Develop understanding of taxation

LO. identify and discuss the role of taxation in the Ethiopian economy

LO2. Identify and discuss direct tax

LO3. identify discuss indirect tax

L04 . identify and discuss stamp duty tax

Lo5. manage tax liability

Meaning of Tax:

A tax is “a compulsory charge imposed by the Government without any expectation of direct
return in benefit ". In other words, a tax is a compulsory payment or contribution by the
people to the Government for which there is no direct return to the taxpayers. Tax imposes a
personal obligation on the people to pay the tax if they are liable to pay it. The general public
should be taxed according to their ability to pay, and the people in the same financial position
should be taxed in the same way without any discrimination. Thus, tax can be defined as, "an
involuntary fee or more precisely, "unrequited payment", paid by individuals or businesses to
a government (central or local)". Taxes may be paid in cash or kind (although payments in
kind may not always be allowed or classified as taxes in all systems). The means of taxation,
and the uses to which the funds raised through taxation should be put, are a matter of hot
dispute in politics and economics, so discussions of taxation are frequently tendentious. A
good tax system should not affect the ability and willingness of the people to work, save and
invest. If not, it will affect the development of trade and industry and the economy as a
whole. Thus, a sound tax system should contribute in the economic development of a
country. Hence, "taxation should not be like killing the goose that lays golden eggs".

General Characteristics of Tax:

A tax has the following characteristics:

1. Tax is a Compulsory Contribution: Tax is a compulsory contribution by the taxpayers

to the Government. The people whom the tax is levied cannot refuse to pay the tax.
Once it is levied they have to pay it. Any refusal in this regard leads to punishments.
2. Benefit is not the Basic Condition: For the payment of tax, there is no direct return or
quid proquo to the taxpayers. That is, people cannot expect any return in benefit for
the amount of tax paid by them. Because, there is no relation between the amount of
tax paid by the people and the services rendered by the Government to the taxpayers.
3. Personal Obligation: Tax imposes a personal obligation on the taxpayers. When a
person becomes liable to pay the tax, it is the duty of him to pay it and in no way he
can escape from it.
4. Common Interest: The amount of tax received from the people is used for the general
and common benefit of the people as a whole. Now the Government has to render

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 enormous range of social activities, which incur heavy expenditure. A part of the
expense is sought to be raised through taxation of various types. Thus, taxes are said
to be the sharing of common burden by the people.
5. Legal Collection: Tax is the legal collection. It can be levied only by the Government
both Central and State.
6. Element of Sacrifice: Since the tax is paid without any return in benefit, it can be said
that there is the prevalence of sacrifice in the payment of tax.
7. Regular and Periodical Payment: The payment of tax is regular and periodical in
nature. It is levied for a fixed period usually a year. Thus, almost all the taxes are
annual taxes. The payment of taxes should be regular also.
8. No Discrimination: Tax is levied on all people without any discrimination of caste,
creed etc. but according to their ability to pay.
9. Wide Scope: Tax is levied not only on income but also on property and commodities.
To enhance the revenue and to bring all the people under the tax net, the Government
imposes various kinds of taxes. This enhances the scope of taxes.

Objectives of Taxation:

Government levies and collects taxes for various objectives. These objectives may be specific
or general.

Specific Objectives:

The basic purposes of levying taxes are as follows:

1. To support the operation of that government itself.

2. To influence the macro economic performance of the economy, the government's
strategy for doing this is called its fiscal policy.
3. To carry out the functions of the government such as national defense and providing
government services.
4. To redistribute resources between individuals or classes in the population. Historically
the nobility were supported by taxes on the poor modern social security systems and
intended to support the poor by taxes on the rich.
5. To modify patterns of consumption or employment within an economy by making
some classes of transaction more or less attractive.

General Objectives

Taxes are compulsory payments to the Government by the taxpayers. In the beginning,
Government imposed taxes for three basic purposes viz., to cover the cost of administration,
maintaining law and order in the country and for defense. But, in modern days, there has been
a sea change in the Government’s expenditure pattern. Today, the Government is in the
position to restore social justice in the society by way of providing various social services
like education, employment, pension, public health, housing, sanitation and the development
of weaker sections of the society. Besides the above, the Government announces heavy
subsidies for agriculture and industry. Thus, Government requires more amount of revenue

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than before. Non-tax revenues are not sufficient to meet the entire expenditures. Hence,
Government imposes taxes of various types.

Let us discuss the general objectives of taxation hereunder:

1. Raising Revenue: The basic purpose of taxation is raising revenue. To render various
economic and social activities, Government requires large amount of revenue. To
meet this enormous expenditure, Government imposes various types of taxes in
addition to the non-tax revenue.

2. Removal of Inequalities in Income and Wealth: The welfare state aims at the
removal of inequalities in income and wealth. By framing suitable tax policy, this
end can be achieved. It is stressed in the Canon of Equality. In Ethiopia, the
progressive taxation on income is the suitable examples in this regard.
3. Ensuring Economic Stability: Taxation affects the general level of consumption and
production. Hence, it can be used as an effective tool for achieving economic
stability. That is, by means of taxation the effects of trade cycle i.e. inflation and
deflation can be controlled. During the period of boom or inflation, the excess
purchasing power in the hands of people leads to rise in the price level. Raising the
existing tax rates or imposing additional taxes can remove such excess purchasing
power. Then the abnormal demand will be reduced and the economic stability can be
achieved. At the same time, by providing grants, tax exemptions and concessions,
production can be encouraged thereby inflation is controlled. Likewise, during the
period of depression or deflation, the role of tax policy in the economy is important.
Reduction in the existing tax rates and removal of certain taxes, consumption can be
induced which in turn results in increasing demand. This encourages business
activities, and the economic growth can be achieved. Thus, through properly devised
tax system, the economic stability can be achieved by controlling the effects of trade
cycle.
4. Reduction in Regional Imbalances: It is normal that certain parts of the country are
well developed, whereas some other parts or states are in backward conditions. To
remove these regional imbalances, the Government can use tax measures. By way of
announcing various tax exemptions and concessions to that particular backward
regions or states, the economic activities in those areas can be induced and
accelerated.
5. Capital Accumulation: Tax concessions or rebates given for savings or investment in
provident funds, life insurance, unit trusts, housing banks, post offices banks,
investment in shares and debentures of certain companies etc. lead to large amount of
capital accumulation which is essential for the promotion of industrial development.
6. Creation of Employment Opportunities: More employment opportunities can be
created by giving tax concessions or exemptions to small entrepreneurs and to the
industries adopting labour-intensive techniques. In this way, unemployment problem
can be solved to certain extent.

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 7. Preventing Harmful Consumption: Taxation can be used to prevent harmful
consumption. By way of imposing heavy excise duties on the commodities like
liquors, cigars etc. the consumption of such articles is reduced to a considerable
extent.
8. Beneficial Diversion of Resources: The imposition of heavy duties on nonessential
and luxury goods discourages the producers of such goods. The resources utilized for
the production of these goods may be diverted into the production of other essential
goods for which various tax concessions are given. This is called as beneficial
diversion.
9. Encouragement of Exports: Now-a-days export oriented industries are encouraged by
way of providing various exemptions like 100% relief from income tax, free trade
zones etc. It results in the large earnings of foreign exchange.
10. Enhancement of Standard of Living: By way of giving various tax concessions to
certain essential goods, the Government enhances the standard of living of people.

Functions of FIRA
The major functions of the authority are to:

 Assess, collect enforce and account for federal and joint revenue lists.
 Administer efficiently and effectively all tax laws of the government.
 Promote voluntary compliance.
 Advise the ministry on the tax issues.
 Safeguard taxes from strand and evasion.
 Improve quality of service to the taxpayers.
 Undertake studies to improve the implementation of tax law’s. regulations and directives.
Principles of taxation

Fairness

Ability to pay
Benefit principles
Efficiency
Cost of administration
Excess burden
Compliance costs

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 Canons Advocated by Adam Smith:

No one has yet come up with a better set of criteria for judging a tax than the Canons of
Taxation first proposed by Adam Smith more than two hundred years ago. Adam Smith in his
book, “Wealth of Nations” has explained the four canons of taxation that are mentioned
above. All accepts them as good taxation policy. We shall now explain them briefly.

1. Canon of Equality: According to this principle of Adam Smith, "the subjects of every
state ought to contribute toward the support of the Government, as nearly as possible,
in proportion to their abilities". That is, a good tax system should be based on the
ability to pay of the people. That is, all people should bear the public expenditure in
proportion to their respective abilities. Tax burden should be more on the rich than on
the poor. Since the rich people can pay more for public welfare, more tax should be
collected from richer section and less tax from the poor. The ability to pay may be
determined either on the basis of income and wealth or on the basis of consumption
i.e. luxury or necessity. In simple terms, canon of equality implies that when ability to
pay is taken into consideration, a good tax should distribute the burden of supporting
government more or less equally among all those who benefit from government.
2. Canon of Certainty: Another important canon of taxation advocated by Adam Smith is
certainty. According to him, "the tax which each individual is bound to pay ought to
be certain and not arbitrary. The time of payment, the manner of payment, the
quantity to be paid, should be clear and plain to the contributor and every other
person". It means the time, amount and method of payment should all be clear and
certain so that the taxpayer can adjust his income and expenditures accordingly. This
principle removes all uncertainties in the payment of tax and ensures smooth
functioning of the tax department.
3. Canon of Convenience: In the canon of convenience, Adam Smith states that, "every
tax ought to be levied at the time or in the manner in which it is most likely to be
convenient for the contributor to pay it". That is, the tax should be levied and
collected in such a way that is convenient to taxpayer. For example, it may be in
installments, land revenue may be collected at the time of harvest etc. This principle
reduces the tendency of tax evasion considerably. It includes the selection of suitable
objects for taxation, and also the choice of convenient periods for requiring payment.
The canon of convenience is a special form of the general principle that the public
power should as far as possible adjust its proceedings to the habits of the community,
and avoid any efforts at directing the conduct of the citizens in order to facilitate its
own operations. The sacrifices that inconvenient methods of fiscal administration
impose may indeed be treated as violations of both economy and equity.
4. Canon of Economy: The next important canon of taxation is economy. According to
Adam Smith,"every tax ought to be so contrived as both to take out and keep out of
the pockets of the people as the little as possible over and above what it brings into
the public treasury of the state". This principle states that the minimum possible
amount should be spent on tax collection and the maximum part of the collection
should be brought to the Government treasury. Taxation should be economical i.e.

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 this should be much more than mere saving in the cost of collection. Undue outlay on
the official machinery of levy is but one part of the loss that taxation may inflict. It is
a far greater evil to hinder the normal growth of industry and commerce, and therefore
to check the growth of the fund from which future taxation is to come. Thus the canon
of ‘Economy' is naturally sub-divided into two parts viz. (1). ‘Taxation should be
inexpensive in collection', and (2). ‘Taxation should retard as little as possible the
growth of wealth'. It may also be remarked that there is a close connection between
"Economy" and "Productivity", since the former aids in securing the latter.

3.5.2. Canons Advocated by Others:

Other researchers of taxation at other times have added to Adam Smith’s criteria. Some have
noted that a tax should be adequate, meaning it should produce sufficient revenue to support
whatever it is that citizens want their government to do. Some have argued for a "Benefit
Principle" whereby the amount of tax each is called upon to pay bears some relationship to
the benefits each taxpayer receives from government. Others have argued that a tax should be
neutral in its effect on the way markets work. But Smith’s Canons are the starting point for
any serious evaluation of a tax. The various canons added by others are explained below:

5. Canon of Productivity: According to C.F. Bastable, the tax system should be

productive enough i.e. it should ensure sufficient revenue to the Government and it
should encourage productive activity by encouraging the people to work, save and
invest.
6. Canon of Elasticity: The next principle advocated by Bastable is elasticity. The taxes
should be flexible. It should be levied in such a way to increase or decrease the tax
revenue depending upon the need. For example, during certain unforeseen situations
like floods, war, famine, drought etc. the Government needs more amount of revenue.
If the tax system is elastic in nature, then the Government can raise adequate funds
without any extra cost of collection. The tax system should be elastic is a desirable
canon of taxation. It may, indeed, be regarded as the agency for realizing at once
"Productivity" and "Economy". Where the public revenue does not admit of easy
expansion or reduction according to the growth or decline of expenditure, there are
sure to be financial troubles. For this purpose some important taxes will have to be
levied at varying rates. The particular taxes chosen will vary according to
circumstances, but the general principle of flexibility should be recognized and
adopted.
7. Canon of Diversity: According to this principle, there should be diversity in the tax
system of the country. The burden of the tax should be distributed widely on the entire
people of the country. The burden of the tax should be decentralized so that everyone
should pay according to his ability. To achieve this, the Government should impose
both direct and indirect taxes of various types. It should not depend upon one or two
types of taxes alone.
8. Canon of Simplicity: This principle states that the tax system should be simple, easy
and understandable to the common man. If the tax system is complex and vague, the

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 taxpayer cannot estimate his tax liability and it will cause irregularities in the
payments and leads to corruption.
9. Canon of Expediency: According to this principle, a tax should be levied after
considering all favorable and unfavorable factors from different angles such as
economical, political and social.
10. Canon of Co-ordination: In a federal set up like Ethiopia, Federal and State
Governments levy taxes. So, there should be a proper co-ordination between different
taxes imposed by various authorities. Otherwise, it will affect the people adversely.
11. Canon of Neutrality: This principle stresses that the tax system should not have any
adverse effect. That is, it shouldn’t create any deflationary or inflationary effects in
the economy.

2. 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. In Ethiopia, Government levies the direct taxes
such as income tax, tax on agricultural income, professional tax, land revenues, taxes on
stamps and registrations etc. From the above discussion, it can be understood that the direct
taxes levied in Ethiopia take the form of taxes on income and property.

3.6.1.1. Merits of Direct Taxes

Direct taxes have the following merits:

1. Ensures the Principle of Ability to Pay: Direct taxes are based on the principle of
ability to pay. They fall more heavily on the rich than on the poor. The tax burden is
distributed on different sections of the society in a just and equitable manner.
2. Reduces the Social and Economical Inequalities: Direct taxes reduce a disparity in the
distribution of income and wealth. By adopting the progressive tax system, rich
people pay on higher rates of adopting the progressive tax system, rich people pay on
higher rates of taxation, while the poor pay on lower rates or given exemptions. This
reduces the gap between the poor and rich to a considerable extent.
3. Certainty: Direct taxes satisfy the canon of certainty. In direct taxes, the time of
payment, mode of payment, the amount to be paid etc. are made clear. Both the
taxpayers and the Government know the amounts to be paid and the Government can
estimate the revenue from these taxes.
4. Economy: The cost of collection of these taxes is low because the government adopts
the different methods of collections like tax deduction at source, advance payment of
tax etc. Besides, the taxpayers pay the amount of tax directly to government. Thus, the
principle of economy is achieved in the case of direct taxes.
5. Elasticity: Direct taxes are elastic in nature. For example, when the income of the
people increases, the tax revenue also increases. Moreover, during the unforeseen

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 situation like flood, war etc. the government can raise its revenue by increasing the
tax rates without affecting the poor.
6. Educative Effect (civic consciousness): Direct taxes create civic consciousness among
taxpayers. Since the taxpayers feel the burden of tax directly, they are interested in
seeing that the Government properly spends the money. They are conscious of their
rights and responsibilities as a citizen of the State.
7. Control the Effects of Trade Cycles: Direct taxes control the effects of trade cycles.
They can be used as a tool to mitigate the effects of inflationary and deflationary
trends by raising or reducing the tax rates.

3.6.1.2. Limitations of Direct Taxes:

The following are the demerits of direct taxes:

1. Arbitrary in Nature: Direct taxes tend to be arbitrary because of the difficulty in

measuring the ability to pay tax. Paying capacity of the people cannot be measured
precisely. The levy is highly influenced by the policies of the Government.
2. Difficulties in the Formulation of Progressive Tax Rates (Direct taxes are arbiterary):
Direct taxes take the form of progressive taxation i.e. the tax rates increases with the
rise in income. It is very difficult to formulate the ideal progressive rate schedules in
this regard, since there is no scientific base.
3. Inconvenience: Under direct taxes, the taxpayer has to adhere to many legal
formalities such as submission of the income returns, disclosing the sources of income
etc. Moreover, he has to follow numerous accounting procedures which are difficult
to comply with. Further, direct taxes have to be paid in lump sum and at times,
advance payment of tax has to be made. This causes much inconvenience to the
taxpayers.
4. Possibility of Tax Evasion: The high rates of direct taxes create the tendency to evade
more. There is possibility for tax evasion by fraudulent activities. Thus, it is said that
the direct taxes are the taxes on honesty.
5. Limited Scope: The scope of the direct tax is very limited. In Ethiopia, most of the
people come under or below the middle-income category. If only direct tax is
followed, these people cannot be brought into the tax net because of the basic
exemption given. Thus, the Government cannot depend upon direct tax alone.
6. Disincentive to Work, Save, and Invest: When the taxpayer earns certain level, they
have to pay more, because of the higher rate of taxes attributed to the higher slabs.
This will in turn discourages them to work further, save and invest.
7. Expensive to Collect: Under direct taxes, each and every taxpayer is separately
assessed. Thus, the large number of taxpayers to be contacted and assessed and the
prevention of tax evasion make the cost of collection more expensive.

3.6.2. 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 the manufacturer of cement, he shifts the burden of tax to the consumers by
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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.

3.6.2.1. Merits of Indirect Taxes:

Indirect taxes have the following merits:

1. Convenience: Indirect taxes are more convenient to the taxpayers. Since the tax is
included in the selling price of the commodities, the consumer pays the tax when he
purchases them. He pays the tax in small amounts (installments) and does not feel its
burden. Thus, indirect taxes are quite convenient and less burdensome.
2. Wide Scope: While the people with income and wealth above a certain limit are
brought under the levy of direct taxes, indirect taxes are paid by all both poor and
rich. Under indirect taxes, everybody pays according to their ability. The tax burden
is not imposed on to the small section but it is widely spread. Thus, the indirect tax
has wider scope.
3. Elastic: The revenue from the indirect taxes can be increased. Whenever the
Government wants to raise its revenue, or lower it, it can be achieved by increasing
and decreasing the rates of taxes on the commodities whose demand is inelastic.
4. Tax Evasion is Not Possible: Indirect taxes are included in the selling price of the
commodities. So, evading of such tax becomes very difficult. If the person wants to
evade the tax, it can be done only by refraining the consumption of the particular
commodity.
5. Substantial Revenue: Indirect taxes yield substantial revenue to both Central and
State Governments. The developing countries like Ethiopia are heavily dependent on
indirect taxes. Direct taxes have a limited scope in these countries because of low per
capita income.
6. Progressive: Indirect taxes can be made progressive by imposing lower rates of taxes
or giving exemption to the necessary articles and heavy taxes on luxurious articles.
Thus, indirect taxes also confirm the principle of equity.
7. Effective Allocation of Resources: Indirect taxes have great influence in the
allocation of resources among different sectors of the economy. Resources allocation
can be made effective by imposing heavy excise duties on low priority goods and by
granting relief to industries producing high priority goods. This results into
mobilization of resources from one sector to another positively.
8. Discourages the Consumption of Articles Injurious to Health: Indirect taxes
discourage the consumption of certain commodities, which are harmful to health. By
imposing very high rates of taxes on commodities like liquors, drugs, cigarettes etc.,
which are harmful to health, their consumption can be reduced.

3.6.2.2. Limitations of Indirect Taxes:

The following are the demerits of indirect taxes:

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 1. Ability to Pay Principle is violated: Indirect taxes are not directly connected to the
taxpayers' ability to pay. Therefore, both the rich and poor equally pay the tax. Thus,
the principle of ability to pay is violated. Indirect taxes are regressive in nature.
2. Uncertainty: If indirect taxes are not levied on the commodities of common
consumption and levied only on luxurious articles, they tend to be inelastic. The
quantity demanded will be affected by the imposition of the taxes. Thus, the revenue
generated from them is uncertain.
3. Discourages Saving: Indirect taxes are included in the selling price of the
commodities. Hence, the people have to spend more on the purchase of the goods.
This, in turn affects the savings of the people.
4. High Cost of Collection: Indirect taxes are uneconomical as they involve high cost of
collection.
5. Civic Consciousness is Not Created: Under indirect taxes, taxpayers don’t feel the
burden of the tax. They are not aware of their contribution to the State. Thus, indirect
taxes do not create the civic consciousness in the minds of the people.
6. Inflationary: The indirect taxes cause an increase in the price all around. The increase
in the prices of raw materials, finished goods and other factors of production creates
inflationary trends in the economy.

3.6.3. Differences between Direct and Indirect Taxes:

Direct and Indirect taxes differ among themselves on the following grounds:

1. Shiftability of the Burden of Tax: In the direct taxes, the impact and incidence fall on
the same person. It is borne by the person on whom it is levied and is not passed on to
others. For example, when a person is assessed to income tax, he cannot shift the tax
burden to anybody else, and he himself has to bear it. On the other hand, in the case of
indirect taxes, the impact and incidence fall on different persons. It is not borne by the
person on whom it is levied. The burden of the tax can be shifted. For example, when
the manufacturer of cement pays excise duty, he can shift the tax burden to the buyers
by including the tax in the price of the cement.
2. Principle of Ability to Pay: Direct taxes conform to the principle of ability to pay. For
example, now people having income above Birr.150 per month, only is liable to pay
income tax. But, indirect taxes are borne and paid by the weaker sections of the
society also. As such, these taxes do not conform to the principle of ability to pay.
3. Measurement of Taxable Capacity: In the case of direct taxes, tax-paying capacity is
directly measured. For example, the taxable capacity for income tax is measured on
basis of the income of the individual. On the other hand, in the case of indirect taxes,
taxable capacity is measured indirectly. The luxurious articles are levied at the higher
rate of taxes on the assumption that they are purchased by the rich people. However,
low rate is charged on the articles of common consumption.
4. Principle of Certainty: Direct taxes ensure the principle of certainty. Both the
Government and the taxpayer know what amount is to be paid and the procedures to
be followed.

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 5. But in the case of indirect taxes, it is not possible. The taxpayer does not know the
amount of tax to be paid and the Government cannot predict the quantum of revenue
generated from the indirect taxes.
6. Convenience: Direct taxes cause much inconvenience to the taxpayers since they are
to be paid in lump sum. But the indirect taxes are paid by the consumers in small
amounts as and when they purchase the commodities. Moreover, the taxpayers need
not follow any legal formalities in the payment of tax. Thus, indirect taxes are more
convenient to them.
7. Civic Consciousness: People felt the burden of direct taxes directly. The taxpayer is
conscious of his contribution to the Government and interested in knowing whether
the tax paid by him is properly used or not. In this way, it creates civic consciousness
among the taxpayers. But indirect taxes do not raise such consciousness among the
taxpayers, because they pay the taxes indirectly.
8. Nature of Taxation: Direct taxes are progressive in nature. The rates of taxes go up
with the increase in the tax base i.e. income of a tax payer. But rich and poor
irrespective of their income equally pay indirect taxes. Thus, they are regressive in
nature.
9. Removal of Disparity in Income and Wealth: Since the direct taxes are progressive in
nature, they reduce the disparities of income and wealth among the people to a
considerable extent. But indirect taxes have a negative effect. Actually they are
widening the gap between the rich and poor when they are levied on the goods of
common consumption.
10. 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.

Major Types of Taxes existing in Ethiopia

Direct Taxes in Ethiopia

Employment income tax (Schedule A)

Every person deriving income from employment is liable to pay tax on that income at the rate
specified in Schedule ‘’A’’ as follows:

Employment Income Tax Rate (in %) Deduction

(Per month) (in Birr)

Over Birr To Birr

0 600 Nil -

601 1,650 10 % 60.00

1,651 3,200 15 % 142.50

3,201 5,250 20 % 302.50

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 5,251 7,800 25 % 565.00

7,801 10,900 30 % 955.00

Over 10,900 35 % 1500.00

Employment income shall include any payments or gains in cash or in kind received from
employment by an individual. Employers have an obligation to withhold the tax from each payment to
an employee, and pay the Tax Authority the amount withheld during each calendar month. In
applying the procedure, income attributable to the months of Nehassie and Pagume shall be
aggregated and treated as the income of one month. If the tax on income from employment, instead of
being deducted from the salary or wage of the employee, is paid by the employer in whole or in part,
the amount so paid shall be added to the taxable income and shall be considered as part thereof.

The following categories of income shall be exempt from payment of personal income tax:

 Income from employment received by casual employees who are not regularly employed
provided that they do not work for more than one month for the same employer in any twelve
months;
 Pension contribution, provident fund and all forms of retirement benefits contributed by
employers in an amount that does not exceed 15% of the monthly salary of the employee;
 Subject to reciprocity, income from employment, received for services rendered in the
exercise of their duties by diplomatic and consular representatives, and other persons
employed in any Embassy and who are national of that state and bearers of diplomatic
passports;
 Payments made to a person as compensation or a gratitude in relation to personal injuries
suffered by that person or death of another person;
 Amounts paid by employers to cover the actual cost of medical treatment of employees;
 Allowances in lieu of means of transportation granted to employees under contract of
employment;
 Hardship allowance;
 Amounts paid to employees in reimbursement of travelling expenses incurred on duty;
 Amounts of travelling expense paid to employees recruited from elsewhere than the place of
employment on joining and completion of employment or in case of foreigners travelling
expenses from or to their country, provided that such payments are made pursuant to specific
provisions of the contract;
 Allowance paid to members and secretaries of board of public enterprises and public bodies
as well as to members and secretaries of study groups set up by the Federal or Regional
Government; Income of persons employed for domestic duties.
 EIT=((GI-D)*TR)-ADG

Example

Mr. Albert gross taxable income from his employers in December 20X3 was Br. 3800.
Calculate the income tax deductible from the salary of Mr. Albert.
Shortcut

(3800 X 30%) – 412.50 = 727.50

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 1. Rental Income tax (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. Carefully note that 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 – schedule C.

Gross rental income also includes any cost incurred by the lessee for improvement to the land or
building and all payments made by the lessee on behalf of the lessor in accordance with the contract
of lease. There are two parties involved in renting a building – the lessee and the lessor. The party
who grants rent of the building is the lessor while 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 to another party in such
circumstances the first lessee will be called sub - lessor. 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 is greater than the amount payable to the 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-lesser fails to pay.

When a building is constructed for the purpose of giving on lease, the owner and contractor should
inform the Kebele Administration about its completion and the intention of giving it on lease. This is
also applicable when the building is rented before its completion. The Kebele Administration will
pass the information to the tax office for the determination of tax. It is also the responsibility of
Kebele Administration to gather any such information and communicate to tax office in case where
the parties fail to do so.

Taxable income

Gross income includes all payments, either in cash or benefits in kind, received by the lessor and all
payments made by the lessee on the behalf of the lessor. The value of any renovation or improvement
to the land or the building is also part of taxable income under this schedule if such cost is borne by
the lessee in addition to rent payable.

Taxable income from schedule B income is determined by subtracting the allowable deductions from
the gross income. Allowable deductions include the following;

- If the lessor does not maintain books of accounts his allowable deductions include
taxes paid on land and buildings being leased and 20% of the gross income received
as an allowance for repairs, maintenance and depreciation of such buildings,
furniture equipment.
- If the lessor maintains books of accounts the allowable deductions (deductible
expenses) include (but not limited to):-
a. Tax on land and buildings being leased
b. Cost of lease (rent) of land
c. Repairs, maintenance and depreciation of building (and
furniture and equipment if furnished) per income tax
proclamations article 23.
d. Interest on bank loan if any
e. Premium paid on insurance of building.
It is important to keep proper accounts for period of times when the building was not leased (kept
idle).

Tax rate
The income tax payable on rented houses shall be charged, levied and collected at the following rates:
- On income of bodies 30% of taxable income

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 - On income of persons according to schedule B below.

Annual Taxable Income Rate Deduction

Over Birr To Birr

0.00 7,200 0%
0
7,201 19,800 10% 2,160

19,801 38,400 15% 6,840

38,401 63,000 20% 16,920

63,001 93,600 25% 33,840

93,601 130,800 30% 59,400

130,801 & above 35% 95,400

Rental Income tax (Schedule “B”)

R
ental income includes all form of income from rent of a building and rent of furniture and equipment

if the building is fully furnished. Carefully note that 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 – schedule C.

Gross rental income also includes any cost incurred by the lessee for improvement to the land or
building and all payments made by the lessee on behalf of the lessor in accordance with the contract
of lease. There are two parties involved in renting a building – the lessee and the lessor. The party
who grants rent of the building is the lessor while 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 to another party in such
circumstances the first lessee will be called sub - lessor. 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 is greater than the amount payable to the 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-lesser fails to pay.

When a building is constructed for the purpose of giving on lease, the owner and contractor should
inform the Kebele Administration about its completion and the intention of giving it on lease. This is
also applicable when the building is rented before its completion. The Kebele Administration will

14
pass the information to the tax office for the determination of tax. It is also the responsibility of
Kebele Administration to gather any such information and communicate to tax office in case where
the parties fail to do so.

Taxable income

Gross income includes all payments, either in cash or benefits in kind, received by the lessor and all
payments made by the lessee on the behalf of the lessor. The value of any renovation or improvement
to the land or the building is also part of taxable income under this schedule if such cost is borne by
the lessee in addition to rent payable.

Taxable income from schedule B income is determined by subtracting the allowable deductions from
the gross income. Allowable deductions include the following;

- If the lessor does not maintain books of accounts his allowable deductions include
taxes paid on land and buildings being leased and 20% of the gross income received
as an allowance for repairs, maintenance and depreciation of such buildings,
furniture equipment.
- If the lessor maintains books of accounts the allowable deductions (deductible
expenses) include (but not limited to):-
f. Tax on land and buildings being leased
g. Cost of lease (rent) of land
h. Repairs, maintenance and depreciation of building (and
furniture and equipment if furnished) per income tax
proclamations article 23.
i. Interest on bank loan if any
j. Premium paid on insurance of building.

Activity 2

1. Compute income tax for A p. l. c assuming that its taxable

income is Birr 135,000.00 for the current year

2. Compute income tax for Ato Thomas who is engaged in private clinic business
and whose annual taxable income is Birr 54,600 based on the books of account
maintained by him.

Example
Total Rental Income of MTZ is Br. 40000 for year 1 costs and expense related to the rental include.

Repair and Maintenance Br. 2000

Premium paid on insurance Br. 1000

Calculate the income tax payable by Mr. X

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Solution
Total Taxable rental income is Br. 37, 000 i.e. 40000 minus Allowable
deductions Br. 3000

Short Cut
(Total taxable rental Income x Rate) – Deduction

(Br. 37000 x25%) – Br. 2820

= Br. 9250 – 2820

= Br.
Br. 6430

Example 2
XYZ Co’s total rental income from building for the year ending 20x2 is Br. 250000 and expenses
incurred that are related to the rental of building include:

Tax on building Br. 3000

Repair and Maintenance 4000

Depreciation 6000

Premium paid on Insurance 2500

Calculate the rental income tax payable by XYZ Co for the year 20x2

Solution
Allowable Deductions:

Tax on building Br. 3000

Repair and Maintenance 4000

Depreciation 6000

Premium paid on Insurance 2500

Total Br.15500

Taxable Rental Income = Total Rental Income – Allowable Deductions

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 = Br. 250000 – 15500

= Br. 234500

Rental Income Tax = Taxable Rental Income x Rate

= Br. 234500 x 35%

= Br. 82075

3. Business Income tax (Schedule “C”)

3.1 MEANING OF BUSINESS

The current income tax proclamation and related regulations defined business as any industrial,
commercial, professional or vocational activity or any other activity recognized as trade by the
commercial code of Ethiopia and carried on by any person for profit. As compared to the previous
income tax rate, the current proclamation provides a reduced tax rate on business income as a measure
of the tax reform program in progress. The reduced tax rate is believed to serve as an investment
incentive.

For the purpose of payments of business income tax, tax payers are categorized into three, namely
category A, Category B, Category C. based on the volume of their sales for a tax year and form of
business. Subsequently, the Tax Authority will determine whether the tax payer shall continue in the
same category or his/her category be changed for the following tax year.

Category A includes any company incorporated under the laws of Ethiopia or in a foreign country
and other entities having annual turnover of Birr 500,000 and more. This group of tax payers have to
maintain all records and accounts which will enable them to submit a balance sheet and profit and loss
account disclosing the gross profit, general and administrative expenses, depreciation, and provisions
and reserves (together, with the supporting vouchers).

Category “B” unless already classified in category “A”, Category “B” includes businesses having an
annual turnover of over Br 100,000. This category of taxpayers must submit profit and loss statement
at the end of the year. The law requires all entries in the records and accounts to be supported by
appropriate vouchers.

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Category “C” unless already classified in categories “A” and “B” include those tax payers whose
annual turnover is estimated by the Tax Authority at Birr 100,000 or less.

Every businessman or body, with the exception of category C, is required to keep proper books of
accounts and other records and documents.

The books of accounts must contain;

- a record of business assets and liabilities including a detailed register of fixed assets;
- a record of all daily income and expenses,
- a record of all purchases and sales of goods and services showing the following:-
 the particular goods and services sold
 the name of the buyers and sellers/providers in such a manner that they
can be identified by the Tax authorities
 Using pre-numbered invoices containing vendor’s tax identification
number.
 a record of trading stock on hand at the end of the accounting period with the method
of valuation
 any other document relevant for the determination of the tax liability
Depreciation rate

a. In determining the amount of depreciation the acquisition or construction cost, and the cost of
improvement, renewal and reconstruction of buildings and constructions shall be depreciated
individually on a straight-line basis at five percent (5%).
b. The acquisition or construction cost, and the cost of improvement, renewal and reconstruction, of
intangible assets shall be depreciated individually on a straight line basis at ten percent (10%).
The above two categories of business assets are depreciated at the given rates based on their cost
(gross value).

The following two categories of business assets shall be depreciated according to a poling system at
the following rates;

a. Computers, Information systems, software products and data storage equipment as a

rate of 25%

a. All other business assets at the rate of 20%. This category includes motor vehicles,
plant and machinery, furniture and equipment, etc.
3.3 Loss Carry Forward
A business is said to have made loss when the total expenses incurred by the business during a fiscal
year are greater than the total income generated by the business in the same year . Loss carry forward

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is a procedure whereby a loss incurred in one tax period is carried forward to the next tax period to be
deducted from the available profit, if any. Loss carry forward is one of the several changes introduced
by new tax law. The importance of the loss carry forward provision to a company is that it preserves
valuable cash which otherwise would have to be paid out in taxes. Such funds are retained in the
business and can be used for working capital and/or expansion of the business. A business, which has
alternate profit and loss years of about the same dimension, would pay no tax at all.

3.6.1 Loss relieves available for companies and related eligibility conditions.
If the determination of taxable business income results in a loss in a tax period, that loss may be set
off against taxable income in 3 years tax periods; earlier losses set being set off before later losses. A
continuous set off will be permitted only for a maximum period of 6 years (two periods of three
years).However, if during a tax period the direct or indirect ownership of the share capital or the
voting rights of a body changes more than 25% by value or by number the provision for set off will
not apply to losses by that body in that tax period.

4. Other Income taxes (Schedule D)

Incomes which are not specifically included under Schedule A, Schedule B and Schedule C is
categorized under this schedule. Schedule D income includes;

 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 royalties
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.

 Income from Rendering of Technical Services

Income from technical service refers to income from 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 this form are subject to a tax rate of 10% which will be
withheld and paid to the tax authority by the payer

 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.

 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. Dividend Income is subject to tax at the rate of 10%. The
withholding agent (payer) shall withhold or collect the tax and account to the tax Authority.

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  Income from rental of property

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.

 Interest Income on Deposits

This includes income derived from interest on deposits. Interest Income will be taxed at the rate of 5%
and the payer must withhold the tax and account to the Tax Authority.

 Gains on Transfer of Certain Investment Property

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 of companies 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.

4 Indirect taxes in Ethiopia

A. Turnover Tax (TOT)

The Turnover Tax would be payable on goods sold and services rendered by persons not registered
for Value Added Tax. The rate of Turnover Tax is:-
 2% on goods sold locally;
 for services rendered locally:
o 2% on contractors, grain mills, tractors and combine-harvesters;
o 10% on others.
The base of computation of the Turnover Tax is the gross receipts in respect of goods supplied or
services rendered. A person who sells goods and services has the obligation to collect the Turnover
Tax from the buyer and transfer it to the Tax Authority. Hence, the seller is principally accountable
for the payment of the tax.

In accordance with the Turnover Tax Proclamation No. 308/2002, the following would be exempted:
 Sale or transfer of dwelling used for a minimum of two years, or the lease of a dwelling;
 Rendering of financial services;
 Supply of national or foreign currency and of securities;
 Rendering by religious organizations of religious or other related services;
 Supply of prescription drugs specified in directives issued by the relevant government
agency, and the rendering of medical services;
 Rendering of educational services provided by educational institutions;
 Supply of goods and rendering of services in the form of humanitarian aid;
 Supply of electricity, kerosene and water;
 Provision of transport
 Permits and license fees;
 Supply of goods or services by a workshop employing disabled individuals (if more than
60% of the employees are disabled);
 Supply of books.

B. Excise tax

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It is believed that this tax should be imposed on luxury goods and basic goods, which are demand
inelastic. It is also believed that imposing the tax on goods that are hazardous to health and which are
causes to social problems will reduce the consumption thereof.

Rates of Excise tax

The excise tax would be imposed on goods imported or either produced locally in accordance with the
following schedule, given in Excise Tax Proclamation No. 307/2002.

Goods to be liable to excise tax (produced locally or imported)

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22
Base of Excise tax computation

The base of computation of Excise Tax is the cost of production for goods produced locally; where as
for goods imported the base of computation would be the cost of production, insurance and freight
costs (CIF value).

C. Custom duty

Custom duty refers to the tax or tariff imposed by Ethiopian Customs Authority (ECuA) directly on
the activities of import and export of goods and services. Custom duties are imposed to raise revenue
for the government and to prevent illegal imports and exports.
Any good imported or exported would be subject to:
 Payment of duties and taxes according to the tariff of Harmonized Commodity Description
and coding system;
 Payment of duties and taxes according to the preferential tariff rate where goods are
imported from the preferred country;
 Payment of duties and taxes at the rate in force on the day the declaration of the goods are
presented to, and accepted by the customs office.

Duty Paying Value: The duty paying value of any import or export goods shall be the actual total
costs of the goods.

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Duty Paying Value of Imports:

1. For the purpose of customs the duty paying value for imported goods would be the sum of the
transaction value, freight cost and insurance premium that is paid to deliver the goods up to a
prescribed customs port;
2. Transaction value and other related costs given by a supplier who is associated in business
with the importer shall be considered genuine unless the given price is influenced by their
relationship;
3. Where a document which show the correct freight cost up to the first customs port is not
produced or the document produced is rejected by the Authority; the freight cost of identical
goods transported at or about the same time with the same means of transport would be taken
to calculate the cost of freight;
4. Goods imported with out insurance coverage or transported under insurance coverage but the
bill produced is rejected by customs, the insurance cost paid for identical goods transported at
or about the same time with the same means of transport would be taken to calculate the cost
of insurance;
5. To determine the accurate value of the goods the following additional costs incidental to the
imported goods shall be considered
A. Commission and brokerage costs incurred by the buyer;
B. Cost of container and cost of packing the goods be it for labouror material;
C. Value of goods and services supplied by the buyer free of charge or at reduced cost, to
the extent that such value has not been included in the price actually paid or payable;
D. Royalties and license fees related to the goods that is paid directly or indirectly by the
buyer;
E. Loading, unloading and handling charges paid up to the port of importation.
6. Where documents necessary to determine duty paying value of the goods are not presented, or
rejected by the Authority, the transaction value of identical goods imported from the same
country at or about the same time shall be taken to determine the value of the goods;
7. Where the value of the goods cannot be determined the transaction value of similar goods
imported from the same country at or about the same time shall be taken to determine the
value of the goods.

Deductibles from Import Value:

1. The following adjustment costs shall be deducted from import values

A. Costs for damages in route;
B. Costs for damages in customs warehouse.
2. When it is requested and agreed upon by the customs office to destroy or dispose any dangerous
goods deposited in the warehouse, the goods shall be destroyed or disposed at the presence of
customs officer and other officials concerned, and the value of the goods destroyed or disposed
should be deducted proportionally from the duty paying value of the goods.

The value of Exportable goods

For customs purpose the value of export goods shall be the transaction value of the goods and the cost
of transaction up to the port of exit.

D. Sur tax on Import of goods

The Ethiopian government so as to increase its domestic revenues, levies Sur – tax (duty) by
regulation No. 133/2007 that shall apply to all goods imported in Ethiopia except those exempted by
the same regulation. This Sur tax on Import comes into force as of 11 th of April, 2007.

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  Exemptions from Sur tax

The following items of goods shall be exempted from Sur tax

 Fertilizers
 Petroleum and lubricants
 Motor Vehicles for fright and passengers, and special purpose Motor Vehicles
 Air craft, spacecraft and parts thereof
 Capital (Investment) goods
 Edible Oil
 Imported goods specifically exempted by law, directives, or by agreement entered in to
by government

 Basis of Sur tax computation

The basis of Sur tax computation for the Sur tax levied by the regulation Number 133/2007 shall be
the aggregate of:
A. Cost, Insurance and Fright (CIF) value
B. Customs duty, Excise tax and Value Addad Tax (VAT) payable on goods.

 Rate of Sur tax

The Sur tax shall be levied and collected at a rate of 10% of the basic value of the import.

Sur tax = 10% * (CIF value + Custom duty + VAT + Excise tax)

E. Valued Added Tax (VAT)

VAT is a tax on consumer expenditure. It is collected on business transactions and imports. A taxable
person can be an individual, firm, company, as long as such a person is required to be registered for
VAT.

Most business transactions involve supplies of goods or services. VAT is payable if they are:
 Supplies made in Ethiopia;
 Made by a taxable person;
 Made in the course or furtherance of a business;
 Are not specifically exempted or zero-rated.

The Value Added Tax would be levied at the rate of 15% of the value of:
 Every taxable transaction by a registered person
 Every import of goods, other than an exempt import; and
 Import of services.
A person who carries on taxable activity and is not registered is required to file an application for
VAT registration with the Authority if:
 At the end of any period of 12 calendar months the person made , during that period, taxable
transactions the total value of which exceeded 500,000 Birr; or
 At the beginning of any period of 12 calendar months there are reasonable grounds to expect
that the total value of taxable transactions to be made by the person during that period will
exceed 500,000 Birr.

25
Registration procedure:

 A person applying to register for VAT is required to do so in such a form as is established by

the implementation directives issued by the Ministry of Revenue;
 When a person carrying out taxable transactions files an application to be registered for
VAT, the Authority is required to register the person in the VAT register, and to issue a
certificate of registration within 30 days of the registration;
 A person registered for VAT is required to use his taxpayer identification number on all VAT
invoices, and on all tax returns and official communications with the Authority.

There is a VAT invoice prepared by the Ministry of Revenue containing the following information:

 Full name of the registered person and the purchaser, and the registered;
 Person’s trade name, if different from the legal name;
 Taxpayer identification number of the registered person and the purchaser;
 Number and date of the VAT registration certificate;
 Name of the goods shipped or services rendered;
 Amount of the taxable transaction;
 Amount of the excise on excisable goods;
 Sum of the VAT due on the given taxable transaction;
 Issue date if the VAT invoice, and
 Serial number of the VAT invoice.

The registered person is required to issue the VAT invoice to the purchaser of goods or services upon
the supply or rendering, but not later than 5 days after the transaction.

Record Keeping Requirement:

A registered person or any other person liable for VAT under the proclamation shall maintain for 10
years in Ethiopia:
 Original tax invoices received by the person;
 Copy of all tax invoices issued by the person;
 Customs documentation relating to imports and exports;
 Accounting records; and
 Any other records as may be prescribed by the Minister of Revenue by directive.

EXEMPLES
IF xyz company purchase equipment for a cash of br 250000 including vat and received
revenue of br 450000 before vat .calculate vat payable
A calculate output vat
B input vat
C vat payable
Solution
Output vat= 450000*15%=br67500
Input vat=250000*15/115=br32608.7
Vat payable output vat – input vat
67500-32608.7
Vat payable=br34891.3

26