Chapter Three
Accounting for Income Taxes From
Employment
AIMS AND OBJECTIVES
This unit aims for explaining the Accounting for
Income tax from employment
After going through this chapter, the students will be
able to:
• Understand the concept of employment income tax
• Identify taxable and non-taxable income
• Compute employment income tax
• Identify the accounting and reporting systems for
employment income tax
Income Tax
Income tax:- refers to the tax based on the
amount
of taxable income of a taxable person.
Taxable income/taxable earning :- is the
amount of income on which income tax
liability is computed and payable. It is the
base for computing of tax liability.
Taxable income:- is the difference between
gross
income and allowable deductions.
Gross income:- is the total income of a taxable
person
Cont ------
• Taxable person can be
1. Any Individual, that is , a natural person or
human being including both meal and
female.
2. Any body which includes any company
incorporated under law that carries out
business activities
3. Any association of persons, that is, two or
more persons join for a common purpose
with a view to produce or generate income,
profit or gain from the operational activity
engaged.
Employment Income Tax
• Article 12 of Proc. 286/2002 , 608/2008,
regulation number 78/2002, Directive
No. 21/2009 states that employment
income shall included any payment or
gains (benefits) in cash or in kind
received from employment by an
individual, including income from former
employment or otherwise or from
perspective emplacement
• The payment is in cash or in kind for the
service provided by the employee to the
employer.
Cont-----
• Types of employment
1. Permanent 2. Contract
3. Casual
• Employer:- any entity such as central
government, state government, public
enterprise, company, firm , individuals,
association etc at which commend service
are rendered. They received a service from
the employee and they controlling the task.
• Difference between employee and self
employed person
1. Control 4.Financial risk and
facilities
Cont------
Scope of employment income
As stated above employment income is any benefits in
cash or in kind received by an employee for the service
rendered to his/her employer.
The major employment benefits are included
1. Basic salary or wage
2. Over time (based on article 66 (1) of labor
proclamation 377/2003 . article 67/1, 67/2 over time
rate is divided in to four
A. Normal Hrs. B. Late hours C.
Week end D. Public holidays
Rates of overtime
Remark for payments of public holidays are total 13
days in Ethiopia context.
3. Allowance:- are additional payments or
benefits accrue to employs for various
reasons. Depending up on the reasons.
Some of the types of allowance s are
A. Transport ( Fuel) Allowance
B. Position (Acting) allowance
C. Housing (House) Allowance
D. Hardship (Disturbance) allowance
E. Desert ( Bad Climate) allowance (35-
40%)
F. Educational Allowance
G. Cash indemnity allowance
Cont.---
H. City compensation Allowance
I. Representation Allowance
J. Milk Allowance
K. Telephone Allowance
L. Uniform Allowance
4. Per- Diem
5. Bonus
6. Commission
7. Employers pension ( Provident fund)
8. Employment termination payment
I. Severance pay – Proclamation 377/2003 Article 39 &
40-494/206
II. Compensation payment proclamation 377/2003
Articles 32(1) &41
III. Job searching payments Proclamation 377/2003
Article 40(3)
Determine Employs income Tax
• Basis of Charge :-In Ethiopian tax structure,
employment income is taxed at source either
on due basis or on receipt basis, whichever
is earlier. (Accrual or Cash based accounting)
• Withholding agent:- is any person who is
obliged by law to collect tax based on tax
laws and transfer it the government ( Tax
Authority) the employer have an obligation
to calculate and withhold the tax from each
payment to an employee and to pay to the
tax authority.
Cont.……..
• Employment tax rate proclamation
no 979/2016
No Employment Income /Per- Deduction In Birr
months/
Tax Rate Adjustments
(%)
From Birr To Birr
0 600 Exempted None
1 (Non-
taxable)
2 601 1,650 10% 60
3 1,651 3,200 15% 142.50
4 3,201 5,250 20% 302.50
5 5,251 7,800 25% 565.00
6 7,801 10,900 30% 955.00
7 Over 10,900 35% 1,500.00
Cont. ---------
• Components of Employee Income
Basic salary / Wage
Over Time earning (OT)
Allowance (Additional payments)
and others as per the payroll
• Taxable income of Employees: the amount of income from employment
which is subjected to employment income tax.
• Tax exempted incomes of the employee
• Common Exemptions Birr 600
• Direct Exemptions
– By proclamation:- Income from Casual employment, retirement
benefit >15%, Diplomatic personnel of foreign countries,
compensation for accident or death,
– By regulation:- Medical Expense, Transportation allowance,
Hardship, per-diem, Board allowance, income of personal
employed for domestic duties.
– By directive : Transport, Telephone, food
• Methods of tax computation
• Progression Methods .
• Deduction /Short cut methods.
Allowance and Per-Diem
• Fully taxable Allowance
Position Allowance
House Allowance
Desert Allowance
Cash indemnity Allowance
• Partially Exempted Allowance
Transportation Allowance
Food Allowance
• Fully Exempted Allowance
Hardship Allowance
Education Allowance
Academic Allowance
Milk Allowance
Uniform Allowance
Telephone Allowance (in case of Tigray)
Cont.-------
• Example
1. Mr. Dawit is an employee of MicroLink
information Technology and Business
College with a basic salary of 10,000 per
month, he earned position allowance of
Birr 2,000 per month and Transport
allowance of 1,500 Birr per month.
Required
Compute Total Earning
Taxable Income
Income tax by using two methods
Cont. --------
Solution
1. Total Earning = Basic Salary + Transport +Position
= 10,000+1,500+2,000
= 13,500
2. Taxable Income= 10,000+2,000
= 12,000
3. Income tax=(Taxable salary*tax rate )-Adjustment
=(12,000*0.35)-1,500
=2,700
Cont -----
Method Two (Progressive Method )
600 Exempted
1,050*.10 105.00
1,550*.15 232.50
2,050*.20 410.00
2,550*.25 637.50
3,100*.30 930.00
1,100*.35 385.00
12,000 2,700.00
OT Calculation
Mr. Birhanu is an employee of MLIT&BC with a basic
salary of Birr 5,000 per month and they work
additional hours of 10 Hr. on late hours , 10 Hr. on
normal , 12 week end and 8 on public holidays.
They earn additional position allowance of Birr 500.
• Compute the total earning of Birhanu.
• Over time earning
• Total taxable salary
• Total tax paid from the monthly income
• Record the report on payment of salary
• Record the report on payment of tax to
government
Bonus, Commission ,Severance, Encashment and Back pay
Calculation
• Bonus:- is a payment of benefits to
employees for making attractive profits as a
result of butter or best performance by the
employees in the given Accounting period.
• Severance payment compensation received
by an employee from the employer in
connection of termination of his employment.
• Encashment compensation paid for unused
annual lives.
• Back pay: compensation payments for
incremental salary that was not paid on time
of increment.
Examples
1. Tax on Bonus
Mr. Teklay earns a basic salary of Birr 15,000
per month. Based on the last year
performance he earns bonus of Birr 12,000
compute the Net pay of Bonus.
• Solution
Step 1:- Compute tax of the total earning
Tax= {(BS+B)*TR}-Adjustment
= {(15,000+2,000)*0.35}-1,500
= (17,000)*.35-1,500
=4,450.00
Cont. -------
Step 2= Compute Bonus per Month
= 24,000/12
= 2,000/month
Step 3 = Income tax on basic salary
= ((GS-D)*T)-Adjustment
=(15,000*0.35)-1,500
=3,750 per month
Cont. --------
Step 4 determine tax from bonus
Tax for Bonus= Total tax- tax for basic salary
= 4,450-3,750
= 700 / month
Step 5 Total tax for bonus
Total tax= Monthly tax *12 months
= 700*12
= 8,400
Step 6 Net pay for bonus
Net pay=Total Bonus- tax on bonus
= 24,000-8,400
= 15,600.00
2.Tax on Encashment for Annual leave
Example Mr. Asefa retired from the college
and has annual leave 22 days at the time of
retirement and have a basic salary of Birr
10,000.
Compute net pay of annual leave for the
employee
Solution
1. Tax on basic salary
Tax = (10,000*.30)-955
= 3,000-955
=2,045
Cont.--------
Total Tax = Basic salary + leave/month*tax rate
= (10,000+833.33)*.35-1,500
=10,833.33*.30-955
=3,249.99-955
=2,295.00
Tax for leave= 2,295-2,045
= 250/month
Tax for leave =250*12
=3,000
Net pay = Leave – Tax
= 10,000-3,000
= 7,000.00
Tax on Back pay
Example:- Mr Alemu has a basic salary of
10,000 and taxable position allowance of
2,500. During 2012 the company promotes
Mr. Alemu 25% the basic salary on the
month of July 1,2012
Required
1. Compute the amount of back pay
September 31
2. Compute tax on back pay
3. Compute the net of Back pay to the
employee
Solution
Back pay= (BS*25%)*3month
= 10,000*.25*3
= 2,500*3
= 7,500
Total Tax= (Basic salary+ position + Back pay) *0.35-
Ajustment
=(10,000+2,500+7,500)*.35-1,500
= 20,000*.35-1,500
=5,500
Tax without back pay = 12,500*.35-1,500
= 2,875
Tax on back pay = 5,500-2,875
= 2,625
Net pay = 7,500-2,625
= 4,875
