Definition of Tax

 Tax Law(s) is a branch of public law.

 As important sources of public revenue, taxes are very important part
of the daily functioning of a government
 According to Hugo Dalton, an economist
◦ “a tax is a compulsory contribution imposed by a public authority,
irrespective of the exact amount of service rendered to the tax payer in
return, and not imposed as a penalty for any legal offence.”
◦ Again to emphasize the compulsory element in tax the author states,
“a tax, by definition, is a payment, in return for which no direct and
specific quid pro quo (give and take) is rendered to the payer.”
 From this definition:
◦ tax is a compulsory charge that is imposed on taxpayers without obtaining
their consent.
◦ The payment of tax does not entitle the payer to demand direct and definite
benefits

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 Tax is a contribution from individuals out of their private property
for the maintenance and defense of government, so that it may
perform its functions and the ends of the state be realized.
 tax is a financial charge or other levy imposed on an individual or a
legal entity by government.
 Taxes are contributions from the national dividend; they must
ultimately come out of the annual earnings of the nation.
 The basis of taxation is wealth.
 Taxes are a portion of private wealth, exacted from individuals by
the State for the purpose of meeting the expenditure essential to
carrying out the functions of government.
 Taxation includes the processes of levying, collecting, and paying
tax

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PUBLIC VS PRIVATE GOODS
Public goods are normally supplied by
public agencies due to their natures of non-
rivalry and non-excludability.
The nature of consumption of public goods
is such that consumption by one does not
reduce consumption for others.
consumption of public goods by an agent
does not exclude others from doing same.

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Purposes of taxation
Distribute and redistribute the resources in the
country
 To influence the macroeconomic performance
To modify patterns of consumption or employment

4
The General Goals of Taxation
Few would argue with the observation
that taxation helps governments raise
revenues for their various activities.
there is hardly any agreement about why
and how governments raise revenues
through taxes. The sentiment about
“the why and how of taxes” appears to
depend on general sentiments about the
end of governments

5
 Those who believe that governments can solve the major ills of
mankind may be inclined to believe that taxes help governments create
employment, fight inflation, stimulate economic growth and even help fight
global warming.
 Those who value greater economic freedom and see the markets as the
major drivers of employment, inflation and economic growth would like to
restrict the government to the provision of those and only those services
which, everyone agrees, could not be provided under free market
conditions.
 And there are those, even when they accept government, who are skeptical
of taxation as an instrument of government policy in the area
of stimulating employment, fighting inflation and of generating economic
growth.
 These “debates” are the stuff of which the subject-matter of “public finance”
is made of. In spite of the contentious views about the role of
governments, taxation remains one of the most prominent powers and
instruments of governments to date.

6
 Richard and Peggy Musgrave who drew up three major
objectives for government budgetary policy and by extension
tax policy:
 “allocation function,” : determines the proportion of government
involvement in the provision of public goods or social goods
 the “distribution function”: determines the distribution of income and wealth
in accordance with “what society considers fair or just,” which is not
usually obtained through the operation of market forces alone.
 the “stabilization function: economies do not stabilize by themselves and
need “policy guidance.”
 From the above contentious views the following can be concluded:
taxation does not and need not have fixed goals. The goals of
taxation have varied from one period to another, and indeed
among different tax systems.
the goals of taxation are inextricably linked with our views and
sentiments about the roles of governments
the role of taxation as instrument of public policy remains
controversial in the literature

7
 Theories and Canons of Taxation
 Criteriafor Design of Taxes and Tax Structures
 Taxes determine the fate of many things in life. They
determine what is taxable and what is untaxable, at least by
omission, if not by intent.
 They determine, in the technical language of taxation,
what constitutes a tax base, the rate or rates under which the
tax base should be taxed and who should pay the tax and
who ultimately bears the economic burden of taxation.
 Richard M. Bird has divided these criteria into “external”
and “internal.”
 The “external” criteria are the policy objectives or goals set
for taxation, which are for him, as already pointed above,
economic growth, distribution and stability.

8
 The “internal” criteria are what he calls the “attributes… which people
would like to see in their tax systems.” Various writers have used
different names referring to “internal criteria.”
 Some call them simply “criteria,” while others have called them by turns
“principles,” “canons” or “maxims.”
 It may be necessary to distinguish the “goals” or “objectives” of taxation
from the “criteria” used to evaluate the good, bad and ugly features of
taxation
 “Equity” may be a good feature of taxation, but it may not be the
goal of taxation. The goal may be “distribution” of income and
wealth or simply satisfaction of the society’s desire to ensure fairness
in the tax system.
 Efficiency may be an attribute of a good tax system, but it is not the goal of
taxation. The goal may be economic growth.
 It must, however, be admitted that the goals of taxation are
sometimes used interchangeably with the principles of taxation
specially in literature..
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 A common encounter with the literature on “principles” or
“maxims” or “canons” of taxation is that every writer has had her
special list of principles, which while overlapping with others
 The German economist, Adolph Wagner, thought taxation needed
nine principles, which were sufficiency, flexibility, choice of sources
upon which tax is applied, choice of kind of tax, generality, fairness,
certainty, comfort and cost efficiency
 the American tax analyst Daniel J. Pilla developed ten (perhaps to
coincide with the ten commendaments?) principles of taxation which
he called “simplicity,” “non-invasiveness,” “efficiency,”
“stability,” “visibility,” “neutrality,” “economic growth,” “broad-
based,” “equality” and “constitutionality.
 A recent study commissioned by the Addis Ababa Chamber of
Commerce and Sectoral Associations (AACCSA) mentioned twelve
principles of taxation: ability-to-pay, equality,
adequacy, neutrality, broad-basing, retroactivity,
compatibility, predictability, earmarking, restricted exemption,
efficiency and simplicity. The list can go on.

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 It will be seen that many of the principles overlap in meanings,
although the emphasis in each particular instance is different.
 Many writers have preferred to speak and write about “equity”
and “efficiency” in part because these principles subsume many
of the other goals of taxation.
 Some of the writers who have chosen to deal with a
more extensive list of principles are obviously of the
opinion that the details which they want to emphasize will
be lost in the generality of the two principles of equity and
efficiency.
 The principles of “simplicity,” “neutrality,” “certainty” and
“administrative feasibility” (all discussed below) can be
subsumed under the principle of “efficiency” but the emphasis
which specific treatment of these principles will obtain will be
lost in the generality of the principle of “efficiency.”

11
 Similarly, “efficiency,” which is an even broader principle
than the principles of “administrative feasibility,” “certainty,”
“simplicity,” “convenience,” etc., can be a shorthand for
all of these principles, but due to its generalities, the
emphasis we wish to place upon specific issues of
taxation may be lost as a result of the tendency to
emphasize some aspects of “efficiency” in taxation at the
expense of other aspects of taxation.
 While it may be difficult to exhaust all the principles of
taxation, it is therefore necessary to deal with more specific
principles of taxation along with the general principles of
“equity” and “efficiency.”
 The number of principles selected by any one writer is
arbitrary.
 There is no reason why twelve is better than six (except
that twelve is twice as much as six), or vice versa.

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Theories of Taxation
 Theories of taxation deal with the justifications for
imposing tax as a duty in a given country.
 The theories dealing with these issues are broadly
classified into two categories:
◦ The first category contains two approaches(SOCIALISTIC):
 the Socio-Political Approach and the Expediency Approach.
 to impose a tax, there need not be any relationship between the taxes paid
and benefits flowing from the authorities to the tax payers.
◦ The second category, on the other hand, links the tax liability of
the payers to the state activities. Two approach:
(INDIVIDUALISTIC)
 the benefits received approach, which links the tax liability to the benefits
 cost of service approach which links tax liability to the cost of
providing the goods or services

13
A) Expediency Theory
 the authorities need not consider various economic or social
objectives or the effects of a tax system
 What they have to take into account is whether that tax proposal
is practicable. Therefore, for this theory, taxes must be
imposed if and only if they are practicable.
 In practice, however, every authority or government is pressurized
by various economic, social and political groups to orient its tax
policy in certain directions.
 And, to build up an entire tax system only on the consideration of
expediency, it will be full of pitfalls. Thus, the tax policy must be
anti-cyclical, pro equity and favorable to the welfare of the society
so that it will develop the economy.

14
B) Socio-Political Theory
 was developed by the well-known German economist Called
Adolph Wager.
 According to him, it is not the expediency but final social and
political objectives, which should be the deciding factors in
designing our tax system.
 He particularly favored the idea of using taxation as an
important means of causing reduction of income inequalities in
society.
 In order to attain this purpose, he stated that all small incomes
should be exempted from taxation.
 Thus, according to this theory, in a modern state taxation is
designed to curb the economic inequalities arising out of the right
to property.

15
 C) Cost of Service Theory
 This approach emphasizes on the semi-commercial relationship between the
state and the taxpayers to a greater extent. The implication is that the taxpayers
are not entitled to any benefits from the state and if they do receive any, they
must pay the cost thereof.
 It thoroughly enables the government to recover the cost of services and
therefore, this approach, unlike the benefits received one, specifically
implies a balanced budget policy.
 In the process, the state is not to be concerned with the problems of
income distribution. Certain sources of public revenue will be ruled out
according to this approach, including for example taxes on capital gains,
inheritance, gifts, expenditure etc. Furthermore, by definition, the welfare
activities of the state are ruled out including all sorts of relief activities. In modern
economy, this principle has a very limited application.
 This principle is also full of many conceptual difficulties. The first problem
pertains to measuring the cost of state services and assigning them to the
proper beneficiaries.

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D) The Benefit Theory of Taxation
 One favorite theory of tax justice through the ages has been the idea that
taxation, like the prices in the market, is a price for the benefits received from
government.
 The views of those who believe that a just tax system is one that is premised on
benefits was colored by the “contract theory of government” in which taxes
serve as a consideration for the services provided by governments.
 While the benefits theory of taxation has had wide appeal among prominent
names, it is now generally acknowledged that the benefit theory of
taxation occupies a marginal (though persistent and resilient) position
in explaining the perceptions of tax equity in modern discourse.
 This has largely been due to the obvious un-tenability of its assumptions. It is
unworkable because the amounts individual citizens receive from public
services cannot be determined or quantified in the majority of cases.
 The implications of the benefits theory of taxation have appeared to its critics as
heartless and indifferent to the plight of the poor.
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 E) The “Ability-to-Pay” Theory of Taxation

 This theory considers the tax liability in its true form-a compulsory
payment to the state without quid pro quo.
 The first problem of the theory is the notion of “ability.” Even
if we were all to agree that taxation be based on ability, a difficulty
immediately arises in how to measure ability.
 Some have understood ability in its negative sense, in terms of the pain
or sacrifice caused by taxation while others have preferred to latch
ability onto objective and positive tests such as net income, property
or consumption.
 In this regard, different indices are available for determining the
relative ability-to pay of the taxpayers. Income, property, and
wealth, or consumption expenditures are some of the indices of
ability.

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a) Income as criterion of ability to
pay:-
 The income figure is the amount, which the family can spend on
consumption goods and save. The amounts of saving that it can
made are the primary determinants of how well the family lives or,
in other words, of its level of living during the period.
 However, living standard and ability to pay may be affected by:
◦ Size of the family,
◦ Earned(higher sacrifice) or unearned income(lower sacrifice):
Consequently, earned income is taxed at a lower rate while unearned
income is taxed at a higher rate.
◦ Windfall income: it is an income where no efforts are involved in
earning it. This income should be taxed at a progressive rate.
 For the purpose of Taxation, net income is regarded as the best
measure of the tax paying ability of a person because it reflects the
sum of net receipts over costs.

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b) Wealth as criterion of ability to
pay:
 The justification of wealth as criterion is based on
consideration of income received from capital. Thus,
a tax on wealth is simply a tax on income earned on it.
 Traditionally, wealth was considered a better index of
the ability to pay than income because in addition to
being a source of income, wealth provided security and
insurance against risk.
 Contemporarily however, Wealth is unsatisfactory as a
primary test of an individual’s ability to pay a tax
although it can provide a possible supplementary index
of such ability.

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C) Consumption expenditure as criterion of ability to pay:-

It has been argued by some economists that

the appropriate measure of an individual’s
ability to pay is not his total income but the
amount of income spent on consumption.
This view was expressed mainly by John
Stuart Mill, Irving Fisher and recently by
Nicholas Kaldor.
 It is claimed that economic well-being
depends upon consumption alone.
Wealth accumulated yields no satisfaction
until it is used for consumption purposes.

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However, this index of ability to pay
is not free from criticisms.
It has been criticized on the round that
it favors the miser and it is difficult to
make taxation progressive or even to
prevent It from becoming regressive and
would reduce the amount of revenue.

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Ability to pay implies:
1. Horizontal Equity: people in equal
positions should be made to pay the same
amount of taxes
II. Vertical Equity: a tax system should
distribute the burden of paying taxes fairly
across people with different abilities to pay.
Thus, people who earn more should pay
more than those people who make less than
them.

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 CANONS OF TAXATION

a. Equity: Equity, Fairness, and Justice: The Elusive but an

unavoidable Questions
 Is used in the literature along often with terms like “fairness” and “justice”
and sometimes “equality”
 The basic problem is that there is no agreement about what is “fair,”
“equitable” or “just.”
 John Bakija pointedly acknowledged:
◦ Fairness is not … a question of economics. Neither an A+ in Economics 101, a
PhD in mathematical economics nor a lifetime study of the theory of political
economy will reveal the one true answer. Fairness in taxation, like fairness of
just about anything, involves ethical issues and value judgments that,
by their nature, cannot be decisively resolved.
 The search for the ultimate meaning of “justice” has remained the
Holy Grail in the literature.
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The Need for Tax Equity
 The first impulse for tax equity thus comes from the
moral claim that it is only right and appropriate to treat
people equally (equality is now a universally recognized
constitutional norm)
 The second impulse for tax equity derives from
utilitarian convention and pragmatic acceptance that a
fair or equitable tax system is good for the tax system
itself, as it encourages voluntary compliance among
taxpayers
 Justice Marshall once wrote that “the tax system must be
perceived to be fair by the taxpaying public inorder to
withstand the public’s scrutiny,

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Theories of Tax Equity
 According to Mill, justice in taxation for some means:
◦ that taxes “should be in numerical proportion
to pecuniary means,”
◦ while others argue that justice requires
“graduated taxation,” and
◦ those with a disposition for natural justice have
argued that everyone should contribute the same
absolute sum,
◦ And still others have argued that the rich should
contribute more to the state as they stand to lose
more from its absence than the poor.

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b. Efficiency
 When efficiency is used alone without any adjective, it implies much more
than administrative and compliance costs of taxation. It implies the so-
called “efficiency cost” of taxation, or what is sometimes referred to
in economic literature as “the dead-weight loss” or “excess burden” of
taxation.
 The dead-weight loss is the hidden cost of taxation to taxpayers, that
which is accounted neither in the amount of tax paid to the
government nor in the compliance cost incurred by taxpayers.
 Under his maxim of “economy,” Adam Smith dealt with an issue
that is today subsumed under the principle of efficiency.
 It can be clearly seen from the writing of Adam Smith that he was fully
aware of and warned against the administrative costs of taxation (taxation
requiring great number of officers), compliance costs of taxation (taxation
exposing taxpayers to frequent visits of tax-gatherers) and the
efficiency costs of taxation (taxation obstructing the industry of the
people and tempting taxpayers to evade taxes).

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c. Administrative Feasibility
 can be taken as subset of “efficiency” in as much as it deals with
the cost implications of taxation, albeit from a limited and narrow
perspective. Nonetheless, there is a need to deal with
“administrative feasibility” separately from that of “efficiency,” for
what is stressed under “administrative feasibility” is often
buried in the generalities of “efficiency.”
 convenience and ease in assessment and collection from the
standpoint of both government and taxpayer, certainty of
obligations imposed on both tax gatherer and taxpayer,
adequate powers in government to deal effectively with the
recalcitrant and fraudulent…”, it is not surprising that much of
the concerns of “administrative feasibility” have been taken over by
other principles of taxation.

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d. Neutrality
 gained prominence in the tax policies of countries during the
1980s and 1990s, when the impact of taxation on economic growth
became a matter of particular concern.
 “neutrality” can be taken as a subset of “efficiency.” As a tax norm,
neutrality commands that taxes avoid distortions in the market. The
problem is that no tax (except perhaps the lump-sum tax) is in
reality neutral, as “any tax inevitably discourages the type of
activity that is taxed.”
 The best one can hope for is that the tax system would interfere
with decision-making “as little as possible.” Taxes that deviate
from neutrality interfere with individual decisions in so many,
multifarious and sometimes mysterious ways.

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e. Certainty
Indeed, Adam Smith considered
“certainty” to be his most important
principle of taxation
the certainty of what each individual
ought to pay is, in taxation, a matter
of great importance, that a very
considerable degree of inequality… is not
near so great an evil as a very small
degree of uncertainty

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Other Principles
 Pilla has suggested the principles of “stability,” “visibility,” “broad-
based[ness],” and “constitutionality” in addition to the common
principles of “equality,” “efficiency,” “simplicity,” and “neutrality.
 “stability” requires avoiding frequent changes to the tax laws so
that reasonable persons can plan ahead on matters that affect their
livelihoods
 “visibility” in taxation as requiring the transparency of the cost
of government,
 “broad-basedness” as the extension of tax bases to all possible
bases so that the government will be able to collect enough
revenues with lower tax rates.
 “constitutionality” is that taxes must be consistent with the
constitution as a supreme law of the land.

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 There are no hard and fast rules for weighting among
multiple and often conflicting goals of taxation. The
relative weight that is to be given to each goal of
taxation “is a matter for the government of the day,
so that any modification of the system should not
impinge on the prerogative of government to determine
policy in any field, not only in respect of taxation.”
 The relative weight attached to a specific goal of
taxation varies from country to country. Some
governments give priority to the efficiency of the tax
system while others are more concerned with the
equity implications of the system.

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 Adam Smith has enumerated the following four canons
of taxation:
1. Canon of Equality-subjects of the state ought to
contribute towards the support of the government ,as
nearly as possible, in proportion of their respective
abilities .
2. Canon of Certainty- taxpayer should be well informed
about the time, amount and method of tax payment.
3. Canon of Convenience-every tax ought to be levied at
the time or in a manner in which it is most likely to be
convenient for the contributor to pay it.
4. Canon of Economy-administrative cost of tax collection
should be minimum

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Other Canons
1. Canon of Productivity- should generate
enough revenue for the government and
must not obstruct and discourage
production in short as well as in the long
run.
2. Canon of Elasticity- taxes should be
increased or decreased according to the
needs of the government.
3. Canon of Diversity- tax system should be
diverse in nature.

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4. Canon of Simplicity-
 Adam Smith sounded the early clarion call for
“simplicity” of taxes in at least two of his maxims of
taxation: certainty and convenience. It is more often
portrayed by its opposite, that of complexity(as it is
difficult to define what is simple).
 One source of complexity is vagueness. Complexity is
also generated by the existence of various exceptions,
exclusions, deductions and credits, which add layers after
layers of complexity over a tax code.
 Lack of simplicity breeds uncertainty. As Adam Smith
said of “uncertainty,” this is the greatest evil in taxation

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5. Canon of Expediency:
◦ According to this canon, tax should be based on certain well-
founded principles so that it may need no justification from the
side of the government. In other words, the taxpayers should
have no doubt about its desirability. According to the criterion
of expediency, the government should, as far as possible,
increase its revenue by increasing the rate of existing taxes.
6. Canon of Co-ordination:
◦ This canon of taxation implies that there must be co-ordination
between different taxes that are imposed by the various tax-
levying authorities. This canon is relevance in federal countries
since tax harmonization is important in these countries.

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Fiscal Federalism
Financial arrangement in the federal
administration.
Both revenue and Expenditure assignment
in federal administration.

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Expenditure Assignment
Article 94 orders both levels of government
to cover their own expenditures.
Power and expenditure goes together.
The combination of article 94 and article
52(1) of the proclamation leaves an
obligation of covering residual expenditures
upon regional administrations.

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Revenue Assignment

1. Exclusive Federal
2. Exclusive Regional
3. Concurrent tax power
4. Rule of undesignated tax power

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Fiscal Imbalance: Vertical Imbalance
Mismatch between the expenditure
responsibility and the revenue capacity of
regional governments called vertical imbalance.
Vertical imbalance is primarily generated by
the constitutionally assigned expenditure and
revenue responsibilities.
Both tiers of government have significant
expenditure responsibilities, the major revenue
sources remain concentrated at the center.

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Horizontal Imbalance
Fiscal disparity between the states.
Sub national governments may not have
equal fiscal capacity to provide public
services to people residing in their territory,
although they are assigned with the same
revenue sources.

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 Classification of Taxes
A commonly applied classification of taxes is into direct
and indirect taxes.
 The classification of taxes into direct and indirect owes to
the relationship between the nature of the taxes and the
reason for payment of the taxes.
 The major types of direct taxes in Ethiopia are personal
income tax, rental tax, business profit tax, withholding tax
and such other taxes like taxes from loyalties, from games
of chance, dividends or property taxes
 The major types of indirect taxes in Ethiopia are value
added tax, custom duties, stamp duties, excise tax and turn
over tax
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Generally: Direct and Indirect taxes
 A tax is considered as direct tax where the shifting is not possible. It is
paid entirely by those persons on whom they are imposed.
 According to J. S. Mill ‘a direct tax is demanded from the very
persons who, it is intended or desired ,should pay it’
 Income tax , capital gains tax ,property or wealth taxes are examples
of direct taxes.
 Direct taxes are progressive in nature , and therefore ,rich people are
subjected to higher taxes ,while poor people pay lower taxes or
exempted from the tax obligation. Hence, reducing inequalities.
 Indirect tax is a tax the burden of which may not necessarily be borne
by the assesses.
 According Mill,’ Indirect taxes are those which are demanded from
one person in the expectation and intention that he shall indemnify
himself at the expense of another.’

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The merits of Direct Taxes
 Create civic consciousness:
◦ A direct tax like income tax pinches the people on whom
it is imposed. Consequently, the taxpayers immediately
become conscious about their rights.
 Economical:
◦ Direct taxes are economical in the sense that the cost of
collecting these taxes for the government is relatively
low as these taxes are usually collected at source.
 Reduce inequality of incomes and wealth
 Direct taxes are certain
 Direct taxes are elastic, increases in the rates

44
weaknesses (demerits) of Direct Taxes
Direct taxes can be easily evaded
Direct taxes are unpopular
Direct taxes violate the principle of
equity

45
The merits of Indirect Taxes
Indirect taxes are convenient
Indirect taxes cannot be evaded
Indirect taxes lead to social welfare
Indirect taxes help production and
investment

46
Weaknesses (demerits) of Indirect Taxes
 Indirect taxes are uncertain
 Indirect taxes do not create civic consciousness
 Indirect taxes promote inflation
 It is not possible to say that one is better than the other
because both of them do have their own advantages and
disadvantages.
 Hence, the existence of both types of taxes is
indispensable if a tax system is expected to function
properly.

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 Classification of Taxes on the Basis of
Rates:
1. proportional:
 All incomes are taxed at a single uniform
rate and it does not matter if the tax payer’s
income is higher or low
 Characteristics:
 (a) It is fixed and its proportionality does not change with
the change in taxpayer’s income and wealth.
 (b) It is fixed in amount and it is not levied in varying
percentages.
 (c) The tax doesn’t alter the proportion of difference of
income after the payment of tax has been made.

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 Advantages:
 It is easy for individuals to evaluate the total amount of tax they
have to pay.
 The proportional tax is simple and easy to understand
 There is no change in the existing distribution of income and wealth in the
society as a result of proportional tax
 Disadvantages:
◦ the burden of tax falls more heavily on the poorer section of
society.
◦ does not reduce the inequalities of income and wealth;
rather it enhances these inequalities and increases the gap
between the haves and the haves-not.

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2. Progressive:
 Varies with the change in the income of the individuals, and the
rate of tax becomes gradually higher for the increasing
incomes and lower for the lower incomes.
 Advantages:
◦ Based on the ability to pay principle
◦ Promotes equality of incomes and wealth
◦ Productive: the government can increase its income substantially
through a progressive tax
◦ Economical: government can bring about a sizable increase in its
income through increases in the rates of tax without any
substantial increase in the cost of tax collection.
◦ Elastic: with minor changes in the tax rates substantial changes
can be brought about in the tax income of the government.

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 Disadvantages:
◦ Ignores the benefit received principle: the government should
tax the poor people more on account of the benefits received
from its welfare activities.
◦ Reduces capital formation: it is only the rich who can save and,
therefore, if they are taxed more heavily than the poor, the
saving potential will either be lost completely or reduced
substantially.
◦ Offers great temptation for tax evasion and tax avoidance: The
taxpayers invariably try to evade the payment of the tax by
presenting false statements of accounts

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3. Regressive:
◦ Is the opposite of the progressive tax.
◦ According to this method of taxation, the rate of tax
diminishes as the income of an individual increases.
4. Digressive:
◦ Can be called a mild progressive tax. the rate of tax
increases up to a certain limit and beyond which a
uniform rate is charged.
◦ The result of this tax is that the higher income
groups make less sacrifice than the lower income
groups.

52
 Classification of Tax on the Basis of their
Nature
1. Specific and Advalorem Taxes: Taxes imposed on commodities
 Specific:
◦ is imposed on a commodity according to its weight, size, or measurement, it
is called a specific tax.
◦ Advantage: it is easy to level and more convenient to collect.
◦ Disadvantage: it does not take into consideration the value of the
commodity. Consequently, a cheap and a costly object may be taxed at
the same rate.
 Advalorem:
◦ is imposed on commodity according to its value. Whatever is the weight or
size of the unit of the commodity, the tax is charged according to its value.
◦ Several imported commodities are subject to advalorem taxes.
◦ Advantage: it is more equitable.
◦ Disadvantage: difficult to know the real value of the commodity at the
time of imposing the tax.
53
2. Single and Multiple Taxes:
 A single tax is a tax that occurs in a system in which the taxes are levied
only on one subject. There is only one tax, which constitutes the
source of public revenue.
 Whereas, multiple tax refers to the tax system in which taxes are levied
on various items. It is absolutely against the single tax. It can be easily
seen why this must be so.
 A modern economy is not one or single objective economy. It tries to
forge ahead simultaneously along the paths of growth, equitable
distribution of incomes and wealth and economic stabilization, etc.
 However, notwithstanding the superiority of the multiple tax system, too
great a multiplicity of taxes is undesirable and should be avoided.
Therefore, it is best to rely on a few substantial taxes for achieving the
major portion of the tax revenue.

54
Brief History of Income Taxes in
Ethiopia
 In traditional Ethiopia, taxation played a pivotal role. The taxation
system of traditional Ethiopia provided for the conservation of
different entities starting from the central government and
extending to lords, clergy, nobles, soldiers and the like
 The taxation of traditional Ethiopia was paid in kind. However,
monetary payments appeared to have steadily increased in the 19 th
and early 20th century, particularly on account of the growing use of
money in the century at large.
 Though not uniform, through the taxation system employed
throughout the country, any productive activity undertaken by any
part of the society was charged with taxation
 This was evident in the facts that traders were subjected to taxation
on the goods they sold; peasants were obliged to pay from what
they produced and collected from their lands; craftsmen were
obliged to supply their products to their superiors and so on.
 Another form of taxation in traditional Ethiopia was imposed upon
the individual members of society. This was manifested in the
imposition of the obligation to render service to superiors.

55
The foundational principle of income tax
in Ethiopia was laid by Emperor Menilik
in 1882, when the emperor issued a
decree requiring all peasants to pay one-
tenth(tithe) of their agricultural products
to tax officials
The decree thus embodied the idea that
each individual would be taxed according
to the amount he/she earns(Ability to pay)

56
 As far as the history of the laws governing income taxation in
Ethiopia go, it is said to have started with the Personal and
Business Tax Proclamation No. 60/1942 which provided for
income taxation in modern form as opposed to the traditional
forms of taxation of earlier times.
 In this law ‘income’ referred to every sort of income derived
from any activity in the Empire of Ethiopia, but it did not
include salaries received from members of the regular armed
forces and income earned from agriculture.
 This proclamation was replaced by the Proclamation No. 107
of 1949, which was replaced seven years later by the Income
Tax Decree No. 19 of 1956.
 Then after, Income Tax Proclamation No. 173/1961 was
enacted followed by Proclamation No. 255/1967.

57
 During the Dergue period, Proclamation No. 77/1976 and
Proclamation No. 152/1978 were adopted as amendments to
Proclamations No. 173/1961 and 255/1967.
 These two amendments changed the income tax structure
levied on agricultural activities; and thus introduced rural
land use fee and tax on income from agricultural activity
(which had been exempted from taxation by the Income Tax
Proclamation No. 255/1967).
 Furthermore, Special Decree No. 18/1990 was passed
thereby changing the rate of taxation on business income.

58
 During the transitional period of Ethiopia, Proclamation
No. 30/1992 was adopted thus amending the previous
laws on personal income taxation.
 This proclamation was further amended by the Income
Tax Amendment Proclamation No. 107/1994, which,
among other things, amended the tax on income from
business and other profits.
 This law was further amended by the Income Tax
Proclamation No. 286/2002 and the Income Tax
Regulation No. 78/2002, and has been amended by proc.
No 608/2008
 The currently operating law regarding Income Taxation in
Ethiopia is Income Tax Proclamation No. 979/2016
59
INCOME TAX
 What is an income ?
 An economic benefit (spiritual benefits are not incomes) received by a person
from whatever source derived and in whatever form paid or credited.
 the benefits accruing to persons may be recurrent or non-recurrent
benefits. That means, they may be periodically maturing benefits or they may
be benefits accruing to the beneficiary only once.
 In addition, the definition tells us that the benefits may accrue to the
beneficiary in cash, in kind, or in any other form.
 For instance, income may be realized on the cancellation of indebtedness
or upon the purchase of property at a lower price than the actual market price
of the property
 Yet, not repaid loan- as per return of capital doctrine. But, interest on loan is
income and shall be taxed.
 Even benefits from illegal sources can be considered as an income for the tax
law purpose.(2(14))

60
Important terms
Gross income-totality of the income received
by a person. GI does not include exempted
incomes.
Taxable income-income that is subject to the
payment of tax.
Exempted income/exemptions- economic
benefits/income received by a person but not
subject to the payment of tax.
Deductions- costs incurred in order to
generate the income.
Creditable Items-prepaid taxes

61
Scope of Jurisdiction: Imposing tax on Income in Ethiopia
ART. 7 cum 5

 Global jurisdictions/Residence/Personality Principle-resident of

Ethiopia are required to pay tax from their worldwide income .
That means from incomes derived in and outside of Ethiopia .
 Source jurisdiction/Territorial Principle- non residents. Non
resident of Ethiopia are required to pay taxes only from incomes
derived in Ethiopia.
 Using combination of global and source jurisdiction may result
in double taxation of income. For instance , if a resident of
Ethiopia derives an income from Sweden , the Swedish
government may impose tax on the income as its source is in
their country at the same time Ethiopia also imposes tax on the
income as the person is resident of Ethiopia. This results in
imposition of two taxes on a single income or double taxation.

62
 Generally, there are three sources of conflict which
result in the problem of double taxation. These are:
◦ ii) source-source conflict: two or more countries may claim the
right to tax a given source based on the fact that they are the
source of income. For example, the raw materials for steel
industries in Ethiopia come from foreign countries.
◦ iii) residence- residence conflict: two or more states assert a right
to tax a certain person, be it legal or physical person, who/which
is a resident in their country.
◦ iv) source-residence conflict: happens when different countries
use different criterion to impose taxes. One country may base its
taxation on source of income criterion and others on residence as
this is legal for both states.

63
For the purpose of income taxation,
residents are defined as including those
individuals who: Art 5
◦ have domiciles within Ethiopia;
◦ Is present in Ethiopia, continuously or
intermittently, for more than 183 days in
one-year period; and/or
◦ Are citizens of Ethiopia and consular,
diplomatic or similar officials of Ethiopia
posted abroad.
64
 As far as bodies are concerned, they will be considered
as residents so long as they:
◦ have their principal office in Ethiopia:
◦ have their place of effective management in Ethiopia; and/or
◦ Are registered in the trade register of the Ministry of Trade and
Industry or the Trade bureaus of the regional governments as
appropriate.????
 An individual, who stays in Ethiopia for more than 183
days in a period of 12 calendar months, either
continuously or intermittently, will be considered as a
resident for that entire tax period.

65
Solutions to double taxation
 Double taxation negatively impacts foreign direct investments as it
reduces the post tax income for the investors. Accordingly, countries use
one of the alternatives in order to reduce the impact of double taxation
on investments:
1. Double taxation avoidance agreement- it is an agreement between two
parties whereby if a tax is imposed on the income in one country , the
other country relives the income from tax.(Exemption Method)
2. Double taxation relief agreement- this is also an agreement , according
to this agreement both countries impose tax on the income . However,
when one of the country imposes tax on the income it takes into
consideration the taxes paid in the other country(Deduction Method)
3. Unilateral tax relief- this is provided in article 45 of the Proclamation.
According to this method , in the absence of agreement a single country
may at its own initiative may give a tax credit for the taxes paid in the
other country. (It could be both deduction or exemption, ours is
deduction)

66
 The Foreign Tax Credit helps to avoid double taxation
◦ Deals with the administration of taxes on income that is derived
from a foreign source.
◦ if during the tax period a resident derives foreign source income,
the Income Tax payable by that resident in respect of that income
shall be reduced by the amount of foreign tax payable on such
income.
◦ According to our law, the maximum amount deductible is the
amount of tax equivalent to the tax payable in Ethiopia.
◦ If the foreign tax exceeds the domestic tax, and if the tax payer is
a schedule c tax payer, he will be entitled for loss carry forward
(26).

67
METHOD: GLOBAL VS
SCHEDULAR
Global Method- tax from difference sources will
be aggregated and the person pays tax on the
aggregate.
Schedular method- Income from different sources
will be taxed based on different tables/schedules.
Ethiopia follows a schedular approach.

68
Schedule A
 is about employment income tax. Taxable income in the case of
schedule A is an income derived from employment.
 So, our first assessment will be whether there is employment or not.
In the absence of employment, there is no employment income tax.
 Article 12 not define employment but only income derived from
employment. Perhaps, we may extend the definition of employment
under labor law to the purpose of tax law.
◦ Of course, we can infer it from the definition of employee of this
proclamation. Article2/7 defines employee as any individual, other than
a contractor, engaged (whether on a permanent or temporary basis) to
perform services under the direction and control of the employer.

69
A contractor is an independent person who works on his own.
For the purpose of income tax, employment income refers to
any payment or gain in cash or in kind even that can be from
previous or prospective employment.
 Officials such as judges of Supreme Court, ministers,
president are fully paid even when they are retired. These
persons are not working; rather, it is income from past
employment.
 To determine whether an income is derived from employment
or not, the employment or the appointment contract may not
necessarily be active
 To know the taxable income, we identify exclusions and
deductions out of the gross income.
 See Article 65 of the Proclamation which under separate
Schedule –E provides for exemptions of income from taxable
income:

70
 When we see tax rate, the first 600 birr is excluded from tax. We
have 7 tax brackets (11) and the tax rate is also progressive. In the
case of our tax rate, the main problem is that it is not of inflation
adjustment.
 As we all know, the purpose of employment income tax is to tax
the employee. But, if we have the bargaining power, we may agree
with our employer to the effect that the employer shall pay our tax
liability.
 The effect of this type of income taxation is that the payment is
considered as payment itself.
 This is because, as per article 12, employment income is any
benefit or gain in cash or in kind received from employment.
 So, the income tax paid by the employer on our behalf is regarded
as income.

71
Schedule ‘C’-Income from business
 Article 2(14) of the proclamation defines income as any economic
benefit from whatever source derived and in whatever form credited
or paid.
 According to the law the nature of the economic benefit ,the form of
the benefit ,source of the benefit and basis of the economic benefit is
irrelevant.
 Presence of the benefit suffices in order to consider it as an income,
thus taxable(art.9).
 Article 2(4) and 21 states that business income broadly than the
business or trades under Commercial law; Please have a look at Art.
5 of the 1960 Commercial Code of Ethiopia)
 Activities that are considered as business (trade) by the two
legal documents are tax bases according to our tax law.

72
 Is lawyering a business activity under article 5 of the commercial
law? what about medical service? Not at all! But, for the purpose of
tax law, any vocational or professional activity is a business.
 An activity is considered to be a business so long as two
requirements are satisfied. The first one is the regularity of the
activity. What is regular does not mean continuous.
 The second condition is that the activity is carried out for the
purpose of profit making.
 Of course, we may use additional criteria such as the incurring of
expenses, devotion of time and energy and so on. A person
purchases a share from a company and takes dividend every year. Is
it a business? No, it cannot be said as a business activity.

73
Determination of the Taxable Income.
Taxable incomes are those incomes that are
subject to tax after the deduction of all expenses
and other deductible items from gross income
are made.
To arrive at the gross business income of a
taxpayer we have to resort to the profit and loss
account or income statement of the taxpayer
Thus, based on these generally accepted
accounting principles(GAAP), the gross income
of the taxpayer is fixed.

74
 In order arrive at the taxable business income of the
taxpayer, there are some major expenses that must be
deducted by virtue of Articles 20, 22, 25- 28 of the
Income Tax proclamation and Articles 8 and 10-14 of
the Income Tax Regulation No. 78/2002.
 Pursuant to Art. 22 of the proclamation, Generally,
deductions are allowed when four critical requirements
are met:
a) The expense must be related to the earning, securing or maintaining of
the business or the trade income.
b) The expense must be ordinary and necessary.
c) The expense must be reasonable and it shall not exceed the limit set by
the law.
d) The expense must be made or incurred during the taxable year.
75
 Taxable income is equal to gross income minus above
the line deductions minus below the line deductions.
 The tax payable is equal to taxable income times the
applicable tax rate. Unlike that of other schedules, the
tax rate is fixed for bodies with 30%.
 For other persons such as association of persons and
individuals is progressive.
 Article 19 reads, Taxable business income of bodies is
taxable at the rate of 30 percent. Taxable business
income of other taxpayers shall be taxed in accordance
with the progressive rate given for Schedule “C”.

76
 Deductible expenses are of two types. They are
above the line deductions and below the line
deductions. Above the line deduction refers to
expenses while below the line deduction refers to
itemized deductions.
 The difference is that above the line deductions
are in fact business expenses.
 On the other hand, Itemized deductions are not
expenses. They are deductible not because they
are expenses to earn income but to achieve
different economic or social purposes.
77
 To identify whether or not a certain expense is
deductible:
◦ firstly, we should check out from the list of deductible expenses
both in the regulation and proclamation. If we do not find it in
the list of expenses, then we should check it out from the list of
non-deductible items.
◦ If we do not find it from both lists, we are required to apply the
general taste (article 20). The general taste is “necessary and
ordinary expenses”. Is the expense necessary?
◦ In addition to the deductions provided in the proclamation, the
regulation also provides that the following are deductible
expenses

78
 Deductible Items(Fully Allowable
Expenses)-see Art.8 Of Regulation
 Direct cost of producing income: such as the direct cost
of manufacturing, purchasing, importations, selling and
such other similar costs
 Selling and distribution expenses( it includes expenses
like sales commission for sales personnel, delivery, fuel
and lubricants expenses, travel and accommodation
expenses etc .
 General and Administrative Business Expense- it
includes salaries and fringe benefits of administrative
personnel, representation expenses, professional fees,
rental costs, utilities costs like water, electricity, and
telephone, postage expenses, renewal of licences fees,
audit fees, research and development expenses,
representation allowance expenses.
 Promotion Expenses

79
Payment of insurance premium-
◦ depending on their nature and type ,businesses are
usually exposed to different types of risks in the
course of their normal operation.
◦ In order to prevent unexpected loss of business, it is
customary to purchase insurance for a business.
◦ When a business purchases an insurance, the insurance
company charges premium.
◦ Premium payments connected with the business
activity are deductible according article 8 of the
Regulation.

80
 Limited Deductible Expenses
 Here are some lists of expenses that must be deducted only to some
level:
◦ Cost of goods sold
◦ Depreciation Expenses
◦ Loss Carry forward
◦ Gains or Losses on disposal of business assets
◦ Interest Expenses-
◦ Bad Debts
◦ Special Reserves for Finance Institutions
◦ Representation expense
◦ Payment of Salaries to children
◦ Payment for a service rendered by the foreign head office to
subsidiary
◦ Donation
◦ Participation Deduction (reinvestment of Profit)

81
Cost of Trading Stock(Article 21and 2(24))-
 This is aimed at ascertaining the income of the
person for a tax period from a business.
 The weighted average (GAAP(average cost method, i.e.
the generally accepted accounting principle) )is used in
order to calculate the cost of goods sold.
 The matching principle of GAAP(average cost method,
i.e. the generally accepted accounting principle) requires
that the cost of the goods sold during an accounting year
shall be matched against the revenue earned from the
sale of inventory in the same year.
 The term trading stock means, as defined by art.2(24) of
the proclamation, any business asset that is either used
in the production process and becomes part of the
product, or that is held for sale.

82
 Ethiopia follows an average cost method of the
expense incurred for producing an item at the
beginning plus the expense incurred for producing
an item at the end which are known as FIFO cost
and LIFO cost.
 Countries that encourage investment follow the
reverse giving the opportunity to choose either
cost of a unit of good at the beginning or at the
end of the tax year for the tax payer.
 FIFO cost and LIFO cost refers to first in, first out
and last in, first out respectively.
83
Depreciation Expenses-Art.27
 Depreciation is mainly related with capital assets. Depreciation can
be taken as a gradual physical deterioration or reduction in strength
of capital assets and so on.
 Depreciation in the case of intangible asset such as debt and loss is
also called amortization.
 Natural resources cannot be said to be physically deteriorating.
Rather, they may decrease in amount in due course of time. So, for
natural resources such as oil, gas, minerals and forest, depreciation
is termed as depletion.
 A patent right is not physically deteriorated, rather amortized
simply because the right becomes obsolete through time.
 So, whenever we talk about depreciation, we should bear in mind
that it includes the three types therein.

84
 Depreciation is a decline in an asset’s value because of
use, wear and tear.
 The depreciation may be classified as accumulated
depreciation (the total depreciation currently recorded
on an asset), annual depreciation (the annual loss to
property due to regular wear and tear) and functional
depreciation (depreciation that results from the
replacement of equipment) that is not yet worn out, but
that is obsolete in light of a new invention or
improved machinery allowing more efficient and
satisfactory production.

85
 In order to determine whether or not a certain item is entitled to
depreciation, it must be shown that the item has a determinable use
life. I.e. it must be shown that its value decreases through the
passage of certain time.
 If it is not such kind of asset, it is not subject to depreciation
 Some items are not, by their very nature, subject to depreciation.
◦ Fine art (for example Mona Liza), antiques ( for example, crown of Haile-silasie),
jewelry, trading stock and other business assets not subject to wear and tear and
obsolescence shall not be depreciated.
◦ Such items are not subject to depreciation for they have no their own determinable
usage life.
◦ Even, as opposed to those subject to depreciation, their value increases from time
to time.

86
 Justification for this systematic way of deducting
expenses:
◦ to prevent the narrowing of the tax base.
◦ capital asset is purchased at once with intent to getting service
there from for the coming years and it is not worn out within a
short span of life time.
◦ the one claiming depreciation must be only the owner of the
business asset.
◦ It must also be shown that the asset is practically and actually in
business; this requirement is necessary in that some buildings,
for example, are idle for long as of their completion of
construction.

87
 We have four categories of assets entitled to depreciation in
Ethiopia. They are:-
◦ buildings,
◦ intangibles (patent or copy right, franchising, trade mark, distribution agreement
and so forth),
◦ computer and related technologies (flash disk, floppy disk, cables, and server) and
◦ other assets (vehicles, machineries, furniture’s, equipment and so on).
 What is the depreciation base of this individual category? In our
case, the depreciation base is the cost basis of each category.
 By useful life, we do not mean actual useful life of the asset but the
useful life determined by law.
 Cars that were bought during the Haile-Selassieregime are still
giving transporting service. We do not take the actual life of the
cars but the legal life determined by the law on the basis of
scientific estimates.
88
Methods-Art-25(2)-

Art.25(2) the amount by which the asset

shall decline in a tax year is as per the
amount to be determined by the regulation
to be enacted by Council of Ministers

89
Loss Carry forward: Article 26
 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 not more than the next 5 tax periods,
earlier losses being set off before later losses.
 The law wants to encourage business in a certain
manner. It does not want traders to be out of business as
a result of the tax system.
 To this end, if they have incurred loss, they are entitled
to deduct that loss from their profit of the coming years.
 It shall be carried forward according to the Regulation-
Art. 25(5)

90
 Interest Expenses- Art.23
Interests paid by the taxpayer can be
deducted provided that:
The benefits from the debt or agreement is used
for business undertaking and
the rate of the interest does not exceed any
rate by National Bank of Ethiopia and not more
than two percent from that set by the
Commercial Bank of Ethiopia; art.23(2)

91
Bad Debts-Art.30
Bad Debts-
a receivable that cannot be collected from a credit
customer or debtor and becomes worthless.
 A company may also enter into different transactions. Such
company may in advance put some amount of money as a
reserve for the would be bad debt simply on the basis of
speculation.
 In this case, it can deduct the reserve from its gross income of
that specific year.
 This is termed as reserve method. Ethiopia follows rate of
method. Because, not the reserve for the would be bad debt but
the actual bad debt is deducted from the gross income.
 The exception goes for financial institutions.

92
Special Reserves for Finance Institutions

In the determination of taxable

business income of finance
institutions, a deduction is allowed
for special (technical) reserves.
The deduction is allowed on the
basis of the directives issued by the
National Bank of Ethiopia.

93
Gifts and Donations
 the deduction of certain gifts or donations when the requirements
stipulated in Art. 11 of the regulation are satisfied.
 Accordingly, gifts and donations made by the taxpayer can be
deducted from gross income if:
◦ the recipient of the donation is registered as a welfare
organization and where it is certified by the registering authority
and that the organization has record of outstanding achievement and its
utilization of resources and accounting system operates with
transparency and accountability or
◦ if the contribution is made in response to emergency call issued
by the government
 however, the grant and donation made for purposes listed above
may only be allowed as deduction where the amount of donation or
grant does not exceed ten percent (10%) of the taxable income of
the taxpayer

94
Non Deductible Expenses-Art.27
Capital Expenditures-the actual costs of
acquisition, construction,
improvement ,renewal, and reconstruction,
and reconstruction of business assets that are
depreciated in accordance with the specific
provisions of the income tax law are treated
as capital expenditures.
Additional investment by shareholders in the
form of increase of the share of a company or
the basic capital of a registered partnership.

95
Payment of dividend and profit to shareholders
Entertainment expenses
Personal Consumption expense
Payment of penalties
Payment of punitive damages
Actual Damage Covered by insurance
Business unrelated loss or expense

96
the tax rate
 Once the taxable income is determined, the tax rate
to be applied as per schedule C is determined.
 The rate applicable for this schedule is to be
found under Art. 19 of the Proclamation.
 As per this article, there are two types of tax rates
to be applied on taxable business income.
 The first one is flat and the other one is the combination
of progressive rate and a flat rate (proportional rate).

97
 Tax Exemption.
 Some incomes are exempted from tax obligation, among
other things, for economic, social, political and
administrative reasons.
 Under Schedule C, we can notice two types of
exemptions.
 The first one is threshold exemption that is applicable
only to physical persons while the second one is general
exemption which is applicable to all taxpayers under
this schedule provided that the criteria set forth in the
law are satisfied.
 The first one is noticeable from the schedule while the
second one is dealt with by Art. 65 of the Proclamation.

98
Creditable items
Deductible v creditable item-
Deductible items will be subtracted
from the gross income/costs incurred in
order to generate the income/
Creditable items- are prepaid taxes that
will be credited against the net tax
payment at the end of the year.

99
Creditable Items
1. TaxesPaid during import
2. Taxes Paid during local supply of
goods and rendition of services

100
Corporate Reorganization-Art.35
 Reorganization is about alteration of forms; and it is related with the
concept of recognitions of gain or loss. In Ethiopia, there are various ways
in which business organization conduct alteration of form. When business
asset are transferred to another person in the form of reorganization, there
may be gain or loss. What is the tax consequence of change in the
corporate form?
 if the transfer of the business is conducted as a result of the process of
reorganization, no gain or loss will be recognized in a sense that there will
be no deduction for the latter. I.e. any gain obtained as a result of
reorganization shall not be taxed; but, any loss incurred as a result of
reorganization shall not be deductible.
 In our law, there are about 5 or 6 forms of reorganization. Each form of
reorganization has its own requirements thereunder: Merger, acquisition or
take over , asset acquisition, division, establish other independent
companies , a spin-off( is a situation that occurs when a company transfers
the shares it has from another company to its shareholders)

101
The Tax Authority shall ensure that the merger,
acquisition, takeover, division, or spin-off is not
having tax avoidance as a principal objective;
art.35(4).
When companies became cognizant of the fact
that their shares or assets are appreciated, they
may be reorganized so as to avoid the possible
tax.
 Therefore, reorganization must have genuine
business purpose behind it

102
Related Party Transactions
 The law is suspicious of transactions among related persons as it
may be mainly for avoiding any possible tax burden.
 for tax purpose, the concept of related persons is provided with
broadened definition by the law of tax, thus it may be between:
◦ natural persons by marriage, blood or adoption
◦ a natural person and business organization in which the former is a
partner.
◦ a natural person and a trust in which the former is a beneficiary
◦ a person and a company in which the former has shares therein and
another business organization in which the first company owns shares
from the latter.
◦ a natural person and other independent and separate companies in which
the former has more than 10% shares in each of the companies.

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 Related parties transaction may also take various forms.
◦ It can be, for example, employment transaction. A partner himself may
be employed in his partnership.
◦ Or he may employ his son as an accountant thereof.
◦ The owner of a private limited company may employ his wife to be a
manager thereof.
◦ It can be commission relationship or it can be transaction of technical
services by the service giving company.
◦ It can be sale of goods or loan transaction in which they may
deliberately raise the interest thereof.
 In such transactions, in order to avoid tax liability, they are not
allowed to carry out transaction over or below the market price.

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Transfer Pricing (Art.79)
 In a certain transaction, the price set by related persons is
suspiciously seen and hence it is not usually acceptable by law.
 The law accepts another price, arm’s length price. Arm’s length
price is the price that would have been set by those persons had
they been unrelated or independent person.
 Arm’s length price may take various forms- defined at art.79(6).
 In our country, the market price which is said comparable price is
practically taken to be arm’s length price.
 Comparable price refers to the price of the same service or the same
commodity to an independent person.

105
 We have two methods of transfer pricing, pre-transaction
agreement or advance pricing agreement and post transaction
agreement.
 In the case of the former, whenever a person thinks to sell or buy
an item to or from a related person, he shall notify it to the tax
authority whether it is acceptable or not by the tax authority. The
tax authority may approve or reverse the transaction. It is said to be
good in that it gets rid of disputes between persons and the tax
authority.
 In the case of post transaction agreement, the person carries out
purchase or sale with a related person and at any time, the tax
authority may audit so as to decide whether the transaction was at
arm’s length price or not.

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Schedule B income tax

 Schedule B income is also a type of business income.

 The type of business is, however, very specific, rental of
buildings. The problem is that the law does not define what a
building is.
 The purpose for which a building is leased does not matter. If
the rental is the primary source of income for the tax payer, then
the income falls under schedule “B”. it is treated separately from
schedule c for it is somehow passive.
 Renting building does not, however, involve significant devotion
of time and energy after the construction thereof is once
completed.
 We must make note of the fact that schedule B is less favorable
than schedule D concerning deduction.
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In general, whether a person is a schedule
b or c tax payer, it will be determined
depending on facts and circumstances.
Pensions and gust houses, even if they are
mainly involved in rental activity, are
included under schedule C.

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 What Is The Gross Income?
 Article five of the regulation provides that Pursuant to Part ll of the
Proclamation, taxable income from sources chargeable under Schedule' 'B"
shall be calculated as follows.
1) Gross income shall include:
◦ (a) all payments in cash and all benefits in kind received by the lessor from the
lessee.
◦ (b) all payments made by the lessee on behalf of the lessor according to the contract
of lease.
◦ (c) the value of any renovation or improvement made under the contract of lease to
the land or building, where the cost of such renovation or improvement was borne by
the lessee in addition to rent payable to the lessor.
◦ (d) According to article 16, if the tax payer leased furnished quarters, the amounts
received attributable to the lease of furniture and equipment shall be included in
income.
2) In calculating taxable income,
◦ only those items mentioned under Article 15 (5) of the Proclamation shall be deductible from
gross income for taxpayer who/which do not hold books of account and items mentioned under
art.15(7) for those holds.

109
 In the case of sub-lease, the gross income of the sub-lesser includes all
payments effected to him as a result of the sub-lease agreement.
 However, his taxable income is the different between the income from
sub-leasing and the rent paid to the lesser.
 If there is no difference or if the difference is negative, the sub-lesser
will not be subject to the income tax proclamation as per schedule B.
 Look at the following example:
◦ Ato A rents a building from Ato B for 1,000,000.00 Birr per year and he (A) sub-leases it to
Ato C for 1,200,000.00 Birr. Now Ato A’s gross income is 1,200,000.00 Birr while his
taxable income is the different between the what he has received from Ato C and what he
has to pay to Ato B (1,200,000.00-1000,000 = 200,000). Thus Ato A is required to pay tax
on his income of 200,000.00 Birr.
 The owner of a building who allows a lessee to sub-lease his building is
liable for the payment of the tax for which the sub-lesser is liable, in the
event that the sub lesser fails to pay. Therefore, the owner of a building is
considered as a guarantor of the sub lesser

110
Deductions:
 deduction is applicable to taxpayers who which do not maintain
books of accounts: Article 15 (5)
◦ a) Fees and Charges that are paid with respect to the land and buildings leased, but
not taxes those imposed by City and State Adm
◦ b) 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 taxpayers maintaining books of account, the necessary deductible
expenses include but are not limited to: Article 15 (7)
◦ b. the cost of lease (rent) of land
◦ c. amounts paid as interests on bank loans and insurance premiums
◦ d. amounts paid to repair the building; and
◦ e. depreciation of the building.
◦ Fees and Charges that are paid with respect to the land and buildings leased, but not
taxes those imposed by City and State Adm

111
 Depreciation
 The amount of the depreciation is to be determined
according to Art. 25(2) of Proclamation in accordance
with the Regulations by Council of Ministers.

112
 The Tax Rate
Once the taxable income is determined by
deducting those deductibles from the gross
income, the tax rate to be applied as per
schedule B is to be chosen.
There are two types of tax rates:
◦ a flat rate- is applicable to bodies
◦ a combination of proportional rate and progressive
rates- is used for physical persons

113
 Schedule D
 Schedule d is related to other income. By other income,
we refer to income not falling under any of the three
schedules, schedule A, schedule B and schedule C.
 Article 63 is provided as Income taxable under this
proclamation shall include, but not limited to….… and
hence, the list of sources of income is open and
enumerative.
 Income under Schedule D is enumerative and further
broadened to include those not mentioned in its
provisions and all other schedules as stated under article
63 of the proclamation

114
These tax sources include income from:
◦ royalties, incomes paid for services rendered outside
Ethiopia, games of chance, dividends, casual rental
of property, interest income and incomes from
specified non-business capital gains.
Unlike the first three schedules, under
schedule D, the tax rates provided are not
uniform.
There are distinct flat rates applicable to each
tax base under this schedule.

115
THE PROCEDURAL PART OF PROCLAMATION NO
979/2016
 The procedural part, unlike the substantive part of the
proclamation deals with procedural matters that helps to
achieve the objectives in the latter.
 Among other things it deals with:
◦ withholding schemes,
◦ tax accounting principles,
◦ declaration of tax,
◦ assessment of tax,
◦ payment of tax,
◦ enforcement mechanisms,
◦ Administrative penalties, tax offences and appeal procedures

116
1.1. Withholding Procedures /Schemes/
 Arts. 88-98 of the Income Tax Proclamation
 are relevant for proper administration of the Income Tax
Proclamation
 articles reveals that the withholding procedures are
applicable to all schedules of the proclamation
except schedule B.
 Why isn’t schedule B?

117
 Withholding of Income Tax on Employment Income

 regulated by Art. 88 of the Proclamation and Art. 25 of

the Income Tax Regulation.
 Art. 81(1) of the Proclamation, an employer is required
to withhold tax from every payment to an employee
unless the income is expressly made tax exempt by
the Proclamation and the Regulation.
 The Obligation of the employer to withhold such
tax has priority over all other obligations
 An employer shall pay the withheld tax to the Tax
Authority within thirty (30) days of the end each
calendar month

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Withholding of Income Tax on Import of Goods

 when such taxpayers import goods for commercial use, a current

payment of income tax is collected at the time of import of goods.
 In this situation, the collected amount is treated as tax withheld that
is creditable against the taxpayer’s income tax liability for the year.
 The amount collected in imports of goods shall be three percent
(3%) of the sum of cost, insurance and freight (“CIF value”).
 Ultimately, when taxpayers declare his/her/ its tax obligation:
◦ if the amount of income tax collected on the import of goods results in
underpayment of business income tax due for the year, the taxpayer is
required to pay the difference with the declaration.
◦ If, on the other hand, the amount represents, an overpayment of income tax, the
Tax Authority shall refund the taxpayer the amount overpaid within three months
period.
◦ The Tax Authority can do this after ensuring the accuracy of the books and
records of the taxpayer.

119
Withholding Income Tax on Payments
 dealt with under Art. 53 of the Proclamation, Arts, 24 and 25 of the
Regulations. In addition, the Tax Authority is also empowered to
issue directives that would help for the proper implementation of
proclamation and the regulation.
 According to Art 53(1) of the Proclamation, withholding agents are:
◦ organizations having legal personality,
◦ government agencies,
◦ private non profit institutions, and
◦ non-governmental organizations are
 Art. 24 of the Regulations (Reg. No. 78/2002) answers on what type
of supplies (goods and services) are such withholding
agents required to withhold income tax?-schemes
 Other persons which /who effect payments to any person who/
which effect payments to any person who/ which supplies goods
and services are not bound to withhold income tax using the
2% rate on the payments.
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Withholding of Schedule D Income on Payments

 As regards the other tax sources, the payer of any payment

subject to tax under schedule “D” is duty bound to
withhold from the payment the amount of tax required.
 The obligation of the payer to withhold tax has priority
over all other obligations to withhold amounts from
payments to a payee (the taxpayer).
 The withholding agent (the payers must pay the withheld
income tax to the Tax Authority within 15 days of the
calendar month and each payment shall be
accompanied by a statement with respect to each
taxpayer who/which received payments during the month.

121
 Tax Accounting and Tax Periods-Art. 28

 Tax Year(Art.2(21) cum 28): Unless otherwise provided,

the period for tax assessment ("tax year") shall be the fiscal
year, that is, the one-year period from 1 stHamle to 30thSene.
 The tax year of a person is:
◦ in the case of an individual or an association of individuals, the
fiscal year;
◦ In the case of a body, the accounting year of the body.
 Where the tax year of a person changes as a result of Sub-
Article (3) or (4), the period between the last full taxes year
prior to the change and the date on which the new tax year
commences shall be treated as a separate tax year, to be
known as the "transitional Year”.

122
The accounting period and Tax
Year
 The accounting period fixed for business purposes may
not be a period for tax purposes.
 The period for accounting income taxes and expenses is
known as tax year. Then, we must decide that we have
to include income and expense obtained and expended
as of when as an income and expense.
 If the expense is expended out of that specific tax
period, the expense shall not be deductible for that tax
year. And, no expense will be deducted in a tax year
other than in which it is incurred; no income will be
recognized as income within that tax year if it is
obtained out of that tax year.

123
??
 In our law, there are three instances where we may have shorter tax
year than 12 months.
◦ change in tax year of the tax payer on the basis of approval by the
authority in which case transitional period maybe created
◦ cessation of taxable business activity: any income after the closure will
be included and there will be tax adjustment.
◦ jeopardy assessment: Article 77/5 provides that If the Tax Authority
makes a finding that the collection of the tax is in jeopardy, a demand for
immediate payment of such tax may be made by the Tax Authority

124
Categories of Tax payers-Art.3
 Category "A", category "B" and category "C" tax payers are
classified as follows:
◦ Category "A" which shall include
 A body/companies
 Any other persons having an annual turnover of Birr 1,000,000 (One
Mill. Birr) or more;
◦ Category "B”, persons, other than a body, having an annual turnover of
over birr 500,000 (Five hundred thousand Birr);
◦ Category C, persons, other than a body, whose annual turnover is
estimated by the Tax Authority as being up to Birr 500,000 (Five
hundred thousand Birr).

125
Tax Declaration-Art.83
There is a form prepared by the tax authority for
the purpose of declaration. The tax payer takes
and fills the form in order to return the file for
the tax authority.
This is called income return or declaration of
income.
What the tax payer does in the case of
Declaration of income is to calculate his gross
income, apply the applicable deductions and
exclusions or exemptions as the case may be and
then obtain the taxable income.
126
 Declaration is an indispensable data for the tax
officials.
 Declaration of income protects the taxpayer from
arbitrary imposition of tax by the officials, as the
taxable income of the taxpayer will be determined
on the basis of his/its declaration unless the
taxpayer falsified the account he/it maintained.
 Then, we apply the tax rate and find the tax due.
Applying the tax rate on the taxable income to find out
the tax due is called as assessment of the tax.
 Assessment of tax (gibrinmewesen) is, therefore, to
compute one’s tax liability.

127
 The imposition of obligations to declare income and pay
income tax is obviously for the purpose of insuring tax
collection.
 To this end, two systems are employed:
◦ the withholding system and
◦ the self-reporting systems in general
 The withholding system works in respect of schedule
A and most of the tax sources of schedule D.
 The self-reporting system (self-declaration) is employed
as regards all other income sources as well as
employment in special situations.

128
 Method of Assessment
 There are two popularly known types of assessment,
These are:
◦ official (government) assessment and
◦ self-assessment.
 They differ from one another in the degree of
participation required from the taxpayer or tax
administrator in determining tax liability.
 When we come to basis of assessment, there are two
bases of assessment. These are:
◦ assessment on the basis of accounts and
◦ assessment by estimation.

129
 According to Article 82, all persons who are engaged in
a business, or who own buildings held all or in part for
rental, except for Category C taxpayers shall keep books
and records.
 In addition to documents of article 82, category “A” tax
payers are required to submit the balance sheet, and the
profit and loss account for that tax year within the time
prescribed for each category.
 Balance sheet refers to asset and liability account or
inventory of assets and liabilities of the tax payer.

130
 For category “B” tax payer, the obligation is to produce
profit and loss account to the tax authority. Category
“B” tax payer is not duty bound to produce balance
sheet before the tax authority. Category “C” tax payers
have no obligation to keep books of account, balance
sheet, profit and loss account and any other documents
necessary to determine their tax liability by law. As
category “A” and “B” tax payers are duty bound to keep
books of account, balance sheet or profit and loss
account, the tax assessment method in the case of them
is a self-assessment method depending on the
documents they have in hand.

131
There is also another method of
assessment called assessment by
estimation. Grounds:
◦ If no records and books of accounts are maintained by
the taxpayer, or
◦ if, for any reason, the records and books of accounts
are invalid to the Tax Authority, or
◦ if the taxpayer fails to declare his or its income
within the time prescribed by this Proclamation

132
 The main point during estimation is that the tax
officials must assess the tax liability in a fair and
equitable manner.
 In other words, they must not assess the tax
liability arbitrarily and they must not have the
intention to punish the taxpayers; rather they
should estimate the tax in good faith.
 In order to achieve this goal, they must assess the
tax in accordance with the available evidence and
the circumstantial evidence that is associated with
the income to be assessed.
133
 Presumptive Tax-Art.49
 The third method is presumptive or standard method of
assessment used for category “C” tax payers. We cannot
assess tax for category “C” taxpayers since they are not
duty bound to keep books of account.
 If they are found to have books of account acceptable to
the tax authority, they can pay tax on the basis of such
books of account.
 There is a standard assessment of tax determined by the
ministry of finance and economy on the basis of
Regulation to be enacted

134
Method Of Accounting: Cash and Accrual Methods

 are by far developed and the most commonly used both in the
world of business and tax.
 Cash method is generally supposed to be simple for it does not
require someone to keep complex books of account.
 Accrual method is also supposed to be more accurate than cash
based method in terms of reflecting the tax payer’s income.
 This is because accrual method reveals not only the income
collected but also the one to be collected yet.
 A taxpayer is at liberty to account on cash or accrual basis.
 However, a company shall account for tax purposes on a accrual
basis. Why is it compulsory for a company?
 According to Art. 29 of the Proclamation any person may
apply in writing for change of method of accounting

135
 Article 60, provides that a person who is accounting for tax purposes on an
accrual basis shall account for amounts to be included in ascertaining that
person's income when they are receivable by that person
 In the case of accrual basis, the item is considered as an income of the tax
payer in the tax year in which it becomes receivable. An expense is also
considered to be the expense of a tax payer in the tax year in which it
becomes payable. Imagine that a person sold an item to another person at
value of 1000,000 birr on January 1st, 2020.
 The payment was agreed to be made in 20021. In this case, the seller
should include the 1000,000 birr to his gross income of 2020 even if
payment is not made yet. Similarly, the buyer should consider the expense
as if made in 2020 even if it is actually to be made yet in 2021.
 An income is said to be receivable in the tax year in which the tax payer is
entitled to receive it. So, in this case, what matters is the right to receive.
The right to receive should not, however, be subject to condition

136
 Payment of Tax and Collection Enforcement:

Tax Credit And Refund:-

 There are tax adjustments (gibirmastekakeya) or refunds
(yegibirtemelash) to be made with respect to the tax due. Tax
adjustment or tax credit (gibirmastekakeya) is to mean off setting
tax (gibirnmatatam or makakas). the adjustment goes as follows.
 Tax due (yemidersibetgibir) under normal circumstances minus any
tax paid before gives us the actual tax payable to the government.
 Every interest, penalty and any other if any is calculated and
imposed on the outcome of the above equation.
 The tax payer may have paid tax (foreign tax, withholding tax that
is not final and so on)).
 In this case, tax adjustment or credit will be made at the time of
paying final tax to the tax authority

137
 PENALTY
Apart from interest, non-payment and late
payment of tax is also subject to
administrative penalties and criminal
offences.
Violation of tax liability or tax obligation
entails administrative penalties and
criminal liabilities

138
 Appeal Procedure
 The law has provided mechanisms of airing grievances
by the taxpayers. These mechanisms are means of
rectifying the errors committed by the Tax Authority.
 Upon receipt of a tax assessment notification, the
taxpayer, in principle, is duty-bound to settle accounts
with the authority within one month.
 If, however, he is not in accord with the assessment
of the Authority the following options are available to
the taxpayer:
◦ administrative,
◦ quasi-judicial and
◦ judicial.

139
 VALUE ADDED TAX(VAT)
It is a consumption tax- unlike income tax
that imposes tax on economic gains by a
person.
VAT imposes a tax only when a person
starts consumption or using his income.
Accordingly ,VAT does not impose tax on
savings.
It is a sales tax-Vat is tax that will be
imposed during sale transactions.
140
 It is multistage:
◦ Sales can either be multistage or single stage. In case of single
stage taxes , even though the good changes hand several times ,
the tax is imposed only once.
◦ In fact, an identical result could be achieved by levying a retail
sales tax, for the latter simply is the total value-added of the
raw materials accumulated throughout the transactions.
◦ However, the fact that the VAT is collected fractionally has a
practical advantage over the retail sales tax.
◦ In case of multistage taxes , tax is imposed every time the good
changes hand.
◦ In effect VAT is nothing but an alternative technique of
collecting sales tax.

141
According to Encyclopedia Britannica VAT is:
“A sales tax designed like other sales taxes, to
tax private consumption by individuals of the
goods or services subjected to tax”
Black’s law dictionary on its part provides that
“VAT is a tax assessed at each step in the
production of a commodity based on a value
added at each step by the difference between
the commodities production cost and its selling
price”

142
 Similarity:
◦ VAT is nothing but it is a sales tax imposed on sales transaction
◦ VAT is a tax on consumption which is to be paid ultimately by
consumers
◦ collected through the medium of business entities.
 Differences:
◦ technique of collecting tax is different:
 Taxpayer(business entity)is liable to collect VAT in proportion to the value it
added to a taxable item
 the crediting system by which firms are allowed to deduct taxes they paid on their
material inputs against their taxable sales= VAT liability.
◦ multi-stage character:
 Imposed on a taxable product every time it changes hands in the chain of production and
distribution.
 VAT greatly resembles the turnover tax, yet TOT is imposed on gross value not value
add

143
Historical Background of Value-added Tax (VAT)

 The concept of value-added tax was analyzed and propounded for by

American fiscal experts in the 1920’s.
 Nevertheless, despite the urgings and pressures of many of its fiscal
experts, the USA failed to implement the tax at a national level.
 is presently the key component in the tax systems of a vast number
of countries
 was initially introduced in France in 1954.
 its introduction was the result of World War II
 gained recognition at an organization level in the Common Market of
the European Economic Community (EEC)in 1970.
 was made a compulsory prerequisite of membership with a view
to harmonizing the tax system of the members-reason for its
widespread recognition
 is now implemented over 120 countries in the world

144
VAT in Ethiopia
 In Ethiopia, VAT was introduced since January 1, 2003 designed to
replace the out dated sales tax, which has served for more than four
decades, which was collected at manufacturing level
 was introduced in the country only recently by Proclamation No.
285/2002. This tax was introduced in lieu of the sales tax collected at
the manufacturer’s level. The turnover tax was also adapted to govern
the area where VAT does not apply.
 was part of the tax reform the Ethiopian State tried to undergo.
 faced resistance from business entities because they feared that they
would be burdened with collection costs.
 was introduced in 2002 and it was implemented in January 2003.

145
Rate of VAT
As provided in article 7 of the proclamation two
rates are used in order to impose VAT:
I. Standard rate(15%)- this rate is used for all goods
and services subject to the payment of VAT except
those specifically made taxable at a zero rate.
II. Zero Rate(0%)- goods and services provided in
article 7(2) are subject to tax using 0%. Zero
rating is similar with exemption in terms of the
burden of the tax on those goods .

146
Types of VAT
Gross product type -taxes paid on purchases of
capital goods fixed capitals and depreciations
there to are not allowed to be refunded.
Income type-refund for the purchase value of
capital goods is prohibited like But, it allows
refund on the periodic allowance for the
depreciation value of capital goods.
Consumption type – Vat paid on all input are
credited.
Art. 21(1) of the proclamation

147
Input Tax vs. Output Tax
 Since the defining features of VAT is its rebating
mechanism, a clear understanding of the terms input tax
and output tax is very important to understand how VAT
operates.
 Input tax is paid by business entities on the purchase of
inputs that are used to produce a taxable product.
 Output tax is the tax a business entity collects from the
sale of taxable products.
 As a result, a firm’s liability is only the difference
between the input tax and output tax.

148
Tax Crediting
The process of returning taxes paid during
purchase of inputs for the registered person.

149
Methods of Computing VAT
Liability
 The value that a firm adds to the goods and services it buys from other firms
can be determined in three different methods. These are:
 a) Credit method: sometimes known as the invoice method, value-added
is determined by deducting the amount of tax that is paid on business input
from the amount of tax that is collected from taxable supplies. This
method of calculating VAT liability is favored since it could minimize
evasion.
◦ Ethiopia has introduced a credit based and invoice method VAT-Art. 20 of the proclamation..
 b) Subtraction method: Under this method, deducting from the total sales of
a taxable activity, the amount of purchases used to make a taxable
transaction and then applying the rate which determines liability of VAT.
 c) Addition method: this approach consists in adding various bookkeeping
items, specifically the payments made by the firm to the factors of
production employed in producing the product, such product, as wages,
interests, rent, royalties and profits and then applying the rate.

150
Advantage of VAT

• It avoids cascading effect of a tax ( Tax on

Tax ).
It is a more comprehensive and equitable
tax system
• It reduces the possibility of tax evasion
• It has less tax burden
• It is neutral
• It improves productivity
• It promotes capital investment and saving
• It enhances exports
151
Criticisms on VAT
 It is regressive in nature
 It requires advanced economic structure.
 It puts additional burden to tax authority
 It is uneconomical
 It has ream loopholes for tax evasion:
◦ Taxpayers could over report sales of zero rated goods;
◦ Taxpayers could use invoices they received for personal purchase to
claim tax credit;
◦ It enables buyers and sellers to strike secret deals with regards the
issuance of receipts;
◦ It could lead to the formation of forged companies receipts to claim
tax credit on input VAT, etc.
152
Registration for VAT
 Two kinds of registration :
1. Obligatory Registration-
◦ trader are required by law to register for VAT.
◦ A person carrying commercial activity may apply to be registered for
VAT. Pursuant to Art 16(1) if the total taxable turnover (transaction)
over a period of 12 months exceeds 500,000 Ethiopian birr; the
person shall be registered for VAT.
◦ Failure to register may entail penalties.
2. Voluntary registration-
◦ these group of taxpayers are not obliged to register but may
voluntarily apply for registration.
◦ But Art 17 provided a condition that shall be satisfied ; Only those traders
having their 75% of their transaction with a registered person may
apply for voluntary registration.
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Application for Registration
 Persons whose total taxable transaction exceed the
minimum threshold and not registered are required
to file application for VAT registration by
themselves.
 The application is made on the form called “
Application for VAT registration” The authority
will issue a VAT registration certificate containing;
◦ Full name and other details of the registered person;
◦ Date of issuance;
◦ Date from which the registration takes effect;
◦ The registered person’s TIN.

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Cancellation of Registration
Causes for cancellation:
◦ if the person ceases to make taxable transactions ;or
◦ If the person’s total taxable transactions falls below
the threshold application for cancellation is allowed.
Effect of cancelation:
◦ the person’s name and details will be removed from
registry
◦ the person shall return the certificate of the authority.

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Zero Rated transactions
 A taxable transaction that is taxed at a zero rate during sale only. The
purchase is taxed at the standard rate.
 the transaction by it self is taxable subject to VAT in the sense included
under Art 7(3) “taxable transaction” But, the Law has given blessings
so that the transaction (supply of goods or rendition of services) are
completely free from tax.
 Pursuant to Art 7(2) of the VAT proclamation, the following
transactions are zero rated.
◦ export of goods and services
◦ The rendition of transportation or other services connected with
international goods or passengers, as well as the supply of lubricants,
consumption, during international flights.
◦ the supply of gold to the National bank of Ethiopia.
◦ transfer of a business from one registered person to another registered
person as going concern
 This kind of incentive is allowed basically to encourage export.
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Destination/Origin principle:
 VAT could be imposed using a destination principle
or origin principle.
 A destination principle provides that VAT is imposed on
goods and services in the area of their consumption. As
a result, exports are untaxed while imports are taxed.
 Inversely, in an origin principle VAT is a tax that is
imposed on goods and services in the area of their origin
or production irrespective of the area of
consumption. Consequently, exports are taxed, while
imports are not.
 The Ethiopian VAT has preferred the destination
principle

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Supply of Goods or Services
 Under the Ethiopian VAT Proclamation,
supply of goods and services has been regulated
under Art. 4 and 5 of the Proclamation.
Art. 3 of the Regulation (Regulation No
79/2002) is also important in order to have a
full picture as to supply of goods or rendition of
services for the purpose of collection of VAT in
Ethiopia.

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Taxable activity
 Is an activity which is carried on continuously or
regularly by any person.
 Also includes:
◦ Sales to the staff (eg. Meals even if supplied free of charge or
goods at reduced prices or frees).
◦ Sales of business assets (eg. Equipment, for nature commercial
vehicles)
◦ Hire or loan of goods to someone else
◦ Goods which the proprietor or his family have taken from the
business for their own use.
◦ Commission received in return for selling something on behalf
of someone else.

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Taxable Transaction
 Art 7(3) of the VAT proclamation provides that A “taxable transaction” is”
a supply of goods or a rendition of services in Ethiopia in the course or
furtherance of a taxable activity other than an exempt supply under. Art 8.
 The terms “good” and” services “shall be treated separately. Pursuant to
Art 2(2), A” good” is all kind of corporeal movable or immovable
property, thermal or electric energy, heat , gas, refrigeration, air
conditioning and water energy.
 Under Art 2(16) “service “is provided as “work done for others which
doesn’t result in the transfer of good. When service is rendered the good is
not transferred from place to place but the service rendered adds certain
value on the good.
 “Supply” as per Art2 (17) is to mean sale of goods or rendition of services
or both.
 A tax- able transaction (supply of goods or rendition of services) is subject
to VAT only if carried out by a person who is registered for VAT.

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Exempt Transactions
 An exempt transaction is a transaction not subject to VAT. Thus the transaction is
not considered taxable transaction for social, economic or development reasons.
 Art 8 (2) of the proclamation states exemptions:
◦ the sale transfer or lease of immovable
◦ rendition of financial services
◦ supply or import of national or foreign currency
◦ the import of gold to be transferred to the national Bank of Ethiopia
◦ the rendering by religious organizations of religious or church related services
◦ the import or supply of prescription drugs specified in directives issued by minister of
Health,
◦ rendition of educational services provided by education institutions..
◦ the supply of goods transferred to state agencies of Ethiopia and public organizations for
purposes of rehabilitation after natural disaster, industrial accidents and catastrophes
◦ the supply of electric and water
◦ the supply of goods for the official use of diplomatic missions
◦ post office operations and the provisions of public transport permit and license fees, etc

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Turnover tax(TOT)
 A form of sales tax(Multistage)
 Considered as equalization tax
 TOT is imposed on those not registered for VAT to equalize
and enhance fairness in commercial relations and make
complete the coverage of tax system so as to increase
government’s revenue from taxation.
 Turn over tax is applicable for those whose annual
transaction is below 500, 000 birr save voluntary
registration for VAT.
 Turn over tax is applicable on supply of goods, rendition of
services and persons not registered for VAT

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Scope of Turn -over Tax

The scope of application of turn over tax

proclamation is on:
◦ supply of goods
◦ rendition of services
◦ persons not registered for VAT

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Rates of Turnover Tax
The base to compute turn over tax is the
goods receipts in respect of goods
supplied or service rendered (Art 5).
Art 4 incorporates two kinds of rates:
 2% on goods sold locally and for services rendered
locally
 again in two rates:
 2% for contractors, grain mails, tractors and combine-
harvesters and
 10% on others

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 Obligations of Tax Payers under the
Turnover Tax Law
Filing of Turn over Tax Return and
payment
Keeping Records
 Notification of changes

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 Excise tax
 Proc. No 307/2002 (as amended by proc. No
610/2009)
 Two kinds of properties are subject to excise tax:
1. Luxurious items or Demand inelastic goods
2. Goods considered as harmful to the health and well
being
 In certain goods the tax rate reaches 100%
implying that the goods are not encouraged to be
imported or produced locally. The end goal seems
to ban their production.

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 Excise tax in Ethiopia is introduced for many reasons. The
preamble of the excise tax proclamation (proc No 307/2003)
dictates the rational in the following manner:
◦ it helps to improve government revenue by imposing excise tax
payable on selected goods.
◦ Tax shall be imposed on luxury goods and basic goods which are
demand inelastic. The imposition of tax on luxury goods usually
has little or no impact on the expenditures of the poor. One basic
rational of introducing tax in a certain state is to redistribute
income and narrow the gap between rich and poor.
◦ Imposition of taxation on goods that are hazardous to health and
which are cause to social problems, will reduce their
consumption.

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 Products subject to Excise tax
◦ Excise tax is applicable to goods which are either produced locally or
imported from other countries.
 Tax Rates
◦ The rate varies from 10% in textiles and textile products to 100% for
other alcohol drinks, perfume and toilet waters; and motor vehicles
above 1800 C.C.
 Bases of Excise-Tax
◦ The base of the taxation according to the proclamation is a produced
thing: whether produced locally or imported from abroad.
◦ Art 5 states that Base of computation of excise tax are:
 in respect of goods produced locally, the cost of production
 in respect of goods imported; cost, insurance and freight (C.I.F)

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Payment of Excise Tax
The excise tax shall be paid within the
time prescribed;
◦ in respect of goods produced locally, by the
producer;
◦ in respect of goods imported by the importer.
Should be paid:
◦ When imported at the time of clearing the
goods from customs area.
◦ when produced locally not later than 30 days
from the date of production;
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Obligation of Tax Payers
 Maintaining books and accounts and supporting documents in
accordance with proper accounting principles and in a manner
acceptable by Tax-Authority.
 Submit every 30 days to the tax authority, in a from which would
be supplied by the authority, a declaration containing the necessary
information for the proper collection of the tax.
 Comply fully with the requirements of inspection of his premises
by the delegates of the Tax Authority.
 Immediately communicate to the Tax Authority the type and
address as well as the commencement and termination date of his
business.
 Pay in full the tax due with in 30 days from the date of the
termination where such business is terminated.

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 Custom Duty
 Proc. No 622/2009:
 Tax on import and export of goods.
 The organ responsible to supervise and control such is Ethiopian
customs authority.
  Its objectives, among others, the following:
◦ collecting duties and taxes on imported or exported goods
◦ implementing laws and treaties related with its goal
◦ Controlling the importation or exportation of prohibited or restricted goods.
 In connection with this, Art 6 of the proclamation enumerates
powers and duties of customs Authority that helps to realize the
objectives set above.

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specific tax, is a tax that is defined as a
fixed amount for each unit of a good or
service sold, such as cents per kilogram. It
is thus proportional to the particular
quantity of a product sold, regardless of its
price.
 ad valorem tax (Latin for "according to
value") is a tax based on the value .

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 Stamp Duty
Proc. No 110/98
Stamp is an official mark or seal placed
on a document especially to indicate that a
requirement tax has been paid.
Thus, stamp duty is a tax raised by
requiring stamps sold by the government
to be affixed to designed documents,
which form one kind of revenue to the
governments treasury
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Bases of the Duty
 Art 3 of the stump duty proclamation exhaustively lists instruments chargeable with
stamp duty in the following manner:
 Memorandum and articles of association of any business organization cooperative or
any other from of association.
 award
 bonds
 ware house bond
 contractor agreements and memoranda thereof
 security deeds
 collective agreement
 contract of employment
 Lease, including sub-lease and transfer of similar rights.
 natural acts
 power of attorney
 documents

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 Rates and Mode of Valuation of stamp
Duty
 As per Art 4 (1) (2) the applicable rates are those specified in the
schedule attached to he proclamation which is considered as
integral part of the former. Incase a document is to be executed
subsequently, a flat rate attached as a schedule in the proclamation
is applied accordingly.
 The rates might be flat or they may depend on the value of the
property for which a document is prepared under the schedule for
memorandum and articles of associations of business organizations
and any association a flat rate of 350. birr ( at first execution) and a
flat rate of birr 100 ( for subsequent exceptional) in imposed
 On the other hand, rather than flat rate system proportional taxation
is imposed on other kinds of documents. Awards, bonds, Ware
house bond, security deeds, leases and registered title to property
are typical examples.

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Final Exam
Exam type : All types ( Including multiple
choice, matching ,true /false , short answers
and hypothetical questions).
Parts covered : All Income tax Schedules-
A, B, C, D and E, VAT, TOT AND Excise
tax
NB: Make sure to review all previous exit
exam questions on tax law.

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End of Class

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