CHAPTER FOUR

ACCOUNTING FOR DIRECT TAXES IN ETHIOPIA

 .Basic Concept of the Ethiopian Tax system
• The Ethiopian tax system follows scheduler tax system,
• in which the tax liability of a taxpayer is determined based on the schedule of each income.
• the loss incurred in one schedule is not allowed to compensate from the income in the other schedule.
• Accordingly as it is depicted in article 8 of the income tax pro 979/16,
• direct taxes are classified in to four schedules and an income exempted from tax is listed in separate
schedule.
• Schedule ‘A’, income from employment;
• Schedule ‘B’, income from rental of buildings;
• Schedule ‘C’, income from business;
• Schedule ‘D’, other income;
• Schedule ‘E’, exempt income.
 Cont’d
• Ethiopia levies tax on residential jurisdiction basis.

• As per the income tax proclamation, every resident of Ethiopia who gets income within the country or from
abroad is charged under the act upon on transferring the amount to Ethiopia.
• That is the income tax is applied to the Ethiopian resident taxpayer on their worldwide income.
• According to the Income Tax Proclamation, residence of Ethiopia includes resident individual; resident body; and
the Government of the Federal Democratic Republic of Ethiopia, and any Regional State or City Government in
Ethiopia and its detail is depicted here under.
 A resident of individual is an individual who has a domicile in Ethiopia;

 is a citizen of Ethiopia who is a consular, diplomatic, or similar official posted abroad; and

 is present in Ethiopia, and continuously or intermittently, for more than 183 days in a one-year period.

 A resident body is a body that is incorporated or formed in Ethiopia; or has its place of effective
management in Ethiopia.
 Cont’d

• Moreover, the tax system of the country is also applied to non-residents with respect to their Ethiopian
source of income.
• That is foreign resident is liable to pay tax to Ethiopian tax authority for its income generated in the
territory of the country.
• Residential tax levy jurisdiction can create double taxation problem and thus double taxation
avoidance treaty is required between countries.
• Foreign tax credit is allowed by the income tax proclamation for a resident that derives foreign source of
during a given tax period.
• However, the tax credit will not exceed the tax payable in Ethiopia.
 Accounting FOR Employment Income Tax

Employment Income Tax in Ethiopia

• Income as defined in the income tax proclamation includes every sort of economic benefit including
non-recurring gains in cash or in kind from whatever source derived and in whatever form paid,
credited or received.
• Taxable income shall mean the amount of income subject to tax after deduction of all expenses and
other deductible items allowed as per the law.
• “Employee” means an individual engaged, whether on a permanent or temporary basis, to perform
services under the direction and control of another person, other than as an independent contractor,
and includes a director or other holder of an office in the management of a body, and government
appointees and elected persons holding public offices;
 Cont’d
What is Employment Income Tax?
• Employment income includes any payment or gain in cash or in kind received from employment by the employee
subject to certain exemptions.
• According to Pro 979/16 of Art 12 Employment income includes the following excluding the exempted incomes under
schedule ‘’E’’
• a) Salary, wages, an allowance, bonus, commission,
• b) The value of fringe benefits received
• c) Employees termination compensation
• *As it is indicated in the income tax regulation No 410/2017 Article 8 the list of fringe benefit includes the following:

 debt waiver;
 household personnel;  meal or refreshment;  an employee share scheme;
 housing or accommodation  private expenditure;  vehicle;
 discounted interest loan;  property or service;  residual fringe benefit

However, the aggregate tax liability on fringe benefit shall not exceed 10%the basic salary of the employees (for
detail refers the regulation).
 The Employment Income Tax Rate: Article 11

Employment income tax (EIT) = (Taxable income)* the tax rate in which the taxable income falls-
deduction allotted for the given rate

Taxable income= Gross income less Direct Exemption except the Common Exemption that is 600
birr
 Employment Income Exemption Indicated in Schedule “E”
• List of exempted employment income and allowances indicated in the proclamation (Art 65) and income tax
regulation (Art 54) and relative directives includes the following:
• The first six hundred birr (600 birr) of monthly income tax of the employees
• An allowance in lieu of means of transportation granted under a contract of employment with limit
that will be issued by the ministry directive.
• Currently 25% of the basic salary but not exceeded 2,200 birr is free from tax, here the transportation
allowance is exempted when the employees performs their work by traveling from one place to the
other, it cannot be granted for movements made from home to office and vice versa.
• Transportation allowance Birr 600.00 for covering transport expenses of the employees from home to
office and vice versa.
• Transport expenses and per diem payments to an employee travelling on a tour of duty subjected to
limit currently per diem payment is exempted up to 4% of the basic salary of the employee or Birr 500
which is the higher.
 Cont’d
• a cash indemnity allowance paid by an employer to an employee, but only to the extent that the allowance
compensates the employee for shortfalls on money counts;
• Employment income of not exceeding five years paid to expatriate professionals recruited for transfer of
knowledge by investors engaged in export business in accordance with a directive to be issued by the Minister;
• Income from employment received by unskilled employee working for the same employer whether continuously
or intermittently for not more than thirty (30) days within any twelve month period.
• An amount paid by an employer to cover the actual cost of medical treatment of an employee including Premium
payments made by an employer on behalf of an employee under employees, medical insurance scheme
• Hardship allowance paid in accordance directives issued by civil service commission
• Food and beverages provided for free to an employee by an employer conducting a mining, manufacturing, or
agricultural business subjected to limit issued by the ministry
 Cont’d
• Allowances paid by the Government of the Federal Democratic Republic of Ethiopia to employees engaged in public
service in a foreign country
• Allowances paid to members and secretaries of boards of public enterprises, public bodies, or study groups established by
the Federal or a State Government or City administration;
• contributions by an employer to a pension, provident, or other retirement fund for the benefit of an employee provided
the monthly total of contributions does not exceed 15% of the monthly employment income of the employee;
• an amount exempt from tax to the extent provided for under an international agreement example remuneration of
diplomatic personnel of foreign countries
• a public award for outstanding performance in any field or an award granted under Article 135 of the Tax Administration
Proclamation
• an amount as compensation for personal injury or the death of another person
• a scholarship or bursary for attendance at an educational institution
• maintenance or child support payments salaries paid to domestic servants
 Declaration and Payment of Employment Income Tax
• As it is indicated in article 88 of the income tax, proclamation the obligation to fill employment income tax is
given to employer.
• That is the employer shall withhold tax from the gross amount of each payment of employment income made to
the employee at the rate applicable to the employee.
• if an employee has more than one employer for a calendar month or a self withholding obligation, the employee
shall file a tax declaration within 30 days from the end of every three months (Art.96).
• That is an employee employed by an international organization or working in an embassy, diplomatic mission, or
other consular establishment in Ethiopia of a foreign government or employed by an entity exempt by law from
tax withholding obligations shall withhold tax from the employment income received from such entities.
• The statement shall be in the form and furnished in the manner prescribed by the Tax Authority
 Payroll Records and Preparation
• Payroll register: - this is a multi-column register (form) for the payment of salaries at the end of the payroll
period.
• The source document for preparing the payroll register includes, Letter of employment, Letter of Promotion,
Letter of Demotion, Attendance list, Time card and Relevant payroll and labor proclamation.
• Payroll Components includes: Employee Name and Employee ID, Earning Columns (parts), Deductions, Net
pays, Signature
• 1. Earning
• Basic Earning /Salary/: Monthly salary of an employee that is paid for carrying out the normal work of
employment.
• Basic salaries are the bases for making other calculation in relation to earning like bonus, compensations,
severance pay, overtime…etc..
 Cont’d
• Allowance: - Additional monthly payment to the employee for one of the following reasons
• Position allowance or Acting allowance: - Sum paid for a person for assuming a certain position.
• Housing allowance: - a monthly allowance paid to an employee to cover for house facility, when the employer is obliged
to provide house but falls to do so and taxable income.
• Transportation /fuel/ allowance: - an allowance paid to an employee for to cover the cost of transposition from office-
home-office or work related transportation costs.
• Cash indemnity allowance: - allowance paid for cashiers to cover the risk of possible cash shortage. Cash indemnity is
used to cover accidental shortage not intentional shortages,
• Hardship allowance: - an allowance paid to an employee for in convenience caused by the employer in the form of
unexpected transfers, hazardous working areas …etc.
• Desert Allowance: - a monthly allowance given to an employee assigned to a relatively hot region. All hot regions (places)
may not entitle an employee to a desert allowance.
• Representation allowance: - Allowance paid to employees whose work requires them to entertain customers and gusts..
 Cont’d
• Over time payment: - is a payment for extra hours worked beyond the regular working
hours
• Labor Proclamation Number 42/1985 E.C. (1993G.C.): Defines the basic legal frame
work for contract of employment, regular working hours limit, overtime rates,
compensation pay, leave benefits, employment termination procedures …etc.
• Maximum regular working hour’s 8hrs/day, or forty eight hours a week,
• but the current practice is maximum 44 hours per week and 192 hours per month. i.e.:
» Monday to Friday 8hours per day X 5 = 40hours
» Saturdays 4 hours per day = 4hours
44 hours
Or there are 22 days in a month; 22 X 8hours /day = 176 hours
There are 4 Saturdays in a month; 4 X 4 hours/day = 16 hours
192 hours
 Cont’d
• Over time payment = regular hourly salary rate* rate for the duration of overtime work *overtime hours
• Regular hourly rate = monthly basic salary divided by normal working hours per month

Overtime rate
• Ordinary time:
• from 6 in the morning (AM) o’clock to 10 o’clock in the evening (PM) Over time rate =1.25 * Regular hourly
rate
• Late hours: from 10PM up to 6 AM, Over time rate =1.5 * Regular hourly rate
• Weekly rest days: Over time rate =2 * Regular hourly rate
• Public holydays: Over time rate =2.5 * Regular hourly rate
• Bonus: - is a material (money) reward for better or best performance by managers or other employees.
 Cont’d
• Gross /earning/ Salary: - is computed by totaling all the earning i.e. Basic Salary + Allowances, if any
+ Overtime payment, if any + Severance pay, if any + compensation, if any + bonus, if any + … etc.
• Taxable income: - includes all earning except for non taxable incomes as specified under exemption
discussed above.
• Deduction: - These are subtractions form the gross earning, so as to identify the net pay of an employee.
– Statutory deduction: - deduction enforced or imposed by low.
• Currently, Pension contribution in Ethiopia applies to both public & private employees as per of the
following rate (Proc. No. 714/2011)
• 7% (of the basic salary) by the employee
• 11% (of the basic salary) by the employer.
• Voluntary deduction: - these are not imposed but are voluntary deductions Example: Credit
association, credit purchase …etc.
– Others: - Like court order, fines, absence …etc.
• Net pay: - the net pay is the difference between the gross earning of an employee and the total of the
deductions.
• Signature: - When an employee receives his/her pay he will sign to confirm that he have received the
net pay.
 Computation of Employment Income Tax
• for the sake of this course we will use the short cut method.
• Employment income tax = (Taxable income)* the tax rate in which the taxable income falls-
deduction allotted for the given rate
• Taxable income= gross income less direct exemption except the common exemption that is 600 birr
 Cont’d

• *The nature of work demands movement from one place to other place and indicated in the employment
contract.
• Required:
• Compute the gross earning
• Compute the taxable income
• Compute the pension fund contribution by the employee and employer
• Compute the employment income tax
• Compute the net payee
• Prepare the payroll register
• Record the salary and payroll expense
 Cont’d
• Solution:
1. Tadesse Abate
A. Gross earning =4500
B. taxable income is also =4500
Deductions
C. Pension contribution
• By the employee: 7%* of basic salary=0.07*4,500=315
• By the employer: 11% of the basic salary=0.11*4500= 495
D. EIT=taxable income * tax rate- deduction(adjustments)
• 4500*0.20-302.50= 597. 50
E. Red Cross society contribution 20 birr
F. Net pay= gross earning- pension contribution- income tax- Red Cross society contribution
4,500-315-597.50 -20 = 3,567.50
 Cont’d
2. Tedros Ephrem
A. Gross earning =basic salary+ over time
Over time per hour = basic salary/monthly working hours
=6000/ (192hours) = 31.25
Ordinary over time = 10*31.25*1.25=390.625
Late time overtime = 15*31.25*1.5=703.125
Total over time payment= 1,093.75
Gross earning = 6,000+1,093.75= 7,093.75
B. Taxable income is also =7,093.75
C. Pension contribution
By the employee: 7%*of basic salary=0.07*6000=420
By the employer: 11% of the basic salary=0.11*6000= 660
D. EIT=taxable income * tax rate- adjustments
7093.75*0.25-565= 1208.44
E. Net pay= gross earning- pension contribution- income tax- Red Cross society contribution
7093.75 – 420 - 1208.44 - 20= 5445.31
 Cont’d
3. Adane Tesfaye
A. Gross earning =Basic salary+ over time+ fuel allowances+ position allowance
Over time per hour = basic salary/monthly working hours
=12,000/ (192hours) = 62.50
Weekly rest days over time payment = 12*62.50*2=1,500
Gross Earning = 12,000+1,500+2,500 +500 = 16,500
B. Taxable income =Gross earning – fuel allowances exemption
C. The fuel allowance is exempted up to 25% of the basic salary but not exceed 2,200 birr. 0.25*12,000=3000 this
is higher than the maximum limit 2,200,Therefore only 2,200 birr is exempted while the rest of transport
allowance (2500-2200=300) is taxable.
Taxable income= 16,500 - 2,200=14,300
Deduction
D. Pension contribution : By the employee: 7%*of basic salary=0.07*12,000=840
By the employer: 11% of the basic salary=0.11*12,000= 1320
E. EIT=taxable income * tax rate- adjustments 14,300*0.35-1,500= 3,505
F. Credit association contribution = 12,000*0.10= 1,200 and red cross society contribution=20 Birr
G. Net Pay = Gross earning- total deduction= 16,500-3,505-840-1,200-20= 10,935
Cont’d
 Computation Employment income Tax on Bonus
• Computation of bonus has the following steps:

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

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

Solution
1. Tadesse abate
A. Taxable income using the basic salary
4500*0.20-302.50=597.50
B. The total bonus is divided to the service duration during the year that is 4500/5=900
• By adding to the basic salary you will get (4500+900=5400)

C. The income tax after bonus is 5400*.25-565=780

D. Total tax from bonus (780-597.50)*5=937.50
E. The net pay =bonus-tax (4500-937.50=3562.50
 Cont’d

2. Tedros Efrem
A. Taxable income using the basic salary
6000*0.25-565=935
B. The total bonus is divided to 12 months 12,000 /12=1000 By adding to the basic salary you will get
(6000+1000=7000)
C. The income tax after bonus is
7000*.25-565=1185
D. Total tax from bonus (1185-935)*12=3,000
E. The net pay =bonus-tax (12,000-3000=9,000
Accounting Treatment for Employment Income Tax
 Accounting for Rental Income Tax
• Rental income tax includes all forms of income arising from rent of building and rent of
furniture and equipment's if the building is furnished.
• There are different parities that involve in renting of the building: the lessor and
lessee.
• The lessor is the owners of the building and provides rental service to another person.

• The lessee is an individual or an entity who rents the building directly from the lessor.

• However there may be sub-lessor that is a third party who leases a building directly
from the lessee for residential, business or any other use.
• In this circumstance the lessee becomes a sub-lessor is a person or entity who further
leases the whole or part of the building with the permission of the lessor.
 Taxable Rental Income Tax
• taxable income from renting of building includes gross amount of income minus
total amount of deductions allowed
• The gross income from rental of building includes:
• All amounts derived by the taxpayer during the year under the lease agreement,
including any lease premium or similar amount;
• All payments made by the lessee during the year on behalf of the lessor
according to the lease agreement;
• The amount of any bond, security, or similar amount that, as a result of damage
to the building not used in repairing the damage to the building;
• The value of any renovation or improvement made under the lease
agreement to the building when the cost was borne by the lessee in addition to
the rent payable to the taxpayer.
• any amount attributable to the lease of the furniture or equipment.
• The taxable rental income does not include exempted incomes.
 Rental Income Tax Rates
The rental income tax rates are two types.
The first rate is applicable to bodies at flat rates of 30% of their
rental income tax.
The second rate is applicable to individual taxpayers in the following
manner.
 Computation of Rental Income Tax
• The computation of rental income tax is two types for these who do not
have an obligation to maintain books of accounts and for theses who
maintains books of accounts(category A and B tax payers).
• In computing the taxable rental income for taxpayer who does not
maintain books of account, a deduction (rental expenses) shall be
allowed for the following amounts:
• a) any fees and charges, but not income tax, levied by a State or City
Administration and paid by the taxpayer during the year;
• b) an amount equal to fifty percent (50%) of the gross rental
income derived by the taxpayer for the year as an allowance for the
 Cont’d
• a taxpayer who maintains books of account, a deduction shall include:

• a) The cost of the lease of land on which the building is situated;

• b) Repairs and maintenance;
• c) Depreciation of the building, furniture and equipment;
• d) Interest and insurance premiums; and
• e) Fees and charges, but not income tax, levied by a State or City
Administration in respect of the land or building leased.
• Here if the allowable deduction exceeds the gross income earned from renting of the
building, there is a Rental Loss.
• Hence loss carry forward is allowed for the tax payers
 Cont’d
• The taxable rental income of a sub-lesser shall be the difference between the

• total rental income received by the sub-lesser and the total rental
income paid to the lesser of the building plus other expenses
• to the extent necessarily incurred by the sub lesser to generate the income.

• Here, the owner of a building who allows a lessee to sub-lease the

building shall be liable for the rental income tax payable by the lessee
if the lessee fails to pay the tax.
• Gross Income from leasing activities XXX
• Less: Allowable deductions XX
• Taxable income XXX
Rental Tax = Taxable income X Tax rate less Adjustments
 Rental Income Tax on Advance Collection
• If a lessor receives rent payments in advance that covers a period longer than one
year from the lessee,
• the computation of rental income tax due on advance payment depends up on
the category of tax payers.
 If the lessor maintains books of account, accrual basis of accounting is applied
 If the lessor does not maintains books of account, cash basis concept is applied
 The amount of rental income tax liability is computed in the period in which the
advance payment is received.
 Here, the advance payment covers more than one year tax period; the tax is
calculated for each year by perorating the advance collection to the number
of the years that covers it.
Declaration and Payment of Rental Income Tax
• The time allowed for declaration of taxable income and payment of taxes
the same as that of schedule ‘C’ tax.
• Remember that a taxpayer who has taxable income from rent shall declare
the income (Art 83).
• Category A taxpayers Within 4 months after the end of fiscal year
• Category B taxpayers Within 2 months after the end of fiscal period
• Category C taxpayers Within 1 month after the end of the fiscal period
 Record Keeping Obligations Related to Rental Income

• these taxpayers who are liable for tax under Schedule “B” shall keep the
following record of accounts:
 Rental income received;
 Fees and charges paid to a State or City Administration in relation to the
building;
 Any expenditures incurred in relation to the building;
 A register of rental buildings showing the acquisition date, the cost of
acquisition, any costs of improvement in relation to the building, and the
current net book value of the building;
 Any sub-lease arrangement in respect of the building.
 Illustration1
• suppose w/ro Abeba has rented her building in July 8, 2007 E.C for monthly rent of birr
10,000 and leases on land paid to A.A city administration during the year was birr 3,000.
• In addition, she was category “C “tax payer.

• Required: Compute the annual rental income tax of w/o Abeba for the year ended July7,
2008 E.C
Solution:
 Gross rental income: ……………………….10, 000*12= 120,000

 Less allowable deductions

 Lease on land…………………………….…………………….. (3000)

 Repair, maintenance and Depreciation

 (50%of the gross rental income)……….0.5*120,000………. (60,000)

 Taxable Income ……………..………………………………………. 57, 000

 Rental income tax payable …………… (57,000*0.20-3630)…………7,770

• Illustration 2: Suppose Abay PLC has rented his building found in AA,
Arada Sub-city for monthly rental of Birr 120,000 in July, 2007 EC.
• The company also provides the following financial information in relation to
the building:
• Cost leases paid on land……………………………….…...12,000
• The cost of the building and accumulated Depreciation were …6,000,000
and 1,500,000
• Insurance premiums paid on the building …………………...30,000
• Outstanding loans taken for construction(at 9.5% interest)….2,000,000
• Wages of building administrators and cleaning expenses……….70,000
• Required: Compute the Rental income tax paid at the end of the year
 Solution

• Gross rental income ……………..( 120,000*12)

…………………………………..1,440,000
• Less allowable Deductions:
• Leases paid on land…………………………12,000
• Depreciation expenses on building (.05*6,000,000)………….300,000
• Insurance premium…………………………….30,000
• Interest expenses(.095*2,000,000)………..…..190,000
• Wages and general expenses……………………70,000………………………….(602,000)
• Taxable Income …………………………………….………………………………………
838,000
• Rental Income tax (838,000*0.30) ……………………………………………………
251,400
 ACCOUNTING FOR INCOME TAXES FROM BUSINESS

• One of the major tax revenue sources

• Currently the tax which, is collected from business income is
computed per schedule “C”.
• Accordingly this section is devoted to discuss the basic concept,
computation and accounting treatment of transactions related to
Ethiopian business income tax in accordance to the new income
tax proclamation of 979/2016, tax administration proclamation
983/2016 and income tax regulation No 410/17 and Tax
Administration Regulation 407/2017.
 Category of Taxpayers, and Tax Reporting period
• For the purposes of payment of business tax, taxpayers are categorized in to
three namely,
 Category A,
 Category B, and
 Category C.

• Category ‘A’ includes any tax payers having annual Sales turnover of Birr
1,000,000.00 and above.
• have to maintain all records and accounts
• Pay tax within 4-month period starting from end of their tax year (from
Hamle 1 to Tikimit 30).
 Cont’d
• Category ‘B’ includes those annual sales turnover of more than Birr 500,000.00 and less
than Birr 1,000,000.00.
• They have to submit the profit and loss statement together with the supporting vouchers.
• Pay tax with in 2 month period of time starting from end of their tax year (from
Hamle 1 to Nehasie 30).
• Category ‘C’ includes whose annual turnover is estimated at Birr 500,000.00 or
less.
• Pay tax with in 1 month period of time starting from end of their tax year (from
Hamle 1 to 30).
• They pay tax based on standard assessment schedule annexed to the income tax regulation.

• Here theses tax payer engaged in business transport service shall pay the withholding tax
from employment income together with their business income tax.
 Preservation of Books and Accounts
• Every businessman (except category C) is required to preserve all books of accounts and other records and
documents for a period of not less than 5 years for category “A” tax Payer and For 3 Years for
category “B” tax Payer after the year of income to which such books and documents relate.

• Category ‘A’ tax payers liable for business income tax shall keep books of account prepared in

accordance with the financial accounting reporting standards and, in particular shall keep the
record of:

 business assets and liabilities of the taxpayer,

 all daily income and expenditures;

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

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

 Any other document relevant in determining the tax liability of the

taxpayer
 Cont’d
• On the other hand Category ‘B’ taxpayers liable for business income tax shall keep the following:

 a record of daily income and expenditures;

 all purchases and sales of trading stock;

 salary and wages register and

 any other document relevant in determining the tax liability of the taxpayer.

• Category ‘C’ taxpayers may keep a record of gross income and other records that category B

taxpayers required to maintain.

• if these taxpayers are employing a worker shall keep documents showing any amount of employment

income paid to the employee and any amount withheld in tax

• Category C tax payer that maintains books of accounts may pay their tax
accordingly if the books of account maintained are accepted by the tax authority.
 Methods of Tax Accounting (Article 64)

• The period of tax assessment is one fiscal year. The fiscal year starts on
Hamle 1 and ends on Sene 30.
• The body can change the accounting year only with the permission of
the tax authority.
• ‘transitional period’.
• Category “A” taxpayers are required to use (IFRS), accrual basis of
accounting
• Category “B” shall follow simplified methods of accounting that is cash basis
of accounting
• However, these taxpayers can voluntary account on accrual basis of
 Cont’d
• Long-term Contracts (Art 32): include amounts in business income and claim

deductions for expenditures arising under a long-term contract for a tax year

based on the percentage of the contract completed during the year.

• Change in Accounting Method: A taxpayer may apply to the Authority, in

writing, for a change in the taxpayer’s method of accounting and

• the Authority may, by notice in writing, approve the application but only when

satisfied that the change is necessary to properly compute the taxable income of

the taxpayer.

• If a taxpayer’s method of accounting changes leads to the change in the

 Depreciation of Business Asset and Business Intangible

• Depreciable asset means tangible movable asset or a structural improvement to

immovable asset that:

1. Has a useful life exceeding one year;

2. Is likely to lose value as a result of normal wear and tear, or obsolescence; and

3. Is used wholly or partly to derive business income

• both diminishing value (declining balance method) and straight-line method
is allowed to compute the depreciation amount.
• The Business intangible and structural improvement should be depreciated only
under straight-line method.
• Here structural improvement means a building or any other addition or alteration
to immovable asset including a road, driveway, car park, fence, or wall.
Rate of Depreciation
 Cont’d
• Here under diminishing value method depreciation is computed by applying the rate on the Net
book value of the asset at the beginning of the year.
• The rate of depreciation applicable for business intangible includes the following:
 Preliminary expenditure or pre-operational costs (25%): an expenditure that provides an
advantage or benefit for a period of more than one year, incurred before the commencement of
a business but not including expenditure incurred to acquire any tangible movable or
immovable asset.
 Business intangible useful life more than 10 year except preliminary expenditure= 10%

 Any other business intangible 100% divided by the useful life of the intangible.

• If the balance of depreciable asset is not more than two thousand birr the amount shall be fully
allowed deductible from the income of the tax year.
• Repair and improvement expense allowable as deduction if it is not exceeded 20% of the net book
value of the asset at the end of the tax year.
 Cont’d
• if the improvement exceeds 20% the whole cost shall be added to the net book
value of the asset.
• Depreciation on assets such as fine art, antiques, jewelry, trading stock etc
(which are not subject to wear and tear) are not allowed.
• gain as a result of revaluation of assets shall not use as a basis for
determining depreciation base.
• For assets for which the pooling method is used, the rate is applied to the
depreciation base for the determination of depreciation.
• Depreciation base is the book value of the asset on the opening day of the tax
period, increased by the cost of acquisition, creation, renewal etc during the
period and reduced by the sales price of the asset disposed during the period.
• Loss incurred during the period due to natural calamity and other involuntary
conversion will also be considered for the computation of depreciation base.
• Any compensation received for these purposes will be deducted from the book
value.
• While determining the depreciation base, if it becomes negative, it will be added
 Taxable Business Income
• The taxable business income shall be the total business income reduced by the total
deductions allowed per the tax law.
• Allowable Deductions
• In order to determine taxable income under Schedule ‘C’, the following items of
expenditures are permissible.
A. Direct cost of producing the income such as the direct cost of manufacturing,
purchasing, importation, selling and such other similar costs.
B. General and administrative expenses incurred for earning, securing and maintaining
the income
C. Depreciation expense computed in accordance the income tax regulation
D. Bad Debt Expenses To be a deductible item, the amount must have been included
previously in income, the debt must have been written off in the books, and legal actions
have been taken for the collection of the debt
E. Insurance Premium payable on insurance directly connected with the business
activity.
F. Expense incurred for the promotion of business. The maximum limit for this
expense will be set by directives to be issued by ERCA.
 Cont’d
G. Commission paid for services rendered, provided that the amount shall not
exceed the normal rates provided by other similar businesses or persons.
H. A loss on disposal of a business asset (other than trading stock) disposed of by the
taxpayer during the year
I. Representation expense not exceeding 10%the income of the employees
J. Medical expense incurred for employees including premium payments under
employees health insurance scheme
K. Expenditures incurred in the provision of food and beverage services to the extent
limit sated by the ministry directives
L. Lease payment made for business asset held under a capital goods lease
agreement is deductable business expenditure
M. Head Office Expenses: Payment made by a permanent establishment doing
business in Ethiopia to its parent non-resident body in reimbursement of actual
expenses incurred by the parent non-resident.
Body for the benefit of the permanent establishment shall be deducted to the extent
that such expense was incurred in deriving, securing or maintaining business
 Cont’d
• N. Interest expense: A deduction for any interest incurred by the taxpayer in a tax year is allowed to the
extent that the taxpayer has used the proceeds or benefit of the debt or other instrument or agreement to
derive business income.
• Here deduction is not allowed if Interest paid or payable by a taxpayer in excess of the rate used between the
National Bank of Ethiopia and commercial banks increased by 2 percentage points; unless the interest is paid
or payable to a financial institution recognized by the National Bank of Ethiopia; or a foreign bank permitted
to lend to persons in Ethiopia. Moreover, interest paid or payable by a taxpayer to a related person who is a
resident of Ethiopia except when the interest is included in the schedule ‘D’ of the related person is not
allowed as deduction from business income.
• O. Charitable Donations under the following conditions.
a. If they are given to welfare organizations that have a record of outstanding achievement and have a good accounting
system showing the utilization of resources.
b. If the payments are made under emergency call issued by Gov’t to defend sovereignty and integrity and to prevent
manmade or natural catastrophe, epidemic or any other similar cause
c. If the donation is made in support of education, health, environment protection or provided in the form of humanitarian
aid otherthan for the taxpayer owns employees.
• (Note: Grants and donation will be allowed as deduction only if it does not exceed 10% of the
taxable income)
• P. Special Reserves: Financial institutions are permitted to deduct special reserves from taxable income in
accordance with the directives issued by NBE.
• Q. Reinvestment of Profit: A Regulation by the Council of Ministers allows a deduction of reinvestment of
profit (of a resident company or registered partnership) not exceeding 5% of the taxable income every year.
 Non - allowable deductions and losses
All those expenses, which are not wholly or exclusively incurred for the business activity, shall not be allowed as
deductions per the provisions of law. Such expenses include:
a) An expenditure of a capital nature
b) An increase in the share capital of a company or the basic capital of a registered partnership;
c) Voluntary pension or provident fund contributions in respect of an employee in excess of 15% of the monthly
employment income of the employee;
d) Dividends and paid-out profit shares;
e) An expenditure or loss to the extent recovered or recoverable under a policy of insurance, or a contract of
indemnity, guarantee, or surety;
f) A fine or penalty imposed, or punitive damages awarded, for violation of any law, regulation, or contract;
g) An amount that a person has transferred, in its financial accounts, to a reserve or provision for expenditures or
losses not yet incurred but expected to be incurred in a future tax year;
h) Income tax paid under this Proclamation or under a foreign tax law, or recoverable value added tax;
i) Representation expenditures of an employee in excess of 10% of the employment income of the employee;
j) Expenditure incurred in the provision of entertainment, except:
(1) When the person’s business involves the provision of entertainment; or
(2) to the extent that the expenditure is allowed as a deduction under a Directive issued by the Minister relating to
food provided for free to employees by an employer conducting a mining, manufacturing, or agricultural business;
k) A donation or gift except as provided for in Article 24 of this Proclamation;
l) Personal consumption expenditure;
m) A loss on the disposal of a business asset by a taxpayer to a related person;
n) Expenditure to the extent disallowed under Regulations to be issued by the Council of Ministers.
Business Income Tax Rates
 Declaration and Payment of Tax
• The following is the procedures for the declaration of taxable
income by taxpayers
A. Taxpayers categorized as ‘A’ within four months.
 They are required to submit statement of financial position and profit loss
statements.
A. Those taxpayers who are categorized as ‘B’ within two months
 They are required to submit profit loss statements.
A. Category C taxpayers within one month.
 The taxable income of category C taxpayers will be determined
through a standard assessment.
• If a taxpayer engages in business in more than one region, taxable
income shall be declared in the respective regions.
 Assessment of Tax
• Assessment is a tax review and a verification of the arithmetical and financial accuracy of
the declared tax liability.
• The procedure for the assessment of business income tax takes two forms,
 assessment by books of accounts, and

 assessment by estimation.

• Assessment by books will be done for those who maintain books of accounts (Category
A&B).
• The revenue authority makes assessment by estimation when the taxpayers do not
maintain the books or when the submitted books are not acceptable.
• This is also done if the taxpayer fails to declare his/her taxable within the time required.

• Tax, of those taxpayers who have different sources of income, will be assessed on the
aggregate of all income.
 Cont’d
• Loss Carry forward (Article-26):

• In such case the taxpayer can carry the amount of the loss forward to the next following tax year

• The loss will be carried forward for a maximum of five consecutive years

• The taxpayer is allowed to carry forward only two tax period losses.

• Here the loss earliest year shall be deducted first and

• loss carry forward is allowed only if the taxpayer maintains books of accounts showing the loss
are audited and acceptable by the tax authority.
• Loss Carry Back: long term contract,

• loss shall be allowed as a deduction and carried back ward till the loss is fully deducted.

• If during a tax period the direct or indirect ownership of the share capital or the voting
rights of body changes more than fifty percent (50%), by value or by number, loss carry
forward and back is not allowed.
 Foreign Tax Credit
• The amount foreign tax credit is equal to the
 foreign income tax paid; or the
 business income tax payable under Schedule ‘C’ in respect of the foreign income.
• Here, foreign tax credit shall be allowed when:
 The resident taxpayer has paid the foreign income tax within 2 years after the end of the
tax year in which the foreign income was derived by the taxpayer or within such further
time as the Authority allows and
 The resident taxpayer has a receipt for the tax from the foreign tax authority.
• If a foreign tax credit of a resident taxpayer for a tax year is not fully credited for the
year,
• the excess credit shall not be
 refunded,
 carried back to the preceding tax year, or
 carried forward to the following tax year.
• Foreign Business Losses (Art 46): If a resident taxpayer has a foreign loss for a tax
year, the amount of the loss can carried forward to the next five consecutive tax year
• The tax payer is allowed only to carry forward losses foreign income only two tax period
losses.
 Withholding Income Tax (Art 88 to 93)
• In theory withholding tax is defined as the amount of tax to be with held by the party making payment
to another party and to be transferred or paid to the tax authority as per the tax law.
• The purpose of withholding tax could be to accelerate tax collection of the government.

• Withholding income tax indicated in the Ethiopian tax law includes the following.

A. Withholding tax from imported goods: A taxpayer under Schedule ‘C’ importing goods for
commercial use shall make an advance payment of business income tax to the Authority equal to 3% of
the CIF value of the goods.
B. Withholding of tax from Domestic Payments (Art 92): Except micro enterprises, bodies having
legal personality, government agencies, non-profit organizations, or non-governmental organizations
and other tax payers required to withhold tax by a directive of the authority, shall withhold tax at the
rate of 2% of the gross amount of a payment made for the following:
 The supply of goods in Ethiopia involving more than 10,000 Birr in one transaction or supply
contract;
 The supply of services involving more than 3,000 Birr in one service contract
 Cont’d
• Here if the supplier of the transaction has failed to provide their TIN and trade license
to the withholding agent, the withholding agent shall withhold tax at the rate of 30% of
the gross amount of the payment made.
C. Withholding of Tax from Employment Income:
D. Withholding of Tax from Payments to Non-residents: indicated in schedule D
E. Withholding of Tax from Dividends, Undistributed profit, repatriated profit,
Interest, and Royalties:
F. Withholding of Tax from Games of Chance Income
G. Self-withholding: for employees who works in organization that don’t have
withholding obligation
• Payment of Withholding Tax: shall be paid to the tax authority within 30 days after the
end of the month in which the withholding income was paid
 Method of Preparing Tax Returns

• Business normally prepares business income tax returns (that is profit and loss
statements for tax purpose)
• There are two methods used to prepare the tax returns.
• Independent approach: business prepares a separate income statement for
income tax reporting.
• The preparation of business tax return ignores the tax exempted business
income and non deductable expenses as indicated in the tax law in the
following format.
 Cont’d
• Dependence approach: in the dependence approach the annual accounting profit taken as the
primary basis for the determination of taxable business income subjected to adjustments per the
relevant provision of the tax law.
• This approach does not require keeping a separate set of record for income tax reporting purpose.
•
Name of the taxpayer
Business income tax Return
For the tax period ending June 30/ 20xx
• Pre tax accounting income in the income statement…………………………..xxxx
• Adjustments
• Add back
• Non deductable expenses but deducted in the income statement..............….xxxx
• Admissible income but no include in the income statement…………..……...xxxx
• Deduct
• Deductable expenses but not charged in the income statement….……….…..xxxx
• Exempted incomes but included in the income statement………….….….….xxxx
• Tax business income ……………………………………………………..……...…xxxx
• Less: provisions for income tax of the period ……………………………….…….xxxx
• Net profit after tax ……………………………………………………….…………xxxx
 Illustration

1. Mr. James is a foreign citizen neither domicile nor a habitual residence in Ethiopia. He comes to
Ethiopia for the first time on Ginbot 11, 2008 E.C for three months to give training in connection with
the shooting of cinematography film in A.A. For this, he has been paid remuneration of Br 50,000 by
master company, an Ethiopian company. Mr. James comes to Ethiopia for the second time on Meskerm
7, 2009 E.C. for the same job and left Ethiopia on Tir 30, 2009 E.C. During this time, he has been paid
birr 85,000 by master company.
• Required:
A. Determine the residential status of Mr James for the tax year 2008 E.C.
B. Is his income chargeable to income tax in Ethiopia? And if your answer is yes under what schedule he
is liable to pay tax?
C. What would the residential status of Mr James for the tax year of 2009?
• Solution
A. During the tax year of 2008 E.C. Mr James stayed only for 50 days only (Ginbot 11 to Sene 30, 2008
E.C). This implies he did not satisfy the condition for resident taxpayer indicated in the income tax
proclamation. Therefore, Mr James is non- resident for the tax year of 2008 E.C.
B. Yes, he is liable to pay a tax based on source of income principle, which is taxed under schedule “D”.
That is income on non-resident’s generated through providing technical services by nonresident to
Ethiopian taxpayer subjected to tax at rate of 15% in the form of withholding tax.
C. In the tax year 2009 E.C Mr James stayed in Ethiopia for184 days implying that he is a resident for
the tax year of 2009 E.C. and his worldwide income is subjected for tax.
2. Adane merchandise enterprise PLC has the following buildings
 Office building acquired in July, 2005 E.C. at the cost of birr 1,500,000

 Factory building acquired in September 1, 2008E.C at the cost of birr 10,000,000 birr

• Required: Compute the depreciation expense for the tax year ending June, 30/ 2008

E.C.

• Solution

• Deprecation of building is 5% straight line.

• Depreciation expense for office building is 1,500,000*0.05= 75,000 and Factor

building is 10,000,000*0.05=500,000 per year. So depreciation expense of building

for the year 2008 E.C is birr 575,000.

3. XYZ plc financial statement shows the following information (the company use diminishing value
method)
• The cost of computers birr 185,000 and accumulated depreciation in June, 30/ 2007 E.C birr 120,000.
• During the 2008 E.C tax period the company under takes the following transactions.
 Three computer and printer was purchased at the cost of Birr 30,000
 Software products costing Br 10,500 was purchased
 Seven used computers with cost of Br 48,000 and accumulated depreciation Br 45,000 was sold for Br 18,000
 Compensation of Br 3,000 was received from the vender since two of the computers acquired during the current tax
year were slightly damaged during in transit. The company incurred Br 1,000 to maintain the computer and place
them in workable condition.

• Solution
• Depreciation Base
• Beginning Book value balance of the pool (185,000-120,000)………………………….Br 65,000
• Plus
 Purchase of cost of computer, printer and maintenance cost………Br 30,000
 Purchase cost of software product……………………………… Br10,500 40,500
• Aggregate value of the pool ……………………………………………………………… ………..105,500
• Less
 Sales Proceeds ………………………………………………………(18,000)
 Compensation received ……………………………………… (3,000) (21,000)
• Depreciation base for the tax Year ending June 30, 2008 E.C ……………………………84,500
5. On January 2008 E.C. Belaye General Importer was imported trading goods costing Br
1,000,000, fright incurred Br 310,000 and insurance charges Br 120,000. Determine the
amount withholding tax paid by the tax payer.
• Withholding tax on import= 3% of CIF 0.03*(1,000,000 + 310,000+ 120,000) = Br 42,900
6. During the tax year ended 2008 E.C Glorious PLC under takes the following transaction and
determine whether or not the transaction are subjected to withholding income tax
A. On Jan 1, 2008 soled electronic items to XYZ plc for one transaction Br 9,000
There is no income tax to be with hold because the transaction is less that Br 10,000
B. On march 15, sold electronic items on account Br 20,000 with term 3/30,n/120 to XYZ plc in a
single transaction.
There is no income tax to be with hold because payment has not been effected.
C. On April 10, the company collected the outstanding receivables for sales made in March 15, the
entity receives Br 19,000 in cash after deduction of the withholding tax Br 400 (0.02*20,000) and
cash discount 3% 0f 20,000 Br 600.
Here the withholding tax is 2% of the gross amount does not affected by sales
discount.
D. on April 30, the company sold electronic items to HM plc for cash of Br. 20,000 in one invoice.
The company receives Br 19,600 after deduction of WIT of Br 400.
E. On June, 25 the company provided maintenance service to XYZ plc for cash of Br 5,000.
In this case the payer with holds 2% of the gross payment Br 100.
• Additionally the following information was obtained for tax reporting purpose.

• The Br.55, 000 ending inventory cost was determined based on the FIFO method. If the LIFO or Average
Cost method had been used, the amount would have been Br.58, 000 and Br.52, 000, respectively.
• Salaries and wages comprise Br.1, 000 disallowable provident fund of employer’s contribution.

• Representation expense calculated at 25% of basic salaries of the employees.

• The Br.15, 000.00 depreciation was reported on the original cost of the Br.120, 000.00 building; and the
Br.5, 000.00 depreciation was also reported on the original cost of the Br.50, 000 vehicles. The
accumulated depreciation at the beginning of the tax year for Building and vehicle was Br 45,000 and
Br 30,000 respectively. The company used straight line method for Building and declining balance
method for depreciating the vehicle.
• The interest is on Br.25,000, and 10% simple annual interest borrowed from a recognized financial
institution By NBE in 2008 E.C. The highest interest rate by NBE and commercial banks for the current
year was 6%.
• Required: Compute the business income tax payable for the tax year using independent and dependent
approach.
Solution:

1. In accordance to the tax law taxpayer should use weighted average for inventory valuation as a
result the cost of goods sold is understated by 3,000 birr

2. The salaries and benefit are overstated by 1,000

3. Since only 10% of the basic salaries of the employees are allowable as representation allowance to
be deducted from the gross income, that is only 2,400 are allowable deductions, as a result the
representation allowance is overstated by 3,600.

4. For building the depreciation rate is 0.05 and using straight line method the annual depreciation
will be 120,000*0.05= 6000 and the depreciation rate for vehicle is 20% if we use the diminishing
value method and the depreciation expense of the year will be (50,000-30,000)*0.20= 4,000. This
implies the total depreciation allowable as deduction will be 6000+4000=10,000 and hence the
depreciation is overstated by 10,000.

5. The full interest expense is allowed as deduction because it is paid to financial institutions
recognized by NBE.

6. Entertainment expense is not allowed as deduction

 Other Income (Schedule “D” Tax)
• Incomes which are not specifically included under Schedule “A”, Schedule B and Schedule C
is categorized under this schedule. Schedule D income includes;
Income Of Non-residents
• A non-resident who has derived an Ethiopian source dividend, interest, royalty, management
fee, technical fee, or insurance premium shall be liable for non-resident tax at the rate
specified as follows:
 For an insurance premium or royalty , 5% of the gross amount of the premium or
royalty;
 For a dividend or interest, 10% of the gross amount of the dividend or interest;
 For a management or technical fee, 15 % of the gross amount of the fee

• However, the income generated by non-residents through permanent establishment cannot

be taxed under this category. Rather, it is taxed under schedule “C” or “D”.
 Cont’d
• Taxation of Non-resident Entertainers
• A non-resident entertainer or group of non-resident entertainers who has derived income
from the participation by the entertainer or group in a performance-taking place in Ethiopia
shall be liable for income tax at the rate of 10% on the gross income derived from the
performance without deduction of expenditures.
• Here, entertainer” includes musician and sports person; “group” includes a sporting team;
and “performance” includes a sporting event.
• Taxation of Royalties
• Royalty refers to a payment of any kind received as a consideration for the use of or the
right to use any copyright of literary, artistic or scientific work, including cinematography
film, and films or tapes for radio or television broadcasting, any patent, trademark, design
or model, plan, secret formula, or process, or for the use or for the right to use of any
industrial, commercial or scientific equipment, or for information concerning industrial,
commercial or scientific experience.
• Royalties is subject to a tax at a flat rate of 5%.
• The withholding agent who effects royalty’s payments, withholds the foregoing tax and
accounts to the Tax Authority.
• However, if the payer resides abroad and the recipient is a resident, the recipient must pay
the tax on royalty income. This tax is final in lieu of income tax.
 Cont’d
• INCOME FROM GAMES OF CHANCE
• This form of income is derived from winning at games of chance (lotteries, Tom bolas, and
other similar activities).
• This income is subject to tax at the rate of 15%, except for winnings of less than Br. 100 similar
to income from rendering technical activities the payer must withhold or collect the tax and
account to the Tax Authority. This tax is final in lieu of income tax
• DIVIDENDS
• The taxable Income is income received in the form of dividend from a share company or
withdrawals of profits from a private limited company.
• Resident of Ethiopia who derives dividend and non resident who derives Ethiopian sources
dividend that is attributable to a permanent establishment are liable to pay dividend income
tax.
• Dividend Income is subject to tax at the rate of 10% of the gross amount of the dividend.
• The withholding agent (payer) shall withhold or collect the tax and account to the tax
Authority. This tax is final in lieu of income tax.
• INCOME FROM CASUAL RENT
• The taxable income under this category is income derived from casual rental of property (land,
building, or moveable asset) not related to a business activity.
• This type of income is subject to tax at a flat rate 15% of the annual gross income.
 Cont’d
• INTEREST INCOME

• A resident of Ethiopia who derives interest and non resident who derives Ethiopian source interest
that is attributed to permanent establishment, are liable for income tax at the rate of:
• 5% of the gross amount of the interest derived from savings deposit with a financial institution that is
a resident of Ethiopia,; or
• 10% of the gross amount of the interest in any other cases

• The payer must withhold the tax and account to the Tax Authority. This tax is a final tax in lieu of
income tax.
• Windfall Profit: windfall profit” means any unearned, unexpected, or other non-recurring gain. The
directive issued by ministry of finance and economic cooperation determines the tax rate imposed on
windfall profit.
• GAINS ON TRANSFER OF CERTAIN INVESTMENT ASSESTS

• Gains obtained from the transfer (sale or gift) of building held for business, factory, and office and a
share of companies is taxable under this category.
 Cont’d

• Such income is taxable at the following rates:-

– Building held for business, factory, and office at the rate of 15%, and

– Shares and Bonds at the rate of 30%

• Nonetheless, Gains obtained from the transfer of building held for residence is exempted from tax
provided that such building is fully used for dwelling for two years prior to the date of transfer.
• Computation of Capital Gain Tax

• In computing capital gain tax, you should follow the following procedures;

• STEP 1.Determine the historical cost of the building or the par-value of the Share, as appropriate.

• STEP 2 Determine allowable deductions which includes

– taxes paid for the land and the buildings

• STEP 3 Determine proceeds from the transfer of capital assets

• STEP 4capital gain taxes equals tax rate mentioned above times the amount obtained after
deducting the sum of step1 andrr step 2 from step 3.
 Cont’d
• Example
• ABC Co. sold a building, which is held for business for Br. 1,000,000, which is acquired at
a cost of Br. 1, 200,000. Depreciation until time of sale amounts Br. 500,000 and property
tax paid for the building Birr 50, 000.
• Calculate the capital gain tax payable by ABC Co.
• Solution
• Book value of the Building = Cost – Accumulated Depreciation

= 1,200,000 – 500, 000

= 700, 000
• Property tax on the building is allowable deduction. Br. 50, 000
• Capital gain tax =( Br. 1000, 000 – (Br. 700,000 + Br. 50,000)) 15%
• = Br. 250,000 X 15% = Br. 37500
 Cont’d

• Undistributed profit

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

• A non-resident body conducting business in Ethiopia through a permanent

establishment shall be liable for tax at the rate of 10% on the repatriated profit
of the permanent establishment.
• Other Income

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