Tax has been defined by various authorities and professionals in various ways.

Conceptually, tax can be defined or seen as a compulsory transfer of resources from the private
to the public sector (Uremadu, 2000). According to The World Bank (2000) reiterated that taxes
are compulsory transfers of resources to the government from the rest of the economy. Adeyeye
(2004) described tax as liability on account of tax payers as contribution in some quantum
measure to the fund available for use by the government in providing necessary infrastructure for
her citizens. Taxes are compulsory levy by the tax subject (government) through her designated
agent on the tax subject (the tax payers). And another study by Lymer and Oats (2009) tax is
defined as ‘a compulsory levy, imposed by government or other tax raising body, on income,
expenditure, or capital assets, for which the taxpayer receives expenditure, or capital assets, for
which the taxpayer receives nothing specific in return’.
According to Ethiopian income tax proclamation No. 286/2002, taxable business income would
be determined per tax period on the basis of the profit and loss account or income statement.
Accordingly, taxable business income of corporate businesses is taxed at a flat rate 30% and
other business (unincorporated individual businesses and PLCs) taxpayers are taxed at a
progressive rate 10% to 35%. The standard rate of VAT is 15% of the value of every taxable
transaction by a registered person and all imports of goods and services other than those
exempted.
According to the Constitution of Federal Democratic Republic of Ethiopia, revenue sources are
assigned between Federal government and Regional states. Regional states can endorse their
income tax proclamation and regulations based on the constitution in conformity with the federal
income tax proclamation. According to the federal income tax proclamation no.286/2002
taxpayers are categorized into three categories, namely category ‘A’, ‘B’, and ‘C’ based on their
volume of sales and form of business.. Therefore, taxpayers with annual gross income of Birr
1,000,000 or more are categorized under Category ‘A’ taxpayers, business income taxpayers
with annual gross income Birr 500,000 or more but less than Birr 1,000,000 are under category
‘B’ and business profit taxpayers with annual gross income less than Birr 500,000 are under
category ‘C’ taxpayers.
2.1.2. Definition of Tax compliance

There is no standard all-embracing definition of compliance adopted across all tax compliance
studies. For example, Kirchler (2007) stated that compliance might be voluntary or enforced
compliance. Voluntary compliance is made possible by the trust and cooperation between tax
authority and taxpayer and it is the willingness of the taxpayer on his own to comply with tax
authority’s directives and regulations. However, in the presence of distrust and lack of
cooperation between authority and taxpayer, which creates tax hostile climate, authorities can
enforce compliance through the threat and application of audit and fine. Alm (1991) and Jackson
and Milliron (1986) defined tax compliance as the reporting of all incomes and payment of all
taxes by fulfilling the provisions of laws, regulations and court judgments. Another definition of
tax compliance is a person’s act of filing their tax returns, declaring all taxable income
accurately, and disbursing all payable taxes within the stipulated period without having to wait
for follow-up actions from the authority (Singh, 2003).
Franzoni (2000) and Chatopadhyay and DasGupta (2002) stated that compliance with tax laws
involves true reporting of the tax base; correct computation of the tax liabilities; timely filling of
tax returns and timely payment of the amount due as tax. Any behavior by the taxpayer contrary
to the above constitutes noncompliance. According to McBarnett (2003), compliance may take
three forms, which include committed compliance, capitulative compliance and creative
compliance. Committed compliance is the willingness to discharge tax obligations by taxpayer
without complaining. While capitulative compliance is the reluctant in discharging of tax
obligations by taxpayer and creative compliance (tax avoidance) refers to any act by taxpayer
aimed at reducing taxes by redefining income and deductible expenditure within the confine of
the law. However, according to Arogundade (2005) and Sandmo (2005) there is conceptual
distinction between tax evasion and tax avoidance. The distinction between these two concepts
hinges on the legality of taxpayer’s actions. Sandomo (2005) distinguishes the two concepts from
legal perspective. According to him tax evasion is carried out in violation of the law, therefore is
illegal while tax avoidance is carried out within the legal framework of the tax law in order to
reduce one’s tax liability, therefore tax avoidance is legal. Since there have been many studies
attempting to define tax compliance, for the purpose of this study, (based on Alm (1991);
Jackson and Milliron (1986), Kirchler (2007)), Franzoni (2000), Chatopadhyay and DasGupta
(2002) and Palil (2010)) tax compliance is defined as taxpayers’ willingness to comply with tax
laws, declare the correct income, claim the correct deductions and exemptions, and pay all taxes
on time.
Tax noncompliance is the failure of taxpayer to meet tax obligations whether the act is done
intentionally or unintentionally (James & Alley, 2004, Loo 2006; Mohani, 2001; Kesselman,
1994 and Allingham and Sandmo, 1972). Soos (1991) and Kirchler, (2007) broadly classified
noncompliance as failing to file a tax return; underreporting of taxable income; overstating tax
claims such as deductions and exemptions and failing to make timely payment of tax liability.
Therefore, for the purpose of this study, tax non-compliance is defined as failure to comply with
tax laws and/or report incorrect income, the act of claiming incorrect deductions and exemptions
and/or paying the incorrect amount of tax beyond the stipulated time frame.

2.1.3. Tax Compliance Theories

Several theories of behavior, borrowed from economics and the psychological sciences, can be
useful in classifying analysis of variables. Theories of taxpayer compliance behavior, including
the decision whether or not to pay taxes, there are two broadly approaches: economic deterrence
theory, and the social-psychological theories.
The Economic (deterrence) theory Allingham and Sandmo (1972) developed the economic
deterrence model, following the economics of crime approach pioneered by Becker (1968). The
model analyses the individual taxpayer’s decision on whether, and to what extent, to evade taxes
through intentional underreporting of taxable income. The model predicts whether a taxpayer
will evade tax, depending on the benefit of evasion relative to the expected cost of being detected
and punished. According to this model, taxpayers evade taxes if their decision maximizes their
expected profit (or utility). Allingham and Sandmo (1972) conclude that an increase in the
penalty rate would increase the fraction of actual income declared, and an increase in the
probability of being detected would also lead to a larger income being declared. The model is
very simplistic, in that it ignores other factors that might affect the decision of whether to comply
or not.
Social-psychology Theory
Researchers like (Alm et al. (1999); Cullis and Lewis (1997); Mc Kerchar (2002)) that Social
and psychological insights have contributed to better understanding of the observed level of tax
compliance. Social psychology theory looks that tax compliance behavior in an environment of
social interactions and conventions. In these models tax compliance is influenced by a range of
factors, including attitudes, perceptions, beliefs, personality traits and interactions between the
actors (taxpayers, tax administrators/the state, tax advisors, and others).
The social psychology theory, unlike the economic deterrence model, pertains to the relationship
between tax compliance and social interactions and conventions. An aspect of this theory says
that perceptions and attitudes towards a tax system and compliance behavior may be affected by
the behavior of an individual’s peer groups. The compliance behavior of peer groups like friends,
neighbors and relatives is expected to impact on the perceptions and compliance decisions of
others. More specifically, noncompliant decisions by peer groups may reduce the level of tax
compliance by others.
The other aspect of social psychology theory is related to social sanctions. Social sanctions and
attitudes towards them may affect the level of tax compliance. The severity of social sanctions
against noncompliant taxpayers and attitudes towards them may increase willingness to comply.
Regarding the above points, Fjeldstad et al. (2012) argue that compliance behavior and attitudes
towards the tax system may be affected by the behavior of an individual’s reference groups. If a
taxpayer knows many people in groups important to him/her who evade taxes, his/her
commitment to comply will be weaker. On the other hand, social relationships may also help
deter individuals from engaging in evasion for fear of the social sanctions imposed once
discovered and publicly revealed.

2.1.4. Factors Affecting Tax Compliance

Previous researcher had identified a number of Factors affecting tax compliance behavior.
Regarding the research subject, the researcher will wants to investigate determinants that affect
tax compliance. To achieve this, the researcher reviews several researches and journals. While
reviewing, different scholars try to list out that compliance is influenced by numerous factors
(Brook, 2001). Scholars identified these factors as economic, social and psychological (Brook,
2001; Devos, 2008; Kirchler, 2007). To have a broad knowledge in the area and to list out the
main factors found by different researchers, Such as; Jackson and Milliron (1986); Loo (2006)
Kirchler (2007), and Palil (2010). To mitigate the challenge of tax non-compliance, it is
necessary to understand factors influencing an individual’s decision to comply with tax laws.
The factors affecting tax compliance has been classified differently by different researchers.
But most of these classification overlap on one another. By considering the most relevant one for
this study, we classified them in to four major groups: economic, institutional, social and
individual factors.

2.1.1.1 Economic Factors

Economic factors in relation to tax compliance refer to actions which are associated with the
costs and benefits of performing the actions (Loo, 2006). Song and Yarbrough (1978) assumed
that taxpayers are rational economic evaders who likely would assess the costs and/or benefits of
evasion. The tax compliance determinants associated with economic factors such as tax rates, tax
audits and perceptions of government spending (Palil, 2010).
The tax compliance determinants associated with economic factors such as tax rates, tax audits
and perceptions of government spending are discussed as follows; previous studies examined the
relationship of tax rate and tax compliance. Such as, Hai and See (2011) found that the high tax
rate causes high tax noncompliance. Spicer & Becker (1980) argue that those taxpayers who are
aware that their tax rate is higher than average tax rate paid by other have higher records of tax
evasion. Evidence suggests tax rates have mixed impact on tax compliance i.e decreasing tax
rates does not necessarily 2008). Increase in tax rates might have positive or negative impact on
evasion and increasing tax rates will not necessarily always decrease compliance behavior
(Allingham & Sandmo, 1972). A recent study by (Modugu, Eragbhe, &Izedonmi, 2012) tax rate
do not have any positive or negative effect on tax compliance.

2.1.1.2 Institutional Factors

With regard to simplicity of tax system, previous studies argue that simplest tax system
encourage tax payers to voluntarily comply with tax system such as (Palil, 2010; Richardson;
2008 & Stephen, 2011). Slemrod (1989) also conclude that a simple tax return and simpler tax
regulations will increase tax compliance especially in a self-assessment system because
taxpayers do not have to spend much time in ascertaining the accuracy of the returns and
calculating their tax liabilities. Another study by Samuel and Viswanadham (2016) assessed
business income taxpayers’ tax knowledge, tax complexity, and tax compliance in Amhara
Regional State of Ethiopia using a cross-sectional survey research design and a qualitative
research approach.
2.1.1.3 Social Factors
Tax compliance determinants from a social perspective relates to taxpayers’ willingness to
comply with tax laws in response to other people’s behavior and their social environment
(Torgler, 2007&Kirchler (2007). The factors discussed in this section include perceptions of
equity and fairness and referent groups. With respect to tax fairness and equity, a good tax
system is the one which is designed on the basis of an appropriate set of principles, such as
equality or fairness and certainty (Bhatia, 1976). The perceived fairness of the tax system also
has an influence on the inclination towards tax evasion (Jackson and Milliron, 1986; Richardson,
2008). When taxpayers perceive unfairness they will react by trying not to pay taxes. Etzioni
(1986) argues that if a public feels increasingly over time that taxes are unfairly imposed, it will
be increasingly likely to evade paying taxes recommended that shorter sentences and active style
of writing will help improve the readability of tax legislation and consequently reduce the
complexity of the tax law.