Income Taxes in Ethiopia(1).

pptx

If there are images in this attachment, they will not be displayed.

Download the original attachment

Income Taxes in Ethiopia

T. Lencho 2012/2013

A note on Terms

list of 4 items

• Income = Consumption + Saving

• Income Tax is a direct Tax, although the fact that it may be collected through withholding may
make it look like an indirect tax.

• Income taxes on employees are withheld by employers, as income taxes on businesses from
imports and supplies of goods and services.

• Income taxes in the plural is apt because Ethiopia has a collection of income taxes, not an
income tax.

list end

2
Brief History

list of 4 items

• Modern income taxation in Ethiopia began in 1944, with the introduction of tax on
agricultural income (tax in lieu of tithe) and tax on individuals and

businesses in the same year.

• The first income taxes were schedular in structure- based on the British tradition of taxation
by sources of income.

• The 1944 income tax law identified three schedules – Schedule A (personal income tax);
Schedule B (businesses grouped as retailers, traders, premises,

sundry establishments which were then sub-classified into three classes); and Schedule C (sur-
tax above a certain income threshold)

• 1944 – income from agriculture (tax in lieu of tithe)

list end

Cont’d

list of 5 items

• 1949 – second income tax law – covered “all income” except income from agriculture

• Schedule A – income from employment and rental of property in a non-commercial setting

• Schedule B – income from businesses – 70 different types of businesses were identified and
divided into seven classes – this is the modern equivalent

of standard assessment.
• Schedule C – sur-tax and withholding of taxes on importers and exporters

• 1949 law was the first to introduce income tax exemptions (tax incentives) in Ethiopia.

list end

Cont’d…

list of 4 items

• 1956 – Income Tax Decree replaced the 1949 law, reorganizing the schedules.

• Schedule A – income from employment only and introduced a monthly accounting period for
Schedule A

• Schedule B – income from rental of lands and property except agriculture;

• Schedule C – income from business, professional, vocational occupation, exploitation of wood

and from all other sources.

list end

Cont’d…

list of 3 items
• 1961 Income Tax Proclamation – the most famous income tax, although it simply substituted
the 1956 Income Tax Decree. In content it was virtually similar

to the 1956 decree, but it is better known because it survived three Ethiopian regimes until it
was finally repealed in 2002

• 1967 – the first truly modern agricultural income tax – added Schedule D to the main income
tax system of Ethiopia – but the 1967 income tax and Schedule

D were short-lived, scupperred by the Revolution of 1974.

• Agricultural income tax regime was part of the main income tax regime for a brief period
between 1967 and 1974. It has operated as a separate income tax

regime ever since.

list end

Cont’d…

list of 4 items

• 1975 – Schedule B was repealed as a result of the nationalization of land and expropriation of
extra-housing. A law issued in 1975 outlawed rental of

buildings, which virtually eliminated the income source for Schedule B.

• 1976 – the 1967 agricultural income tax was repealed and replaced by an autonomous
agricultural income tax regime, and with it, Schedule D.

• 1978 – a different Schedule D with completely different sources was added – called
miscellaneous sources – royalties (40%); income from technical services

(10%); income from games of chance (10%); dividends (25%)

• The 1978 income tax also raised tax rates to unknown heights – personal income tax top
marginal rates (89%) and business top marginal rates (85%); corporate

rate 50%

list end

Cont’d…

list of 5 items

• 1986 – petroleum income tax – mainly to attract foreign exploration companies into Ethiopia

• 1990 – the steep marginal tax rates of 1978 were brought down from the high of 89% to 59%

• 1993 – Schedule B – was re-added (top marginal tax rate – 45%

• 1993 – mining law and mining income tax law was issued – similar in content to the 1986
petroleum income tax law.

• 1994 – the income brackets and tax rates for schedule A and B were revised (from 59% to
40%)

list end

Cont’d…
list of 3 items

• 2001 – withholding taxes on imports and payments were re-introduced – to improve the cash
flow to the Government.

• 2002 – replaced and repealed all the income taxes that were in force up to that time except
the autonomous income tax regimes of petroleum, mining and

agriculture.

• The 2002 income tax law was a product of the so-called “Comprehensive Tax Reforms of
2002” as a result of which most taxes of Ethiopia were revised –

VAT, ToT, Excise Taxes.

list end

Major changes of 2002 Income Tax Reforms

list of 2 items

• Consolidation of piecemeal income tax laws and amendments since 1961 – reducing the level
of uncertainties. Unfortunately, the situation has since then

returned to the old days.

• Uniformity of income brackets and tax rates between Schedules A, B, and C, except Schedule
D. However, subtle differences persist as a result of differences

in accounting periods and rules of aggregation. Differences in characterization also account for
significant discrimination in tax burdens on income.

list end
10

Cont’d…

list of 3 items

• Introduction of anti-avoidance rules into the income tax law – rules on relationships (Articles
2(4) (5); transfer pricing (article 29); thin capitalization

(Article 21(3) and many others were official recognitions of avoidance as an income tax
problem.

• Income Tax Jurisdiction – from source-based to residence-based jurisdiction.

• The reintroduction of standard assessment for small businesses and hard-to-tax groups (so-
called Category C businesses)- but there were series glitches

in implementation.

list end

11

Cont’d…

list of 4 items

• Vast improvements in enforcement powers – introduction of tax foreclosure powers and

securitization can potentially cut down the red tape in collection

of tax arrears;
• Introduction of modern accounting principles for tax (e.g., pooling in depreciation, cash and
accrual methods, claim of right doctrine, long term contract

accounting);

• Reforms in income tax administration – introduction of TIN, withholding at source (imports

and payments) and later the cash registers.

• Reforms in Tax Dispute settlement – the introduction of Review Committees within the Tax
Administration.

list end

12

General Rules of Income Taxes: types and Number of Income Taxes

list of 2 items

• The Main Income Tax – employment income tax, rental income, business and/or professional
income tax (profit tax); miscellaneous income taxes (royalties,

technical services, games of chance, dividends, interest, investment property and windfall
profits)

• Autonomous income tax regimes – agricultural income taxes (under Regional Governments);
petroleum and mining income tax regimes.

list end

13
Organization of the Main ITP

list of 3 items

• Loosely divided into two main chapters: substantive and procedural provisions.

• Chapter I – has five sections – One Section devoted to General Provisions and the four others
for the four schedules.

• Chapter II – has eleven sections, stipulating procedural or administrative provisions on

matters ranging from withholding procedures to assessment, payment,

collection as well as dispute resolution and income tax offenses and penalties. Although this
chapter looks like it contains common rules, the reality

is that it contains procedural rules that are in some ways unique to each of the four schedules.
But there are some common rules.

list end

14

Income Tax: General Issues: Tax Avoidance Provisions

list of 4 items

• Distinguishing tax avoidance from tax evasion.

• The main objective of tax avoidance rules is to prevent taxpayers from taking advantage of
loopholes.

• Anti-avoidance or anti-abuse rules are found scattered throughout the ITP and the ITRs.

• The three major anti-abuse rules in the ITP are: a) Rules of Relationships; b) Transfer Pricing;
and c) Thin Capitalization
list end

15

Cont’d…. Rules of Relationships

list of 4 items

• Relevant Provisions: Articles 2(4) (5) (ITP); Articles 8(7) (8), 9 of the ITR. Together with Articles
21(3), 24(6), 29, and 37(6)(a).

• Relationships can be categorized for ITP purposes into two: a) Natural and b) juridical

• Natural/Individual Relationships: see Article 2(5) (ITP), and Article 2(4) (i) & (ii).

• Juridical Relationships – Article 2(4(iii). Here relationship is fixed either by a) membership (Art.
2(4) (iii) – for partnerships, joint ventures, unincorporated

associations, private companies or bodies; or by b) control (Art. 2(4) (iv)) for incorporate
companies.

list end

16

Cont’d… why regulate relationships? and problems

list of 5 items

• The main aim is to police relationships so that they would not thereby be used for tax
avoidance. Relations may and have been known to use their special
relationships to reduce tax liability.

• Unfortunately, the definitions suffer from the problem of poor drafting and the use of terms
that are alien to Ethiopian tax system.

• Alien terms: unincorporated association, private company, registered partnership, close

corporation, unincorporated company, even trusts.

• Long definitions: poorly copied from some common law source.

• Too abstract and ill-designed for the poor tax administration of Ethiopia.

list end

17

Cont’d… Transfer Pricing

list of 5 items

• Definition: a transfer pricing is price set by a taxpayer when selling to, buying from or sharing
resources with a related person. The opposite of a transfer

price is a market price or a price set at arm’s length.

• Transfer pricing rules empower Tax Authorities to allocate gross income, deductions, credits
and other allowances so that a country collects its fair

share of tax revenue.

• Taxpayers can take advantage of differences in tax rates or deduction rules among countries
(international taxation) or tax benefits or allowances available

domestically (e.g., tax incentives/holidays).

• Transfer pricing contracts are otherwise unimpeachable.

• See Article 29
list end

18

Cont’d… thin Capitalization

list of 3 items

• Thin capitalization describes a situation where a company relies disproportionately upon debt
financing as opposed to equity financing.

• Thin capitalization arises out of the different tax consequences accorded to interest as
opposed to dividends (interest is deductible while dividends

are not).

• The standard threshold for thin capitalization is 1:3 (equity: debt ratio); in Ethiopia it is 1:4.

list end

19

Cont’d… Taxation of Individuals and Entities

list of 4 items

• Ethiopian income tax laws target both individuals and entities – the rules are mostly common
and found in the same laws. The main difference b/n individual

taxation and entity taxation is that the income tax rates on most types of individual income are
progressive while the tax rate on entities is flat (30%).
• The problem is that it is not clear which entities are subject to individual taxation and which
entities are subject to entity taxation.

• We know businesses organized as companies are subject to entity income taxation (otherwise
known as corporate income taxation)

• The situation is murky with respect to partnerships.

list end

20

Cont’d…

list of 5 items

• In other countries, partnerships are flow-through, pass-through, or transparent entities. The

partnership income is not subject to tax; instead the income

is allocated among members, and individual partners are subject to individual income tax on
their partnership income.

• In Ethiopia, partnerships are subject to the tax on partnership income as corporate bodies but
the distributions are not subject to additional tax. The

exception is cooperatives.

• Companies are subject to tax on corporate income and shareholders are subject to dividend
withholding tax.

• Poor drafting and mindless transplantation (mis-implantation) have marred the organization
of the ITP. E.g., registered partnership – that Frankenstein

of mindless transplantation.

• See Articles 2(1) (2), 6(h) (i) and Article 34.

list end

21

Cont’d… Income Tax jurisdiction

list of 3 items

• Income itself has no fixed place – it can be anywhere and nowhere.

• There are two bases of jurisdiction: personal and source /territorial jurisdiction. Personal
jurisdiction can be based on nationality (in very few countries)

or residence (in most countries).

• Ethiopian income tax jurisdiction was territorial prior to 2002 but has since then become
residence based. But the truth is that Ethiopia applies all

sorts of jurisdiction in different contexts (residence (see Article 3(1); source (Article 3(2); and
nationality (see Article 5(1)(c)

list end

22

Cont’d… Residence for individuals

list of 6 items

• Three identifiers – i) physical presence; ii) domicile; and iii) habitual abode.
• The physical presence test is fixed in the law while the other tests are not defined. Perhaps,
we need to refer to the Civil Code and Income Tax Treaties

to which Ethiopia is a party to unlock the meaning of these tests.

• Physical presence requires evidence of presence in a country for an aggregate of 183 days in a
period of 12 calendar months.

• What does presence mean? Days of arrival and days of departure? Part of the day, weekends,
national holidays? Days of transit?

• For which tax period is an individual considered a resident? For both tax periods in which her
presence falls?

• Suppose an American professor stays in Ethiopia for a month long lecture on taxation and is
paid a lump-sum amount? Is she subject to Ethiopian income

tax jurisdiction for that income? Why? Why not? Should the University-employer withhold the
tax from the professor’s lump-sum salary regardless of her

period of stay?

list end

23

Cont’d…

list of 3 items

• What is domicile? See the Civil Code – Article 183 it is defined as “permanent residence”.
Domicile connotes a permanent link with the state.

• What is habitual abode? In tax treaties, habitual abode is used a tie-breaker in cases where a
person has a permanent home or residence in two or more
countries, and decision has to be made to prefer one of them. In that case, the place where a
person frequently stays is considered the habitual abode.

Sometimes, nationality serves as a tie-breaker.

• In fixing the residence of individuals, we should proceed from the most objective (and easiest)
– physical presence – to less objective tests of ‘domicile’

and ‘habitual abode’.

list end

24

Cont’d… Residence for entities

list of 3 items

• The criteria for residence of entities are different from individuals. Why?

• There are three criteria: a) Principal office; b) Place of effective management; and c)
registration in MoT or Trade bureaus – see Article 5(3)).

• Registration – is a formal requirement which may render the other requirements

unnecessary. Every foreign business interest or organization must be registered

to conduct any kind of business in Ethiopia. Registration must not therefore be sufficient to fix
the residence of business organizations.

list end

25
Cont’d… residence for entities

list of 2 items

• Principal office – is less formal than registration but it is still reasonably formal. It denotes the
head office of a business organization.

• Place of effective management – is probably the most substantial link for establishing
residence. According to Model Tax Treaties (e.g., OECD Model Tax

Treaty), place of effective management refers to the place where key management and
commercial decisions for the conduct of the business are made; place

where senior management (e.g., board of directors) meet, etc. It all depends on the facts and
circumstances of each case. In international tax treaties,

place of effective management is often used as a tie-breaker in cases where a business

organization is a resident of multiple countries. Registration (or

incorporation) may make an entity a resident of multiple countries, but place of effective
management will make it a resident of only one.

list end

26

Cont’d… Source rules

list of 2 items

• Source is an important basis for exercising the power of taxation. While residence determines
the issue of whether a country has the right to tax the

worldwide income of taxpayers, source rules determine the country which has the primary right
to tax income. In many cases, a source country has the primary
right to tax any income that has a source in its territory. It is therefore critical to understand the
concept of “source” in income taxation. Article

3(2) of ITP establishes this basic principle.

• Unfortunately, the source rules of ITP are far from clear. Article 6 – which is supposed to be a
source rule- ends up being a complete bungling of the

idea of ‘source’. It lists the potential sources of income (as if we were to be told about that)
without providing for rules defining or fixing cases in

which these sources are said to have occurred in Ethiopia.

list end

27

Cont’d…

list of 4 items

• Better source rules are found in Article 2(9) and Article 31-36 of the ITP.

• Problems: when is employment (one of the sources) said to be in Ethiopia? where the
contract is signed, where the payment is made, where the employment

service is provided, where beneficiary of the service is found?

• The source rules of the ITP should have provided for so-called “allocation” rules – rules that
help a country fix the source of the income with respect

to various sources of income – employment, independent contract, investment, etc.

• Source rules help locate the source of income: e.g., employment and personal services(where
services are performed); business income involving sale of

inventory (where sold, or allocation); interest (residence of payer); rents, sale of property
(location of property); royalties (where property is used),
etc.

list end

28

Cont’d… source: Permanent establishment (PE).

list of 5 items

• A PE is a source concept intended to determine when a business organization has sufficient

link with a country to subject it to tax on its income attributable

to the PE.

• Consider points of link: i) a business organization imports goods to a country; ii) a business
organization establishes a subsidiary company in a host

country; iii) a business organization has a branch, an office, or installation or a specific contract
in which it operates in a host country and leaves

the country upon the completion of the project. The PE is intended to capture the third type of
link.

• The PE does not stand on ceremonies as to how businesses are conducted in a host country.
However businesses are conducted whether through formal establishment

of subsidiaries or through branch offices, the PE helps countries isolate the PE from the main
office or parent company for purposes of taxation.

• A PE may therefore be place of management, branch, office, factory, workshop, mine, a

quarry, installation or any other place of extraction of natural

resources.

• However, it does not cover situations stated in Article 2(9) (b).

list end
29

Cont’d…

list of 1 items

• In cases where a foreign business organization operates through agents, the existence of a PE
depends on the status of the agent, and the relationship

between the foreign business organization and the agent. If the agent is a dependent agent
(e.g., an employee), the agent is treated as a PE. If the agent

is independent, the agent is not treated as the PE and therefore not an extended arm of the
foreign business organization.

list end

30

Double Taxation and Reliefs

list of 3 items

• Double taxation describes cases where the same tax base is taxed more than once.

• Distinguish legal double taxation from economic double taxation. Taxation of dividends in
addition to taxation of corporate income is not double taxation

in a legal sense, although economists have decried for a long time that it is.
• Legal double taxation arises from overlapping jurisdictions. There are three principal sources
of jurisdictional conflict: residence- residence conflict;

residence- source conflict; and source- source conflict.

list end

31

Cont’d… solutions

list of 4 items

• Two solutions have been in use in the world: unilateral and bilateral.

• Unilateral double tax reliefs: due to the chilling effect of double taxation upon investment and
the flow of capital, many countries have taken it upon

themselves to relieve income from double taxation.

• The unilateral reliefs can range from exemption, to deduction to credit methods.

• Exemption Method: when a country adopts the territorial jurisdiction in income taxation, it at
once relieves income generated outside its territory from

taxation, thus removing one of the sources of double taxation, namely residence – source
conflict. NB: this does not always overcome all the problems of

double taxation.

list end

32
Cont’d…

list of 2 items

• Deduction Method: this is less often used in domestic legislation. In a deduction method, a
foreign tax is deductible from gross income and thus treated

as much an expense as the other costs of business, such as labor costs. The deduction method
is less beneficial to taxpayers, as it only reduces the gross

income and serves merely as a reduction of tax.

• Credit Method (the Foreign Tax Credit – FTC) – in FTC, taxes paid on foreign source income
are credited against domestic income tax due on the same source.

It is the second best option for double tax relief. The value of a credit is equal to the amount of
tax that would have been payable to a country in the

absence of the FTC. It benefits taxpayers dollar for dollar. See Article 7 of ITP.

list end

33

Cont’d…

list of 4 items

• Ethiopia followed the exemption method prior to 2002 and the foreign tax credit method
since 2002.

• Limitations: FTC is subject to a number of limitations.

• i) Per-Country Limitation – see Art. 7(4).

• Case: Ethiopian Company (ABC) generates 50K in Sudan, 20K in Djibouti and 30K in Kenya. The
corporate tax rate in Sudan, Djibouti and Kenya is 40%, 10%

and 20% respectively. What does the per-country limitation imply in this hypothetical case? NB:
Ethiopian rate is 30%.

list end

34

Cont’d…

list of 2 items

• 2. Excess Credit Limitation – the tax credit may not exceed the amount of domestic tax due on
foreign income. What does this imply?

• 3. Losses may not be swapped against gains in another country – this is simply an extension of
the per-country limitation. See Article 7(3). Question:

modify the facts in the hypothetical case above so that ABC incurred a loss in one of the
countries and apply the loss limitation to the factual situations.

Read Art. 7(3) with Art. 28 of ITP

list end

35

Cont’d… issues in FTC in Ethiopia

list of 3 items

• How does FTC apply in a schedular system like that of Ethiopia – how does one find sources in
foreign countries that correspond with the source of income

taxation in Ethiopia? Example: US has a global income tax system. How does a person who pays
income tax in the US get a tax credit in Ethiopia? Against

which source?

• Should Ethiopia give complete freedom to taxpayers to calculate taxable income in

accordance with the foreign country’s income tax system? some expenses

are deductible in a foreign country and non-deductible in Ethiopia.

• How should attribution issues be overcome? Suppose a multinational company borrows

money internationally and then uses the money for both its international

operations and domestic operations in Ethiopia. To which is the interest cost attributable?

list end

36

Double Taxation Treaties

list of 4 items

• Tax treaties are known mainly for avoidance of double taxation, but they serve multiple
purposes.

• 1. Treaties provide for tie-breaker rules in cases of conflicts of jurisdiction.

• 2. Treaties provide for fiscal cooperation to combat fiscal evasion – administrative

cooperation and information exchange rules can help countries enforce

taxes across borders.

• 3. Double Tax Reliefs – tax treaties can overcome double taxation arising from residence-
residence, as well as source-source conflicts.

list end

37

Double taxation Treaties: Ethiopia

list of 5 items

• Ethiopia has signed double taxation treaties with a number of countries: France, Turkey,
Russia, Yemen, Sudan, South Africa, Saudi Arabia, and most recently

the Netherlands.

• Tax treaties serve the symbolic purpose of golden handshakes in diplomatic relations. They
are rarely invoked as source of authority in practice.

• The tax treaties of Ethiopia imitate both models – OECD and UN models.

• The treaties with Russia and the Netherlands for example imitate that of OECD while the ones
with Yemen and Algeria imitate that of UN model.

• Note: The OECD Model is more favorable to residence (developed) countries while the UN
model was designed to favor source (developing countries). For

example, an operation in a country qualifies as PE in the OECD model if it lasts for twelve
months, but six months is enough under the UN model convention.

list end
38

Definition of Income

list of 3 items

• Economic Definition: Henry Simons (Personal Income Taxation (1938): “The algebraic sum of :
(1) the market value of rights exercised in consumption; and

(2) the change in the value of the store of property rights between the beginning and end of the
period in question”. This is also called the “Comprehensive

Income Tax Base” or the “Shanz-Haig-Simons” (SHS) notion of income.

• Ethiopian Law: Article 2(10) “… every sort of economic benefit including nonrecurring gains in
cash or in kind, from whatever source derived and in whatever

form paid, credited or received”

• Question: do you recognize any affinity between Simons’ definition and that of Ethiopian law?

list end

39

Definition breakdowns

list of 4 items

• Economic benefit – must be capable of being quantifiable in monetary terms. Psychic

pleasures are not taxable (e.g., pleasures from leisure, or reading

books, or watching movies).

• Kinds of economic benefits: in cash (money), in kind (property), in services, barter. Question:
are self-produced goods and services income? Suppose a

lawyer defends herself? Or a homeowner grows fruits and vegetables in her garden?

• Non-recurring – the frequency of the benefit is immaterial. Example: lottery winnings are
income.

• From whatever source: the source of income is immaterial. The source may not even be
identified. At least theoretically.

list end

40

Income: the theory and the reality

list of 2 items

• There are at least three reasons why the expansive definition of income in Article 2(10) is not
what it seems.

• 1. Structural Limitations: the operation of the schedular system of taxation circumscribes the
reach of income tax system. What is not included in the

schedules is practically un-taxable. Shell Ethiopia Ltd vs. IRA (1978) is the best illustration. There
are many kinds of income that are not taxable as

a result of the structural limitation of Ethiopian income tax system – remittance money, prize
money, scholarship money, treasure trove, annuities, profits

distributed by partnerships.

list end
41

Cont’d…

list of 3 items

• 2. practical limitations – many in-kind benefits remain outside the purview of the income tax
system largely because of lack of valuation rules. Example:

fringe benefits received by employees: in the form of company cars, meals, free tickets,
discount services or goods. Some cash receipts also escape taxation

because they are hard to detect: the income of informal traders, underground businesses,
brokers, etc.

• 3. Legal Limitations: there are many types of income received even in cash which are not
taxable because they are excluded or exempted: example: transportation

allowance for employees.

• These limitations beg a question: is it at all necessary to have a general definition of income
when the generality of the definition almost never settles

specific cases in which the question of income is at issue? The Authorities have invoked the
general definition when they are confronted with exotic or

novel cases, but they must be able to attach any income to recognized sources in order to be
able to impose tax on it.

list end

42

The Schedules of the Main Ethiopian Income Tax

list of 5 items

• Schedule A – Income from Employment

• Schedule B – Income from rental of buildings

• Schedule C – Income from business

• Schedule D – Income from Miscellaneous Sources (or Other Income) – royalties, technical
services, games of chance, dividends, interest, casual rental

of property, capital gains and windfall profits.

• The schedules represent the portal/window through which we should view income taxation in
Ethiopia. They determine the fate of a specific income, whether

it is taxable or not taxable at all, at what rate it is taxable, etc. Therefore, understanding the
schedules is critical.

list end

43

The schedules – main differences

list of 7 items

• Tax bases: theoretically, the schedules must not overlap, but in practice, the overlaps and
conflicts among the schedules are one of the most common sources

of disputes among taxpayers and tax authorities. Much of the energy is spent on properly
delimiting where one schedule ends and the other schedule begins.

The Schedules have resulted in the doctrine of “mutual exclusivity”.

• Income Brackets and Tax rates: the tax rates are separate for all schedules, although there are
apparent uniformities among the three schedules of Ethiopian
income tax law. When it comes to Schedule D, the tax rates are as many as the individual
sources.

• Tax preferences – the tax reliefs, exclusions, exemptions or deductions are separate for each
schedule although there are few cases in which the rules

of one schedule apply to others.

• Tax accounting rules – many accounting principles are also separately stated for each of the
schedules. The accounting periods as well as methods are

different.

• Assessment – some schedules rely upon withholding while others make use of self-
assessment methods.

• Aggregation: the rules of aggregation are different for each of the Schedules.

• Conclusion: the schedules are separate legal regimes in the ITP and ITR although all of the
rules are found the same source.

list end

44

Schedule A – Employment Income Tax

list of 3 items

• Schedule A is sometimes referred to as “Personal Income Tax,” but that in the scheme of
things is a misnomer. There is no personal income tax in Ethiopia

in the truest sense of that expression. Employment income tax is not a personal income tax any
more than rental income tax or profit tax is.

• Tax Base: applies to “income from employment” –see Articles 8(1), 10(1);
• Although not clearly stated, two conditions need to be met for Schedule A to kick in. i)
employment relationship; and ii) income must be derived from

employment relationship. This suggests that the existence of employment relationship is a

necessary, but not sufficient condition for the application of

Schedule A.

list end

45

Condition One: Employment Relationship

list of 7 items

• The ITP offers a definition of not employment but “employee” in order to, apparently,
distinguish, it from “contractor” –see Article 2(12).

• An employee performs services under the direction and control of an employer.

• Contractor: retains substantial authority to direct and control in the manner in which services
are performed.

• NB: the scope of employment for income tax purposes is not coterminous with that of labor
law or the civil code or other legislations, although these

other laws might come in handy.

• The key phrase: “direction and control”.

• The ITP, by not defining “direction and control” leaves specifics to the “facts and
circumstances” of each case.

• Does this mean “direction and control” are irreducible to rules of thumb? Certainly not.

list end
46

Cont’d…

list of 2 items

• There is no well-established tradition in Ethiopia for this, but in other countries, a

jurisprudence has developed around what factors suggest employment

relationship and what factors do not. It therefore behooves courts to provide that guidance and
the Tax Authorities to collect these factors into readily

usable standards for distinguishing employment from independent contract services or self-
employment.

• Cases involving these issues seldom appear before courts in Ethiopia as a result of the narrow
dispute settlement channels.

list end

47

Cont’d…

list of 2 items

• Instead, another window of dispute settlement has opened in Ethiopian Tax Administration
practice – that of providing guidance through letters or circulars
whenever issues are referred to the Tax Authorities. These referrals are some of the most
common requests made of the Tax Authorities.

• Unfortunately, the Authorities have never been able to provide uniform set of standards, a
situation leading to inconsistent withholding practices in

different parts of the country.

list end

48

Cont’d…

list of 3 items

• The ITP considers “direction and control” to be the key features of an employment
relationship, but the Authorities have almost always disregarded this

requirement and instead provided for easy-to-apply factors like whether a person is a full-time
or part-time employee, whether a person possesses a TIN

or not, or most recently whether a person possesses a business license as a professional. None
of these factors is determinative of whether a person is

an employee or a contractor.

• The most troubling part of the practice is that these so-called ‘guidance letters’ are not
provided from one center –which means that what one tax office

regards as critical is not so in another tax office. As a result, certain organizations withhold tax
under Schedule A and others under schedule C for virtually

identical factual situations, leaving certain employees distressed, unhappy and offended by
disparate treatments.

• Question: Why does it matter under what schedule withholding is done?

list end

49

Employment vs…

list of 5 items

• Employment vs. independent contract;

• Employment vs. intellectual services enjoying copyrights and other intellectual property
rights;

• Employment vs. profit-sharing (schedule A vs. Schedule D (dividends) – e.g., directors’ fees.

• Employment vs. interest…

• In practice, the most common conflict arises from “employment vs. independent contract”
cases, but the others are not uncommon.

list end

50

Income from employment

list of 7 items

• Income must arise from the employment.

• Not every income in the context of employment arises from employment.

• Shell Eth. Ltd vs. IRA (1978) – employees of Shell derived interest from a provident fund,
which was made available to Shell Eth. (employer).

• Wedding gifts by employers.

• More difficult cases: employees are allowed to buy shares of a company at a discount.

• Employers compensate employees for transferring to another place;

• Golden handshakes in football or for some key employees.

list end

51

Taxable income

list of 6 items

• Gross Income = all income from employment

• Taxable income = gross income from employment – exclusions/exemptions.

• Exclusions distinguished from exemptions and deductions.

• See Articles 13 of ITP, and Article 3 of ITRs.

• Exemptions and exclusions are expressions of public policy.

• Some exemptions are provided for economic reasons – e.g., floor exemptions (up to 150 a
month or 1800 a year); exemptions for income of casual employees;

exemptions of

list end
52

Cont’d…

list of 5 items

• Some exemptions are provided for administrative reasons – example: exemptions for
domestic employees

• Some exemptions are granted for political reasons – example: exemptions for income of
diplomatic communities.

• Some exemptions are found in the ITP (see Article 13), many in the ITRs, some in directives
and some in double taxation treaties.

• The ITP uses the expression ‘exemptions’, the regulations ‘exclusions’ mainly and directives
‘exemptions.

• Exclusions should refer to exemptions by virtue of the nature of the income; while
exemptions should be restricted to cases in which reliefs are provided

as a result of the person.

list end

53

Exclusions from Employment Income

list of 4 items

• The ITRs exclude a number of incomes from employment – see Article 3

• The exclusion of these types of income expresses some legislative policy with respect to
certain types of income from employment.

• First, some of these incomes are excluded largely because they represent reimbursements of
certain employee expenses. For example transportation allowances

are reimbursements by employers for transportation expenses incurred for the purpose of
discharging their functions. The same can be said of hardship and

traveling allowances.

• Secondly, some exclusions partially reflect a public policy of encouraging certain kinds of
payments to employees – e.g., medical allowances.

list end

54

Cont’d…

list of 2 items

• In any case, exclusions represent a departure from a comprehensive definition of income.

They might also be discriminatory, because some allowances are

not excluded. Example: housing allowance.

• Medical Allowances: the ITRs stipulate that medical allowances are excludable only if these
are clearly stated in the contract, which means that ad hoc

medical allowances are not excludable. The nature as well as scope of medical allowances is not
defined in the law. This leaves many questions unanswered:

what is a medical allowance? Is a payment for yoga classes, or a gym or alternative medicine a
medical allowance? How about if employers reimburse employees

for dietary supplements ordered by physicians?

list end

55

Cont’d…

list of 4 items

• Transportation allowance: the scope of transportation allowance has been restricted by

directives to cases in which the allowance is paid to employees

whose jobs require them to travel from one place of work to another (e.g., attorneys, insurance
brokers and salespersons). This means that transportation

allowances (called commuting allowances) paid to reimburse employees for the costs of
transportation from home to work and back are not excluded from income.

In addition, the directive places a cap on the amount of the allowances excluded at one time
– the amounts may not exceed 1/4th of the salary of the employee

or 800 ETB, whichever is the lesser.

• This is not adjusted for inflation, which is a problem.

• The other problem with this restriction is that some employers can easily avoid this restriction
by providing for the means of transportation rather than

reimbursing in cash.

• Exclusions in general suffer from a uniform tax policy.

list end

56
Cont’d…

list of 5 items

• Hardship allowance: the meaning of hardship allowance has also been restricted by a
directive that defines it as an allowance for a weather condition.

• There are questions as to whether hardship allowance should be restricted to weather

conditions.

• St. Paul Hospital Case; Cement Factory Cases; Ethio-Telecom Case, and others raise serious
questions about whether weather should be a decisive and sole

factor ‘hardship allowances’.

• Travelling allowance – distinguish it from transportation allowance.

• Board fees – this is partly a reimbursement for additional expenses – somewhat similar to
transportation allowance because it forces board members to

travel from one place of work to another.

list end

57

Cont’d…

list of 2 items

• The problem with board fees is that it is discriminatory – it is available only to those who
serve in government boards – high gov’t officials. It is
therefore a tax subsidy to high government officials. It is also not for transportation because
most government officials spend not even a penny for their

transportation as they are already provided means of transportation.

• The effect of tax payment by employers in lieu of deduction from salaries – see Article 4 ITRs.

list end

58

Fringe benefits

list of 4 items

• Fringe benefits are in-kind benefits that various employees receive from their employment.
They vary from one workplace to another – company cars, fuel,

housing, meals, clothing, discount goods and services, free medical services, free entertainment
and fitness services, free training and educational opportunities,

etc.

• High valued fringe benefits are usually made available to highly paid employees.

• Fringe benefits are not exempted by law, but lack of proper valuation rules has effectively
resulted in their exemption.

• Ethiopian income tax system is harsh against those employees who receive their income in
cash.

list end

59
Cont’d…

list of 5 items

• An employee who receives a commuting allowance in the form of cash is taxable; an

employee who gets transportation service is not.

• An employee who receives housing allowance in cash is taxable; an employee who is provided
housing is not.

• The practical exemption of fringe benefits is a subsidy to those employees.

• The CoMs has so far failed to issue regulations for taxation of fringe benefits, partly because
council members are some of the greatest beneficiaries

of fringe benefits in the form of cars and housing.

• At this government subsidy, some clever employers are able to provide certain benefits free
of tax. As usual, it is the low income people who lose out

in this game of fringe benefits. Only highly qualified employees can negotiate for fringe
benefits.

list end

60

Assessment of Schedule A Income

list of 4 items

• Withholding – almost all of the tax on schedule A is collected through withholding by

employers.
• PAYE – Pay-As-You-Earn.

• Ethiopian law follows the “Simple PAYE” in which the withholding by employers each month is
considered final. No adjustment is made at the end of the

year.

• The Simple-PAYE is one source of discrimination between employees as well as between

employees and other taxpayers like renters and business persons.

list end

61

Self-assessment by employees

list of 4 items

• There are exceptional cases in which employees are required to pay income tax themselves.

• 1. Employees who derive income from two or more employments – few employees report
their income to the Authorities. The Authorities rely upon the goodwill

of some employers who aggregate income from multiple employments. Few employers do this.

• 2. Non-diplomatic employees of embassies and international organizations – again few non-

diplomatic employees report their income and the Authorities

have yet to devise a scheme for enforcing the income tax against these employees. One of the
most exasperating and maddening feature of Ethiopian income

tax system is that Ethiopia has not been able to collect tax from most highly-paid employees of
embassies and international organizations.

• 3. Employees who derive income from sources falling under Schedule B or C (e.g. rental of
buildings).
list end

62

Computation and accounting

list of 4 items

• Tax on income from employment is deducted every month. See Art. 10

• This is easy for monthly payments.

• The problem arises with respect to irregular, lump-sum payments or payments for piece of
work.

• Problems: bonuses, payments for specific work like research, writing, installation, etc;
payments for termination; even payments for accepting employment.

list end

63

Cont’d… computation – employee with 4000 monthly salary

table with 3 columns and 8 rows

Income bracket
Rate

Tax

0-150(150)

150-650 (500)

10

50

650-1400(750)

15

112.5

1400-2350(950)
20

190

2350-3550 (1200)

25

300

3550-4000 (450)

30

135

Total

19.68 (average tax rate)

787.5

table end
64

Schedule B

list of 9 items

• Tax base: income from rental of buildings

• The scope of Schedule B is more contested than Schedules A or C, for example.

• Rental of buildings can be conducted by real estate businesses as well as businesses engaged
in non-real estate activities.

• Real estate businesses can be involved in a variety of ‘real estate’ activities. Some are involved
in building and selling of buildings – apartments,

villas, condos, etc. Some are involved in building and rental of buildings. Some are involved in
both selling and renting of buildings.

• Rental of buildings can also done by non-real estate businesses and individuals. Businesses
involved in other activities – e.g., banking, insurance, retailing,

exporting, manufacturing – are routinely involved in rental of buildings, offices, apartments,

guest houses and rooms beside their main activities of banking,

retailing, etc.

• Many individuals are also involved in rental of buildings and houses as additional or sole
source of income. Individuals rent out their residential buildings

as a whole, or a section of their residential buildings. In different parts of Addis Ababa, this
constitutes a significant source of livelihood for countless

residents of Addis Ababa.

• There are also certain businesses for which renting of rooms is part and parcel of their
business – e.g., hotels, pensions, guest houses, etc.

• Some businesses lease the business to others.

• Last but not the least there are many businesses that are involved in occasional renting out of
equipments and other forms of movable property.

list end

65

Cont’d…

list of 3 items

• The fundamental question is in which of these cases is Schedule B applicable and in which of
these cases is it not applicable?

• The answer to this question is complicated by the lack of clarity in the law and the
arbitrariness of the practice in this regard.

• The problem of the law: Ethiopian income tax laws appear to split rental income among
multiple schedules of Ethiopian income tax – rental of buildings

falls under Schedule B; casual rental of property falls under Schedule D (Article 35) and
rental/lease of businesses falls under Schedule C (see Art. 7

of the ITRs). These provisions of the IT law are the subject of varying interpretations in practice.

list end

66

Cont’d…
list of 8 items

• The practice is a complete disarray. Let’s consider some of the practice:

• Real estate engaged in both rental and selling of buildings – required to split its activities to
report income under Schedule B (for rental) and Schedule

C (for selling of buildings).

• Real estate wholly engaged in selling of buildings – Schedule C

• Real estate wholly engaged in rental – Schedule B

• Non-real estate business involved in rental of apartments, buildings, and offices on the side
should report the rental income separately from the income

from its other business – thus, should report income under Schedule C and B.

• There are conflicting reports about the scope and meaning of casual rental of property –
some say it applies to those that are involved in rental of property

although this is not part of their regular business (e.g., if Edirs rent out utensils and furniture for
special occasions); some say it applies to all

Schedule C businesses that are involved in occasional rental of equipments and tools (e.g., if a
construction company rents out construction equipments

during lean periods). Some say it applies to organizations that do not normally report income
under Schedule C (e.g., universities renting out halls for

special occasions. Income from casual rental of property is rarely reported, contributing to the
confusion surrounding the scope of this provision vis-à-vis

Schedule B.

• There equally conflicting reports about the scope and meaning of ‘lease of businesses’ which
is currently chargeable with tax under Schedule C. Once again,

income on this source – whatever it means – is seldom reported to the Authorities.

• In general, the practice does not exhibit any internal logic as to why Schedule B applies in
some cases and the other schedules apply in others. The practice

is what it just is.

list end

67

Cont’d…

list of 5 items

• The split of income from rental (of whatever) among the different schedules leads to
problems.

• First, it provides a perfect opportunity for some businesses not only to split their income but
also transfer their expenses to reduce their total tax

liability.

• Secondly, it forces certain companies to maintain separate books of accounts simply to

comply with their tax obligations although their business is essentially

one.

• Thirdly, it can potentially lead to a tug of jurisdictional war between the Federal Government
and Regional Governments.

• The proper role of Schedule B has never been properly rationalized and justified by the Tax
Authorities – that is why it sits uncomfortably among the

schedules. It is also important to remember the checkered history of Schedule B in the modern
history of income taxation in Ethiopia.

list end

68
Cont’d… Schedule B deductions

list of 5 items

• Schedule B operates on the principle of income taxation upon taxable income.

• Taxable income – (gross income under Schedule B – deductions).

• Deductions can be in the form of standard deductions for those who do not maintain books
and records (20% of gross income) or actual deductions for those

who maintain books and records. The amount of standard deductions has been a subject of
political bargaining over the years – sometimes up to 80% of the

income has been deductible just to win some political votes (A.A.).

• Deductible Expenses: the scope of deductible expenses under Schedule B has been a matter
of some controversy. The general rules of deduction under Schedule

C appear to apply in some cases (for example, the rules of depreciation deduction). In other
cases, it is not clear how far a schedule B taxpayer can obtain

deduction for an expense which would be allowable under Schedule C.

• Mekwor Ethiopia PLC v. IRA: a real estate company was denied deduction of expenses
incurred on the salary of security guards on the ground that these

expenses were the kinds of expenses a schedule C taxpayer would incur. This is an isolated case
but it illustrates that Tax Appeal Commissions and Courts

might be inclined to deny certain expenses to schedule B taxpayers even though they would
allow for Schedule C taxpayers.

list end

69
Schedule C – Income from Businesses

list of 5 items

• Key words: business, entrepreneurial activity, professional, vocational, industrial,

occupational activities.

• The interface b/n commercial code and income tax law.

• Business – see Article 2(6) – business is used interchangeably with ‘trade’. In the Commercial
Code, business is a property and trade is an activity.

• The ITP is not confined to those activities that are regarded as ‘trade’ in the Commercial Code.
For example, consultancy services and legal practice

are considered as trades for ITP, but not trades in the Commercial Code. While the Commercial
Code helps in defining some types of trades subject to tax

under Schedule C, it is not the limit to the application of Schedule C.

• Elements of business – i) the nature of the activity can really be anything - industrial,
commercial, professional, vocational, or any other activity;

ii) it must be engaged on for profit. The cumulative existence of these elements makes an
activity a business.

list end

70

Cont’d…

list of 5 items
• In other systems, courts have developed ‘badges of trade or business’.

• These badges of trade may take account of i) the subject-matter of the trade; ii) the length of
period of ownership; iii) the number and frequency of

similar transactions; iv)the extent of any supplementary work on the property sold; v)
circumstances surrounding the sale and vi) the taxpayers motive

(these six badges are developed by the Royal Commission in Australia).

• A business is any activity that occupies the time, attention, and labor of individuals for the
purpose of livelihood (US).

• In this sense, businesses are often contrasted with hobbies or entertainment activities that
yield income on the side.

• In some tax systems, all activities that occupy the time of a person (including employment)
are considered to be business. Ethiopian income tax law does

not regard employment as business.

list end

71

Cont’d…

list of 2 items

• The term ‘business’ has a ring of ‘regularity’ to it – the commercial code defines ‘trade’ as an
activity in which one is engaged professionally (i.e.,

regularly). The question is how regular should an activity be for it to qualify as a business? What
do we make of artists (e.g, graphic designers), brokers,

go-betweens, who are doing business as much as anybody else but who do not have regular
place of business and who do business as they find?
• Practice: the practice follows pretty much the professional or business license to pursue a
person for purposes of taxes.

list end

72

Cont’d…

list of 2 items

• “for profit” – this phrase has resulted in a number of controversies particularly with religious
organizations and charitable institutions. Many religious

organizations in Ethiopia believe that they can engage in profit-making activity on the side and
still remain exempted from the income tax, and the VAT

and other taxes. The Tax Authorities hold the opposite view, but they have yet to fully enforce
the rules against religious organizations and charitable

organizations.

• Question: do you think they should be engaged in businesses without having to pay income
taxes and VAT?

list end

73

Gross income…
list of 5 items

• Gross income under schedule C is all income from sources falling under Schedule C. See
Article 70. If a person carries several businesses all falling

under Schedule C, she is required to aggregate all and pay tax on the whole. There are
exceptions to this.

• 1. If one of the businesses is subject to standard assessment (because it is a category C

business), it is assessed separately.

• 2. If businesses fall under two or more regional jurisdictions, no aggregation is required as tax
is paid to multiple jurisdictions (see Art. 97(4) –

Constn).

• 3. Foreign income is not aggregeable with domestic income. See Art. 7 of ITP.

• Question: Can you think of any other exceptions?

list end

74

deductions

list of 4 items

• Schedule C, like Schedule B, operates on the principle that income tax should be imposed on
taxable income. A number of expenses are made deductible in

order to arrive at taxable income.

• Principle: See Article 20 – expenses incurred for the purpose of earning, securing and
maintaining business income are deductible.

• Whether any expense is incurred for earning, securing and maintaining business income is a
question of fact, to be resolved according to the facts and
circumstances of each case.

• Business judgment rule: ordinarily, it should not be the business of the authorities or the
courts to question the business acumen of taxpayers.

list end

75

Analysis of deduction rules

list of 4 items

• Although Art. 20 lays down the principle which theoretically should guide us in all cases, the
income tax laws of Ethiopia are not content with laying

down general principles of deductions. In addition to the general rule, we have specific rules of
deductions, which may be grouped as either:

• 1. Positive limb deduction rules: list down specific deductions which are allowed by law and
sometimes set limits to the amounts or conditions under which

they remain deductible. See Art. 22 (for cost of trading stocks) of ITP and Article 8 of the
Regulations (e.g. for general and administrative expenses,

for insurance, commissions, etc).

• 2. Negative Limb deduction rules: list down specific deductions that are not allowed and in
exceptional cases lay down conditions under which these otherwise

non-deductible expenses may become deductible. See Art. 21 of ITP and Art. 9 of the ITRs.

• In a general, a helpful rule of thumb is to go from specific deductions rules to the general
principle of deduction under Art. 20.

list end
76

Non-business deductions

list of 2 items

• As a rule, deductions are allowed only when they are related to the business (Art. 20 lays
down this principle). As a matter of principle, therefore,

all expenses not directly related to the business income are non-deductible.

• Exceptionally, however, certain expenses not directly related to business income may be
deductible by the grace of law. These exceptions reflect economic,

social, or political policies of the government towards certain forms of non-business expenses.
They can also be conceived as incentives.

list end

77

Cont’d…

list of 3 items

• There are two types of non-business deductions recognized as deductible under certain
conditions:

• 1. Reinvestment /Participation Deductions (see Arts. 27 ITP and 16 ITRs);

• 2. Charitable contributions (Art. 11 ITRs).

list end
78

Computation of Taxable Income

list of 4 items

• Gross Income – all income from business activities falling under Schedule C (* exceptions);

• Adjusted Gross income = Gross income – deductible business expenses (above-the-line

deductions);

• Taxable Income = Adjusted Gross Income – deductible non-business expenses (below-the-line

deductions).

• It is necessary to maintain this process of computation to preserve the integrity of the Income
tax laws of Ethiopia.

list end

79

Analysis of some non-deductible expenses

list of 5 items

• The income tax laws list a number of expenses as non-deductible. Theories may vary from one
form of expense to another, but there are four principal reasons

for non-deductibility in Ethiopia:

• 1. Personal Expenses are non-deductible not only because they are somehow unrelated to
business income but also because they constitute income (remember

Henry Simons). See Arts. 21(1)(k) (m) and 21(3); Arts. 9(1) (a) and (b).

• 2. Capital Expenditures – they are not deductible at once but will be deductible through
depreciation allowance – see Art. 21(1) (a) and 23 of ITP

• 3. Public Policy – allowing deductions for some expenses may violate public policy – see Arts.
21(1)(g) and 21(1)(d);

• 4. Excessive Expenses – see Arts. 21(c), (e) (j) of the ITP; and Arts. 8(5)(7)(8) of ITRs.

list end

80

Analysis of Some Deductible Expenses – Ordinary Expenses

list of 3 items

• The law does not make an explicit reference to ordinary and capital expenses, but it is
necessary to distinguish the two.

• The basic difference is that ordinary expenses are deductible at once in the year in which they
are incurred, while capital expenses are deductible only

in a number of years through depreciation allowance.

• There are many examples of ordinary expenses – general administrative expenses, costs of
raw materials (inputs), etc. see Art. 8 of ITRs.

list end
81

Ordinary expenses – Trading Stocks (inventory) and others

list of 3 items

• Art. 22 of ITP lays down an accounting rule for deduction of the cost of trading stock, but it
can also be seen as a provision that recognizes cost of

trading stock as deductible.

• General and Administrative Expenses – how do we distinguish general expenses from costs of
trading stocks?

• GAAP – Ethiopian law requires accounting for expenses and income to be done in accordance
with generally accepted accounting standards(GAAS). See Art.

18. The problem is that no body really knows what these principles are in practice. On income
tax accounting, later

list end

82

Capital Expenditures

list of 3 items

• Capital expenses are not deductible at once, but may be deductible through depreciation
allowance.

• Capital expenses are incurred in connection with capital assets.

• Capital assets/also called fixed assets/ – not defined. But generally, all assets that are useful
for more than a year. Property, machines that a business

owns and uses but which it does not buy and sell as part of its regular trade. NB: it is the nature
of the business that defines the nature of the asset

rather than some intrinsic qualities of an asset. A vehicle is an ordinary asset for some
businesses and a capital asset for others.

list end

83

Cont’d…

list of 6 items

• Capital expenditures: not all expenses on capital assets are necessarily capital expenditures.
Can you identify expenses on capital assets that are nevertheless

treated as ordinary expenses?

• Depreciation: is the wear, tear and/or obsolescence of capital assets.

• Depreciation may have different connotations in engineering (structural and physical),

accounting and tax law. In accounting, depreciation refers to a

process of reducing the value of an asset as it is used in business.

• In tax law, the aim of depreciation to help taxpayers recover the costs of capital assets
through depreciation deductions.

• This may have very little to do with the underlying physical or non-physical asset. An asset
may therefore remain useful in business even after it has

fully depreciated. An asset may also depreciate multiple times in the hands of multiple
taxpayers. The depreciation of an asset in the hands of one taxpayer
does not impair its depreciation in the hands of another taxpayer except in non-recognition
cases (see Art. 24).

• Useful life/depreciable life – the period over which the cost of an asset may be spread for
recovery of depreciation allowance.

list end

84

Cont’d… terms

list of 3 items

• Depreciation: is of general application, but more appropriate for physical capital assets like
machinery.

• Amortization: is for depreciation on intangible assets like good will.

• Depletion: is depreciation for natural resources like minerals. It is an allowance for the using
up of mining, quarrying, drilling or felling natural

resources (minerals, rocks, oil or trees respectively). Depletion allowances are common in
mining income tax laws.

list end

85

Cont’d… conditions
list of 4 items

• 1. Depreciation is available to an owner or someone exercising rights equivalent to ownership

– example: in hire-purchase or finance lease cases, the

lessee is entitled to depreciation, not the lessor; however, in ordinary lease cases, the lessor
rather than the lessee is entitled to depreciation. The

reason: in hire purchase cases, the lessee exercises the right to purchase the property at the
end of the lease period. In order lease cases, the property

reverts to the lessor at the end of the lease.

• 2. The property must be depreciable and must have a determinable useful life. Land and
objects of art are not depreciable. With respect to land, while

land itself is not depreciable, it may become depreciable as an intangible as land can only be
obtained on a long-term lease in Ethiopia (which is equivalent

to ownership).

• 3. It must be expected to last more than one year.

• 4. It must be used in business generating business income (Art. 20)

list end

86

Cont’d… concepts to unlock

list of 6 items

• Depreciation base – describes the cost basis upon which the depreciation rate falls.

• Adjusted depreciation base (ADB) – describes the base for depreciation after adjusting
factors.
• Adjusting factors – are those described under Art. 23(7) (A) and (B) – maintenance costs, sale,
etc.

• Total Depreciation Taken (TDT) – the sum of depreciation taken so far. This is necessary to
ensure that taxpayers recover only the costs incurred for

the acquisition, renewal or maintenance of capital assets.

• Un-depreciated Balance (UDB) – is the flip side of the TDT.

• These concepts are useful tropes to understand how depreciation works.

list end

87

Types of Depreciable Assets

list of 5 items

• Buildings –subject to straight line depreciation at 5%; they depreciate individually.

• Intangible assets – subject to straight line depreciation at 10% (purchased goodwill,

copyrights, patents, franchises, trademarks, trade names, etc.);

they depreciate individually. Can start up costs be included? (e.g., costs of business surveys,
advertisements, training of employees)

• 25% pool – information technology assets – depreciate as a pool (computers, printers,

scanners, photocopiers, projectors, etc.)

• 20% pool – other (miscellaneous) assets – depreciate as a pool (vehicles, machinery, tools and
implements, furniture)

• Pool depreciation is devised for those capital assets which are normally owned in large
numbers by businesses. Example: large to medium businesses own
large stock of computers and furniture (hundreds and perhaps thousands of these assets). It
would be cumbersome for businesses to account individually

for these assets. On the contrary, most businesses can count their buildings and intangible
assets on their fingers.

list end

88

Buildings

list of 6 items

• Buildings depreciate individually and at straight-line method. This means that if nothing
significant happens to a building, it will depreciate fully

in twenty years.

• Economic and Physical Metamorphosis of buildings in the course of depreciation.

• Maintenance of buildings – additional costs of maintenance after construction – see Art. 23(7)
(a) – increases the depreciation base.

• Significant maintenance (above 20%) is added to depreciation base, increases the depreciable
life of an asset. This is called capitalization. If it is

not significant, the maintenance cost is deductible as an ordinary expense. This is called
expensing.

• Sale of buildings – reduces or perhaps eliminates the DB – see Art. 23(7)(b). In the case of
buildings, it also triggers capital gains provisions – Art.

37.

• How about destruction of the building by fire or earthquake?

list end
89

Cont’d… example

list of 8 items

• Construction of a building at the cost of 1 million ETB in 1995.

• At straight line depreciation this building depreciates in 20 years.

• But in the intervening years, many things can happen to this building.

• Maintenance – ten years later. What is the effect of this?

• Destruction of the building to fire and assuming that the building is not ensured.

• Revaluation of the building five years later for purposes of valuation of the company or for
loans.

• Sale of the building.

• What is the relationship between the application of Schedule C and capital gains rules in
Article 37 of ITP?

list end

90

Pool depreciation

list of 6 items
• There is controversy about what the phrase “in the opening balance sheet of the tax
period” means (Art. 23(7)). Does it mean the opening balance of the

depreciation tax period or every tax period since the start of depreciation?

• Accountants in practice employ declining balance deprecation for assets subject to pool
depreciation. This practice leads to variable useful lives for

similar assets.

• A straight-line depreciation on a pool would have resulted in uniform useful lives for pool
assets.

• A declining balance depreciation varies with the cost of the asset rather than the type of
asset as is the case under straight line depreciation.

• For example: under a declining balance method, a computer bought at the cost of 10, 000 ETB
takes nine years to fully depreciate while a computer bought

at the cost of 100, 000 ETB takes eighteen years to fully depreciate. Under the straight line
method, both of them depreciate at a uniform rate and will

have useful lives of four years.

• Expensive vehicles can take more than thirty years to depreciate long after they have become
economically useless. The declining balance method, while

it is an accounting convention, is not consistent with economic reality.

list end

91

Recognition of income and depreciation

list of 5 items
• The recovery of depreciation can sometimes yield income, which is clawed back as gross
income (see Art. 23(8)). This is one of the few instances in which

deduction actually results in income.

• The effect of recognition rules (Art. 24) is that it is not just the sale of inventory (trading
stocks) or the provision of services that results in the

realization of gross income under Schedule C. It is also the sale of all business assets, including
capital assets.

• Sale of some capital assets yields capital gains (buildings)

• Sale of other capital assets results in ordinary income under Schedule C. But, normally this
sale is submerged in the reduction of the depreciation base.

• The sale of capital assets (e.g., vehicles) overflows into the gross income only when the
difference between the un-depreciated balance (UDB) and the

sale price is negative – in other words, when the sale price of a capital asset is higher than the
un-depreciated balance.

list end

92

Cont’d…

list of 6 items

• Recognition rules also stipulate exceptions in which the sale of assets does not result in the
recognition of income or loss. See Art. 24

• Non-recognition rules allow businesses to enter into certain transactions without the fear of
income tax and capital gains taxes. In other countries,
exchange of one capital asset for another, immediate replacement of a destroyed asset
(involuntary conversion) do not result in recognition of income

• In Ethiopia, non-recognition results when assets are transferred in the context reorganization
of business. In these cases, the depreciation bases of

the transferor are transferred to the transferee business.

• The non-recognition rules allow businesses to engage in business reorganizations without fear
of income taxation. Without non-recognitions, business reorganizations

(e.g., mergers) will be rare for fear of taxation.

• Non-recognition rules operate in both gains and losses.

• Concepts: mergers, takeovers, acquisitions, divisions/splits, spin-offs.

list end

93

Losses and deductions

list of 6 items

• Businesses may lose in different contexts.

• Casualty losses – result from casualties like theft, fire, accidents etc.

• Financial losses – result from fall in demand or any other market conditions.

• Do you think casualty losses not covered by insurance are deductible? Why? Why not?

• Net Operating Losses (Art. 28): these are ordinary losses resulting from the excess of
deductible expenses over gross income. The first consequence of

that is that the taxpayer will not pay tax in the NOL year. The second, and more significant
consequence is the right to carry the losses forward and deduct
the losses from future gross income. The Amharic version limits this right to carry forward
losses to the next three years. It is not clear if the next

three years have to be consecutive or if the taxpayer can exercise this right from any future
three tax years.

• Conditions and restrictions: 1) losses incurred during tax years in which a taxpayer was
involved in a major reorganization or went through ownership

changes in a significant way are not recognized as losses (28(2)); 2) Losses can be carried-
forward for two consecutive tax years, which means the taxpayer

must jump the third year (this is quite significant for those businesses that are unable to fully
set off the losses from one or two tax years of gross

income) – see Art. 28(3). Does this mean that losses can be offset from non-consecutive years
as long as the number of years remains three? Why do you

think are these restrictions placed?

list end

94

Cont’d…

list of 4 items

• Capital losses – can be carried forward indefinitely – see Article 37(6)(a)

• Capital losses can only be offset against capital gains, and not against ordinary Schedule C
income.

• NB: capital losses are losses resulting from two forms of assets only: buildings and shares.
Losses resulting from many capital assets (e.g., vehicles,
computers, machinery, etc) are regarded as ordinary losses. These losses may affect the
depreciation base and sometimes result in net operating losses,

which trigger Art. 28 rules.

• Losses resulting from long term contracts can be carried backwards – see Article 63(3).

list end

95

Schedule D: Miscellaneous Income

list of 2 items

• Schedule D became part of the Schedular canon as of 1978 – when an income tax amendment
singled out a number of specific sources of income for withholding

income taxation at source – royalties, income from technical services rendered abroad, income
from games of chance (mainly lottery), dividends and income

from casual rental of property. Since then, Schedule D has become a receptacle for adding
newly discovered sources of income – capital gains (1994), interest

(2002), and windfall profits (2010).

• Unlike the other schedules, Schedule D gathers disparate sources of income under a single
schedule. The only features that unite these sources is that

they are usually irregular, infrequent and some of them are income from capital (interest,
dividends and capital gains). A common administrative factor

among them (with the exception of casual rental of property and capital gains) is that they are
all collected through withholding taxes and they are final.

list end
96

Cont’d…. royalties

list of 2 items

• Royalties can have different meanings in different contexts. 1. Payments for the use of a
person’s intellectual property; example: royalties to authors/writers

for printing and publishing books; to musicians, songwriters, singers and directors for producing
and distributing music; to inventors for using their

patented products. 2. Lump-sum payments for the transfer of intellectual property (treated in
some countries as a capital gain). 3. Payments for extraction

and/or exploitation of natural resources – these payments are made to landowners in countries
where land is privately owned; or to governments where land

is publicly owned or where control over natural resources generally belongs to governments.

• In which sense do you think is the term ‘royalties’ used in Article 31?

list end

97

Cont’d…

list of 3 items
• The withholding taxation on royalties is not properly enforced in practice largely due to
neglect by the Authorities. The slapping of royalties with 40%

tax in 1978 provoked lots of protests from literary writers, who managed to win a concession
from successive governments and received suspension for many

years. There are still many within the authorities that believe that the tax is suspended.

• Royalties withholding tax is effected at a retail level almost haphazardly by organizations that
feel duty bound to comply with the income tax.

• Conflicts: conflicts over characterization may arise with ‘income from employment’ and
sometimes with ‘income from technical services’. Since the tax

rates are wildly divergent, these ambiguities create opportunities for tax planning.

list end

98

Cont’d… income from technical services

list of 2 items

• This is the only withholding tax intended for taxation of non-residents alone. It applies to
cases in which ‘technical services’ are rendered outside

Ethiopia to a resident Ethiopian business or any other juridical person. Unfortunately, although
the law is clear, some tax officers misunderstand the

nature and meaning of this withholding tax and compel some organizations to withhold this tax
even when the services are performed by non-residents for

a brief period of time. Example, if a geological surveyor comes to Ethiopia and conducts a
survey in return for payment, this is not an Art. 32 matter.
• Much of the debate in practice centers around the meaning of ‘technical services’. Some
withholding agents have argued that non-technical services are

not the subject of this tax (e.g., consultancy, management services). They tend to restrict the
tax to cases involving some highly technical or technological

service. But it is not clear why the nature of the service should matter in disposing a case.

list end

99

Cont’d… income from games of chance

list of 4 items

• This withholding tax targets income from lottery and other games of chance.

• Since lottery and many other games of chance are the monopoly of the government (National
Lottery), this tax has been quite effective against money lottery.

• A problem arises with respect to in-kind winnings – e.g., tombola.

• Games of chance have also become so widespread with the advent of the internet and mobile
technology that it is difficult to police all kinds of games

of chance played almost informally.

list end

100
Cont’d… dividends

list of 5 items

• The withholding taxation on dividends confirms Ethiopia’s position on the taxation of

corporate income: that corporate profits are first taxed at the

corporate level at flat rate (30%) and withholding taxes apply when the company distributes its
profits in the form of dividends (10%).

• This tax suffers from a number of problems:

• The first problem is the meaning of dividends. Companies have so many avenues for
distributing profits: in cash, in-kind (property), in the form of interest,

even in shares (stock dividends). The ITP fails to define dividends, opening the income tax law
to income tax planning by companies.

• The second problem is the fate of ‘undistributed profits’. If there are no checks, companies
can easily avoid this tax by putting off distributing anything

in the form of dividends. This is a bonanza to private companies. The Authorities have argued
with varying degrees of success against companies that decide

not to distribute profits for several years. The root of the problem is the law. It is silent on
undistributed profits.

• The third problem is cascading of the tax upon those shareholders who receive dividends
from companies that are themselves shareholders of other companies.

Example: Addis Ababa University Credit Union owns shares in Zemen Bank. When Zemen Bank
distributes dividends to the Credit Union, it withholds 10% dividend

tax, and when the Credit Union distributes dividends to individual members, it too withholds
10% tax.

list end

101
Cont’d… casual rental of property

list of 4 items

• This is one of the least known taxes in the whole of the income tax system.

• As a result, much of what it means is a matter of widespread speculation: occasional rental of

both immovable and movable property; occasional rental

of only movable property; occasional rental of equipment, furniture, machinery, tools by

otherwise schedule C taxpayers; occasional rental of private property

like vehicles; rental of guest houses, etc.

• One problem is how casual rental should be to qualify as Art. 35 tax rather than Schedule B.

• The third problem: how should the tax be collected: through self-assessment or withholding?

list end

102

Cont’d… interest on a bank deposit

list of 4 items

• Interest: payment by a borrower to a lender for the use of money.

• But the ITP talks about a much narrower source of interest – interest accruing on a bank
deposit.

• Question: Company A lends Company B in exchange for payment of 10% interest. Is that
interest taxable? If yes, under which Schedule? Will it make any

difference if the lender is an individual who does not have a business?

• Also consider the deductions rules on interest. See Art. 10 (ITRs) – interest is deductible only
when loan is raised from recognized financial institutions.

list end

103

Cont’d… capital gains

list of 5 items

• The scope of capital gains tax in Ethiopia is much narrower than other countries: buildings
held for business and shares. But, remember, all other business

assets are subject to business profit tax under Schedule C. It is only the non-business capital
assets that are currently un-taxable.

• When is a building held for business? Suppose a person wants to transfer a building which has
been rented out for business.

• Valuation: the main problem in capital gains taxation. How much power do the Authorities
have to set aside the price fixed in a contract and revaluate

the property? The paradox is that the Authorities are more inclined to follow their own
valuation when the agreement of the parties is for donation of

the property. As a result, the parties agree to transfer the property at its book value so that the
capital gains tax is zero or close to zero.

• With respect to shares, the real problem emerges from the absence of stock market. So most
transferors simply transfer the shares at par value. Sometimes,

the Authorities resort to the questionable practice of revaluating the shares based on the
earnings of the company in the past five years, but there is
no legal basis for this practice.

• In general, the capital gains provisions are susceptible to abuses of one kind or another.

list end

104

Cont’d… windfall profits

list of 3 items

• Windfall profits were added in 2010 three months after the Government of Ethiopia
devaluated Birr by more than 20% at once.

• After devaluation, the Government realized that financial institutions (in particular banks)
cashed in huge windfall profits by mere virtue of the devaluation.

The windfall profits tax was an action to use taxation to recover the windfall profits obtained
then.

• The windfall profits tax law was controversial because it was retroactive. The law gave the
power to the MoFED to define windfall profits from time to

time – which is also quite controversial.

list end

105

Accounting Period and Accounting Methods

list of 4 items

• The timing of income and expense recognition is as important as the definition of income and
the regulation of deductions in income tax law. The definition

of income (by Henry Simons) contains the time period for measurement of income, which
shows that time is an essential unit of measurement in income. Ideally,

the unit of measurement should be the lifetime of a taxpayer, but no actual income tax system
can wait until a person dies to assess income tax. Such a

proposition can even be dangerous.

• Accounting periods and accounting methods regulate the timing of recognition of income and
of expenses.

• Financial accounting vs. tax accounting – should they be different?

• The conventional period for assessment of tax is a year, although shorter and sometimes
longer time periods may be chosen in special circumstances (e.g.,

a month for employees).

list end

106

Cont’d… Accounting Period (Tax Period)

list of 4 items

• Accounting period generally describes the time period for computing income and expenses.

• The accounting period for schedule B and Schedule C in Ethiopia may be the fiscal year (for
most taxpayers) or any accounting period a company chooses

to adopt (some companies may choose the Gregorian calendar – particularly foreign owned or
affiliated companies). The Ethiopian fiscal year is the governmental
budgetary period- which runs from Hamle 1 (July 8/9) – Sene 30 (July 7/8) every year. See Art.
64.

• Once a company adopts an accounting year, it cannot change it without the approval of the
Authorities (why?)

• Short tax years (transitional tax years)- identify cases in which short tax years are prescribed.

list end

107

Tax Accounting methods

list of 3 items

• Principle – books and records should be maintained in accordance with ‘generally accepted
accounting principles’ (GAAP). See Art. 58(1).

• GAAP – summary of best practice in respect of the form and content of financial statements
adopted for the preparation of financial information. It is

in use in many countries like the USA, Canada, where accounting boards publish accounting
standards from time to time.

• The problem in Ethiopia is that there is no such body, and it is not clear if the accountants
should follow the best practice in the USA or some of these

other countries.

list end

108
Two basic Accounting Methods

list of 2 items

• Cash Method: commands the recognition of income when it is ‘actually’ or

‘constructively’ received in cash (or its equivalent) or in other property; and

expenses in the year in which the expenses are actually paid. Art. 59 (income when it is
received or made available (constructive receipt); (expense when

it is actually paid).

• “The cash method – simple, plodding, elemental – stands firmly in the physical realm. It
responds only through the physical senses, recognizing only the

tangible flow of currency. Money is income only when this raw beast actually feels the coins in
its primal paw; expenditures made only when it can see

that it has given the coins away” (Goldberg J).

list end

109

Cont’d…

list of 4 items

• Accrual Method: Income should be reported in the year in which it is earned as well as
actually or constructively received; and expenses should be taken

in the year which the expenses are accrued or sustained.

• Accounts receivable – are income; and accounts payable are expenses although the income is
not yet received nor the expenses not yet actually paid.

• Accrual method contains cash method accounting and more.

• “The accrual method … moves in a more ethereal, mystical realm. The visionary prophet, it
recognizes the impact of the future on the present, and with

grave foreboding or ecstatic anticipation, announces the world to be. When it becomes sure
enough of its prophesies, it actually conducts life as if the

new age has already come to pass. Transactions producing income or deductions spring to life
in the eyes of the seer though nary a dollar has moved” (Goldberg

J)

list end

110

Cont’d…

list of 7 items

• Accounts received…

• Accounts receivable…

• Accounts paid…

• Accounts payable…

• Cash basis tax payers should report accounts received and accounts paid (either actually or
constructively.

• Accrual basis taxpayers should report accounts received, accounts receivable, accounts paid
and accounts payable.
• An income is received when it is actually or constructively received (in cash, cash equivalents
and sometimes property).

list end

111

Cont’d…

list of 5 items

• Accounts receivable – these are recorded in the accounts prior to the actual or constructive
receipt of the income (sometimes long before the receipt).

• Presumption: accounts are considered receivable when the taxpayer ‘becomes entitled to the
payment, even if the time for the payment is postponed or

the payment is to be made in installments’ (Art. 60(3)). This rule results in pre-recognition of
income.

• The question of when the person is entitled to payment is a question of law and requires
adequate understanding the laws of contracts in general, and

special contracts of sale, lease, mortgage, etc.

• When is a seller entitled to receive payment – at the time of the signing of the contract? At
the time of the payment by the buyer? At the time of the

delivery of goods by the seller? Can the parties push the entitlement to receipt of payment in
their contract? Why? Why not?

• When is a lessor entitled to receive payment of the lease?

list end
112

Cont’d…

list of 4 items

• Accounts payable (Expenses) – this rule requires recognition of expenses before (sometimes
long before) the expenses are actually paid.

• Presumption: “when all events that determine liability have occurred, and the amount of
liability can be determined with reasonable accuracy, but not

before economic performance… occurs” (Art. 60(4)).

• The term “economic performance” is defined in Art. 60(5) – in respect of contracts for the
provision of goods or services “at the time the goods or services

are delivered or rendered”; in respect of contracts for use of property (e.g. lease) “at the time
the property is used”; and in any other cases, “at the

time of full payment for the performance of contract” (which is somewhat similar to cash basis
accounting.

• Once again, understanding accounts payable requires full understanding of the rules of
contracts in general and all other special contracts.

list end

113

Cont’d… special accounting provisions…

list of 5 items
• Costs of Goods Sold (Trading Stocks – Art. 22) – the perpetual movement of trading stocks in
business requires an accounting convention – out of the possible

hundreds of costs of the stocks in a year, which one do we take as representative of the whole
stock?

• The costs of the trading stocks that is taken into account is: (the trading stocks at the
beginning of the tax year + additional trading stock acquired

throughout the year – the ending trading stock). The ending trading is transferred to the next
tax year and becomes a beginning trading stock – this process

repeats itself indefinitely.

• Accounting conventions – FIFO (first-in-first-out); LIFO (last-in-last-out); and in the case of

Ethiopian law the average cost method. Taxpayers who have

trading stocks are required to do the average cost every year – perhaps take the average costs
of first goods in and last goods in.

• NB: accounting for trading stocks is relevant only for some types of businesses –
production/processing/manufacturing/wholesale and retail businesses.

Service sectors (e.g. insurance companies) do not really have trading stocks.

• Bad organization of the ITP has placed trading stock accounting far away from the accounting
provisions.

list end

114

Cont’d… bad debts accounting

list of 5 items
• Bad debt: is a debt that will not be paid, largely because the debtor is out of business or
unable to pay for any other reason. It has to be written off

somehow.

• Bad debt accounting – Art. 25 – once again placed far away from accounting provisions, but it
is an accounting rule.

• Bad debt like a loss is deductible, but it is a mere adjustment of recognition of income in
expectation of the income.

• Bad debt is relevant only for those businesses that report income on an accrual basis. They
are the ones that report income before they receive and they

are the ones that need to revise their accounts when the debt becomes bad.

• Accounts receivable reported as income (e.g., 2010) and in 2011, the debtor is declared
bankrupt. The taxpayer that reported the accounts receivable as

income in 2010 can obtain a deduction of the bad debt in 2011 if she fulfills the conditions and
restrictions of Art. 25. In essence, the bad debt accounting

provisions are there to help taxpayers make appropriate adjustment in light of the
developments.

list end

115

Cont’d…

list of 2 items

• Prepayments (Art. 61) – rules regarding prepayments are there for expenses which are not
normally capital expenditures but are useful to a taxpayer for
more than one tax year. If they are capital expenditures, the rules of accounting regarding
depreciation apply (Art. 23). If not, prepayment accounting

applies if the expenses extend for more than one tax period. There are in effect two conditions
here: 1) there must be a prepayment; 2) the prepayment

must cover more than one tax period. Example: a prepayment of rent covering five years.

• NB: cost of lease of land becomes a prepayment matter only if the lease is a short-term one. If
it is long-term lease, it is a capital expense, deductible

as an intangible asset (10%)

list end

116

Cont’d… claim of right doctrine

list of 3 items

• Claim of right doctrine was developed by courts (US) originally to arrest the uncertainties
occasioned by disputes over payments or claims.

• Taxpayers may obtain income or incur expenses but still be uncertain whether the income is
theirs to keep or the expense is theirs to incur. The cloud

of uncertainty hangs over the income or expense.

• Taxpayers may use this cloud of uncertainty to delay recognition of income or expense
indefinitely – at the expense of government revenue claims.

list end
117

Cont’d…

list of 2 items

• Art. 62 lays down claim of right doctrine for both cash and accrual basis taxpayers; in effect, it
prescribes that these taxpayers should report income

and expenses in accordance with their accounting system (cash or accrual) regardless of the
cloud of uncertainty hovering over the income or expense. An

ongoing legal dispute should be disregarded for the moment. If a buyer raises issues of defect
in goods and refuses to pay the price in spite of the delivery

of the goods, an accrual basis taxpayer should report that as income nonetheless.

• Adjustment: the flip side of the claim of right doctrine is that a taxpayer who reported income
and expenses under the claim of right rules may obtain

deduction for the income included and must include as income what she reported as expenses.
This adjustment may not be exactly like looking-back and making

appropriate adjustments but this the consequence of the accounting rule. Looking-back is not
permitted. Every accounting period is presumed closed. The

claim of right doctrine allows adjustment of future tax periods only.

list end

118

Cont’d… long-term contracts accounting – Art. 63

list of 3 items

• Long-term contracts require a special accounting method because of uncertainties involved in

long-term contractual projects (buildings, dams, roads, canals,

all kinds of constructions).

• Long-term contracts are not synonymous with long term contractual relationships. long-term
contracts are those contracts that take more than twelve months

to complete the project. Example: Zamra Construction Co. agrees to construct a Registrar
Building for AAU and complete its construction in two years (24

months time). The payments for the contract may be paid up-front; in installments; at the end
of the completion of the building; etc. The expenses vary

throughout the contractual period. The question is how should Zamra account for the income
and costs of this contract?

• Long-term contract accounting is transactional: every long term contract is considered to be

separate from other contracts. It is not the taxpayer but

the contract that becomes the focus of attention for long-term contracting.

list end

119

Cont’d…

list of 4 items

• It is possible to follow the “Completion Method” under which we have to wait until the
project is completed to account for both income and expenses of

a long-term contract project.

• We can also follow the “percentage of Completion Method” which can be based on the
reports of expert engineers or in the case of the income tax based

on the cost of the project every year. The cost in effect drives how much income from the total
contractual payment is to be recognized.

• What is the effect of loss upon long-term contract?

• Dagalecon agrees to construct a building and complete its construction in three years time for
a total price of 50 million ETB. Dagalecon estimates that

the construction will cost it 40 million ETB. Suppose, Dagalecon incurs 20 million during the first
tax year, how much of the income from the construction

should Dagalecon recognize for the first tax year?

list end

120

Declaration and payment of tax

list of 3 items

• Relevant provisions: Arts. 66, 74, 75, 76 (ITP); Arts. 18-25 (ITRs).

• Tax Forms – income tax declaration forms are prepared by the Authorities (most issued in the
form of Directors and some existing informally).

• For Schedule B and C taxpayers (except category C) consists in filling out those forms and
submitting them to the Authorities. But as most taxpayers are

not as literate as the tax laws require, there is a lot of mutual helping involved.

list end
121

Books and Records – keeping Accounts – art. 48 (ITP)

list of 5 items

• Maintaining books and records is an essential part of the income tax declaration process.
What is declared in tax forms must be extracted from the books

and records of a taxpayer.

• Categories of taxpayers: the obligation to maintain books and records depends on the
category of taxpayers.

• Category A – all companies, and other businesses with annual volume of turnovers above half
a million ETB.

• Category B – any business (other than companies) with annual turnovers of less than 500, 000
ETB but more than 100, 000 ETB.

• Category C – any business (other than companies) with annual turnovers of less than 100, 000
ETB.

list end

122

Cont’d…

list of 6 items
• Category A – profit and loss statement (income statement) and balance sheet with details
under Art. 19(1).

• Category B – profit and loss statement

• Category C – do not have to maintain books and records (see Art. . Theoretically, they have
the option to maintain books and records, but the Authorities

accept these books and records only when the tax due from the books and records is greater
than the tax due under the standard assessment methods. See

Art. 21(3) (ITRs).

• In addition to maintaining books and records, taxpayers have the obligation to register the
type and quantity of vouchers they use (Art. 20, ITRs).

• For other obligations, see Arts. 38 – 50

• The main source of controversy in this regard is the invoices that are acceptable to the
Authorities. The Authorities (or their auditors) insist on formal

invoices, but some taxpayers (e.g., hotels and construction companies) are usually unable to
supply these invoices as they deal with informal traders and

farmers.

list end

123

Time for declaration – Art. 66

list of 7 items

• Category A – within 4 months from the end of the tax period.

• Category B – within two months

• Category C – within one month

• For non-residents – see Art. 22(3) (ITRs) – their agents have a joint responsibility to declare.

• Withholders – see Arts 24-25 (ITRs)

• Place of declaration – depends on jurisdiction (federal or regional).

• See in general Art. 23 (ITRs).

list end

124

Payment of income tax

list of 5 items

• Relevant provisions – Arts. 52-53; 74-76 (ITP); Arts. 24-25 (ITRs).

• Withholding at source (advance payments) – income tax is withheld at source for Schedule B
and C taxpayers.

• Imports – import of goods for commercial use (3% of CIF).

• On Payments for Goods and Services (2% of the gross payments if the recipient has TIN, if not
it is 30% see Art. 90). Withholding organizations are all

organizations having legal personality, government agencies, private non-profit institutions and
NGOs (Art. 53). For goods, an obligation exists if a single

supply is worth more than 10, 000 ETB and in the case of services, if more than 500 ETB (Art.
24(ITRs). Splitting of supplies in order to avoid withholding

obligations is a criminal offense.

• For obligations of withholding agents – see Art. 25 of ITRs.

list end
125

Self-assessment form (based on the ITP and ITRs) for category A and B taxpayers

table with 3 columns and 12 rows

No.

1.

Gross Income (from sale of goods, services, business assets, etc)

2.

Business Deductions (ALD)

Cost of goods sold (Art. 22)

General and administrative expenses (Art. 8 ITRS)

Other expenses (please specify * commissions, insurance, etc)

Depreciation Deductions (Art. 23

Buildings (if sold, go to Art. 37

building 1

building 2

building 3

Buildings total

table end

126

Cont’d…

table with 3 columns and 10 rows

No.

Amount

Intangible assets (add boxes if more than one)

20 % pool depreciation (add to income if negative)

25% pool depreciation (add to income if negative)

Total deductions

Adjusted gross income (Gross Income (1) – total business deductions)

Non-business deductions (below the line deductions

Charitable contributions (deduct if less than 10% of AGI)

Reinvestment deductions (deduct if more than 25%....)

Total below the line deductions

table end

127

Cont’d…
table with 3 columns and 12 rows

No.

item

amount

Taxable income (deduct 3 from 2)

Apply tax rate (flat if a company)

Total tax due (multiply 5 by 4)

Tax credits

Tax withheld on imports

Tax withheld on payments

Total tax credits

Deduct 7 from 6

If positive pay the difference

If negative seek refunds

table end

128

Assessment

list of 2 items

• Self-assessment – category A and B taxpayers are in principle subject to self-assessment

regimes, but in practice, there is much official assessment by

the authorities.

• Estimated assessment – this is in theory applicable to category A and B taxpayers that do not
maintain books and records or maintain books that are unacceptable
to the Tax Authorities. This is now based on some modified standardized tabled modeled upon
the tables for Schedule C taxpayers.

list end

129

Standard assessment –category C

list of 3 items

• Category C taxpayers are subject to the presumptive regime of standard assessment based
not on their actual income, but on the type, size and location

of business.

• Standard assessment theoretically means the tax is based on type, size and location of
business. The type of business affects the profitability rate;

size obviously shows the size of the income in some respects; and location is of course critical to
income generation.

• Standard tables must be developed based on adequate research about the profitability rate of
businesses, and if possible, the tables must show not just

the type of business, but also the size and location of business. Unfortunately, tables in practice
only show the types of businesses, the profitability

rates and the number of days in which businesses are assumed to be open for business.

list end

130
Cont’d…

list of 2 items

• A standard table developed by Addis Ababa City Administration in 2003 identifies 103 types of
businesses with sub-categories in each type, fixes profitability

rates and the number of days it is assumed the business is open for business.

• The tables mask a number of assessments which are estimations – location is left out; size is
left out. These numbers are gathered by estimators (assessors

in the past, committees, and recently by fresh graduates). It is these estimations that cause
rancor among taxpayers – as they are extremely subjective

and at times corrupt. The estimators go around literally every business (however small) and
gather daily sale numbers and multiply that by the number of

days for which the business is assumed to be open, and the taxable income is determined to be
the profitability rate for that business in the tables.

list end

131

Cont’d…

list of 4 items

• So what makes the assessment standard is the tables which determine only part of the
liability (and an insignificant part as that).

• Ethiopian income tax assessment for small businesses therefore remains ‘estimated
assessments,’ not standard assessment.
• It is the failure of the authorities to develop standard tables of assessment with complete
information about the type, size and location of businesses.

• The profitability rates also fluctuate wildly due to political winds of bargaining. In the 2002
ITRS, the APR of transit services was 70% in the 2010

AP, it was 13% (this can’t be true); on the other hand, the APR of fruits & vegetables was 10% in
the 2002 tables and ranges from 9% to 12% in the 2010

tables – while the profitability rate of fruits and vegetables dropped some 57 points, that of
fruits and vegetables actually increased over the same period.

list end

132

Cont’d…

list of 3 items

• Turnover thresholds – the 100, 000 ETB turnover threshold was fixed back in 2002 (ten years
ago). Due to inflationary pressures in the Ethiopian economy,

this threshold is gives a false impression that small businesses are big businesses. The cost of
goods since then has probably quadrupled since then.

• Graduation – it is assumed that the moment the turnover of a business crosses over 100K
ETB, it should maintain books as category B taxpayer, but there

are no clear tracks for that. As a result, many taxpayers do not know when to maintain books or
do not want to know.
• Estimation – the biggest problem is the assessment mode – it is subjective, abusive, corrupt
and expensive.

list end

133

Understanding the tables

list of 3 items

• Standard tables of assessment first identify the types of businesses (there are now more than
hundred different types of businesses), second fix the average

profitability rate (APR) (initially the APRs ranged from 10% to 70%) and third divide each
businesses into sub-categories.

• The sub-categories are mainly based on annual turnovers (at the intervals of 10, 000, for
example).

• Most businesses are assessed on the basis of their annual turnovers (which is usually the
multiplication of the daily sales figures collected from businesses

multiplied by the number of days in which the business is assumed to be open for business).

list end

134

Cont’d…
list of 6 items

• A few businesses are assessed not on their annual turnovers but on some external indicators.

• Attorneys – first grade/second grade

• Flour mills –based on the energy used;

• Public transport svcs – carrying/seating capacity

• It is interesting to note that standard assessments based on external indicators are the least
controversial of all the assessments, because the indicators

are clearly out there.

• It is the assessments that are based on estimations of turnovers that often cause
controversies and frictions b/n taxpayers and tax authorities.

list end

135