Chapter 6

International Taxation
Issues
Would Ethiopia tax worldwide income or domestic
income? Of Whom? Its citizens? Its residents? To what
extent?

Should a company seeking to expand operations to

neighboring country open a branch or setup a subsidiary?
How should it finance it?

What are the implications of the answers to the above

questions for individuals? For MNCs?

The above questions/answers/analysis are the realm of

international Taxation.
Tax Jurisdiction

Basis for taxation

 The three most common bases for taxation are source,
citizenship, and residence.
 Almost all countries assert the jurisdictional authority to
tax income where it is earned—in effect, at its source—
regardless of the residence or citizenship of the
recipient.
 The citizenship basis taxes income of the country’s
citizens regardless of source or where they reside.
 The residence basis taxes income of the country’s
residence regardless of source or citizenship.
Residence rules:- Examples
Individuals’ residence –number of days /months
supplemented by other requirements;
 France 180 days;
 Germany 6 months;
 USA 122 days;
 UK 91 days,
 Ethiopia 183 days; ( continuously or intermittently,
in a one-year period)
In Ethiopia
 Residents are subject to tax on their worldwide income. Non-
residents are subject to tax on their Ethiopian-source income
only

 An individual is considered to be resident in Ethiopia if ANY

of the following circumstances exist:
 He or she has a domicile in Ethiopia and a habitual abode in
Ethiopia.
 He or she is physically present in Ethiopia for more than 183 days
in a period of 12 calendar months, either continuously or
intermittently.
 He or she is a citizen of Ethiopia who serves abroad as a consular,
diplomatic or similar official of Ethiopia.
 In the case of a body corporate, residency crystallizes when;
 It is incorporated or formed in Ethiopia; or
 Has its place of effective management in Ethiopia.
Taxation approaches

 Tax Jurisdiction issue is related to the taxation

of income earned overseas, known as foreign
source income. There are two approaches
taken on this issue.
 Worldwide approach and
 Territorial approach
 Worldwide approach. Under this approach, all
income of a resident of a country or a company
incorporated in a country is taxed by that country
regardless of where the income is earned.

 Examples of countries using WWT method:

 A resident in the UK or US is liable to tax on worldwide
income;

 A resident of Ethiopia is also subject to tax on worldwide

income;
 Non-residents are subject to tax on their Ethiopian-source income
only
 Territorial approach. Under this approach, only
the income earned within the borders of the
country (domestic source income) is taxed.

 Any business income earned in a territory is subject to income

tax in that territory, regardless of whether the business is
owned by foreigners.

 Any foreign source income earned by residents are exempt

from taxation.
Tax Jurisdiction and Double Taxation
 The worldwide approach to taxation can lead to
overlapping tax jurisdictions that can in turn lead to
double or even triple taxation.

 Double taxation has effects on the cost of operations

and effectively may act as a hindrance to cross border
activities (investments)

 To alleviate double taxation in these cases, the country

of residence generally defers to the country where the
income was earned.

 In other words, source takes precedence over

residence.
 Solutions to double taxation

 The question is, which country should give up its right to tax the
income? The international norm is that source should take
precedence over residence in determining tax jurisdiction.
 It will be up to the parent company’s home country to
eliminate the double taxation

 One solution is for a country to adopt the territorial approach.

 deduct
Another solution is for a country to allow domestic companies to
all taxes paid to foreign governments in their tax
returns.
 A third solution is for a country to provide a tax credit to domestic
companies for taxes paid to foreign governments.
 Most countries, including the U.S. (where the tax rate is 35%) use this
approach.
Foreign Tax Credit or Deduction?

FTC – Example
 Assume ASD Company’s foreign branch earns income
before income taxes of $100,000. Income taxes paid
to the foreign government are $30,000 (30 percent).
 Sales and other taxes paid to the foreign government
are $10,000. ASD Company must include the $100,000
of foreign branch income in its U.S. tax return in
calculating U.S. taxable income. The options of taking
a deduction or tax credit are as follows:
.
Foreign Tax Credit Vs Deduction(FTC)

• Ethiopia allows a foreign tax credit on income generated from

business activities abroad by a resident taxpayer.

• However, the foreign tax credit is limited to the amount of tax

that would be applicable on that income in Ethiopia.
Tax Treaties
 Tax treaties – bi-national agreements regarding how
individuals from one country are taxed on income
earned in the other country.
 Tax treaties are designed to facilitate international
trade and investment by reducing tax barriers to the
international flow of goods and services.

 Their purpose is to alleviate double taxation problems.

 Reducing double taxation helps facilitate international

trade and investment.
 Tax treaties also involve information sharing between
governments that helps in domestic enforcement.
Tax Treaties

 Many countries have entered into tax treaties with

other countries to avoid or mitigate double taxation.

 In general, the benefits of tax treaties are available

only to tax residents of one of the treaty countries.

 The intention most agreement is to alleviate double

taxation and combat corporate tax avoidance through
companies setting up a subsidiary in a low tax
jurisdiction, but in reality, sourcing their income in
higher-tax jurisdictions.
The OECD Model for tax treaties

 The OECD model treaty is the basis for most bilateral

treaties of developed countries.

 A key part of the OECD model is that host countries

only tax business profits of foreign companies
associated with permanent establishments.

 A permanent establishment: Under the OECD

definition, a PE may be defined as a fixed place of
business through which activities of an organization
are wholly or partially carried on.
 Examples of PEs, include branches, offices, workshops, and others
Tax competition
 Tax competition occurs when countries adapt their tax policies
strategically to make themselves attractive to new enterprises or to
keep themselves attractive for existing ones;

 Small countries benefit from reducing tax because the resulting tax
deficit on ‘home’ capital can be over-compensated by the attraction of
foreign capital;

 From the perspective of small countries, reducing the tax rate leads to
the inflow of foreign capital, especially from large countries and leads
to an income and welfare gain for them;

 In a situation of tax competition, the welfare of small states rises

while that of large states falls.
 An important reason for the stiff competitive
pressure in corporate taxation is that multinationally
integrated companies can avoid taxes by transferring
‘profits’ from high to low tax jurisdictions;

 Through this, they can benefit from the good

infrastructure and other locational advantages in
high tax countries and the tax advantages offered in
low tax countries or tax havens;

 ‘profit shifting’ happens through various techniques

such as the (legal) manipulation of internal transfer
pricing for products
Transfer pricing

 The transfer price is the accounting value assigned

to a good or service as it is transferred from one
affiliate to another;

 Transfer pricing refers to the prices that related

parties charge one another for goods and services
passing between them;

 These prices can be used to shift profits to

preferential tax regimes or tax havens;
 Hence, unless prevented from doing so, corporations or
other related persons engaged in cross border
transactions can escape from paying tax by
manipulating the transfer prices;

 Most countries have transfer pricing rules which

regulate the prices charged by related parties.

 Methods of determining the arm’s length price;

 Market Price Method,
 Cost Plus Method.
Tax Havens
 A tax haven is a jurisdiction which serves as a means by
which firms and individuals resident in other
jurisdictions can reduce the taxes that they would
otherwise be obliged to pay there;

 Tax havens may be identified by reference to the

following factors:
 No or very low taxes
 Lack of exchange of information
 Lack of transparency
International Trade Tax In Ethiopia
 Unless exempted by law, items imported into Ethiopia
are subject to a number of taxes;
 Currently the Government levies five kinds of taxes
on imported items;
 These taxes are assigned priority levels and are
calculated in a sequential order;

These taxes, in their sequential order, are:

 Customs Duty;
 Excise Tax;
 VAT;
 Surtax; and
 Withholding Tax. 21
Customs Duty and Rates
 The first of the five taxes levied on import items is Customs Duty;

 The term Customs Duty denotes taxes imposed on goods entering or

leaving the country; by all persons and entities that have no duty-
free privileges.

 However, there is a 150 percent export tax particularly on certain

hides and skins of animals;

 Customs Duty provides significant revenue to the Government;

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 Currently, the Ethiopian Customs Duty has 6 bands or
groups of rates which are applied to imported goods;

 These bands of rates are 0%, 5%, 10% 20%, 30% and 35%;

 The minimum Customs Duty Rate is 0(zero), while the

maximum is 35% of the CIF (Cost + Insurance + Freight)
value of an imported item;

 To calculate the Customs Duty, the CIF is multiplied by

tariff rate applicable to each imported item.

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Preferential Tariffs
 Ethiopia is a member of the Common Market for Eastern and
Southern Africa (COMESA), and which administers Preferential
Tariffs that favor trade with member countries of COMESA;

 Currently, Ethiopia provides a varying preference (reduction) of its

regular Customs Duty Rates to the goods imported from the
COMESA member States;

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Excise Tax
 Excise Tax is the second of the five taxes levied on
imported items and it is one of the most well known forms
of tax in Ethiopia;

 It is a tax levied on selected luxury goods and basic goods

which are relatively demand inelastic

 Excise Tax is also applied to goods which are considered

hazardous to health and that may cause social problems;

 Additionally, the Government uses excise tax as a

revenue-producing device;
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 MoR is responsible for collecting Excise Tax for the Federal
Government and collects Excise Tax levied on locally
produced and imported items;

 Excise Tax on goods locally produced is paid by the

producer, whereas Excise Tax on imported items is paid by
the importer;

 There were 10 bands or groups of rates to which excise can

be charged- before the MoF introduced a new Excise Tax
Proclamation (Proclamation No. 1186/2020) in 2020,
 These band rates are 10%, 20%, 30%, 33%, 40%, 50%, 60%, 75%, 80% and
100%;
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…
 The base of calculation for goods locally produced was
the cost of production (excluding depreciation)
multiplied by its excise tax rate;

 In calculating Excise Tax payable on textile and textile

products locally produced in a factory and vehicles
assembled locally, the tax paid on import of inputs
that are used to produce such goods shall be
deducted;

 Likewise, Cost + Insurance + Freight (CIF) + Customs

Duty multiplied by Excise Tax Rate is the base of
computation for goods imported into the country;
…
 The reform on excise tax in 2020 changed the tax base for
locally produced goods from the ‘production cost’ to ‘ex-
factory prices’.

 The new law also raised the maximum applicable excise tax
rate on certain imported items, mainly on old vehicles, from
100% to 500%.

 Some additional goods have been included in the excise tax

base (which were not subject to excise previously).
 For example, tractors and three-wheeler motor vehicles are
now subject to rates of up to 400% and 405% respectively
depending on age,
Value Added Tax (VAT)
 VAT is the third of the five taxes to be levied on import
items;

 In Ethiopia, VAT is levied at a standard flat percentage

rate of 15%;

 To the exclusion of goods detailed in in the VAT

Proclamation No.285/2002, VAT is levied on every
imported item;

 Importers are liable to pay 15% of the sum of Cost,

Insurance, Freight, Customs Duty, and Excise Tax;
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Surtax
 Surtax was first introduced into the Ethiopian tax system
in 1999 but it was abolished in 2001. It was reintroduced
then in 2007 by Council of Ministers Regulation No.
133/2007)
 Surtax is levied on goods imported into Ethiopia at a flat
rate of 10% – albeit with significant exemptions
 All goods imported by persons/organizations facing preferential
customs duty rates are to be exempted from surtax.
 Fertilizer, Petroleum and Lubricants, Capital (Investment Goods)
and some Medicines, Raw Materials and other goods which are
already decided by law are exempted from payment of the
Surtax;

 The tax base is the CIF value of imported goods, plus all
customs duty, excise tax and VAT payable on these goods.
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Withholding Tax on Imports
 Proclamation No 227/2001 has introduced the Withholding
Tax and requires importers of commercial goods make an
advance payment of business income tax

 This tax is not an import tax in the strict sense, but formally
part of the income tax system – as the collected amount is
creditable against the income tax liability of the taxpayer
for the relevant fiscal year.

 The amount collected on imported goods shall be 3% of the

sum of Cost, Insurance, and Freight (CIF Value);

 If the amount of Income Tax collected on the imported goods

results in underpayment of Business Income Tax due for the
year, as determined at the time of declaration of Income
Tax, the taxpayer is required to pay the difference with the
declaration;
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An Example of Imported Goods Tax
Calculation in Ethiopia

 Consider a typical example: An Importer

brought in a new automobile with 1300 cc for
personal use; How do you think the total
Customs Duty and other taxes can be
calculated?

 To determine Customs Duty and other taxes on

the automobile, the importer may use the
following seven key steps:

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1. The first step is to identify the duty paying value of the
automobile:

 The duty paying value of any import item is the actual total cost
of the goods i.e. Cost + Insurance + Freight;

 Cost stands for the transaction value and other related costs or
payments made in exchange for the purchase of an item;

 Insurance represents the money or premium that is paid to

deliver the item to be imported up to a prescribed Customs
Port;

 Freight is money paid for the commercial means of transport for

delivering the imported item up to the first Customs Port.
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2. Once the Duty Paying Value of the imported item is
calculated, the next step is to calculate Customs Duty
Payable on the automobile:
– Suppose the Duty Paying Value of the imported item is
60,000 Birr;
– The importer is liable to pay Customs Duty of 21,000 Birr;
– This figure is obtained by multiplying Customs Duty Rate
with the Duty Paying Value of the imported item i.e. 60,000
x 35% = 21,000;

3. Having calculated the Customs Duty, next is the third

step used to reflect how Excise Tax is calculated:
– In this step, the importer multiplies the sum of the
Duty Paying Value and the Customs Duty by Excise
Tax Rate (60,000 + 21,000) x 5%;

– This will be 4,050 Birr, which is the payable Excise

Tax. 34
4. The fourth step shows the way the Value Added Tax
(VAT) is calculated:
– In this step, the importer multiplies the sum of the Duty
Paying Value, Customs Duty, and Excise Tax by the VAT (
60,000 + 21,000 + 4,050) x 15%, which is VAT Rate;
– The result of this calculation is 12,757.05 Birr, which is
VAT to be paid on the automobile.

5. The fifth step is calculating Surtax:

– It involves multiplying the sum of the Duty Paying Value,
Customs Duty, Excise Tax, and VAT, by the Surtax Rate
(60,000 + 21,000 + 4,050 + 12,757) X 10%, which is the
Surtax Rate;

– Accordingly, the payable Surtax is 9,780. Birr.

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6. The sixth step is to calculate the Withholding
Tax:
– In this step, the importer multiplies the Duty Paying Value
by the Withholding Tax Rate, i.e., 60,000 x 3%;
– The result is 1,800 Birr, which is the Withholding Tax to be
paid.
7. The last step involves adding the Payable
Customs Duty, Excise Tax, Value Added Tax,
Surtax, and Withholding tax to arrive at the
figure of the Total Payable Customs Duty and
other taxes:
– Accordingly, the calculation results in a sum of 75,005 Birr
i.e., (21,000 + 4,050 + 12,757+ 9780+1800)= 49,387.05

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The Formula for Calculating the Taxes

 Duty Paying Value (DPV) =Cost + Insurance + Freight

 Customs Duty =DPV x Customs Duty Rate =A

 Excise Tax = (DPV + A) x Excise Tax Rate = B

 Value Added Tax = (DPV + A + B) x VAT Rate =C

 Surtax = (DPV + A + B + C) x Surtax Rate =D

 Withholding Tax = DPV x Withholding Tax Rate = E

Total Tax Payable = A + B + C + D + E

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
 Exercise (Home work)
Assume an importer imported a 2,500 cc NEW automobile at
a cost of 120,000 Birr for personal use. The importer also
paid Freight cost of Birr 20, 000, insurance cost of Birr
2,000. If the tax rate for customs, excise tax, VAT, Sur tax
and withholding tax is 35%, 100%, 15%, 10% and 3%
respectively is applied, what would be the amount of
a. Custom duty Tax
b. Excise Tax
c. VAT
d. Sur Tax
e. Withholding Tax

 Calculate the Tax Liability

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End of Chapter

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