Unity University

Department of Accounting and Finance

Public Finance and Taxation Course Module
COURSE OVERVIEW
Course title Public Finance and Taxation
Course code ACFN 341
ETCTS Credits 5
Contact Hours (per week) 4
Credit Hour 3

COURSE OBJECTIVES & COMPETENCE TO BE ACQUIRED

Upon the successful completion of this module, students should be able to:
 Discuss the essence of Public Finance and Taxation in theory and in Ethiopian context
 Understand the meaning and characteristics of Taxation
 Understand the concept of public finance in Ethiopia, specifically Expenditure assignment, Revenue
assignment, Intergovernmental transfer, Borrowing and Budget process
 Apply basic Ethiopian tax concepts to various circumstances relating to the Employment, Business
and Other Income taxes
 Apply basic Ethiopian tax concepts to various circumstances relating to Value Added Tax (VAT),
Turnover Tax (TOT), Excise taxes, and Custom duty
 Apply the concept of Stamp duty, Import procedure and Export procedure
 Understand the concept of Investment Incentives in Ethiopian context

COURSE DESCRIPTION
The course focuses on the taxing and spending activities of a government and their influence on the allocation
of resources and distribution of income in general and with special reference to Ethiopia as per the new
economic policy. Moreover, the course will provide a reliable foundation in the core areas of public finance and
Ethiopian taxation, and enable students understand the operation of the Ethiopian tax system. The topics
covered includes: Introduction to public finance, tools of public finance mainly taxation, analysis of the finance
system of the Federal Democratic Republic of Ethiopia with emphasis on the Taxation System. This material
has six chapters and the following list describe content of each chapter.
1. Basics of Public Finance
2. Ethiopian Public Finance
3. Meaning and Characterstics of Taxation
4. Ethiopian Tax System
5. Accounting for Direct Taxes in Ethiopia
6. Accounting for Indirect Taxes in Ethiopia

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 CHAPTER I
BASICS OF PUBLIC FINANCE

Chapter objectives:
Students, after reading this chapter you will be able to:
 Define public finance
 Identify scope of public finance
 Identify similarity and difference between public finance and private finance
 Understand the role of government in the economy
Introduction

Governments, all over the world have started number of public projects. To provide social facilities, the
government requires adequate revenue. Public Finance, therefore, deals with the income and expenditure of
public authorities. It deals with the financial operations or finances of the government. The government raises
revenue from internal as well as external sources to incur huge expenditure on various functions the government
has to perform. Public finance is thus concerned with the use and accomplishment of essential monetary
resources of the government. Public finance deals with how and through what different sources the government
gets income, how it spends it and how it controls and administers its incomes and expenditures. Therefore, the
subject matter of public finance deals with public revenue, public expenditure, and public debt.

Definition and Scope of Public Finance

 Public finance is a very old science and different economists have defined it in their own ways.
1. Is concerned with the income and expenditure of public authorities and with the adjustment of one to the
other.” Huge Dalton
2. Deals with the provision custody and disbursement of resources needed for conduct of public or
government functions.” Lutz
3. Is a science which deals with the activity of the statement in obtaining and applying the material means
necessary for fulfilling the proper functions of the state.” Carl Plehn
4. Is the study of the principles underlying the spending and raising of funds of public authorities.”
Findley Shirras
5. Studies the economic activity of government unit.” Buchanan
6. Deals with expenditure and income of public authorities of the state and their mutual relations as also
with the financial administration and control.” Bastable

Scope of Public Finance

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The subject matter of the public finance is classified under five broad categories.
1. Public Revenue
2. Public Expenditure
3. Public Debt
4. Financial Administration and Control, and
5. Economic Stability and Growth.
Similarities and Differences between Public Finance and Private Finance
Similarities
(1) Satisfaction of Human Wants;-
(2) Maximum Advantage from expenditure;-
(3) Borrowings;-.
(4) Engagement in Similar Activities;-
(5) Scarcity of Resources;-
(6) Problem of Adjustment of Income and Expenditure;
Dissimilarities
(1) Motive;-
(2) Adjustment Approach of Income and Expenditure;-
(3) Nature of Resources:-
(4) Coercive Methods:-
(5) Secrecy of Budget:-
(6) Long/Short-term Consideration: -
(7) Elasticity of Finance:-
(8) Deliberation in Expenditure:-
(9) Right to Print Currency: -
PUBLIC REVENUE

Sources of Public Revenue

The important and common sources of public revenue are:
 Taxes
 Income from currency
 Sale of public assets
 Commercial revenues
 Administrative revenues e.g., Fees, fines, licenses.

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  Grants and gifts
Basic Categories of Government Receipt
• Revenue Receipts
• Capital Receipts
Revenue Receipt: It includes “routine” and “earned” ones
1. Tax-revenue Receipts
2. Non-tax revenue receipts
I. Tax Revenue Receipts
• Tax revenue itself is divided into three sections:
i. Taxes on income ;It covers corporation tax, income tax and similar other taxes, if any, in force.
ii. Taxes on property and capital transactions: taxes on specific forms of wealth and its transfers such as
estate duty, wealth tax, gift tax, house tax, land revenue and stamps and registration fees, etc.
iii. Taxes on commodities and services: This section includes taxes on production, sale, purchase, transport,
storage, and consumption of goods and services.
2. Non-tax Revenue Receipt
i. Currency, coinage and mint: This category covers the receipts of Currency Notes Press, Mints and Profit
from circulation of small coins.
ii. Interest receipts, dividends and profits: Interest receipts on loans by the government to other parties,
Dividends and profits from public sector undertaking. E.g contributions from railways and posts and
telecommunications,
iii. Other non–tax revenue: It covers revenue from various government activities and services such as from
administrative services, public service commission, police, jails , agricultural and allied services, industry and
minerals, water and power development services, transport and communications, supplies and disposal, public
works, education, housing, information and publicity, broadcasting, grants-in-aid and contributions etc.
II. Capital Receipts
Capital receipts of the government take money forms. The most important one comprises of borrowings which
can be classified in terms of their origin and maturity
They may be
 marketable or non- marketable,
 interest-free or interest bearing, etc.
• Some capital receipts may be in the form of grants and donation.
Sources of public revenue in Ethiopia
i. Tax revenue

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 ii. Non-tax revenue
ii. Non-tax revenue
 Administrative revenues
 Government investment income
 Dividend
 Privatization proceeds
 Capital income from sale of goods and services

PUBLIC EXPENDITURE
Current and Capital Expenditure
Current expenditures
 They are also referred to as non-developmental expenditure.
 All sorts of administrative and defense expenditure
 They are intended for continuing the existing flow of goods and services and maintaining the
capital of the country whole.
 Capital expenditures
 Capital expenditures contribute to increased productive capacity of the nation.
 They are also known as development expenditure.
 Example: Expenditures on construction of dams, public works, state enterprises, agricultural and
industrial development.
Objectives of Public Expenditure
 Security of life against the external aggression and internal disorder and injustice.
 Development or up gradation of social life in the community.
Reasons for Growing Expenditure
1. Population growth.
2. Increasing urbanization.
3. Maintenance of law and order.
4. Welfare activities.
5. Provision of public goods and utility services.
6. Servicing of public debt.
7. International obligation.
8. Defense:-
9. Transport and Communication:

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10. Rising Trend of Prices:
11. The Rural Development Effect

Canons of Public Expenditure

It used for the fundamental rules or principles governing the spending policy of the government. According to
Prof. Findley Shirras, the canons are:
Canon of Benefit
Canon of Economy
Canon of sanction
Canon of Surplus
Canon of Elasticity
Canon of Productivity
Canon of Equity
Canon of certainty.
Effects of Public Expenditure
In modern government Public Expenditure regarded as a means of securing social ends. Public Expenditure
produces many direct and indirect socio-economic effects.
 The effects of public expenditure;
 Effects of public expenditure on production.
 Effects of public expenditure on distribution.
 Effects of public expenditure on employment.
 Effects of public expenditure on economic stability.
 Effects of public expenditure on economic development.

PUBLIC DEBT: NATURE AND KINDS OF PUBLIC DEBT

Classification of public debt
1. Source of Borrowing (internal debt and external debt).
2. Purpose of the loan (Productive and unproductive debt)
3. According to nature: Compulsory and voluntary debt
4. Funded debt and unfunded or floating debt.
5. Time Duration of loan (short, medium, and long term loan).

Effects of PD

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Public borrowing from individuals and firms has effects on all aspects of economic life
 Effects on Consumption
 Effects on Production and Investment.
 Effects on Distribution
 Effects on National Income
 Effects on Liquidity
 Effects on Money Market
Burden of Public Debt
Public borrowings are to be paid along with interests. Govt. imposes new taxes upon the people to repay the
loans and meet the annual interests on such loans. The sacrifice of the people in the form of tax payment is the
burden of public debt. If the debt is taken for productive purposes, for e.g., for irrigation, transportation,
roads, information technology, human skill development, etc., it will not mean any burden. But if the debt is
unproductive it will impose both money burden and real burden on the economy.

REDEMPTION OF PUBLIC DEBT: Redemption means repayment of loans. The various methods available
to the government to pay off its debt are:
A. Repudiation of Debt.
B. Conversion of Loans:-
C. Serial Bond Redemption
D. Sinking Fund.

Learning activities:
1) What are the subject matters included within the scope of public finance?
2) What public revenue?
3) What are the different sources of revenue for a government? Could you give example for each category?
4) What is public expenditure?
5) What are the objectives of public expenditure?
6) What are the principles of public expenditure?

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 Chapter II

ETHIOPIAN PUBLIC FINANCE

Objectives of the chapter:

 Understand the basic idea of budget

 Understand the concept of Fiscal Federalism in Ethiopian context
 Understand the process of Budget preparation in Ethiopia

Introduction on budget in Ethiopia

The budget reflects what the government intends to do. The budget has become the powerful instrument for
fulfilling the basic objectives of government. The budget covers all the transactions of the central government.
Budget is a time bound financial program systematically worked out and ready for execution in the ensuing
fiscal year. It is a comprehensive plan of action, which brings together in one consolidated statement all
financial requirements of the government. The budget goes into operation only after it is approved by the
parliament. A rational decision regarding allocation of resources to satisfy different social wants requires
considerable thinking and planning. Thus budget is an annual statement of receipts and payments of a
government.
Functions of Budget
 proper allocation of resources: - to relate expenditure decisions to specified policy objectives and to
existing and future resources;
 to relate all major decisions to the state of the national economy;
 long term economic growth:- to ensure efficiency and effectiveness in the implementation of
government programs;
 to facilitate legislative control over the various phases of the budgetary process.
 equitable distribution of income and wealth and
 Securing economic stability and full employment.

The Concept of Budgeting in Ethiopia

The government budget represents a plan/forecast by government of its expenditures and revenues for a
specified period. Commonly government budget is prepared for a year, known as a financial year or fiscal year.
In Ethiopia the fiscal year is from July 7 of this year to July 6 of the coming year (Hamle 1-Sene 30 in
Ethiopian calendar). Budgeting involves different tasks on the expenditures and revenues sides of government
finance. On the side of expenditure, it deals with the determination of the total deals with the determination of

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the total size of the budget (i.e total amount of money for the year), size of outlays on different functions, and
the magnitude of outlays on various activities; on the revenue side, it involves the determination of the size of
the overall revenue and foreign aid.

Furthermore, budgeting also address the issue of the budget deficit (i.e. the excess of outlays over domestic
revenues), and it’s financing. Budgeting is not solely a matter of finance in the narrow sense. Rather it is an
important part of government’s general economic policy. Budget is not solely a description of fiscal policies
and financial plans, rather it is a strong instrument in engineering and dynamiting the economy and its main
objectives are to devise tangible directives and implement the long term, medium term, and annual
administrative and development programs”.

Budget Structures in Ethiopia

Budget structures are the formats that organize budget data. Budget data could be classified in different ways
and for different purposes. In the early days, for instance, budget classification basically focused on providing a
better understanding of the intentions and purposes of government for which funds were planned and to be
spent. Later on, the budget structures started to be influenced largely by the issue of accountability. That is in
addition to providing information on what the government proposed to do, the budget structures indicate the full
responsibility of the spending agency. To this end the budget heads or nomenclatures the full responsibility of
the spending agency. To this end the budget head or nomenclature of the budget are mostly mapped to each
spending agency. This should not, however, imply unnecessarily extended and detailed structure (or mapping).
Perhaps, due consideration must be taken to make the structure manageable and appropriate. The first
classification of the budget is between revenue and expenditure.

Revenue Budget

It represents the annual forecast of revenues to be raised by government through taxation and other
discretionary measures. In Ethiopia, the revenue budget is usually structured into three major headings:
ordinary revenue, external assistance, and capital revenue. Hence, the funds expected from these three
sources are proclaimed as the annual revenue budget for the country. The revenue budget is prepared by the
Ministry of Finance (MoF) for the federal government and by Finance Bureaus for regional governments.

Ordinary revenues include both tax and not tax revenues. the tax revenues being direct taxes (personal income
tax, rental income tax, business income tax, agricultural income tax, tax on dividend and chance wining, land
use fee and lease); indirect taxes (excise tax on locally manufactured goods, sales tax on locally manufactured
goods, service sales tax, stamps and duty); and taxes on foreign trade (customs duty on imported goods, duty
and tax on coffee export). Non tax revenues include charges and fees; investment revenue; miscellaneous
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revenue (e.g. gins); and pension contribution. The second major item in revenue budget is external assistance. It
includes: cash grants, these are grants from multilateral and bilateral donors for different structural adjustment
programs; and technical assistance in cash and material form. The third item is capital revenue. This could be
from domestic (sales of movable properties and collection of loans), external loan from multilateral and bilateral
creditors mostly for capital projects, and grants in the form of counterpart fund.

Categories of Revenues to Government

A. Tax Revenue
I. Tax on Income
a) personal income, and
b) Corporation profits.
II. Taxes on Property: It is the tax revenue from properties including rental income tax land use tax etc.
III. Taxes on Commodities: The important taxes levied by the Government on commodities are:
a) Customs Duty,
b) Excise Duty,
c) Value Added Tax
d) Turnover Tax
 Customs Duty includes both import and export duties. These duties are le vied when the
goods cross the boundaries of the country.
 Excise duties are levied on the commodities produced in the country. Excise duties now
constitute the single largest source of revenue to the Union Government.
 Value Added Tax is levied by the Government on the commodities sold at specified
percentage on the value of sales.
 Turnover Tax is levied by the Government on the sales which are not covered under Vat.
B. Non-Tax Revenues

 Administrative Revenue : It includes the following:

I. Fees
II. Licenses
III.Fines and Penalties
IV. Forfeitures
V. Escheats
VI. Special Assessment

BUDGET DEFICIT

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A budget is considered as surplus or deficit according to the position of the revenue accounts of the
government. Thus a surplus budget is one in which revenue receipts exceed expenditure charged to revenue
account regardless of the gap in capital accounts; while a deficit budget is one in which expenditure is greater
than current revenue receipts. Budget deficit is the excess of total expenditure over total revenue of the
government.

The deficit financing denotes the direct addition to gross national expenditure through budget deficits whether
the deficits are on revenue or capital accounts”. It implies that the expenditure of the government over and
above the aggregate receipt of revenue account and capital account is treated as budget deficit of the
government.

Methods of Financing Deficit

A. borrowing from central bank
B. The running down of accumulated cash balances
C. The government may issue new currency
D. Borrowing from market or from external sources.
Objectives of Deficit Financing
1. Deficit financing has generally been used as a method of meeting the financial needs of the government in
times of war, when it is considered difficult to mobilize adequate resources.
2. Keynes advocated deficit financing as an instrument of economic policy to overcome conditions of
depression and to raise the level of output and employment.
3. The use of deficit financing has also been considered essential for financing economic development
especially in under developed countries.
4. Deficit financing is also advocated for the mobilization of surplus idle and unutilized resources in the
economy.
Pattern of Revenue Sharing
Ethiopia has chosen the federal structure in which a clear distinction is made between the union and state
functions and sources of revenue, but residual powers, belong to the center, although the states have been
assigned certain taxes, which are levied and collected by them, they also share in the revenue of certain federal
taxes. In addition, the states receive grants-in-aid of their revenue from the federal government, which further
increase the amount of transfers between the two levels of government. The transfer of resources from the
central government to the states is an essential feature of the present financial system.
Distribution of Revenues between Central and States
The present federal fiscal system in Ethiopia is of a recent origin. The distribution of revenues between the
centre and states is followed on the basis of "constitution of Ethiopia” and proclamation no.33/1992-

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proclamation “to define sharing of revenue between the central government and the national/regional self
governments”. The articles 96, 97, 98, 99 and 100 of the constitution of Ethiopia make a clear demarcation of
areas where the central alone or state alone have authority to impose taxes. It contains a detailed list of the
functions and financial resources of the center and states.
Basis for Revenue Sharing

The sharing of revenue between the central government and the National/ Regional governments shall take in to
consideration the following Principles:
1. Ownership of source of revenue;
2. The national or regional character of the sources of revenue;
3. Convenience of levying and collection of the tax or duty;
4. Population, distribution of wealth and standard of development of each region;
5. Other factors that are basis for integrated and balanced economy.
Categorization of Revenue

According to "Constitution of Ethiopia” and Proclamation No.33/1992-Proclamation, revenues shall be

categorized as Central, Regional and Joint. That is there are three lists given in the Articles. They are as
follows:

A. Central List,
B. Regional List, and
C. Joint/Concurrent List
The important sources of revenue under "Constitution of Ethiopia” and The Proclamation No.33/1992-
Proclamation “To Define sharing of Revenue between the Central Government and the National/Regional Self
Governments” are explained below:
A. Central List
The sources of revenue are given under Federal/Central List are as follows:
I). Duties, tax and other charges levied on the importation and exportation of goods;
II). Personal income tax collected from the employees of the central Government and the
International Organizations;
III). Profit tax, Personal income tax and sales tax collected from enterprises owned by the
Central Government. (Now sales tax is replaced with VAT and Turnover taxes).
IV) Taxes collected from National Lotteries and other chance winning prizes;
V). Taxes collected on income from air, train and marine transport activities;

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 VI). Taxes collected from rent of houses and properties owned by the central Government;
VII) Charges and fees on licenses and services issued or rented by the central Government;
B. Regional List

The following shall be Revenues for the Regions:

I). Personal income tax collected from the employees of the Regional Government and
Employees other than those covered under the sources of central government.
II) Rural land use fee.
III) Agricultural income tax collected from farmers not incorporated in an organization.
IV) Profit and sales tax collected individual traders.
V) Tax on income from inland water transportation.
VI) Taxes collected from rent of houses and properties owned by the Regional Governments;
VII) Profit tax, personal income tax and sales tax collected from enterprises owned by the
Regional Government:
VIII) With prejudice to joint revenue sources, income tax, royalty and rent of land collected from mining
activities.
IX). Charges and fees on licenses and services issued or rented by the Regional Government;
C. Joint/Concurrent List
The following shall be Joint revenues of the Central Government and Regional Governments.

I. Profit tax, personal income tax and sales tax collected from enterprises jointly owned by the
central Government and Regional Governments;
II. Profit tax, dividend tax and sales tax collected from Organizations;
III. Profit tax, royalty and rent of land collected from large scale mining, any petroleum and gas
operations;
IV. Forest royalty.
Learning Activities:

1. What are the merits and demerits of Fiscal Federalism/decentralisation?

2. What are the common techniques used to transfer resources between governments to minimize imbalances?
3. What is budget and budgeting?
4. What are the steps followed to prepare budget of a federal government in Ethiopia context?

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 CHAPTER III

MEANING AND CHARACTERISTICS OF TAXATION

Objectives of the chapter

 Understand the concept of tax

 Identify the classification of taxes
 Explain the tax system employed in the country

Introduction

Government has played an important role in the socio economic development of society. Social development
may be in the form of raising the level of living and social welfare in the form of providing social amenities to
the people. Social amenities are in the form of education, health and sanitation, utilities like electric supply,
water supply etc, and recreation facilities.

The process of socio-economic development requiring huge expenditure cannot be carried unless the
government has the perennial source of income. Every government has two important sources of revenue. These
are: (a) Tax sources, and
(b) Non-tax sources.
Every Government imposes two kinds of taxes:
(1) Direct taxes, and
(2) Indirect taxes
A tax, in the modern times, therefore is a compulsory levy and those who are taxed have to pay the sums
irrespective of corresponding return of services or goods by the government. It is not a price paid by the tax-
payer for any definite service rendered or a commodity supplied by the government. The tax-payers do get
many benefits from the government but no tax-payer has a right to any benefit from the public expenditure on
the ground that he is paying a tax. The benefits of public expenditure may go to anyone irrespective of the taxes
paid. Therefore, we may say that taxes are compulsory payments to government without expectation of direct
return or benefit to the tax-payer.

Objectives of Taxation
1. Raising revenue:
2. Removal of inequalities in income and wealth:
3. Ensuring economic stability:
4. Reduction in regional imbalances:

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5. Capital accumulation
6. Creation of employment opportunities
7. Preventing harmful consumptions
8. Beneficial diversion of resources
9. Encouragement of exports
10. Enhancement of standard of living
Characteristics of a Good Tax System

(1) Tax is a Compulsory Contribution

(2) The Assesses will be required to pay Tax if is due from him
(3) Taxes are levied by the Government
(4) Common Benefits to All
(5) No Direct Benefit
(6) Certain Taxes Levied for Specific Objectives
(7) Attitude of the Tax-Payers
(8) Good tax system should be in harmony with national objectives
(9) Tax-system recognizes basic rights of tax-payers
Principles of taxation
The four canons of taxation as prescribed by Adam Smith are the following:
(1) Canon of Equality
(2) Canon of Certainty
(3) Canon of Convenience
(4) Canon of Economy
In addition to the above four canons given by Adam smith, the following other canons have been advanced
by Basable and other economists
(5) Canon of Productivity
(6) Canon of Elasticity
(7) Canon of Diversity
(8) Canon of Simplicity
(9) Canon of Expediency

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EFFECTS OF TAXATION

Taxation these days is not used as means of raising revenues only, but it is an important instrument for
achieving socio-economic objectives, such as, regulation of consumption and production, controlling booms
and depression, promoting economic growth and removing inequalities of income. The economic effects of
taxation may be good as well as bad. Therefore, the government should not keep only the revenue
considerations in mind, but the economic effects of taxation should also be considered. To put it in the words of
Dalton, “The best system of taxation from the economic point of view is that which has the best, or the least bad
economic effects.” Effects of taxation can be analyzed in terms of production, distribution and stabilization.

Thus, in this we will discuss the economic effects under the following three heads:

 Effects of taxation on production (to work, save, and invest) - Effects of Taxation on the Composition
and Pattern of Production
 Effects of taxation on distribution : Income Generation and Income Distribution
Effects of taxation on stabilization : There may be two abnormal economic situations: such as Inflation
and Deflation

The effects of taxation on the distribution of income and wealth among different sections of the society,
however, depend upon two factors: nature of taxes and tax rates and kinds of taxes.

1) Nature of Taxes and Tax Rates

By nature, taxation may be proportional, progressive or regressive. The nature of taxation also implies as how
the burden of taxation is distributed among different section of the community.

A tax is called as proportional, if all the tax payers pay the same proportion of their income as tax. A tax is said
to be progressive, if larger is the tax payers income, the greater is the proportion that he pays as tax. A tax is
regressive, if larger is the tax payee’s income, the smaller is the proportion, which he pays as tax.

a) Effects of Regressive Taxation on Distribution

If regressive taxation is followed, the inequalities may increase in the distribution of income and wealth, as the
burden of taxation will fall more heavily on the poor than on the rich. A toll-tax is regressive as the amount of
the tax is the same for the rich and the poor, while the utility of money, which is paid in tax, is greater for the
poor than the rich. A regressive tax thus tends to widen the gap of inequality.

b) Effects of Proportional Taxation on Distribution

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Under proportional taxation, inequalities would continue as before, if the income remains the same. However, if
the income changes in unequal proportions, the inequalities in income will increase. For instance if A’s income
is $500 and B’s income is $1,000 and both are taxed at the rate of 10% the net income of A and B, after tax
payment, would be $450 and $900 respectively. The burden of taxation falls heavily on A than on B. Hence, the
burden of taxation is higher on the poor than on the rich.

c) Effects of Progressive Taxation on Distribution

Under the progressive system of taxation, inequalities would be reduced, because a higher proportion of the
income and wealth of the rich would be taken away by taxes than that of poor. Hence, a sharply progressive tax
system tends to reduce inequalities in the distribution of income and wealth. Sharper the progression, greater is
the tendency to reduce inequalities. Obviously, progressive system is desirable in order to bring about a more
equitable distribution wealth. However, the tax system should be based on the principle of ability to pay. The
higher the income of a person, the greater would be his ability to pay taxes and vice-versa. People who get
unearned income should be taxed at higher rate than poor because of their greater capacity to pay taxes. The
progressive tax system may be designed in such a way that it may not have adverse effects on production.

In other words, tax system should be progressive to the highest income group, the middle income groups should
be subjected to lower tax rates and the low income groups should be exempted from taxation.

2) Tax Rates

While fixing the rates of taxes, progression should be kept in mind. Higher taxes should be imposed on the
richer section of society and revenue realized from the rich should be utilized for the benefit of the poorer
section of the society by way of providing social amenities to them. In other words taxes should be progressive
because sharper the progression, greater is the tendency to reduce inequalities.

Classification and choice of Taxes

Direct and Indirect Taxes

I: Direct Taxes: A direct tax is paid by a person on whom it is levied. In direct taxes, the impact and
Incidence fall on the same person. If the impact and incident of a tax fall on the same person, it is called as
direct tax. It is borne by the person on whom it is levied and cannot be passed on to others. For example, when a
person is assessed to income tax or wealth tax, he has to pay it and he cannot shift the tax burden to anybody
else.

II: Indirect Taxes: Under indirect taxes, the impact and incidence fall on different persons. It is not borne by
the person on whom it is levied and can be passed on to others. For example, when the excise duty is levied on
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the manufacturer of cement, he shifts the burden of tax to the consumers by raising the selling price. Here the
impact of excise duty falls on the manufacturer and the incidence on the ultimate consumers. The person who is
required to pay the tax does not bear its burden. Thus, indirect taxes can be shifted.

Differences between Direct and Indirect Taxes:

1. Shiftability of the Burden of Tax:

2. Principle of Ability to Pay:

3. Measurement of Taxable Capacity:

4. Principle of Certainty:

5. Convenience:

6. Civic Consciousness:

7. Nature of Taxation:

8. Removal of Disparity in Income and Wealth:

9. Examples: The examples for direct taxes are income tax, wealth tax, gift tax, estate duty etc. The examples
for indirect taxes are customs duty, excise duty, sales tax, service tax etc.

Single Vs Multiple Tax System

 On the basis of volume (Single and Multiple tax)

Single tax:- It refers to the system in which the taxes are levied only on the ‘item’ or ‘head of tax’. There is
only one kind of tax, which constitutes the source of public revenue.

Multiple taxes: - It refers to the system in which the taxes are levied on various items.

 On the basis of method

Proportional taxes: - A system that taxes everyone at the same rate, regardless of his or her income brackets. It
is amount increase with the increase in income and decreases with the decrease in income.

Progressive taxes: - It is the tax which varies with the change in income of the different individuals. The rate of
tax is gradually higher for the increasing incomes and lower for the decreasing incomes.

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Regressive tax: - Under it, the larger the income of tax-payer, the smaller is the proportion that he contributes.
A schedule of regressive tax rate is one in which the rate of taxation decreases as the base increases.

SHIFTING AND INCIDENCE OF TAXES

The impact of a tax is on the person who pays the money in the first instance. In other words, the man who pays
the tax to the government in the first instance bears its impact. The impact of a tax is, therefore, the immediate
result of the imposition of a tax on the person who pays in the first instance. It corresponds to what is often, but
erroneously called the “original incidence” or the “primary incidence” of a tax. The impact of tax as such,
denotes the act of imposing.

Impact of a tax, therefore, refers to the immediate burden of the tax and not to the ultimate burden of the tax.

Meaning of Shifting

Shifting of a tax refers to the process by which the money burden of a tax is transferred from one person to
another. Whenever there is shifting of taxation, the tax may be shifted forward or backward.

Meaning of Incidence

Incidence of a tax refers to the money burden of a tax on the person who ultimately bears it. In other words,
when the money burden of a tax finally settles or comes to rest on the ultimate taxpayer, is called the incidence
of a tax. The incidence of tax remains upon that person who cannot shift its burden to any other person, i.e.,
who ultimately bears it.

Thus, there are three distinct conceptions- the impact, the shifting and the incidence of a tax, which correspond
respectively to the imposition, the transfer, and the settling or coming to rest of the tax. The impact is the initial
phenomena, the shifting is the intermediate process, and the incidence is the result.

Distinction between Impact and Incidence

The impact refers to the initial burden of tax while incidence refers to the ultimate burden of the tax. Impact is
felt by the tax payer at the point of imposition of the tax, while the incidence is felt by the tax payer at the point
of settlement or rest of the tax.

The impact of the tax is felt by the person from whom the tax is collected, while the incidence is felt by the
person who actually bears the burden of the tax.

Impact of a tax can be shifted, but the incidence of a tax can not be shifted.

19
Thus, impact of the tax is always on the person who is responsible by law to pay the tax amount to the
Government treasury, in the first instance. Incidence may fall on somebody from whom the manufacturer
ultimately recovers the amount, provided he shifts the tax.

Tax Shifting

Shifting of a tax refers to the process by which the money burden of a tax is transferred from one person to
another. Shifting can occur only in connection with the price transaction. Price is the only vehicle through
which a tax can be shifted. Thus, shifting is common in commodity taxation. If a tax is shifted, the price of the
taxed commodity increases. Whenever, there is shifting of taxation, the tax may be shifted forward or backward.

Types of Tax Shifting

Forward Shifting

A tax is said to have shifted forward if price of the commodity which constitutes the medium for shifting the
money burden of tax is increased. Under complete shifting; the price will be higher by the full amount of tax. In
forward shifting of commodity taxation, the money burden of a tax is transferred from the producer or seller to
the consumer or buyer when the tax is initially imposed on the producer. Thus, forward shifting is possible with
regard to all indirect taxes which are generally passed partly or shortly to the buyer of goods.

Backward Shifting

Backward shifting refers to the process by which the money burden of commodity tax is shifted from the
consumer or buyer to the producer or seller, if the tax is initially imposed on the consumer. In other words, it is
a typical situation in which the tax burden is shifted backward, that is, from the buyer of good to the seller of
goods under the following conditions:

Backward shifting is applicable in the case of property tax only. Backward shifting is effected when the buyer
of property shifts the entire tax burden to the seller of property. The shifting is done by buyer of property by
way of capitalizing the value of tax by the life of the property and deducting it out of the total value of the
property.

Factors Influencing Shifting and Incidence

(i) Elasticity of Demand.
(ii) Elasticity of Supply.
(iii) Market Conditions.
(iv) Magnitude of Tax.
(v) Coverage of Tax.

20
(vi) Substitutability of Product.
(vii) Public Policy and Tax Laws.

Tax Evasion and Tax Avoidance

Tax Evasion
Tax evasion is the general term for efforts by individuals, firms, and other entities to evade the payment of taxes
by breaking the law. Tax evasion means fraudulent action on the part of the taxpayer with a view to violate civil
and criminal provisions of the tax laws. It can be defined as “tax evasion implies the activities involving an
element of deceit, mis-representation of facts, and falsification of accounts including downright fraud”. Thus, it
may be said that the tax evasion is tax avoidance by illegal means i.e. tax evasion is against the law and is an
unsocial act. There are two forms of tax evasion. They are as follows:
1. Suppression of income, and
2. Inflation of expenditure.
Examples for Tax Evasion: The following are the examples for tax evasion:
1. A trader makes a sale for Birr.20, 000 and does not account it, in his books under sales. He is evading tax.
2. An individual lends his money of Birr.50, 000 to another person at 20% interest per annum and does not
include this income in his total income.
3. Under-invoicing of sales and inflation of purchases.
4. A manufacturing business employs 30 workers but include 2 more additional namesake workers (not in
actual) in the muster roles. The sum shown as paid to such additional namesake workers will amount to evasion.

Causes of tax evasion

 High rates of taxation;- Prevalence of high tax rates is the first and foremost reason.
 Complexity of tax laws;- Complicated tax laws are another reason for tax evasion. The tax laws contain
a number of exemptions, deductions, rebates, relief, surcharges ..
 Inadequate Information as to Sources of Tax Revenue:-Lack of adequate information as to the sources of
revenue also contributes to tax evasions. In Ethiopia, small businessmen and farmers rarely maintain any
accounts of their income.
 Lack of publicity;-Lack of publicity of information of a person’s return or assessment, is yet another
reasons for tax evasion.
 Moral and Psychological factors;- moral and psychological factors have also been pointed out as
responsible for tax evasion.
 Every person should realize his responsibility towards the govt.

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  Unfortunately, all citizens do not realize their duties to the govt. and the necessity of paying the
correct amount of taxes and paying them in time.
 officers of the department should be men of integrity;- Lack of integrity in some of the officers of the
department is also responsible for tax evasion

Methods/Sources of Tax Evasion

1. Omission to report taxable income.
 One of the methods of tax evasion is the omission of the tax-payer to report taxable income to
taxation authorities.
 Under law, every individual, sole proprietorship, partnership firms and corporations have to
furnish their income tax returns in time in case his or her total income from all sources exceeds
the maximum exemption limit.
 But many people do not supply any such information to the govt.
 They cheat their govt. by concealing facts with regard to their income and wealth returns.
1. Maintenance of multiple set of books of accounts.
 Many big business houses have been showing some baseless transactions of expenditure to lower
down their tax burden.
 Most of the business people are maintaining double set of books of accounts by tax evaders.
 One set of books of accounts is for personal use and another for tax purpose.
2. Opening accounts under dummy names.
 Tax evaders have been opening number of bank accounts under dummy names.
3. Deduction of personal expenses as business expense.
 Some employees of big business houses regularly deduct their personal expenses from office.
 For example, an officer using official transportation for personal purposes.
 By treating personal expenses as business expenses, people increase business expenses thus
lowering the profit of the enterprise.
4. Omission to report several incomes from irregular sources.
 Many individuals are in receipt of different types of income from different irregular sources.
 For example, people receive interest on deposits in the banks or dividend on shares.
 But they rarely report such income to the taxation authorities.
5. Understatement of receipts.
 Receipts received from credit sales add to the total income of the business man.
 This addition to the income due to credit sales, increases his tax liability.

22
  Hence, he takes such steps as to underestimate his receipts so that he could reduce his tax
liability.
6. Over-estimation of business expenses.
 A person who evades the payment of tax, over estimated his business expenses by showing more
salaries to employees as compared to actual amount paid.

Tax avoidance – An Overview

 Tax avoidance is method of reducing ones tax liability by making use of loopholes in tax law.
 Therefore, tax avoidance is not illegal.
 But whatever be the method an assessee adopts whether it is avoidance or evasion, the
consequences of his action is the same.
 i.e., loss of revenue to the state and increase in the burden of the tax on other tax-payers.
 Thus, tax avoidance is the art of escaping taxes without breaking the law.
Examples for Tax Avoidance:
Suppose a taxpayer’s total income exceeds the maximum tax-free amount, then he has to pay the tax on such
excess amount. But if he invests the excess amount in any of the approved schemes for which there is a relief in
the tax law, he can save on tax altogether.
2. An individual sells his let out house property (long-term capital asset) for Birr.2,00,000 making a capital gain
of Birr 60,000. This capital gain would normally be taxed. But, if he invests the sale proceeds in a particular
mannerstipulated by law, he need not pay any tax.

Learning Activities:

1) What is taxation?
2) What is tax?
3) What is Tax Accounting?
4) What are the basic characteristics of a tax system (taxation)?
5) What are the objectives of taxation?
6) What are the canons of taxation?
7) What is Direct tax? Can you give some examples of direct tax?
8) What are the merits and demerits of Direct tax?
9) What is Indirect tax? Can you give some example of indirect tax?
10) What are the merits and demerits of Indirect tax?
11) What is proportional tax rate structure? What are the merits and demerits of proportional tax rate
structure?

23
12) What is progressive tax rate structure? What are the merits and demerits of progressive tax rate
structure?
13) What is Tax shifting?
14) What is Impact and Incidence of a tax
15)

24
 Chapter I V

Ethiopian Tax System

Objectives of the chapter-

 Identify the sources of income tax in Ethiopia

 Explain the schedules of income tax in Ethiopia
 Understand the categories of taxpayer as pe their income
 Compute income tax from different taxable incomes

Introduction:

Income tax is a very important direct tax. It is an important and most significant source of revenue of the
government. The government needs money to maintain law and order in the country; safeguard the security of
the country from foreign powers and promote the welfare of the people. It is the foremost duty of the
government to bring out welfare and development programs which will bridge the gap between the rich and the
poor. All this requires mobilization of fund from various sources. These sources may be direct or indirect.

“Taxable income” means the amount of income subject to tax after deduction of all expenses and other
deductible items allowed under this Proclamation 286/2002 and Regulations 78/2002 issued.

Sources of Income (Article-6):

Income taxable under this proclamation shall include, but not limited to:
a) Income from employment;
b) Income from business activities;
c) Income derived by an entertainer, musician, or sports person from his personal activities;
d) Income from entrepreneurial activities carried on by a non-resident through a permanent establishment in
Ethiopia;
e) Income from immovable property and appurtenances thereto, income from livestock and inventory in
agriculture and forestry, and income from usufruct and other rights deriving from immovable property is much
property is situated in Ethiopia;
f) Dividends distributed by a resident company;
g) Profit shares paid by a resident registered partnership;
h) Interest paid by the national, a regional or local Government or a resident of Ethiopia, or paid by a non-
resident through a permanent establishment that he maintains in Ethiopia;
i ) License fees (including lease payments, and royalties paid by a resident or paid by a non resident through a
permanent establishment that he maintains in Ethiopia.
 The above sources of income are grouped under the following four Schedules:
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Schedules of Income (Article-8):

The proclamation provides for the taxation of income in accordance with four schedules.

Schedule 'A' Income from employment;

Schedule 'B' Income from rental buildings;
Schedule 'C' Income from business;
Schedule 'D' Income from other sources including:

Determination of Employment Income (Schedule ‘A’)

A. Determination of Gross employment income: all type of income like Basic salary, allowance, overtime and
bonus
B. Taxable income
Exemptions
I. Income from casual employment
II. Contribution of retirement benefits by employers:
III. Income from Diplomatic and consular representatives and similar persons.
IV. Payments as compensation: (i) Personal injuries, (ii) The death of another person.
V. Allowable Deductions

 Reimbursed medical expenses

 Transportation allowance (if provided in the contract)
 federal 25% of basic salary or not more than Br 800
 Addis Ababa 15% of basic salary or not more than Br 500
 Hardship Allowance
 Desert Allowance
 Reimbursed traveling expense (incurred on duty)
C. Tax Rate

The tax payable on income from employment shall be charged, levied and collected at the following rates:

Schedule A

No. Taxable monthly income(Birr) Rates of tax (10%) Deduction (Br.)

1 < 600 Exemption 0

2 (600 – 1,650] on the next 1,050 10% 60

26
 3 (1,650 – 3,200] on the next 1,550 15% 142.5
4 (3,200 – 5,250] on the next 2,050 20% 302.5
5 (5,250 – 7,800 ] on the next 2,550 25% 565
6 ( 7,800-10,900] on the next ,3100 30% 955
7 over 10,900 35% 1,500

Methods of employment income tax computations

1. Progression method: The amount of tax is calculated for each layer of tax bracket by multiplying the
given rate under schedule A For each additional income.
2. Deduction methods : Income Tax =Taxable Income x tax rate - Deduction
Deduction = upper taxable income pervious tax bracket tax rate of given bracket-cumulative threshold.

Tax on Income from Rental of Buildings (Schedule ‘B’)

Any income arising from rental of buildings is taxable under schedule ‘B’. Rental income includes all form of
income from rent of a building and rent of furniture and equipment if the building is fully furnished. Income
from the lease of business including goods, equipments and building which are part of the normal operation of a
business, (called business lease) are taxable under another schedule that is in schedule ‘C’

Gross rental income also includes any cost incurred by the lessee for improvement to the land or building all
payments made by the lessee on behalf of the lessor in accordance with the contract lease. In the lease contract
there are two parties involved in renting a building, the lessor and the lessee. The party who grants rent of the
building is the lessor. The one who leases the property for use is the lessee. In some occasions the lessor may
allow the lessee to sub lease the building for another party. In such circumstances the first lessee becomes the
sub-lessor and the third party who rents the building from the lessee is called sub-lessee. The sub lessor must
pay tax on the difference between income from the sub leasing and the rent paid to the lessor, provided that the
amount received by the sub lessor. The owner of the building who allows a lessee to sub- lease is liable for
payment of the tax for which the sub lessor is liable, in the event the sub-lessor fails to pay.

Taxable Income

i. Gross income includes all payments, either in cash or benefited in kind,

ii. All payments made by the lessee on the behalf of the lessor.

iii. The value of any renovation or improvement to the land or the building

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Deduction
For lessor that do not maintain books of accounts

 taxes paid with respect to the land and buildings being leased; except income taxes; and
 for taxpayers not maintaining books of account, half (50%) of the gross income received as rent for
buildings furniture and equipment as an allowance for repairs, maintenance and depreciation of such
buildings, furniture and equipment;
For lessor that maintain books of accounts
 For taxpayers maintaining books of account, the expenses incurred in earning, securing, and maintaining
rental income, to the extent that the expenses can be proven by the taxpayer and subject to the limitations
specified by this Proclamation, deductible expenses include (but are not limited to) the cost of lease (rent) of
land, repairs, maintenance, and depreciation of buildings, furniture and equipment in accordance with
Article 23 of this Proclamation as well as interest on bank loans, insurance premiums.

Tax Rate

The tax payable on rented houses shall be charged, levied and collected at the following rates:

(a) if the lessor or owners are bodies , they pay thirty percent (30%) of taxable income,

(b) On income of persons according to the Schedule B (hereunder) Schedule –B

Schedule B

Taxable income from rental of building Tax rate Deduction in

No (Income per year) birr
Over Birr To Birr % Birr
1 0 7200 Exempt threshold
2 7201 19800 10 720
3 19801 38400 15 1710
4 38401 63000 20 3630
5 63000 93,600 25 6780
6 93601 130800 30 11460
7 Over 130800 ***** 35 18000

COMPUTATION OF INCOME TAX ON INCOME FROM RENTAL OF BUILDING

RENTAL INCOME RECEIVED XXXXX
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Add: Amount received on the
i) Lease of furniture xxx
ii) Lease of equipment xxxxx
Less: Deductions:
i) Taxes paid on land and buildings Leased xxxx
ii) For those not maintain books of Accounts
Allowance for repair, maintenance and depreciation (50% of gross income) xxxx
iii) For those maintain books of Accounts
 Expenses on
a) Cost of lease of land xxxx
b) Repairs xxxx
c) Maintenance xx
d) Depreciation of building, furniture and
Equipments xxx
e) Interest on bank loans xxx
f) Insurance premiums -- xxxxxx (xxxxxx)
TAXABLE INCOME FROM RENTAL OF BUILDINGS XXXXXX

Accounting for Business Income Tax

Business means manufacture or purchase and sale of a commodity with a view to make profit. It includes any
trade, commerce or manufacture or any other adventure or concern in the nature of entrepreneurial activity.

Taxable Business Income

Taxable business income shall be determined per tax period on the basis of the profit and loss account or
income statement, which shall be drawn in compliance with the Generally Accepted Accounting Standards, or
IFRS subject to the provisions of this Proclamation and the directives issued by the Tax Authority.

Category of Taxpayers

Category “A” taxpayer includes;

a. Business that have separate legal personality (share company, PLC and public enterprise) regardless of
their annual sales revenue.
b. Any company incorporated under the laws of Ethiopia or in a foreign country and other entities having
annual turnover of more than Br500, 000.
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Category “B” Taxpayer

Category “B” taxpayers includes, unless already classified in Category “A” Taxpayer , business with no legal
personality and those enterprises having annual income of more than Br 100,000 and less than Br 500,000 ( i.e.
Br 100,000 < sales < Br 500,000). Category “B” taxpayers have to submit the profit and loss statement together
with the supporting vouchers.

Category “C” Taxpayer

Category “C” includes all taxpayers who are not classified under the other two categories and whose annual
turnover is estimated at Br 100,000 or less.

Tax payment Period

The fiscal year starts on Hamle 1 and ends on Sene 30. The body can change the accounting year only with the
permission of the tax authority. When the tax period of a body is changed (with the permission); the period
between the previous tax period and the new period will be treated as a “transitional period”.

Allowable Deductions

1) Direct cost of producing the income such as the direct cost of manufacturing, purchasing, importation,
selling and such other similar costs.

2) General and administrative expenses incurred for earning, securing and maintaining the income. such costs
are salary of administrative personnel , utility cost, rental cost ,repair and maintenance and e.t.c.

3) Bad debt

4) Premium payable on insurance directly connected with the business activity

5) Expense incurred for the promotion of business

6) Commission paid for services rendered, provided that the amount shall not exceed the normal rates
provided by other similar businesses or persons

7) Any payment made by a branch, subsidiary or associated company in

8) Salaries, wages or other benefit paid to the children of proprietors or member of partnership.

9) Salaries and other personal benefit paid to manager or managers of a private limited company.

10) Interest expense, if the lending institution is recognized by NBE or a foreign bank permitted to lend to
enterprises in the country.
30
11) Depreciation expenses

Non-allowable Deductions

1) Additional investment: an increase in the share capital of a company or the original capital of a registered
partnership

2) Pension or provident fund contribution in excess of 15% of the monthly salary of employees

3) Business profit tax and input value added tax ;-

4) Fines or penalty paid under violation of law

5) Losses that are not connected with the business activity

6) Losses recoverable by insurance

7) Entertainment expenses

8) Personal consumption expenses

9) Salary, wages, and other personal benefit paid to the partner, or proprietor of an enterprise

Declaration and Payment of Tax

A) Taxpayers categorized as “A” are required to declare their taxable income within four months from the end
of the tax period

B) Those taxpayers who are categorized as “B” are required to declare their taxable income within two months
from the end of the tax period

C) Category “C” taxpayers shall declare taxable income within one month i.e. between July 07 and August each
year

Assessment of Tax

Assessment is a tax review by a tax official of the tax declaration and information provided by a taxpayer and a
verification of the arithmetical and financial accuracy of the declared tax liability. The procedure for the
assessment of business income tax takes two forms:

A) Assessment by books of accounts, and

B) Assessment by estimation.

31
Business Income Tax Rates

According to the income tax proclamation, the following tax rates are used for computation of business income
tax under Schedule “C”. The Range of Taxable Business.

Taxable income from Schedule C (Income Tax rate Deduction in

No per year) birr
Over Birr To Birr % Birr
1 0 7200 Exempt threshold
2 7201 19800 10 720
3 19801 38400 15 1710
4 38401 63000 20 3630
5 63000 93,600 25 6780
6 93601 130800 30 11460
7 Over 130800 ***** 35 18000

Provision for Loss Carry Forward

If a business incurs a loss in a year, that loss may be set off against taxable income in the next three years. If
there is operating loss for more than one period, earlier losses being set off before later losses. A net operating
loss may be carried forward and deducted only for two periods of three years. However, the loss cannot be
carried forward: If during a year, the direct or indirect ownership of the share capital or the voting rights of a
business changes more than twenty-five percent, by value or by number and if the business cannot provide a
books of account showing the loss, which are acceptable by the authority.
Penalties
The following penalties are provided in the proclamation regarding business income tax.
1.For Non-declaration
Taxpayers who do not declare tax income within the period specified in the regulation will be liable to pay Br
1,000 for the first 30 days of non-declaration. The penalty is Br 2,000 for the next 30 days of non-declaration.
Br 1,500 will be charged for each 30 days for failure to declare the taxable income thereafter.
2. For understatement of taxable income
Understatement of taxable income results in a penalty of 10% of the amount Understatement. If the
understatement is substantial, the penalty will be 30%.
3. For late payment
When a taxpayer fails to pay tax within the due date, he/she will be required to pay a penalty of 5% of the
amount unpaid. An additional 2% penalty on the amount unpaid is imposed on the first day of each month for
non-payment.
4. For failure to keep records
32
Failure to keep books of accounts, records and other documents by any taxpayer results in a penalty of 20% of
the tax assessed. If this failure continues for two consecutive years, the license of the taxpayer will be
suspended. One more year’s failure leads the tax authority to revoke the license of the taxpayer.
5. For failure to withhold
A withholding agent, who fails to withhold tax per the proclamation, will be personally liable to pay tax (which
has been withheld). In addition, this failure obliges the agent to pay Br 1,000 per case. The following
individuals are also liable in this regard:
1) The manager that has known of the failure
2) The chief accountant or a senior officer who was responsible for the supervision of the withholding activities.

SCHEDULE ‘D’ INCOME: OTHER INCOMES

The following incomes shall be chargeable to income tax under the Schedule-D:

1. Royalties (Article- 31): The term “royalty” means a payment of any kind received as a consideration for the
use of ,or the right to use, any copyright of literary, artistic or scientific work, including cinematography films
and films or tapes for radio or television broadcasting, any patent, trade work, design or model, plan secret
formula or process, or for the use or for the right to use of any industrial, commercial or scientific equipment, or
for information concerning industrial, commercial or scientific experience. Royalties shall be liable to tax at a
flat rate of flat rate of 5%

2. Income from Rendering of Technical Services (Article- 32): The term “technical service” means any kind
of expert advice or technological service rendered. All payments made in consideration of any kind of
technical services rendered outside Ethiopia to resident persons in any form shall be liable to tax under this
Article. It is Taxable at a flat rate of 10%.The amount of tax shall be withheld and paid to the Tax Authority by
the payer.

3. Income from Games of Chance (Article- 33): Every person deriving income from winning at games of
chance (for example, lotteries, tom bolas, and other similar activities) shall be subject to tax. It is Taxable at the
rate of 15% except for winnings of less than 100 Birr.

4. Dividends (Article- 34): It is Taxable at the rate of 10%

1) The withholding Agent shall withhold or collect the tax and account to the Tax Authority.

2) This tax is a final tax in lieu of income tax.

5. Income from Rental of Property (Article- 35):

33
Every person deriving income from the casual rental of property (including any land, building, or moveable
asset) not related to a business activity taxable under Article 17 shall pay tax on the annual gross income. It is
Taxable at the rate of 15%

6. Interest Income on Deposits (Article- 36): It is Taxable at the rate of 5%

SCHEDULE ‘D’ INCOME: OTHER INCOMES

• This is the last Schedule of income.

• Any income which is taxable under the Income Tax Proclamation but does not find place under any of
the remaining three Schedules of income (i.e., Schedules A, B and C) will be taxable under this
residuary Schedule “D” Other Incomes.

Learning activities

Recording Business Income Tax

Example Melat enterprise, unincorporated business has reported earnings before tax of birr 80,000 at the tax
year ended Sene 30,2006.

Required

A. Determine the amount of business income tax?

B. Record necessary journal entries?

34
 CHAPTER V

ACCOUNTING FOR DIRECT TAXES IN ETHIOPIA

Objectives of the chapter

 Understand the scheduler tax system in Ethiopia

 Indentify the taxable income and exemptions in each Schedule
 Compute tax liabilities using the proper tax rates and deductibles.

Introduction

The Ethiopian tax system follows scheduler tax system, in which the tax liability of a taxpayer is determined based on
the schedule of each income. This implies the loss incurred in one schedule is not allowed to compensate from the
income generated in the other schedule. Accordingly as it is depicted in article 8 of the income tax pro 979/16, direct taxes
are classified in to four schedules and an income exempted from tax is listed in separate schedule.

 Schedule ‘A’, income from employment;

 Schedule ‘B’, income from rental of buildings;
 Schedule ‘C’, income from business;
 Schedule ‘D’, other income;
 Schedule ‘E’, exempt income.
Ethiopia levies tax on residential jurisdiction basis. As per the income tax proclamation, every resident of Ethiopia
who gets income within the country or from abroad is charged under the act on transferring the amount to
Ethiopia.

ACCOUNTING FOR EMPLOYMENT INCOME TAX

Income as defined in the income tax proclamation includes every sort of economic benefit including non-recurring
gains in cash or in kind from whatever source derived and in whatever form paid, credited or received. Taxable
income shall mean the amount of income subject to tax after deduction of all expenses and other deductible items allowed
as per the law.

According to Pro 979/16 of Art 12 Employment income includes the following excluding the exempted incomes under
schedule ‘’E’’

a) Salary, wages, an allowance, bonus, commission,

b) The value of fringe benefits received by an employee in respect of a past, current, or future
employment*;*As it is indicated in the income tax regulation No 410/2017 Article 8 the list of fringe benefit
includes th following: debt waiver; household personnel; housing or accommodation, discounted interest loan,

35
 meal or refreshment, private expenditure, property or service; an employee share scheme, vehicle;residual fringe
benefit
c) Employees termination compensation
The Employment Income Tax Rate: Article 11
Employment Income Employment Income Deductions for short
(per month) Birr Tax Rate cut method

0 –600 0% 0
601-1,650 10% 60
1,651-3,200 15% 142.50
3,201-5,250 20% 302.50
5,251-7,800 25% 565
7,801-10,900 30% 955
Over 10,900 35% 1500

Employment Income Exemption Indicated in Schedule “E”

List of exempted employment income and allowances indicated in the proclamation (Art 65) and income tax regulation
(Art 54) and relative directives includes the following:

 The first six hundred birr (600 birr) of monthly income tax of the employees
 An allowance in lieu of means of transportation granted under a contract of employment with limit that will
be issued by the ministry directive. Currently 25% of the basic salary but not exceeded 2,200 birr is free
from tax, here the transportation allowance is exempted when the employees performs their work by
traveling from one place to the other, it cannot be granted for movements made from home to office and vice
versa.
 Transportation allowance Birr 600.00 for covering transport expenses of the employees from home
to office and vice versa.
 Transport expenses and per diem payments to an employee travelling on a tour of duty subjected to
limit currently per diem payment is exempted up to 4% of the basic salary of the employee or Birr
500 which is the higher.
 a cash indemnity allowance paid by an employer to an employee, but only to the extent that the
allowance compensates the employee for shortfalls on money counts;
 Employment income of not exceeding five years paid to expatriate professionals recruited for
transfer of knowledge by investors engaged in export business in accordance with a directive to be
issued by the Minister;
 Income from employment received by unskilled employee working for the same employer whether
continuously or intermittently for not more than thirty (30) days within any twelve month period.
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  An amount paid by an employer to cover the actual cost of medical treatment of an employee
including Premium payments made by an employer on behalf of an employee under employees,
medical insurance scheme
 Hardship allowance paid in accordance directives issued by civil service commission
 Food and beverages provided for free to an employee by an employer conducting a mining,
manufacturing, or agricultural business subjected to limit issued by the ministry
 Allowances paid by the Government of the Federal Democratic Republic of Ethiopia to employees
engaged in public service in a foreign country
 Allowances paid to members and secretaries of boards of public enterprises, public bodies, or study
groups established by the Federal or a State Government or City administration;
 contributions by an employer to a pension, provident, or other retirement fund for the benefit of an
employee provided the monthly total of contributions does not exceed 15% of the monthly
employment income of the employee;
 an amount exempt from tax to the extent provided for under an international agreement example
remuneration of diplomatic personnel of foreign countries
 a public award for outstanding performance in any field or an award granted under Article 135 of the
Tax Administration Proclamation
 an amount as compensation for personal injury or the death of another person
 a scholarship or bursary for attendance at an educational institution
 maintenance or child support payments salaries paid to domestic servants

Payroll Records and Preparation

Payroll register: - this is a multi-column register (form) for the payment of salaries at the end of the payroll period.
Payroll Components includes: Employee Name and Employee ID, Earning Columns (parts), Deductions, Net pays,
Signature

1. Earning

A. Basic Earning /Salary/:

B. Allowance: - Additional monthly payment to the employee for one of the following reasons
 Position allowance or Acting allowance:
 Housing allowance: -
 Transportation /fuel/ allowance: -
 Cash indemnity allowance: -
 Hardship allowance:.

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  Desert Allowance: -
 Representation allowance:
C. Over time payment: - is a payment for extra hours worked beyond the regular working hours
Over time payment = regular hourly salary rate* rate for the duration of overtime work

Regular hourly rate = monthly basic salary divided by normal working hours per month

Overtime rate

Ordinary time: from 6 in the morning (AM) to o’clock to 10 o’clock in the evening (PM)

Over time rate =1.25 * Regular hourly rate

Late hours: from 10PM up to 6 AM, Over time rate =1.5 * Regular hourly rate

Weekly rest days: Over time rate =2 * Regular hourly rate

Public holydays: Over time rate =2.5 * Regular hourly rate

D. Bonus: - is a material (money) reward for better or best performance by managers or other employees. Bonus
could be based on net income for managers or based on monthly salary (basic salary) for other employees. Bonus to
top manager is most of the time based on annual income of the business enterprise.
2. Gross /earning/ Salary: - is computed by totalling all the earning i.e. Basic Salary + Allowances, if any + Overtime
payment, if any + Severance pay, if any + compensation, if any + bonus, if any + … etc.
3. Taxable income: - includes all earning except for non taxable incomes as specified under exemption discussed
above.
4. Deduction: - These are subtractions form the gross earning, so as to identify the net pay of an employee.
a. Statutory deduction: - deduction enforced or imposed by low.
Currently, Pension contribution in Ethiopia applies to both public & private employees as per of the following rate (Proc.
No. 714/2011)

 7% (of the basic salary) by the employee

 11% (of the basic salary) by the employer.
Voluntary deduction: - these are not imposed but are voluntary deductions Example: Credit association, credit
purchase …etc.

b. Others: - Like court order, fines, absence …etc.

5. Net pay: - the net pay is the difference between the gross earning of an employee and the total of the deductions.
6. Signature: - When an employee receives his/her pay he will sign to confirm that he have received the net pay.

Computation Employment income Tax on Bonus

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Computation of bonus has the following steps:

A. Determine the amount of bonus to be paid for the employees

B. Calculate the monthly tax amount using the basic salary
C. Divided the bonus amount in 12 months because bonus is paid for outstanding performance that employees
achieved in the year. However if the employees have service duration of less than 12 months the amount of bonus
should divided to the numbers of months in which the employees serves in the year.
D. Calculate the monthly income tax using the taxable income you get in “C”
E. Find the difference of the monthly income tax you get in step “D” and “B” and multiply by 12 months or by the
service duration of the employees in the year expressed in months. This is the total tax to be paid from the bonus.
F. Net pay= total bonus-tax amount on the bonus
Accounting Treatment for Employment Income Tax

To explain the journal entries consider the above ABC plc payroll register and recorded in the general journal as
follows.

Date Items post ref. Debit Credit

salary expenses 28,093.7

Cash 19,947.81

Employees’ Pension cont. payable 1,575

Employment income tax payable 5,310.94

Credit association contribution payable 1,200.00

Red cross society contribution payable 60

To record the employees’ pension contribution and employment income tax

Date post ref. Debit Credit

Payroll expenses 2,475

Employer Pension cont. payable 2,475

To record the employer pension contribution

Date post ref. Debit Credit

Employees’ Pension cont. payable 1,575

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 Employer Pension cont. payable 2,475

Employment income tax payable 5,310.94

Credit association contribution payable 1,200.00

Red cross society contribution payable 60

Cash 10,620.94

When it is declared and paid to tax authority

Accounting for Rental Income Tax

Rental income tax includes all forms of income arising from rent of building and rent of furniture and equipments if the
building is furnished. In Ethiopia the rules for rental income tax is indicated in the income tax pro. 979/16 from Art 13 up
to Art 17. The income tax proclamation classifies income from renting of building as Schedule B income.

Taxable Rental Income Tax

All amounts derived by the taxpayer during the year under the lease agreement, including any lease premium or similar
amount;

 All payments made by the lessee during the year on behalf of the less or according to the lease agreement;
 The amount of any bond, security, or similar amount that, during the year, the taxpayer is entitled to retain as a
result of damage to the building and that has not been used by the taxpayer in repairing the damage to the
building;
 The value of any renovation or improvement made under the lease agreement to the building when the cost was
borne by the lessee in addition to the rent payable to the taxpayer.

Rental Income Tax Rates

The rental income tax rates are two types. The first rate is applicable to bodies at flat rates of 30% of their rental income
tax. The second rate is applicable to individual taxpayers in the following manner.

Rental Income Deduction or

Taxable Rental Income
Adjustments for
(per year)Birr Tax Rate short cut method

0 -7,200 0% 0

7,201-19,800 10% 720

19,801-38,400 15% 1,710

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 38,401-63,000 20% 3,630

63,001-93,600 25% 6,780

93,601-130,800 30% 11,460

Over 130,800 35% 18,000

Rental income tax (RIT) =Taxable income*Tax rate-Adjustments

Computation of Rental Income Tax
The computation of rental income tax is two types for these who do not have an obligation to maintain books of
accounts and for theses who maintains books of accounts(category A and B tax payers).

In computing the taxable rental income for taxpayer who does not maintain books of account, a deduction (rental
expenses) shall be allowed for the following amounts:
a) any fees and charges, but not income tax, levied by a State or City Administration in respect of the land or building
leased and paid by the taxpayer during the year;
b) an amount equal to fifty percent (50%) of the gross rental income derived by the taxpayer for the year as an
allowance for the repair, maintenance, and depreciation of the building, furniture, and equipment.

In computing the taxable rental income for a tax year of a taxpayer who maintains books of account, a deduction shall be
allowed for any expenditures to the extent necessarily incurred by the taxpayer in deriving rental income and paid
during the year including:
a) The cost of the lease of land on which the building is situated;
b) Repairs and maintenance;
c) Depreciation of the building, furniture and equipment;
d) Interest and insurance premiums; and
e) Fees and charges, but not income tax, levied by a State or City Administration in respect of the land or
building leased.
Here if the allowable deduction exceeds the gross income earned from renting of the building, there is a
Gross Income from leasing activities XXX

Less: Allowable deductions XX

Taxable income XXX

RENTAL TAX = TAXABLE INCOME X TAX RATE LESS ADJUSTMENTS

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Declaration and Payment of Rental Income Tax

The time allowed for declaration of taxable income and payment of taxes the same as that of schedule ‘C’ tax. Remember
that a taxpayer who has taxable income from rent shall declare the income (Art 83).

 Category A taxpayers Within 4 months after the end of fiscal year

 Category B taxpayers Within 2 months after the end of fiscal period
 Category C taxpayers Within 1 month after the end of the fiscal period
Record Keeping Obligations Related to Rental Income: the income tax proclamation 979/2016 clearly indicates the
record keeping obligation related to Category of “A” and “B” taxpayers engaged in renting of buildings. That is these
taxpayers who are liable for tax under Schedule “B” shall keep the following record of accounts:
 Rental income received;
 Fees and charges paid to a State or City Administration in relation to the building;
 Any expenditures incurred in relation to the building;
 A register of rental buildings showing the acquisition date, the cost of acquisition, any costs of improvement in
relation to the building, and the current net book value of the building;

 Any sub-lease arrangement in respect of the building.

Date Description Items post ref. Debit Credit

Rental income tax expenses Xxxxxxx

Prepaid withholding rental income tax Xxxxx

Rental income tax payable Xxxxx

ACCOUNTING FOR INCOME TAXES FROM BUSINESS

C ATEGORY OF T AXPAYERS , AND T AX R EPORTING PERIOD

For the purposes of payment of business tax, taxpayers are categorized in to three namely, Category A, Category B, and
Category C.

Preservation of Books and Accounts

Every businessman (except category C) is required to preserve all books of accounts and other records and documents for
a period of not less than 5 years forcategory “A” tax Payer and For 3 Years for category “B” tax Payer after the
year of income to which such books and documents relate.

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Particularly in accordance the income tax proclamation (ITP) of article 59, Category ‘A’ tax payers liable for business
income tax shall keep books of account prepared in accordance with the financial accounting reporting standards and, in
particular shall keep the record of:

 business assets and liabilities of the taxpayer,

 all daily income and expenditures;

 all purchases and sales of trading stock, and services provided;

 trading stock on hand at the end of the taxpayer’s tax year,;

 Any other document relevant in determining the tax liability of the taxpayer

On the other hand Category ‘B’ taxpayers liable for business income tax shall keep the following: a record of daily
income and expenditures; all purchases and sales of trading stock; salary and wages register and any other document
relevant in determining the tax liability of the taxpayer.
Category ‘C’ taxpayers may keep a record of gross income and other records that category B taxpayers required to
maintain. In addition, if these taxpayers are employing a worker shall keep documents showing any amount of
employment income paid to the employee and any amount withheld in tax from such income (Income tax regulation Art
59). Category C tax payer that maintains books of accounts may pay their tax accordingly if the books of account
maintained are accepted by the tax authority.
4.4.3. Methods of Tax Accounting (Article 64)

The period of tax assessment is one fiscal year. The fiscal year starts on Hamle 1 and ends on Sene 30. The body can
change the accounting year only with the permission of the tax authority. When the tax period of a body is changed (with
the permission) the period between the previous tax period and the new period will be treated as a ‘transitional period’.

Category “A” taxpayers are required to use international financial reporting standards (IFRS) particularly accrual
basis of accounting to record their business transactions.

Category “B” shall follow simplified methods of accounting that is cash basis of accounting to account for business
income and deductible expenditures.

Depreciation of Business Asset and Business Intangible

Depreciable asset means tangible movable asset or a structural improvement to immovable asset that:

(1) Has a useful life exceeding one year;

(2) Is likely to lose value as a result of normal wear and tear, or obsolescence; and
(3) Is used wholly or partly to derive business income
As it is stipulated in the income tax regulation of Art 36 to 41, both diminishing value (declining balance method) and
straight-line method is allowed to compute the depreciation amount. The Business intangible and structural
improvement should be depreciated only under straight-line method. Here structural improvement means a building or
43
any other addition or alteration to immovable asset that becomes part of, or is permanently affixed to, the immovable asset
including a road, driveway, car park, fence, or wall.

Rate of Depreciation

Depreciable Tangible Asset Straight line rate Diminishing value rate

Computer, software and data storage equipment 20% 25%

Green house 10% Not allowed

Structural improvement otherthan greenhouse 5% Not allowed

Any other depreciable assets 15% 20%

Depreciable assets used in mining and petroleum 25% 30%

development operation

Here under diminishing value method depreciation is computed by applying the rate on the Net book value of the asset at
the beginning of the year.
The rate of depreciation applicable for business intangible includes the following:
 Preliminary expenditure or pre-operational costs (25%): an expenditure that provides an advantage or benefit
for a period of more than one year, incurred before the commencement of a business but not including
expenditure incurred to acquire any tangible movable or immovable asset.
 Business intangible useful life more than 10 year except preliminary expenditure= 10%
 Any other business intangible 100% divided by the useful life of the intangible.
If the balance of depreciable asset of the taxpayer is not more than two thousand birr the amount shall be fully allowed
deductible from the income of the tax year.

Repair and improvement expense allowable as deduction if it is not exceeded 20% of the net book value of the asset at the
endof the tax year. However, if the improvement made to the fixed asset exceeds 20% of the netbook value of the asset at
the end of the tax year, the whole cost of improvement or repair shall be added to the net book value of the asset.
Depreciation on assets such as fine art, antiques, jewelry, trading stock etc (which are not subject to wear and tear) are not
allowed. Likewise, gain obtained as a result of revaluation of assets shall not use as a basis for determining
depreciation base.
For assets for which the pooling method is used, the rate is applied to the depreciation base for the determination of
depreciation. Depreciation base is the book value of the asset on the opening day of the tax period, increased by the cost
of acquisition, creation, renewal etc during the period and reduced by the sales price of the asset disposed during the
period. Loss incurred during the period due to natural calamity and other involuntary conversion will also be considered
for the computation of depreciation base. Any compensation received for these purposes will be deducted from the book
value.While determining the depreciation base, if it becomes negative, it will be added to the taxable income.

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4.4.5. Taxable Business Income
1. Allowable Deductions

A) Direct cost of producing the income

B) General and administrative expenses
C) Depreciation expense computed in accordance the income tax regulation
D) Bad Debt Expenses
E) Insurance Premium payable on insurance directly connected with the business activity.
F) Expense incurred for the promotion of business.
G) Commission paid for services rendered,
H) A loss on disposal of a business asset (other than trading stock) disposed of by the taxpayer during the year
I) Representation expense not exceeding 10%the income of the employees
J) Medical expense incurred for employees including premium payment sunder employees health insurance
scheme
K) Expenditures incurred in the provision of food and beverage services by Hotels, restaurants, or other similar
establishments for their employees, to the extent limit sated by the ministry directives
L) Lease payment

N. Head Office Expenses:

O. Interest expense:
P. Charitable Donations
Q. Special Reserves: Financial institutions are permitted to deduct special reserves from taxable income in
accordance with the directives issued by NBE.

R. Reinvestment of Profit: A Regulation by the Council of Ministers allows a deduction of reinvestment of

profit (of a resident company or registered partnership) not exceeding 5% of the taxable income every year.

2. Non - allowable deductions and losses

a) An expenditure of a capital nature

b) An increase in the share capital of a company or the basic capital of a registered partnership;
c) Voluntary pension or provident fund contributions in respect of an employee in excess of 15% of the monthly
employment income of the employee;
d) Dividends and paid-out profit shares;
e) An expenditure or loss to the extent recovered or recoverable under a policy of insurance, or a contract of
indemnity, guarantee, or surety;
f) A fine or penalty imposed, or punitive damages awarded, for violation of any law, regulation, or contract;

45
 g) An amount that a person has transferred, in its financial accounts, to a reserve or provision for expenditures or
losses not yet incurred but expected to be incurred in a future tax year;
h) Income tax paid under this Proclamation or under a foreign tax law, or recoverable value added tax;
i) Representation expenditures of an employee in excess of 10% of the employment income of the employee;
j) Expenditure incurred in the provision of entertainment, except:
(1) When the person’s business involves the provision of entertainment; or
(2) to the extent that the expenditure is allowed as a deduction under a Directive issued by the Minister
relating to food provided for free to employees by an employer conducting a mining, manufacturing, or
agricultural business;
k) A donation or gift except as provided for in Article 24 of this Proclamation;
l) Personal consumption expenditure;
m) A loss on the disposal of a business asset by a taxpayer to a related person;
n) Expenditure to the extent disallowed under Regulations to be issued by the Council of Ministers.
4.4.6. Business Income Tax Rates

The rate of business income tax applicable to a body is [30%]. While, The rates of business income tax applicable to
an individual are:
Taxable Business Income Deductions for
Business Income
(per year) Birr Short cut method
0 - 7,200 0% 0
7,201-19,800 10% 720
19,801-38,400 15% 1710
38,401-63,000 20% 3630
63,001-93,600 25% 6780
93,601-130,800 30% 11460
Over 130,800 35% 18000
Business Income Tax = Taxable business income* tax rate less Adjustmentfor individual tax payers
Assessment of Tax
Assessment is a tax review by a tax official of the tax declaration and information provided by a taxpayer and a
verification of the arithmetical and financial accuracy of the declared tax liability. The procedure for the assessment of
business income tax takes two forms, A) assessment by books of accounts, and B) assessment by estimation.

Foreign Tax Credit: If a resident taxpayer has foreign income taxable under “Schedule C” in respect of, which the
resident has paid foreign income tax, the taxpayer shall be allowed a tax credit (referred to as a “foreign tax credit”). The
amount foreign tax credit is equal to the foreign income tax paid; or the business income tax payable under Schedule ‘C’
in respect of the foreign income.

46
Foreign Business Losses (Art 46): in relation to a resident taxpayer for a tax year, means the amount by which the
deductible expenditures incurred by the taxpayer in deriving foreign income taxable under Schedule “C” exceeds the
amount of that income for the year.
Withholding Income Tax (Art 88 to 93)

A. Withholding tax from imported goods:

B. Withholding of tax from Domestic Payments (Art 92):
C. Withholding of Tax from Employment Income:

D. Withholding of Tax from Payments to Non-residents:indicated in schedule D

E. Withholding of Tax from Dividends, Undistributed profit, repatriated profit, Interest, and Royalties:

F. Withholding of Tax from Games of Chance Income

G. Self-withholding: for employees who works in organization that don’t have withholdingobligation

Payment of Withholding Tax: Tax that a withholding agent is required to withhold from withholding income shall be
paid to the tax authority within 30 days after the end of the month in which the withholding income was paid

4.4.12. Method of Preparing Tax Returns

Names of the taxpayer
Business income tax return
For the tax period ending June 30, 20xx
Admissible business income
Net Sales……………………………………………………………………..……xxxx
Less cost of goods sold……………………………………………………………xxxx
Gross profit…………………………………………………………………………xxxx
Add other admissible incomes
Income from lease of business……………………………………………..…..…….xxx
Gain on foreign exchange ………………………………………..………….……..xxxx
Commission income ……………………………………………………………….xxxx
Recovery of bad debt expenses previously write off……………………………….xxxx
Gross taxable profit………………………………………………………………....xxxx
Less tax deduction expenses
Selling and distribution expenses………………………….xxxx
Utility expenses………………………………………..…..xxxx
Salary and fringe benefit expenses…………………….…..xxxx
Interest expenses ………………………….………………xxxx
Depreciation expenses ………………....…….………..….xxxx
Advertizing expenses ……………………..…….………...xxxx

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 Donation expenses………………………….….………..…..xxxx
Tax business income ……………………………………………………………...xxxx
Less provision for tax………………………………..…………xxxx
Net profit tax after tax………………………………………………………………xxx

Other Income (Schedule “D” Tax) : Incomes which are not specifically included under Schedule “A”, Schedule B and
Schedule C is categorized under this schedule. Schedule D income includes;
1. INCOME OF NON-RESIDENTS
A non-resident who has derived an Ethiopian source dividend, interest, royalty, management fee, technical fee, or
insurance premium shall be liable for non-resident tax at the rate specified as follows:
 For an insurance premium or royalty , 5% of the gross amount of the premium or royalty;
 For a dividend or interest, 10% of the gross amount of the dividend or interest;
 For a management or technical fee, 15 % of the gross amount of the fee
However, the income generated by non-residents through permanent establishment cannot be taxed under this category.
Rather, it is taxed under schedule “C” or “D”.
2.Taxation of Non-resident Entertainers
A non-resident entertainer or group of non-resident entertainers who has derived income from the participation by the
entertainer or group in a performance-taking place in Ethiopia shall be liable for income tax at the rate of 10% on the
gross income derived from the performance without deduction of expenditures. Here, entertainer” includes musician and
sports person; “group” includes a sporting team; and “performance” includes a sporting event.
3. Taxation of Royalties
Royalty refers to a payment of any kind received as a consideration for the use of or the right to use any copyright of
literary, artistic or scientific work, including cinematography film, and films or tapes for radio or television broadcasting,
any patent, trademark, design or model, plan, secret formula, or process, or for the use or for the right to use of any
industrial, commercial or scientific equipment, or for information concerning industrial, commercial or scientific
experience.

Royalties is subject to a tax at a flat rate of 5%. The withholding agent who effects royalty’s payments, withholds the
foregoing tax and accounts to the Tax Authority. However, if the payer resides abroad and the recipient is a resident, the
recipient must pay the tax on royalty income. This tax is final in lieu of income tax.

4. INCOME FROM GAMES OF CHANCE

This form of income is derived from winning at games of chance (lotteries, Tom bolas, and other similar activities). This
income is subject to tax at the rate of 15%, except for winnings of less than Br. 100 similar to income from rendering
technical activities the payer must withhold or collect the tax and account to the Tax Authority. This tax is final in lieu of
income tax

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5. DIVIDENDS

The taxable Income is income received in the form of dividend from a share company or withdrawals of profits from a
private limited company. Resident of Ethiopia who derives dividend and non resident who derives Ethiopian sources
dividend that is attributable to a permanent establishment are liable to pay dividend income tax. Dividend Income is
subject to tax at the rate of 10% of the gross amount of the dividend. The withholding agent (payer) shall withhold or
collect the tax and account to the tax Authority. 6. INCOME FROM CASUAL RENT

The taxable income under this category is income derived from casual rental of property (land, building, or moveable
asset) not related to a business activity. This type of income is subject to tax at a flat rate 15% of the annual gross income.
This tax is a final tax in lieu of a net income tax.

7. INTEREST INCOME

A resident of Ethiopia who derives interest and non resident who derives Ethiopian source interest that is attributed to
permanent establishment, are liable for income tax at the rate of:
 5% of the gross amount of the interest derived from savings deposit with a financial institution that is a
resident of Ethiopia,; or
 10% of the gross amount of the interest in any other cases
The payer must withhold the tax and account to the Tax Authority. This tax is a final tax in lieu of income tax.

8. Windfall Profit: windfall profit” means any unearned, unexpected, or other non-recurring gain. The directive issued by
ministry of finance and economic cooperation determines the tax rate imposed on windfall profit.

.9. GAINS ON TRANSFER OF CERTAIN INVESTMENT ASSESTS

Gains obtained from the transfer (sale or gift) of building held for business, factory, and office and a share of companies is
taxable under this category. Such income is taxable at the following rates:-

- Building held for business, factory, and office at the rate of 15%, and
- Shares and Bonds at the rate of 30%
Nonetheless, Gains obtained from the transfer of building held for residence is exempted from tax provided that such
building is fully used for dwelling for two years prior to the date of transfer.

10. Undistributed profit

Tax shall be paid at the rate of 10% on the net undistributed profit of a body in a tax year to the extent that it is not
reinvested, in accordance with the directive to be issued by the ministry of finance and economic cooperation.
11. Repatriated Profit

A non-resident body conducting business in Ethiopia through a permanent establishment shall be liable for tax at the rate
of 10% on the repatriated profit of the permanent establishment.

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12. Other Income
A person who derives any income that is not taxable under Schedule A, B, C, or D is liable for income tax at the rate of
15% on the gross amount of the income.

Learning Activities

Example 1: suppose Glorious plc has four employees and assume that the normal working hours per week are
44 hours. The total earning for Jan. 2009 E.C stated as follows

No Employees name Basic Over time work fuel Position

salary allowance allowance

1 Tadesse Abate 4500 - - -

2 TedrosEphrem 6000 10 hours in the ordinary time and - -

15 hours in the late time

3 AdaneTesfaye 12,000 12 hours in the weekly rest days 2,500* 500

Additionally all employees contributes 20 birr per month to Ethiopian Red Cross society, Adane is member of
the Credit association of the company monthly saves 10% of his basic salary.

*The nature of work demands movement from one place to other place and indicated in the employment
contract.

Required:

A. Compute the gross earning

B. Compute the taxable income
C. Compute the pension fund contribution by the employee and employer
D. Compute the employment income tax
E. Compute the net payee
F. Prepare the payroll register
G. Record the salary and payroll expense

Example 2: Suppose w/roAbeba has rented her building in July 8, 2007 E.C for monthly rent of birr 10,000 and leases on
land paid to A.A city administration during the year was birr 3,000. In addition, she was category “C “tax payer.

Required: Compute the annual rental income tax of w/o Abeba for the year ended July7, 2008 E.C
50
Example 3: Suppose Abay PLC has rented his building found in AA, Arada Sub-city for monthly rental of Birr 120,000
in July, 2007 EC. The company also provides the following financial information in relation to the building:
 Cost leases paid on land……………………………….…...12,000
 The cost of the building and accumulated Depreciation were …6,000,000 and 1,500,000
 Insurance premiums paid on the building …………………...30,000
 Outstanding loans taken for construction(at 9.5% interest)….2,000,000
 Wages of building administrators and cleaning expenses……….70,000
Required: Compute the Rental income tax paid at the end of the year 2008 E.C and journalize the rental income tax at
july 7, 2008.

Example: 4 Mr. James is a foreign citizen neither domicile nor a habitual residence in Ethiopia. He comes to Ethiopia for
the first time on Ginbot 11, 2008 E.C for three months to give training in connection with the shooting of cinematography
film in A.A. For this, he has been paid remuneration of Br 50,000 by master company, an Ethiopian company. Mr. James
comes to Ethiopia for the second time on Meskerm 7, 2009 E.C. for the same job and left Ethiopia on Tir 30, 2009 E.C.
During this time, he has been paid birr 85,000 by master company.

Required:

A. Determine the residential status of Mr James for the tax year 2008 E.C.
B. Is his income chargeable to income tax in Ethiopia? And if your answer is yes under what schedule he is
liable to pay tax?
C. What would the residential status of Mr James for the tax year of 2009?
Example 5. XYZ plc financial statement shows the following information (the company use diminishing value method)
 The cost of computers birr 185,000 and accumulated depreciation in June, 30/ 2007 E.C birr 120,000.
 During the 2008 E.C tax period the company under takes the following transactions.
 Three computer and printer was purchased at the cost of Birr 30,000
 Software products costing Br 10,500 was purchased
 Seven used computers with cost of Br 48,000 and accumulated depreciation Br 45,000 was sold for Br 18,000
 Compensation of Br 3,000 was received from the vender since two of the computers acquired during the
current tax year were slightly damaged during in transit. The company incurred Br 1,000 to maintain the
computer and place them in workable condition.
Example 6 The following was extracted from HM plc fixed asset record maintained for financial reporting purpose for
the tax years ended June, 30 2007 E.C (use diminishing value)
 The cost of pool machines at the beginning of tax year 2007 E.C. was 1,800,000 and accumulated depreciation Br
500,000
 The company acquired new machine costing Br 50,000 in the tax year 2007 E.C
 The company had sold two used machines during the tax year, 2007 as follows
Acquisition cost Accumulated depreciation Selling proceeds
51
 200,000 170,000 83,800

95,000 90,000 48,000

Required: compute the depreciation expenses deductable from gross business income of the tax year 2007 E.C.

Example 7: Suppose X Bank Ethiopia Share Company has its head office located in A.A and its financial statement for
the tax year ended June 30, 2008 E. C shows the following information.

Particulars Head Office Kenya South Sudan Tanzania

Taxable Business income (in Br) 100,000 100,000 30,000 60,000

Tax rate of respective countries 30% 20% 30% 40%

Required: compute the business income tax payable to the Ethiopian tax authority.
Example 8: The HM plc financial statement for the tax year ending June 30, 2008 E.C shows the financial information.
HM PLC
Income Statement
For the year ended, June 30, 2008 E.C
Net Sales Br.327, 000
Less: Cost of Goods Sold 155,000
Gross Profit 172,000
Less: Operating Expenses:
Salaries and Wages Br.22, 000
Representation 6,000
Utilities 3,100
Supplies 1,200
Advertising 9,100
Entertainment 2,200
Depreciation 20,000
Interest 2,500
Miscellaneous 1,300 67,400
Operating Income Br.104,600

Additionally the following information was obtained for tax reporting purpose.

52
 The Br.55, 000 ending inventory cost was determined based on the FIFO method. If the LIFO or Average Cost
method had been used, the amount would have been Br.58, 000 and Br.52, 000, respectively.
 Salaries and wages comprise Br.1, 000 disallowable provident fund of employer’s contribution.
 Representation expense calculated at 25% of basic salaries of the employees.
 The Br.15, 000.00 depreciation was reported on the original cost of the Br.120, 000.00 building; and the Br.5, 000.00
depreciation was also reported on the original cost of the Br.50, 000 vehicles. The accumulated depreciation at the
beginning of the tax year for Building and vehicle was Br 45,000 and Br 30,000 respectively. The company used
straight line method for Building and declining balance method for depreciating the vehicle.
 The interest is on Br.25,000, and 10% simple annual interest borrowed from a recognized financial institution By
NBE in 2008 E.C. The highest interest rate by NBE and commercial banks for the current year was 6%.
Required: Compute the business income tax payable for the tax year using independent and dependent approach.

Example 9. ABC Co. sold a building, which is held for business for Br. 1,000,000, which is acquired at a cost of Br. 1,
200,000. Depreciation until time of sale amounts Br. 500,000 and property tax paid for the building Birr 50, 000.

Calculate the capital gain tax payable by ABC Co.

53
 CHAPTER VI

TAX ACCOUNTING FOR INDIRECT TAXES

Objectives of the chapter

 Explain the different types of indirect taxes applied in Ethiopia

 Understand the tax rates used for each indirect tax

 Compute the tax liability from taxable transactions

 Understand the penalties for failure to report the tax liability

Introduction

Indirect taxes occupy a dominant position, as direct taxes, in the tax policies of many governments. Especially,
in developing countries like Ethiopia the lion share of the government revenue were collected from indirect
taxes. Indirect taxes which are levied and collected in Ethiopia includes value added tax, turnover tax, excise
tax, custom duty and sure tax.

BASIC CONCEPT OF VAT

Value added Tax (VAT) is also known as General sales tax (GST) or Consumption tax. According to Carl
S.Shoup . VAT is defined as a consumption tax charged on the value added to goods and services (or
intermediate products) by importers, Manufacturers, and traders at each stages of production and
distribution process. The salient elements embodied on the definition are:

 VAT IS A CONSUMPTION TAX IN THE SENSE THAT INDIVIDUALS PAY VAT WHEN THEY SPEND ON

GOODS AND SERVICES.

 VAT IS IMPOSED ON THE INCREMENTAL VALUE OF GOODS AND SERVICES MADE AT EACH STAGES OF

PRODUCTION AND DISTRIBUTION PROCESS.

 VAT IS IMPOSED NOT ONLY ON TANGIBLE GOODS BUT ALSO ON SERVICES

 VAT HAS A WIDER SCOPE: IT IS LEVIED AND COLLECTED FROM IMPORTER, PRODUCERS,

WHOLESALERS AND RETAILERS.

 THE TAX BURDEN IS VISIBLE AT EACH STAGES OF PRODUCTION AND DISTRIBUTION PROCESS

54
VAT HAS TWO PRINCIPAL COMPONENTS THAT ARE INPUT VAT AND OUTPUT VAT.

INPUT VAT: IS VAT PAID OR PAYABLE BY A TAXABLE PERSON ON PURCHASE OF GOODS AND SERVICES. IT

IS NOT THE COMPONENTS OF THE COST OF PURCHASE RATHER IT IS DEDUCTED FROM THE COLLECTED

VAT ON SALES.

OUTPUT VAT: IS THE VAT COLLECTABLE BY TAXABLE PERSON AT THE TIME OF TAXABLE SALES. OUTPUT
VAT IS NOT A COMPONENT OF SALES REVENUE OF THE PERSON RATHER IT IS A LIABILITY TO THE

TAXABLE PERSON, WHICH IS COLLECTED BY HIM ON THE BEHALF OF THE TAX AUTHORITY.

NET VAT LIABILITY: IS THE DIFFERENCE BETWEEN THE INPUT VAT AND OUTPUT VAT. WHEN THE

OUTPUT VAT EXCEEDS THE INPUT, VAT THE TAXPAYER HAS A NET VAT LIABILITY OR PAYABLE, ON THE
OTHER HAND IF THE INPUT VAT EXCEEDS THE OUTPUT VAT SHOWS THE NET VAT CREDIT/NET VAT
REFUNDABLE.

Computation of Net VAT Liability

Net VAT liability is the excesses of output VAT over the input VAT for a given tax accounting period. It can be
computed using one of the following three methods:

Credit/Invoice method: Net VAT liability is equal to Output VAT less Input VAT. This method widely used
in many countries

Subtraction Method: Net VAT liability is calculated by subtracting the cost from the selling price and
applying the tax rate on the difference.

ADDITION METHOD: THE NET VAT LIABILITY IS CALCULATING BY ADDING THE PAYMENT MADE TO THE

FACTORS OF PRODUCTION (WAGE, RENT, INTEREST ETC) AND PROFIT MARGIN AND THEN APPLYING THE

TAX RATE TO THE SUM.

VAT IN ETHIOPIA

The introduction of value Added Tax (VAT) is probably the most important tax development in the world. VAT
has been introduced for the first time almost 50 years ago, and its applications remained confined to a handful
of countries until the late 1960’s. Today, VAT is applied in over 120 countries. This makes about 4 billion
people or 70% of the world’s populations live in countries with a VAT. In these countries VAT raises about $18
trillion in tax revenue, roughly a quarter of all governments revenue.

VAT replaced the former sales tax because of the following deficiencies:
55
  Sales tax was collected at single stage of production or distribution
 Sales tax is a tax on tax it creates cascading effect and
 VAT reduces tax evasion more than sales tax

Types of VAT Registration

According to VAT law, Ethiopia provides three types of registration for its VAT administration purpose
depending up on the criteria to be meet and the nature of the business activity: - mandatory registration,
voluntary registration, and trade sector requirement registration.

A. Obligatory Registration

A person who carries on a taxable activity is required to be registered mandatory if:

 At the end of any period of the 12 calendar months, the person made taxable transactions whose value
exceeds Br. 1,000,000.00

 There is a reasonable ground to expect that the person’s taxable activity shall exceed Br. 1,000,000.00 at
the beginning of any period of 12 calendar months.

B. Voluntary Registration

Even if the annual gross income of a taxpayers is less than Br 1,000,000 in 12 months of VAT accounting
period, the taxpayer can voluntary registered for VAT if the person regularly supplies or renders services at
least 75% of his taxable goods and services to VAT registered persons, in any 12 months period.

C. Trade Sector Requirement for Registration

Some persons who carry out taxable supply may compulsory registered for VAT regardless of their annual sales
turnover because of the nature of trade sector engaged. Specifically, these persons that engaged in highly
priced and highly demanded taxable activities and trade sectors that requires high initial capital and which
have high production volume. These sectors includes

 Gold and ornament material traders

 Electronic materials traders
 Importers
 plastic and plastic product manufacturers
 shoe factors
 Contractor above grade 10 (grade 1-9)
 Computer and their accessories traders
 Lather and Lather product manufacturers

56
Cancellation of Registration

Cancellation of registration can by conduct in two ways. In the first way, a registered person can apply to have
his registration cancelledif he/she ceases to make taxable transactions. The taxpayer must apply in writing
within 30 days of the date he ceases to make taxable transactions.

In the second way, cancellation of registration can also be initiated by a registered person if at any time after a
period of three years of his most recent registration, his total transaction for the period of 12 months then
beginnings are expected to be not more than Br. 1,000,000.

When registration is cancelled the registered person is deemed to have sold the goods on hand in a taxable
transaction.Any obligation or liability including the furnishing of returns, in respect of anything done by that
person while the person was a registered person, is not affected by cancellation of registration.

Following cancellation, the authority will remove the person’s name and all other details from the VAT register
and the person is required to return the issued certificate of registration back to the authority.

VAT Rates: In Ethiopia, there are two types of VAT rates, Zero rate and Standard supplies.

Zero VAT rate: it is applied on zero rate supplies. In this case, the input VAT incurred on purchase to make
taxable supply is allowed to be credited. The taxable person who supplies zero rate supplies charges zero rate on
its supplies indicating that have no VAT liability. The following supplies/ transaction are subjected to zero
rates:

 Export of goods and services

 Rendering international transport services
 Disposal or transfer of taxable activity as a going concern
 Supply of gold to the national bank of Ethiopia (NBE)
Here, these taxpayers eligible to request VAT refund paid on purchase or on raw materials used to produce
these good and service subjected to zero rate.
Standard Rate: the standard rate is 15%, which is applied on standard rated supplies. The input VAT incurred
to make taxable supply is allowed to be credited and the taxable person has a responsibility to charge 15% of
output VAT on its taxable activity.

VAT Exempted Supplies, In the case of exempted supplies, the input VAT incurred on purchase cannot be
claimed rather it is included in the cost of purchase. In accordance with the VAT proclamation, regulation and
directives the following good and service supplies are exempted from VAT:

 Supply or import of basic food items such as agricultural crops, milk, flour, bread, Enjera, and edible
palm oil etc
  rendering educational service and child care services
 sale or transfer of a used dwelling, or the lease of dwelling;
 rendering of financial services;
 supply or import of national or foreign currency (except for that used for numismatic purposes), and
of securities;
 The import of good to be transferred to the National Bank of Ethiopia.
 The rendering by religions organizations of religious or church related services;
 The import or supply of prescription drugs specified in directive issues by the Minister of Health,
and the rendering of medical services.
 The supply of goods and rendering of service in the form of humanitarian aid, as well a import of
goods transferred to state agencies of Ethiopia and public organizations for the purpose of
rehabilitation after natural disasters, industrial accidents, and catastrophes;
 The supply, kerosene, and water;
 Goods imported by the government, organizations, institutions or projects exempted from duties and
other import taxes to the extent provided by law or agreement.
 Supplies by the post office authorized under the Ethiopian Postal Services Proclamation, other than
services rendered for a fee or commission.
 The provision of transport;
 Permits and license fees;
 The import of goods to the extent provided lender schedule 2 of the customs Tariffs Regulations;
 The supply of goods or services by a workshop employing disabled individuals if more than 60% of
the employees are disabled;
 The import or supply of books and there printed materials to the extent provided in regulations.
Value of Taxable Supplies

Value of the taxable supply is the amount of the taxable supply on which the VAT base is charged.

 Value of taxable supplies for price consideration= Purchase cost/production cost

excluding input VAT+ Profit margin. In other words, it is the difference between the Selling price and
Input VAT.
 Value of taxable supplies on import is (CIF value + customs duty + excise tax)
 The value of taxable supply in case of exchange and free supply we will considers the
fair market value of the goods
 The value of supplies on own uses the cost of the goods and services
  the value of supplies in case of transfer of assets as going concern= the acquisition
cost of the assets
 The value of taxable supplies for VAT inclusive price= the Price divided by (1.15)
Adjustment of the Value of a Taxable Transaction
Adjustment of the value of a taxable transaction in relation to a taxable transaction made by a registered person
is necessary when

 the transaction is cancelled;

 the nature of the transaction is changed;
 the previously agreed consideration for the transaction is altered, whether due to a reduction of
prices or for any other reason; or
 The goods or services are returned in full or in part to the registered person.
Claiming Input VAT at the Time of Registration
Input VAT Claim at the time of Deregistration

Book Value= (remaining useful life/total useful life)*Acquisition cost

VAT creditable= Book value*0.15

Input VAT Claim in making Taxable and Exempted supplies

According to the VAT Law, input VAT incurred to make taxable supply is fully credited or claimed. But, the
Input VAT incurred on purchases which is used to make exempted supplies is not allowed to be credited rather
it is considered as cost of purchase.

In case of Input VAT incurred on purchase used to make composite supply, the input VAT claimed is
determined by the following formula
Input VAT claimed = Total input VAT*(value of total taxable supplies divided by total value of supplies)

If the total value of taxable supplies over total value of supplies is greater than 90% full amount of the Input
VAT is claimed.

Input VAT Claim for Capital Asset under Construction

VAT Deceleration and payments

VAT registered taxpayers whose 12 months sales turnover is Birr 70,000,000.00 and above shall declare and
pay their VAT liability every month. While, these VAT registered taxpayers whose 12 months sales turnover is
less than Birr 70,000,000.00, shall declare and pay their VAT liability every three months.

Recognition of VAT Transactions

 Taxable import Transaction
 Inventory or other account………………xxxx
Prepaid WIT………………………………xxxx
VAT Account (receivable)……………….xxxx
L/C or cash…………………………xxxx
 Taxable Local Purchase
Inventory or other specific assets…………xxx
VAT account………………………………xxxx
Cash or payable………………………………………xxxx
WIT payable*……………………………………......xxxx
*if it meets the criteria indicated in the WIT
 Local sales
Cash (receivable)……………….xxxx
Prepaid WIT*……………………xxxx
Sales……………………………………xxxx
VAT account (payable)………………...xxxx
 Exported Transaction
Cash (receivables)………………………xxxxx
Sales………………………………xxxx
VAT Refund System

If at least 25 percent of the value of a registered person’s taxable transactions for the accounting period is taxed
at a zero rate, the Authority will refund the amount of VAT applied as a credit in excess of the amount of VAT
charged for the accounting period within a period of two months after the registered person files an application
for refund, accompanied by documentary proof of payment of the excess amounts.

VAT Withholding by Buyer

To minimize the damage that may cause by attempting to evade VAT and to ascertain the collection of accurate
VAT by the gov’t introduced VAT withholding by VAT amendment proclamation No 609/2008.

Accordingly, the following entities are considered as VAT withholding agents:

 Federal gov’t organizations or agencies

 Regional gov’t agencies
 City administration agencies and
 Public enterprise

These VAT withholding agent is obliged to withhold 50% of the required amount of VAT that should have
been paid to a taxable supplies on the transaction if the value of the transaction exceeds Br 20,000 and must be
declare and pay to the tax authority with 30 days from the end of the month in which the VAT is withheld.

Recording sales made to VAT withholding agent

Cash or receivable………………………..…xxxx
VAT withheld……………………………….xxxx
Prepaid WIT…………………………………xxxx
Sales………………………………………………..xxxx
VAT account……………………………………….xxxx
Turnover Tax (TOT)

In Ethiopia TOT was introduced by proclamation No 308/2002to enhance fairness in commercial dealings, to
make a complete coverage of the tax system, and to enable the non-VAT registered taxpayers to discharge their
responsibility. A turnover tax is imposed on those persons who are not required to register for VAT, but supply
taxable goods and services in the country.

Turn over tax rate:

 2% (two percent) on Goods sold locally
 for Services rendered locally;
i. 2% ( two percent) on Contractors, grain mills, tractors and combine-harvesters;
ii. 10% (ten percent) on others services rendered locally such as consultancy, auditing, legal advice,
hotel, printing, advertizing, laundry, etc.

COMPUTATION BASE FOR TOT

TOT is calculated and levied on the gross receipt or selling price that the supplier receives from supply of
taxable goods and services. In exchange for supply of goods and rendering services, the base for imposition of
TOT is the market price of goods supplied or services rendered. If the owner consumes its good and services
for its personal use the TOT will be computed by considering the cost of purchase.
Turnover Tax Exempted Supplies
 Transactions such as sale, transfer or lease of dwelling house; rendering of financial services;
 Supply of national or foreign currency and securities;
 Rendering of church related services by religious organizations;
 Supply of drugs (specified by Ministry of Health);
 Rendering of educational and child care services;
 Supply of humanitarian services as humanitarian aid;
 Supply of electricity, kerosene and water;
 Provision of transport;
 Permits and license fees;
 Supply of goods and services of a workshop where more than 60% of the employees are disabled;
 Supply of books and printed materials; and
 Any other items specified through a directive issued by the MEFEC
TAX PERIOD

A. Non VAT registered Category “A” taxpayer are required to declare and pay TOT every Month
B. Non VAT registered Category “B” taxpayer are required to declare and pay TOT quarterly ( within one
month after the end of every three months
C. Category “C” taxpayers are required to declare and pay TOT Annually from Hamle1 to Hamle 30 by
Presumptive taxation.
Tax Accounting for TOT
Non-VAT registered Category “A” and “B” taxpayers who supplies taxable good and services are required to
maintain books of accounting. The VAT and TOT incurred on purchase by these taxpayers are considered as
cost of purchase. While sales transaction is made these taxpayers should collect TOT by applying the correct
TOT rate. The journal entries made during purchase and sales are stated as follows.
Purchase of goods and services
Inventory or other account………………………xxxx
Cash or payable …………………………xxxx
Sales of goods and services
Cash…………………….xxxx
Sales……………………..xxx
TOT payable……………..xxx

EXCISE TAX
Excise tax is an indirect tax or a specific tax levied and collected on imported and locally produced goods,
which are hazardous to health and causes social problem, demand inelastic basic good and luxurious goods.
Usually excise taxes are imposed on advelorem basis. It is the determination of duty or tax based on the value of
goods.

As per the excise tax proclamation No 1186/2020, the items of goods that are subject to excise tax in the
country are:

A. goods imported to the country

B. goods produced locally and
C. services supplied in Ethiopia
Tax Base for computation of Excise Tax
The base of calculation for goods locally produced is the cost of production multiplied by its excise tax rate.
However, the cost of production means direct labor and raw material cost incurred in the production process,
cost of indirect inputs and overhead costs, but does not include depreciation costs of machineries. 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.
Declaration and payment Period
Excise tax on imported items is paid at the time of clearing those goods from customs area. While, excise tax on
locally produced goods is to be paid, within 30 days of the next month following production.
Excise Tax Rate
Excise tax is determined at the rates indicated in the specific schedule provided in the excise tax proclamation.
The rates indicated in the proclamation are equally applied for goods imported and goods produced locally. The
rates of tax range from 5% for three wheeler motor vehicle items to 400% for used vehicle age exceeding seven
years.

Recording Excise tax Transactions:

Excise tax ……………………xxxx

Excise tax payable………………………………xxxx

Stamp Duty

Stamp duty is a tax levied on legal documents or instruments that requires affixing of seals. The type of
documents subject to stamp duty and the practice in relation to this varies throughout the world. Stamp duty is
regulated by Stamp duty Proclamation No.110/1998 (the “Proclamation”) as amended by Proclamation
No.612/2008.
Documents Subject to Stamp Duty
Under the stamp duty Proclamation, the following documents are charged with stamp duty:
A. Memorandum and Articles of Association of business organizations, cooperatives or any other form of
associations;
B. Award;
C. Bonds; warehouse bond;

D. Contract and agreements and memorandum thereof;

E. Security deeds: any instrument whereby borrower or guarantor gives to a lender a charge upon a part or
the whole of his property;

F. Collective agreement;

G. Contract of employment;

H. Lease, sub-lease and transfer of similar rights;

 I. Power of attorney; and

J. Document of title to property

Exemption from Stamp Duty

Under the Proclamation the documents and bodies are relieved from stamp duty includes, Public bodies, goods
imported for sale by traders, Share certificates and Embassies and Consulates
Stamp Duty Rate
There are two types of stamp duty rates, namely fixed duty and on value duty. Unlike fixed duty, on value duty
is an amount, which varies based on the value of the products, services, or property on which it is levied. Since
there is no detailed guideline in practice and, as a result of that, tax officers working on stamp duty report that
they require only payment of 1% of the value of the debt guaranteed even in the event where several assets are
given as pledges in a single instrument.
Customs Duty and computation of Taxes imposed on imported Goods
In Ethiopia generally there are five taxes imposed on imported goods. These includes Customs duty, WIT,
Excise tax, VAT and Surtax. In the previous sections, we have discussed the VAT, excise tax and WIT and
hence in this section only customs duty and surtax will be discussed.
Customs Duty
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. ERCA collects customs duty only on import items as no tax on export
is levied. The government waived taxes on export items on purpose- just to encourage export. However, there is
a 150 percent export tax particularly on certain hides and skins of animals. ERCA collects customs duty based
on the rules stipulated in the customs proclamation No. 859/2014 and other regulation and directives.

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%. From these bands of rates one can see that the minimum customs duty rate is
0(zero) while the maximum is 35 percent of the CIF (Cost + Insurance + Freight) value of an imported item.
ERCA collects customs duty on a great variety of goods which can be classified into two categories. The
classification is based on the primary purpose of the imported goods. Those import items used for productive
purpose, items to be re-exported and for public use are classified in category one while import items for all
other (non-productive) purpose are classified in category two.
Category 1
Raw materials, semi finished goods, producers goods, and import items for public use such as minibuses, buses
etc fall under category one. Raw materials can be processed or unprocessed materials that would be used as
industrial or agricultural input while producers’ goods are goods such as capital goods and others imported by
business organization for productive purposes. To encourage business organizations involved in activities such
as producing goods and services, special privileges are granted to them including the exemption of customs
duty and other taxes. As a result, raw material, and producers goods are largely zero (0) rated.

Though there is up to a 10 percent customs duty rate applied to some of them. For example, the importation of
agricultural production inputs such as a tractor is charged with 10 percent customs duty rate. The importation of
raw material and producers goods are highly encouraged for they promote domestically produced goods which
replace imported goods and helps to save cash flow out of the country. Generally speaking, the more the
imported goods are to be used for productive purpose, the more would get the customs duty rate near to zero.

Semi finished goods are also classified under category one. These goods are imported into the country for
further processing and their importation is encouraged next to raw materials and producers goods. ERCA
charges semi finished goods at a 10 and 20 percent customs duty rate.
Category 2
Imported goods which are classified in category two are items such as consumer or finished goods imported for
personal use or for a nonproductive purpose. Consumer goods may also be sub classified into durable and non-
durable goods. Durable consumer goods are goods like automobiles, furniture that have an expected useful life
of three or more years. Non-durable goods such as foods, gasoline, articles of clothing etc that are depleted or
discarded relatively soon. The highest customs duty rates are usually applied to consumer goods. For example,
an automobile is heavily taxed at a 35 percent customs duty rate on the grounds that it is imported for personal
use while ambulances which are primarily used for public use is imported free of customs duty and other taxes.
The general principle in setting customs rate in Ethiopia is that the more the imported item is to be used solely
for personal use the higher the rate of customs duty and other taxes. Full information on rates of customs duty
on each item to be imported can be obtained from the Ethiopian Customs Tariff prepared based on the
harmonized commodity description and coding system (H-S).

Surtax

Surtax is the fourth of the five taxes imposed on import items. Surtax was introduced in the Ethiopian tax
system on April 9, 2007. The council of Ministers issued a regulation to levy 10 percent surtax on imported
goods. The imposition of surtax was necessitated to build the financial capacity of the government for
interventions to solve the rise in the cost of living which is affecting consumers with low and medium income
level.
Ten percent of the sum of cost, insurance, freight, customs duty, excise tax, and VAT is the base of computation
for surtax on all goods imported into the country. However, the following items and services are exempted from
payment of surtax.
Fertilizer, Petroleum and lubricants, Motor vehicles for freight and passenger and other special purpose motor
vehicles, Air craft, spacecraft and part thereof , capital (investment goods) and some medicines, raw materials
and other goods which are already decided by law to be tax free.
Computation of taxes Imposed on imported Goods
To determine customs duty and other taxes on the imported goods the importer may use the following seven key
steps.
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 payment 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.
2 Step two calculates customs duty payable: by applying the customs duty rate on the duty paying value
3 Step three compute excise tax if the imported item is subjected to excise tax., the importer multiplies the
sum of duty paying value and customs duty by excise tax rate
4 Step four compute VAT, In this step, the importer multiplies the sum of duty paying value, customs
duty, excise tax by value added tax
5 The fifth step, to calculate surtax, involves multiplying the sum of duty paying value, customs duty,
excise tax, VAT, by surtax rate
6 The sixth step is to calculate withholding tax. In this step, the importer multiplies the duty paying value
by withholding tax rate.
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.
Generally the formula for calculating customs duty and other taxes imposed on imported goods are summarized
as follows
DPV =Cost + Insurance + Freight
Customs duty= DPV x CUDU =A
Excise tax= (DPV + A) x EXTA= B
VAT= (DPV + A + B) x VAT=C
Surtax= (DPV + A + B + C) x SURTAX =D
Prepaid WIT= DPV x WHT = E
Total tax payable = A + B + C + D + E
Where, DPV= Duty Paying Value, CUDU= Customs Duty Rate, EXTA = Excise Tax Rate
SURTAX= Surtax, and WHT = Withholding Tax rate

Journalizing imported goods and customs duty and other taxes paid
First, the importer must build its cost sheet to determine the cost of the imported goods. The cost of imported
goods includes CIF value, custom duty, excise tax, sure taxes, bank services charges related to L/C services, and
other costs such as transistors’ services charge, transport costs incurred from the customs office up to the
importer warehouse and unloading costs. Once the cost sheet is build by the importer the transaction will be
recorded as follows.

Inventory ……………………………xxxx
Prepaid WIT…………………………xxxx
VAT account………………………...xxxx
L/C or cash………………………………xxxx

In case customs data base price higher than the commercial invoice, the customs duty and other taxes should be
computed by using the customs data base price and the difference between the customs price and commercial
invoice is treated as customs difference account during recording the transaction.
Inventory ……………………………xxxx
Prepaid WIT…………………………xxxx
VAT account………………………...xxxx
L/C or cash………………………………xxxx
Customs difference………………………xxxx

Learning Activities
Example 1: Hanan Super market has been registered for VAT on 1Jan 2008 E.C. the taxpayer incurs the
following VAT on purchase before registration.
 July 10 ,purchase computer inventory excluding VAT at Br 50,000 from VAT registered tax payers

 August 10, pay Br 20,000 for service received including VAT

 Sep 14, purchase Vehicle at cost of 500,000 plus VAT

 Oct 19, purchase inventory at Br 100,000 plus VAT of which 50,000 of inventory value excluding
VAT was on hand at the time of registration.

Required: Compute the VAT claim at the time of registration

Example 2; LG Company is a VAT registered taxpayer located in A.A and its books of account for October,
2008 E.C shows the following transaction excluding VAT.
3. Purchase of Inventory from VAT registered Br 1,500,000 and non VAT registered Br 30,000
4. Import inventory at CIF value Br 2,500,000 , Excise tax and customs duty Br 265,000
5. Selling and admin expenses incurred Br 432,000 and 32, 000 was for entertainment
6. Sales 900,000 units at VAT exclusive price Br 6 to local market and export 300,000 units at VAT
exclusive price Br 6.5 per unit.
Required: determine the Net VAT liability (VAT Return) for the month of OCT, 2008 E.C

Example 3. Belen PLC is a VAT registered taxpayer that sells electronic materials in A.A. In June, 2008 E.C
the company undertakes the following transaction
 A) June 1 purchase inventory from YBZ company for cash at price Br 8,000 plus VAT
B) June 5, purchase inventory from KK plc at Br 18,000 + VAT
C) June 10, import inventory at C=80,000, insurance 7,000, freight charge 10,000, customs duty and excise
tax 48,5000. In addition the company also incurs 2,00 customs ware house cost before VAT is paid
D) June 13, purchase consulting service at Br 800+ VAT
E) June 15, paid telephone bill to Ethio-telecom Br 6,000+ VAT
F) June 18, defective inventory costing 2,000 excluding VAT charges purchased on June 1 from YBZ
company was returned to the supplier
G) June 20, withdrawal of by an owner inventory costing before VAT Br 2,000 for personal use
H) June 22, sales of inventory to various customers at price Br 300,000 +VAT and the CGS was Br 200,000
I) June 25, sales of inventory to XYZ plc at 200,000 +VAT and the CGS was Br 110,000
J) June 28, sales of inventory to A.A university at price 300,000 + VAT and the CGS was 200,000
Required: journalize the above transaction by considering perpetual inventory system and determine the Net
VAT liability of the tax payer during the months.

Example 4; ABC Traders had taxable turnover of Birr 120,000.00 for the three-month ended on ‘September’
30, 2007 E.C. Assuming that the taxpayer belongs to category ‘B’, how much will be the turnover tax payable
by the trader? Tax rate 2%

Quarterly turnover Birr 120000

Tax rate 2%

Example 5: HM PLC is a Non VAT registered taxpayer that sells alcohol drinks in A.A. In June, 2008 E.C the
company undertakes the following transaction
 June 1 purchase inventory from YBZ company for cash at price Br 50,000 plus VAT
 June 5, purchase inventory from non VAT registered taxpayer at Br 8,000 excluding TOT
 June 10, sales inventory to w/ro Genet at Br 60,000 including TOT
 June 10, sales inventory to YM PLC at Br 40,000 excluding TOT
Required: Record the above transaction

Example 6; Sunshine Traders, an import export firm in Ethiopia, imported textile items to the country in
‘Miazia’, 2005 E C. The cost, insurance, and freight of goods imported amount to Birr 320,000.00, 80,000.00,
and 80,000.00 respectively. In addition, the customer also pays 50,000 customs duties and excise tax rate shall
be 8%. How much does the firm pay as excise tax on this import?
Example 7: FincheaSugar Manufacturing Company produced 2,000 quintals of sugar in ‘Hidar’, 2009 E C.
The company gives the following data regarding the cost of production of 2.000 quintals in the month.

Material used Birr 875,000

Direct labor Birr 102,000
Indirect labor Birr 62,000
Heat, light, and power Birr 72,000
Other factory cost
(Other than depreciation of machinery) Birr 68,000
Tax rate 20%
Required: Compute the excise tax payable by the company for the month’s production.

Example 8: AB general importer imports 10 latest Toyota Double Cup Pickup vehicles with Motor Engine
power 3,600 C.C, Origin Japan and manufactured in 2018 for resale in A.A. The purchase cost of one Vehicle
was Br 600,000, Insurance Premium paid for all cars BR 100,000 , Transport costs paid up to A.A Kality
customs office for all vehicles Birr 200,000, Bank services charges, Transitory and other costs incurred Br
200,000. The customs duty rate of such vehicle is 35% and excise tax rate= 35%.
Required:
 Compute the customs duty and other taxes paid during import when the Ethiopian customs valuation
system (ECVS) indicates the same price.
 Record the transaction
 Compute the customs duty and other taxes paid on import if the Ethiopian customs valuation system
shows the purchase price per vehicle is Br 700,000.