated tax rates, uniform commodity taxes are rarely optimal.
The outcomes from optimal tax models depend on the set of possible taxes the government can implement. A
longstanding debate surrounds the choice between indirect (e.g., commodity) and direct (e.g., income) taxation.
That is, when the government can use both direct and indirect taxes, what is the optimal mix of taxes?
Commodity taxes are said to be a relatively inefficient way of increasing the equity of a tax system that includes
an optimally designed income tax. However, there may be administrative reasons for using indirect taxes.
One major consideration in designing an optimal tax system is how taxes interact with market imperfections.
Externalities, such as pollution, are one example of a market imperfection that can affect optimal tax policy.
Taxes on activities that create externalities can be one mechanism to reduce the economic inefficiency caused
by externalities. For example, a tax on polluting may have the social benefit of reducing the level of pollution.
Optimal tax models aim at correcting externalities suggest that the optimal tax balances the marginal social
damage from the externality with the marginal social benefit of the activity that generates the externality.
The optimal tax does not necessarily eliminate the activity that generates the externality; for example, even with
an optimal tax there may still be some pollution. One of the criticisms of optimal tax theory—which among other
things prescribes that each good in an economy should be taxed at a separate rate, higher for necessities and
lower for things with good substitutes—is that it ignores the administrative costs of tax systems.
Explain one of the major considersations of designing an optimal tax system
Answer to TY 1
Economic purpose of taxation Social purpose of taxation

Taxes are used to promote goals such as full Taxes are used to reduce the gap between poor and
employment, satisfactory rates of economic growth, rich. Taxes are therefore used as a redistribution of
and stability of the money supply. wealth.
Tax revenues are important because of governments In addition to taxing the rich more than the poor
need to manage the economy, regulate society, government can use cash transfer system to reduce
develop society and provide public goods. poverty and promote social equality.
Answer to TY 2
(a) Taxes are mandatory charges; they are compulsory payment made to the government. People on whom a
tax is imposed must pay the tax. Taxes differ from contributions, donations or gifts to the state, which are
voluntary. Furthermore refusal to pay the tax are a punishable offence.
(b) A tax is not levied as a fine or penalty for breaking law. On the other hand, fines or penalties are imposed as
a form of punishment for breach of law or non-fulfilment or certain conditions or for failure to observe some
regulations.
Though individuals and legal persons pay taxes to government, the government does not have an obligation to
provide an individual account of how tax is utilised; in most cases; however governments account to parliaments
of behalf of taxpayers.
Answer to TY 3
The advantages of indirect taxes in comparison to direct taxes are as follows:
¾ Indirect tax is convenient to both the Government and the taxpayer. It is convenient to taxpayer as the
taxpayer do not feel the burden much because they do not pay a lump sum amount for tax and that tax is
paid only when making purchases. Moreover, the tax is "price-coated" i.e it is wrapped in price and
therefore the burden can not be easily felt. It is convenient to the Government as well because the business
owners collects the tax on the Government’s behalf when they charge a price.
¾ There is mass participation. Each and every person getting goods or services has to pay tax. Indirect taxes
are the only means of reaching the poor who are always exempted from paying direct taxes. It is a sound
principle that every individual should pay something, however little, to the Government.
¾ Unlike direct taxes, the indirect taxes have a wide coverage. Majority of the products or services are subject
to indirect taxes. The consumers or users of such products and services have to pay them.
Answer to TY 4
Two canons of taxation are as follows:
(i) Canon of elasticity
An ideal system of taxation should consist of those types of taxes that can easily be adjusted. This means that
taxation must have built-in flexibility.Taxes, which can be increased or decreased, according to the demand of
the revenue, are considered ideal for the system. An example of such a tax is the income tax, which is
considered very much ideal in accordance with the canon of elasticity. Taxation should be elastic in nature in
the sense that more revenue is automatically fetched when income of the people rises.
(ii) Administrative efficiency and simplicity
The collection and disbursement of taxes should take place with the lowest possible cost, e.g. tax revenue must
be collected in an efficient way. Efficiency is concerned with neutrality, compliance and administrative efficiency.
Taxes should be levied in an economical manner that spurs a country’s economic development. Furthermore,
compliance of law should be at the lowest possible compliance costs. Compliance costs are cost paid by
taxpayers in fulfilling their obligation for keeping records, buying electronic fiscal devices for VAT, paying for
financial annual audit or tax preparers etc. The more simple and efficient the tax system is, the ‘cheaper’ it
becomes.
Answer to TY 5
One major consideration in designing an optimal tax system is how taxes interact with market imperfections.
Externalities, such as pollution, are one example of a market imperfection that can affect optimal tax policy.
Taxes on activities that create externalities can be one mechanism to reduce the economic inefficiency caused
by externalities. For example, a tax on polluting may have the social benefit of reducing the level of pollution.
Optimal tax models aim at correcting externalities suggest that the optimal tax balances the marginal social
damage from the externality with the marginal social benefit of the activity that generates the externality.
Quick Quiz
Which of the following statements is true?
1. A user fee entitles the payer to a specific good or service from the government
2. When designing a tax, governments try to identify tax bases that taxpayers can easily avoid or conceal
3. A tax is a payment to support the cost of government.
4. The Tanzanian income tax is a regressive tax
5. Ad-valorem tax is levied on the physical measures of what is being taxed

1. True
2. False
3. True
4. False
5. False
Self –Examination Questions
Question 1
Describe briefly the following terms:
(a) Progressive taxes

(b) Proportional taxes
(c) Regressive taxes
(d) Marginal rate of tax
(e) Average rate of tax
Question 2
Discuss the non-taxation sources of government revenue in the country apart from Tax revenue.
Answers to Self-Examination Questions
Answer to SEQ 1
(a) A progressive tax is a tax where the tax rate increases as the taxable base amount increases. The term
"progressive" refers to the way the tax rate progresses from low to high, with the result that a taxpayer's
average tax rate is less than the person's marginal tax rate. The term can be applied to individual taxes or to
a tax system as a whole; a year, multi-year, or lifetime. Progressive taxes are imposed in an attempt to
reduce the tax incidence of people with a lower ability-to-pay, as such taxes shift the incidence increasingly
to those with a higher ability-to-pay. (Progressive taxes can also be thought of as taxes where the marginal
tax rate is higher than the average tax rate.)
(b) A proportional tax (sometimes called a flat tax) is a tax where everyone, regardless of income, pays the
same fraction of income in taxes. (Proportional taxes can also be thought of as taxes where marginal and
average tax rates are the same.)
(c) A regressive tax is a tax where lower-income entities pay a higher fraction of their income in taxes than do
higher-income entities. (Regressive taxes can also be thought of as taxes where the marginal tax rate is
less than the average tax rate. This will be discussed in more detail later.)
(d) Marginal tax is simply the amount of tax paid on an additional dollar of income. As income rises, so does the
tax rate. This is different than a flat tax rate where you pay the same rate of tax no matter what your income
level is.
(e) Average tax is the percentage of tax paid based on your total gross income and reflects the total tax you are
paying. It is the total amount of tax you will pay through all the brackets divided by total income and will
mathematically always be lower than the marginal tax rate.
Answer to SEQ 2
Revenues obtained by the government from sources other than tax are:
¾ Fees charged by government for rendering certain services. These are payment made by users of public
services on government cost sharing in health and education, That is to say the payment made by user of
public services i.e. health and education is not the actual cost that they were required to pay rather than
contribution on cost already payable government.
¾ Grants and Gifts
¾ Fines and penalties are the payments made for the contravention of law.
¾ The Government also gets revenue by way of surplus from public enterprises.
¾ Borrowing of money.
SECTION B

POLICY
B2
STUDY GUIDE B2: THEORIES OF TAX
DISTRIBUTION
Traditionally there are two theoretical notions of how tax payments should be assigned. One is the benefit
principle and another is the “ability to pay” principle. According to the benefit theory, the persons who receive
benefits from the government should pay amount as taxes which are equivalent to the benefits received. On the
other hand, the “ability to pay” principle suggests that people with higher incomes should pay more than
those with lower incomes.
Knowledge of this Study Guide will provide you with an insight into the assessment of the application of both the
benefit principle and the ability to pay principle. It discusses how best to measure the distribution of taxes
among types of taxpayer or across income classes and shows that pays how much tax. Distributional issues
often lie at the centre of tax policy debates. Distributional analysis may address several issues: How should the
tax burden be distributed or, are progressive (increasing as a share of income as income rises) taxes justified?
What is the estimated distribution of the current system? How does a particular proposal change that
distribution?
a) Explain the benefits theory.

b) Explain the sacrifices theory.
c) Explain the ability to pay theory.
1. Explain the benefits theory.

According to the benefits theory, tax burden should be split up according to the benefit gained from the
government expenditure that are funded by taxation. The persons who receive benefits from the government
should pay amount as taxes which are equivalent to the benefits received. Therefore those who receive greater
benefits should pay more as taxes than those receiving less benefits. The government should not impose taxes
greater than the benefits received by the tax-payer. If the taxes are greater than the benefits received, then the
tax system would not be equitable one.
Under the benefit principle therefore, taxes are seen as serving a function similar to that of prices in
private transactions; that is, they help determine what activities the government will undertake and who will
pay for them. If this principle could be implemented, the allocation of resources through the public sector would
respond directly to consumer wishes.
The following are examples of the public services that are currently funded, in some part, on the basis of the
benefit principle.
¾ Public college tuition fees (only paid by the people who attend public colleges)
¾ National park admission fees (only paid by the people who visit public parks)
¾ Fuel taxes (only paid by the people who purchase fuel)
¾ Bus fares (only paid by the people who take the bus)
¾ Bridge tolls (only paid by people who use the bridge)
¾ Road licence tax paid by motor vehicle owners
Diagram 1: Benefits theory
Comment on the following statement: Taxation under the ‘benefits theory’ operates on the similar lines as prices
function in a free market.
© GTG Theories of Tax Distribution: 71
2. Explain the Sacrifices theory.

Explain the Ability to Pay Theory.
[Learning Outcomes b and c]
2.1 The Ability to Pay Theory
The “ability to pay” principle suggests that people with higher incomes should pay more than those with
lower incomes. However the principle does not answer the question of how much more. Its policy implications
are based on a diminishing marginal benefit of a dollar assumption: the widely-accepted belief that the value
of an additional dollar of income falls, as income rises, i.e. a rich man values an additional dollar less than a
poor.
The ability-to-pay approach treats government revenue and expenditures separately. Taxes are based on
taxpayers’ ability to pay; there is no quid pro quo. Taxes paid are seen as a sacrifice by taxpayers, which raise
the issues of what the sacrifice of each taxpayer should be and how it should be measured. Potential measures
of “equal sacrifice” include equal absolute sacrifice (each person’s welfare declines by the same amount), equal
proportional sacrifice (each person’s welfare declines by the same proportion), and equal marginal sacrifice
(each person’s “displeasure” from taking away an additional dollar is the same).
Equal absolute sacrifice would suggest proportional taxation if the marginal benefits of a dollar of income fell
proportionally with income.
Based on the above principle, if James earns $25,000 and Jack earns $5,000 during 20X3 and John values a
dollar approximately a fifth as much as James, then for every dollar one collects from John, one collects $5 from
James.
In the above example, the principle implied a proportional tax system.
If the marginal benefit of a dollar diminishes, but at a fairly slow rate, a regressive tax system could also be
consistent with the principle, while if it diminishes at a faster rate, a progressive tax would be appropriate.
An alternative measure of sacrifice is equal proportional sacrifice. This method is much more likely to justify a
progressive tax system, but it too depends on how fast the value of an additional dollar declines with income.
There are many reasonable functional forms that do not support progressivity.
The equal marginal sacrifice principle suggests steeply progressive taxes that will collect the least valued
dollars in the economy. The result also uses the assumption that the value of a dollar falls as income rises.
Under this principle, in contrast with the previous two cases, the progressivity does not depend on the rate with
which the value declines.
Thus, without further information on the nature of welfare and the exact standard to be used, the ability to pay
criterion does not necessarily justify regressive, proportional, or progressive taxes. The equal marginal
sacrifice principle suggests an extreme degree of progression
2.2 The Sacrifice Theory
This theory emerged from discussions of “ability to pay” theory in which taxes paid are seen as a sacrifice by
taxpayers. Although it is now decidedly going out of fashion, the many variants of the "sacrifice" approach are
similar to a subjective version of the "ability-to-pay" principle.
Under this doctrine, ability to pay is assumed to increase as incomes increase, and the objective is to
impose taxes on a basis that would involve “equal sacrifice” in some sense. Tax payers should make
equal sacrifices in contributing to the cost of the government activity. However there is disagreement about
whether there should be equal absolute sacrifice, where the rich and the poor should suffer the same absolute
decline in utility; Equal proportional sacrifice where the proportional loss of utility as a result of taxation should
be equal for all taxpayers; or equal marginal sacrifice where the immediate loss of utility as a result of taxation
should be equal for all taxpayers. This will entail the least aggregate sacrifice (the total sacrifice will be the
least).
The traditional justification for progressive taxation is that it causes all the taxpayers to sacrifice
equally. The equal sacrifice doctrine can be traced back to J.S.Mills, who argued for it as a principle of
distributive justice. A government ought to make no distinctions of persons or classes in the strength of their
claims on it. Whatever sacrifices it requires from them should be made to bear as nearly as possible with the
same pressure upon all.
Equality of taxation means equality of sacrifice. However, equality of sacrifice by itself does not
necessarily imply progressive taxation. If the marginal utility of income or wealth decreases the richer
one is, then a given amount of tax falls more lightly on the richer than on the poor. Equal loss of utility
therefore, implies that the richer should pay more in tax than the poorer. But that is the extent of the matter; it
does not require that the richer pay a higher proportion of their income/wealth in taxes.
Diagram 2: Theories of taxation
2.3 The Assumptions of Sacrifice Theory
The theory rests on three general premises:
¾ the utility of a unit of money to an individual diminishes as his stock of money increases;
¾ these utilities can be compared interpersonally and thus can be summed up, subtracted, etc.; and
¾ everyone has the same utility-of-money schedule.
The assumptions of sacrifice theories that the relative utility of different incomes is measurable and that the
relation between income and utility is approximately the same for all taxpayers—cannot be verified by actual
data or experience. The marginal utility of money does diminish, but it is impossible to compare one person's
utilities with another, let alone believe that everyone's valuations are identical. Utilities are not quantities, but
subjective orders of preference. Any principle for distributing the tax burden that rests on such assumptions
must therefore be declared fallacious. Nevertheless, the ability-to-pay idea has been a powerful force in history
and has undoubtedly contributed to the widespread acceptance of progressive taxation.
However, several aspects of this theory are of interest. Utility and "sacrifice" theory has generally been used to
justify progressive taxation, although sometimes proportional taxation has been upheld on this ground. Briefly, a
dollar is alleged to "mean less" or be worth less in utility to a "rich man" than to a "poor man" ("rich" or "poor" in
income or wealth?), and therefore payment of a dollar by a rich man imposes less of a subjective sacrifice on
him than on a poor man. Hence, the rich man should be taxed at a higher rate. Many "ability-to-pay" theories
are really inverted sacrifice theories, since they are couched in the form of ability to make sacrifices.
The sacrifice theory divides into two main branches:
1. Equal-Sacrifice Theory
The equal-sacrifice theory states that every man should sacrifice equally in paying taxes; it asks that equal hurt
be imposed on all. As a criterion of justice, this is as untenable as asking for equal slavery. One interesting
aspect of the equal-sacrifice theory, however, is that it does not necessarily imply progressive income taxation!
For although it implies that the rich man should be taxed more than the poor man, it does not necessarily say
that the former should be taxed more than proportionately. In fact, it does not even establish that all be taxed
proportionately! In short, the equal-sacrifice principle may demand that a man earning Tshs.10 millions be taxed
more than a man earning Tshs.1 million but not necessarily that he be taxed a greater percentage or even
proportionately.
When the utility of money declines slowly, the equal-sacrifice principle may well call for regressive taxation
under which a wealthier man would pay more in amount but less proportionately (e.g., the man earning Tshs10
millions would pay Tshs.500,000 and the man earning Tshs.1 million would pay Tshs.200,000). Likewise when
the utility of money declines rapidly the equal-sacrifice curve will yield progressivity.
2. Minimum-Sacrifice Theory
The minimum-sacrifice theory, like the equal-sacrifice theory rest on the same set of assumptions, but the
minimum-sacrifice theory advocates very extreme progressive taxation.
Suppose, for example, that there are two men in a community, Jones making Tshs. 50 millions, and Smith
making Tshs. 30 millions. The principle of minimum social sacrifice, resting on the three assumptions described
above, declares: Tshs.1,000 taken from Jones imposes less of a sacrifice than Tshs.1,000 taken from Smith;
hence, if the government needs Tshs.1,000, it takes it from Jones. But suppose the government needs
Tshs.2,000; the second dollar will impose less of a sacrifice on Jones than the first dollar taken from Smith, for
Jones still has more money left than Smith and therefore sacrifices less. This continues as long as Jones has
more money remaining than Smith. Should the government need Tshs. 20 millions in taxes, the minimum-
sacrifice principle counsels taking the entire Tshs. 20 millions from Jones and zero from Smith. In other words, it
advocates taking all of the highest incomes in turn until governmental needs are fulfilled.
The minimum-sacrifice principle depends heavily, as does the equal-sacrifice theory, on the untenable view that
everyone's utility-of-money schedule is roughly identical. Both rest also on a further fallacy, which now must be
refuted: that "sacrifice" is simply the equivalent of the utility of money. For the subjective sacrifice in taxation
may not be merely the opportunity cost forgone of the money paid; it may also be increased by moral outrage at
the tax procedure. Thus, Jones may become so morally outraged at the above proceedings that his marginal
subjective sacrifice quickly becomes very great, much "greater" than Smith's if we grant for a moment that the
two can be compared.
Both versions abandon completely the idea of government as a supplier of benefits and treat government and
taxation as simply a burden, and the question becomes one of justly distributing this burden. But taxpayers’ are
constantly striving to sacrifice as little as they can for the benefits they receive from their actions. Yet here is a
theory that talks only in terms of sacrifice and burden, and calls for a certain distribution without demonstrating
to the taxpayers that they are benefiting more than they are giving up.
Today equal sacrifice is not very fashionable as a basis for tax policy not because it lacks intuitive appeal, but
because it seems to rely so heavily on interpersonal welfare comparisons. To apply the equal sacrifice approach
in a real case, specific form for the utility function would have to be agreed upon, and as practical matter the
same function would have to be assumed to hold for all taxpayers. These assumptions seen to be completely
unwarranted one might as easily assume tax distribution itself.
2.4 Benefit principle versus sacrifice and ability-to-pay principles
The benefit principle differs radically from the sacrifice and ability to pay theories of taxation. The sacrifice and
ability-to-pay principles depart completely from the principles of action and the accepted criteria of justice on the
market. On the market people act freely in those ways which they believe will confer net benefits upon them.
The result of these actions is the monetary exchange system, with its inexorable tendency toward uniform
pricing and the allocation of productive factors to satisfy the most urgent demands of all the consumers.
The sacrifice and ability-to-pay principles forget about the free choice and uniform pricing, and the discussion is
all in terms of sacrifice, burden, etc. If taxation is only a burden, it is no wonder that coercion must be exercised
to maintain it. The benefit principle, on the other hand, is an attempt to establish taxation on a similar basis as
market pricing; that is the tax is to be levied in accordance with the benefit received by the individual. It is an
attempt to achieve the goal of a neutral tax, one that would leave the economic system approximately as it is on
the free market. It is an attempt to achieve praxeological soundness by establishing a criterion of payment on
the basis of benefit rather than sacrifice.
Briefly explain the sacrifice theory and discuss its relationship with the ability to pay theory
Answer to TY 1
The benefit principle is an attempt to establish taxation on a similar basis as market pricing; that is the tax is to
be levied in accordance with the benefit received by the individual.
It is an attempt to achieve the goal of a neutral tax, one that would leave the economic system approximately as
it is, on the free market. It is an attempt to establish a criterion of payment on the basis of benefit rather than
sacrifice.
Answer to TY 2
taxpayers’ ability to pay; there is no quid pro quo. Taxes paid are seen as a sacrifice by taxpayers, which raise
the issues of what the sacrifice of each taxpayer should be and how it should be measured:
(a) Equal sacrifice: The total loss of utility as a result of taxation should be equal for all taxpayers (the rich will
be taxed more heavily than the poor).
(b) Equal proportional sacrifice: The proportional loss of utility as a result of taxation should be equal for all
taxpayers.
(c) Equal marginal sacrifice: The instantaneous loss of utility (as measured by the derivative of the utility
function) as a result of taxation should be equal for all taxpayers. This will entail the least aggregate
sacrifice (the total sacrifice will be the least).
Quick quiz
Fill in the blanks
1. Taxes are seen as serving a function similar to that of prices in private transactions under the
______________ theory.
2. The _______________ theory states that every man should sacrifice equally in paying taxes
3. Road licence tax paid by motor vehicle owners is an example of public services that are currently funded, in
some part, on the basis of the ______________ principle.
4. The _______________ principle suggests that people with higher incomes should pay more than those
with lower incomes.
5. The minimum-sacrifice theory advocates very extreme ______________ taxation.
1. benefit theory
2. equal-sacrifice
3. benefit
4. “ability to pay”
5. progressive
Question 1
Briefly explain the benefit theory of taxation.
Question 2
Briefly explain the ability to pay theory and differentiate it from the benefit theory
Answers to Self-Examination Questions
Answer to SEQ 1
A taxation principle stating that taxes should be based on the benefits received. The benefit principle works from
the proposition that those who receive the greatest benefits should pay the most taxes. The benefit principle is
commonly used for near-public goods such as highways, libraries, college, and national parks. This is one of
two taxation principles. The other is the ability-to-pay principle, which states taxes should be based on income
or the ability to pay taxes.
Answer to SEQ 2
The ability-to-pay principle works from the proposition that those who have the greatest income should pay the
most taxes. The ability-to-pay principle is the only reasonable way to finance the provision of public goods such
as national defence, public health, and environmental quality. This is one of two taxation principles. The other is
the benefit principle, which states taxes should be based on the benefits received.
.
SECTION B

POLICY
B3
STUDY GUIDE B3: APPROACHES TO TAX
EQUITY
Equity is a basic criterion for design of every tax structure. Equity in taxation means equitable or just distribution
of burden of tax among members of the society. Everyone agrees that the tax system should be equitable, i.e.
each tax payer should contribute his/her fair share to the cost of government. It is argued that taxes must not
only be fair, they must be seen to be fair if the taxpayers are to find them acceptable. There are two approaches
to equity; the “benefit” and “ability to pay”.
This Study Guide provides the assessment of the application of both the benefit principle and the ability to pay
principle.
a) Assess the application of the benefit principle.

b) Assess application of the ability to pay principle (horizontal equity and vertical equity).
1. Assess the application of the benefit principle.

The principle of benefit arises from the need that greatest beneficiaries should make the greatest tax
contribution. This is indeed the essence of fairness. It finds common application in near public goods
whereby only those who pay and consume the goods are liable for such taxation.
The benefit principle is utilised most successfully in the financing of bridges, roads and highways through levies
on motor fuels and road-user fees (tolls). In these specific cases, it is easy to implement tax according to the
benefits received because it is possible to quantify a direct and reasonable benefit.
Formidable examples include tourist paying their levies, students paying for their tuition, patients paying for their
medical charges among many other instances. The people who do not directly benefit from such goods and
services are thus exempted from the associated charges. Such manner of fairness is elaborately justifiable.
Under the benefit principle each individual pays for the amount of government provided goods and services they
consume. Because the exchange is voluntary, at least as envisioned by many promoting this principle, and
payments are in accordance with benefits, it satisfies this notion of equity.
In the absence of benefit taxation, it is impossible to tax persons who benefit from a specific
government project. For example: If the government does not follow the principle of benefit, and imposes tax
on the basis of ability to pay, then it would end up in imposing tax upon people in Musoma for meeting the
expenditure of a bridge constructed in Kigamboni making persons in musoma, who do not use the bridge, worse
off. This unfairness in taxation can be avoided, if the government follows the benefit principle.
Limitations of Benefit Principle
Although simple in its application, the benefit theory has the following difficulties in its application:
i. Despite the logical fairness identified in the principle of benefit, it suffers a setback in terms of efficiency.
Inefficiency in provision of goods is based on the notion that there would be a decline in quantity demanded
if direct beneficiaries pay a price equal to the derived value as it is for private goods.
ii. The principle is based on the assumption that it is possible to determine the benefit received for every
individual for each government expenditure. However, the implementation of this principle faces daunting
challenges on public goods. Excluding non-payers and identifying the received benefits is complicated thus
making it almost impossible to set the amount of tax. In some public expenditures such as defence, fire
force, expenditure in advanced scientific research etc the benefits available to each individual is very difficult
to calculate separately.
iii. It is difficult to trace benefits (example defense, justice, law and order) to each individual in the
society. So the application of this principle depends on the person himself to reveal information about the
amount of benefits he receives. But citizens generally have no inclination to pay for a publicly provided
service such as a police department unless they can be excluded from the benefits of the service.
iv. In modern times, government is welfare oriented with the objective of increasing the welfare of the society
as a whole. It is thus impossible to individualize the benefits rendered to the society. Therefore, an individual
cannot be taxed but the taxation should be taken as a collective instrument for supporting the services of
the government.
v. Under the benefit principle the rich and poor people pay equal tax for the same benefits received. However
since the marginal utility of income of rich people is lower than the poor people, it is unjust to tax both rich
and poor equally. Therefore the principle ignores the income re-distribution objective of taxation, that
requires the government to take away income from rich people by way of higher taxes and give it to poor
people.
vi. Again, it can be argued that some services provided such as infrastructural development and national
defence may benefit everyone but not in equal proportions. A criterion for identifying the major
beneficiaries in such scenarios may therefore be erratic. Indeed it is difficult to establish who benefits more.
The benefit received from government spending might be used as a way of determining vertical equity
where persons enjoying many services pay more taxes than others. For example, road taxes are paid only
by all taxpayers who own motor vehicles, while this can be seen as fair, but other road users are not
contributing toward it. Is it proper for elders to pay more taxes because are more likely to be sick and enjoy
free health services than youths who pay for the services? It is still problematic.
© GTG Approaches to Tax Equity: 79
Some benefit received are difficult to trace to taxpayers, for instance, how can we measure the cost of
service of the police, armed forces, or judiciary to different individuals. And if taxes base on tax benefit
received, then the poor will have to pay the heaviest taxes, because they benefit more from the services of
the state than the rich.
vii. The benefit theory holds that the rich benefit more from protection because their property is more valuable;
if those with higher incomes also consume more government provided resources, then this would justify a
progressive tax structure. But which income groups use the most resources is an empirical question. If
lower income groups consume more government goods, then this could also support a regressive structure.
However the cost of protection may have little relation to the value of the property.
For example it costs less to police a bank vault (belonging to Mr. Ally) containing Tshs.1 billion than to guard
100 acres of land worth Tshs.1 million per acre, the poor landowner (Mr Bakari) receives a far greater
benefit from the government's protection than the rich owner. Neither would it be relevant to say that Mr.
Ally earns more money than Mr. Bakari because Mr. Ally receives a greater benefit from "society" and
should therefore pay more in taxes. In the first place, everyone participates in society. The fact that Mr. Ally
earns more than Mr. Bakari means precisely that Mr. Ally’s services are individually worth more to his
fellows. Therefore, since Mr. Ally and Mr. Bakari benefit similarly from society's existence, the reverse
argument is far more accurate: that the differential between them is due to Mr. Ally’s individual superiority in
productivity, and not at all to "society."
What is the benefit received principle of taxation?
2. Assess application of the ability to pay principle (horizontal equity and vertical equity).
Due to the inconsistencies in the benefit principle, the ability to pay principle forms a better alternative for equity
in taxation. The principle suggests that the ability to pay should form basis of taxation to maintain fairness. This
means that citizens who earn more should pay more taxes than their counterparts in lower income cadres. In
spite of everyone sharing the benefits, only those who can afford are taxed accordingly. The principle correctly
addresses the concerns of efficiency since goods are provided to citizens at zero prices and tax payment is not
pegged on the beneficiaries alone.
taxpayers’ ability to pay; there is no quid pro quo. The approach also makes a great deal of sense, especially
for the provision of public goods that are consumed by all. If everyone benefits from public goods, without
exclusion, then everyone should pay. However, not everyone can pay, so those who can afford to pay need to
bear the burden.
Because taxes are a means of transferring the purchasing power of income to governments, the ability to pay is
based on income. Those who have more income can afford to pay more taxes, that is, they have a greater
ability to pay.
Analysis of tax equity is concerned with the distribution of tax burdens among persons in different economic
circumstances, i.e., with vertical equity as well as persons in essentially the same economic circumstances—
horizontal equity.
2.1 Horizontal equity and Vertical equity
Horizontal equity is the equal treatment of equals and this is a means for achieving a distribution of tax burdens
that is vertically equitable. Horizontal equity is an important starting point for any tax system and can be
consistent with also achieving vertical equity. Horizontal equity is simple and direct.
Horizontal equity:
¾ If two accounts clerks earn Tshs.15,000,000 each annually, they should both pay the same amount of
income tax.
¾ If an accountant earns Tshs.100,000,000 and pays Tshs.30,000,000 in taxes, by horizontal equity, a sales
executive will equally be taxed Tshs.30,000,000 for earning the same salary as the said accountant.
Therefore, horizontal equity this principle shields taxpayers from discrimination (such as race, gender or type of
work) and upholds the tenet of equal worth.
The horizontal equity considers the taxable capacity of taxpayers and requires taxpayers with the same taxable
capacity to bear the same tax burden.
However there is a challenge in measuring taxable capacity of taxpayers and consideration of other factors to
achieve the required fairness. It is easy to measures income of individual taxpayers doing similar job and
earning the same amount, for example two people employed as accounts clerks in the same organisations
might be earning the same income. But, for the non employed people who work in the informal sector (in poultry
farming or investing in real estate); their income may be difficult to establish. Apart from the difficulty to
determine the taxable income, other factors like number of dependents, married or single, financial difficulties
are important in considering the fairness of a tax system.
Vertical equity on the other hand reflects the proportionality in tax payment, the unequal should be treated
unequally. As seen earlier, there is a very thin line that separates this from horizontal equity. An assertion that
people earning different taxes should proportionately pay different taxes can be interpreted to mean that people
earning same income will automatically have to pay similar taxes. It is a method of collecting income tax in
which the taxes paid increase with the amount of earned income. The driving principle behind vertical equity is
the notion that those who are more able to pay taxes should contribute more than those who are not. Vertical
equity seeks to tax in a proportional or progressive way – People with more ability to pay should pay more tax.
Vertical equity
If two accounts clerks earn Tshs.15, 000,000 and Tshs.10, 000,000 respectively each annually, they should pay
different amounts of income tax, with the one earning more paying a higher rate of tax.
In considering vertical equity, all the factors that cause variation in income are taken into account. The essence
of this form of taxation is to ensure that every person pays taxes that conform to proportional standards in terms
of his earnings.
2.2 Limitations of Ability to Pay Principle
Although the ability to pay approach is more popular, the main challenge lies on the determination of the ‘ability
to pay’. Ability to pay is mostly determined by income, wealth or expenditure. Wealth is however considered as
a poor indicator of one’s ability to pay because property may not be easily convertible into cash with which to
pay tax. A progressive tax structure based on wealth may thus run on serious liquidity problems.
Furthermore we can measure ability to pay by expenditure incurred by a taxpayer. However this may be
inequitable or unfair as taxpayers with many dependents may expend more and hence end up paying more
taxes.
Lastly, ability to pay can be measured by an income base which is the most accepted measure of the ability to
pay. In fact the ability to pay approach assumes “income” to be the basis for the ability to pay.Individuals with
higher income is not only better able to bear the tax burden than the lower income earners, but they can bear
heavier tax burdens of tax. A tax system that takes away proportionately more income from the higher income
earners than from the lower income earners is known as a progressive tax system. On the other hand a tax
system that takes away proportionately more income from the lower income earners than from the higher
income earners is known as a regressive tax system
© GTG Approaches to Tax Equity: 81
Another challenge is in the measurement of the ability to pay. It is not an easier task to measure the wealth or
income of taxpayers; specifically we have to choose either potential earning capacity or actual amount earned.
For instance, if two persons having identical earning capacities but one opt to go to watch football match and
the second person continue working consequently the second person will pay more tax if actual earning is a
measure ability to pay which may be seen to be unfair to the taxpayer. The ability to pay can be measured by
ownership of assets yet others have high income without having assets.
In the ability to pay approach, taxes paid are seen as a sacrifice by taxpayers, which raise the issues of what
the sacrifice of each taxpayer should be and how it should be measured:
taxpayers.
In the utility approach the suggestion is that all taxpayers should suffer an equal amount of utility loss resulting
from payment of taxes. This requires measurement of utility lost before setting tax rates. Therefore this
approach call for the richer to pay more than the poor but the problem is how the utility should be measured.
Fairness of sacrifice is sometimes measured against the benefit received which is an equally poor indicator of
fairness because of the limitations mentioned in the previous section.
How does the ability-to-pay principle of taxation differ from the benefit principle? What problems are
encountered in implementing both these tax philosophies?
Answer to TY 1
Benefit principle: A principle of taxation in which taxes are based on the benefits received by people using the
goods financed with the tax. The benefit principle is often difficult to implement because by their very nature,
many government produced goods (public goods) do not have easily measured benefits. But in those cases
where benefits are identifiable, government is not shy about establishing taxes, fees, or charges in accordance
with the benefit principle. Public college tuition, national park admission fees, and gasoline excise taxes are
three common examples. The beneficiaries of education, a wilderness experience, and highway use are asked
(required) to pay accordingly.
Answer to TY 2
The benefits received principle of taxation asserts that people and businesses who receive the benefit of a good
or service financed by taxes should pay the tax it requires. The ability to pay principle is the opposite of the
benefits received principle.
It can be difficult for governments to implement the benefits received principle because of its nature. It is not
easy to measure the benefits that certain people receive from a public good. Most governments, however,
normally implement taxes in cases where benefits are easily identified.
Charges, fees and taxes are often levied against those who use public universities, gasoline or national parks.
Because the specific people who use these government resources receive much of the benefit from their
existence, those people are asked to pay for the benefit they received. As an example, gasoline taxes are often
used to construct and repair highways. This is because those who buy gasoline are assumed to be the users
and the major beneficiaries of roads and highways.
The ability to pay principle is very different from the benefits received principle. The ability to pay principle
asserts that the tax burden should be split up according to how able someone is to pay for government services.
Quick Quiz
Fill in the blanks
1. ____________ equity is the equal treatment of equals and this is a means for achieving a distribution of tax
burdens that is vertically equitable.
2. _________ equity reflects the proportionality in tax payment, the unequal should be treated unequally.
3. ____________ of sacrifice is sometimes measured against the benefit received which is an equally poor
indicator of fairness.
4. The _____________ principle is utilised most successfully in the financing of bridges, roads and highways
through levies on motor fuels and road-user fees (tolls)
1. Horizontal
2. Vertical
3. Fairness
4. benefit
Self-Examination Question
Question 1
In the ability to pay approach, what should be the sacrifice of each taxpayer and how should it be measured?
Answer to Self-Examination
Answer to SEQ 1
The ability-to-pay principle in taxation maintains that taxes should be levied according a taxpayer's ability to pay.
This progressive taxation approach places an increased tax burden on individuals, partnerships, companies,
corporations, trusts and certain estates with higher incomes. The theory is that individuals who earn more
money can afford to pay more in taxes.
The sacrifice of each taxpayer and the method of how should it be measured is as follows:
taxpayers.
SECTION B

POLICY
B4
STUDY GUIDE B4: TAX AND EXPENDITURE
INCIDENCE: CONCEPTS AND PRINCIPLES
Taxes are an important source of revenue for the government. However, taxes decrease both supply and
demand in the market, because buyers have to pay a higher price and sellers receive less for their product.
Careful tax incidence analysis is essential to understanding the distributional implications of a country's tax
system.
This Study Guide provides the various concepts and principles relating to tax and expenditure incidence.
a) Explain the nature of tax burden.

b) Differentiate the concepts of incidence (statutory incidence, economic incidence, tax shifting; and
absolute/differential incidence).
c) Differentiate between specific taxes and ad valorem taxes.
d) Apply principles of incidence in competitive markets.
e) Apply principles of incidence in environment without perfect competition.
1. Explain nature of tax burden.

Differentiate the concepts of incidence (statutory incidence, economic incidence, tax,
Shifting; and absolute/differential incidence).
[Learning Outcomes a and b]
1.1 Nature of taxation
This is discussed in detail in Study Guide B1, Learning Outcome 1.
1.2 Incidence of taxation
One of the important concepts of taxation is the incidence of tax. Taxes are not always borne by the person who
pays the tax; in many instances the burden of tax is shifted to another person.
Tax incidence is said to be on the person who ultimately bears the burden of tax whereas impact of tax is on the
person from whom government collects money in the first instance. It is important for the government to know
who ultimately bears the tax in order to achieve equality in taxation.
James bought a shirt for the consideration of Tshs5,000. The shop owner gives James the suit in return for
payment of Tshs 5,000. VAT of Tshs1,000 is included in the cost of the suit. In this case James will bear the
VAT expense, although the shopkeeper will pay the VAT to the tax authorities.
Tax incidence is on James and the tax burden is on the shopkeeper.
Burden of tax may be shifted from one person to another; shifting finally ends in incidence. A person on whom
tax is levied may shift the burden of tax on another person either entirely or partly or he may not be able to pass
on the burden at all.
¾ Forward shifting of tax takes place if burden of tax falls entirely on user and not on the manufacturer/
supplier of the goods or service;
¾ Backward shifting occurs when the price of the product/ service remains same but the cost of tax is borne
by the manufacturer.
¾ In certain cases, there would be no shifting of tax at all.
Tax incidence depends on the price elasticity of demand and supply.
¾ Price elasticity of demand is the responsiveness of the quantity demanded of a good or service to a change
in its price or in other words it is the percentage change in quantity demanded to a one percentage change
in price.
¾ Price elasticity of supply is the responsiveness of the quantity supplied of a good or service to a change in
its price.
An excise duty of Tshs5,000 is charged on the manufacture of motorcycles. If the product is price inelastic (that
means if the price is increased, there would only be a small loss in demand that will be compensated by the
additional revenue by increase in price), then the manufacturer will be able to pass on the entire burden of tax
on the consumers. The incidence of tax will be on the consumer.
If the product is price elastic (that means if the price is increased, loss in demand would be more than the
revenue earned by increase in price), then the manufacturer will not be able to pass on the entire tax burden to
the consumers and the tax burden may have to be shared. Incidence of tax will be on both the manufacturer
and the consumer.
© GTG Tax and Expenditure Incidence: Concepts and Principles: 85
Contribution is made to social security scheme for all employees by the employers however the incidence of tax
does not fall on the employer as it is reduced by the employers from the salary of the employee.
Demand for cigarettes is more or less inelastic that means even if the price increases, demand for cigarettes
remains more or less unchanged. If a higher tax is imposed by the government, the manufacturers will increase
the price equal to the entire amount of increased tax. If the demand for cigarettes remains unchanged even after
the increase in price, then it can be said that the incidence of increased tax is on the buyer.
The study of tax incidence is important because the objective of the tax system is not merely to raise a certain
amount of revenue but to raise it from those sections of society who are capable of bearing the tax. Hence it is
important for the policy makers to know who is ultimately bearing the tax.
The tax system of an economy generally comprises of direct tax and indirect tax. In case of direct tax, the
burden of tax is borne by the person who pays the tax so the incidence of tax is very simple. Question of
incidence primarily arises in case of indirect tax.
Indirect tax is tax where the burden is shifted from the tax payer to the consumer and the price is affected by the
tax. Generally tax on commodities is an indirect tax; however that may not necessarily be true in all cases.
Generally the incidence of direct tax like income – tax falls on the richer sections of society. However a good tax
system requires a proper balance between direct and indirect tax.
If the amount of tax is small, a manufacturer may not be keen to pass on the burden to the consumers however
he will do so in case of a high amount of tax. Similarly if the labour and capital is freely available to the
manufacturer, he will be in a position to shift the incidence of tax to the consumer.
A tax of 1% is charged on every onion produced by a farmer. Explain in what circumstances the farmer will be
able to pass on the entire tax to the consumers?
An important consideration in assessing the economic effect of taxation is the incidence of the tax. Tax
incidence is the analysis of the effects of a particular tax on the distribution of economic welfare. It refers to the
burden of tax and where that burden rests. The analysis begins with the insight that the person who has a legal
obligation to pay a tax may not be the person whose welfare is reduced by the tax. Tax incidence is said to fall
upon the group that ultimately bears the burden of or ultimately has to pay the tax.
1.3 Statutory and economic incidence
It is usual to distinguish between statutory / legal and economic incidence.
The statutory / legal incidence refers to the person on whom the law says the tax obligation falls. Legal
incidence is established by law when new taxes are enacted, and specifies which individuals or companies must
physically remit tax payments to the revenue authorities.
For example, the statutory incidence of the excise duty on whisky is on the importer since he is responsible for
making the tax payment.
The incidence of a tax on cigarettes
If the government puts an extra tax of Tshs1,000 on each packet of cigarettes, the legal incidence is on the
cigarette smoker. However, the local market may be very competitive, with many sellers, so that a retailer may
fear they will suffer from lost sales, and decide to put up the price by only Tshs500, and pay the balance of
Tshs500 to the government themselves. In this case, the economic incidence is shared because both are worse
off. The smoker is worse off because of the price increase of Tshs500, and the seller is worse off because
Tshs500 must come out of their revenue to pay the government.
1.4 Tax shifting and economic incidence
The statutory incidence of taxes is generally very different from their final economic burden. Taxes, disrupt what
otherwise would be an efficiently functioning market by influencing the relative prices facing individuals, they
lead to changes in individual behaviour. This disruption is seen as a tax wedge between the demand price and
the supply price. Changes in the demand and supply prices after a tax, when compared to the equilibrium price
before the tax, is called incidence or burden of the tax. The tax incidence identifies who ultimately pays the
tax.
While one side of the market or the other might superficially appear to pay a tax, that is, the ones writing the
check, more often than not both sides of the market share the tax burden. They share the burden by way of
changes in their demand and supply prices. If a Tshs 10,000 tax, for example, results in a Tshs8,000 increase in
the demand price and a Tshs2,000 decrease in the supply price, then buyers pay 80% of the tax and sellers pay
the remaining 20%.
The division of the tax payment between buyers and sellers depends on the relative price elasticity of demand
and supply. If the demand curve is less elastic (more inelastic) than the supply curve, then buyers pay a
relatively larger share of the tax. If the supply curve is less elastic (more inelastic) than the demand
curve, then sellers pay a relatively larger share of the tax. In the extreme, buyers pay the entire tax only if
the demand curve is perfectly inelastic or the supply curve is perfectly elastic. Alternatively, sellers pay the
entire tax only if the supply curve is perfectly inelastic or the demand curve is perfectly elastic.
These tax-induced changes in behaviour cause some portion of the economic burden of taxes to be shifted from
those bearing the legal incidence onto others in society. Tax shifting refers to the fact that the person making
the tax payment may shift the burden or part of the burden to other groups in the community.
Suppose a tax of Tshs1,000 per unit is imposed on sale of product X. If the demand of the product is perfectly
inelastic and supply elastic, the suppliers will be able to shift the entire economic incidence of the tax to
consumers by restricting supply causing increase in price of product X by Tshs1,000. Producers will be able to
earn same amount of revenue as before the imposition of tax. Only consumers will suffer in this case. For
example, the burden of the excise duty on whisky which statutorily falls on the importer may be shifted on to the
consumers as part of the price.
If the above Tshs1,000 tax per unit is imposed under perfectly inelastic supply, producers will have to bear all
the burden of the tax since they will not be able to control the price of the product when supply is perfectly
inelastic.
When both demand and supply are moderately elastic, the product's price will increase slightly as a result of
Tshs1,000 tax per unit but the increase will be lower than Tshs1,000. Consumers will bear some burden of the
tax by paying slightly higher price. Producers will also face moderate tax incidence because the increase in
price is less than the tax per unit.
This tax-shifting behaviour often causes the economic burden of taxes to differ dramatically from the legal
incidence. Once these tax-induced changes in behaviour throughout the economy are accounted for, the final
distribution of the economic burden of taxes is called the economic incidence. Economists refer to measures
of this economic incidence as the tax burden faced by individuals.
Economic incidence differs from statutory incidence because of changes in behaviour and consequent changes
in equilibrium prices. For example, a heavy tax on a commodity may lead to a substantial fall in the quantity
demanded, and thus resources will tend to move out of this industry and some sectors may experience
unemployment. In such a case it is said that part of the burden of tax is borne by those who have suffered as a
result of the fall in demand.
1.5 Absolute incidence and differential incidence of tax
The distributional impact of tax or systems of taxes depends partly on how the question is framed.
An absolute incidence examines the effects of a tax when there is no change in either other taxes or
government expenditure. The examination considers the burden of change in taxes without regard to the use
the tax proceeds. However, the true burden of the tax cannot be properly assessed without knowing the use of
the tax revenues. If the tax revenues are employed in a manner that benefits owners more than producers and
consumers then the burden of tax will fall on producers and consumers. If the proceeds of the tax are used in a
way that benefits producers and consumers, then owners will suffer the tax burden.
A differential incidence examines how incidence differs when one tax is replaced with another, holding the
government budget constant. The differential incidence analysis carries out a revenue-neutral change in tax by
raising one tax while lowering another.
2. Differentiate between specific taxes and ad valorem taxes.

There are two types of indirect tax; specific and ad valorem.
2.1 Ad valorem tax
An ad valorem tax is a tax based on the value of real estate or personal property. It is specified as a proportion
of the product price. An ad valorem tax is typically imposed at the time of a transaction (a sales tax or value-
added tax (VAT)), but it may be imposed on an annual basis (real or personal property tax). Value Added Tax
(VAT), currently at 18%, is the most important ad valorem tax.
Items charged under ad-valorem rates include: Money transfer services, electronic communication services, pay
to view television services, imported furniture, motor vehicles, plastic bags, specified aircrafts, firearms,
specified cases, cosmetics and medicaments.
Ad-valorem rates are: 0%, 0.15%, 5%, 10%, 17%, 15%, 20%, 25% and 50%.
2.2 Specific tax
A Specific Tax is a system of taxation where the level of tax is fixed and independent of the value of the item
being purchased. A unit tax is a set amount of tax per unit sold, such as a 500/= tax on packets of cigarettes. In
contrast, an ad valorem tax is a percentage tax based on the value added by the producer.
Items charged under specific rates in Tanzania include: Wine, spirits, beer, soft drinks, mineral water, fruit
juices, Recorded DVD,VCD,CD and audio tapes, cigarettes, tobacco, petroleum products and Natural
gas.
One advantage of ad valorem taxes is that the tax revenue to the government can rise automatically as the
economy grows. This means that the tax rate does not need to be adjusted frequently, as in the case of specific
unit taxes, such as duties on cigarettes and alcohol.
The imposition of either type of indirect tax has an effect similar to a rise in production costs. This means that a
firm's supply curve will shift up vertically by the amount of the tax.
2.3 Specific taxes versus ad-valorem taxes
Specific taxes Ad-valorem

A Specific Tax is a system of taxation where the level An ad valorem tax is a tax based on the value of real
of tax is fixed and independent of the value of the item estate or personal property. It is specified as a
being purchased. proportion of the product price.
The tax rate needs to be adjusted frequently, as in the The tax revenue to the government can rise
case of specific unit taxes, such as duties on automatically as the economy grows. This means that
cigarettes and alcohol. the tax rate does not need to be adjusted frequently,
as in the case of specific unit taxes, such as duties on
cigarettes and alcohol.
A specific tax is typically imposed at the time of a An ad valorem tax is may be imposed at the time of a
transaction. transaction (a sales tax or value-added tax (VAT)), or
it may be imposed on an annual basis (real or
personal property tax).
3. Apply principles of incidence in competitive markets.

Who bears the burden of the tax also depends on the demand and supply elasticity, and on whether the market
is competitive or non-competitive. Taxes induce changes in relative prices, and it is this market response that
determines who bears the tax.
Competitive markets
In a purely competitive market, there are large numbers of firms producing a standardized product. Market
prices are determined by consumer demand; no supplier has any influence over the market price, and thus, the
suppliers are often referred to as price takers. The primary reason why there are many firms is because there is
a low barrier of entry into the business.
The best examples of a purely competitive market are agricultural products, such as corn, wheat, and
soybeans.
Tax incidence is concerned with the effect of taxation upon prices and profits. Since perfectly competitive firms
earn zero profits, under perfect competition there is only a price effect. Consumer prices increase by just the
amount of the tax if the long run supply curve is horizontal, and by less than that if it is upward sloping. Price
rising by more than the amount of the tax is not a possibility in this market. It is difficult to shift tax burden in
perfect market containing many buyers and sellers, full knowledge, no restrictions on exit and entry as small
increase in price lead to significant decrease in sales.
In a perfectly competitive partial equilibrium framework, the economic incidence of a tax is unaffected by which
side of the market the tax is levied on. Second, the economic burden of a tax is borne more heavily by the side
of the market that is less elastic (in absolute value). No more than 100 percent of the tax can be shifted to a
party.
In the competitive market, if the supply is completely inelastic or if demand is completely elastic or demand is
completely inelastic, the tax is entirely borne by consumers.
Explain the incidence of taxes in a competitive market.

4. Apply principles of incidence in environment without perfect competition.

Imperfect competition market structure is where the firms that operate in a market have a lot of control over the
good or service they produce. This will happen when the numbers of firms that produce that good or supply a
certain services are very few in the market. Imperfect competition market structure is the most common type of
market structure in the market.
We can illustrate imperfect competition by an example in the energy sector in Tanzania where there is only one
supplier of electricity TANESCO, another example is in railway transportation where we have two companies
TRC and TAZARA that operate two different railway systems. TANESCO for example can price its commodity
above the prevailing market prices because there is no competition from other firm. The consumers do not have
any choice but to purchase from TANESCO at the inflated prices. In this case TANESCO has therefore created
an imperfect market.
When taxpayers are operating in imperfect market as monopoly, oligopoly, and duopoly where products are
differentiated and there is imperfect communication, tax incidence may easily be shifted. Under imperfect
competition there are both price and profit effects. Since prices are set above marginal cost, an increase in cost
due to a change in taxation need not be reflected in an identical increase in price. In this market, commodity tax
over shifting can occur (in the sense that the consumer price rises by more than the tax rate). Overshifting
occurs when price rises by more than the amount of the tax and undershifting occers when prices rises by less
than the tax. The degree of tax shifting depends on the relative curvature of industry demand and the firm’s cost
function. With constant marginal cost, concavity of industry demand leads to undershifting and sufficient
convexity leads to overshifting.
What is the difference between impact of tax and incidence of tax?
Answer to TY 1
The farmer will be able to pass on the entire burden of tax on the consumers if the product is price inelastic (that
means if the price is increased, there would only be a small loss in demand that will be compensated by the
additional revenue by increase in price). In case the price of the product inelastic, the farmer may be able to
shift the burden of tax only partly on the consumer or may not be able to shift at all.
Answer to TY 2
Tax incidence is concerned with the effect of taxation upon prices and profits. Since perfectly competitive firms
earn zero profits, under perfect competition there is only a price effect. Consumer prices increase by just the
amount of the tax if the long run supply curve is horizontal, and by less than that if it is upward sloping. Price
rising by more than the amount of the tax is not a possibility in this market. It is difficult to shift tax burden in
perfect market containing many buyers and sellers, full knowledge, no restrictions on exit and entry as small
increase in price lead to significant decrease in sales.
In a perfectly competitive partial equilibrium framework, the economic incidence of a tax is unaffected by which
side of the market the tax is levied on. Second, the economic burden of a tax is borne more heavily by the side
of the market that is less elastic (in absolute value). No more than 100 percent of the tax can be shifted to a
party.
In the competitive market, if the supply is completely inelastic or if demand is completely elastic or demand is
completely inelastic, the tax is entirely borne by consumers.
Answer to TY 3
The impact of tax refers to the way the introduction of taxation, or the raising of tax levels, on a particular
product or service, affects the way the product or service is used. The introduction or increase of tax, for
example, usually results in the product or service being purchased less often. As a result, the impact of tax, or
tax impact, is usually negative for the development of an economy, as it hinders and reduces spending, which is
necessary for the growth of an economy.
On the other hand, the incidence of tax refers to the people who carry the burden of tax. For example, if you
own a large portion of land, but your neighbour owns a small portion of land, and tax on land goes up, you
would be said to be part of the population subject to the incidence of tax.
Therefore, a simple way of describing the difference between the impact and the incidence of tax would appear
as follows: The incidence of tax relates to the effects upon the people who pay the taxes, while the impact of tax
relates to the effects upon the goods and services which are taxed. It could be argued that the two are linked, as
if taxes on goods and services are raised, the impact of tax would mean that less people pay for them - as a
result, the government and other large bodies have to find a source of income other than VAT, and therefore
other taxes may be raised, effecting the incidence of tax.
Quick Quiz
1. The property tax on a rented house owned by Mr. Johnson increased by $1,200 this year. Mr. Johnson
increased the monthly rent charged to his tenant, Mrs. Sara Lincoln, by $45. Who bears the incidence of
the property tax increase?
A Mr. Johnson
B Mrs. Sara
C Both Mr. Johnson and Mrs. Sara
D Neither Mr. Johnson nor Mrs. Sara
2. In 2013 Twiga Cement Plc. corporate income tax increased by $100,000. As a result, Twiga Cement
reduced the annual dividend paid on its common stock by $100,000. Who bears the incidence of the
corporate tax increase?
A Twiga Cement Plc.

B Twiga Cement's customers
C Twiga Cement's employees
D Twiga Cement's shareholders
3. Twiga Cement Plc property taxes increased by $19,000 this year. As a result, the company eliminated
$19,000 from its budget for the employee Christmas party. Who bears the incidence of the company’s tax
increase?
A Twiga Cement Plc.

4. Twiga Cement Plc.'s property taxes increased by $65,000 this year. As a result, Twiga Cement increased
the sale prices of its products to generate $65,000 more revenue. Who bears the incidence of the
company’s tax increase?
A Twiga Cement Plc.

5. Market failure refers to the situation where
A a market does not create a deadweight loss.

B a market uses resources inefficiently.
C the government prohibits free riding.
D None of the above.
6. Income taxes ____ employment and ____ a dead-weight loss
A increase; do not create

B increase; create
C decrease; do not create
D decrease; create
1. C
2. D
3. C
4. B
5. D
6. B
Self Examination Question
Question 1
Explain the concepts of statutory incidence and economic incidence.
Answer to Self Examination Question
Answer to SEQ 1
The statutory / legal incidence refers to the person on whom the law says the tax obligation falls. Legal
incidence is established by law when new taxes are enacted, and specifies which individuals or companies must
physically remit tax payments to the revenue authorities.
The statutory incidence of taxes is generally very different from their final economic burden. Taxes, disrupt what
otherwise would be an efficiently functioning market by influencing the relative prices facing individuals, they
lead to changes in individual behaviour. This disruption is seen as a tax wedge between the demand price and
the supply price. Changes in the demand and supply prices after a tax, when compared to the equilibrium price
before the tax, is called incidence or burden of the tax. The economic tax incidence identifies who ultimately
pays the tax.
SECTION B

POLICY
B5
STUDY GUIDE B5: TAXATION AND
ECONOMIC EFFICIENCY
A tax system is regarded as efficient if it causes little or no interference in the functioning of an economy. The
assumed starting point is then a competitive economy where resource allocation is efficient. Allocation of
resources is considered to be optimal if no rearrangement of resources could make one person better off
without making someone else worse off.
Apparently, the transfer of money to the government in form of taxes leaves a taxpayer with lower purchasing
power and subsequently affecting his economic behaviour in various ways. As a result of taxation individuals
may either have to adjust the amount of work so as to earn more and sustain their consumption pattern, or are
compelled to cut down consumption to match the after tax income. Taxation results in what is termed as income
effects and substitution effects. When individuals are unable to capture fully the benefits, they have less
incentive to undertake productive activity to help others in exchange for income. Thus, they engage in fewer
wealth-creating activities.
This Study Guide explains the effect of taxes borne by consumers and producers, the effect of taxes on savings
and on labour. Knowledge of this Study Guide will be useful to understand the effect of taxes on economic
efficiency.
a) Explain effect of taxes borne by consumers.

b) Explain effects of taxes borne by producers.
c) Explain effect of taxation of savings.
d) Explain effect of taxes on labour.
1. Explain effect of taxes borne by consumers.

Explain effects of taxes borne by producers.
In a market without taxes, the difference between the market price of a good and the highest amount
consumers would be willing and able to pay for it is referred to as consumer surplus. Consumer surplus
occurs because first, every consumer has his own maximum price he would be willing to pay for a good
(although the market aggregates this demand, along with supply, to produce a market price); secondly, is due to
the fact that demand is rarely perfectly elastic. For most goods there is a limit to how much or how little
consumers will buy, no matter how much the price changes. For example, people are unlikely to stop buying
bread if the price rises, and they are unlikely to buy a lot more bread if the price falls. In effect, consumer
surplus can be seen as the total use or value that consumers get without paying for it.
On the other hand producer surplus represents the difference between the market price and the lowest
amount for which producers would be willing and able to sell a good in a market without taxation. It is
possible -- and, in fact, normal -- that there will be consumer surplus and producer surplus for the same good. In
the same way each consumer has her own maximum price for a good, each producer has a minimum price for
the good. In most cases, this is at or slightly above the producer's costs, because there is no benefit to
producing and selling more cheaply than this. In effect, producer surplus means profit.
1. Tax Effects on Demand and Supply
Putting a tax on a good distorts the relationship between demand and supply. Taxes have an effect on the
amount of supply produced and consumer’s demand for goods. Taxation puts both consumers and producers in
a worse position because with the introduction of taxes, the price that consumers pay is higher than what they
would have paid before. On the other hand, the price that producers get after the introduction
of taxes is lower than what they would have received before taxation.
The resulting change in relative cost of goods and services will have an effect of motivating consumers to switch
from one product or activity to another. The act of switching from one product to another as a result of a tax,
given a certain income level, leads to substitution effect. The substitution effect interferes with consumer choice
and subsequently leads to economic inefficiency. Taxes that affect relative prices and influence consumers
to substituting consumption of the taxed commodity for another are also termed distortionary taxes and
the substitution changes the consumer’s tax liability. The distortionary effects are not limited to commodity
tax alone but are also associated with tax on income as an individual may decide to reduce his tax liability by
working less as will be shown in the following sections.
The market has narrowed because lower quantity of goods is being exchanged. The decrease in consumers'
and producers' welfare turns into tax revenue of the state. Thus, for the purpose of full understanding of the
impact of taxes on welfare, the decrease in welfare of consumers and producers should be compared with the
tax revenue collected by the state. Such an analysis will show that the decrease in consumers' and producers'
welfare exceeds the tax revenue collected by the state. The loss of welfare that takes place after
introduction of taxes (a part of which belongs to no one - neither to a consumer or producer, nor to the
state) represents a dead weight loss or excess tax burden, or a degree of inefficiency that taxes
introduce to economy.
2. Tax Effect on Consumer and Producer Surplus
The addition of the tax will also remove some consumer and producer surplus. Consumers are forced to pay
more for the same good because the price has risen. Meanwhile, producers are losing out on potential profits
because their revenue has not increased by as much as the price rise would suggest. Total surplus will
therefore be reduced, because people and firms sell or buy less of a good when the tax adds to its price. The
effective price paid may rise, causing the demand curve to shift to the left, or the effective price received may
fall, causing the supply curve to shift to the left, creating the Deadweight Loss. This means that some people
that would have engaged in trade without the tax, no longer are "willing and able" to buy or sell the good,
meaning their surplus disappears, and the tax revenue that would have been derived from their market
participation disappears as well. Thus, taxes always cause deadweight Losses for society and always
negatively affects the free market system.
© GTG Taxation and economic efficiency: 95
Graphic example of the effect of sales tax on producers and consumers
The initial equilibrium is at point E, with price Pe and quantity Qe At the outset, the gains from trade are shown
by PmaxEPmin, allocated as before between consumers and producers. Suppose now that the government
imposes a per unit sales tax of say, $T dollars per disk on the sale of compact disks (A to E'). We know that the
tax raises the costs of production by $T for each disk that is produced. As a result, the industry supply curve
shifts up vertically by the $T, leading to a higher equilibrium price, PT and a lower equilibrium quantity, QT.
The impact of the tax on consumers' surplus is clear: From consumers' perspective, the price of disks rises, and
they reduce consumption in response. Instead of enjoying a surplus of PmaxEPe, they now must make do with
the smaller surplus PmaxE'PT. Thus, consumers lose the area PTE'EPe.
As viewed by producers, the tax-inclusive price of CDs rises to PT, but of course $T per disk must be handed
over to the tax collector. Thus, the net (after-tax) price received by sellers falls to PN (which equals (PT - T)). The
new level of producers' surplus is shown by the triangular area PNAPmin, which is clearly smaller than before the
tax. Indeed, producers lose the area PeEAPN
Diagram 1: The welfare cost of sales tax
Explain the meaning of consumer surplus and producer surplus.
2. Explain effects of taxation of savings.

Taxes can reduce economic growth by affecting savings and investment. The higher the proportion of
income that is being saved and invested, the higher will be the future income level. In other words,
through its impact on the amount of the income being saved or invested, taxation policy has a crucial effect on
the future level of income per capita. The effect of taxes on saving (of individuals and companies) is briefly
presented below.
Impact of Taxes on Savings of Individuals
The gross savings in private sector are accumulated in households and companies. However, a large part of the
gross savings is used for covering depreciation and is needed for the maintenance of the existing capital. The
net savings, consisting of savings in households and retained earnings of companies, represent the real
potential, available for new investments. The major part of these savings is accumulated in households, while
the retained earnings account for only a small part of them.
If all individuals would save the same proportion of income, then the impact of income tax on the total savings
would be the same, regardless of the pattern of the distribution of tax burden to individuals. But, wealthy
individuals save more than poor citizens, so it is expected that the taxes collected from higher tax brackets
create more burden on savings than the ones collected from lower tax brackets. Consequently, a more
progressive income tax seems to be creating a heavier burden on savings than a less progressive tax
system. This claim suggests that a less progressive income tax system would be favorable to the increase in
savings of individuals. However, research has established that the impact of income progressiveness on level of
savings is much less important than it could be expected: replacement of progressive income tax with a
proportional one could increase household savings by not more than 10 percent. This implies that propensity
to save is affected by other non tax factors: for example it varies with stage in a life cycle: in youth and in old
age it is much lower than in middle age when income is highest and when people save for education of their
kids, for a house or a flat and for the old age.
Income tax also affects savings by lowering the net return from savings, that is, by lowering the interest rate on
savings. In such conditions, savings are expected to drop. However, the savings of individuals are motivated
with various other reasons and their final amount does not have to depend on interest rate trends only. For
example, many households will not save less when interest rates are lower, because they are in that part of life
cycle when they have to save for retirement.
Besides income tax, consumption tax also affects savings of individuals. While income tax is generally
progressive, consumption taxes are mostly regressive, that is, they are mostly paid by lower-income
households. Since these households have a higher marginal propensity to consume than the households with
higher income and since their marginal propensity to save is lower than the one of wealthy individuals,
consumption taxes burden total consumption more and savings less. This is why it is often recommended to the
countries with low level of savings that they should direct their tax systems to taxation of consumption much
more, because this will boost savings and growth, too.
Impact of tax on gross savings of companies
Retained earnings and depreciation reserves account for the predominant part of company savings. Since profit
is taxed after deduction of depreciation, income tax does not reduce the depreciation reserves. But if profit
taxation law allows accelerated depreciation, then depreciation reserves and company savings will increase in
the first years following the purchase of fixed assets. Profit is divided in the dividends distributed to company
owners and undistributed profit remaining in the company. Different taxation of the dividends and retained
profit has an impact on savings, too. Higher taxation of the retained profit will stimulate its distribution
to dividends, while lower taxation of the retained profit will increase the company's savings. The amount
of savings also depends on whether profit taxation system and income taxation system are reconciled. If they
are, double taxation of the dividends on company level and again on the level of individuals is thus avoided.
Briefly explain the effects of taxation on savings of individuals.
3. Explain effects of taxes on labour.

In regard to the labour market, labour is the supply and wages are the price of labour. Because the supply of
unskilled labour is highly inelastic, unskilled workers bear most of the burden of the payroll tax. However,
when workers offer valuable skills, they are generally much more highly compensated because there is more
competition for their abilities and services. Thus, highly compensated individuals bear less of the burden of
the payroll tax than the employers. The overall effect is that the tax incidence of the payroll tax falls more
heavily on lower income workers than on higher income workers.
3.1 Impact of income tax on wages and employment
Taxation of labour introduces a difference between real gross cost of labour for a company and real net wage
that employees receive. Thus, taxes create a difference between the cost of labour and net wage that is called
tax wedge in economic theory.
Tax wedge is the difference between before-tax and after-tax wages. The tax wedge measures how much the
government receives as a result of taxing the labour force.
In some countries, the tax wedge increases as employee income increases. This reduces the marginal benefit
of working therefore employees will often work less hours than they would if no tax was imposed. Some argue
that the tax wedge on investment income will also reduce savings, create less innovation, and ultimately lowers
living standards.
By having a tax wedge the inefficiency will cause the consumer to pay more and the producer to receive less.
This is due to higher equilibrium prices paid by consumers and lower equilibrium quantities sold by producers.
Tax wedges are the basic value with which impact of tax on labour market, that is, on the amount of supply and
demand for labour is analysed. The amount of real gross cost of labour determines the amount of labour
demand, while the amount of real net wage determines the amount of labour supply. What part of tax wedge will
be distributed on the entrepreneur, thus determining the labour demand, and what part of tax wedge will be
distributed on the employee, thus influencing the amount of labour that he can supply to the market, depends on
the possibility of shifting of the tax incidence.
In analysing the impact of tax on employment rate and growth, it is essential therefore to analyse tax incidence.
It depends on the elasticity of supply and demand in labour market, as well as on other factors that determine
flexibility of wages (e.g. negotiating skills of unions, minimum wage etc.).
Thus, for example, in markets where negotiating skills of unions are not strong, or where labour supply is not
flexible to change of wages, an entrepreneur will be able to shift taxes on the worker, which will result in a lower
net wage and the same gross cost of labour for the employer. In a real situation, workers will eventually react on
reduction of their net wages, i.e. reduction of their income.
Are they to offer a higher or lower amount of labour to the market now? If substitution effect prevails, they will
offer less labour, expanding their leisure time. If income effect prevails, the workers will want to work more, in
order to compensate for the lost income, which will result in a higher amount of labour in the market. This
means that workers' reaction on taxes can be to work more or to work less, depending on what will prevail -
substitution effect or income effect. Which way the combination works out depends upon preferences. For some
preferences labour supply increases with taxation, with others it decreases.
In the context of economic theory, the income effect is the change in an individual's or economy's income and
how that change will impact the quantity demanded of a good or service. The relationship between income and
the quantity demanded is a positive one, as income increases, so does the quantity of goods and services
demanded.
Income effect where a tax is imposed on the labour income as a result the worker will not be able to buy most of
the things he wants thus the effect is to persuade him to do more work in order to restore his disposable income
to its previous level
Substitution effect describes the relationship between a change in relative prices and any resulting change in a
person’s expenditure pattern. It describes the effect on a person’s choice between work and leisure as the
marginal benefit from either or both.
Only empirical research can help finding out which of the effects prevails in a given market, that is, will
introduction of taxes and reduction of real net wage encourage people to offer more or less labour. In markets
where negotiating skills of unions are strong and where labour supply is flexible to changes of wage, an
entrepreneur will not be able to shift taxes on workers. The workers will react to introduction of taxes with
demands for increased net wages. This will make the cost of labour higher for the entrepreneur and he will
reduce the demand for labour. Such reduced demand for labour results in reduced employment rate and, with
constant use of capital, could lead to lower growth. Empirical research indicates that labour markets are mostly
rigid, that is, entrepreneurs bear higher tax burden than. So, when conditions in labour market are rigid, workers
will oppose paying labour tax, thus initiating a negotiating process and pressure for wage increase. This will
increase the cost of labour for entrepreneurs.
For its part, higher cost of labour for entrepreneurs reduces demand for labour; by changing relative costs of
labour and capital, it stimulates capital-intensive production. Thus, reduction of tax burden on labour, as well as
reduction of rigidity in a labour market (reviewing the amount of minimum wage; unemployment benefit;
increased mobility of labour force) would lead to a higher supply and demand for labour. This would result in
increased employment rate on the one hand and increased output on the other hand.
3.2 Impact of taxes on consumption on wages and employment
Beside direct taxes, indirect taxes (that is, consumption taxes) also have impact on the supply of labour by
reducing the purchasing power of net wage. However, workers seem to be reacting somewhat slower to a
change in the consumption taxes, and the impact of the consumption taxes on labour supply also appears within
a longer period of time than normally is the case with direct taxes.
Taxes on labour income and consumption spending encourage households to shift away from work in the legal
market sector and toward untaxed uses of time such as leisure, household production, and work in the shadow
economy. Emperical evidence also show that taxes affect work activity directly through labour supply-and-
demand channels and indirectly through government spending responses to available tax revenues. Higher tax
rates on labour income and consumption expenditures lead to less work time in the legal market sector, more
time working in the household sector, a larger underground economy, and smaller shares of national output and
employment in industries that rely heavily on low-wage, low -skill labour inputs.
Briefly explain on the term “tax wedge”
Answer to TY 1
In a market without taxes, the difference between the market price of a good and the highest amount
consumers would be willing and able to pay for it is referred to as consumer surplus. Consumer surplus
occurs because first, every consumer has his own maximum price he would be willing to pay for a good
(although the market aggregates this demand, along with supply, to produce a market price); secondly, is due to
the fact that demand is rarely perfectly elastic. Consumer surplus can be seen as the total use or value that
consumers get without paying for it.
Producer surplus represents the difference between the market price and the lowest amount for which
producers would be willing and able to sell a good in a market without taxation. It is possible -- and, in
fact, normal -- that there will be consumer surplus and producer surplus for the same good. In the same way
each consumer has her own maximum price for a good, each producer has a minimum price for the good. In
most cases, this is at or slightly above the producer's costs, because there is no benefit to producing and selling
more cheaply than this. In effect, producer surplus means profit.
Answer to TY 2
Taxes can reduce economic growth by affecting savings and investment. The higher the proportion of
income that is being saved and invested, the higher will be the future income level.
The net savings of individuals, consisting of savings in households and retained earnings of companies,
represent the real potential, available for new investments. The major part of these savings is accumulated in
households, while the retained earnings account for only a small part of them.
If all individuals would save the same proportion of income, then the impact of income tax on the total savings
would be the same, regardless of the pattern of the distribution of tax burden to individuals. But, wealthy
individuals save more than poor citizens, so it is expected that the taxes collected from higher tax brackets
create more burden on savings than the ones collected from lower tax brackets. Consequently, a more
progressive income tax seems to be creating a heavier burden on savings than a less progressive tax
system. The propensity to save is affected by non tax factors like demography i.e. it varies with stage in a
life cycle: in youth and in old age it is much lower than in middle age when income is highest and when people
save for education of their kids, for a house or a flat and for the old age.
Income tax also affects savings by lowering the net return from savings, that is, by lowering the interest rate on
savings. Furthermore the savings of individuals are motivated with various other reasons and their final amount
does not have to depend on interest rate trends only.
Besides income tax, consumption tax also affects savings of individuals. While income tax is generally
progressive, consumption taxes are mostly regressive, that is, they are mostly paid by lower-income
households. Since these households have a higher marginal propensity to consume than the households with
higher income and since their marginal propensity to save is lower than the one of wealthy individuals,
consumption taxes burden total consumption more and savings less. This is why it is often recommended
to the countries with low level of savings that they should direct their tax systems to taxation of consumption
much more, because this will boost savings and growth, too.
Answer to TY 3
Labour taxes drive a wedge between what workers receive and what firms pay, and empirical analysis suggests
that employment falls as a result, thereby lowering potential output. The extent of the fall in employment
depends on labour-market institutions and the wage-bargaining framework. In countries with flexible labour
markets, the taxes tend to get shifted back onto labour, reducing the take-home wage. The effect on labour
supply of this lower wage appears to be empirically small for men, but appears to be significant for women, for
whom tax elasticities are high. In countries with inflexible labour markets, by contrast, labour taxes tend to get
shifted forward to producers, at least in the short run, and therefore reduce labour demand. This reduces
employment and lowers growth if lower demand for labour is not replaced by higher demand for capital, for
example if investment reacts negatively to higher costs of production. Empirical work shows that labour-demand
elasticities are much higher than overall supply elasticities, so that labour taxes tend to be much more
distortionary in countries where there are inflexible labour markets, and most of the tax effect falls on the
demand rather than the supply of labour. The absolute level of the labour-tax burden also tends to be high in
such countries.
Quick Quiz
Fill in the blanks
(a) The difference between the market price of a good and the highest amount consumers would be willing and
able to pay for it is referred to as ________________ surplus.
(b) ____________ surplus represents the difference between the market price and the lowest amount for
which producers would be willing and able to sell a good in a market without taxation..
(c) Taxes that affect relative prices and influence consumers to substituting consumption of the taxed
commodity for another are also termed ________________ taxes.
(d) Taxes always cause deadweight Losses for society and always ________________ affects the free market
system.
(e) A more _____________ income tax seems to be creating a heavier burden on savings than a less
____________ tax system.
(f) The tax incidence of the payroll tax falls more heavily on _____________ income workers than on
_________ income workers.
(a) consumer
(b) producer
(c) distortionary
(d) negatively
(e) progressive, progressive
(f) lower, higher

Self-Examination Question
Question 1
Explain the income and substitution effect
Answers to Self-Examination Question
Answer to SEQ 1
The substitution effect is the change in consumption patterns due to a change in the relative prices of goods.
For example, if private universities increase their tuition by 10% and public universities increase their tuition by
only 2%, then it is very likely that we would see a shift in attendance from private to public universities (at least
amongst students accepted to both). The same can be said across brands, goods, and even categories of
goods. Examples would be the relative price of Pepsi vs. Coke, Red Meat vs. Poultry and Clothes vs.
Entertainment.
The income effect is the change in consumption patterns due to the change in purchasing power. This can
occur from income increases, price changes, or even currency fluctuations. For example, a decrease in the
price of all cars allows you to buy either a cheaper car or a better car for the same price, thus increasing your
utility. Goods typically fall into one of two categories: normal and inferior. These categorizations relate
consumption of a good with a particular individual’s income. Normal goods increase in consumption as income
increase while inferior goods decrease as income increases. Also, some goods can be normal or inferior only
on certain ranges of an income spectrum. For example, education is a normal good: as one’s income increases
(family income), demand for education increases. As one’s income increases, hot dog consumption, however,
typically decreases. The income effect is the change in consumption patterns due to the change in purchasing
power and the substitution effect is the change in consumption patterns due to a change in the relative prices of
goods.
SECTION B

POLICY
B6
STUDY GUIDE B6: TAX POLICY CONCEPTS
It can be seen from previous discussions that taxation is the main or primary source of revenue of many
governments. It has inherent advantages over other sources of government revenues. So taxation is one of the
most important thing that governments do, it is therefore important that governments should get the tax policy
right. In carrying out this function (of taxation), governments should formulate tax policies, enact tax laws and
translate these policies and laws into the desired tax structure and administer its attainment.
This Study Guide looks at the nature and objectives of tax policies and describes the relationship between tax
policy, tax law, tax administration, as well as tax revenue and tax reforms. As a prospective tax consultant,
knowledge of the contents of this Study Guide will be very useful while offering tax advice to your clients.
a) Describe the nature of tax policy.

b) Identify objectives of tax policy.
c) Describe the relationship between tax policy, tax law and tax administration.
d) Explain the relationship between tax policy, tax revenue, and tax reform.
1. Describe the nature of tax policy.

[Learning Outcome a,
Tax policy is an integral part of fiscal policy and administrative apparatus that is built to levy and collect tax,
through applying different tariff and basic taxation. Tax policy is concerned with the reasoning behind how
much revenue the government is collecting, how the revenue is used for and whether the government is
collecting revenue in the most appropriate way.
Responsible tax policy formulation requires that tax policies be rational and have wider benefits in mind. Any
indication of arbitrariness or favouritism in the tax policy and in the tax system undermines public confidence in
government and generates resistance to the taxes imposed by government.
On the other hand where there is public confidence in the fairness of taxation the cooperation between the tax
administration and the tax payers is enhanced and thus raising the level of voluntary tax compliance. It is very
critical that taxes are fairly imposed and that the public must see that fairness exhibited both: in content of the
tax laws and in the administration of the tax laws.
A tax policy is judged by the following three factors:
(a) How much should government gather as tax?
Ideally, the tax collected should be enough to meet public spending needs and contribute to fiscal stability, but
not so big as to encourage the government itself to be wasteful or to appropriate money that could be better
used in private hands.
(b) How should the tax burden be distributed among actual or potential tax payers?
Is the tax burden fair? Or how is the potential advantage of using tax policy to help achieve other public policy
goals such as encouraging business to locate in certain regions (eg. poorer regions), to invest in particular
underserved sectors; or redistributing income or wealth from one group of citizens to another.
(c) How can the potential adverse economic costs of taxation be contained or minimized?
Both tax payers and legislators would want to know about the efficiency of the tax administration. How much
money that is raised is absorbed in the collection process? What are indirect costs of raising revenue? Because
the indirect costs of raising revenue: taxing any activity almost inevitably discourages it. For example taxing
coffee exports may bias the whole economy in an inefficient way, against producing coffee for export. It is
probably more efficient simply to spread the tax burden more widely.
Tax policy is influenced by worldwide economic influences such as international defence policy and
overseas aid.
Briefly explain the three factors which are used to judge a taxation policy.
2. Identify objectives of tax policy.

The objectives of Tax Policy are similar to those of public policy in developing countries and overlap with the
purpose of the tax system.
These are:
(i) Generation of revenue for government expenditure: this is a traditional objective of any tax policy. Tax
policy is considered to be a substantial source of funding for most government operations.
(ii) Enable the government to provide and support social development by ensuring appropriate
distribution of income (redistribution of wealth): the distributional role of tax policy is very critical
especially in developing countries due to large disparities in income between people. Disparities in income
can block development and increase demand for the government social spending. Existence of numerous
exemptions and government favours to the high income earners / the rich make the rich pay less.
© GTG Tax Policy Concepts: 103
(iii) Device for reduction of income disparities among geographical regions with different factor
endowments: tax policy is also a device for reduction of income disparities among geographical regions
with different factor endowments. The policy may direct the government acting as the central revenue
collection and planning authority to undertake particular programmes for the direct benefit of some less
favourable group of citizens such as destitute or the lowliest paid or zero income earners. The revenue may
also be used to subsidise social and economic development of geographical areas that may not be naturally
well favoured.
(iv) To enhance economic stability and growth: tax policy enables to ensure elasticity with respect to
changes in value of money and income levels. If tax yields rise when national income rises the government
have less need to rely on deficit financing to maintain and expand the level of public sector activity in the
growing economy.
Although all the above objectives of taxation are incorporated into tax policies, taxation measures which seek
to stimulate economic growth and to redistribute wealth have not been the driving force behind tax
policy. These objectives tend to be overshadowed by the pursuit of revenue to fund government
expenditure. As a result even where these objectives are incorporated into fiscal policy or written into
tax statutes, tax administrators tend to find ways not to give full effect to these objectives as reflected in
cases of tax incentives and reliefs.
Briefly explain any two objectives of tax policies.
3. Describe the relationship between tax policy, tax law and tax administration.
It has been argued that the best tax policy in the world is worth little if it can’t be implemented effectively and
therefore tax policy design must take into account the administrative dimension of taxation. The real tax
system people and businesses face reflects not just tax law but also how that law is actually implemented in
practice. How a tax system is administered affects its yield, its incidence, and its efficiency. Tax administration
is too important to policy outcomes to be neglected by tax policy reformers.
Tax Policy and Tax Law
Do the existing tax laws ensure that every person pays tax to the fullest level required? Are the tax laws
effective? Do they carry an ability to drive compliance? The need to have tax laws apply equally to everyone
is important because taxpayers’ sense of fairness stem from the belief that every person will fulfil their
tax paying obligation so that the cost of running the country is evenly distributed. Thus no person should
cause another person to bear more tax burden by escaping his/her own tax obligation.
Regardless of how carefully tax laws have been made, they could not eliminate conflict between tax
administration and tax payers. Tax administration with a skilled and responsible staff is almost the most
important precondition for realization of “tax potential” of the state. Tax laws and tax policies are as good as is
the tax administration. In tax reforms there is close correlation between successful tax policy and efficient tax
administration i.e. there is no good tax policy without efficient tax administration.
Tax Policy and Tax Administration
The efficiency of a tax system is not determined only by appropriate legal regulations but also by the
efficient and integrity of the tax administration. Indeed the objectives of tax policy cannot be achieved when
the policy is not properly administered. Strong tax administration is a requisite for ensuring high compliance.
Good tax administration requires strong technical capacity supported by a well-designed tax laws.
In many countries, especially in developing countries like Tanzania, small amount of collected tax revenue can
be explained by either incapability of tax administration in realization of its duty, or with some degree of
corruption.
Tax policy and tax administration interact at three distinct levels:
¾ The formation and drafting of tax legislation

¾ Administrative procedures and institutions needed to implement laws
¾ Actual implementation of the tax system
For tax administrations to be successful, tax administrators must act as facilitators and enable the process of
achieving maximum compliance with the least possible compliance cost to the taxpayer. A focus on, and
recognition of the needs of the taxpayers are necessary prerequisites of a modern efficient tax
administration.
The human side of taxation must be translated into action. It must be reflected in tax and tax administration
policies and procedures. The taxpayer must be able to see that tax administrations are managed by officials
who are humane, sensitive and caring. In other words, tax administrators must have a heart.
Tax administrations must recognise that the “carrot” is a much more powerful and effective
motivational tool, than the “stick”. This point is further augmented by the fact that the tax net is now
comprised of taxpayers who are much more informed and educated as to their rights. This means that tax
administration may not deliberately or otherwise, impose policies and procedures that are not
consistent with the tax legislation or are perceived to be unfair to the taxpayer.
The “Human side” must translate into tax administration becoming more aware of the effects of tax policies on
the wider society. Issues relating to compliance must be given priority since to be perceived as “fair”, tax
administrations must ensure that all persons liable to tax are indeed paying their fair share. Failure to properly
administer the tax policy, therefore, defeats its very purpose and threatens equity. This will cause
deficiencies in tax operations, reduce overall tax collection and cause corruption. In this situation the
government will only collect taxes from easy to tax sectors and in a disproportionately large share of the tax
burden being borne by who cannot avoid paying taxes.
The human side of taxation must also be seen in the “tax mix” that is used and the nature and quantity of
exemptions. To have too many exemptions and nuisance taxes can result in the taxpayers having to incur
significant administrative cost in order to comply with tax law.
There is need to establish a tax administration structure which, by means of a coherent professional career,
within a framework of ongoing training, makes it possible for it to be managed by officers with aptitudes that
have enabled them to achieve evaluations beyond the standards required of them in the various stages of their
career development. This involves having knowledge in line with the pertinent responsibilities in each case and,
despite changes in the political sphere, the officers in charge of this body should be respected and kept in their
posts. The highest echelons of management should, after preliminary selection on the basis of their track
records.
Explain the relationship between tax policy and tax administration.
4. Explain the relationship between tax policy, tax revenue, and tax reform.
One of the traditional objectives of any tax policy is generation of revenue for government expenditure. All
nations need money to support them, and taxation is one way of collecting this money.
Tax revenue is used to pay for public education and health, public health, national defense, and a wide variety
of other government activities ranging from scientific research to providing security to citizens. In addition to this
Tax systems are also used to promote other objectives, such as equity, and to address social and economic
concerns.
However, taxes on the other hand, are a cost to taxpayers and thus affect the decisions of households to save,
decisions to supply labor and to invest in human capital. Taxes affect the decisions of firms to produce, create
jobs, invest and innovate. In making these decisions, the taxpayers take into considerations not only the level of
taxes but also the way in which different tax instruments are designed and combined to generate revenues.
Taxes also distort prices and therefore result in inefficiency and deadweight losses. Therefore, tax policies
need to be set up to minimize these distortions as well as taxpayers’ compliance costs and
government’s administrative cost, while also discouraging tax avoidance and evasion. The effects of tax
levels and tax structures on agents’ economic behaviour are likely to be reflected in overall living standards.
Ensuring that all people living in a country contribute to the expense of running it is a challenge. No matter how
well designed the tax policies are they cannot be implemented by a tax administration that is not well organized.
There continues to be a huge gap between policy formulation and their actual implementation due to insufficient
consultation among those who formulate policy and the tax administrators who implement these policies. Since
good tax policy cannot exist without good tax administration, the reform of tax policies has attracted much
attention.
Tax reform gives two meanings of to “re-form”: “to make better by removal or abandonment of imperfections,
faults or errors”; and “to re-form.” Some technical modifications of the tax system might be universally regarded
as improvements, but few, if any, major restructurings which alter the distribution of the tax burden, would be
regarded as an improvement by everyone. Whether a “tax reform” constitutes an improvement is very much a
matter of value judgment
The Oxford Dictionary
Tax reform is a process in which the tax policies of a government are changed, changes include changing the
way taxes are collected or managed by the government.
Goals of tax reforms
Tax reformers have different goals.
¾ Some seek to reduce the level of taxation of all people by the government.
¾ Some seek to make the tax system more progressive or less progressive.
¾ Others seek to simplify the tax system and make the system more understandable or more accountable.
The usual goal of advocates for tax reform is more fairness in taxation, but there are a number of ways to
assess fairness, and what seems fair to one person might seem like a gross imposition to another. Many
nations have groups of citizens which push for changes to tax policy, and some also have highly organized
reform movements which may engage in lobbying and other activities to change the way taxes are handled.
The goals of tax reform can cover things like how taxes are administered, collected, and handled, as
well as how the tax code is structured. Some tax reformers actually want to abolish taxes altogether,
while others would like to see changes in how taxes are handled. For example, a reformer might advocate
to get rid of income taxes and focus on sales taxes for the purpose of taxing consumption, rather than income,
arguing that this method would be fairer.
Some opponents of taxation argue that government spending patterns should be adjusted to reduce the
demand for taxes; very few advocates for tax reform push for increases in taxes.
There is a great deal of argument within the tax reform community about which aspects of the tax code need to
changed and how these changes should be accomplished. Some of these arguments follow political ideologies,
while in other cases people from diverse political perspectives may uniformly support or oppose proposed
changes to the way in which taxes are handled.
This has become central especially in developing countries for mobilizing domestic tax resources for the
provision of financial and technical support aimed at establishing productive, efficient, and equitable tax
systems, as well as enhancing the institutional and operational capacity of their tax administration. Recognizing
the importance of combining improvements in revenue administration with supportive, efficient, and fair and
effective tax policy, it is important that:
¾ Tax policies are reformed so as to broaden the tax base and combat tax avoidance and evasion through tax
policy design that support tax reforms; revenue forecasting and tax gap estimates, simplification of tax laws,
tax expenditure analysis and rationalization.
¾ Reforming revenue administration that include institutional reform, strengthening of the operational capacity
of tax administration, etc
Numerous organisations have been set up to reform tax systems worldwide, often with the intent to reform
income taxes or value added taxes into something considered more economically liberal. Other reforms propose
tax systems that attempt to deal with externalities.
When reforming tax systems, policymakers have to weigh up the different goals that tax systems try to achieve.
Policymakers will have to balance the efficiency and growth-oriented objectives of tax reform with their
distributional impact. The impact of tax reforms on revenues, tax avoidance and evasion and tax compliance
and enforcement costs will have to be taken into account. The impact on sub-central levels of government, the
transitional costs of changing tax systems and complex timing issues will also have to be considered as well as
the different administrative, institutional and political environment factors.
Maximizing revenue for a given administrative outlay is only one dimension of the task of tax administration.
Revenue outcomes may not always be the most appropriate basis for assessing administrative performance.
How revenue is raised, i.e. the effect of revenue generation effort on equity, the political fortunes of the
government, and the level of economic welfare, may be equally (or more) important as how much revenue is
raised. Private as well as public costs of tax administration must be taken into account, and due attention must
be paid to the extent to which revenue is attributable to enforcement (the active intervention of the
administration) rather than compliance (the relatively passive role of the administration as the recipient of
revenues generated by other features of the system).
Assessing the relation between administrative effort and revenue outcome is by no means a simple task. There
is a great deal of argument within the tax reform community about which aspects of the tax code need to
changed and how these changes should be accomplished. Some of these arguments follow political ideologies,
while in other cases people from diverse political perspectives may uniformly support or oppose proposed
changes to the way in which taxes are handled.
Legislatures routinely engage in tax reform, making small adjustments to tax policy to meet a nation's changing
needs and to address the concerns of citizens. Heads of state may also push through reforms such as tax cuts
in order to make themselves more popular among citizens.
The following comments from a taxpayer show the concerns of a taxpayer on certain reforms based on
increasing tax revenue:
……..The rich are becoming richer and poor becoming poorer. Economic wealth is unequally spread. Hence,
our country still requires its social, economic and political development policies to be polished and fine tuned to
cater for its ever-growing and dynamic requirements.
The current taxation policies need to be closely reviewed. The tax policies for 2013/2014 have resulted in lots of
double taxation and daunting tax administration procedures.
The government needs to avoid portraying a desperate revenue collection strategy. There are more and better
innovative ways for collecting taxes.
(a) Withholding tax of 5% on service fees has imposed a lot of daunting tax administration procedures on the
relevant taxpayers. Chasing each and every client for a withholding tax certificate makes our life very
difficult and warrants additional investment of time and labour which is not productive.
¾ What is the point in registered taxpayers (with TIN numbers) to suffer withholding tax and then claim the
same from TRA at the end of the year
¾ What fines and penalties would TRA even fine a taxpayer who did not allow his clients to withhold tax and
pay all his corporate tax for the year on time and accurately? Extending imposition of this tax on registered
taxpayers was not a correct and productive decision in my opinion.
(b) Excise duty on money transfers is another such example of double taxation. The same money is made to
pay 0.15 per cent excise duty as many times as it changes hands in the country and outside the country.
Does this make economic sense? In which developing economy has such a tax been imposed? I am not
aware of any.
¾ Less than 50 per cent of Tanzanians use banking services. Imposition of this tax will further hinder
penetration of banking facilities and services in rural and other areas. As if commercial money transfers was
not enough, this tax also extends its arms around salary transfers. This makes salary costs go even higher.
Multinational employers now take this tax into account during manpower planning. This is not healthy for our
country.
¾ Consider a business which has imported goods from a foreign country. The Tanzanian importer pays import
duty value added tax, local charges and ‘excise duty’ on clearing these goods at the ports.
¾ The same importer will also suffer additional excise duty when making payment to the same overseas
supplier. This is a clear double taxation instance.
(c) The same concept also applies to retailing of internet bandwidth services. Every time internet bandwidth is
retailed, the internet service provider (ISP) has to charge 17 per cent excise duty. This is another instance
of double taxation. Internet service prices have significantly shot up across the country after July 2013. We
all have seen significant negative reactions to implementation of TRA’s EFD Phase II Programme.
Explain briefly the goals of tax reform.
Answer to TY 1
A tax policy is judged by the following three factors;
(a) How much should government gather as tax?
Ideally, the tax collected should be enough to meet public spending needs and contribute to fiscal stability, but
not so big as to encourage the government itself to be wasteful or to appropriate money that could be better
used in private hands.
(b) How should the tax burden be distributed among actual or potential tax payers?
Is the tax burden fair? Or how is the potential advantage of using tax policy to help achieve other public policy
goals such as encouraging business to locate in certain regions (eg. poorer regions), to invest in particular
underserved sectors; or redistributing income or wealth from one group of citizens to another.
(c) How can the potential adverse economic costs of taxation be contained or minimized?
Both tax payers and legislators would want to know about the efficiency of the tax administration. How much
money that is raised is absorbed in the collection process? What are indirect costs of raising revenue? Because
the indirect costs of raising revenue: taxing any activity almost inevitably discourages it. For example, taxing
coffee exports may bias the whole economy in an inefficient way, against producing coffee for export. It is
probably more efficient simply to spread the tax burden more widely.
Answer to TY 2
Two objectives of Tax Policy are as follows:
(i) Generation of revenue for government expenditure: this is a traditional objective of any tax policy. Tax
policy is considered to be a substantial source of funding for most government operations.
(ii) Enable the government to provide and support social development by ensuring appropriate
distribution of income (redistribution of wealth): the distributional role of tax policy is very critical
especially in developing countries due to large disparities in income between people. Disparities in income
can block development and increase demand for the government social spending. Existence of numerous
exemptions and government favours to the high income earners / the rich make the rich pay less.
Answer to TY 3
The efficiency of a tax system is not determined only by appropriate legal regulations but also by the
efficient and integrity of the tax administration.
In many countries, especially in developing countries like Tanzania, small amount of collected tax revenue can
be explained by either incapability of tax administration in realization of its duty, or with some degree of
corruption.
Tax policy and tax administration interact at three distinct levels:
¾ The formation and drafting of tax legislation

¾ Administrative procedures and institutions needed to implement laws
¾ Actual implementation of the tax system
A focus on, and recognition of the needs of the taxpayers are necessary prerequisites of a modern
efficient tax administration.
Tax administrations must recognise that the “carrot” is a much more powerful and effective
motivational tool, than the “stick”. Tax administration may not deliberately or otherwise, impose
policies and procedures that are not consistent with the tax legislation or are perceived to be unfair to
the taxpayer.
Failure to properly administer the tax policy, therefore, defeats its very purpose and threatens equity.
This will cause deficiencies in tax operations, reduce overall tax collection and cause corruption. In this situation
the government will only collect taxes from easy to tax sectors and in a disproportionately large share of the tax
burden being borne by who cannot avoid paying taxes.
Answer to TY 4
Goals of Tax reforms
Tax reformers have different goals.
¾ Some seek to reduce the level of taxation of all people by the government.
¾ Some seek to make the tax system more progressive or less progressive.
¾ Others seek to simplify the tax system and make the system more understandable or more accountable.
The usual goal of advocates for tax reform is more fairness in taxation, but there are a number of ways to
assess fairness, and what seems fair to one person might seem like a gross imposition to another.
The goals of tax reform can cover things like how taxes are administered, collected, and handled, as
well as how the tax code is structured. Some tax reformers actually want to abolish taxes altogether,
while others would like to see changes in how taxes are handled.
Some opponents of taxation argue that government spending patterns should be adjusted to reduce the
demand for taxes; very few advocates for tax reform push for increases in taxes.
Recognizing the importance of combining improvements in revenue administration with supportive, efficient, and
fair and effective tax policy, it is important that:
¾ Tax policies are reformed so as to broaden the tax base and combat tax avoidance and evasion through tax
policy design that support tax reforms; revenue forecasting and tax gap estimates, simplification of tax laws,
tax expenditure analysis and rationalization.
¾ Reforming revenue administration that include institutional reform, strengthening of the operational capacity
of tax administration, etc
When reforming tax systems, policymakers have to weigh up the different goals that tax systems try to achieve.
Policymakers will have to balance the efficiency and growth-oriented objectives of tax reform with their
distributional impact. The impact of tax reforms on revenues, tax avoidance and evasion and tax compliance
and enforcement costs will have to be taken into account. The impact on sub-central levels of government, the
transitional costs of changing tax systems and complex timing issues will also have to be considered as well as
the different administrative, institutional and political environment factors.
Quick Quiz
Fill in the blanks
(a) _______________ is concerned with the reasoning behind how much revenue the government is collecting,
how the revenue is used for and whether the government is collecting revenue in the most appropriate way.
(b) The _______________ role of tax policy is very critical especially in developing countries due to large
disparities in income between people.
(c) The need to have _____________ ____________ apply equally to everyone is important because
taxpayers’ sense of fairness stem from the belief that every person will fulfil their tax paying obligation so
that the cost of running the country is evenly distributed.
(d) The efficiency of a tax system is not determined only by appropriate legal regulations but also by the
efficient and integrity of the________ ____________.
(e) Tax policies need to be set up to minimize taxpayers’ compliance costs and government’s
administrative cost, while also discouraging tax ___________ and __________.
(a) Tax policy
(b) Distributional
(c) tax laws
(d) tax administration
(e) avoidance, evasion
Question 1
Briefly explain the relationship between tax policies and tax revenue.
Answer to SEQ 1
One of the traditional objectives of any tax policy is generation of revenue for government expenditure. All
nations need money to support them, and taxation is one way of collecting this money.
Tax revenue is used to pay for public education and health, public health, national defence, and a wide variety
of other government activities ranging from scientific research to providing security to citizens. In addition to this
Tax systems are also used to promote other objectives, such as equity, and to address social and economic
concerns.
However, taxes on the other hand, are a cost to taxpayers and thus affect the decisions of households to save,
decisions to supply labour and to invest in human capital. Taxes affect the decisions of firms to produce, create
jobs, invest and innovate. In making these decisions, the taxpayers take into considerations not only the level of
taxes but also the way in which different tax instruments are designed and combined to generate revenues.
Taxes also distort prices and therefore result in inefficiency and deadweight losses. Therefore, tax policies
need to be set up to minimize these distortions as well as taxpayers’ compliance costs and
government’s administrative cost, while also discouraging tax avoidance and evasion. The effects of tax
levels and tax structures on agents’ economic behaviour are likely to be reflected in overall living standards.
SECTION C
TAX LAW AND PRACTICE C1

STUDY GUIDE C1: BASIC PROVISIONS OF
THE INCOME TAX ACT (AN OVERVIEW)
Income Tax Act 2004 covers incomes from employment, business and investment. The basics of computing
these incomes were covered are Paper B4.
In this Study Guide we will once again review the computation of income from investment, business and
employment. Furthermore we have demonstrated how to fill a complete tax returns and statement of estimated
tax
Knowledge of this Study Guide will be useful to you in your career as a tax consultant.
a) Determine residential status of taxpayers.

b) Calculate total income.
c) Calculate employment income.
d) Calculate business income.
e) Calculate investment income.
f) Prepare tax returns and statement of estimated tax.
112: Tax Law and Practice © GTG
1. Determine residential status of taxpayers

1.1 Residential status of individuals
Individuals are regarded residents of the United Republic for a year of income if he / she:
¾ has a permanent home in the United Republic and is present in the United Republic during any part of the
year of income;
¾ is present in the United Republic during the year of income for a period or periods amounting in aggregate
to 183 days or more;
¾ is present in the United Republic during the year of income and in each of the two preceding years of
income for periods averaging more than 122 days in each such year of income; or
¾ is an employee or an official of the Government of the United Republic posted abroad during the year of
income (Section 66(1))?
‘Individual’ means a natural person

Section 3
‘A permanent home’ is any form of accommodation (owned or rented) which is continuously available to you
for your personal use.
HMRC
Consider the following individuals’ information:
(a) Maj who has permanent home in Tanzania and Saudi Arabia, but she had been in Tanzania in 2008 for one
day.
(b) Maj who has no permanent home in Tanzania but she had been in Tanzania for 5months i.e. from
1st January to 31st May 2008.
(c) Maj who has no permanent home in Tanzania spent 100 days in 2006, 200 days in 2007 and 90 days in
2008.
(d) Maj who has no permanent home in Tanzania has been living in Saudi Arabia as Tanzania Consul at
Tanzania embassy.
Required:
Determine the residential status of Maj for the year ending 31st December 2008.
Answer
(a) Since she has a permanent home and presence in Tanzania for one day, she was resident of the United
Republic of Tanzania in 2008.
(b) She spent 152 days i.e. from 1st January to 31st May 2008 in Tanzania, far below 183 days, so she was
non-resident in Tanzania in that year.
(c) Since she spent 100 days in 2006, 200 days in 2007 and 90 days in 2008, Maj was non-resident because
she did not stay in Tanzania for periods averaging more than 122 days in 2006 and 2008.
(d) Since she was working for the Tanzania government she was resident in 2008 despite spending who year
and Saud Arabia and having no permanent home.
© GTG Basic Provisions of the Income Tax Act (an Overview): 113
1.2 Residential status of partnership
In case of partnerships, the partnerships are treated as resident partnerships for a year of income if at any time
during the year of income a partner is a resident of the United Republic (section 66(2)). So the residential
statuses of partnerships are determined by residential status of individual partners.
‘Partnership’ means any association of individuals or bodies corporate carrying on business jointly, irrespective
of whether the association is recorded in writing
Section 3
Consider the following Maj partnership’s information:
(a) Maj partnership had four partners in 2008 one of them was resident in Tanzania for the year ending 31st
December 2008.
(b) Maj partnership had four partners in 2008; all of them were non-resident in Tanzania for the year ending 31st
December 2008.
Required:
Determine the residential status of Maj partnership for the year ending 31st December 2008.
Answer
(a) Since one of its partners was resident in 2008, the partnership would also be resident partnership.
(b) Since all of the partners were non-resident partners, the partnership would also be non-resident partnership
1.3 Residential status of a trust
While a trust is a resident trust for a year of income when:
¾ it was established in the United Republic;
¾ at any time during the year of income, a trustee of the trust is a resident person; or
¾ at any time during the year of income a resident person directs or may direct senior managerial decisions of
the trust, whether the direction is or may be made alone or jointly with other persons or directly or through
one or more interposed entities.
‘Trust’ means an arrangement under which a trustee holds assets but excludes a partnership and a
corporation.
Section 3
‘Trustee’ means an individual or body corporate holding assets in a fiduciary capacity for the benefit of
identifiable persons or for some object permitted by law and whether or not the assets are held alone or jointly
with other persons or the individual or body corporate is appointed or constituted trustee by personal acts, by
will, by order or declaration of a court or by other operation of the law; and includes:
any executor, administrator, tutor or curator; any liquidator, receiver, trustee in bankruptcy or judicial manager;
any person having the administration or control of assets subject to a usufruct, fidei commissum or other limited
interest; any person who manages the assets of an incapacitated individual; and any person who manages
assets under a private foundation or other similar arrangements.
Section 3
Consider the following Maj trust’s information:
(a) Maj trust had four trustees in 2008 one of them was resident in Tanzania for the year ending 31st December
2008 but the trust was not established in the United Republic .
(b) Maj trust has four trustees in 2008; all of them were non-resident in Tanzania for the year ending 31st
December 2008 but the trust was established in the United Republic.
Required:
Determine the residential status of Maj trust for the year ending 31st December 2008.
Answer
(a) Since one of its trustees was resident in 2008, the trust would also be resident trust.
(b) Though all of the trustees were non-resident trustees, the trust would be resident trust because the trust
was established in the United Republic
1.4 Residential status of a corporation
Finally, a corporation is a resident corporation for a year of income when:
¾ it is incorporated or formed under the laws of the United Republic; or
¾ at any time during the year of income the management and control of the affairs of the corporation are
exercised in the United Republic (section 66(4)).
‘Corporation’ means any company or body corporate established, incorporated or registered under any law in
force in the United Republic or elsewhere, an unincorporated association or other body of persons, a
government, a political subdivision of a government, a parastatal organisation, a public international
organisation and a unit trust but excludes a partnership
Section 3
It is board of directors of a corporate who manage and control the affairs of the corporates, so it is only when the
meeting of board of directors are held in Tanzania the income the management and control of the affairs of the
corporation are said to have been exercised in the United Republic.
Consider the following Maj Ltd’s information:
(a) Maj Ltd had four hundreds shareholders in 2008 who were resident in Tanzania for the year ending
31st December 2008 but the corporation was not established under law of the United Republic.
(b) Maj Ltd has been operating in Kenya since 2008; and has 20% non-resident shareholders but the
corporation was established under law of the United Republic.
Required:
Determine the residential status of Maj trust for the year ending 31st December 2008.
2. Calculate employment income.

2.1 Component of employment
Employment includes in particular:
¾ a position of an individual in the employment of another person;
¾ a position of an individual as manager of an entity other than as partner of a partnership;
¾ a position of an individual entitling the individual to a periodic remuneration in respect of services performed;
or a public office held by an individual, and includes a past, present and prospective employment (section
3).
Normally, employment is demonstrated by presence of contract of service or employment. The contract of

service exists when an employer dictates what an employee should do and how, in return for period payments.
In a case of Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National Insurance [1968]
2 QB 497 it was decided that contract of service might exist when
(i) “an employee agrees that, in consideration of a wage or other remuneration, he will provide his own work
and skill in the performance of some service for his master.
(ii) He agrees, expressly or impliedly, that in the performance of that service he will be subject to the other's
control in a sufficient degree to make that other master.
(iii) The other provisions of the contract are consistent with its being a contract of service." Control was
associated with power of the employer to decide things to be done, the way in which it shall be done, the
means to be employed in doing it, the time when and the place where it shall be done.
However, in the same case it was suggested that contract for service (sole trading or businesses) occurs
when a contractor hires his own employees, provides and maintains his own tools or equipment; the contractor
paid by reference to the volume of work done; have invested in the enterprise and bore the financial risk; have
the opportunities of profit or the risk of loss; and the relationship is not permanent.
Likewise, in McManus v Griffiths (1997) 70 TC 218 case the judge suggested in deciding whether a person
was employed (contract of service or self-employed (contract for service) we should consider the substance
of the contractual arrangements rather than their form or the parties' labels (incorporated companies).
For instance, in F S Consulting Ltd v McCaul case it was decided that the owner of F S Consulting Ltd, Mr
Frank Simpson earned income under contract of service not contract for service. Mr Simpson was a computer
consultant and the sole director and shareholder of F S Consulting Ltd. During the relevant time of the contract
Mr Simpson supplied his services to the F S Consulting Ltd who supplied them to an agency called Topper
Recruitment Limited (Topper) who supplied them to Better Investments Plc (Better). It was disputed that Mr
Simpson was an employee of Better Investment Plc.
The judge asserted that:
¾ Mr Simpson did agree, in consideration of remuneration, to provide his own work and skill to Better and it
was also part of the arrangements that the standard working week was 37.5 hours. Any absence of Mr
Simpson had to be agreed and approved in advance by Better (although in fact there were no difficulties).
¾ Mr Simpson was a man of skill and experience and so it would not be expected that Better would tell him
how to do his work; however, Mr Simpson was part of a team made up mainly of employees of Better and of
which the project manager was an employee of Better. The project manager controlled what was to be done
and when it was to be done although he left it to Mr Simpson to decide how it should be done. Also, the
contract between the appellant and Topper provided that Mr Simpson had to take all necessary instructions
from Better and comply with Better's rules, regulations and procedures.
¾ In the performance of his work Mr Simpson was also subject to Better's control to the extent that the
contract between the Appellant and Topper provided that it could be terminated immediately if Better
terminated its agreement with Topper because of the incompetence, unsuitability or unprofessional conduct
of Mr Simpson.
¾ Mr Simpson did not hire his own employees; the members of his team were mainly permanent employees of
Better and one other consultant who had entered into his own contract with Better.
¾ Mr Simpson did not provide and maintain his own tools and equipment; he used the mainframe computer
and other equipment provided by Better.
¾ Mr Simpson was not paid by reference to the volume of work done but by reference to the number of hours
he worked.
¾ Mr Simpson did not invest in any enterprise and he did not bear any financial risk; he had no opportunity of
profit and no risk of loss. All his invoices were paid.
¾ The relationship between Mr Simpson and Better had some element of permanency as it lasted for two and
a half years from December 1998 to June 2001.
¾ While working for Better Mr Simpson only provided work for Better and for no other client. Before working
for Better he worked for two other clients and since leaving Better he has worked for one other client but has
never worked for more than one client at a time.
¾ Mr Simpson was integrated into the structure of Better to the extent that he worked closely with its
employees; also the project manager was an employee.
¾ Therefore, Mr Simpson was an employee of Better
2.2 Employment income items
Income in connection with employment income (contract of service) means:
¾ Wages, salary, payment in lieu of leave, fees, commissions, bonuses, gratuity or any subsistence, travelling,
entertainment or other allowance received in respect of the employment or services rendered;
¾ Reimbursement by an employer of personal expenditure by the employee or an associate of an employee;
¾ Payments for the employee’s agreement to any conditions of the employment;
¾ Retirement contributions and retirement payments paid by an employer on behalf of employees;
¾ Payment for redundancy or loss or termination of employment relating to the year of payment;
¾ Other payments made in respect of the employment including benefits in kind (section 7(2)).
2.3 Taxation of benefits in kind as employment income
Quantification of employment benefits in kind are dealt with section 27 of the Income Tax Act 2014. Generally,
benefits in kind are valued on market values of the benefits, but with exception of car benefits,
beneficial loans and house benefits. These three benefits have specific approaches concerning their
valuations. Therefore, this section explains in details these approaches.
1. Private uses of motor car
When an employee uses an employer’s car for official purposes he / she derive no taxable income. However,
there is taxable benefit when the employee uses the car for private purposes, provided the employer claim
maintenance and ownership allowances of the car when computing his/her taxable income (section 7(3) (e)). In
that case, the benefit car benefit is value as per table below. As you can see, the value of car benefit depends
on engine size of cars and age of the car; the age is counted from the first registration of the car in United
Republic of Tanzania.
Quantity of payment per annum (maximum car benefit)

Engine Size of Vehicle Vehicle less than 5 years old Vehicle more than 5 years old
Not exceeding 1000cc Tshs 250,000 Tshs 125,000
Above 1000cc but not exceeding 2000cc Tshs 500,000 Tshs 250,000
Above 2000cc but not exceeding 3000cc Tshs 1,000,000 Tshs 500,000
Above 3000cc Tshs 1,500,000 Tshs 750,000
When examiners want to test this part the table may or may not be provided so spending little time remembering
it may pay in an examination room.
Robots and Assembler Design makers employed M/s Spices Lowery as the Company Accountant with effect
from 1st January 2004.
Her emoluments included a self-driven car for private use, which is 3000 cc, brand new. The company claims
expenditure of car maintenance.
Required:
Calculate the taxable car benefit in kind of M/S Spice Lowery for the year 2005.
Answer
From the information available in the question the car is new and of 3,000 cc, so from the table above, the
annual car benefit was Tshs 1,000,000
2. Beneficial loans
When an employer provides staff loans at lower interest rates compared to statutory rates or interest free loans,
recipient employees enjoy taxable income. The taxable income is the whole forgone interest in case of interest
free loans and when the lower interest rate is offered the benefit would be calculated basing the relinquished
part of interest rate.
However, no taxable benefit is derived when the loan made by an employer to an employee is for the less than
12 months and the aggregate amount of the loan and any similar loans outstanding at any time during the
previous 12 months do not exceed 3 times month’s basic salary (section 27(1) (b)).
‘Statutory rate’ in relation to a calendar year means the prevailing discount rate determined by the Bank of
Tanzania;
Section 3
In short taxation of beneficial interest consists of these parties:
(a) Check whether the loan made by an employer to an employee is for the less than 12 months and the
aggregate amount of the loan and any similar loans outstanding at any time during the previous 12 months
do not exceed 3 times month’s basic salary. If yes, no taxable benefit arise from the loans given. Otherwise,
go to next steps
(b) The loans are given to employees because they are just employees, otherwise loan provide in normal cause
of business at market terms are not employee beneficial loans.
(c) The benefit bases on the forgone interest rate which can be statutory rate when the loans concerned are
interests free; otherwise the benefit is statutory rate less interest paid by employees.
(d) Interest = Outstanding amount x (statutory rate – interest rate paid) x time/12
from 1st January 2004. Her emoluments for 2004 included the following:
¾ Basic monthly salary Tshs600,000
¾ Loan advances of Tshs 3,000,000 payable after 15 months and free of interest was given at the beginning
of the year. Statutory rate was 10% per annum.
Required:
Calculate the loan benefit of M/S Spice Lowery for the year 2005.
Answer
The loan made by an employer to an employee is for the more than 12 months (in this case 15 months term)
also the aggregate amount of the loan and any similar loans outstanding at any time during the previous
12 months exceed 3 times month’s basic salary ( Tshs3,000,000 is greater than 3 times basic salary i.e.
Tshs600,000). So the beneficial loan is taxable.
As the loan balance did not change the formula of simple interest can be used to determine the forgone interest
So Interest = Principle x time/12 x saved interest rate = Tshs 3,000,000 x 12/12 x 10%= Tshs300,000
But, the actual computation of the interest can basis on average or reducing methods when the loan balance or
principle keeps changing during a year because of periodic payments as the income tax laws do not specify
which method should be used. These methods are discussed briefly below.
(i) Computation of interest using average method
In this method, the principle amount is taken as simple average of opening and closing balances of the staff
loan. Then the taxable loan benefit is given by the product of this average value and the statutory rates after
deducting any interest paid by the borrower.
Employees of Jet ltd has been entitled to 4% annual interest loans of Tshs 60,000,000 since 2005. A new
employee got the loan on 1st July 2013 and agreed to pay it in 60 monthly instalments starting 1st August 2013.
If the employee basic salary was Tshs 2,000,000 and statutory rate for the year 2013/14 was 12%, establish the
taxable employment loan benefits using average method.
This loan benefit is taxable as it has a period of more than 12 months besides the amount of the loan exceeds
3 times the month basic salary.
Date Tshs
1st July 2013 Loan given 60,000,000
30th June 2014 60,000,000-12,0000 48,000,000
108,000,000
Average loan balance 108,000,000/2 54,000,000
Loan duration during the year 12 months
Taxable loan benefit 54,000,000x(12%-4%)x12/12 4,320,000
(ii) Reducing balance method
This method uses the actual outstanding balances over the cause of the loan terms. So, it is important to find,
the outstanding balance every time after making periodic payment and the length of time the balance is
outstanding. The period can be in months or days as both days and months might produce comparable results.
All other procedures of computing taxable loan benefit remain the same in this method.
Employees of Jet Ltd have been entitled to 4% annual interest loans of Tshs 60,000,000 since 2005. A new
employee got the loan on 1st July 2013 and agreed to pay it in 60 monthly instalments starting 1st March 2014.
If the employee basis salary was Tshs 2,000,000 and statutory rate for the year 2013/14 was 12%, establish the
taxable employment loan benefits using reducing method.
Date Amount outstanding Duration in months Interest benefit in Tshs

1st March 2014 60,000,000.00 1/12 400,000.00
1st April 2014 59,000,000.00 1/12 393,333.33
1st May 2014 58,000,000.00 1/12 386,666.67
1st June 2014 57,000,000.00 1/12 380,000.00
Total interests 1,560,000.00
from 1st January 2004. Her monthly emoluments include:
(i) Basic monthly salary Tshs600,000
(ii) Loan advances of Tshs 3,000,000 payable in 15 months installments and free of interest, was given at the
beginning of the year. Statutory rate was 10% per annum.
Required:
Using the reducing balance method, calculate the loan benefit of M/S Spice Lowery for the year 2005.
3. Living accommodation benefit
There is taxable employment benefit when an employee lives in a subsidized house and the employee claim
maintenance and ownership allowances in his / her tax returns (section 27(1)(c)). This valuation of taxable
house benefit in kind includes any furniture or other contents provided by an employer for residential occupation
by an employee during a year of income. Actually, the taxable benefit is the lower of (i) and (ii) after being
reduced by any rent paid for the occupation by the employee:
i. is the market value rental of the part of the premises occupied by the employee for the period occupied
during the year of income; and
ii. is the greater of
¾ 15% of the employee's total income for the year of income, calculated without accounting for the provision
of the premises and, where the premises are occupied for only part of the year of income, apportioned as
appropriate;
¾ and expenditure claimed as a deduction by the employer in respect of the premises for the period of
occupation by the employee during the year of income.
The total income of a person is the sum of the person's chargeable income for the year of income from each
employment, business and investment less any reduction allowed for the year of income under section 61
relating to retirement contributions to approved retirement funds
Section 5(1)
from 1st January 2004. By the time the company submitted a statement of employment income for year 2005,
the following information was revealed to her as her monthly emoluments:
Tshs
Basic monthly salary 600,000
Transport allowance monthly 250,000
Lunch allowance monthly 150,000
Medical allowance monthly 100,000
The employer housed her freely. The market value of rental at that area was Tshs 400,000 per month and the
expenditure claimed by the company for that premise was Tshs 150,000. The contribution made monthly by the
employee was Tshs 50,000 as rent. Beside the emoluments stated above, the employee had the following
benefits.
(i) Self driven car for private use, which is 3000 cc, brand new. The company claims expenditure of car
maintenance.
(ii) Loan advances of Tshs 3,000,000 payable after 15 monthly and free of interest. Statutory rate was 10% per
annum.
(iii) Business income of Tshs 1,000,000 and investment income of Tshs 500,000
Workings
Calculation of total income before house benefit in kind
Items Tshs Tshs

Basic salary 600,000 x12
Transport allowance 250,000 x12
Lunch allowance 150,000 x 12
Car benefit as above 1,000,000
Loan benefit as above 300,000
Electricity 30,000 x12
Water 25,000 x12
Employment income 12,760,000 12,760,000
Business income 1,000,000
Investment income 500,000
Total income 14,260,000
House benefit is the lower of:
1. the annual market value Tshs 4,800,000
2. the greater of
¾ 15% of Tshs 14, 260,000 = Tshs 2,139,000

¾ Tshs 1,800,000.
Reduced by monthly contribution made during the year of Tshs 600,000 (Tshs 50,000 x12), the house benefit
without deduction of monthly contribution was Tshs 2,139,000, it is the lower of Tshs 4,800,000 and Tshs
2,139,000. The ultimate house benefit was Tshs 1,539,000
2.4 Redundancy, or loss or termination benefit paid in arrears
Usual employment benefits are taxable on cash basis that is when payments are received. However, an
individual’s gains or profit from payment for redundancy or loss or termination of employment, any payment
received in respect of a year of income which expired earlier than five years prior to the year of income in
which it was received, or which the employment or services ceased if earlier are not taxed on the date of receipt
(section 7(4)).
Rather, the payments should be allocated equally between the years of income in which it is received or, if the
employment or services ceased in an earlier year between such earlier year of income and the five years
immediately proceeding such earlier year of income. Actually, each such portion, allocated to any such year of
income is deemed to be income of that year of income in addition to any other income in that period (section
7(4)).
In short the allocation process of redundancy, or loss or termination benefit paid in arrears can be summarized
into four major steps:
Step 1 Decide the earlier period between the year of receipt, or which the employment (services) ceased.
Step 2 Total redundancy, or loss or termination benefits relating to periods earlier than five years prior to the
earlier of the year of receipt, or which the employment/ services ceased.
Step 3 Divide the total above by 6 allocate the amount to 5 years immediately proceeding such earlier year
of income in step 1 above and in that earlier period.
Mr. Jaffer was employed by Kahama Mining Corporation Ltd since 2000. His monthly salary was Tshs960,000
per month with effect from 1st. Mr. Jaffer was also provided with free residential house accommodation by the
employer and the resulting benefit from the house benefits was correctly determined to be Tshs200,000 per
month and employer claimed ownership allowances. However, he was terminated on 31 December 2010 and
paid a lump sum compensation of Tshs18,560,000 on termination of his contract of employment on September
2013. The amount was earned equally throughout ten years of employment.
You are required to establish his taxable termination and stated which year it will be taxable
(a) The earlier period between the year of receipt i.e. 2013 or which the employment or services ceased i.e.
2010, is 2010.
(b) Totalling redundancy, or loss or termination benefits relating to periods earlier than five years prior to 2010,
i.e. before 2005 i.e. 2000-2004. This amount is equal to Tshs 1,856,000 x 5 = Tshs 9,280,000
(c) Divide the total above by 6, then allocate the amount to 5 years immediately proceeding 2010 in step an
above and in 2010. That is allocating Tshs 1,546,667 to 2010, 2011, 2012, 2013, 2014, and 2015. The
amount allocated will be taxed in the period allocated.
(d) Finally, the remaining balance (from 2005 to 2010) of terminal benefit will be taxed on cash basis on the
date of receipt i.e. September 2013.
2.5 Taxation of employment termination benefits
Likewise taxation of employment termination benefits has three special treatments.
Fixed employment contract
First, when a fixed employment contract is terminated before its expiration and the affected employee gets
termination benefits; taxable termination benefits should not exceed the amount which would have been
received in respect of the unexpired period (Section 7(5) (a)). Also this amount is assumed to have accrued
evenly in such unexpired period.
Employment contract (which provides for compensation on termination) having unspecified term
Second, when an employment contract which has unspecified term and provides for compensation on its
termination, the compensation thereon is deemed to have accrued in the period immediately following such
termination at a rate equal to the rate per annum of the gains or profits from such contract received immediately
prior to such termination (section 7(5)(b)).
Employment contract (which does not provide for compensation on termination) for an unspecified term
Finally, when an employment contract is for an unspecified term and does not provide for compensation on its
termination thereof, any compensation paid on the termination thereof is deemed to have accrued in the period
immediately following such termination at a rate equal to the rate per annum of the gains or profits from such
contract received immediately prior to such termination, but the amount so included in gains or profits must not
exceed the amount of three years’ remuneration at such rate (section 7(5)(c)).
Mr. Jaffer was employed by Kahama Mining Corporation Ltd since 2000. His monthly salary was Tshs 960,000
per month gross with effect from 1st. Mr. Jaffer was also provided with free residential house accommodation by
the employer and the resulting benefit from the house benefits was correctly determined to be Tshs 200,000 per
month and employer claimed ownership allowances. However, he was terminated on 31 December 2005 and
paid a lump sum compensation of Tshs 18,560,000 on termination of his contract of employment.
You are required to establish his taxable termination benefit and stated when i.e. year it will be taxable if:
(a) The contract of employment was for ten years.
(b) The contract of employment was for unspecified term and provides for termination benefits
(c) The contract of employment was for unspecified term and does not provide for termination benefits.
Answer:
Fixed employment contract
When the contract is for specified term the taxable benefits of termination benefits should not exceed the
amount that could have been received in absence of termination of the contract in an unexpired period. In this
case the amount is (Tshs 960,000 + Tshs 200,000) x 5 years. X12 months= Tshs 69,600,000.
So as the amount received is lower than Tshs 69,600,000 the whole amount will be taxable termination benefits.
However, it should be allocated equally in the five remaining years from 2006 to 2010. So each year gets Tshs
3,712,000 from Tshs 18,560,000/5.
Employment contract (which provides for compensation on termination) having unspecified term
In case of unspecific employment contract but provides for termination compensation benefit, the taxable benefit
should not exceed annual employment income immediately before termination. As the termination happened on
st
31 December 2005, the annual employment income should base on this year. So the taxable amount should
not exceed Tshs 13,920,000 ((960,000+200,000) x 12). Consequently, the taxable termination benefits were
Tshs 13,920,000 and deemed to have accrued in the next year 2006.
Employment contract (which does not provide for compensation on termination) for an unspecified term
Finally, when the contract is for unspecified term and does not provide for termination benefits, in case
termination benefits is received, the maximum taxable amount should be 3 times the annual employment
income immediately before the .termination. In this case it should not exceed Tshs 13,920,000 x 3 =
Tshs 41,760,000. So as this amount is higher than Tshs 18,560,000, the amount received should be taxed in
2006.
2.6 Excluded employment income
According to section 7(3) of the Income Tax Act 2004, the following income earned by employees from their
employments is not taxable:
(a) exempt amounts and final withholding payments;
(b) on premises cafeteria services that are available on a non-discriminatory basis;
(c) medical services, payment for medical services, and payments for insurance for medical services to the
extent that the services or payments are -
(i) available with respect to medical treatment of the individual, spouse of the individual and up to four of their
children; and
(ii) made available by the employer (and any associate of the employer conducting a similar or related
business) on a non-discriminatory basis;
(d) any subsistence, travelling, entertainment or other allowance that represents solely the reimbursement to
the recipient of any amount expended by him wholly and exclusively in the production of his income from his
employment or services rendered;
(e) benefits derived from the use of motor vehicle where the employer does not claim any deduction or relief in
relation to the ownership, maintenance or operation of the vehicle;
(f) benefit derived from the use of residential premises by an employee of the Government or any institution
whose budget is fully or substantially out of Government budget subvention;
(g) payment providing passage of the individual, spouse of the individual and up to four of their children to or
from a place of employment which correspond to the actual travelling cost where the individual is domiciled
more than 20 miles from the place of employment and is recruited or engaged for employment solely in the
service of the employer at the place of employment;
(h) retirement contributions and retirement payments exempted under the Public Service Retirement Benefits
Act;
(i) payment that it is unreasonable or administratively impracticable for the employer to account for or to
allocate to their recipients and
(j) allowance payable to an employee who offers intramural private services to patients in a public hospital; and
housing allowance, transport allowance, responsibility allowance, extra duty allowance, overtime allowance,
hardship allowance and honoraria payable to an employee or the Government or its institution whose
budget is fully or substantially paid out of Government budget subvention
In addition board members sitting allowance are exempted because they are deemed as reimbursement of
members’ time (Income Tax Act 2004, Practice Note No. 11/2004) as well as gifts, tips, prizes, incentives and
voluntary payments made to an employee with no reference to the employment as acknowledging faithfulness,
and consistency and readiness of the employee (Income Tax Act 2004, Practice Note No. 11/2004;
Ball v Johnson 1971; Cooper v Blakiston HL 1908, Calvet v Wainwright 1947).
1. Exempt income
Exempt income items are normally given in the schedules reproduced below to assist you in understanding
exempt employment income, please take time to familiarize yourself with this schedule, particularly paying
attention to employment income.
Second schedule and section 52 and 86
The following amounts are exempt from income tax
(a) amounts derived by the President of the United Republic or the President of the Revolutionary Government
of Zanzibar from salary, duty allowance and entertainment allowance paid or payable to the President from
public funds in respect of or by virtue of the office as President;
(b) amounts derived by the Government (including Executive Agency established under the Executive Agencies
Act, 1997) or any local authority of the United Republic or by the Revolutionary Government of Zanzibar or
any local authority of Zanzibar except amounts derived from business activities that are unrelated to the
functions of government;
(c) amounts derived by any person entitled to privileges under the Diplomatic and Consular Immunities and
Privileges Act to the extent provided in that Act or in regulations made under that Act;
(d) amounts derived by an individual from employment in the public service of the government of a foreign
country provided -
(i) the individual is a resident person solely by reason of performing the employment or is a non-resident
person; and
(ii) the amounts are payable from the public funds of the country;
(e) foreign source amounts delivered by:
(i) an individual who is not a citizen of the United Republic and who is referred to in paragraph (d); or
(ii) a spouse or child of an individual referred to in subparagraph (i) where the spouse is resident in the United
Republic solely by reason of accompanying the individual on the employment;
(f) amounts derived by:
(i) the East Africa Development Bank;
(ii) the Price Stabilization and Agricultural Inputs Trust;
(iii) the Investor Compensation Fund under the Capital Markets Regulatory Authority; and
(iv) The Bank of Tanzania.
(v) Dar es salaam Stock of Exchange
(g) amounts derived during a year of income by a primary cooperative society:
(i) registered under the Co-operative Societies Act;
(ii) solely engaged in activities as a primary cooperative in one of the following fields:
¾ agricultural activities, including activities related to marketing and distribution;
¾ construction of houses for members of the cooperative;
¾ distribution trade for the benefit of the members of the cooperative;
¾ savings and credit society; and
(iii) whose turnover for the year of income does not exceed Tshs50,000,000;
(h) pensions or gratuities granted in respect of wounds or disabilities caused in war and suffered by the
recipients of such pensions or gratuities;
(i) a scholarship or education grant payable in respect of tuition or fees for full-time instruction at an
educational institution;
(j) amounts derived by way of alimony, maintenance or child support under a judicial order or written
agreement;
(k) amounts derived by way of gift, bequest or inheritance, except as required to be included in calculating
income under sections 7(2), 8(2) or 9(2)
(l) amounts derived in respect of an asset that is not a business asset, depreciable asset, investment asset or
trading stock;
(m) amounts derived by way of foreign living allowance by any officer of the Government that are paid from
public funds and in respect of performance of the office overseas;
(n) Income derived from gaming by a gaming licensee who has paid gaming tax under Gaming Act;
(o) income derived from investment or business conducted within the Export Processing Zone, and Special
Economic Zone during initial period of ten years;
(p) income derived from investments exempted under any written laws for the time being in force in Tanzania
Zanzibar;
(q) rental charges on aircraft lease paid to a non-resident by a person engaged in air transport business;
(r) amounts derived by a crop fund established by farmers under a registered farmers cooperative society,
union or association for financing crop procurement from its members;
(s) gratuity granted to a Member of Parliament at the end of each term; and Cap.79
(t) the fidelity fund established under the Capital Markets and Securities Act
(u) Amounts derived from gains on realization of asset by a unit holder on redemption of a unit by a unit trust.
(v) payment of withholding' tax on dividend arising from investment in the Export Processing Zone and Special
Economic Zone during initial period often years; and
(w) payments of withholding tax on rent payable by an investor licensed under the Export Processing Zone and
Special Economic Zone during initial period of ten years, provided that the rent is payable to an investor
licensed under the Economic Processing Zones or the Special Economic Zones."
(x) Distributions of a resident trust or unit trust shall be exempt in the hands of the trust's beneficiaries (section
52)
(y) Rent which does not exceed Tshs 500,000, received by a resident individual (the "landlord") in respect of
residential premises situated in the United Republic that are leased by another individual as the residence
of that other individual and the rent is not received by the landlord in conducting a business (section 86(4)).
2. Final withholding payments
‘Final withholding payments’ are payments which are taxed only at the source by withholding the tax by the
payers of the payments.
Section 86
So these payments are normally excluded in computation of income from employment, investment or
businesses. The following payments are final withholding payments as per section 86.-(1):
¾ Dividends paid by a resident corporation or non-resident corporation to a resident individual resulting from
investment activities.
¾ Interest paid by financial institution to a resident individual where the interest is paid with respect to a
deposit held with the institution, other than interest received by the individual in conducting a business; or
foreign source interest paid to non-resident individual.
¾ Rent paid to a resident individual under a lease of land or a building and associated fittings and fixtures,
other than rent received by an individual in conducting a business; or foreign source rent paid to non-
resident individual.
¾ Service fees paid to a resident person who is conducting a mining business in respect of management or
technical services provided wholly and exclusively for the business by another resident persons and money
transfer commission to a resident money transfer agent.
¾ Payments made to non-resident persons other than through a domestic permanent establishment of the
person) that are subject to withholding taxes.
¾ Interest paid to a unit trust.
¾ Dividends distributed by a resident corporation not in a virtue of its ownership of redeemable shares (section
54(1)).
2.7 Pension contribution and contribution to education fund
Voluntary contribution of any amount to education establishment made under section 12 of the Education Fund
Act by an employee is deductible expenses in determining his or her taxable employment income (section
16(3)). In addition, employees are can deduct pension contributions made by themselves or their employers on
employees’ behalf (or for the employees’ spouses) to approved pensions. Actually the law allows deduction of
pension contribution made by the individual; or an employer of the individual to approved pension funds
where the contribution is included in calculating the individual's income from the employment (section 61(1)).
However, the reduction claimed by an individual for any year of income should be the lesser of the actual
contribution or the statutory amount required (Section 61(2)).
‘Retirement contribution’ means a payment made to a retirement fund for the provision or future provision of
retirement payments.
Section 3
‘Retirement fund’ means any entity established and maintained solely for the purposes of accepting and
investing retirement contributions in order to provide retirement payments to individuals who are beneficiaries of
the entity.
Section 3
‘Statutory contribution’ is when the total contribution to an approved retirement fund required by statute in
relation to an employee is in excess of Tshs 2,400,000 per year, the amount of that obligation or in any other
case, Tshs 2, 400,000.
Income Tax Regulation 10
‘Approved retirement fund’ means a resident retirement fund having a ruling under section 131.
Section 3
So in computation of deductions in respect of contribution to approved retirement fund you should first
determine the statutory contribution though has no effect as shown below. Then, check if the employer has or
has not included his contribution in taxable income. Though, this inclusion is not defined in the act, may mean
that the employer what this amount be part of taxable employment income. If so, the employer should choose
either to deduct his contribution or his employer’s contribution in arriving at taxable employment income. If not
include, then take the employee’s contribution and proceed to the next step. Finally, compare the chosen
amount with statutory amount and select the lesser amount as deduction.
from 1st January 2004.
Her emoluments include:
Basic monthly salary Tshs600,000
The employer was contributing 15% of basic salary to the approved retirement fund, while the employee
contributed 5%.
Required:
Calculate deduction in respect of contribution to approved pension fund when:
(a) There is no inclusion of employers’ contribution in employee taxable income
(b) There is an inclusion of employer’s contribution in employee taxable income
(c) The total contribution to an approved pension is assumed to be Tshs2,600,000.

Answer
(a) There is inclusion of employer’s contribution (as provided in the information)
Total contribution to an approved retirement fund required by statute in relation to an employee was Tshs 20 %
x 600,000 x12 = Tshs1,140,000; which is lesser than Tshs2,400,000 per year. Therefore, the statutory amount
was Tshs 2, 400,000.
In second step an employee should either deduct his contribution of 5% or employer’s contribution of 15% of his
salary. Basing on tax advantage point, it is in his advantage to deduct employer’s contribution to reduce income
available to pay as you earn. In that case, the employer contributed Tshs 15% x 600,000 x 12 = Tshs1,080,000
on behalf of the employee.
In the final stage compare Tshs2,400,000 and Tshs1,080,000, and then select the lower amount as deduction
for contributing to an approved pension fund. Therefore the deduction is equal Tshs1,080,000.
(b) There is no inclusion of employers’ contribution in employee taxable income
Total contribution to an approved retirement fund required by statute in relation to an employee was Tshs 20 %
x 600,000 x12 = Tshs 1,140,000; which is lesser than Tshs 2,400,000 per year. Therefore, the statutory amount
was Tshs 2, 400,000.
Since the employer does not include his contribution in taxable employment income, in second step just
compute employee’s contribution that Tshs 5% x 600,000 x 12 = Tshs 360,000.
In the final stage compare Tshs 2,400,000 and Tshs 360,000, and then select the lower amount as deduction
for contributing to an approved pension fund. Therefore the deduction is equal Tshs 360,000.
(c) The total contribution to an approved pension is assumed to be Tshs 2, 600,000
Total contribution to an approved retirement fund required by statute in relation to an employee was Tshs
2,600,000; which is higher than Tshs 2,400,000 per year. Therefore, the statutory amount was Tshs 2, 600,000.
Since the employer does not include his contribution in taxable employment income, in second step just
compute employee’s contribution that Tshs 5% x 600,000 x 12 = Tshs 360,000.
In the final stage compare Tshs 2,600,000 and Tshs 360,000, and then select the lower amount as deduction
for contributing to an approved pension fund. Therefore the deduction is equal Tshs 360,000.
You can see we have always chosen the actual amount contributed to approved pension regardless whether
the statute contribution exceeded Tshs 2,400,000 or not.
When the question is silent about whether the employer includes or does not include his contribution in
computation of employment income, assume he does not. Most employers do not include their contribution to
reduce tax burden to their employees as the contribution go direct to approved fund not to employees. Including
it increases tax burden without real increase is monetary benefits.
By now we have learnt that not all income from employment are taxable, some are final withholding payments,
some are exempt income and some simply not related to employment. Also we saw how employment income in
kind is calculated and determination of allowable deductions when computing employment income. This section
deals with how to establish taxable income from employment. The employment income is generally computed
on cash basis unless specifically required by tax laws. The statement below can help us when computing
taxable employment income.
In a ‘cash basis’ income is derived or earned when payment is received or made available to the person.
Section 22(a)
‘Chargeable business income’ of resident person, includes all his or her income for the year of income
irrespective of the source of the income, while chargeable income of non-resident persons income only to the
extent that the income has a source in the United Republic.
Section 6
from 1st January 2004. By the time the company submitted a statement of employment income for year 2005,
the following information was revealed to her as her monthly emoluments:
Tshs
Basic monthly salary 600,000
Transport allowance monthly 250,000
Lunch allowance monthly 150,000
Medical allowance monthly 100,000
The employer housed her freely. The market value of rental at that area was Tshs 400,000 per month and the
expenditure claimed by the company for that premise was Tshs 150,000. The contribution made monthly by the
employee was Tshs 50,000 as rent. Beside the emoluments stated above, the employee had the following
benefits.
(i) Self-driven car for private use, which is 3000 cc, brand new. The company claims expenditure of car
maintenance.
(ii) Loan advances of Tshs 3,000,000 payable after 15 months and free of interest. Statutory rate was 10% per
annum.
(iii) Other benefits included electricity Tshs 30,000 and water Tshs 25,000 per month.
The employer was contributing 15% of basic salary to the approved retirement fund, while the employee
contributed 5%.
Other income she received in 2005 was Tshs 300,000 interest from CRDB Bank, Tshs 1,500,000 – lease
amount from Milk Shake Company for the building she leased to the company since 2003.
Required:
Calculate chargeable income from employment for the year 2005.

3. Calculate business income.

3.1 Component of business
Normally, business is demonstrated by presence of contract for service as discussed before. Shortly, that
contract for service (sole trading or businesses) occurs when a contractor hires his own employees, provides
and maintains his own tools or equipment; the contractor paid by reference to the volume of work done; have
invested in the enterprise and bore the financial risk; have the opportunities of profit or the risk of loss; and the
relationship is not permanent (Ready Mixed Concrete (South East) Ltd v Minister of Pensions and National
Insurance [1968] 2 QB 497). Likewise, in McManus v Griffiths (1997) 70 TC 218 case the judge suggested in
deciding whether a person was employed (contract of service or self-employed (contract for service) we
should consider the substance of the contractual arrangements rather than their form or the parties' labels
(incorporated companies).
‘Business’ includes a trade, concern in the nature of trade, manufacture, profession, vocation or isolated
arrangement with a business character; and a past, present or prospective business, but excludes employment
and any activity that, having regard to its nature and the principal occupation of its owners or underlying owners,
is not carried on with a view to deriving profits.
Section 3
The act does not define the term manufacturing. Therefore, we can only base on case laws. One of the best
case laws which attempted defining this term is the case between Teejan Beverages Ltd. vs State Of Kerala
And Ors S.R.O. No. 1729 of 1993. In that case, the appellant was issued with government letter exempting her
from paying sales tax on the ground that she was involved in manufacturing or purification of bottled water
because manufacturing of any goods was exempted from the taxes. However, the letter was later revoked by
the government on the basis that purification of water does not satisfy the meaning of manufacturing given in
the sale taxes. Hence, the person appealed.
The court definition of manufacturing did not include packing of goods, polishing, cleaning, grading, drying,
blending or mixing different varieties of the same goods by mixing with chemicals or gas, fumigation or any
other process applied for preserving the goods in good condition or for easy transportation”. Hence,
manufacturing occurs only when raw materials are used (converted) in producing another product which is
commercially distinct from the raw materials.
'Manufacturing’ refers to production of goods commercially different from the raw material used
Teejan Beverages Ltd. vs State Of Kerala and Ors S.R.O [1993] TC.1729
Similarly, no definition of trade is given in the act. However, cases laws have provided indicators “badges of
trade” which can be used to tell whether a trade is being contacted. These indicators include methods of
acquisition; assets acquired through inheritance or gifts might indicate no trade motive than those acquired
through purchases (Taylor v Good [1974] 49TC277). Second, length of the period of ownership; purchasing
and selling an asset in hast might indicate trading while holding the assets for long period may indicate
investment (Marson v Morton and Others [1986] 59TC381). Third, frequency or number of similar transactions
by the same person; too many similar transactions might imply trade (CIR v Livingston and Others [1926]
11TC538). Fourth, doing supplementary work on or in connection with the asset realized to increase saleable
condition might indicate trading (CIR v Livingston and Others [1926] 11TC538. Fifth, circumstances that were
responsible for the realisation; forced realization for example in emergency might indicate absence of trade (CIR
v Livingston and Others 11TC538). Sixth profit motive; reason for transaction involved being gain profit from it
rather than holding it as an investment (Salt v Chamberlain [1979] 53TC143).
Also nature of assets involved; if the nature of the assets involved is not always involved in trade might not
indicate not trade. This assets include purchase of shares might highly indicate investment than trading and
purchasing of classic cars may be for person consumption than trading while purchase of chemical for example
might definitely indicate trade (CIR v Fraser [1942] 24TC498). Finally, existence of similar trade transaction, the
close the proximity of the transaction undertaken to the existence trade transactions the more it can be taken to
be a trade transaction (Harvey v Caulcott [1952] 33TC159).
‘Trade’ is an act of providing goods or services to others in exchange for a reward.

Cambridge dictionary
However, in many cases presences of these badges of trade do not indicate presence or absence of trade.
Therefore, all facts surrounding the transaction should be considered. For instance, the definition of business
above includes even “isolated arrangement with a business character” which might means trading. For
instance, in a case of CIR v Fraser [1942] 24TC498; Fraser bought a large consignment of whisky and sold it at
profit, using the above indicators the transaction could be none trade transaction. However, the court decided
that “The purchaser of a large quantity of a commodity like whisky, greatly in excess of what could be used by
himself, his family and friends, a commodity which yields no pride of possession, which cannot be turned to
account except by a process of realisation, I can scarcely consider to be other than an adventurer in a
transaction in the nature of a trade… Most important of all, the actual dealings of the respondent with the whisky
were exactly of the kind that take place in ordinary trade.”
‘Profession’ any type of work that needs special training or a particular, skill, often one that is respected
because it involves a high level of education.
Cambridge dictionary
‘Vocation’ is a type of work that you feel you are suited to doing and to which you should give
all your time and energy, or the feeling that a type of work suits you in this way and indicates a calling.
Vocations include religion or high-minded service to others, a bookmaker and a jockey, authors, dramatists and
professional singers.
Graham v Green [1925] 9TC309
3.2 Business income items
Income in connection with businesses income (contract for service) means:
(a) service fees;
(b) incomings for trading stock;
(c) gains from the realisation of business assets or liabilities of the business
(d) Gains from realisation of the person's depreciable assets of the business;
(e) amounts derived as consideration for accepting a restriction on the capacity to conduct the business;
(f) gifts and other ex gratia payments received by the person in respect of the business;
(g) amounts derived that are effectively connected with the business and that would otherwise be included in
calculating the person's income from an investment; and
(h) Other amounts including reverse of amounts as bad debts, bad debts writing off, discount allowed,
fluctuations in foreign exchanges and seizures of untaken deposits and advances (section 8(2)).
Reverse of amounts including bad debts
Business transactions can be reversed by business taxpayers for various reasons. First, when there is
overturning of transactions already recorded in financial statements as sales returns or purchase return
culminating into a refund, reduces sales or purchase figure previous recorded in the financial statements.
Second, disclaiming of accrued expenses which don't culminate into refund must be eliminated in the business
expenses. Finally, failing to realize accrued income items overstate business revenues, therefore, accrued items
not realized must be deducted for instance in bad debt written off (section 25).
There are no restrictions or conditions which must be satisfied before a reverse can occurs. For instance, a
taxpayers can write off a debt after taking all necessary steps to cover it unsuccessful, consequently the
taxpayer feels that the debt might not be recovered and the amount written off is tax deductible expenses
(section 25(5) (b)). However, when a taxpayer is a financial institution, the taxpayer can only write off a debt
after satisfaction of standards established by Bank of Tanzania (section 25(5) (a)).
3.3 Excluded business income
According to section 8(3) of the Income Tax Act 2004, exempt business income, final withholding payments and
non-business income should be excluded in computing business income. Both exempt income and final
withholding income items were covered in the employment income section. So in this section they are not
discussed. Please take time to peruse them. In addition receipt from realization of capital assets should be
excluded as well because they are used in computing gain from realization of assets.
3.4 Allowable expenses
Then after knowing elements which constitute business income the next step is to understand deductible
business expenses. In fact it is very important to understand these allowable expenses because they affect how
much is left for business income taxes. In general all expenses incurred ‘wholly and exclusively’ in the
production of business income are allowable expenses (section 11(3)). Therefore, only expenditure incurred for
sole purposes of producing business income are allowable expenses and expenditure incurred not wholly and
exclusively for business purposes are not allowable.
In Boarland V Kramat Pulai Ltd [1953] 35 TC case, the company claimed costs of publishing and circulating a
political pamphlet concerning a critical evaluation of government policies. It was decided by judge Dankwerts J
that the costs of the article was not wholly and exclusive expended on production of income, though there was
some business benefits from the article. Hence, it was concluded that the costs claimed contravened the
statutory requirement that the expenditure should be used wholly and exclusive for business purposes to be
allowable deduction; because there was non-business purpose on that transaction, the wholly expenses
involved was deductible.
‘Wholly’ refers to the quantum of money and the word ‘exclusively’ refers to the purpose
Romer L.J
Therefore, expenses incurred for dual purposes are normally not allowed deductible even when there is
significant portion of expenditure incurred wholly and exclusively for the purposes of the trade, profession or
vocation. In case between Bowden v Russell & Russell [1965] 42 TC 301 the taxpayers travelled from the
UK to the US for both business and private purposes i.e. vocation with his wife, and the taxpayer accepted that
there trip was for dual purpose. Though, the taxpayer claimed only expenses used in the business purposes,
the whole expenses were disallowed because the expenses were incurred both for private and businesses
against the so ‘wholly and exclusively’ requirements.
“Dual-purpose’ expenditure is an expenditure that is incurred for more than one reason.
HMRC
However, when there is definite portion of expenditure incurred for wholly and exclusively for business
purposes can be established, the amount can be deducted even if the entire amount of expenses were not
incurred for production of income (Wildbore v Luker [1951] 33 TC 46). The taxpayer claimed whole of public
house rate in which some areas were used as an office. It was decided that a definite portion of the rate related
to business was deductible. Consequently, a cost of running a car for example can be apportioned when the car
is used both for private and trade purpose.
Similarly, when expenditure is wholly and exclusively incurred in producing business purposes but the taxpayers
deliver an iincidental benefit, the expenditure should still be allowed (Bentleys Stokes & Lowless V Beeson
[1952] 33 TC 491. For instance when a person travel to national park on business trip might derive an incidental
benefits, but the whole expenditure of travelling is allowable.
However, deduction of capital, consumption and excluded expenditures is not allowed (section 11). Yet, the
capital expenditures on depreciable assets are deductible in form of depreciable annual allowance under the
third schedule Income Tax Act 2004. Therefore, depreciation charges calculated under taxpayers’ accounting
policies are not allowed too.
‘Consumption expenditure’ means any expenditure incurred by any person in the maintenance of himself, his
family or establishment, or for any other personal or domestic purpose.
Section 11(5)
Expenditure of a capital nature" means expenditure that secures a benefit lasting longer than twelve months; or
incurred in respect of natural resource prospecting, exploration and development.
Section 11(5)
‘Excluded expenditure’ means:
(a) tax payable under this Act except skills and development;
(b) bribes and expenditure incurred in corrupt practice;
(c) fines and similar penalties payable to a government or a political subdivision of a government of any country
for breach of any law or subsidiary legislation;
(d) expenditure to the extent to which incurred by a person in deriving exempt amounts or final withholding
payments;
(e) distributions by an entity or
(f) Mining operation" should not include exploration activities conducted outside the mining licence area which
shall be accumulated and allowed when the commercial operations commence.
Section 11(5)
Distribution by an entity’:
(a) means
i. a payment made by the entity to any of its members, in any capacity to the extent that the amount of the
payment exceeds the amount of any payment made by the member to the entity in return for the entity's
payment; or
ii. any re-investment of dividends which enhances the value of shares
iii. any capitalisation of profits;
(b) includes a payment made by the entity to one of its members on cancellation, redemption or surrender of a
membership interest in the entity, including as a result of liquidation of the entity or as a result of the entity
purchasing a membership interest in itself;

(c) excludes a payment of the type referred to in paragraph (a) (i) or (b):
i. to the extent to which the payment is directly included in calculating the member's income or in calculating a
final withholding payment, other than by reason of being a distribution; and
ii. without limiting any amount treated as a distribution by paragraph (a)(ii), that consists of the issue of further
membership interests in the entity to the entity's members in approximate proportion to the members'
existing rights to share in dividends of the entity; and
(d) in the case of a controlled foreign trust or corporation, is interpreted in accordance with section 75.
Section 3
The rest of this part describes how various items are determined to be or to be wholly and exclusively incurred
for businesses purposes.
1. Interest expense
Interests bearing external financing activities are normal in any business venture. Therefore, interest expenses
incurred on a finance debt obligation which is incurred wholly and exclusively and the amount is employed
during the year of income or was used to acquire an asset that is employed during the year of income wholly
and exclusively in the production of income from the business is deductible (section 12(1) (a)). Likewise, interest
incurred on non-monetary debts is also deductible when the debt obligation was incurred wholly and exclusively
in the production of income from the business (section 12(1)(b)). However, when interest incurred on foreign
currency debt obligation is deductible only when they are actually paid (39(g)).
Nevertheless, interest expenses incurred wholly and exclusive in production of business income for exempt-
controlled resident entity are restricted. In fact, interest expenses deducted by an exempt-controlled
resident entity must not exceed sum of interest equivalent to debt-to-equity ratio of 7 to 3 (section 12(2). In
case of changes in debt or equity amounts; the amount of the equity or debt should be the average of balances
of amount of debt or equity at the end of each period (section 12(4)).
‘An exempt-controlled resident entity’ for a year of income if it is resident and at any time during the year of
income 25% or more of the underlying ownership of the entity is held by entities exempt under the Second
Schedule, approved retirement funds, charitable organisations, non-resident persons or associates of such
entities or persons.
Section 12(4)
‘Debt’ means any debt obligation excluding: a non-interest bearing debt obligation, a debt obligation owed to
resident financial institution and a debt obligation owed to a non-resident bank or financial institution on whose
interest tax is withheld in the United Republic. While ‘equity’ includes: paid up share capital, paid up share
premium and retained earnings on an unconsolidated basis determined in accordance with generally accepted
accounting principles.
Section 12(5)
‘Period’ means a month or part of month

Section 12(5)
‘Parastatal organisation’ means: a local authority of the United Republic, a body corporate established by or
under any Act or Ordinance of the United Republic other than the Companies Act, and any company registered
under the Companies Act where -(i) in the case of a company limited by shares, not less than 50 percent of the
issued share capital of the company is owned by the Government or an organisation which is a parastatal
organisation under this definition; or (ii) in the case of a company limited by guarantee- (aa) the members of the
company include the Government or an organisation which is a parastatal organisation under this definition; and
(bb) such members have undertaken to contribute not less than 50 percent of the amount to be contributed by
members in the event of the company being wound up.
Section 12(5)
2. Trading Stock Allowance
Costs of goods sold are tax deductible business expenses. They are calculated by taking the opening value of
trading stock of the business for the year of income; plus expenditure incur red by the person during the year of
income that is included in the cost of trading stock of the business; less the closing value of trading stock of the
business for the year of income (Section 13(2)). The closing stock should be valued at the lower of the cost of
the trading stock of the business at the end of the year of income; or the market value of the trading stock
of the business at the end of the year of income (section 13(4).
The opening value of trading stock of a business for a year of income is the closing value of trading stock of
the business at the end of the previous year of income.
Section 13(3)
3. Repair and maintenance expenditure
Revenue expenses incurred on repair and maintenance of depreciable assets owned and employed by the
person wholly and exclusively in the production of income from the business are deductible. But, expenditures
incurred to improve lives of assets or repairs and maintenance of capital nature should be capitalized in the
costs of assets rather than be deducted as revenue expenses (section (14)(2)).
4. Agriculture improvement, research development and environmental expenditure
Agriculture improvement, research development and environmental expenditure are deductible expenses when
incurred for business purposes (section 15 (1)). In addition mining business might make a provision allowance
account under environmental expenditure and apply for their deductions to the Commissioner; if approved they
become deductible expenses (section 15(3)).
‘Agricultural improvement expenditure’ means expenditure incurred by the owner or occupier of farm land in
conducting an agriculture, livestock farming or fish farming business where the expenditure is incurred in
clearing the land and excavating irrigation channels; or planting perennial crops or trees bearing crops.
Section 15(2)
‘Environmental expenditure’ means subject to subsection (3) expenditure incurred by the owner or occupier of
farm land for the prevention of soil erosion; or in connection with remedying any damage caused by natural
resource extraction operations to the surface of or environment on land.
Section 15(2)
‘Research and development expenditure’ means expenditure incurred by a person in the process of
developing the person's business and improving business products or process and includes expenditure
incurred by a company for the purposes of an initial public offer and first listing on the Dar es Salaam Stock
Exchange but excludes any expenditure incurred that is otherwise included in the cost of any asset used in the
use in any such process, including an asset referred to in paragraph 1(3) of the Third Schedule .
Section 15(2)
From definitions of agriculture improvement expenditure, the expenditure can be deducted by a person
conducting agriculture business while, environmental expenditure are deductible by both those in agriculture
and mining businesses for the reason explained in the definitions. Finally, the research and development
expenditure can be deducted by any type of business.
‘Agricultural business’ means the practice of rearing of crops or animals including forestry, beekeeping,
acqua-culture and faming with a view to deriving a profit but excludes extraction of natural resources or
processing of agricultural produce other than preparing such produce for the purpose of sale in its original form.
Section 19(4)
5. Capital receipts
Receipts from capital transactions i.e. sales of fixed and investment assets are normal included in business
income. However, proceeds from sale of depreciable assets would be treated in computation of gain from
realization of depreciable assets as required in the schedule of the Income Tax Act 2004. Likewise, receipts
from disposal of investment income should be used in calculating investment capital gain and the investment
income not in computing business income.
6. Foreign currency exchange gain
Gain or loses from foreign exchanges if related to business transactions are taxable income and deductible
expenses respectively. Yet the computation of foreign exchange gains should be done when there is actual
receipt of the foreign currency. Because it is at that point the foreign currency debt is realized (section 40(2)
(c)).
7. Insurance claims
When there are receipts from insurance compensation relating to depreciable assets; they should be treated as
incoming from realization of the depreciable assets and used from computation of gain or loss from realization
of depreciable assets. Also insurance compensation relating to investment assets are used in computing capital
loss or gain from that investment assets. However, any receipt of insurance against current assets, business
losses and other accident are taxable business income.
8. Losses on realisation of business assets and liabilities
Losses from realisation of a business asset of the business that is or was employed wholly and exclusively in
the production of income from the business; a debt obligation incurred in borrowing money, where the money is
or was employed or an asset purchased with the money is or was employed wholly and exclusively in the
production of income from the business; or a liability of the business other than a debt obligation incurred in
borrowing money, where the liability was incurred wholly and exclusively in the production of income from the
business are all deductible expenses (section 18).
9. Losses from a business
Similarly losses incurred by businesses with exceptional of partnership or a foreign permanent establishment
are deductible expenses. These losses include any unrelieved loss of the year of income of the person from any
other business and any unrelieved loss of a previous year of income of the person from any business (section
19(1)). Additionally, unrelieved losses from other foreign source losses can be deducted only in calculating the
person's foreign source income and unrelieved loses from agriculture business can only be deducted from
calculating business income from agriculture.
While, unrelieved losses incurred on petroleum operations can only be deducted from the person’s income
derived from contract area and in case of loss incurred on mining operations the loss can only be deducted from
the person’s income derived from mining area.
But, where the ownership structure of an entity changes by more than 50% in comparison with the structure of
the entity three years ago, the business’ losses is not deductible; if after the changes the entity changes its
business it had been carrying 1 year before the changes within two years after the change (Section 56(2)).
‘Loss’ of a year of income of a person from any business or investment is the excess of amounts deducted in
calculating the person's income from the business or investment over amounts included in calculating such
income.
Section 19(4)
‘Unrelieved loss’ means the amount of a loss that has not been deducted in calculating a person's income.
Section 19(4)
10. Accountancy charges
Expenses incurred in preparation of financial accounts and tax returns are generally allowable expenses.
However, legal and expenses incurred in tax appeal are not deductible (Smiths Potato Estates Ltd v Bolland
1948 30 TC 267). In that case, the judge argued that they not incurred wholly and exclusive in production of
income but in ascertaining tax liabilities therefore the expense were disallowed.
11. Business entertainment and gifts
Expenses and gifts incurred in entertaining employees in relationship to their employment are generally allowed
as they constitute employment income. But, those expenses incurred for non-employee persons are disallowed
expenditures if they are not wholly and exclusively incurred for businesses purposes.
12. Pension scheme contributions and other employee benefits
Payment made to both approved and unapproved pension schemes and other employee’ benefits are
deductible businesses expenses so long as they payments are included in calculations of employment income
(Income Tax Regulation 4). In addition, any employment benefits as training costs and redundancy incurred by
employers are deductible expenses provided they are included in employees’ income.
13. Legal and other expenses
Legal and other expenses in connection with normal business activities and they are incurred wholly and
exclusive for business purpose are deductible expenses. However, those expenses incurred in connection of
acquisition of capital assets should be capitalized in the costs of assets and therefore they are not deductible
expenses (section 37).
14. Other losses and defalcations
Only losses from trade activities incurred wholly and inclusive for businesses purposes are allowable
expenditures. These losses might include fire, burglary, accident and loss of profits and when there is insurance
against them insurance costs are deductible too. However, losses arising from loss of capital assets are not
straight deductible from business income. They have either to go to the computation of gain or loss from
realization of business, depreciable or investment assets. But, insurance expenses against depreciable assets
are allowable expenses.
On the other hand, when employees defraud their employers the loss incurred is deductible expenses, while
defalcations by directors, sole traders or partners in partnership are not deductible (Curtis v J & G Oldfield
Ltd [1925] 9 TC 319). In this case, the judge argued that misappropriations of assets by persons in control of
businesses are allocations of profit of the businesses not trade activities of the businesses; therefore these
losses are not deductible.
15. Bad and doubtful debts
Businesses’ bad debts of revenue nature are deductible expenses when they become bad and actually written
off (section 25(4); section 39). Therefore, general and specific provision for bad debts is not deductible
expenses. Furthermore, a bad debt arising out of business activities and its associated costs is not allowable
(Curtis v J & G Oldfield Ltd [1925] 9 TC 319).
16. Contribution and donations
Contribution and donations made by taxpayers are generally not incurred wholly and exclusive for business
purposes. Then generally all these expenses should not be deducted. However, contribution and donations
made under section 12 of the Education Fund Act and amount paid to local government authority, which are
statutory obligations to support community development projects, are deducted 100%. Conversely, deduction of
amounted contributed to a charitable institution or social development project should not exceed 2% of the
person's income from the business calculated without such deduction (section 16(2).
‘Charitable organisation’ means a resident entity of a public character that satisfies the following conditions:
(a) the entity was established and functions solely as an organisation for: the relief of poverty or distress of the
public, the advancement of education or the provision of general public health, education, water or road
construction or maintenance; and
(b) the entity has been issued with a ruling by the Commissioner under section 131 currently in force stating
that it is a charitable organisation or religious organisation.
Section 64(8)
Others donations and contributions can only be deducted if they are incurred wholly and exclusively for the
purposes of business. For instance, contributions to trade organisations can be deductible if the trade
association furthers the businesses of its members (Lochgelly Iron and Coal Co Ltd v Crawford [1913] 6 TC
267). Similarly, contribution to charitable organizations of clothes with businesses’ advertisements or to support
exhibition might qualify as deductible expenses (Morley v Lawford [1928] 14 TC 229). Also costs incurred on
businesses entertainment for the purposes of business might be allowable expenses (Bentleys Stokes &
Lowless v Beeson [1952] 33 TC 491).
17. Depreciation allowances for depreciable assets
Depreciation allowance for depreciable assets owned and employed by the person during the year of income
wholly and exclusively in the production of the person's income from the business the allowances granted under
the Third Schedule of the Income Tax Act 2004 is allowable expenses (Section 17). So, depreciable allowance
of depreciable assets basing on taxpayer’s accounting policies is not deductible.
Costs incurred in purchasing depreciable assets used wholly and exclusively in production of business income
are not deductible. However, the law allows deduction of those costs in term of depreciation charges under the
third schedule of the Income Tax Act 2004. This schedule deal with classification of depreciable assets, pooling,
depreciation rates, depreciation method realization of depreciable assets and depreciable assets allowances.
(a) Classification of depreciable assets
The schedule places all depreciable assets into eight classes. Care should be taken when deciding in which
class a depreciable assets as classification depends not only on type or kind of the assets involved, but also its
size and type of business of taxpayers. For instance, buses of seating capacity not exceeding 30 passengers
are classified in class 1, while their counterpart with carrying capacity more than 30 passengers belongs in class
2. Likewise tractors used in construction industry belong in class 1 while those used in agriculture business are
placed in class 8. The table 1 below shows how depreciable assets are grouped according to the third schedule
of the Income Tax Act 2004.
Class
Depreciable assets
number
Computers and data handling equipment together with peripheral devices; automobiles, buses
1 and minibuses with a seating capacity of less than 30 passengers, goods vehicles with a load
capacity of less than 7 tonnes; construction and earth-moving equipment.
Buses with a seating capacity of 30 or more passengers, heavy general purpose or specialised
trucks, trailers and trailer-mounted containers; railroad cars, locomotives, and equipment; vessels,
2 barges, tugs, and similar water transportation equipment; aircraft; other self-propelling vehicles;
plant and machinery used in manufacturing or mining operations; specialised public utility plant,
equipment, and machinery; irrigation installations and equipment
3 Office furniture, fixtures and equipment; any asset not included in another Class
Natural resource exploration and production rights and assets in respect of natural resources
4
prospecting, exploration and development expenditure
Buildings, structures and similar works of a permanent nature used in agriculture, livestock
5 farming or fish farming, dams, reservoirs and fences, like buildings, storage transportation
infrastructure (docks, bridges, etc.) others in agriculture.
Buildings, structures and similar works of a permanent nature other than those mentioned in
6 Class 5. Like factories or manufacturing and industrial buildings, storages hotels, transportation
infrastructure [docks, bridges, etc.] houses for workers, offices.
7 Intangible assets other than those in Class 4 like patent, copy right, trade mark, property rights.
Plant and machinery (including windmills, electric generators and distribution equipment) used in
8 agriculture, electronic fiscal devices purchased by a non -value added tax registered trader,
equipment used for prospecting and exploration of minerals or petroleum
Magic Company Limited is a newly formed company carrying out agricultural business. During the first year of
its operations 20X0, it purchased the following depreciable assets:
(i) Computers and data handling equipment, which were used by the company secretary and the account
department; 2 computers, were purchased at Tshs900,000 each.
(ii) Three 25 seats minibuses which were used to shuttle staff were purchased, each at Tshs15,000,000; and
two more 50 seats buses were added during the year at a value of Tshs 80,000,000 in total.
(iii) 2 bulldozers each costing Tshs10,000,000; one second hand Dustan pickup for Tshs5,000,000; one brand
new saloon car for Tshs18,000,000 furniture and fittings costing in total Tshs7,500,000 were acquired
during the same year of business.
(iv) The company also purchased two lawn mowers, which were used in keeping the surroundings clean at
Tshs450,000 each.
(v) During the year, the following agricultural equipment, which arrived at Mtwara port, were cleared
immediately and transported to Songea to commence farming work.
¾ One CAT Comatus Caterpillar Tshs 40,000,000; 5 Fuso tractors @ Tshs12,000,000 each.
¾ Harrows and one planter all costing Tshs 600,000; three heavy-duty Isuzu trucks costing Tshs180,000,000
in total.
¾ A grain storage warehouse and rice milling building were constructed and completed at a cost of
Tshs5,000,000 and Tshs2,000,000 respectively and were put into use on 15th May, 20X0.
¾ One helicopter for taking tourist to the top of Mountain Kilimanjaro was purchased for Tshs40,000,000
¾ The adjusted income from business without depreciation allowance for Magic Company Limited for year
20X0 was Tshs253,206,180.
Required:
Classify the depreciable assets as per Income Tax Act 2004 third schedule.
An asset is plant or machinery if it is used for carrying on the business and is not stock in trade, the business
premises or part of the business premises.
HMRC
(b) Pooling system
In many cases depreciable assets are pool together and depreciation allowance of a pool is computed rather
than of single assets. Particularly, the assets in class 1, 2, 3, 4, 5 or 8 are normally pooled together; excluding a
moveable tangible asset used by a person who conducts a business of land, sea or air transport operator or
chatterer to carry passengers, mail, livestock or other moveable tangible assets between different countries.
These assets should be pooled in their separate pool distinct from other assets. Likewise, depreciable assets in
class 7 should not be pooled together.
(c) Depreciation rates and methods
According to the third schedule the depreciation rate are as follows:
¾ class I is 37.5%,
¾ class II is 25%,
¾ class III is 12.5%,
¾ class IV is 20%,
¾ class V is 20%,
¾ class VI is 5%
¾ class VIII is 100%
There are two depreciation methods stated in the third schedule:
¾ diminishing method which is used in computation of depreciation allowances for class I, II, III and VIII; and
¾ straight line method which is used in computation of depreciation allowances for class IV, V, VI and VII.
(d) Realisation of depreciable assets
When depreciable assets are realized there might taxable business income or losses when pools are dissolved.
A pool is dissolved when incomings from realization of depreciable assets exceed the sum of tax written down
value brought forward and any additional of depreciable to the pool. Also a pool is dissolved when all assets in
the pool are realized.
As we saw previously, there is capital gain when incoming from realization of depreciable assets exceed the net
cost of assets at the time of realization i.e. tax written down brought forward plus additional made during the
year and any portion of initial allowance not deducted. Similarly, there is capital loss when incoming from
realization of depreciable assets is lower than the net cost of assets at the time of realization i.e. tax written
down brought forward plus additional made during the year and any portion of initial allowance not deducted.
In addition to realization of assets we saw depreciable assets in class 4 are realized at later of:
i. when a person ceases to conduct natural resource prospecting, exploration, development and production in
the country where the prospecting, exploration or development giving rise to the asset occurred; or
ii. two years prior to the time at which the person and all associates of the person cease to conduct natural
resource prospecting, exploration, development and production in the country.
(e) Depreciable assets allowances
Initial allowance and annual depreciation allowance are the two allowances available to depreciable assets.
Initial allowance is given in the form of accelerating allocation of costs of depreciable assets. The initial
allowance is usually 50% of net costs of the assets at the time the asset is added to the pool. The allowance is
granted in two portions: (a) the first portion in the year of income in which the asset is added to a pool of
depreciable assets, and the remaining portion is available during the year of income following that in which the
first portion is added, but not if the pool has been dissolved. This allowance is available to plant or machinery:
(i) that is:
¾ used in manufacturing processes and fixed in a factory;

¾ used in fish farming; or
¾ used for providing services to tourists and fixed in a hotel; and
(ii) that is added to the person’s Class 2 or 3 pools of depreciable assets for a business of the person.
Juma Ltd who deals with selling and buying merchandises and manufacturing business, made the acquisition of
the following depreciable assets during the year ending 31 December 2009:
Tshs
Land rover 10,000,000
Factory plant 40,000,000
Pick up 7,500,000
Land cruiser 35,000,000
All these assets were used in the businesses during the year and the tractor was used in construction business.
The written down value as at 31/12/2008 after pooling assets based on the Income Tax Act, 2004 showed the
following:
Class I II
Written down value in Tshs 50,000,000 123.000,000
Required:
Use this information to calculate the initial allowance if any and show how will it be allowed.
Answer
Factory plant qualifies initial allowance because it must be fixed before using in manufacturing and it is
classified in class II. So the person would have 50% of Tshs 40,000,000 i.e. Tshs 20,000,000 available in two
equal portions of Tshs 10,000,000 in 2009 and 2010.
Depreciation annual allowances
Depreciation annual allowances on the other hand are computed using the depreciation rates and methods
discussed early. First step of computing depreciation allowance is proper classification and pooling of
depreciable assets. Once you have classified and pooled the asset, the next step is to compute annual
depreciation charges. The annual depreciation charges are computed basing on using the following formula:
A x B x C/365
Where,
A is the depreciation basis of the pool at the end of the year of income;
B is the depreciation rate applicable to the pool; and
C is the number of days in the person's year of income.
The depreciation basis of a Class 1, 2, 3 or 8 pools of depreciable assets of a person at the end of a year of
income is the total of
¾ the depreciation basis of the pool at the end of the previous year of income, if any, after deducting
depreciation of the previous; and
¾ amounts added to the depreciation basis of the pool during the year of income in respect of additions to the
cost of assets in or added to the pool,
¾ Reduced, but not below zero, by incomings for the assets in the pool or that have been in the pool derived
during the year of income.
The depreciation basis of a Class 4, 5, 6 or 7 pools of depreciable assets of a person at the end of a year of
income shall be the total of
¾ the depreciation basis of the pool at the end of the previous year of income; and
¾ amounts added to the depreciation basis of the pool during the year of income in respect of additions to the
cost of assets in or added to the pool,
¾ Reduced, but not below zero, by incomings for the assets in the pool derived during the year of income.
Thereafter, depreciation annual allowances are computed using classes’ balances not on values of individual
assets. The two definitions of depreciation basis above can be presented in the following template.
Items Depreciable assets classifications (Tshs)

Pools II III IV V VIII
Depreciation rates B 25% 12.5% 20% 20% 100%
Tax written down brought forward/ costs brought
Add: Addition during the year
Furniture
Tractors
Less: Incomings during the year
Buses
Generator
Depreciation basis A
Annual allowance A x B x C / 365=D
Tax written down carried forward A-D A-D A A A-D
Note: Tax written down balances applies to class I, II, III and VIII because they use diminishing method, while
costs balances of depreciable assets are used in class IV, V, VI and VII because they use straight line methods.
‘Written down value’ of a pool of depreciable assets at the end of a year of income in the case of a Class 1, 2,
3 or 8 pool, the depreciation basis of the pool at the end of the year of income, if any, after deducting
depreciation for that pool for that year of income. In the case of a Class 4, 5, 6 or 7 pools, the depreciation basis
of the pool at the end of the year of income reduced by all allowances granted to the person for that year of
income and any previous year of income in respect of the pool.
Income Tax Act 2004 Third schedule
Dates when depreciable assets are purchased in a year are irrelevant but the number of days of taxpayers’ year
of income is important as denoted C in the annual allowance.
Depreciable assets are added to a pool at the later of time when costs are incurred and when they owned and
employed wholly and exclusively for production of business income. While, the costs of assets granted initial
allowance are added to the pool twelve months after the time after the initial allowance has been granted.
Furthermore, when assets which are granted initial allowance are added to a pool their costs should be reduced
by any initial allowance given. Additionally, addition expenditure in acquiring a road vehicle, other than a
commercial vehicle should not exceed Tshs 15,000,000.
However, when depreciation basis of depreciable assets after deducting previous depreciation allowance is less
than Tshs 1,000,000, the annual depreciation allowance of that class will be income to that amount. Additionally,
care should be taken when computing depreciation charges for class 4, 5, 6 and 7 because of straight line
method; with this method there are always depreciation basis even when the assets are fully depreciated. Make
sure the allowed depreciation allowance for class 4, 5, 6 and 7 do not exceed the costs of the assets or the
depreciation basis.
‘Commercial vehicle’ means a road vehicle designed to carry loads of more than half a tonne or more than
thirteen passengers; or a vehicle used in a transportation or vehicle rental business
Income Tax Act 2004, Third Schedule
Juma Ltd who deals with selling and buying merchandises and construction business, made the acquisition of
the following depreciable assets during the year ending 31 December 2009:
Tshs
Tractor 40,000,000
Factory plant 40,000,000
Pick up 7,500,000
All these assets were used in the businesses during the year and the tractor was used in construction business.
The written down value as at 31/12/2008 after pooling assets based on the Income Tax Act, 2004 showed the
following:
Class I II
Written down value in Tshs 50,000,000 123.000,000
Required:
Use this information to calculate the annual depreciation and initial allowance for 2009 and 2010.
Answer
The initial allowance with respect with factory plant in 2009 was Tshs 10,000,000 and annual allowance was
Tshs 76,687,500 So the total allowance was Tshs 86,687,500 in 2009. On the other hand, the other portion of
initial allowance was Tshs 10,000,000 and annual allowance was Tshs 59,273,437.50 in 2010. Therefore the
total allowance in 2010 was Tshs 69,273,437.50.

Class I II
Written down value in Tshs b/f 50,000,000 123,000,000
Add:
Tractor 40,000,000
Factory plant -
Pick up 7,500,000
Depreciation basis 122,500,000 123,000,000
Depreciation rate 37.50% 25%
Annual allowance 45,937,500 30,750,000
Written down value in Tshs c/f 2009 76,562,500 92,250,000
Add:
Factory plant 20,000,000 -
Depreciation basis 96,562,500 92,250,000
Depreciation rate 37.50% 25%
Annual allowance 36,210,937.50 23,062,500.00
Written down value in Tshs c/f 2010 60,351,562.50 69,187,500.00
Note:
¾ The value of land cruiser has been restricted to Tshs 15,000,000 because of it can carry more than
13 passengers.
¾ The initial allowance of Tshs 20,000,000 was granted in two portions: (a) the first portion in the year of
income in which the asset is added to a pool of depreciable assets in 2009, and the remaining portion is
available during the year of income following that in which the first portion is added in 2010.
¾ The costs of factory plant granted initial allowance were added to the pool 12 months after the time after the
initial allowance has been granted i.e. 2010 its costs Tshs 40,000,000 should has been reduced by any
initial allowance given of Tshs 20,000,000.
i. Computers and data handling equipment, which were used by the company secretary and the account
department; 2 computers, were purchased at Tshs 900,000 each.
ii. Three 25 seats minibuses which were used to shuttle staff were purchased, each at Tshs 15,000,000; and
iii. 2 bulldozers each costing Tshs 10,000,000; one second hand Dustan pickup for Tshs 5,000,000; one brand
new saloon car for Tshs 18,000,000 furniture and fittings costing in total Tshs 7,500,000 were acquired
iv. The company also purchased two lawn mowers, which were used in keeping the surroundings clean at
Tshs 450,000 each.
v. During the year, the following agricultural equipment, which arrived at Mtwara port, were cleared
¾ One CAT Comatus Caterpillar Tshs 40,000,000; 5 Fuso tractors @ Tshs 12,000,000 each.

¾ Harrows and one planter all costing Tshs 6,00,000; three heavy-duty Isuzu trucks costing Tshs 180,000,000
in total
¾ A grain storage warehouse and rice milling building were constructed and completed at a cost of Tshs
5,000,000 and Tshs 2,000,000 respectively and were put into use on 15th May, 20X0.
¾ One helicopter for taking tourist to the top of Mountain Kilimanjaro was purchased for Tshs 40,000,000
20X0 was Tshs 253,206,180.
Required:
Calculate the depreciation allowances as per Income Tax Act 2004 third schedule.
Answer
The annual depreciation allowance was Tshs366,737,500
I II III V VIII
Depreciation rates 37.50% 25% 12.50% 20% 100%
Opening written down value or cost - - - - -
Computers and data handling equipment 1,800,000
25 seats minibuses 45,000,000
50 seats buses 80,000,000
2 bulldozers 20,000,000
Dustan pickup 5,000,000
New saloon car 15,000,000
Furniture and fittings 7,500,000
Lawn mowers 900,000
CAT Comatus Caterpillar 40,000,000
5 Fuso tractors 60,000,000
Harrows and one planter 6,000,000
Three heavy-duty Isuzu trucks 180,000,000
Storage warehouse 5,000,000
Rice milling building 2,000,000
One helicopter 40,000,000
61,800,000 120,900,000 7,500,000 7,000,000 311,000,000
Less: Incomings
Incomings - - - - -
Depreciation basis 61,800,000 120,900,000 7,500,000 7,000,000 311,000,000
Annual depreciation allowance 23,175,000 30,225,000 937,500 1,400,000 311,000,000
Written down value and costs c/f 38,625,000 90,675,000 6,562,500 7,000,000 -
By now we have learnt that not all income from business are taxable, some are final withholding payments,
some are exempt income and some simply not related to business. Also we saw how to identify allowable
deductions and non-deductible expenses when computing business income. This section deals with how to
establish chargeable income from business. The business income of sole trader can be computed on cash or
accrual basis unless specifically required by tax laws, while corporations compute their business income on
accrual basis.
However, all business persons prepare their accounting records using General Accepted Accounting Practices
(GAAPs). So for tax purposes, we do not establish new financial statements. But we adjust profit or losses
shown by the accounting statements by adding items which are not taken into accounting by GAAPs and
deducting items which are not allowed by tax laws but included by the GAAPs. The statement below can help us
when computing taxable employment income.
Kigongo Company Limited was incorporated in Tanzania and commenced its business on 1st February 2005 as
a retailer of audio-visual products in Tanzania. It has drawn up its first accounts to 31st December 2005, the
draft of which together with the additional information was as follows:
“000” “000”
Notes
Tshs Tshs
Sales 1 950,000
Dividends 2 5,000
Interest income 3 12,000
Contractual penalties 4 5,000 972,000
Expenses:
Directors fees 5 320,000
Salaries 300,000
Interest expenses 6 80,000
Rent and rates 220,000
Legal and professional fees 7 20,000
Contributions to retirement fund 8 15,000
Depreciation 9 120,000
Travelling and entertainment 22,000
Provisions 10 28,000
Insurance 18,000
Sundries 11 10,000 (1,153,000)
Loss for the year (186,000)
Additional notes:
1. Sales figure includes Tshs 1,000,000 for sale of furniture which was used by the company.
2. The company had bought some shares from City Stock Exchange. These were shares of Sungura Cement
Company which distributed dividends during the period.
3. The Company earned Tshs 8,000,000 as interest from its bank deposits and another Tshs 4,000,000 from a
director to whom the company had extended a personal loan. The Director used the loan to acquire a
building in Kenya.
4. The amount was received as a result of a business contract which the other party breached it.
5. Directors fees were paid to the following persons:
Tshs
Mr. A. 200,000,000
Mrs. A (wife of Mr. A) 50,000,000
Mr. B. (Mr. A’s brother) 70,000,000
320,000,000
6.
Tshs
Interest paid to bank on overdraft 20,000,000
Finance charge on hire purchase agreements 50,000,000
Interest on failure to pay previous years 10,000,000

Value added taxes 80,000,000
7.
Tshs
Audit fees 10,000,000
Legal fees for staff contracts and retirement funds 6,000,000
Amount paid to Tender Board members to facilitate winning a bid 4,000,000
20,000,000
8.
Tshs
Employees contributions 7,500,000
Employer’s contributions 7,500,000
15,000,000
The contributions were made to an approved retirement fund.
9.
The company acquired the following assets:
Tshs
On 15th February 2005 – Furniture and equipment 100,000,000
On 15th February 2005 – Computers and accessories 300,000,000
On 1st September 2005 – Motor car (station wagon) 200,000,000
The computers were acquired on hire purchase terms for 12 months. The down payment of Tshs 120,000,000
was made on 15th February 2005 and the first monthly instalment of Tshs 20,000,000 was due on 15th February
2005 and the first monthly instalment of Tshs 20,000,000 was due on 15th March 2005. The cash price of the
computers was Tshs 300,000,000.
10.
Tshs
Provision for debtors (specific) 11,000,000
Provision repairs (estimated) 8,000,000
Provision for stock obsolescence 9,000,000
28,000,000
11. Sundries included a traffic fine of Tshs 3,500,000. The balance was general consumables used by the
office.
Required:
Calculate business income for the year 2005 after ignoring depreciation allowance.

Answer
Building on the above arguments, the taxable loss will be Tshs 19,000 from:
Tshs '000' Tshs '000'

Loss for the year as per account (186,000) (186,000)
Add: Non allowable expenses
Interest on failure to pay VAT 10,000
Tender Board member payments 4,000
Employee contribution 7,500
Provisions 28,000
Traffic fines 3,500
Depreciation 120,000 173,000
Less: Not business income
Sales of furniture 1,000
Dividend 5,000 6,000
(19,000)
4. Calculate investment income

[Learning Outcomes e]
4.1 Investment activities
Income from investment activities is also taxable income. It is important to differentiate when someone is doing
business or investment because of difference in tax rates. Unlike business person who expects benefiting from
regular or many frequencies transactions, someone doing investment normally takes a long term view of his/her
activities. For example, shareholders of a corporate might hold shares for expectation of getting periodic
dividends and long term capital gains after disposing off the shares. However, share brokers in most cases buy
shares in order to profit from short term rises or fall of share prices. So if the share brokers get dividends or
capital gain from realization of shares, these incomes are more likely to be business income than investment
income.
Furthermore, another important distinction between business and investment activities is that business activities
are normally the major occupations of a person while investment activities are subsidiary ones. Take an
example of interest income; the interest income received by an individual from a saving or fixed deposit
accounts might be investment income. While, the interest income received by financial institutions or money
lenders is definitely business income. Likewise, rent income received by property Management Company is
business income, the same income received by trading company owning few properties may be investment
income.
Finally, it is important too to look at the substance of the income not the form of it. For instance, interest
received from the business accounts is business income not investment income. Also income from short term
investments using business funds are business income not investment income as income from letting and extra
business space.
‘Investment’ means the owning of one or more assets of a similar nature or that are used in an integrated
fashion, on similar terms and subject to similar conditions, including as to location and includes a past, present
and prospective investment, but does not include a business, employment and the owning of assets, other than
investment assets, for personal use by the owner.
Section 3
4.2 Investment income items
According to section 9 (1) of the Income Tax Act 2004, the following items are investment income.
(a) Dividend,
(b) Distribution of a trust,
(c) Gains of an insured from life insurance,
(d) Gains from an interest in an unapproved retirement fund,
(e) Interest,
(f) Natural resource payment,
(g) Rent
(h) Royalty;
(i) Net gains from the realisation of investment assets of the investment
(j) Amounts derived as consideration for accepting a restriction on the capacity to conduct the investment.
’Trust’ means an arrangement under which a trustee holds assets but excludes a partnership and a
corporation.
Section 3
‘Royalty’ means any payment made by the lessee under a lease of an intangible asset and includes payments
for
(a) the use of, or the right to use, a copyright, patent, design, model, plan, secret formula or process or
trademark;
(b) the supply of know-how including information concerning industrial, commercial or scientific equipment or
experience;
(c) the use of, or right to use, a cinematography film, videotape, sound recording or any other like medium;
(d) the use of, or right to use, industrial, commercial or scientific equipment;
(e) the supply of assistance ancillary to a matter referred to in paragraphs (a) to (d); or
(f) a total or partial forbearance with respect to a matter referred to in paragraphs (a) to (e), but excludes a
natural resource payment.
Section 3
‘Natural resource’ means minerals, petroleum, water or any other non-living or living resource that may be
taken from land or the sea.
Section 3
‘Natural resource payment’ means any payment, including a premium or like amount, for the right to take
natural resources from land or the sea or calculated in whole or part by reference to the quantity or value of
natural resources taken from land or the sea.
Section 3
’Interest’ means a payment for the use of money and includes a payment made or accrued under a debt
obligation that is not a repayment of capital, any gain realised by way of a discount, premium, swap payment or
similar payment.
Section 3
1. Net gain from realization of investment assets
‘Investment asset’ means shares and securities in a corporation, a beneficial interest in a non-resident trust
and an interest in land and buildings but does not include:
(a) business assets, depreciable assets and trading stock;
(b) a private residence of an individual that has been owned continuously for three years or more and lived in
by the individual continuously or intermittently for a total of three years or more, other than a private
residence that is realised for a gain in excess of 15,000,000 shillings;
(c) an interest in land held by an individual that has a market value of less than 10,000,000 shillings at the time
it is realised and that has been used for agricultural purposes for at least two of the three years prior to
realisation; and
(d) shares or securities listed on the Dar es Salaam Stock Exchange that are owned by a resident person or a
non-resident person who either alone or with other associate controls less than 25% of the controlling
shares of the issuer company.
Section 3
There is a taxable capital gain when costs of investment asset are lower than the incomings from its realisation.
However, it is not individual investment assets gain which are included in the computation of investment income
but net gain of realizing investment assets. The net gain from realization of investment assets is calculated as
follows:
(a) Total of all gains from the realisation of investment assets during the year
(b) Less
¾ Total of all losses from the realisation of investment assets of the investment during the year;
¾ Any unrelieved net loss of any other investment of the person for the year.
¾ Any unrelieved net loss of an investment for a previous year of income (section 36(3)).
‘Unrelieved net loss’ of an investment for a year of income is the excess of losses over gains from the
realisation of investment assets of the investment during the year of income.
Section 36(6)
However, capital loss from foreign sources can only be netted off with capital gain from foreign sources (section
36(4)). Also, capital losses from realization of investment assets should only be used to reduce capital gain from
investment of assets. Also investment loss can be used again investment income. So in case where there is no
capital gain, foreign capital gain, investment income whatever situation, the capital losses or investment losses
should be brought forward. But, where the ownership structure of an entity changes by more than 50% in
comparison with the structure of the entity three years ago, the business’ losses is not deductible; if after the
changes the entity changes its investment it had been carrying 1 year before the changes within two years after
the change (Section 56(2)).
Robots and Assembler Design makers Ltd acquired properties for Tshs 50,000,000 in 2010. The person also
paid for legal charges amounting to Tshs 5,000,000 on the date of acquisition. The properties had been let out
to resident individuals who pay Tshs 20,000,000 as rents every year. However, the company incurred Tshs
5,000,000 and Tshs 100,000 per annual for major and minor maintenance respectively.
Required:
If the properties are investment assets, and were sold on 31st December 2013 for Tshs 100,000,000 after
incurring selling cost of 2% of the proceeds, calculate the capital gain or loss from realization of the assets.
Answer
The capital gain is Tshs 38,000,000
Tshs Tshs
Proceeds of sales 100,000,000
Less: Expenses
Cost of acquisition 50,000,000
Major repairs 5,000,000
Legal charges 5,000,000
Selling costs 2,000,000 62,000,000
Capital gain 38,000,000
paid for legal charges amounting to Tshs 5,000,000 on the date of acquisition. The properties had been let out
Required:
incurred selling cost of 2% of the proceeds, compute the capital gain or loss from realization of the assets.
The unrelieved loss is Tshs 20,800,000 which will be carried forward.
Tshs Tshs
Less: Expenses
Selling costs 800,000 60,800,000
Capital gain (20,800,000)
paid for legal charges amounting to Tshs 5,000,000 on the date of acquisition. The properties have been let out
Required:
incurred selling cost of 2% of the proceeds, compute the capital gain or loss from realization of the assets if
the company had unrelieved loss of Tshs 20,800,000.
Robots and Assembler Design makers disposed an investment asset for Tshs 2,000,000 which had cost of Tshs
1,000,000 and net costs before disposal of Tshs 100,000. The person incurred selling costs of Tshs 800,000
and transport expenses of 100,000.
Required:
Determine gain or loss from the realization of the assets.
Answer
Gain or loss of realization of assets= Incomings less cost of the assets less realization expenses. Therefore,
Gain on realization = Tshs 2,000,000 –Tshs 800,000 – Tshs 100,000 - Tshs 1,000,000= Tshs 100,000.
4.3 Excluded investment income
According to section 8(3) of the Income Tax Act 2004, exempt investment income, final withholding payments
and non-investment income should be excluded in computing investment income. Both exempt income and final
withholding income items were covered in the employment income section. So in this section they are not
discussed. Please take time to peruse them. In addition receipt from realization of capital assets should be
excluded as well because they are used in computing gain from realization of investment income assets.
4.4 Deductible expenses
As it was for business income, taxable investment income is established after deducting allowable deductions.
Almost all the criteria of allowing or not allowing expenses we saw in business income apply as well. In short,
only expenses incurred ‘wholly and exclusively’ in the production of business income are allowable expenses
(section 11(3)). Therefore, only expenditure incurred for sole purposes of producing investment income are
allowable expenses and expenditure incurred not wholly and exclusively for business purposes are not
allowable.
Likewise, deduction of capital, consumption and excluded expenditures is not allowed (section 11). Also, unlike
business persons who are allowed to deducting depreciation annual allowance under the third schedule of
Income Tax Act 2004, investors cannot claim depreciation charges on their investment assets. Therefore,
depreciation charges of investment assets calculated under taxpayers’ accounting policies are not allowed too.
paid for legal charges amounting to Tshs 5,000,000 on the date of acquisition. The properties have been let out
5,000,000 and Tshs 1,000,000 per annual for major and minor maintenance respectively.
Required:
incurred selling cost of 2% of the proceeds, calculate the investment income for the year ending 2013 if the
company had unrelieved loss of Tshs 20,800,000.
By now we have learnt that not all income from investment are taxable, some are final withholding payments,
some are exempt income and some simply not related to investment. Also we saw how to identify allowable
deductions and non-deductible expenses when computing investment income. This section deals with how to
establish chargeable income from investment activities. The investment income of sole trader can be computed
on cash or accrual basis unless specifically required by tax laws, while corporations compute their investment
income on accrual basis.
Magic Company Limited is a newly formed company carrying out agricultural business.
(a) During the year the company received Tshs 300,000 as rent from Mr. Chagula a Tanzanian, with respect of
a house occupied by Mr. Chagula situated at Mabibo – Dar es Salaam.
(b) Also the company received a royalty from Mazimbu Limited amounting to Tshs 4,500,000 out of lease of
videotapes used for promotion.
(c) During the year, Magic Company Limited sold 5 hectors of land, which was at Mikocheni and received Tshs
20,000,000. This land was purchased for Tshs 3,000,000 in 1980. 3 year prior to its sale, this land had
been used as agricultural land.
Required:
Calculate chargeable investment income for the year 20X0.
Answer
Computation of chargeable investment income for the year 20X0
Tshs '000' Tshs '000'

Royalty 4,500,000
Rent from Mr Chagula 300,000 4,800,000
Capital gain from selling land
Proceeds 20,000,000
Less: Costs 3,000,000 17,000,000
Investment income 21,800,000
5. Calculate total income.

Prepare tax returns and statement of estimated tax.
[Learning Outcomes b and f]
5.1 Calculation of total income
Once you know how business, employment and investment income are calculated it becomes easy to compute
total income. In addition one should consider the residential status of a taxpayer.
The ‘total income’ of a person shall be the sum of the person's chargeable income for the year of income from
each employment, business and investment.
Section 5
(a) Compute and Data handling equipment, which were used by the company secretary and the accounts, 2
computers, were purchased at Tshs 900,000 each.
(b) Three 25 seats minibuses which were used to shuttle staff were purchased, each at Tshs 15,000,000; and
(c) 2 bulldozers each costing Tshs 10,000,000; one second hand Dustan pickup for Tshs 5,000,000; one brand
new saloon car for Tshs 15,000,000 furniture and fittings costing in total Tshs 7,500,000 were acquired
(d) The company also purchased two lawn mowers, which were used in keeping the surroundings clean at
Tshs 450,000 each.
(e) During the year, the following agricultural equipment, which arrived at Mtwara port, were cleared
¾ One CAT Comatus Caterpillar Tshs 40,000,000; 5 Fuso tractors @ Tshs 12,000,000 each.
¾ Harrows and one planter all costing Tshs 6,00,000; three heavy-duty Isuzu trucks costing Tshs 180,000,000
in total
¾ A grain storage warehouse and rice milling building were constructed and completed at a cost of Tshs
th
5,000,000 and Tshs 2,000,000 respectively and were put into use on 15 May, 20X0.
¾ One helicopter for taking tourist to the top of Mountain Kilimanjaro was purchased for Tshs 40,000,000
20X0 was Tshs 253,206,180.
During the year, Magic Company Limited also conducted the following transactions:
(f) Received dividend, from TTT Limited, a resident corporation, amounting to Tshs 5,500,000. Magic limited
owns 45% of the shares of TTT Limited.
(g) Dividends amounting to Tshs 2,500,000 were received from HP Williamson Limited, which is listed on the
DSE, and is owned 20% by TIKA limited a non-resident company.
(h) Dividends amounting to Tshs 1,550,000 received from Chuwa Company limited a resident corporation.
(i) Magic Company Limited has its office along Ali Hassan Mwinyi Road, the office was underutilized. The
company decided to rent the front part of its office to Juma Bakari a shop businessman, who used it as a
shop. Mr. Bakari paid Tshs 800,000 as rent.
(j) During the year the company received Tshs 300,000 as rent from Mr. Chagula a Tanzanian, with respect of
a house occupied by Mr. Chagula situated at Mabibo – Dar es Salaam.
(k) Also the company received a royalty from Mazimbu Limited amounting to Tshs 4,500,000 out of lease of
videotapes used for promotion.
(l) During the year, Magic Company Limited sold 5 hectors of land, which was at Mikocheni and received Tshs
20,000,000. This land was purchased for Tshs 3,000,000 in 1980. 3 year prior to its sale, this land had
been used as agricultural land.
Required:
Calculate total income of the company for the year 20X0.

5.2 Prepare statement of estimated tax
Preparation of statement of estimated tax is a responsibility of many taxpayers. In this task, they are required to
estimate their income from business, investment and in case of individuals taxpayers they have to estimate their
income from employment. In essence this task requires involving creating income statement budgets for
investment and businesses income, as well as estimating income from employment.
Then, once those statements are ready, the next task is to transfer the information i.e. estimated income to the
statement of estimated tax forms and calculate instalment tax payments. These forms are available at
http://www.tra.go.tz/index.php/forms/151-domestic-revenue-forms. They normally contain similar information
except that forms for individual taxpayers included employment income while for other taxpayers do not include
item for employment income.
Assume that the previous example above for Magic Company Limited was concerning with forecast of
income and expenses from investment and business income.
Required
Prepare statement of estimated tax
TANZANIA REVENUE AUTHORITY
STATEMENT OF ESTIMATE/REVISED ESTIMATE OF TAX PAYABLE BY INSTALMENT MADE ON

BEHALF OF AN ENTITY
YEAR OF INCOME:
TIN:
To:
NOTE
An estimate/revised estimate of tax payable to be made by an entity under Section 89 of the Income Tax Act,
2004. You are required to furnish the estimate of income for the year 200x within three (3) months of the
beginning of your accounting date or after the preceding calendar year.
Please, read the notes carefully in the appendix before filling in the form.
There are penalties for not/late filing an estimate or for giving false information.
Date of issue: …………….. Issuing office: ………………………………………………
P.O. Box: …..……………………………………………….

Tel: ………………………………Fax:……..………………..
E-mail address: ……………………………………………..
GENERAL INFORMATION
1 TIN:
2 Name of entity:
Postal Address:
3 P. O. Box Postal City
Contact Numbers:
4 Phone number Second Phone
Third Phone Fax number
5 E-mail address
6 Person’s status and category of taxation (Please tick the appropriate box):
Resident Non-Resident
¥
Day Month
7 Accounting date:
8 Particulars of bank accounts:
Name of Bank Branch Address Account No. Type of account
ESTIMATE OF INCOME AND TAX
(Do not include final withholding payments)
9 Business income -112,731,320

10 Investment income 21,800,000
11 Total estimated income (sum 9+10) -90,931,320
12 Tax on total estimated income Nil
13 Repatriated income from a Domestic Permanent Establishment Nil
14 Tax on repatriated income from a Domestic Permanent Establishment Nil
15 Total tax payable (12+14) Nil
Deductions:
16 Withholding tax actually paid (Do not include final Withholding Tax) 2,885,000
17 Foreign Tax Credit Nil
18 Single instalment tax paid Nil
19 Total of deductions (Sum 16 to 18) 2,885,000
20 Tax payable by instalment (15 minus 19) -2,885,000
21 Instalments payable:
1st instalment 2nd instalment 3rd instalment 4th instalment

Amount Nil Nil Nil Nil
Due Date
DECLARATION
I hereby declare to the best of my knowledge and belief that the above estimate is true and correct.
Title: Mr Mrs Ms
First Name Middle Name Surname
Position
Day Month Year

Signature…………………………………………….. Date/
Note: the non-final withholding taxes are coming from royalties at 15%, rents at 10% and capital gain at 10%
5.3 Prepare tax returns
On the other hand, preparation of tax returns bases on actual historical financial data and it is more details.
Unlike, the adjustment of business income, tax returns and their appendixes show business income, deduction
business expenses, investment income, deductible investment expenses and employment income in case of tax
returns filed by individual taxpayers. These appendixes are not shown here However, when knowledge of
calculation of investment income, business income and employment income is known, the task of preparing tax
returns is simple too.
Assume that the previous example above for Magic Company Limited was concerning with forecast of income
and expenses from investment and business income.
Required
Prepare tax return for the company
TANZANIA REVENUE AUTHORITY
RETURN OF INCOME
MADE ON BEHALF OF AN ENTITY
YEAR OF INCOME:
2 0 0 x
To: TIN:

Note:
This return is submitted under the provisions of Section 91 of the Income Tax Act, 2004. You are hereby
required to furnish the return of income not later than six (6) months after the end of the year of income,
showing your total worldwide income if you were resident in Tanzania or income the source of which is
Tanzania if you were not resident during the year …………. You are required to make payment of the income
tax still to be paid for the year of income based on the declared income.
Please, read the notes carefully in the appendix before filling in the form.
There are penalties for not filing a tax return or for filing false return.
Date of issue: …………….. Issuing office: ………………………………………………

P.O. Box: …..………………………………….……………
Tel: ………………………………Fax: ……..….…………
E-mail address: ……………………………………………..
GENERAL INFORMATION/ENTITY’S PARTICULARS
1 TIN:
2 Name of entity:
3 Residential status (Please tick the appropriate box):
Resident Non-Resident
4 Postal Address:
P.O. Box Postal City
5 Physical Address:
Street/Location Plot No. Block No.
Contact Numbers:
6 Phone number Second Phone
Third Phone Fax number
7 E-mail address:
From: Day Month Year To: Day Month Year
8 Period covered by this return (basis period):

COMPUTATION OF INCOME AND TAX
Business Income Taxable income Tax payable

TZS
9 Business Income (other than Agriculture & Mining)
10 Mining Business Income Nil
11 Loss brought forward from Mining Nil
12 Net Mining Business Income (10-11) Nil
13 Agricultural Business Income Nil
14 Loss brought forward from Agricultural Business Income Nil
15 Net Agricultural Business Income (13-14) Nil
16 Technical services (Mining) Nil
17 Transport for non-resident operators/charterers Nil
18 Insurance premium for non-resident Nil
19 Service fees (e.g. management fee, professional fee) for non- Nil
resident
20 Total Business Income (9+12+15+(16 to 19))
Investment Income
21 Dividends
22 Dividends (DSE listed)
23 Interest/Discount
24 Rent
25 Royalties
26 Natural resource payment
27 Capital gain
28 Other investment (specify in separate schedule)
29 Total Investment Income (from 21 to 28)
30 Total of Business and Investment Income (20+30) and Tax
31 Repatriated Income of a Domestic Permanent
Establishment and Tax
32 Final withholding payments
33 Total Tax (30+31+32)
34 Tax deducted at source
35 NET TAX PAYABLE (33-32-34)
36 DUE DATE
DECLARATION
I hereby declare that the information I have given on this form and any accompanying
accounts/documents are correct, complete and contain a full and true statement of the entity’s income
to the best of my knowledge and belief.
Title: Mr Mrs Ms
Position
Day Month Year

Signature………………………………………………… Date
In accordance with the provision of Section 135(1) of the Income Tax Act, 2004 I declare that I prepared
or assisted in the preparation of this return and to the best of my knowledge, the return and
attachments thereof present a true and fair view of the financial position of the entity.
Title: Mr Mrs Ms
Position
(Certified Public Accountant)
Day Month Year/

Signature ……………………………………………… Date
In the exam you would only have to show the computation and tax, the formats given above are only for
enhancing your practical knowledge; students are not expected to draw up the form.
Answer to TY 1
(a) Since the corporation was not established under law of the United Republic the corporate would also be
non-resident corporate.
(b) Since the corporation was established under law of the United Republic the corporate would also be
resident corporate.
Answer to TY 2
Using the reducing balance as presented in the table below the interest changeable income for the year 2002 is
Tshs 190,000:
Dates Amount (A) in Tshs Repayment Time Interest =A x time x saved interest
31.1.2005 3,000,000 200,000 0.08 25,000
28.2.2005 2,800,000 200,000 0.08 23,333
31.3.2005 2,600,000 200,000 0.08 21,667
30.4.2005 2,400,000 200,000 0.08 20,000
31.5.2005 2,200,000 200,000 0.08 18,333
30.6.2005 2,000,000 200,000 0.08 16,667
31.7.2005 1,800,000 200,000 0.08 15,000
31.8.2005 1,600,000 200,000 0.08 13,333
30.9.2005 1,400,000 200,000 0.08 11,667
31.10.2005 1,200,000 200,000 0.08 10,000
30.11.2005 1,000,000 200,000 0.08 8,333
31.12.2005 800,000 200,000 0.08 6,667
Total interest 190,000
Answer to TY 3
Using the format presented earlier the total employment income was Tshs
Item Tshs Tshs

Basic monthly salary 600,000 x12
Transport allowance monthly 250,000 x 12
Lunch allowance monthly 150,000 x12
Medical allowance monthly 100,000x12
Car benefit 1,000,000
Electricity 30,000 x12
Water 25,000 x12
Loan benefit as calculated previously 300,000
Less: Contribution to approved fund by an employee as above 360,000
Income before house benefit 14,800,000 14,800,000
Add: House benefits Working 1 1,845,000
Taxable employment income 16,645,000
Working 1
House benefit is the lower of:
i. the annual market value Tshs 4,800,000

ii. the greater of
¾ 15% of (Tshs 14, 800,000 + Tshs 1,500,000) = Tshs 2,445,000
¾ Tshs 1,800,000.
Reduced by monthly contribution made during the year of Tshs 600,000 (Tshs 50,000 x12). So the house
benefit without deduction of monthly contribution was Tshs 2,445,000, it is the lower of Tshs 4,800,000 and
Tshs 2,445,000. The ultimate house benefit was Tshs 1,845,000 (i.e. 2445,000 – 600,000).
Note that interest from CRDB bank is final withholding payments and while rent was not final withholding
payment as it was not a residential house of a resident individual.
Answer to TY 4
(i) Computers and data handling equipment are classified in Class I.
(ii) Three 25 seats minibuses are classified in Class II, while 50 seats buses belong in Class II as they are not
directly used in agriculture business
(iii) 2 bulldozers and one second hand Dustan pickup are used in agriculture businesses are grouped in Class
VIII. Whereas the brand new saloon car belong to class I as its seating capacity may not exceed 30
passengers and furniture and fittings are grouped in class III
(iv) Two lawn mowers are assumed to be self-propelling equipment so classified in Class II.
(v) During the year, the following agricultural equipment, which arrived at Mtwara port, were cleared
i. Both the CAT Comatus Caterpillar and Fuso tractors .are classified in Class VIII.
ii. Harrows and one planter and three heavy-duty Isuzu trucks also belong to Class VIII.
iii. A grain storage warehouse and rice milling building, these assets belong to Class V.
iv. One helicopter for taking tourist to the top of Mountain Kilimanjaro belongs to Class II.
Answer to TY 5
The capital gain is Tshs 17,200,000
Tshs Tshs
Less: Expenses
Unrelieved loss 20,800,000
Selling costs 2,000,000 82,800,000
Answer to TY 6
The investment income for the year ending 2013 is Tshs 36,200,000
Tshs Tshs
Less: Expenses
Unrelieved loss 20,800,000
Selling costs 2,000,000 82,800,000
Other Investment income
Annual rents 20,000,000
Less: minor repairs 1,000,000
19,000,000
Total investment income 36,200,000
Answer to TY 7
The total income will be Tshs -90,931,000
Tshs '000' Tshs '000' Tshs '000'

Royalty 4,500.00
Rent from Mr Chagula 300.00 4,800.00
Capital gain from selling land
Proceeds 20,000.00
Less: Costs 3,000.00 17,000.00
Investment income 21,800.00 21,800.00
Adjusted business income before depreciation allowance 253,206.00
Add: Business income not included-Juma Bakari 800.00
Less: Depreciation allowance (see below) 366,737.50 (112,731.32)
Total income (90,931.00)
The annual depreciation allowance was Tshs 366,737,500
I II III V VIII
Depreciation rates 37.50% 25% 12.50% 20% 100%
Opening written down value
0 0 0 0 0
or cost
Computers and data handling
1,800,000
equipment
25 seats minibuses 45,000,000
50 seats buses 80,000,000
2 bulldozers 20,000,000
Dustan pickup 5,000,000
New saloon car 15,000,000
Furniture and fittings 7,500,000
Lawn mowers 900,000
CAT Comatus Caterpillar 40,000,000

5 Fuso tractors 60,000,000
Harrows and one planter 6,000,000
Three heavy-duty Isuzu
180,000,000
trucks
Storage warehouse 5,000,000
Rice milling building 2,000,000
One helicopter 40,000,000
61,800,000 120,900,000 7,500,000 7,000,000 311,000,000
Less: Incomings
Incomings - - - - -
Depreciation basis 61,800,000 120,900,000 7,500,000 7,000,000 311,000,000
Annual depreciation
23,175,000 30,225,000 937,500 1,400,000 311,000,000
allowance
Written down value and
38,625,000 90,675,000 6,562,500 7,000,000 -
costs c/f
Quick Quiz
1. In computation of income from business of resident sole traders, the following items should be included
except:
A Sales.
B Service fees.
C Interest income.
2. The following items are taxable business income except:
A Rents.
B Sales of capital assets.
C Debt recovery.
D All of the above.
3. Which of the following statement(s) is incorrect with reference to expenses deductions?
A Only those incurred wholly and exclusively for businesses purposes are deductible
B Depreciation allowances computed on third schedule is deductible
C Salaries to employees are generally deductible
D All of the above
4. Rose earned the following income in 2010:
¾ Basic salary Tshs 10,000,000

¾ Subsistence allowance on business trip Tshs4,000,000
¾ Scholarship income from her employer Tshs 5,000,000
¾ Business income Tshs 20,000,000
The amount of employment income will be:
A Tshs 10,000,000
B Tshs 30,000,000
C Tshs 15,000,000
D Tshs 19,000,000
5. In computation of income from investment of resident individual, the following items should be included
except:
A Sales.
B Service fees.
C Interest income.
6. The following items might be taxable investment income except:
A Rents.
B Dividends.
C Debts recovery.
D All of the above.
All of the items should be included as business income. However, interest paid by financial institution to a
resident individual where the interest is paid with respect to a deposit held with the institution is final
withholding payment, other than interest received by the individual in conducting a business; or foreign
source interest paid to non-resident individual. So it is not known whether the interest came from business
or investment.
Capital receipts are not included direct in the computation of business income rather they are used in
computing gain or loss from realisation of the assets. .
Though the general rules of expenses deduction requires expenses should be wholly and exclusively
incurred for businesses, but other expenses are deductible even if they are not wholly and exclusively
incurred for business purposes. For example, contribution to education under Education Fund Act is
deductible though not incurred wholly and exclusively for businesses purposes.
Business income is not party of employment income, and scholarship income is exempt income while the
subsistence amount are earned wholly and exclusive in production of employment income therefore not
taxable.
All of the items should not be included as investment income. Because, interest paid by financial institution
to a resident individual where the interest is paid with respect to a deposit held with the institution is final
withholding payment, and sales and services are all business income.
Interests, dividends and debts recovered can be taxable investment income when they are not specifically
exempted.
Question 1
Connossa Andrew’s Limited (CAL) is a manufacture of wood products, vanish, glue and wood preservatives.
Its Profit and Loss Account for the year 2010 information is as follows:
Cannosa Andrew’s Limited
Profit & Loss Account for the year ended 31st December, 2010
Tshs
Sales 686,678,300
Less: Cost of Sales 1 631,191,047
Gross Profit 55,487,253
Less: Operating Expenses
Administrative Expenses 2 100,710,048
Selling Expenses 3 89,595,126
Financial charges 4 21,925,128
Audit Fees 22,718,79
Management Fees 12,000,000
226,502,180
Operating Profit (Loss) (171,014,927)
Other Income 5 38,004,308
(133,010,619)
Profit (Loss) Brought Forward
(Tax Adjusted) (61,837,765)
Prior year’s accounting Adjustment (84,482,935)
Accumulated Profit (Loss) C/F (279,331,319)
Notes:
1.
(a) Ending inventory excludes Tshs 5,666,777 being loss of stock due to an employee’s negligence.
(b) Cost of Sales:
The valuation of stock was based on market value. The value of ending inventory was found to exclude the
goods on transit costing Tshs 25,000,000, whose market value is Tshs 31,191,047
2.
Administrative Expenses
Tshs
Salaries and Wages 9,439,851
Overtime 3,111,947
Pension and NSSF 2,974,341
Leave pay and terminal Benefits 1,398,078
Sports Expenses 3,616,312
Uniforms 578,700
Travelling Expenses 4,692,221
Medical Expenses 2,037,859
Professional Expenses 2,124,837
Building Repair and Maintenance 2,501,449
Entertainment/Business promotion 14,823,312
Bad Debts provision 93,470
Hotel Accommodation and House Rent 1,778,542
Land Rent Expenses 49,398
Payroll Levy 358,630
Printing and Stationery 3,297,083
Telephone, Telex, and Postage 3,980,299
Vehicle Running Expenses 1,064,862
Insurance 1,357,553
Political parties contributions 1,007,450
Board Meeting Expenses 4,753,205
Donations and Gifts 1,972,938
Casual Wages 1,725,131
Incentives 1,473,741
Vehicles Hire Expenses 5,429,800
Workmen’s compensation 38,610
Training and Recruitment 12,991,413
Fires and Penalties 23,747
Depreciation 6,019,822
Repairs and Maintenance - Furniture 1,082,322
Books and Periodicals 355,765
Electricity and Water 2,103,777
Other Expenses 197,031
Staff Meetings 94,800
Repair and Maintenance - vehicle 2,161,752
Total 100,710,048
(a) Pension contributions include a monthly amount of Tshs 150,000 being contributions for 2 employees who
lost their limbs during the war between Tanzania and Uganda.
(b) Terminal benefits include Tshs 500,000 for retrenchment of two employees.
(c) Professional Expenses include Tshs 401,000 legal fees incurred on the requisition of an additional goodwill
for the storage of logs Tshs 3,543,123 for the acquisition of the Treasury loan, which was used by the
Director to go abroad on vacation and Tshs 1,232,456 for preparing revised accounts to negotiate a back
duty settlement.
(d) Business promotion includes Tshs 13,520,620 incurred for the construction of a new laboratory building for
experiments designed to improve the quality of the company products. The Lab was being used from
30.5.2010.
(e) Insurance includes Tshs 766,323 being a premium under a policy insuring the company against loss of
profits consequent upon breakdowns of plant and machinery.
(f) Donations include Tshs 1,000,000 granted to Uyola vocational Centre.
(g) Training and Recruitment includes Tshs 12,000,000 for 3 years Master of Science Programmes for Mr
Chagula an IT manager of the company. It was agreed with Mr Chagula that after completion of his course,
he has to service the company for not less than 4, before he decides to quit the company.
(h) Repair and Maintenance of motor vehicles includes Tshs 2,000,000 repairs on a vehicle damaged in an
accident. The company however, expects to recover the same from its insurers.
Selling expenses Tshs

Motor Vehicle Expenses 15,234,311
Trading License 373,590
Office Accommodation 806,362
Export Duty 23,000
Stamp Duty 4,325,425
Salaries Wages and Incentives 11,492,524
Travelling and Hotel Expenses 1,376,488
Trade Fair Expenses 1,315,490
Advertisement and Publicity 2,328,666
Discount on Sales 22,334,014
Other Selling Expenses 18,143,332
Provision for Bad and Doubtful Debts 8,479,074
Hired Transport 3,362,850
Total 89,595,126
i. CAL had entered into a contract with the Precision Company Limited for the supply of ten delivery trucks. It
however, decided to cancel this contract and had to pay Tshs 8,326,124 as damages for the cancellation.
This has been included in motor vehicle expenses.
ii. Stamp Duty includes Tshs 3,461,789 being a composition fee. The Commissioner for Customs had
compounded an offence following an infringement by the company of the Customs Regulations on the
importation of raw materials.
iii. Other selling Expenses include:
Tshs 6,577,000 paid to sales personnel being salaries for future services. These employees had their services
terminated before these future services were rendered. The company therefore had to write off the amount.
The company had to incur legal costs of Tshs 627,000 in an unsuccessful attempt to recover these salaries from
the employees. This amount has also been included under other selling expenses. Tshs 7,800,000 being a
sum paid to a retired Director in consideration of agreeing not to carry on business dealing with products
manufactured by CAL. Tshs 426,000 being legal costs on litigation which ensured after two customers with held
payment on account of inferior workmanship.
Financial charges Tshs

Interest on Treasury loan 12,556,899
Interest on overdraft 6,317,176
Bank charges 3,051,053
Total 21,925,128
(a) The Treasury loan was for the purchase of plant and machinery
(b) The overdraft was for the purchase of timber logs.
Other income Tshs

Miscellaneous income 30,421,981
Gain (loss) on Disposal of Fixed Assets 1,171,575
Rent Received 4,170,567
Interest on loans 1,037,116
Interest on Fixed Deposit 1,203,069
Total 38,004,308
(a) The company has contracts with a number of selling agents. One of the agents cancelled his contract
during 2010 and paid CAL Tshs 1,600,000 as compensation. This is included in miscellaneous income.
(b) Also included under miscellaneous income is compensation, of Tshs 25,000,000. During 2003 CAL
disclosed secret processing of one of its products to BIT Company Limited which from then onwards
acquired the sole right of producing and marketing that product in Tanzania. In consideration for this
disclosure, CAL received the compensation.
(c) Rent is received from a sister Company which is occupying CAL’s extra factory space. Assume this is gross
rent.
Interest on loans is in respect of small advances made to employees. The company has a policy of charging a
token interest on such advances.
Required:
Calculate the total taxable business income for the year of income 2007 after ignoring capital allowance.
Question 2
Mr. Boma was employed by the British Council in Dar es Salaam from 1.1.2002 to 31.12.2011. The following
terms and conditions of employment were offered to him:
i. His gross salary per month was Tshs 2,600,000.
ii. He was entitled to 100% gratuity on the basic salary for each successful completed year of service.
iii. The Council also provided Mr. Boma with the following:
¾ Free use of the Council’s old motor vehicle valued at Tshs 10,000,000, with 2,000 cc. The Commissioner for
Income Tax has accepted this valuation of the car. Mr. Boma was provided with a car for the whole year
and the company does claim allowance for ownership and maintenance.
¾ One night security guard for ensuring night security of the house allocated to him. The guard is on the
Council’s payroll at a monthly wage of Tshs 50,000.
¾ A residential house for the whole of the year 2011 for which he paid a token rent amounting to Tshs 20,000
per month and the company does not claim capital allowance in respect of the house.
¾ Mr. Boma has two children who were enrolled at the International School of Tanganyika. During the year
2011 the British Council subsidized the school fees and board expenses for the two children amounting to
Tshs 4,000,000 in total.
Required:
Calculate the total taxable gains or profits from employment for Mr. Boma for the year of income 2011.
Question 3
Dr. Maringo has been a Professor of Marketing and head of the Executive Development Programme of the
University of Mwanza, Tanzania. The University has a housing scheme, under which it provides taxable
accommodation to its staff who then suffer a 10% deduction on their salaries as rent. The market value of the
house was Tshs 400,000 per month and the company claim Tshs 500,000 per annum as allowance in
relationship to the house.
(a) Dr. Maringo was however employed under expatriate terms which provided for among other things a salary
of Tshs 2 million per month and free housing; the total bills for 2003 for electricity, telephone and water
facilities was Tshs 680,000.
(b) He was appointed by the Centre for the Promotion of Exports from Developing Countries to carry out a
market survey in Tanzania on the market for developed countries and products for exports to Europe.
(c) He was paid the full costs of the study and an additional fee of Tshs 2,500,000. This study was carried out
during the months of March and April, 2003.
(d) On a part time basis, he was offering consultancy services to Nyakato Business Consultants. For this, he
was paid Tshs 100,000 per hours. During 2003 he spent 22 hours with the Nyakato firm.
(e) His birthday coincided with Easter, 2003. During the 2003 Easter celebrations, the University awarded him
a birthday present worth Tshs 460,000. In addition, another present was given to him by his fellow workers.
This was valued at Tshs 210,000.
(f) He was required to appear in the quarterly meetings of the University Senate. The University paid him Tshs
300,000 for attendance of such meetings. During 2003, he attended all such meetings held, while he was
still in employment.
(g) A distribution of the surplus made from short courses and consultancy carried out at the University during
2002 was made in May 2003 to all the workers. Dr. Maringo received Tshs 1,500,000 from this distribution
during 2003.
(h) He was provided with a new car which was wholly used for domestic purposes by his wife. This car was
purchased by the University for Tshs 6,000,000 and had 3000cc. The running expenses of the car, Tshs
800,000 during 2003 were fully met by the University.
(i) As part of the contract of employment, the employer was required to contribute an amount equivalent to
Tshs 150,000 per month to a private pension scheme established in the Netherlands. The scheme was not
approved by the Commissioner.
(j) He received interest from the National Bank of Commerce of Tshs 800,000 and a dividend from a local
company of Tshs 600,000 during 2003. No withholding tax was deducted at source.
(k) The employer met the expenses of Tshs 2 million for transporting him and his belongings back home to the
Netherlands.
Required:
Calculate Dr Maringo’s total income clearly showing income from employment, investment and business.
Answer to SEQ 1
Tshs Tshs
Losses for year as per account (279,331,319)
Add: None allowable expenses
Bad debt provision 93,470
Political parties contribution 1,007,450
Donational and gifts 1,972,938
Fines and penalties 23,747
Depreciation 6,019,822
Prior year adjustment 84,482,935
Director vacation 3,543,123
Business promotion-laboratory 13,520,620
Provision for bad debt 8,479,074
Composition fees 3,461,789 122,604,968
Less: None business income
Gain on disposal of fixed assets 1,171,575
Miscellenous income-secret 25,000,000 26,171,575
Less: Business expenses not
deducted
Loss of stock 5,666,777 5,666,777
Add: Business income not included
Insurance receivable 2,000,000
Goods on transit 25,000,000 27,000,000
Losses before deduction of charity contribution (161,564,703)
Note:
¾ Loss of stock are wholly and exclusively incurred in production of business income
¾ Exclusion of goods in transit overstates the costs of goods sold.
¾ Good will is not a depreciable asset so its related costs can be deductible expenditure.
¾ Deduction in respect of donation to Uyola Vocational centre is limited to 2% of the profit before its
deduction, since the company had loss; the whole amount of Tshs 1,000,000 is not deductible.
¾ Motor vehicle repairs of Tshs 2,000,000 is allowed in the sense that when the insurance compensation is
also taxable income on accrual basis.
¾ Compensation from copy right agreement is capital expenditure, therefore not business income.
Answer to SEQ 2
Items Tshs
Gross salary 31,200,000
Gratuity 2,600,000
Security guard 600,000
School subsidized 4,000,000
Total employment income 38,400,000
Note:
House benefits and car benefits are excluded because the company does not claim ownership allowance.
Answer to SEQ 3
Tshs '000'
Salaries 24,000
Electricity, telephone and water facilities 680
Nyakato Business Consultants 2,200
University meeting 300
Surplus-distribution 1,500
Pension contribution 1,800
Car benefit 1,500
House allowance (Note d) 4,800
Employment income 36,780
Add:
Business Income
Market survey 2,500
Add: Investment income -
Total income 39,280
(a) There is no investment income taxable in the hand of Dr Maringo as both interests and dividends are final
withholding payments. But, Dr Maringo has to pay taxes not withheld at the source.
(b) Transport expenses to Netherlands are excluded income.
(c) Birthday present are not related to employment so are exempt income.
(d) The house benefit is the lower of Tshs 4,800,000 and (i) the higher of 15% of Tshs 34,480,000 and
(ii) Tshs500,000.
SECTION C

STUDY GUIDE C2: TAXATION OF NON-
RESIDENT INVESTMENT AND HOLDING
COMPANIES
In additional to corporate income tax, non-resident investment and holding companies pay repatriated income
tax which is applied on income deemed repatriated. However, the companies might also be subjected to other
income taxes in their countries of residence. In fact, Tanzania’s income tax laws charge resident taxpayers on
worldwide income, so taxpayers with foreign income might be taxed twice: one in the countries where the
income was derived and then in Tanzania.
This Study Guide covers specific sections from the Income Tax Act 2004 dealing with taxation of non-resident
investment and holding companies, calculating their tax liabilities and determination of whether taxpayers are
related or not. In addition, the Study Guide covers approaches to provision of foreign tax relief.
a) Describe the concept of permanent establishments.

b) Calculate tax liability in relation to permanent establishments.
c) Describe the concept of related parties as applied in income taxation.
d) Discuss the approaches to provision of foreign tax relief.
1. Describe the concept of permanent establishments.

Calculate tax liability in relation to permanent establishments.
1.1 Meanings of terminologies
‘Permanent establishment’ means a place where a person carries on business and includes
(a) a place where a person is carrying on business through an agent, other than a general agent of
independent status acting in the ordinary course of business as such;
(b) a place where a person has used or installed, or is using or installing substantial equipment or substantial
machinery; and
(c) a place where a person is engaged in a construction, assembly or installation project for six months or
more, including a place where a person is conducting supervisory activities in relation to such a project.
Section 3
Mix is a trader of auto spare parts. In June 2000, Mix Ltd acquired a shop for business purposes. The shop
stores the inventories and is also used as a place from where customers buy their spare parts.
Therefore Mix’s shop is a ‘permanent establishment’.
If Mix’s shop is run by a manager, who handles the operations of the shop, singlehandedly, the shop will still be
considered as a permanent establishment.
Mix has taken a place on rent and set up an after-sales service centre there. All his service equipment is stored
therein. The service centre will still be considered as a permanent establishment.
‘Domestic permanent establishment’ means all permanent establishments of a non-resident individual,

partnership, trust or corporation situated in the United Republic.
Section 3
‘Foreign permanent establishment’ means all permanent establishments of an individual, partnership, trust or
corporation that are situated in any one country that is not the country in which the individual, partnership, trust
or corporation is resident but excludes a domestic permanent establishment.
Section 3
‘The owner’ means the owner of the permanent establishment.

Section 71(7)
The owner of permanent establishment and the permanent establishment should be treated as two independent
persons but related and the residential status of the permanent establishment is determined by the location of
its business (Section 70(1)). Therefore, income of domestic or foreign permanent establishment should be
calculated distinctly from that of its owner (Section 71(1)).
© GTG Taxation of Non-Resident Investment and Holding Companies: 175
According to Section 71(2), the following amounts derived and expenditure incurred shall be attributed to the
permanent establishment, namely:
¾ amounts derived and payments received in respect of assets held by, liabilities owed by or the business of
the permanent establishment; and
¾ expenditure incurred and payments made for the purposes of assets held by, liabilities owed by or the
business of the permanent establishment, but only to the extent the expenditure is recorded in the accounts
of the permanent establishment.
Diagram 1: Amounts attributed to the permanent establishment (PE)
Additionally, the following assets and liabilities are owned by the permanent establishment:
(a) tangible assets situated in the country of the permanent establishment;
(b) intangible assets created by or through the permanent establishment;
(c) intangible assets, to the extent that they may be exploited in the market of the country of the permanent
establishment;
(d) debt obligations incurred in borrowing money but not borrowed by the owner who is doing banking business
(Section, 71(6)), to the extent that the money is employed in or used to acquire an asset that is employed in
the business of the permanent establishment; and
(e) other liabilities arising directly out of the business of the permanent establishment (Section 71(3)).
However, in addition to other ways of realizing assets and liabilities,
¾ the permanent establishment realizes tangible assets when the asset is no longer situated in the country of
the permanent establishment,
¾ intangible assets, to the extent the asset is available for exploitation in the country in which the owner is
resident or a country in which the owner has another permanent establishment; or
¾ liabilities when the money or asset is no longer employed in the business of the permanent establishment
(Section 71(4)).
Also, only the transfer of an asset or liability between the permanent establishment and the owner or vice versa
is recognized, but where the owner carries on a banking business through the permanent establishment, the
owner has to receive a written approval from the Commissioner and enter a debt obligation between the owner
and the permanent establishment or vice versa; and interest derived or incurred with respect to a debt as
instructed by the commissioner (Section 71(6)).
However, the non-resident person with domestic permanent establishments pays tax on repatriated
income.
According to section 72(1), the repatriated income = A + B - C
Where:
A = net cost of assets of the permanent establishment at the start of the year of income + market value of
capital contributed to the permanent establishment by the owner during the year.
B = net total income of the permanent establishment for the year of income; and
C = net cost of assets of the permanent establishment at the end of the year of income + any unrelieved loss for
the year of income (where the establishment has no total income for the year of income),
Nevertheless, the repatriated income must not exceed the net total income of the permanent establishment for
the year of income plus the balance of the permanent establishment's accumulated profits account, less where
the permanent establishment has no total income for the year of income, any unrelieved loss for the year of
income referred to in section 19(4) for the year of income (Section 72(2)). The accumulated profits account is
credited with the net total income of the permanent establishment for the year of income and debited with the
repatriated income and any unrelieved loss for the year of income in case of a loss (Section 72(3)).
‘Net cost of assets’ of a domestic permanent establishment:
(a) at the start of a year of income equals the net cost of assets at the end of the previous year of income, if
any; and
(b) at the end of a year of income is calculated as
¾ the written down value of the permanent establishment's pools of depreciable assets at the end of the year
of income plus the net cost of other assets of the permanent establishment at the end of the year of income;
less the net incomings for liabilities of the permanent establishment at the end of the year of income.
Section 72(4)
‘Net cost of assets’ of a domestic permanent establishment (DPE) at the start of a year of income = net cost of
assets at the end of the previous year of income
‘Net cost of assets’ of a DPE at the end of a year of income =

Written down value of the permanent establishment's pools of depreciable assets at the end of the year of
income
Plus: the net cost of other assets of the permanent establishment at the end of the year of income;
Less: the net incomings for liabilities of the permanent establishment at the end of the year of income
‘Net incomings for a liability to a particular period’ means the amount by which cumulative incomings for the
liability exceed cumulative costs for the liability in that period.
Section 72(4)
‘Net total income’ of a domestic permanent establishment for a year of income is its total income for the year of
income calculated without any deduction of any unrelieved loss brought forward less income tax payable with
respect to that income.
Section 72(4)
Tanzania residents are subject to employment tax
Tanzanian non-residents are subject to:
¾ tax on employment if employed with a Tanzanian resident employer or a permanent establishment in

Tanzania
¾ tax on other sources of income generated from Tanzania
Robots and Assembler Design Makers, a domestic permanent establishment of a non-resident entity, has the
following information about its financial affairs for year ending 31st December 2013.
(a) Net cost of assets at the start of the year was Tshs20,000,000
(b) During year 2013 it issued 2,000 shares each at Tshs1,000 but the market value of shares has since
increased to Tshs1,050.
(c) Written down value of the depreciable assets at the end of the year was Tshs10, 000,000 and the values of
other assets were Tshs5,000,000.
(d) The company borrowed Tshs3,000,000 from various lenders and the costs of liability were Tshs1,500,000
during that year.
(e) The company has total income of Tshs40,000,000 during the year before deducting previous unrelieved
loss.
(f) Corporate tax rate was 30% and tax rate for repatriated income was 10%.
(g) The balance of accumulated profit account was Tshs10,000,000 on the credit side.
Required:
st
Calculate the tax liability of the company for the year ending 31 December 2013.

Answer
(a) Corporate tax i.e. 30% of Tshs40,000,000 = Tshs12,000,000
(b) Repatriated income tax i.e. 10% of Tshs36,600,000 = Tshs3,660,000 (refer to W1)
(c) Total tax liability is Tshs15,660,000 (Tshs12,000,000 + Tshs3,660,000)
W1: Workings for repatriated income
Repatriated income = A + B - C
Where,
A = Tshs20,000,000 plus Tshs1050 x 2, 000 = Tshs22,100,000
B = Tshs40,000,000 less Tshs12,000,000= Tshs28,000,000 and
C = Tshs10,000,000 + Tshs5,000,000 – (Tshs3,000,000 - Tshs1,500,000)= Tshs13,500,000
So repatriated income is equal to Tshs22,100,000 + Tshs28,000,000 - Tshs13,500,000 = Tshs36,600,000. But it

should not exceed Tshs28,000,000 + Tshs10,000,000 = Tshs38,000,000. So since it does not exceed
Tshs38,000,000 the repatriated income is Tshs36,600,000.
How does a non-resident person with domestic permanent establishments compute tax on repatriated income?
2. Describe the concept of related parties as applied in income taxation.

Taxpayers are related to each other, in case of individuals when the individuals originate from one family, unless
there is no close relationship between them to the extent that one individual cannot influence the other.
Also partners in partnership are considered related unless it is proved that one partner cannot influence another
partner.
In case of an entity, two entities are related when one controls another either alone or with others by owning
50% or voting rights to income or capital or voting power of the entity.
Finally, except in the relationship of employee and employers, as stipulated in the employment contract, any
relationship between persons where one person is expected to act according to the wishes of another, the
persons are said be related (Section 3).
Diagram 2: Related parties as applied to income taxation
Limca Co owns nominal share capital of $1,000 in Fanta Co out of its total share capital of $10,000. Limca Co
also owns shares worth $15,000 in Rose Co and $27,500 in Wine Co. The share capital of Wine Co is $50,000
and that of Rose Co is $15,000.
Required:
If Limca Co is the reporting entity, determine the related parties.
3. Discuss the approaches to provision of foreign tax relief.

Each country has the right to impose taxes on its citizens and non-citizens.
As we saw earlier resident taxpayers are taxed on their total income irrespective of the source of income.
In situations related to taxpayers with foreign sourced income; the income might be taxed twice: first taxed in the
foreign country and then in the country of residence i.e. international double taxation.
So, OECD has provided two methods that a nation can use to relieve foreign income tax of their
taxpayers.
1. Exemption method
The first method is through exemption. The exemption method can be implemented either unilaterally or
bilaterally by contracting countries:
¾ where certain income is completely exempted in the taxpayers’ countries of residence.
¾ subsequently, the countries of residence give up the taxing rights to the countries where income is derived,
so the former countries get no income from that foreign income.
However, exemption method can be divided into full exemption and exemption with progression.
¾ In the full exemption method, the country of residence omits the foreign income from its own tax
system and taxes only domestic income
¾ On the other hand the exemption with progression method includes the exempted income when
determining the tax rate to apply to domestic income in case of progressive tax rate systems.
A resident taxpayer earned Tshs 8,000 from Tanzania and Tshs 2,000 from Kenya, so the worldwide income
was Tshs 10,000. The tax rate in Kenya was 20% flat rate, while in Tanzania there were two tax rates one for
income above Tshs 8,000 which was 30% and another for income not above Tshs 8,000 which was 25%.
Required:
(a) Determine the tax burden of the person without foreign tax relief
(b) Determine the tax relief if full exemption method is used
(c) Determine the tax relief if exemption with progression approach is used
Answer
(a) The tax burden without foreign tax relief will be Tshs3,400
Items Tshs
Tax paid in Tanzania 30% of Tshs10,000 3,000
Tax paid in Kenya 20% of Tshs2,000 400
Total taxes 3,400
(b) Tax relief if full exemption method is used is Tshs 1,000; from tax burden without relief i.e. Tshs3,400
deduct taxes after full exemption i.e. Tshs 2,400.
Items Tshs
Total taxes 2,400
(c) Tax relief if exemption with progression method is used is Tshs 600; from tax burden without relief i.e.
Tshs3,400 deduct taxes after giving the relief i.e. Tshs 2,800.
Items Tshs
Total taxes 2,800
2. Foreign income tax relief method
The second approach to foreign income tax relief is the tax credit method. The credit method does not exempt
the income earned in foreign countries but it taxes it and provides for foreign tax credit for any foreign
tax paid in the foreign countries.
Under this method the country of residence has the subsidiary right to tax the income when the tax rates in the
sourced countries is lower than the tax rates in the residence countries. So in that case, the country of
residence may collect some taxes from the foreign income when the worldwide income is computed.
Likewise credit method is divided into full credit and ordinary credit.
Full Credit method
In the full credit method, the countries of residence allow deduction of the total amount of foreign tax when
computing the tax liability of resident taxpayers.
Ordinary credit method
Yet, in the ordinary credit method the deduction of foreign tax is restricted i.e. maximum deduction to the
proportional of taxes that could have been paid on the foreign income if the income were earned in the
residence country.
A resident taxpayer earned Tshs8,000 from Tanzania and Tshs2,000 from Kenya, so the worldwide income was
Tshs10,000. The tax rate in Kenya was 20% flat rate, while in Tanzania there were two tax rates one for income
above Tshs8,000 which was 30% and another for income not above Tshs8,000 which was 25%.
Required:
(a) Determine the tax burden of the person without foreign tax relief
(b) Determine the tax relief if full credit method is used
(c) Determine the tax relief if ordinary credit approach is used
Answer:
(a) The tax burden without foreign tax relief will be Tshs3,400
Items Tshs
Total taxes 3,400
(b) Tax relief if full exemption method is used is Tshs 400; from tax burden without relief i.e. Tshs 3,400 deduct
total taxes paid by the person i.e. Tshs 3,000.
Items Tshs
Tax in Tanzania 30% of Tshs10,000 3,000
Less: Tax paid in Kenya 20% of Tshs2,000 (400)
Total taxes paid in Tanzania 2,600
Plus tax paid in Kenya 400
Total tax paid by the person 3,000

(c) Tax relief if ordinary credit method is used is Tshs400 from tax burden without relief i.e. Tshs3,400 deduct
total taxes paid by the person i.e. Tshs3,000.
Items Tshs
Tax in Tanzania 30% of Tshs10,000 3,000
Less: Tax paid in Kenya 20% of Tshs2,000 (400)
Total taxes paid in Tanzania 2,600
Note: The maximum deduction is 30% of Tshs2,000 which is Tshs600 below the tax paid in Kenya.
However, several countries including Tanzania use both methods in providing relief to foreign income tax. For
example, foreign income paid from business income earned under foreign controlled entities of resident persons
is given through ordinary tax credit (Section 77). Income earned by non-resident persons in foreign countries is
exempted by income tax laws.
‘Foreign income tax’ means income tax imposed by a foreign country and includes a final withholding tax or
branch profits tax imposed by a foreign country.
Section 3
A resident taxpayer earned Tshs 8,000 from Tanzania and Tshs 2,000 from Kenya, so the worldwide income
was Tshs 10,000. The tax rate in Kenya was 40% flat rate, while in Tanzania the tax rate was 30%.
Required:
Discuss the treatment of foreign income tax paid in Kenya under the Tanzania income tax laws.
Answer to TY 1
According to section 72(1), the repatriated income = A + B - C
Where:
A = net cost of assets of the permanent establishment at the start of the year of income + market value of
capital contributed to the permanent establishment by the owner during the year.
B = net total income of the permanent establishment for the year of income; and
C = net cost of assets of the permanent establishment at the end of the year of income + any unrelieved loss for
the year of income (where the establishment has no total income for the year of income),
‘Net cost of assets’ of a domestic permanent establishment (DPE) at the start of a year of income = net cost of
assets at the end of the previous year of income
‘Net cost of assets’ of a DPE at the end of a year of income =

Written down value of the permanent establishment's pools of depreciable assets at the end of the year of
income
Plus: the net cost of other assets of the permanent establishment at the end of the year of income;
Less: the net incomings for liabilities of the permanent establishment at the end of the year of income
Nevertheless, the repatriated income must not exceed the net total income of the permanent establishment for
the year of income plus the balance of the permanent establishment's accumulated profits account, less where
the permanent establishment has no total income for the year of income, any unrelieved loss for the year of
income referred to in section 19(4) for the year of income (Section 72(2)).
The accumulated profits account is credited with the net total income of the permanent establishment for the
year of income and debited with the repatriated income and any unrelieved loss for the year of income in case
of a loss (Section 72(3)).
Answer to TY 2
.
Fanta Wine Rose
Total share capital ($) 10,000 50,000 15,000
Limca share of share capital ($) 1,000 27,500 15,000
Limca share of share capital (%) 10% 55% 100%
Fanta is not a subsidiary of Limca

Wine is a partially-owned subsidiary of Limca
Rose Co is a fully-owned subsidiary of Limca
Therefore if Limca Co is a reporting entity, Wine Co and Rose Co is the related parties, being members of
the same group. However, Fanta Co is not a related party.
Answer to TY 3
The Income Tax Act 2004 offers tax credit to resident taxpayers for tax paid in foreign countries; this is the
ordinary credit method, where the deduction of foreign tax is restricted i.e. maximum deduction to the
proportional of taxes (at 30% of Tshs2,000 in this case) that could have been paid on the foreign income if the
income were earned in the residence country..
Tax relief if ordinary credit method is used is Tshs 400 from tax burden without relief i.e. Tshs3,400 deduct total
taxes paid by the person i.e. Tshs3,000.
Items Tshs
Tax in Tanzania 30% of Tshs 10,000 3,000
Less: Tax allowed under ordinary credit method 30% of Tshs2,000 (although paid (600)
40% of Tshs2,000)
Total taxes paid in Tanzania 2400
Note: The maximum deduction is 30% of Tshs 2,000 which is Tshs 600 below the tax paid in Kenya.
Quick Quiz
1. John is James’ uncle but they have not talked to each other for years because of a family feud. How can
you classify their relationship?
A Related parties.
B Non-related parties
C None of the above.
2. The following companies are domestic permanent establishments of a non-resident person except:
A Barclays Bank Co. Ltd controlled by Barclays group Ltd.

B CRDB Branch controlled by CRDB Co. Ltd.
C Citi Bank Co. Ltd controlled by Citi Bank group.
3. The following are examples of permanent establishments except:
A A branch
B An office
C A factory
D All of the above
4. How does the full exemption method differ from the full tax credit method for providing foreign income tax
relief?
A Full exemption method omits foreign income while full tax credit omits foreign income tax
B Full exemption method omits the foreign income tax while full tax credit omits foreign income
C Full exemption method omits foreign income while full tax credit deducts foreign income tax
D None of the above
5. Which of the methods of providing foreign tax relief provide complete foreign tax relief?
A Full exemption method

B Full credit method
C Ordinary credit method
D All of the above
Though they are genetically related it is not likely that either of them can influence the other because of the
family feud.
CRDB Bank is a domestic permanent establishment of a resident person.
Places of business might include all of the above except when they are managed by an independent agent.
4. The correct option is C.
The only difference is that when full exemption method is applicable, the foreign income is completely
omitted from the total income calculation, but the full tax credit method includes foreign income in the total
income calculation but deducts foreign income tax in determining the tax payable.
5. The correct option is A and B.
Both full exemption and full tax credit methods offer full tax credit for foreign income tax, but the ordinary
credit method may only offer full tax credit for foreign income tax when the tax rate at the residence country
is higher than that of the foreign country.
Question 1
Describe the two main methods used to eliminate double taxation.
Question 2
Distinguish between the terms “Domestic permanent establishment” and “Foreign permanent establishment”.
Answer to SEQ 1
OECD has provided two methods that a nation can use to obtain relief from foreign income tax of their
taxpayers.
(a) Exemption method
The first method is through exemption. The exemption method can be implemented either unilaterally or
bilaterally by contracting countries:
¾ where certain income is completely exempted in the taxpayers’ countries of residence.
¾ subsequently, the countries of residence give up the taxing rights to the countries where income is derived,
so the former countries get no income from that foreign income.
However, exemption method can be divided into full exemption and exemption with progression.
¾ In the full exemption method, the country of residence omits the foreign income from its own tax
system and taxes only domestic income
¾ On the other hand the exemption with progression method includes the exempted income when
determining the tax rate to apply to domestic income in case of progressive tax rate systems.
(b) Tax Credit method
The second approach to foreign income tax relief is the tax credit method. The credit method does not exempt
the income earned in foreign countries but it taxes it and provides for foreign tax credit for any foreign
tax paid in the foreign countries.
Under this method the country of residence has the subsidiary right to tax the income when the tax rates in the
sourced countries is lower than the tax rates in the residence countries. So in that case, the country of
residence may collect some taxes from the foreign income when the worldwide income is computed.
Likewise credit method is divided into full credit and ordinary credit.
Full Credit method
In the full credit method, the countries of residence allow deduction of the total amount of foreign tax when
computing the tax liability of resident taxpayers.
Ordinary credit method
Yet, in the ordinary credit method the deduction of foreign tax is restricted i.e. maximum deduction to the
proportional of taxes that could have been paid on the foreign income if the income were earned in the
residence country.
Answer to SEQ 2
Domestic permanent establishment means all permanent establishments of a non-resident individual,

partnership, trust or corporation situated in the United Republic.
However, foreign permanent establishment means all permanent establishments of an individual, partnership,
trust or corporation that are situated in any one country that is not the country in which the individual,
partnership, trust or corporation is resident but excludes a domestic permanent establishment.
SECTION C

STUDY GUIDE C3: TAXATION OF
MULTINATIONAL COMPANIES
The amount of taxes that multinational companies pay and the ways in which these taxes are managed across
the world are under the most scrutiny in recent memory. The main argument focuses on whether companies are
paying their “fair share of tax”.
This Study Guide covers specific issues related to taxation of multinational companies including the instruments
used in tax planning. Moreover, the standards and methods used by multinationals in setting transfer prices that
are acceptable for taxation purposes will also be discussed.
Knowledge of this Study Guide will not just enable you to pass this exam, but also in your career as a tax
consultant.
a) Explain the concept of multinational corporation.

b) Differentiate between tax avoidance and tax planning.
c) Explain the transfer pricing problem.
d) Discuss the standards and methods used in setting transfer prices that are acceptable for taxation
purposes.
1. Explain the concept of multinational corporation.

Differentiate between tax avoidance and tax planning.
Globalization has enabled free movement of goods, capital and sometimes people. Additionally, it has helped
organisations which are capable to expand their operations beyond their borders. These organisations are
called multinational corporations (MNCs) or transnational corporations. Usually, they create wealth and jobs
where they operate. Good examples of these companies are: Barclays bank, Exim Bank, Shoprite, Vodafone
and others. Because of their cross border operations multinational corporations pose great risks to tax
authorities, as multinational corporations can set up foreign operations not only for economic gains but also for
tax minimization through tax avoidance and / or tax planning.
‘Multinational corporation’ is a corporation that has its establishments like offices and manufacturing set-ups
and assets in different countries (at least one country, other than the home country). Such companies have a
centralized head office where they co-ordinate global management.
‘Tax avoidance arrangement’ means any arrangement:
(a) one of the main purposes of which is the avoidance or reduction of liability to tax any person for any year of
income;
(b) one of the main purposes of which is prevention or obstruction in collecting tax; or
(c) where the main benefit that might be expected to accrue from the arrangement in the three years following
completion of the arrangement is -
(i) an avoidance or reduction of liability to tax of any person for any year of income; or
(ii) prevention or obstruction in collecting tax, but excludes an arrangement where it may reasonably be
considered that the arrangement would not result directly or indirectly in a misuse of the provisions of this
Act or an abuse having regard to the provisions of this Act, other than this section, read as a whole.
Income Tax Act 2004, Section 35(3)
‘Tax planning’ is an arrangement of one's financial affairs to take full advantage of all eligible tax exemptions,
deductions, concessions, rebates, allowances permitted under tax laws.
HMRC
From the definitions above, both tax avoidance and tax planning aim at reducing taxpayers’ tax liability legally,
and both of them are legal. But, tax avoidance may involve abuse of tax laws and aggressive tax arrangements
to avoid taxes without commercial substance; in that case the tax avoidance practices may be illegal.
In other words, tax avoidance may involve artificial transactions to get tax benefits not intended by tax laws i.e.
they comply with form of tax laws not in its spirit, whereas tax planning involves getting tax benefits intended by
tax laws for example deferring or accelerating of income, purchases and other expenditures, selection of
investments, uses of all overall deductions, claiming capital allowance, investing in export processing zones,
investing in tax haven countries, and using transfer pricing.
Correspondingly, in the case between M/s McDowell and Co Ltd Vs Commercial Tax officer, 1985, (154 ITR 148
(SC), the High Court ruled that for tax arrangements to be legal they must not contravene tax laws and the
arrangements should not be colourable activities. Therefore, t/ax and legal authorities do examine suspected
tax arrangements to determine their substance not only their form.
In the examination, the authorities may check whether the transactions were conducted at arm’s length, they did
not misuse or abuse the tax laws provisions, they had commercial substance, and they are related to the
taxpayers’ normal businesses. If the transactions were not genuine, the authorities may only demand repayment
of unpaid taxes.
© GTG Taxation of Multinational Companies: 189
Explain the meaning of tax avoidance
2. Explain the transfer pricing problem.

A Tanzania resident company might attempt to reduce its tax liability by transferring goods at artificially low
prices to an overseas subsidiary. This would have the result of decreasing the UK resident company’s profits
and increasing the foreign subsidiary’s profits which are not taxable in the UK. The overseas subsidiary may
also have a lower tax rate in its own country of domain.
To avoid this situation, “transfer pricing legislation” was brought into existence.
This applies to the transactions between the two companies if one of the two companies is under the control of
the other company or both the companies are under the control of a third party (i.e. individual, partnership or
company).
According to the provisions of this legislation, the profits of a Tanzania resident company in such circumstances
are to be calculated as if the transaction had been carried out at arm’s length prices i.e. the true market
price should be substituted for the transfer price and the UK resident company has to make
adjustments to its profits accordingly.
Therefore, companies must self-assess their tax liability under transfer pricing provisions and pay corporation
tax due.
Small and medium-sized companies are generally exempt from the transfer pricing legislation.
‘Transfer pricing’ refers to the allocation of profits for tax and other purposes between parts of a multinational
corporate group.
HMRC
Problems with transfer pricing
Transfer pricing may result from expansion of business either within a country or outside the country. Indeed,
when a business has more than one branch or production facilities certain products may be produced at one
facility and then transferred to another facility as input material for further processing or sale.
Thus, though all branches or facilities belong to a single corporation, the transfers of goods from one branch to
others create suppliers and buyers relationship within the corporation. In that case, the corporation may want to
measure the profit of each branch separately for performance appraisal. To do so, the corporation establishes a
price/value at which goods should be moved within the corporation; this price is called transfer price. The
transfer pricing when happens within a single tax jurisdiction can hardly pose any problem to tax authorities.
However, when a corporation becomes a multinational corporation, transfer pricing becomes an important
aspect for the tax authorities of the jurisdiction in which the corporation operates; because, transfer pricing can
be used to transfer profit from one jurisdiction to another tax jurisdiction.
Therefore, all tax authorities want to ensure that they are getting their right share of tax on transactions taking
places within their tax jurisdictions. In this situation, the multinational corporation may want to avoid sales made
in a single tax jurisdictions being taxed in more than one tax jurisdiction.
Moreover, this problem may be compounded by the fact that different tax jurisdictions may use / accept different
transfer pricing methods. In conclusion, transfer pricing problem refers to how transfer pricing can be used
to avoid taxes and how it can cause international double taxation.
Explain the transfer pricing problem.
3. Discuss the standards and methods used in setting transfer prices that are acceptable for
taxation purposes.
Organization for Economic Co-Operation and Development (OECD) has provided guidelines to both
multinational corporations and tax authorities about transfer pricing methods to minimize international double
taxation and tax avoidance. Basically, the guideline explains five transfer pricing methods; which can be
used to gauge whether transfer prices are in conformity with the arm's length principle.
These five methods are:
¾ the comparable uncontrolled price method,

¾ the resale price method,
¾ the cost plus method,
¾ the transactional net margin method and
¾ the transactional profit split method
3.1 Comparable uncontrolled price method
This method compares the transfer prices of goods or services between related parties (controlled transactions
to the prices of similar / identical goods or services between unrelated parties (uncontrolled transactions).
Therefore, the prices of uncontrolled transactions can be taken from the transactions between the
taxpayers and other independent parties (internal comparables) or the transactions between
independent parties (external comparables).
The aim of the comparison is to determine whether the transfer prices differ from the prices between unrelated
parties. If there is a difference, the transfer pricing may not comply with the arm’s length principle and
may need adjustment or substitution with the prices between unrelated persons. Actually, the transfer
prices are comparable to the prices between independent parties when the differences between them cannot
affect the market price and reasonable adjustments can eliminate those differences.
The comparable uncontrolled price method is useful in determining the arm’s length transactions when
the market prices of transacted goods or services are available and it is the most reliable method, but it
is very difficult to make adjustments of the differences between controlled and uncontrolled
transactions when the goods or services involved are so unique.
In this case, the first step is to establish whether the transactions are comparable. Then, the difference of
Tshs20 per barrel may reflect additional risks, costs or other justifiable causes. In that situation the controlled
transactions may reflect the arm’s length transactions otherwise; a tax authority may add the Tshs20 per barrel
to the transfer price to equal Tshs120 per barrel.
3.2 The resale price method
Using the resale price method, the transfer price is calculated by deducting resale price margin or gross
margin from the resale price. The gross margin may be taken from comparable uncontrolled
transactions or from gross margin normally earned from comparable controlled transactions. Indeed,
the gross margin covers among other things, risks taken, selling expenses and profit.
Finally, after deduction of the gross margin and other expenses of transferring goods or services from
associated supplier company to associated buyer e.g. insurance, fares, customs duties from the resale price,
the transactions can be regarded as arm’s length transactions of the supplied goods or services. This approach
may be useful in determining transfer prices of distributors, and may have a few adjustments.
‘Resale price’ is the price at which a product that has been purchased from an associated enterprise is resold
to an independent enterprise by reseller.
OECD
Tshs
Sale price to independent parties 1,000
Less Resale margin (40%) 400 Tested under the resale price method in uncontrolled
transactions
Costs of goods sold-transfer price 600 Purchase price from an associate
Resale margin (40%) 400
Less: Selling and other expenses 300
Operating profit 100
3.3 The cost plus method
This method calculates production related direct and indirect costs incurred by a supplier of goods or
services in producing them. Therefore, the method starts with the supplying associate and not the buying
associate. Thereafter, a mark-up earned by the supplier is added to determine the transfer price.
The arm’s length mark-up may be taken from the same supplier from similar but uncontrolled
transactions (internal comparables) or by referring to mark-up that could have been obtained by an
independent supplier in uncontrolled transactions (external comparables).
This method may be used mostly by manufacturers of semi-finished goods who do not incorporate
intangible assets (because of measurement problems) or service providers who do not include unique
services. Furthermore, the cost plus method is the easiest method but it can discourage production and
efficiencies. Additionally, the method may be affected by accounting policies and fluctuations of costs of raw
material and other items.
Tshs
Cost of raw materials 200
Other direct and indirect costs of 100
productions
Total costs 300
Add mark-up (20%) 60 Tested under the cost plus method in uncontrolled
transactions
Transfer price 360 Sale price to an associate
Mark-up (20%) 60
Overhead and others expenses (40)
Operating profit of seller 20
3.4 The transactional net margin method
The method determines transfer prices using net profit figures; i.e. net profit relative to costs, sales or
assets of the taxpayer earned from controlled transactions but which is comparable to uncontrolled
transactions.
Generally, the net profit is weighted
¾ to costs for manufacturing and service activities when the taxpayer is doing manufacturing activities;
¾ to sales for sales activities when a taxpayer is mainly doing sales; and
¾ to assets for asset-intensive activities when the activities of the taxpayers are asset intensive.
It is important that the indicator selected should be reliable and measurable, verifiable by independent data and
echo the chief activities of the taxpayer.
As to other methods, the arm’s length net profit indicator can use either net profit indicator realized by the same
taxpayer in uncontrollable transactions (internal comparables) or from net profit indicator earned by an
independent party in comparable transactions (external comparables). Furthermore, when sale or cost of sales
is selected, the method is similar to the cost plus and resale price methods, but the method equates the net
profit ascending from controlled and uncontrolled transactions (after relevant operating expenses have been
deducted) instead of comparing a gross profit on resale or gross mark up on costs.
The method may not be affected by transactions and functional differences between controlled and uncontrolled
transactions as the difference is reflected in operating costs, and does not require classification of expenses as
in the case of cost plus method.
Also, the when using this method you just test only one indicator of the concerned taxpayer. Nevertheless, the
method requires information about uncontrolled transactions which may not be available, and other factors may
affect the net profit than the selected indicator. Finally, the method may be difficult to apply when data is
hindering working back to the transfer price.
Comparison between the transactional net margin method and cost plus method
Tshs
Cost of raw materials 200
Other direct and indirect costs of 100
productions
Total costs 300
Add mark-up (20%) 60 Tested under the cost plus method in uncontrolled
transactions
Transfer price 360 Sale price to an associate
Overhead and others expenses (45)
Operating profit of seller (5% of total 15 Tested under the transactional net margin method
costs)
Comparison between the transactional net margin method and resale method
Tshs
Sales price to independent parties 1,000
Less Resale margin (40%) 400 Tested under the resale price method in uncontrolled
transactions
Costs of goods sold-transfer price 600 Purchase price from an associate
Operating profit (20% of sales) 200 Tested under the transactional net margin method
Final items 10
Exceptional items (30)
Profit before tax 180
Income tax (60)
Net profit 120
3.5 The transactional profit/loss split method
This method divides profit/loss of controlled transactions between associated businesses. The profit/loss
involved may be the total profit/loss earned from the controlled transactions done or residual profit/loss that
cannot be attributed easily to any associate. Moreover, the division may base on sales, research and
development expenses, operating expenses, assets or headcounts of the associated enterprises. The selection
of a base of division depends on economic realities of the controlled transactions and the base must be able to
be independently verified, and independent of the involved parties.
The method is useful when activities are so strongly integrated that separation of contributions of individual
associates is difficult or impossible. Furthermore, the method may apply when involved parties contribute unique
intangible assets or services to the controlled transactions; this contribution may lack independent and reliable
data to compare with the internal data.
Also, both associates may get their respective shares of profit or loss to include in their performance. Moreover,
the method offers great flexibility by accommodating uniqueness of controlled transactions; transactions which
lack comparable uncontrolled transactions. However, the method may be difficult to apply when financial
information from associate companies is missing. Additionally, difference in accounting policies and currencies
in case of foreign operations may complicate the consolidation process of financial data.
Transaction split method
Explain the the comparable uncontrolled price method of determining transfer pricing.
Answer to TY 1
According to sectio353 of Income tax ; ‘Tax avoidance arrangement’ means any arrangement:
(a) one of the main purposes of which is the avoidance or reduction of liability to tax any person for any year of
income;
(b) one of the main purposes of which is prevention or obstruction in collecting tax; or
(c) where the main benefit that might be expected to accrue from the arrangement in the three years following
completion of the arrangement is -
i. an avoidance or reduction of liability to tax of any person for any year of income; or
ii. prevention or obstruction in collecting tax, but excludes an arrangement where it may reasonably be
considered that the arrangement would not result directly or indirectly in a misuse of the provisions of this
Act or an abuse having regard to the provisions of this Act, other than this section, read as a whole.
Answer to TY 2
‘Transfer pricing’ refers to the allocation of profits for tax and other purposes between parts of a multinational
corporate group.
Transfer pricing may result from expansion of business either within a country or outside the country. Indeed,
when a business has more than one branch or production facilities certain products may be produced at one
facility and then transferred to another facility as input material for further processing or sale.
Thus, though all branches or facilities belong to a single corporation, the transfers of goods from one branch to
others create suppliers and buyers relationship within the corporation. In that case, the corporation may want to
measure the profit of each branch separately for performance appraisal. To do so, the corporation establishes a
price/value at which goods should be moved within the corporation; this price is called transfer price. The
transfer pricing when happens within a single tax jurisdiction can hardly pose any problem to tax authorities.
However, when a corporation becomes a multinational corporation, transfer pricing becomes an important
aspect for the tax authorities of the jurisdiction in which the corporation operates; because, transfer pricing can
be used to transfer profit from one jurisdiction to another tax jurisdiction.
Therefore, all tax authorities want to ensure that they are getting their right share of tax on transactions taking
places within their tax jurisdictions. In this situation, the multinational corporation may want to avoid sales made
in a single tax jurisdictions being taxed in more than one tax jurisdiction.
Moreover, this problem may be compounded by the fact that different tax jurisdictions may use / accept different
transfer pricing methods. In conclusion, transfer pricing problem refers to how transfer pricing can be used
to avoid taxes and how it can cause international double taxation.
Answer to TY 3
This method compares the transfer prices of goods or services between related parties (controlled transactions
to the prices of similar / identical goods or services between unrelated parties (uncontrolled transactions).
Therefore, the prices of uncontrolled transactions can be taken from the transactions between the
taxpayers and other independent parties (internal comparables) or the transactions between
independent parties (external comparables).
The aim of the comparison is to determine whether the transfer prices differ from the prices between unrelated
parties. If there is a difference, the transfer pricing may not comply with the arm’s length principle and
may need adjustment or substitution with the prices between unrelated persons. Actually, the transfer
prices are comparable to the prices between independent parties when the differences between them cannot
affect the market price and reasonable adjustments can eliminate those differences.
The comparable uncontrolled price method is useful in determining the arm’s length transactions when
the market prices of transacted goods or services are available and it is the most reliable method, but it
is very difficult to make adjustments of the differences between controlled and uncontrolled
transactions when the goods or services involved are so unique.
Quick Quiz
1. Identify the five transfer pricing methods
2. What is the purpose of the transfer pricing guidelines provided by the OECD?
3. Identify the type of transactions to whom transfer pricing issues occur.
4. What is meant by tax planning?
1. These five methods of transfer pricing are:
¾ the comparable uncontrolled price method,

¾ the resale price method,
¾ the cost plus method,
¾ the transactional net margin method and
¾ the transactional profit split method.
2. Basically, he purpose of the transfer pricing guidelines provided by the OECD is to explain five transfer
pricing methods; which can be used to gauge whether transfer prices are in conformity with the
arm's length principle.
3. The transfer pricing issues occur in respect of transactions between the two companies if one of the two
companies is under the control of the other company or both the companies are under the control of a third
party (i.e. individual, partnership or company).
4. ‘Tax planning’ is an arrangement of one's financial affairs to take full advantage of all eligible tax
exemptions, deductions, concessions, rebates, allowances permitted under tax laws.
Question 1
Distinguish between tax avoidance and tax planning.
Answer to SEQ 1
Both tax avoidance and tax planning aim at reducing taxpayers’ tax liability legally, and both of them are legal.
But, tax avoidance may involve abuse of tax laws and aggressive tax arrangements to avoid taxes without
commercial substance; in that case the tax avoidance practices may be illegal.
In other words, tax avoidance may involve artificial transactions to get tax benefits not intended by tax laws i.e.
they comply with form of tax laws not in its spirit, whereas tax planning involves getting tax benefits intended by
tax laws for example deferring or accelerating of income, purchases and other expenditures, selection of
investments, uses of all overall deductions, claiming capital allowance, investing in export processing zones,
investing in tax haven countries, and using transfer pricing.
SECTION C

STUDY GUIDE C4: DOUBLE TAXATION
TREATIES
Many countries tax their taxpayers (citizens and non-citizens) in their territories when the taxpayers’ income
originates from within the countries. Also, even when income is earned in foreign countries, many countries tax
foreign income on residence basis. This in turn can cause double taxation.
With a view to encourage trade and development, double taxation treaties are entered into by various nations.
They are largely designed to reduce the impact of international double taxation.
This Study Guide discusses the nature and history of double taxation treaties as well as the functions of double
taxation treaties.
Knowledge of this Study Guide will help you in your career as a tax consultant as well as in your role in the tax
department of a corporate.
a) Explain the nature and history of Double Taxation Treaties.

b) Describe the functions of Double Taxation Treaties.
1. Explain the nature and history of double taxation treaties.

1.1 Need for double taxation treaties
The situation may arise where a Tanzania company is taxed both in Tanzania and overseas on the same
profits. The income earned overseas by a Tanzania resident company is taxable in Tanzania and might also be
taxed in the country in which the income arises, depending upon that country’s taxation laws.
During the year ended 31 March 2014, JouJou Ltd, a Tanzania resident company had Tanzania trading income
of Tshs18millions and received a remittance on account of overseas profits of Tshs8 millions from its overseas
branch located in Canada. The actual profits earned by the branch for the year ended 31 March 2013 are
Tshs10millions.These profits were taxed overseas at the rate of 15%.
The actual profits earned by the overseas branch for the year ended 31 March 2013 Tshs10millions is subject to
overseas tax @15% (i.e. Tshs1.5 million). Furthermore the Tanzania taxation would also impose tax on
Tshs10millions @30% (i.e. Tshs3 million). This demonstrates how two economies can impose tax on the same
assets held by a tax payer.
Double taxation relief is granted in such a situation. This relief is granted by providing tax credit to the
Tanzania resident company. Hence, it is also referred to as a ‘credit relief’. Under this method, the income
earned overseas by the Tanzania resident company has to be grossed up and included gross while calculating
its corporation tax liability. A tax credit is then available equal to the lower of the overseas tax suffered or the
amount of Tanzania tax payable on the overseas income.
Continuing the example of Joujou Ltd
The tax credit will be equal to the lower of:
¾ the overseas tax suffered (i.e. Tshs1.5 million) or
¾ the amount of Tanzania tax payable on the overseas income (i.e. Tshs3 million).
The double taxation relief is granted only if there exists a double taxation treaty between Tanzania and Canada.
Double taxation treaties are treaties largely designed to reduce the impact of international double taxation.
Currently, three reasons may cause international double taxation.
1. First, many countries tax their taxpayers (citizens and non-citizens) in their territories when the taxpayers’
income originates from within the countries. Also, even when income is earned in foreign countries, many
countries tax foreign income on residence basis; consequently, tax jurisdictions of many countries overlap.
.
2. Second, international double taxation may occur when a taxpayer is said to be resident in more than one
country or, when an economic transaction is said to occur in more than one tax jurisdiction.
3. Lastly, international double taxation may occur when a country taxes its citizens regardless of their
residential status.
‘International juridical double taxation’ is the imposition of comparable taxes in two (or more) states on the
same taxpayer in respect of the same subject matter and for identical periods.
Klaus Vogel, 1986
© GTG Double Taxation Treaties: 199
1.2 History of double taxation treaties
International double taxation arguably started in the US in 1913 when the Congress enacted laws allowing
taxation of income of Americans wherever their sources i.e. worldwide, but the laws gave foreign tax credit. This
allowance of foreign tax credit was basically unilateral.
Then, in 1928 the League of Nationals provided draft bilateral income tax treaties; these drafts aimed at
providing reciprocal relief of double taxation of international income. This draft was later adopted by the
Organization for Economic Cooperation and Development (OECD), the United Nations, the UK, the United
States and other countries, including Tanzania.
1.3 Nature of double taxation treaties
Therefore, double taxation treaties are international contracts among nations or states. The contracts have four
main characteristics:
¾ First, they allow contracting parties to use their domestic tax laws but the contract may restrict the
application of the domestic tax laws in agreed areas. For instance, restrictions of domestic tax laws may
include exemption of income or provision of foreign tax credit for tax paid in contracting countries.
¾ Second, the contracts allocate tax claims among contracting parties to escape international double
taxation. For example, the contracting parties may agree to tax their taxpayers based on sources of income,
rather on both sources and residence status.
¾ Third, the contracts normally do not expand contracting nationals’ right to tax nor invent new taxing
rights.
¾ Finally, the contracts do not divide tax jurisdictions among contracting parties but the parties remain with
their tax jurisdictions; yet the contracts signify agreements among contracting parties over their
mutual (reciprocals) restrictions of tax jurisdictions either through exemption, tax credit or both
exemption and tax credit.
Tanzania has double taxation treaties with the following countries: Sweden, Canada, Denmark, Finland, India,
Italy, Norway and South Africa.
Identify the causes of international double taxation
2. Describe the functions of double taxation treaties.

Double taxation treaties have five main functions.
1. They reduce or eliminate international double taxation impact on taxpayers with foreign income. This
function can be achieved through either exemption of foreign income, provision of foreign tax credit or both
exemption of foreign income and provision of foreign tax credit.
2. Second, double taxation treaties enable investors to know the income earned in a foreign country, and
in fact it facilitates or encourages foreign trade, labour or international capital flows by eliminating or
reducing foreign tax burden.
3. Third, double taxation treaties help in avoiding unfair tax liabilities in foreign countries, and
discrimination against foreign investments.
4. Fourth, double taxation treaties may help to prevent tax avoidance or evasion as, in main cases, the
double taxation treaties may include provisions for the exchange of information among contracting
countries. This information may help tax authorities during tax audits to verify taxpayers’ foreign income and
taxes.
Also, the provisions for the exchange of information among contracting countries are important in enforcing
domestic tax laws as tax laws based on residential status of taxpayers may include income earned in
foreign countries. In this case, exchange or request of information from foreign countries is paramount in
ensuring that foreign income is taxed accordingly.
5. Finally, double taxation treaties defend countries’ right to tax economic transactions or income earned
in their tax jurisdictions or by resident taxpayers in foreign countries through contracts.
‘Tax information exchange agreements’ are bilateral agreements under which territories agree to co-operate
in tax matters through exchange of information.
Klaus Vogel, 1986
Paying tax more than once on the same tax base, is a serious problem for taxpayers. This is why double
taxation has been termed “the central problem of international taxation” and it causes much of the complexity in
the international tax system.
Required:
Define the term “international double taxation”.
Double tax treaties and reduced rates
Country Royalty % Interest % Dividends %

Sweden 20 15 25*
Norway 20 15 20
Italy 15 12.5 10
India 20 12.5 15*
Finland 20 15 20
Denmark 20 12.5 15
Canada 20 15 25*
* * These rates are further reduced for certain percentages of ownership.
Answer to TY 1
Double taxation treaties are treaties largely designed to reduce the impact of international double taxation.
Currently, three reasons may cause international double taxation.
1. First, many countries tax their taxpayers (citizens and non-citizens) in their territories when the taxpayers’
income originates from within the countries. Also, even when income is earned in foreign countries, many
countries tax foreign income on residence basis; consequently, tax jurisdictions of many countries overlap.
.
2. Second, international double taxation may occur when a taxpayer is said to be resident in more than one
country or, when an economic transaction is said to occur in more than one tax jurisdiction.
3. Lastly, international double taxation may occur when a country taxes its citizens regardless of their
residential status.
Answer to TY 2
International double taxation is the imposition of comparable taxes in two (or more) states on the same
taxpayer in respect of the same subject matter and for identical periods.
© GTG Double Taxation Treaties: 201
Quick Quiz
Fill in the blanks
(a) ______________ are treaties largely designed to reduce the impact of international double taxation.
(b) ____________________ may occur when a taxpayer is said to be resident in more than one country or,
when an economic transaction is said to occur in more than one tax jurisdiction.
(c) _____________________ is the imposition of comparable taxes in two (or more) states on the same
taxpayer in respect of the same subject matter and for identical periods.
(d) International double taxation arguably started in the US in _________.
(e) _____________________ help in avoiding unfair tax liabilities in foreign countries and discrimination
against foreign investments.
(a) Double taxation treaties
(b) International double taxation
(c) International juridical double taxation
(d) 1913
(e) Double taxation treaties
Question 1
Explain two functions of double taxation treaties.
Answer to SEQ 1
Double taxation treaties have the following main functions.
1. They reduce or eliminate international double taxation impact on taxpayers with foreign income. This
function can be achieved through either exemption of foreign income, provision of foreign tax credit or both
exemption of foreign income and provision of foreign tax credit.
2. Second, double taxation treaties enable investors to know the income earned in a foreign country, and
in fact it facilitates or encourages foreign trade, labour or international capital flows by eliminating or
reducing foreign tax burden.
SECTION C

STUDY GUIDE C5: TAXATION OF
SPECIALISED INDUSTRIES
Some businesses are taxed slightly differently from others. The industries of these businesses are generally
called specialised industries. They include businesses in mining, insurance, banking and pension funds. This
Study Guide discusses the computation of tax liability for these specialised industries.
Excluding the provisions of The Income tax Act 2004 discussed in this Study Guide, the treatment of business
income for all other entities remains the same.
Knowledge obtained from this Study Guide will be useful to you when you are employed / act as a consultant for
companies dealing in specialised business.
a) Calculate tax liability for insurance businesses.

b) Calculate tax liability for banks.
c) Calculate tax liability for pension funds.
d) Calculate tax liability for mining companies.
1. Calculate tax liability for insurance businesses.

1.1 Meanings
‘Insurance business’ means the business of an insurer in effecting, issuing and carrying out insurance
Section 3
‘Life insurance’ means insurance of any of the following classes:
(a) insurance where the specified event is the death of an individual who is the insured or an associate of the
insured;
(b) insurance where:
(i) the specified event is an individual who is the insured or an associate of the insured sustaining personal
injury or becoming incapacitated; and
(ii) the insurance agreement is expressed to be in effect for at least five years or without limit of time and is not
terminable by the insurer before the expiry of five years except in circumstances prescribed by the
regulations;
(iii) insurance under which an amount or series of amounts is to become payable to the insured in the future;
and
(iv) re-insurance of insurance referred to under paragraphs (a) to (c).
Section 3
‘Life insurance business’ means the business of an insurer in effecting, issuing and carrying out life insurance
Section 3
‘General business’ means any insurance that is not life insurance;

Section 3 of The Income Tax Act, 2006
1.2 Calculation of tax liabilities for insurance business
The calculation of tax liabilities for insurance businesses does not differ much from other businesses.
Taxpayers who carry on insurance business should, for tax purpose, separate general insurance and
life insurance business from other businesses (Section 58(1) and 59(1)).
This separation is very important because taxation of insurance payments may depend on whether they are
received from general or life insurance business.
General insurance business income
In fact, when calculating income from general insurance businesses, all premiums derived during the year of
income by the person as insurer, including as re-insurer, and proceeds derived during the year of income by the
person under any contract of re-insurance should be included in the person’s income.
Likewise, the persons should deduct proceeds incurred during the year of income by the person as insurer,
including as re-insurer and premiums incurred during the year of income by the person under any contract of re-
insurance (Section 58(2)). Furthermore, the insurance company may deduct ordinary business expenses and
commissions.
© GTG Taxation of Specialised Industries: 205
Income from general insurance business (during a year) =
Premiums received by the person as insurer, re-insurer
Add: Proceeds from re-insurance

Less: Proceeds you pay out as insurer or re-insurer
Less: Any premiums paid to re-insurers where you take out re-insurance
Less: Ordinary business expenses and commissions.
Life insurance business income
However, the calculation of income from life insurance business should not include premium derived during
the year of income by the person as insurer, including as re-insurer and proceeds derived during the year of
income by the person under any contract of re-insurance (Section 59(1)). Likewise, no deduction or inclusion in
the costs of assets or liability of proceeds incurred during the year of income by the person as insurer, including
as re-insurer and premiums incurred during the year of income by the person under any contract of re-insurance
is allowed (Section 59(2)). However the insurance company may deduct ordinary business expenses and
commissions.
Income from life insurance business (during a year) should not include the premium received as insurer,
re-insurer and proceeds earned under any contract of re-insurance.
Ordinary business expenses and commissions can be deducted as expenses.
Also do not include expenditure on proceeds you pay out as insurer or re-insurer, or premiums paid to
re-insurers where you take out reinsurance.
With the exception of these differences, all other treatments of income and expenses remain the same as we
have discussed in the earlier Study Guides.
Best insurance company carries on both general and life insurance. In the last year, the company received
Tshs100,000,000 as premium from general insurance and paid Tshs20,000,000 as compensation to general-
insured customers.
Also, the company received Tshs50,000,000 as premium from life insurance and paid Tshs20,000,000 as
compensation to life insured customers. The management expenses for general and life insurance were
Tshs10,000,000 and Tshs7,000,000 respectively. Additionally, the company has taxable income of
Tshs10,000,000 from non-insurance business activities.
Required:
Calculate the tax liability of the company if the tax rate was 30%.
Answer
The income from general insurance, life insurance and other businesses should be computed separately.
(a) Income from general insurance is Tshs70,000,000,000 (Tshs100,000,000 – Tshs20,000,000 -
Tshs10,000,000 = Tshs70,000,000)
(b) Loss from life insurance is Tshs7,000,000 (0 - Tshs7,000,000 = Tshs-7,000,000) as premium and payment
in life insurance are not included.
(c) Income from other business activities is Tshs10,000,000.
(d) Total income is Tshs73,000,000 (Tshs70,000,000 - Tshs7,000,000 + Tshs10,000,000 = Tshs73,000,000).
(e) Tax liability at 30% is Tshs21,900,000.
New insurance Co carries on general insurance. The details of its income and expenses are as follows:
¾ The company received Tshs240,000,000 as premium from general insurance
¾ The company paid Tshs50,000,000 towards reinsurance premium
¾ Tshs 20,000,000 out of premium of Tshs240,000,000 was paid to JM Insurers in the form of proceeds
¾ Furthermore the company has earned underwriting income of Tshs12,000,000
¾ The company has incurred administrative expenses of Tshs10,000,000 and discharged insurance claims of
Tshs25,000,000
¾ The company holds assets in the Zambia that have been insured. The premium paid to Professional
Insurers, Zambia amounted to Tshs2000,000.
Required:
Calculate the tax liability of the company if the tax rate was 30%.
2. Calculate tax liability for banks.

Though banks are categorized as special entities, taxpayers who conduct banking businesses are taxed as
other businesses. However, debt claim of a financial institution may become a bad debt, and is therefore
deductible only after the debt claim has become a bad debt as determined in accordance with the relevant
standards established by the Bank of Tanzania (Section 25(5)).
As in other businesses, exempt income is not included, final withholding payments are excluded and only
deductible expenses are deducted as discussed previously. In short, there is no difference between other
businesses and banks, other than the sources of income and types of expenses. For example, banks have
interest as the main source of income while other businesses usually have sales the as main source of revenue.
‘Banking businesses’ means business of a financial institution approved under the Banking and Financial
Institutions Act.
Section 3
‘Financial institution’ means a bank or financial institution approved under the Bank of Tanzania Act or the
Banking and Financial Institutions Act.
Section 3
Robots Bank Ltd is a resident company doing banking business in Tanzania. The following information relates
to its financial performance for the year ending 31st December 2012.
Tshs '000'
Interest income from:
Cash and cash equivalent 200,000.00
Loan advance to banks and customers 400,000.00
Investment securities 350,000.00 950,000.00
Less:
Interest expenses 100,000.00
Interest-deposits from banks 200,000.00
Interest-deposits from customers 50,000.00
Securities deals expenses 20,000.00
Interest bearing loans and borrowings 30,000.00
Other borrowing funds-interests 20,000.00
Other interest expenses 200,000.00 (620,000.00)
Net interest income 330,000.00
Fees and commission income
Credit related fees and commission 40,000.00
Commission on turnover and handling fees 20,000.00
Others fees and commissions 10,000.00 70,000.00
Less:
Fees and commission expenses 20,000.00
Brokerage fees 15,000.00
Interbank transaction fees 20,000.00 (55,000.00)
Net fees and commission 15,000.00
Foreign exchange 120,000.00
Net trading income 465,000.00
Other income 80,000.00
Less: Other expenses
Net impairment loss on financial assets as per BOT
10,000.00
regulations
Personnel expenses 100,000.00
Operating lease expenses 20,000.00
Accounting depreciation and amortization 40,000.00
Other expenses 18,000.00 (188,000.00) (108,000.00)
Profit before tax 357,000.00
Tax expense at 30% (107,100.00)
Profit for the year 249,900.00
Required:
Calculate the income tax liability of the bank for the year of income if it paid taxes amounting to Tshs50,000,000
during the year by way of installments and the annual depreciation allowance was Tshs30,000,000.
3. Calculate tax liability for pension funds.

‘Retirement fund’ means any entity established and maintained solely for the purposes of accepting and
investing retirement contributions in order to provide retirement payments to individuals who are beneficiaries of
the entity.
Section 3
Moonbeam Ltd contributes each month to a pension fund. This fund invests the amounts of contributions and
makes payments towards pension out of the returns on investments. This plan is a funded plan.
‘Retirement payment’ means a payment, by way of a lump sum, pension or commuted pension, made by a
person to an individual in the event of the individual's retirement or a relative of an individual in the event of the
individual's death.
Section 3
There are some differences between approved pension funds and other businesses on how they compute their
taxable revenues and deductible expenses.
In the case of taxable revenue, retirement contributions received by a retirement fund are not taxable
(Section 62(2)). On the other hand, retirement payments made by the fund are not deductible, and are
not included in the cost of any asset or liability of the fund (Section 62(2)).
The following information relates to the financial data of Joseph Pension fund for the year ending 2012. Your
duty is to determine the tax liabilities of the company for that year.
Tshs
Retirement contribution 6,000,000
8,000,000
Less:
Retirement payments 1,000,000
Management expenses 2,000,000
Depreciation allowance as per ITA 2004 1,000,000
Income before tax 4,000,0000
There is no tax liability as the company incurred a loss of Tshs 1,000,000.
Tshs
Profit as per account 4,000,000
Retirement payment 1,000,000
Less: Non-taxable income
Retirement contribution (6,000,000)
Taxable loss 1,000,0000
However, when an approved retirement fund ceases to be an approved retirement fund during a year of income,
its income tax payable for the year of income should be increased by an amount equal to the income tax rate
applicable to corporations; applied to:
¾ all retirement contributions received by the fund from or on behalf of resident individuals and total income of
the fund during the period from its most recent approval as an approved retirement fund to when it ceased
to be so approved, less;
¾ all retirement payments made by the fund from its most recent approval as an approved retirement fund to
when it ceased to be so approved in respect of individuals who were resident during that period (Section
62(3)).
Continuing the example of Joseph Pension fund
The information below relates to the financial data of Joseph Pension fund for the year ending 2012. The fund
has been an approved fund since 1st January 2008, but it ceased to be approved on 31st December 2011.
From the time when it was an approved pension fund to 31st December 2011, it collected Tshs 150,000,000 and
Tshs 50,000,000 as retirement contribution from resident and non-resident payers respectively. And it made
retirement payments of Tshs 80,000,000 and Tshs 20,000,000 to resident and non-resident individuals
respectively.
Determine the tax liabilities of the company for the year ending 31st December 2012 with its annual information
presented below.
Tshs
Retirement contribution from residents 6,000,000
8,000,000
Less:
Retirement payments to resident individuals 1,000,000
Management expenses 2,000,000
Depreciation allowance as per ITA 2004 1,000,000
If the fund was approved, there will be no tax liability as the company incurred a loss of
Tshs1,000,000 (discussed in earlier example).
However the information provided above mentions that the fund is approved only up-to 31 December 2011,
therefore we should re-compute the taxable income as follows:
Item Tshs
Profit as per account 4,000,000
Add: Taxable income due to removal of approval
Less: Deductible expenses due to removal of approval
Retirement payments to resident individuals (80,000,000)
Taxable income 74,000,000
Tax payable at 30% 22,200,000
Transfer of funds among retirement benefits
Also, in the case of transfer of funds among retirement funds, the treatment of the transfer depends on whether
the retirement funds involved are approved or not.
When the transfer of funds involves approved retirement funds the transfer is neither considered a
retirement contribution nor a retirement payment (Income Tax Act 2004, Regulation 11(1)).
But, in the case of a transfer of funds from approved retirement funds to unapproved retirement funds;
it is not considered retirement payment from the point of view of the approved retirement funds, but it is
a part of taxable income of the unapproved retirement funds (Income Tax Act 2004, Regulation 11(2)).
However, in the case of a transfer of funds from unapproved retirement funds to approved retirement
funds; the transfer is not deductible by the unapproved retirement fund and it is neither considered a retirement
payment nor a contribution (Income Tax Act 2004, Regulation 11(3)). Yet, when the transfer of funds involves
unapproved retirement funds, the transfer is not considered a retirement payment and the transfer will be
exempt in the recipients’ hands but not deductible by the payers (Income Tax Act 2004, Regulation 11(1)).
Diagram 1: Accounting of pension funds
The following information relates to the financial data of Jack Pension fund, an approved pension fund for the
year ending 2013.
Determine the tax liabilities of the company for that year.
Tshs
Transfer of funds from approved pension fund 15,000,000
Less:
Retirement payments (1,000,000)
Management expenses (2,000,000)
Transfer of funds to unapproved pension fund (8,000,000)
Depreciation allowance as per ITA 2004 (1,000,000)
Required:
Calculate the tax liability of the company for the year 2013.
4. Calculate tax liability for mining companies.

4.1 Important terminologies
‘Contract area’ in respect of petroleum operations means the area that is subject of petroleum agreement and
whenever any part of contract is relinquished pursuant to petroleum agreement, it represents the contract area
as originally granted.
Section 3
‘Mining operations’ means prospecting mining or operations connected with prospecting or mining carried out
pursuant to rights granted under the Mining Act.
Section 3
‘Mining area’ means an area of land that is subject to a special mining licence, a mining licence, or a primary
mining licence.
Section 3
‘Petroleum agreement’ means a contract, license, permit, or other authorization made or given pursuant to the
applicable law and it includes authorization or production sharing contract made under the respective law.
Section 3
‘Natural resource’ means minerals, petroleum, water or any other non-living or living resource that may be
taken from land or the sea.
Section 3
There are two major differences between taxation of mining companies and other businesses: treatment of
provision, restriction of expenses and loss deduction, (i.e. ring fencing of the deduction of revenue expenses)
and the treatment of capital expenses in exploration and development activities.
4.2 Deduction of provision expense, restriction of expense and losses
Where all other persons are not allowed to deduct any provisions, taxpayers conducting a resource extraction
business are allowed to deduct provision for environmental expenditure but they have to apply and be
allowed by the commissioner. (Section 15(3)). Also where taxpayers engaged in mining or petroleum operations
have separate and distinct mining or petroleum operations in a different mining area or petroleum contract area,
they should determine allowable deductions separately for each mining area or petroleum contract area
(Section 11(4)).
Additionally, expenditures incurred in exploration activities outside the mining licence area of the mining
operation are not deductible, but they should be accumulated and allowed when the commercial operations
commence (Section 11(5)). Finally, deduction of loss incurred on petroleum operations is allowed in
computation of income derived from the contract area as it is the deduction of loss incurred on mining
operations, which is allowed only in computation of income from the mining area (Section 19(2)). These
restrictions of deduction imply that taxable income or loss from each mining area or petroleum contract area
should be calculated separately.
4.3 Exploration and development expenditure
There is 100% deduction of capital expensing on exploration and development expenditure incurred in
mining activities. The question here is what does exploration and development expenditure mean. These
definitions are still provided by the second schedule of the Income Tax Act 1973 (Section 145).
According to the schedule there is 100% deduction of expenses incurred in searching for or in discovering
and testing deposits of minerals, or in winning access to those deposits, whether or not such search is, or
such deposits are, in an area contiguous to any mine in relation to which such person carries on mining
operation (Section 16 (1), ITA 1973). This also includes expenditure incurred in the acquisition of rights in
or over such deposits, other than the acquisition from a person who has carried on mining in relation to
such deposits.
Furthermore, they include expenditure incurred in acquisition or uses of machinery which would have
little or no value to such person if the mine ceased to be worked on the end of the year. Other deductible
capital expenditures include those incurred on the construction of any building or work which would have
little or no value if the mine ceased to be working at the end of the year, and on development, general
administration and management prior to the commencement of production or during any period of non-
production (Section 16 (1), ITA 1973).
However, expenses incurred on the acquisition of the site of such deposits, or of the site of any such buildings,
work, or of right in or over any such site, works constructed wholly or mainly for subjecting raw produce of such
deposits to any process except a process designed for preparing the raw product for use as such are not
deductible (Section 16 (1) ITA 1973).
Furthermore, when a person purchases the right to carry on mining production from other persons who have
explored and developed the mining, the price by the buyer should be treated as exploration and development
expenditure (Section 20 (2)); while the seller is treated as receiving taxable revenues and used in calculating
taxable income (Section 21).
However, the commissioner may divide the amount received by the seller into maximum of 6 portions and one
such portion should be used to ascertain the total income of such vendor for the year of income in which such
sale took place and for each of the previous years of income corresponding to the number of such portions
(Section 21).
The following is the financial information of Walaa Mining Company for the year ending 2012. Calculate the
taxable income and liability of the company for the year ending 2012.
Items Mining areas Total

ZZ-Mining KK-Mining
Tshs Tshs Tshs
Sales 60,000,000 26,000,000 86,000,000
Less: Expenses
Depreciation, depletion and amortization (Note 1 ) 27,000,000 10,000,000 37,000,000
General exploration and business development (Note 2) 10,000,000 8,000,000 18,000,000
Finance costs 2,000,000 1,000,000 3,000,000
Administrative expenses 10,000,000 8,000,000 18,000,000
Income before tax 11,000,000 (1,000,000) 10,000,000
Income tax expenses 3,300,000 - 3,000,000
Net earning 7,700,000 (1,000,000) 700,000
Notes:
1. The depreciation, depletion and amortization costs are based on the accounting policy of the company,
while the depreciation allowances given by the ITA 2004 schedule were Tshs18,000,000 and
Tshs11,000,000 for ZZ-mining and KK-Mining respectively.
2. General exploration and business development include business development costs of Tshs4,000,000 in
each mining areas to develop exploration ramps.

The company had tax payable amounting to Tshs6,000,000 from ZZ-Mining and there was no tax liability from
KK-Mining area, and the loss of Tshs 2,000,000 cannot be used to reduce the company’s tax liabilities.
ZZ-Mining KK-Mining
Items
Tshs Tshs
Income /loss as per account 7,700,000 (1,000,000)
Add: Non-allowable expenses
Depreciation, depletion and amortization 27,000,000 10,000,000
Income tax expenses
3,300,000 -
Less: Depreciation allowance (18,000,000) (11,000,000)
Taxable income 20,000,000 (2,000,000)
Tax liability 6,000,000 -
The following information relates to the financial information of WM Mining Company for the year ending 2012.
Compute the taxable income and liability of the company for the year ending 2012.
Items Mining areas Total

AA-Mining KK-Mining
Tshs Tshs Tshs
Sales 90,000,000.00 39,000,000.00 129,000,000.00
Less: expenses - - -
Depreciation, depletion and amortization (Note 1 ) 40,500,000.00 15,000,000.00 55,500,000.00
General exploration and business development (Note 2) 15,000,000.00 12,000,000.00 27,000,000.00
Finance costs 3,000,000.00 1,500,000.00 4,500,000.00
Provision for provision for environmental expenditure 15,000,000.00 12,000,000.00 27,000,000.00
Administrative expenses 16,500,000.00 (1,500,000.00) 15,000,000.00
Income before tax 4,950,000.00 - 4,500,000.00
Income tax expenses 11,550,000.00 (1,500,000.00) 1,050,000.00
Net earning 90,000,000.00 39,000,000.00 129,000,000.00
Notes:
1. The depreciation , depletion and amortization costs based on accounting policy of the company, while the
depreciation allowance given by ITA 2004 schedule was Tshs 18,000,000 and Tshs 11,000,000 for ZZ-
mining and KK-Mining respectively.
2. General exploration and business development include business development costs of Tshs 4,000,000 in
each mining to develop an exploration ramps.
Answer to TY 1
Income statement of New Insurance Co
Premium Amount in Tshs

Premium received (240,000,000 less 20,000,000) 220,000,000
Reinsurance paid (50,000,000) 170,000,000
Underwriting income 12,000,000

Total 182,000,000
Less: Expenses
Administrative expenses 10,000,000
Insurance claims discharged 25,000,000
Insurance premium paid 2,000,000 (37,000,000)
Total taxable income 145,000,000
Answer to TY 2
Tshs '000'
Income as per account 249,900
Tax expenses 107,100
Depreciation and amortization 40,000
Net impairment loss 10,000
Less: Expenses not deducted
Annual depreciation allowance (30,000)
Taxable income 377,000
Tax payable 30% 113,100
Less: Tax paid (50,000)
Tax liability 63,100
Answer to TY 3
Tax liability for the year 2013
Tshs '000'
Income as per account 65,000
Transfer of funds to unapproved pension fund 8,000
Retirement payments 1,000
Less: Non-taxable income
Transfer of funds from approved pension fund (15,000)
Retirement contribution (60,000)
Taxable loss 1,000
Tax liability 30% Nil
Answer to TY 4
ZZ-Mining KK-Mining
Tshs Tshs
Income as per account
11,550,000.00 (1,500,000.00)
Add: Non-allowable expenses - -
Depreciation, depletion and amortization 40,500,000.00 15,000,000.00
Income tax expenses 4,950,000.00 -
Less: Depreciation allowance (27,000,000.00) (16,500,000.00)
Taxable income 30,000,000.00 (3,000,000.00)
Tax liability 9,000,000.00 Nil
Quick Quiz
1. In computation of income from business of general insurance of a resident insurance company,, the
following items should be included, except:
A Sales
B Premium
C Proceeds
2. The following items are included in the taxable business income of an insurance company engaged in life
insurance, except:
A Rent
B Interest
C Debt recovery
D None of the above
3. Which of the following option is incorrect about insurance business?
A It should separate income from life and general insurance business

B It should separate income from life insurance and other businesses
C It should separate income from general insurance and other businesses
D None of the above
4. Musa Bank Ltd and a resident company had the following income:
¾ Business income Tshs 3,000,000

¾ Investment income Tshs 3,000,0000
The chargeable income will be:
A Tshs 3,000,000
B Tshs 6,000,000
C None of the above
5. The following items are included in the retirement benefits, except:
A Health insurance provided to members

B Education fund provided to members
C Compensation to members after being fired from their jobs
D None of the above
6. Consider the following information of a mining company:
¾ Sales Tshs 10,000,000

¾ Exploration costs Tshs 4,000,000
¾ Development costs Tshs 3,000,000
¾ Provision for environmental costs Tshs 30,000,000
The amount of profit/(loss) will be:
A Tshs (20,000,000)
B Tshs (27,000,000)
C Tshs 3,000,000
D None of the above
Income from general insurance business does not include sales.
The income from insurance should include all of them, but the income from life insurance business should
be calculated separately.
It should compute income from life insurance business, general insurance business and other businesses
separately.
The chargeable income will be the total income which is Tshs 6,000,000.
Retirement payment means a payment, by way of a lump sum, pension or commuted pension, made by a
person to an individual in the event of the individual's retirement; or a relative of an individual in the event of
the individual's death.
All the costs given are deductible so the loss incurred would be Tshs 27,000,000.
Question 1
The ABC Company Limited is a mining company incorporated in the United Republic of Tanzania. The
company’s Income Statement for the year ending 2004 is provided below:
ABC Co. Ltd. Income Statement for the Year ended 31st December, 2004
2004 2003
Particulars Notes
Tshs ‘000’ Tshs ‘000’
Turnover 241,477,000 207,448,000
Other income
Management fee income 50,000 50,000
241,527,000 207,498,000
Operating costs 133,644,000 102,203,000
Royalties 7,496,000 6,160,000
Depreciation 18,570,000 15,376,000
159,710,000 123,739,000
Profit on ordinary activities before interest and taxes 81,817,000 83,759,000
Net finance costs 5,659,000 7,668,000
Profit before taxation 76,158,000 76,091,000
During the period, the company had the following additional information:
a) The company acquired computers on 31st December, 2003 for Tshs90,548,000. This is a balance brought
forward on 1st January, 2004. On 1st March, the company purchased additional computers for
Tshs212,027,000. It was learnt by the tax consultant that this equipment does not quality for 100%
deduction.
b) The company purchased buses from Canada for Tshs341,912,000 on 31st December, 2003. This is a
balance brought forward on 1st January, 2004. On 1st May, 2004 the company decided to dispose of one of
the buses for Tshs2,164,000. However, in the same period, the company acquired another bus for
Tshs40,749,000.
c) The balance brought forward on 1st January, 2004 in respect of the office furniture was Tshs121,783,000.
However, on 23rd June the company added additional furniture to the pool for Tshs499,237,000.
d) The following provisions were made available during the calendar year 2004.
i. Plant decommissioning Tshs2,210,000

ii. Stock obsolescence Tshs506,547,000 and
iii. Environmental restorations Tshs824,868,000
e) The operating costs include Tshs11,324,000 relating to staff welfare, Tshs216,744,000 for fines and
penalties, and donations of Tshs244,343,000.
f) There is an amount of Tshs77,891,000 accrued as gratuity and Tshs570,458,000 of management fees paid
that have not been allowed in year 2003.
g) There were also exploration costs of Tshs4,646,959,000 that qualify to be capitalized and Tshs425,000,000
transferred to fixed assets.
h) It was observed that qualifying additions for 100% amounted to Tshs2,844,260,000.
Required:
Calculate the taxable income and the tax to be paid by ABC Co. Ltd.
Question 2
The Income Statement of The Migo Bank of Commerce for the period ended 30.6.2005 is as shown below:
The Migo Bank of Commerce (MBC)
Income Statement for the year ended 30.6.2005
Tshs
30.6.2005 30.6.2004
Interest 46,490,989 46,521,996
Discount 171,918 403,989
Commissions 10,248,777 8,458,044
Exchange basis 5,163,852 9,222,206
Bad debts recovery 4,560,000 6,000,000
Postage recovery 3,320 -
Management fees 800,000 -
Divided received Note 1 89,000,000 750,000
Rent received Note 2 150,000,000 -
306,438,856 71,356,235
Expenditure
Interest paid 27,013,291 23,009,767
Sundry foreign expenses 328,460 24,868
General expenses Note 3 30,094,027 153,400,805
57,435,778 176,435,440
Profit/Loss before tax 249,003,078 (105,079,205)
Less provision – tax 3,251,600 -
Profit/Loss after tax 245,751,478 (105,079,205)
Profit/Loss brought forward (105,079,205)
Less: prior years adjustments (11,111,682)
Profit/Loss carried forward 129,560,591
Notes:
Note 1: Dividend received
¾ Tshs. 15,000 is in respect of respect of dividend received from PCS Ltd, a resident corporation where MBC
is holding 35% shares in PCS.
¾ Tshs. 25,000 was received from Spectra Co. Ltd, a company listed on the DSE.
¾ Tshs. 10,000 was received from Kasha Company limited, a resident company.
¾ Tshs. 25,000 was received from TK Jessie Ltd. TK Jessie is a non-resident company and 65% of TK Jessie
is owned by MBC.
Note 2: Rent received
¾ Tshs. 80,000 is in respect of rent from JTM Towers, an office building situated at Zanaki Street, rented out
to various tenants.
¾ Tshs. 45,000 is in respect of 6 residential houses owned by MBC, rented to Nyangai Advocates &
Associates.
¾ Tshs. 25,000 is from Azania Motors Ltd. who rented the front part offices of MBC. The offices were
unoccupied and MBC decided to rent that part to Azania Motors Ltd.
Note 3: General Expenses Include
Tshs
Sundry wages and allowances 4,205,505
Overtime 2,452,532
Staff Training Note (a) 285, 851.00
Travelling Expenses 2,978,138
Donations Note (b) 4,287,738
Maintenance costs 4,188,259
Computer Purchases 1,200,528
Depreciation Note (c) 2,137,735
Office Expenses 1,104,624
Legal Expenses Note (d) 477,494
Audit fees 24, 650.00
Advertising 300,472
Short till Note (e) 300,000
Regional Office Expenses 6,461,002
Sub total 30,094,027
Notes:
Note (a) Long course, whose benefit will last at least for 5 years for Tshs205,851.00 and short course for
Tshs80,000, under which the bank expects to use the employees’ knowledge for only 6 months.
Note (b) Included under donations are:
¾ Contribution to Easter Kakaya Nursery School TShs1,000,000.
¾ Donation of 10,000 bricks and 3 tons of cement used to construct a public hospital valued at Tshs1,000,000.
¾ Tshs500,000 paid to CITY WATER for water connections at the neighbourhood villages.
¾ Tshs800,000 donated to Al Jumaa private hospital. The balance was donations made to Muhimbili Maternity
and Children’s ward.
Note (c) Depreciation is computed using the provisions laid down in the ITA 2004.
Note (d) Included in the legal fees are: Tshs200,000 in respect of acquisition of copy right from KJ Traders to
st
use their sounds tracts. Useful life is 5 years, acquired from 1 April, 2005.
Note (e) this short balance was caused by employee’s negligence in cash counting. It was agreed by the CIT
that only 5% of the till short can be accepted.
Required:
Compute the tax payable by MBC for the year ended 30th June, 2005.
Answer to SEQ 1
Taxable income and the tax to be paid by ABC Co. Ltd
Items Tshs '000'

Income as per account 76,158,000
Plant decommissioning 2,210
Fines and penalties 216,744
Depreciation 18,570
Donations 244,343
Stock obsolescence 506,547
77,146,414
Less: Excluded and non-deductible expenses
Gratuity 77,891
Management fees 570,458
Annual depreciation allowance (Working 1) 1,321,859
Exploration costs -addition 2,844,260
Tax payable 30% 21,699,584
Working 1
Classes and rates, value in Tshs

IV(20%:
I (37.5%): II (25%): III (12.5%): Exploration
Items Computers Buses Office furniture expenses
Tax written down value b/f 90,548 341,912 121,783
Add:
Computers 212,027
Buses 40,749
Exploration costs 4,646,959
Fixed assets-mining 425,000
Furniture 499,237
302,575 807,661 621,020 4,646,959
Less: Incoming (2,164)
Depreciation basis 302,575 805,497 621,020 4,646,959
Annual allowance 113,466 201,374 77,628 929,392
Tax written down value c/f 189,109 604,123 543,393 3,717,567
Note: Buses are placed in class II by assuming that they have seating capacity of 30 or more passengers
Answer to SEQ 2
Items Tshs
Income as per account 129,560,591
Add: Non allowance expenses
Provision taxes 3,251,600
Loss b/f 105,079,205
Prior year adjustment 11,111,682
Donations to hospitals 1,800,000
Legal-copy right 200,000
Short till 15,000
Donations to Muhimbili Maternity and Children's home 1,987,738
Donations to City Water 500,000
253,505,813
Less: Excluded income and expense
Dividends from PCS Ltd, Spectra Co. Ltd and Kasha Co. Ltd 50,000
Annual depreciation allowance for copy right-excluded 40,000
Taxable income before donation to charitable organization 253,415,813
Deduct donation to charitable organization (Note 1) 4,287,738
Tax payable 30% 74,738,423
Note:
The allowable deduction of donations to charitable organizations is the lower of actual contribution i.e.
Tshs4,287,738 and 2% of profit before deduction of contribution i.e. 2% of Tshs253,415,813. Also the
contribution made to Easter Kakaya Nursery school is assumed to have made under section 12 of the
Education Fund Act.
SECTION C

STUDY GUIDE C6: SETTLEMENT OF TAX
DISPUTES
Taxpayers and the tax authority may disagree on the amount of tax assessed. The disagreement may be on
interpretation of tax laws, biased decisions, flawed evidence etc. which may lead to higher tax liabilities than
taxpayers themselves think. To avoid damaging taxpayers and the tax authority’s relationship, the Tax Revenue
Appeals Act, Cap.408 allows taxpayers to appeal against any tax assessment made by the Tanzania Revenue
Authority (section 16 (1)). Consequently, that assessment is known as disputed assessment.
This Study Guide deals with procedures to follow when taxpayers dispute Tanzania Revenue Authority’s
decision. It is important to know how tax disputes are dealt with in order to have an equitable, efficient and
reliable tax system.
a) Explain handling of tax objections in Tanzania.

b) Elucidate tax revenue appeals system in Tanzania.
c) Compare and contrast the work of Tax Appeals Board and that of Appeals Tribunal.
1. Explain handling of tax objections in Tanzania.

Tax objections and Appeals are governed by Tax Revenue Appeals Act, Cap.408 as revised from time to time.
Tanzanian tax laws allow any person who feels aggrieved to request a formal change to an official decision
regarding tax assessment made by the commissioner general. A taxpayer who feels that the
commissioner general misapplied the law, came to an incorrect factual finding, abused his powers, was biased,
considered evidence which he should not have considered or failed to consider evidence that he should have
considered in making an assessment, may object against such an assessment.
The process of the tax objections normally starts with a taxpayer who objects to an assessment of tax liability
made by the commissioner general. The objection to the tax assessment is made by serving the commissioner
general a notice of objection to the assessment (Tax Revenue Appeals Act, section 12 (1)).
A valid notice of objection should contain the following qualities otherwise the commissioner general may not
admit it (section 12):
(a) It should be in writing;
(b) it should be addressed to the commissioner general;
(c) it should contain a statement in a precise form, stating grounds in respect of which the objection to an
assessment is made;
(d) It should be relating to interpretation of laws or any other facts affecting the disputed assessment.
(e) Unless the taxpayer is sick, outside the country or for any reason which is restraining the taxpayer to submit
the notice of assessment within time required; the notice of objection should be filed not more than 30 days
from the date the disputed assessment was serviced. When the commissioner general is satisfied with
those reasons, he may accept the notice of objection after the expiration of 30 days (section 12(7)).
(f) Unless the amount is reduced or waived by the commissioner general (section 12(4)), the notice of
objection should be accompanied by a payment of a tax deposit of the higher of:
i. the amount of tax which is not in dispute or
ii. 1/3 of the assessed tax in the disputed assessment.
(g) On receipt of the notice of objection, the Commissioner General shall:
i. admit the notice of objection to assessment of tax; or
ii. refuse to admit the notice of objection to assessment of tax.
The notice of assessment is considered served in case of physically handling of the notice at the time of
handling, in case of a way of unregistered post within the United Republic, 10 days after posting; in case of
registered post at the time the document is delivered or the person is informed that the document awaits them;
in the case of service by fax or electronic mail, at the time the transmission is sent and in the case of other
service by post to an address outside the United Republic, the time at which the document would normally be
delivered in the ordinary course of post (section 136 of Income Tax Act 2004).
© GTG Settlement of Tax Disputes: 225
Imagine a certain taxpayer who was served with a notice of assessment by post on 31 October 2013 by the
commissioner general of domestic revenue. The taxpayer had 30 days to appeal the notice assessment. In
addition, the notice is considered served after 10 days from the day of deposit, so the taxpayer should appeal
within 40 days from 31st October 2013.
The tax not in dispute is the amount that is accepted by taxpayers (section 12(10)). Moreover, this amount is
payable at the earlier of the due date specified in the disputed assessment or when the notice is filed (section
12 (9) (a)). And it remains deposited waiting a final decision (section16 (6)). However, when the objector and the
commissioner general finally agree to a lower amount of tax liability, the balance of the tax deposit should be
refunded (section 12 (9) (b)).
After filling the notice of objections, the commissioner general may admit or not admit to the notice of objection
of tax assessment (section12 (5). By admitting the objection, the commissioner general has power to fully
accommodate the objection, partially accommodate or adjust the objections according the new evidence
obtained (section13). On another hand, the commissioner general may not admit the notice of objection when:
the objector does not comply with qualities of valid notice of objections, when the notice is not based on
misinterpretation of laws or facts, filed after expiration of 30 days after the disputed assessment was served, or
when the objection is contravening the tax laws or equity or when it is not clear (section 12 (5)).
Furthermore, whether the notice of objection is admitted or not the commissioner general is required to
communicate his/her decision to the objector with reasons for such decision. Where a full accommodation of
notice of objection is decided, the commissioner should send the objector a final assessment (section 13 (2)).
While another notice of assessment or notice communicating rejection of the notice of objection would be sent
to the objector by the commissioner when the notice of objection is amended not as objected or rejected as the
case may be (section13 (3)). Then, the objector again has 30 days from the date of receipt of the notice to
inform the commissioner general on his/her acceptance of new amendment or the commissioner general’s
decision to reject the notice of objections.
If the objector responds within 30 days the commissioner can again fully accommodate the objection, partially
accommodate, or adjust the objection according to the new evidence obtained (section13 (5)). Otherwise, the
final assessment of tax which must be paid and accepted by the commissioner general. So the commissioner
general may not reopen the matter unless the objector commit fraud, gross or wilful neglect during the case
(section 15 (3 and 4)).
The Commissioner-General shall, upon admission of an Objection with the section 12, determine the objection
as filed, or call for any evidence as may appear to be necessary for the determination of the objection, and may,
in that respect:
¾ amend the assessment in accordance with the objection;
¾ amend the assessment in the light of any further evidence that has been received; or refuse to amend the
assessment.
Where the Commissioner-General agrees to amend the assessment in accordance with the objection, he shall
serve a notice of the final assessment to the objector. Either Where the Commissioner General:
(a) Proposes to amend the assessment in accordance with the Objection and any further evidence; or
(b) proposes to refuse to amend the objection, he shall serve the objector with a notice setting out the reasons
for the proposal.
Upon receipt of the notice the objector shall, within thirty days make submission in writing to the Commissioner
General on his agreement or disagreement with the proposed amended assessment or the proposed refusal.
The Commissioner General may, after the receipt of the submissions by the objector made:
¾ determine the objection in the light of the proposed amended assessment or proposed refusal and any
submission made by the objector; or
¾ determine the objection partially in accordance with the submission by the objector; or
¾ determine the objection in accordance with the proposed amendment or proposed refusal.
¾ Where the objector has not responded to the Commissioner General’s proposal to amend the assessment
or proposal to refuse to amend the assessment served in accordance with subsection (3), the
Commissioner General shall proceed to make the final assessment of tax and accordingly serve the
objector with a notice thereof.
An assessment is called a finality assessment when:
(a) Taxpayers do not object to the notice of assessment issued by the commissioner general
(b) If they object, the notice of assessment is amended according to taxpayers’ objections.
(c) The notice of assessment is rejected but no appeal is launched
(d) The final assessment is determined on appeal (section 15 (1)).
Diagram 1: Handling tax objections in Tanzania
List the qualities of a valid notice of objection.

2. Elucidate tax appeals system in Tanzania.

Compare and contrast the work of Tax Appeals Board and that of Appeals Tribunal.
[Learning Outcomes b and c]
Appellant machineries and tax appeals system in Tanzania
When the commissioner general and the objecting taxpayers fail to agree over the concerning issues the
taxpayers can follow the appeal system. But, no appeal can be made when the commissioner general has
amended the assessment as proposed by the notice of objection or as proposed by objectors (section 16 (2)). In
any other case, the taxpayers may appeal first to the board, then to the tribunal and finally to the court of
appeal. In total, these three institutions are known as appellant machineries.
The power and procedures of the revenue appeals board and tribunal resemble those of the court system. They
have power to take evidence on oath, resolve any complaint or appeal by mediation, reconciliation or arbitration,
issue warrants of arrest for failure to comply with summons, order payment of appeal costs, dismiss any matter
before it, and adjourn the hearing of any proceedings before it (section 17(1)). Likewise, proceedings in the tax
revenue appeals board and tribunal follow the civil case procedure hearing (section 18). The following section
explains in detail each of these appellate machineries.
2.1 Tax revenue appeals board
Tax revenue appeals board consists of a ministerial appointee chairperson; who is the principal legal officer or
has adequate knowledge of taxation and two vice-chairpersons; one from Tanzania Zanzibar subject to the
consultation with the minister of finance in the Revolutionary Government of Zanzibar (section 4(4)). In addition,
it consists of four other members appointed by the minister from each region specifically to hear and consider
appeals from their respective regions (section 4). Also it has ministerial appointee secretary of the board who
must be a senior public officer to run all administrative and judicial activities (section 6).
The board has the sole original jurisdiction in all civil nature cases for the tax laws governed by the Tanzania
Revenue Authority (section 7). So taxpayers can only appeal to the tax revenue appeals board when:
(a) the Commissioner General declines to admit the notice of objection but after payment of tax deposit as
required and the board’s decision on admittance of the notice of objection is final (section 12(8)).
(b) The commission refuses to make tax refunds (section 14 (1b)). The commissioner general is required to pay
the refund not in dispute awaiting the appeal board decision (section 14 (3)).
(c) There is disagreement over the calculation of refund, drawback or repayment (section 14 (1) (a)).
(d) When the commissioner and taxpayers disagree over VAT registration i.e. whether liable or not liable for
registration (section 14 (1)(c)
(e) When taxpayers disagree over payment of any taxes as required by the commissioner general (section 14
(2)).
Nevertheless, the appeal to the tax revenue appeals board can only be accepted by the board when:
(a) The commissioner general is served with notice of appeal not more than 30 days from the date when the
final assessment was served to tax objectors (section 16 (3)(a)). However, the board can accept the
delayed appeal when the appellant was not in Tanzania, sick or other reasons which may prevent the
appellant to file or inform the other party on time (section 16(5));
(b) The notice of appeal must be filed to the board not more than 45 days after the date when the final
assessment was served to tax objectors (section 16 (3) (b)).
(c) The notice should give all details relating to the tax assessment and further correspondences made
between the commissioner and the taxpayer.
2.2 Revenue appeals tribunal
Revenue appeals tribunal is the second level of appeals. The tax revenue appeals tribunal comprises of the
presidential appointee chairperson following consultation with the Chief Justice; who should be a judge of the
High Court (section 8(2)(a) and section 8(3)(a)).
The chairperson should be assisted by two presidential appointee vice chairpersons; one of from Tanzania
Zanzibar following a consultation with President of Zanzibar and four other ministerial appointee members
(section 8(2)(b and c). A member should have knowledge of, and experience in, taxation, commercial or
financial matters. Furthermore, the tribunal share has the registrar who is a senior lawyer to perform its
administrative and judicial roles (section 10).
In addition to supervising the work of the tax revenue appeals board, the tribunal has sole jurisdiction in all
appeals arising from the decision of the tax revenue appeals board (section 11). Consequently, the revenue
appeals tribunal has power over those appeals against the tax revenue appeals board’s decision raised not
more than 30 days since the date of the tax revenue appeals board’ decision. Also the appellant should inform
the commissioner general about the appeal within 15 days from the date of the decision of the board (section 16
(4). However, the tribunal can accept the delayed appeal when the appellant was not in Tanzania, sick or for
other reasons which may prevent the appellant to file or inform the other party on time (section 16(5)).
2.3 Appeal to the Court of Appeal
Finally, if the appellant is still not satisfied with the tribunal’s decision, the appellant can appeal to the court of
appeal (s.25 (1)). But the appeal to the court of appeal is limited to the matter of interpretation of laws only (s.25
(2)).
2.4 Work of Tax Appeals Board and that of Appeals Tribunal
Work of Tax Appeals Board Work of appeals tribunal

Revenue appeals tribunal is the first level of appeals. Revenue appeals tribunal is the second level of
appeals.
Tax revenue appeals board consists of a ministerial The tax revenue appeals tribunal comprises of the
appointee chairperson; and two vice-chairpersons; presidential appointee chairperson following
four other members appointed by the minister from consultation with the Chief Justice; who should be a
each region. Also it has ministerial appointee secretary judge of the High Court (section 8(2)(a) and section
of the board who must be a senior public officer to run 8(3)(a)).
all administrative and judicial activities
The board has the sole original jurisdiction in all civil In addition to supervising the work of the tax revenue
nature cases for the tax laws governed by the appeals board, the tribunal has sole jurisdiction in all
Tanzania Revenue Authority. appeals arising from the decision of the tax revenue
appeals board (section 11). Consequently, the
revenue appeals tribunal has power over those
appeals against the tax revenue appeals board’s
decision raised not more than 30 days since the date
of the tax revenue appeals board’ decision. Also the
appellant should inform the commissioner general
about the appeal within 15 days from the date of the
decision of the board
Briefly explain the power and procedures of the revenue appeals board and tribunal.
Answer to TY 1
A valid notice of objection should contain the following qualities otherwise the commissioner general may not
admit it (section 12):
(a) It should be in writing;
(b) it should be addressed to the commissioner general;
(c) it should contain a statement in a precise form, stating grounds in respect of which the objection to an
assessment is made;
(d) It should be relating to interpretation of laws or any other facts affecting the disputed assessment.
(e) Unless the taxpayer is sick, outside the country or for any reason which is restraining the taxpayer to submit
the notice of assessment within time required; the notice of objection should be filed not more than 30 days
from the date the disputed assessment was serviced. When the commissioner general is satisfied with
those reasons, he may accept the notice of objection after the expiration of 30 days (section 12(7)).
(f) Unless the amount is reduced or waived by the commissioner general (section 12(4)), the notice of
objection should be accompanied by a payment of a tax deposit of the higher of:
i. the amount of tax which is not in dispute or
ii. 1/3 of the assessed tax in the disputed assessment.
Answer to TY 2
The power and procedures of the revenue appeals board and tribunal resemble those of the court system. They
have power to take evidence on oath, resolve any complaint or appeal by mediation, reconciliation or arbitration,
issue warrants of arrest for failure to comply with summons, order payment of appeal costs, dismiss any matter
before it, and adjourn the hearing of any proceedings before it (section 17(1)). Likewise, proceedings in the tax
revenue appeals board and tribunal follow the civil case procedure hearing (section 18).
Quick Quiz
1. Name the appellant machineries
2. _________________ is the second level of appeals.
3. The board has the_____________________ in all civil nature cases for the tax laws governed by the
Tanzania Revenue Authority.
4. The process of the tax objections normally starts with a taxpayer who objects to an assessment of tax
liability made by the_____________________________..
1. The following institutions are known as appellant machineries:
¾ revenue appeals board

¾ revenue appeals tribunal
¾ court of appeal
2. Revenue appeals tribunal
3. sole original jurisdiction
4. commissioner general
Question 1
Differentiate between the Tax Revenue Appeals Tribunal and the Tax Revenue Appeals Board.
Question 2
What are the powers of the Commissioner General in relation to the notice of objection made by the Appellant to
the Appellant Bodies under the Tax Revenue Appeals Act, 2002? What are the limitations to the power as far
as adjusted assessments are concerned?
Answer to SEQ 1
There are two main differences between them: appointment of board members and board jurisdictions. The
members of Tax Revenue Appeal Boards are ministerial appointees, whereas the president of United Republic
of Tanzania appoints members of the Tanzania Revenue Appeal Tribunal. In the case of jurisdictions, the Tax
Revenue Appeal Boards has sole original jurisdictions of all civil nature against the general commissioner’s
decisions while those appeals against Revenue Appeal Boards go to Tanzania Revenue Appeal Tribunal.
Answer to SEQ 2
The Commissioner General has the power to admit or refuse to admit the notice of objection to assessment of
tax (section 13 (5)). However, the refusal power can only apply when the notice of objection is not valid, the
notice does not raise any question of law or fact in relation to the assessment, the relief sought cannot be
granted in law or equity; the objection is time barred; or the objection is otherwise misconceived (section 13
(6)).
SECTION C

STUDY GUIDE C7: RECENT REFORMS IN THE
TANZANIAN TAXATION SYSTEM
In Study Guide B6, we have discussed the concept of tax reforms which relates to a process in which the tax
policies of a government are changed; changes includes changing the way taxes are collected or managed by
the government.
The goals of tax reform can cover things like how taxes are administered, collected, and handled, as well as
how the tax code is structured. Some tax reformers actually want to abolish taxes altogether, while others would
like to see changes in how taxes are handled.
This Study Guide discusses tax refoms that were made in the Tanzania over the period of the last 12 months.
Knowledge of this Study Guide will not just help you in the rexam but will also help you in your carrer as a tax
consultant.
a) Discuss tax reforms made within 12 months.

1. Discuss tax reforms made within 12 months

[Learning Outcomes a]
Over the last year, 2013 to 2014 three major tax reforms in addition to numerous tax rates changes, have taken
place to help the government to raise more tax revenues.
These reforms are:
¾ introduction of excise duty on money transfer through banks, financial institutions or telecommunication
companies,
¾ expansion of compulsory acquisition of electronic fiscal devices to non-value added taxpayers who has
annual turn of over Tshs 14,000,000, and
¾ introduction of SIM Card tax.
(a) Introduction of excise duty on money transfers
Starting with the first major reform, the introduction of excise duty of 0.15% on money transfer came into
effect on 1st July 2013.
The tax is payable to Tanzania Revenue Authority by the last day of the month following the month of its
collection.
i. Scope
The tax targeted all money transfers through a bank, a non-bank financial institution or a telecommunication
company (section 125 of the Excise (Management and Tariff) Act Cap 147). Actually, it is banks, financial
institutions or telecommunication service providers which withhold the tax for money transfer service including
for payment for goods and services of more than Tshs 30,000. Furthermore, when a responsible person fails to
collect (withhold) the required taxes from the transactions the person will be required to pay the amount of taxes
not collected regardless the possibility of recovering the taxes from the transferors (section 56 of the Excise
(Management and Tariff) Act Cap 147).
ii. Exemptions
However, transfers of money between banks and non-bank financial institutions, transfers of government money
for its operations including money transfer for payment of taxes and duties, transfer of money for payment of
salaries and operations of diplomats and diplomatic missions, transfer of money for payment of interest or
principal to the bank by bank customers on loans or any form of financial service, and any transfers for money
deposits by bank customers are exempted.
Other exempted transactions are: any money transfers between banks or one bank account to another account
within the same bank or interbank money transfers provided such transfers are made within the United Republic
of Tanzania and money transfers from a customer’s bank account to the same customer’s mobile money or
bank account in another bank within the United Republic of Tanzania, and vice versa.
iii. Consequences of non-compliance
Furthermore, in order to ensure its compliance, TRAA have imposed penalty and offence on the defaulters as
shown on the table below:
Particulars Penalty Fine imposed (Note1)

Delay up to 1 month Higher of Tshs 100,000 or 1% of tax withhold Not exceeding the higher of
Delay between 1 to 2 months Higher of Tshs 200,000 or 2% the tax Tshs200,000 or 2% of the
withhold for each or part of the month. evaded tax.
Note 1:
Fine imposed on offence of intentionally:
¾ failing to provide information or accounts as requested,
¾ avoiding paying taxes (include penalty imposed)
¾ evading the tax, and
¾ falsifying documents
© GTG Recent Reforms in the Tanzanian Taxation System: 233
(b) Extension of electronic fiscal devices to non-value added taxpayers
Electronic fiscal devices (EFDs) were previously constrained to value added taxpayers as discussed in the
value added tax chapter in Paper B4: Public Finance and Taxation I. As discussed in that chapter, EFDs offer
several advantages to both taxpayers and Tanzania Revenue Authority.
Owing a successful implementation of EFDs on value added taxpayers, EFDs were extended to non-valued
added taxpayers who has annual turnover of over Tshs 14,000,000 from 1st July 2013. However, its
implementations were hindered by protests and discontents among the taxpayers mainly about the prices of the
EFDs. Consequently, Tanzania Revenue Authority lowered the prices of EFDs from over Tshs 1,000,000 to
between Tshs. 600,000 and 778,377 per equipment. Hopefully, this price range would be acceptable.
(c) Introduction of SIM card tax
The SIM card excise duty tax on telecommunication sim card at the rate of Tshs 1,000/= per month was also
introduced by Finance Act 2013. The tax aimed to raise tax revenues over Tshs 178 billion. However, the tax
faced a significant opposition by taxpayers (mobile subscribers), politicians and mobile phone companies over
its regressive nature. Consequently, the tax was scrapped by president Kikwete, and the government ended up
raising mobile communication tariff from 14.5% to 17%, and introduction of tax on data, call wait and call baring
and other mobile phone services to compensate for the lost revenues.
Briefly explain the consequences of non-compliance of excise duty of 0.15% on money transfers through banks.
Answer to TY 1
Consequences of non-compliance
Furthermore, in order to ensure its compliance, TRAA have imposed penalty and offence on the defaulters as
shown on the table below:
Particulars Penalty Fine imposed (Note1)

Delay up to 1 month Higher of Tshs 100,000 or 1% of Not exceeding the higher of Tshs
tax withhold 200,000 or 2% of the evaded tax.
Delay between 1 to 2 months Higher of Tshs 200,000 or 2% the
tax withhold for each or part of the
month.
Note 1:
Fine imposed on offence of intentionally:
¾ failing to provide information or accounts as requested,

¾ avoiding paying taxes (include penalty imposed)
¾ evading the tax, and
¾ falsifying documents
Quick Quiz
1. The introduction of excise duty of 0.15% on money transfer came into effect on ______________.
2. Transfers of money between banks are exempted from payment of _________________ on money
transfers.
3. Extension of electronic fiscal devices to _______________ is a new tax reform introduced recently
4. The SIM card excise duty tax on telecommunication sim card at the rate of _______________ was also
introduced by Finance Act 2013.
1. 1st July 2013.
2. excise duty
3. non-value added taxpayers
4. Tshs1,000/- per month

11
A
Diversity 62
A permanent home 112 Divisible projects 35,36
Ability to Pay Theory 71 Domestic permanent establishment 174
Absolute incidence 87 Donations 138
Accountancy charges 137 Double taxation treaties 198,199
Administrative efficiency 61 Dual-purpose 132
Ad-valorem tax 58
Agricultural business 136 E
Agricultural improvement expenditure 135 Economic incidence 86
Allowable expenses 132 Elasticity 63
An exempt-controlled resident entity 134 Electronic fiscal devices to non-value
Appellant machineries 227 added taxpayers 233
Approved retirement fund 127 Environmental expenditure 135
Audit 29 Equal marginal sacrifice 81
Average Rates of Taxation 60 Equal proportional sacrifice 81
Equal-Sacrifice Theory 72
B Equity 61
Bad and doubtful debts 138 Excise duty on money transfers 232
Balanced budget 43 Excluded employment income 123
Banking businesses 206 Excluded expenditure 133
Beneficial loans 117 Excluded investment income 152
Benefits theory 70 Executives 28
Borrowing for deficit financing 53 Exempt income 124
Budget process 42 Exemption method 179
Business 130 Exemption with progression method 180
Business entertainment 137 Exploration and development
expenditure 212
C
Capital receipts 136 F
Cash basis 129 Final withholding payments 126
Certainty 62 Financial institution 206
Chargeable business income 129 Fines or Penalties 54
Commissioner General 226 Five sector model 15
Comparable uncontrolled price method 190 Fixed budget 34
Competitive markets 88 Fixed employment contract 122
Consumption expenditure 133 Flexibility 62
Contract area 211 Foreign currency exchange gain 136
Contribution 138 Foreign income tax 182
Contribution to education fund 126 Foreign income tax relief method 181
Convenience 62 Foreign permanent establishment 174
Corporation 114 Four sector model 15
Court of Appeal 228 Full Credit method 181
Full exemption method 180
D
Debt 134 G
Deductible expenses 152 General business 204
Defalcations 137 General insurance business income 204
Deficit budget 44 Gifts 137
Depreciable assets 138 Government budget 42
Depreciable assets allowances 141 Grants and Gifts 53
Depreciation allowances 138 Gross domestic product 17
Differential incidence 87 Gross national product 19
Distribution by an entity’ 133
2: Index © GTG
H Period 134
Horizontal equity 79 Permanent establishment 174
Hypothecated taxes 59 Petroleum agreement 211
Plant or machinery 140
I Pooling system 140
Imperfect competition market structure 89 Principles of public expenditure 32
Incidence of taxation 84 Private Sector 3
Individual 112 Profession 131
Insurance business 204 Progressive taxes 59
Insurance claims 136 Proportional taxes 59
Interest 150 Public expenditure policy 24
Interest expense 134 Public finance 2
Interest using average method 118 Public Sector 3
Investment activities 148
Investment asset 150 R
Reducing balance method 119
L Redundancy 121
Legal and other expenses 137 Regressive taxes 59
Legal incidence 85 Repair and maintenance expenditure 135
Life insurance 204 Research and development
Life insurance business 204 expenditure 136
Life insurance business income 205 127,
Living accommodation benefit 120 Retirement fund 208
Retirement payment 208
Local government authority 4
Loss 137 Revenue appeals tribunal 228
Loss or termination benefit paid in Royalty 149
arrears 121
Losses from a business 136 S
Losses on realisation of business Sacrifice Theory 71
assets and liabilities 136 SIM card tax 233
Lumpy projects 35, 36 Specific tax 58
Statutory contribution 127
M Surplus budget 45
Manufacturing 130 Surplus from Public Enterprises 53
Marginal rate of taxation 60
Minimum-Sacrifice Theory 73 T
Mining area 211 Tax 50
Mining operations 211 Tax administration 103
Multinational corporation 188 Tax avoidance arrangement 188
Tax effect on consumer and producer
N surplus 94
National income accounting 16 Tax effects on demand and supply 94
Natural resource 149,211 Tax Law 103
Natural resource payment 150 Tax planning 188
Net gain from realization of investment Tax Policy 103
assets 150 Tax reform 105
Net incomings for a liability to a Tax revenue appeals board 227
particular period 177 The owner 174
Net total income 177 The resale price method 191
Three sector model 15
O Total income 153
Opening value of trading stock 135 Trading stock allowance 135
Ordinary credit method 181 Transactional net margin method 192
Transactional profit/loss split method 193
P Transfer pricing 189
Parastatal organisation 135 Transfer pricing legislation 189
Parliament 28 Transparency 63
Partnership 113 Trust 113,149
Pension contribution 126 Two sector model 15
Pension scheme contributions 137
©GTG Index: 3
U
Unrelieved net loss 150
User Fees 53
V
Variable budget 36
Vertical equity 79
Vocation 131
W
Wholly 132
Written down value 142
4: Index © GTG

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C4

PUBLIC FINANCE AND

National Board of Accountants and Auditors

Dr. Mariam I. Nchimbi

Senior Lecturer, University of Dar es Salaam Business School,

© Get Through Guides 2014

Section A Public finance

Section B Taxation - theory and policy

Section C Tax law and practice

1. Introduction to public finance and the role of the public sector

a) Explain the nature of public finance.

2. Public sector and the national economic accounts

3. Public expenditure policy

B Taxation - theory and policy

1. Theoretical concepts of taxation

a) Explain the nature and essence of taxation.

2. Theories of tax distribution

a) Explain the benefits theory.

3. Approaches to tax equity

a) Assess the application of the Benefit Principle.

4. Tax and expenditure incidence: concepts and principles

a) Explain the nature of tax burden.

a) Explain effect of taxes borne by consumers.

6. Tax policy concepts

a) Describe the nature of tax policy.

C Tax law and practice

1. Basic provisions of the income tax act (an overview)

a) Determine residential status of taxpayers.

2. Taxation of non-resident investment and holding companies

a) Describe the concept of permanent establishments.

3. Taxation of multinational companies

a) Explain the concept of Multinational Corporation.

4. Double taxation treaties

a) Explain the nature and history of Double Taxation Treaties.

5. Taxation of specialised industries

a) Calculate tax liability for insurance businesses.

6. Settlement of tax disputes

a) Explain handling of tax objections in Tanzania.

7. Recent reforms in the tanzanian taxation system

a) Discuss tax reforms made within 12 months.

Contents of each Study Guide

The Learning Outcomes include:

9 ‘Example’: makes easy complex concepts.

9 ‘Tip’: helps to understand how to deal with complicated portions.

9 ‘Important’: highlights important concepts, formats, Acts, sections, standards, etc.

9 ‘Summary’: highlights the key points of the Learning Outcomes.

9 ‘Diagram’: facilitates memory retention.

The syllabus is assessed by a three hour paper based examination.

The examination will consist of two sections.

Section A One compulsory question (covering a range of syllabus content) 40 marks

a) Explain the nature of public finance.

1. Explain the nature of public finance.

1. Public finance as a science

2. Public finance as a branch of economics

3. Public finance as a process

Public finance can also be regarded as a process in view of the following:

4. Public finance as an art

2. Explain nature of the public sector and different levels of government.

2.1 Difference between private sector and public sector

1. The Private Sector

2. The Public Sector

Which of the following statements is true in respect of the public sector?

A Big companies own most of the assets