PFT Chapter 4

Public Finance and Taxation Chapter Four August, 2019
CHAPTER FOUR: ETHIOPIAN TAX ACCOUNTING
4. DIRECT TAXES IN ETHIOPIA (INCOME TAXES: PROCLMATION 797/2008)
The taxes on earning of tax payers during a given period of time are in general called income taxes. In
Ethiopia incomes are taxed based on scheduler approaches of taxation where incomes are categorized
in to different schedules based on their nature and sources for tax purpose. Accordingly there are four
schedules of income for tax purpose as it is provided in income tax proclamation.
 Schedule A: Employment Income tax

 Schedule B: Rental income tax
 Schedule C: Business profit tax
 Schedule D: Other income taxes
 Schedule E: Tax exempted income
4.1 EMPLOYMENT TAX (SCHEDULE ‘A’)
The primary goal of any income tax system is the equitable collection of revenue. To this effect, the
Ethiopian government has taken measures to broaden the tax base and introduced new taxes and
reformed the tax structure. As stated earlier, to meet the expenditures of government, the Government
of Ethiopia levies both direct and indirect taxes. One of the direct taxes, the employment tax, is levied
and collected as per the proclamations issued from time to time.
“Income” means every sort of economic benefit including gains in cash or in kind, from whatever
source derived and in whatever form paid, credited or received.
“Taxable income” means the amount of income subject to tax after deduction of all expenses and
other deductible items allowed under this Proclamation 979/2008.
“Employee” means any individual, other than a contractor, engaged (whether on a permanent or
temporary basis) to perform services under the direction and control of the employer
In Ethiopian income tax system, employment income tax, also called personal income tax, refers to an
income tax imposed by the government on employment income of an employee. It is a tax on earnings.
That is, money that individuals receive in different ways from their employer(s).
4.1.1 Determination of Employment Income
The major components of earnings (employment income) of an employee include the following:-
Determination of Gross employment income: all type of income like Basic salary, allowance, overtime
and bonus
A. Basic Salary- means a regular payment to which an employee is entitled in return for the
performance of the work that he performs under a contract of employment this is payment received
Admas University Bishoftu Campus FB Department of ACFN (By Firomsa T.) pg. 1
by the employee for regular or normal working hours. That is, the time during which a worker
actually performs work or avails himself for work in accordance with law, collective agreement or
work rules.
- is flat monthly salary of an employee for carrying out the normal work of employment and subject
to change when the employee is promoted.
B. Allowances- money paid monthly to an employee for special reasons or special payments or
benefits made to employees for various reasons, like:
 Position allowance- a monthly paid to an employee of earning a particular office
responsibility.
 Housing allowance- a monthly allowance given to cover housing costs of the individual
employee when the employment contract requires the employer to provide housing but the
employer fails to do so.
 Hardship allowance- a sum of money given to an employee to compensate for an inconvenient
circumstance caused by the employer. For instance, unexpected transfer to new different and
distant work area or location.
 Desert allowance- a monthly allowance given to an employee because of assignment to a
relatively hot region.
 Transportation (fuel) allowance- a monthly allowance to an employee to cover cost of
transportation up to his/her workplace, if the employer has committed itself to provide
transportation service.
B. Overtime Earning: is a payment made to an employee for overtime work done during a
specific payroll period. That is a payment made for the work done in addition to one’s regular
working hours. Overtime work is the work performed by an employee beyond the regular
working hours.
C. Per-Diem: is payment of daily expenses of an employee incurred for duty such as expenditures
for food, bed, transportation (traveling expenses) and others.
4.1.2 Taxable income
 Every person deriving income from employment is liable to pay tax on that income at the rate
specified in Schedule “A”, shown below. The first Birr 600(six hundred Birr) of employment
income is excluded from taxable income.
 Employers have an obligation (Liability) to withhold the tax from each payment to an
employee, and to pay to the Tax Authority the amount withheld during each calendar month.
In applying preceding income attributable to the months of Nehassie and Pagumen shall be
aggregated and treated as the income of one month.
Every person deriving income for employment is liable to pay tax on that income at the rate specified
in schedule `A`, set out in Article 11. The first Birr 600 (six hundred Birr) of employment income is
excluded from taxable income. If the tax on income from employment, instead of being deducted from
the salary on wage of the employee, is paid by the employee in whole or in part, the amount so paid
shall be added to the taxable income and shall be considered as part there of
4.1.3 Exemptions
The following categories of income shall be exempted from payment of income tax.
 Income from casual employment :Income from employment received by casual employees
who are not regularly employed provided that they do not work for more than one month for
the same employer in any twelve months period.
 Contribution of retirement benefits by employers: Pension contribution, provident fund and
all forms of retirement benefits contributed by employers in an amount that does not exceed
15% (fifteen percent) of the monthly salary of the employee.
 Income from Diplomatic and consular representatives, and Other persons employed in
any Embassy, Legation, Consulate or Mission of a foreign state performing state affairs,
which are national of that state and bearers of diplomatic passports or who are in accordance
with international usage or custom normally and usually exempted from the payment of
income tax..
 Payments as compensation: Payments made to a person as compensation or gratitude in
relation to:
(i) Personal injuries suffered by that person;
(ii) The death of another person.
 Allowable Deductions: The following payments, made to an employee by an employer, are
allowed as deductions to determine taxable income.
 Reimbursed medical expenses
 Transportation allowance (if provided in the contract)
 Hardship allowance
 Reimbursed traveling expense (incurred on duty)
4.1.4 Tax Rate
The tax payable on income from employment shall be charged, levied and collected at the following
rates:
Schedule A
No Employment income (Income per month) Tax rate Deduction in birr
Over Birr To Birr % Birr
1 0 600 Exempt threshold
2 601 1651 10% 60
3 1651 3200 15% 142.5
4 3201 5250 20% 302.5
5 5251 7800 25% 565
6 7801 10,900 30% 955
7 Over 10,900 ***** 35% 1500
There are two methods of employment income tax computations
A. Progression method: The amount of tax is calculated for each layer of tax bracket by
multiplying the given rate under schedule A.
B. Deduction methods: Income tax= Taxable income x Tax rate – Deduction
Example: The following data were take;n from the records of Bravo Co. for July 2010 E.C. that pays
payroll to its employees according to Ethiopian payroll system.
Name Basic salary Allowance Overtime worked Duration of overtime work
Chala T. Br.6,800 1000 30hrs Up to 10:00pm
Abel Ch. 5,200 600 20hrs 10:00pm-6:00am
Alem G. 3,600 100 10hrs Weekends
18hrs Public holiday
Additional information:
1. All employees are expected to render services of 160hrs per month and all of them did except
Chala who has served only 150hrs.
2. All employees are permanent employees except Abel.
3. The allowance of Chala T. is not taxable.
4. All employees promised to contribute 10% of their basic salary to the credit association of company
Required:
Determine the
 Gross earnings,  Total deductions and
 Taxable income,  Net pay of all employees and.
Computation of Earnings, Deductions and Net Pay
Gross Earnings = Basic salary + Allowance + Overtime Earning
Overtime Earning
Overtime earning = OT hrs worked X (ordinary hourly rate X relevant OT rate)
1. Chala T.:
 You should compute the regular hourly rate first:
Regular Hourly Rate = Monthly salary (Basic Salary)
Total Hours worked in the Month
= br. 6800
160 Hours
 Therefore, the regular Hourly payment = br. 42.5
NB Every employee is expected to work 160 hours per month
(I.e. 40 hours x 4 weeks)
The regular hourly payment must be multiplied by the appropriate OT rate as follows;
br. (42.5 x 1.25) x 30 hours-------------------Birr.1, 593.75
2. Abel
= br. 5200
160 Hours
 Therefore, the regular Hourly payment =Birr. 32.5
 OT Earning = 20 hours X br.32.5 x 1.5 ----------------Birr. 975.00
3. Alem
= br. 3600
160 Hours
 Therefore, the regular Hourly payment =Birr. 22.5
 OT Earning = 10 hours X br.22.5 x 2 ----------------Birr. 450.
 OT Earning = 18 hours X br.22.5 x 2.5 ----------------Birr. 1012.5
Total--------------------------------------------------------------1462.5
GROSS EARNINGS
Gross Earnings = Basic salary + Allowance + OT Earnings
1. Chala
 Gross Earnings = br. 6800 + br. 1000 + br. 1,593.75 = Birr. 8,493.75
 Remember taxable income in this case is br. 7,493.75 because the allowance of br. 1000 is not
subject to taxation.
2. Abel
 Gross Earning = br. 5200 + br. 600+975 = Birr. 6,775
3. Alem
 Gross Total Earnings br. 3600 + br. 100 + br. 1462.5 = Birr.5162.5
DEDUCTIONS AND NET PAY
1. Chala:
 Gross Total Earnings-------------- Birr. 8,493.75
 Gross Taxable Income (Birr. 8,493.75– br. 1000)------- 7,493.75
 Employee Income Tax: (7,493.75 x30%) – 565---------------------------------1298.125
 Pension contribution: Basic salary x 7%(br. 6,800 x 0.07-----------------476.00
 Credit Association(br. 6800 x 0.1-------------------------------------------680.00
 Total Deduction -------------------------------- ---------------------------- br.2,454.125
2. Abel:
 Gross Total Earning-----br. 6775.
 Employee Income tax: (6775 x 25%) – 565----------------------1,128.75
 Pension Contribution (br. 5200 x 0.07)----------------------------364
 Credit Association---------------------------------------------------520.00
 Total Deduction---------------------------------------------br. 2,012.00
3. Alem:
 Gross Total Earnings------br. 5,462.00
 Employee Income Tax: (5162.5x 20%) – 302.5-----------------730
 Credit Association---------------------------------------------------360.00
 Total Deductions------------------------------------------br.1,090
NB. No pension contributions because she is not permanent employee of the organization. Therefore,
total deduction is the same as Employee Income Tax, br. 1,090.00.
NET PAY:
Net pay = Gross Total Earnings – Total Deductions
1. Chala:
Net pay = br. 8493.75 – br. 2454.125
Net pay= Birr. 6039.625
2. Abel:
Net pay = br. 6775 – br. 2012.00
Net pay= Birr. 4,763
3. Alem:
Net pay = br. 5162.5 – br. 1090
Net pay= Birr. 4072.5
Practical examples
The following data relates to the payroll of the employees of a privately owned business organization
known as “ZUQALA Retail Enterprise”, for the month of Hamle, 2011 E.C.
Serial Name Basic Allowance Overtime Worked
No. Salary Hours Duration
01 Lami T. Br. 8300 1200 4 up to 10 PM
02 Selina S. 6,960 950 12 10PM to 6 AM
03 Chemdessa N. 5,450 1050 8 weekly rest days
04 Dawit T. 4,632 ___ 10 Public holiday
05 Leli A. 12,000 850 ___ ___
Additional Information
 The management of the business organization usually expects a worker to work 160 hours in a
month.
 There were no absentees during Hamle.
 All employees are permanent except Selina S and Dawit T.
 Lami and Leli agreed to contribute monthly Br. 600 and Br. 650 respectively from their salary as
a monthly saving in the credit association.
 An allowance to Lami and Leli is House allowance.
 An allowance to Selina and Chemdessa is Hardship allowance.
 An Organization uses 7% and 11% of pension contribution by an employee and an employer
respectively.
4.2 TAX ON INCOME FROM RENTAL OF BUILDINGS (SCHEDULE ‘B’)
Any income arising from rental of buildings is taxable under schedule ‘B’. Rental income includes all
form of income from rent of a building and rent of furniture and equipment if the building is fully
furnished. Income from the lease of business including goods, equipment’s and building which are
part of the normal operation of a business, (called business lease) are taxable under another schedule
that is in schedule ‘C’
Gross rental income also includes any cost incurred by the lessee for improvement to the land or
building all payments made by the lessee on behalf of the lessor in accordance with the contract lease.
In the lease contract there are two parties involved in renting a building, the lessor and the lessee. The
party who grants rent of the building is the lessor. The one who leases the property for use is the lessee.
In some occasions the lessor may allow the lessee to sub lease the building for another party. In such
circumstances the first lessee becomes the sub-lessor. The sub lessor must pay tax on the difference
between income from the sub leasing and the rent paid to the lessor, provided that the amount received
by the sub lessor. The owner of the building who allows a lessee to sub- lease is liable for payment of
the tax for which the sub lessor is liable, in the event the sub-lessor fails to pay.
When a building is constructed for the purpose of giving on lease, the owner and contractor should
inform the Kebele Administration about its completion and the intention of giving it on lease. This is
also applicable when the building is rented before its completion. The Kebele Administration will pass
the information to the tax office for the administration of tax. It is also the responsibility of Kebele
administration to gather any such information and communicate to tax office in case where the parties
fail to do so.
4.2.1 Taxable Income
Gross income includes all payments, either in cash or benefited in kind, received by the lessor and all
payments made by the lessee on the behalf of the lessor. The value of any renovation or improvement
to the land or the building is also part of taxable income under this schedule if such cost is borne by
the lessee in addition to rent payable.
4.2.2 Deduction
Taxable income from schedule B income is determined by subtracting the allowable deductions
from the gross income. Allowable deductions include the following:
 Taxes paid with respect to the land and buildings being leased; except income taxes; and
 For taxpayers not maintaining books of account, 50%of the gross income received as rent for
buildings furniture and equipment as an allowance for repairs, maintenance and depreciation of
such buildings, furniture and equipment;
 For taxpayers maintaining books of account, the expenses incurred in earning, securing, and
maintaining rental income, to the extent that the expenses can be proven by the taxpayer and subject
to the limitations specified by this Proclamation, deductible expenses include (but are not limited
to) the cost of lease (rent) of land, repairs, maintenance, and depreciation of buildings, furniture
and equipment in accordance with Article 23 of this Proclamation as well as interest on bank loans,
insurance premiums.
4.2.3 Tax Rate
The tax payable on rented houses shall be charged, levied and collected at the following rates:
(a) On income of bodies thirty percent (30%) of taxable income,
(b) On income of persons according to the Schedule B (hereunder) Schedule –B
No Taxable income from rental Tax rate Deduction
(Income per year)
Over Birr To Birr %
1 0 7,200 0
2 7201 19,800 10 720
3 19,801 38,400 15 1710
4 38,401 63,000 20 3630
5 63001 93600 25 6780
6 93601 130,800 30 11,460
7 Over 130,800 ***** 35 18,000
 Computation of income tax on income from rental of building

In order to compute the taxable income from rental of building we use the following approach.
Sources (income) Amount in birr Amount in birr
Rental Income Received xxxxx
Add: Amount received on the
i) Lease of furniture xxx
ii) Lease of equipment xxxxx xxxxxx
Less: Deductions:
i) Taxes paid on land and buildings
Leased xxxx
ii) For those not maintain books of
Accounts
Allowance for repair, maintenance
And depreciation (50% of gross income) xxxx
(OR)
iii) For those maintain books of Accounts
 Expenses on
a) Cost of lease of land xxxx
b) Repairs xxxx
c) Maintenance xx
d) Depreciation of building, furniture and
Equipment’s xxx
e) Interest on bank loans xxx
f) Insurance premiums -- xxxxxx (xxxxxx)
Taxable Income from rental of Buildings xxxxxx
Example1) Mr. X has a building that is available for rent. The following are the details of the
property let out
 He has let out for twelve month
 Actual rent for a month is birr 4000
 He paid 5% of the actual rent received as land taxes and 3% as other taxes
 He spent birr 5000 for maintenance of the building
 Depreciation expense one year 160
 He does not maintain any books of accounts in this regard
Required: compute the taxable income and tax liability
Solution:
Annual rental income (birr 4000*12 months) ---------------------------------------48,000
Less: allowable deductions
 Land tax(5% of 48000)-------------2,400
 Other taxes(3%of 48,000)--------------1,440
 Depreciation expense ----------------------160
 Maintenance (50% of 48,000)----------24,000 (20,000)
Taxable income………………………………………………20,000
 Then tax liability should be calculated as follows
= taxable income* tax rate- deduction
=birr20, 000*15%-1,710
=birr 1,290
Example 2) Assumes that in example 1, Mr. X has maintained books of accounts.
Required: Compute the taxable income and tax liability
Solution:
Annual rental income (birr 4000*12 months) ---------------------------------------48,000
Less: allowable deductions
 Land tax(5% of 48,000)-------------2,400
 Other taxes(3%of 48,000)-----------1,440
 Depreciation expense -------------------160
 Maintenance ---------------------------5,000 (9,000)
Taxable income………………………………………………39,000
 Then tax liability should be calculated as follows
= taxable income* tax rate- deduction
=birr39, 000*20%-3,630
=birr 4,170
Example 3) Assume that Sunshine Private Limited Company rented a furnished office building to
Desta Company for Br 40,000 per month on Hamle 1, 200 for 3years. The following data pertain to
the expenses incurred and other allowable deductions. The company keeps books and records properly.
Tax on building Br 2,400
Tax on land 2,160
Maintenance on building 12,000
Depreciation on building (for 12 months) 28,000
Interest on loan (for 12 months) 12,000
Insurance premium (for 12 months) 5,720
Required: Computes rental income tax for the year ended Sense 30, 2011.
Solution:
Annual Rental Income 40,000 X 12 = Br 480,000
Less: Deductions
Tax on building Br2,400
Tax on land 2,160
Maintenance 12,000
Depreciation 28,000
Interest 12,000
Insurance 5,720 (62,280)
Taxable Income Br 417,720
Rental Income Tax for The year ended Sene 30, 2011
= Br 417,000 X 30%
= Br 125,316
Practical Examples
Ato. Dawit owns four houses. The details regarding which are as follows for year 2009/10:
(1) The first house of the annual rental value (FMV) of Birr.12, 000 was occupied by him for his own
residence.
(2) The second house of the annual rental value of Birr.10, 000 (FMV) was let out at Birr.900. He
paid Birr 600 as interest on money borrowed for the construction of the house, Birr.120 as land
tax and Birr.200 as insurance premium of the house.
(3) The FMV of the third house is Birr.16, 000 pm and its actual rent is 1,500 birr. But in respect of
this house maintenance charge of Birr.1600 per year including repair charges.
(4) The fourth house, the FMV of which is Birr.6000 pa was let out at 1,300 .It remained vacant for
4 months. The unrealized rent in respect of this house during the year was Birr.1200, which
satisfies the conditions for claiming this loss.
Required: Find out the income from house property for the year 2009-10.
(5) ZUQALA Plc rented one of its new office buildings for a monthly rent of Birr 45000 on Hamle
1, 2010. The company gives the following data in relation to the building
Tax paid on land and building Birr 4200
Cost of the building Birr 2000000
Insurance premium paid on the building Birr 3018
Loan taken for construction at 6% a year Birr 1000000
Required: - Compute the rental tax payable by the company for the year ended Sene 30, 2011
4.3 INCOME FROM BUSINESS (SCHEDULE “C”)
Business means manufacture or purchase and sale of a commodity with a view to make profit. It
includes any trade, commerce or manufacture or any other adventure or concern in the nature of
entrepreneurial activity. It is not necessary that there should be a series of transactions in a business
and it should be carried on permanently. Neither repetition nor continuity of similar transactions is
necessary. Profit of an isolated transaction is also taxable under this Schedule, provided that it is a
venture in the nature of business or trade. In this connection, it is important that the intention of
purchase or manufacture should be sell at a profit.
4.3.1 Taxable Business Income
Taxable business income shall be determined per tax period on the basis of the profit and loss account
or income statement, which shall be drawn in compliance with the Generally Accepted Accounting
Standards, subject to the provisions of this Proclamation and the directives issued by the Tax Authority.
4.3.2 Category of Taxpayers
For the purposes of payment of business tax, taxpayers are categorized into three namely: Category
“A”, Category “B”, and Category “C”.
Category “A” includes any company incorporated under the laws of Ethiopia or in a foreign country
and other entities having annual turnover of more than Br1000, 000. Those who are categorized under
“A” have to maintain all records and accounts which will enable them to submit a balance sheet and
profit and loss account disclosing the gross profit, general and administrative expenses, depreciation,
and provisions and reserves (together with the supporting vouchers).
Category “B” includes those enterprises having annual income of more than Br 500,000 and less than
Br 1000,000. Category “B” taxpayers have to submit the profit and loss statement together with the
supporting vouchers.
Category “C” includes all taxpayers who are not classified under the other two categories and whose
annual turnover is estimated at Br 500,000 or less. 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 after the year of income to which such books and documents relate.
4.3.3 Tax payment Period
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. When the tax period of a body is changed (with the
permission); the period between the previous tax period and the new period will be treated as a
“transitional period”.
4.3.4 Allowable Deductions
In the determination of business income subject to tax in Ethiopia, deductions shall be allowed for
expenses incurred for the purpose of earning, securing, and maintaining that business income to the
extent that the expenses can be proven by the taxpayer and subject to the limitations specified by this
Proclamation. In order to determine taxable income under Schedule “C” the following items of
expenditures are allowable for deduction.
1) Direct cost of producing the income such as the direct cost of manufacturing, purchasing,
importation, selling and such other similar costs.
2) General and administrative expenses incurred for earning, securing and maintaining the income.
3) Bad debt
4) Premium payable on insurance directly connected with the business activity
5) Expense incurred for the promotion of business
6) Commission paid for services rendered, provided that the amount shall not exceed the normal
rates provided by other similar businesses or persons
7) Any payment made by a branch, subsidiary or associated company in
Ethiopia to the foreign head office for services rendered (actually), provided that such a services
cannot be rendered by any other person at a lower cost
8) Salaries, wages or other benefit paid to the children of proprietors or member of partnership,
provided it should be proved that they possess the required qualification
9) Salaries and other personal benefit paid to manager or managers of a private limited company.
10) Interest expense, if the lending institution is recognized by NBE or a foreign bank permitted to
lend to enterprises in the country.
11) Depreciation expense
The following are the rates of depreciation permitted per the rule:
1) Building: 5% of the original cost. The cost includes the cost of acquisition, construction,
improvement, reconstruction and renewal.
2) Intangible Assets: 10% (straight-line basis).
3) Computers, information systems, software products and data storage equipment: 25% (on a
pooling system).
4) All other business assets: 20
According to the Regulation issued by the Council of Ministers, depreciation will be allowed as
deduction only if the tax payers keep satisfactory record and submit the same to the tax authority
regarding the date and cost of acquisition and a record of the total amount of depreciation deducted on
the asset so far. However, depreciation on assets such as fine art, antiques, jewelry, trading stock, etc
(which are not subject to wear and tear) are not allowed.
Financial institutions are permitted to deduct special reserves from taxable income in accordance with
the directives issued by NBE. However, the amount drawn from such reserves will be added to the
taxable income of such institutions.
4.3.5 Non-allowable Deductions
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:
1) Capital expenditure: the cost of acquisition, improvement, renewal, etc that is depreciated
2) Additional investment: an increase in the share capital of a company or the original capital of a
registered partnership
3) Pension or provident fund contribution in excess of 15% of the monthly salary of employees
4) Any tax, fine or penalty paid under any proclamation and recoverable value added tax
5) Fines or penalty paid under violation of law
6) Losses that are not connected with the business activity
7) Losses recoverable by insurance
8) Entertainment expenses
9) Personal consumption expenses
10) Salary, wages, and other personal benefit paid to the partner, or proprietor of an
enterprise
4.3.6 Declaration and Payment of Tax
The following is the procedures for the declaration of taxable income by taxpayers.
A) Taxpayers categorized as “A” are required to declare their taxable income within four months
from the end of the tax period
B) Those taxpayers who are categorized as “B” are required to declare their taxable income within
two months from the end of the tax period
C) Category “C” taxpayers shall declare taxable income within one month i.e. between July 07 and
August each year and paid from Hamle,1-Hamle,30.The taxable income of Category “C” taxpayers
will be determined through a standard assessment. It is a fixed amount of tax determined through
the regulation (of Council of Ministers), considering variations such as type of business, business
size and location.
4.3.7 Assessment of Tax

Assessment is a tax review by a tax official of the tax declaration and information provided by a
taxpayer and a verification of the arithmetical and financial accuracy of the declared tax liability.
Pursuant to the proclamation, each taxpayer is required to furnish the tax authority with all information
required for the assessment of income tax including information about his operations, and relationship
with other bodies that may be necessary for the declaration of income or for supporting the books of
accounts.
The procedure for the assessment of business income tax takes two forms:
A) Assessment by books of accounts, and
B) Assessment by estimation.
Assessment by books will be done for those who maintain books of accounts (Category A and 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 income within the time required. Tax, of those taxpayers who have different sources of income,
will be assessed on the aggregate of all income.
Assessment by Estimation: If the taxpayers keep no records, or if the income tax authority does not
accept the submitted books, or if the taxpayer fails to declare tax within the time specified, the
income tax authority estimates tax by the use of certain indicators. Category “C” should pay tax at
fixed rate on the income estimated by the income tax authority. Tax assessors will be assigned by the
tax office to estimate the daily sales of the taxpayers. The estimates will be done using the best of
their judgment and objectivity. The estimated daily sales will be converted to annual income using
the number of working days.
4.3.8 Business Income Tax Rates
According to the income tax proclamation, the following tax rates are used for computation of
business income tax under Schedule “C”. The Range of Taxable Business
No Taxable business income Tax rate Deduction
(Income per year)
Over Birr To Birr %
1 0 7,200 0
2 7201 19,800 10 720
3 19,801 38,400 15 1710
4 38,401 63,000 20 3630
5 63001 93600 25 6780
6 93601 130,800 30 11,460
7 Over 130,800 ***** 35 18,000
4.3.9 Provision for Loss Carry Forward
If a business incurs a loss in a year, that loss may be set off against taxable income in the next five
years, earlier losses being set off before later losses. A net operating loss may be carried forward and
deducted only for two periods of five years. However, the loss cannot be carried forward: If during a
year, the direct or indirect ownership of the share capital or the voting rights of a business changes
more than twenty-five percent, by value or by number and if the business cannot provide a books of
account showing the loss, which are acceptable by the authority.
Like any business transaction, profit tax payment must be properly accounted for.
To record business profit tax, Income Tax Expense will be debited and Income Tax payable will be
credited (if the tax is not paid yet) or cash will be credit (if recording is made at the time when the tax
is paid).
Example: Mela enterprise, unincorporated business has reported earnings before tax of birr 30,000
at the tax year ended Sene 30, 2011.
Required:
1. Determine the amount of business income tax using progression method
2. Determine the amount of tax using deduction method
3. Record necessary journal entries?
Sol.
1. Business income Tax rate Business income tax
7,200 Excepted 0
12,600 10% 1,260
10,200 15% 1,530
Total 30,000 2,790
2. Deduction method:
= 30,000* 15%-1,710
= 4,500-2,790
= 2,790
3. To record recognition of income tax expense
Income tax expense ……………………2,790
Income tax payable ………………………. 2,790
4. To record payment of tax
Income tax payable……………..2,790
Cash …………………………………2,790
The starting point in the assessment of taxable income is the net income disclosed by the income
statement. Adjustments are made to it if it is not determined as per the provisions of the law. Those
expenses which are included in the income statement but are not allowed are added back to the declared
income. Likewise, any expense, which is allowed for tax deduction, but not included in income
statement, will be included in the determination of taxable income. The taxable income so arrived is
multiplied by the tax rate to compute tax from business activities. This may be summarized as follows:-
Declared net income XXX

Audit adjustments:
Add: Expenses deducted but not allowed XX
Income not indicated XXXX
Less: Expenses not deducted but allowed XX
Income not taxable XXXX
Taxable Income XXX
Business tax = Assessed Taxable income X Rate
Example I
The following income statement is submitted by ABC metal works enterprise (in brief) on Sene 30,
1995.
ABC metal works Enterprise
Income statement
Year ended Sene 30, 1995
Sales 1157894
Cost of goods sold 1064218
Direct cost of production 27753
Gross profit 65923

Operating expenses 27002
Profit before tax 38921

On assessment, the tax office revealed the following points
1. Depreciation expense was over allocated by Birr230.
2. Capital expenditure of Birr 8580 was wrongly recorded in the income statement. Depreciation on
this asset was Birr 715, not recorded in the income statement
3. Miscellaneous expenses include Birr 768 without any source document
4. Donations for commercial business of Birr 200, penalty of Birr 80, and salary of proprietor Birr
580 were recorded in the income statement.
5. 25% of the telephone expenses (expense totaled Birr 552) were incurred for personal purposes.
Required: Compute the taxable income as per the income tax regulation, and determine the tax
liability.
Solution:
Profit tax assessment
For the year ended Sene 30, 1995
Declared income 38921
Audit adjustments:
Add: Disallowed expenses:
Depreciation expenses 230
Capital expenditure less depreciation 7865
Miscellaneous expenses 768
Donation 200
Penalty 80
Salary of proprietor 580
Telephone expenses 138
Adjusted income 48782
Income tax 14634.6
(Tax=48782 X 30% = 14634.6)
Example II
XYZ Share Company declared the following taxable income for the year ended Sene 30, 1995.
Sales 4631576.40
CGS: Beg. Inventory 1309211.40
Purchases 4194075.80
Yr end inventory (1246413.80)
4256873.40
Gross profit ------------- 374703.00
Operating expenses:
Salary& admin. Expenses 64393.54
Rent expenses 12000.00
Stationary expenses 2141.40
Depreciation Expenses 28450.00
Communication expenses 6067.80
Maintenance expenses 15317.00
INSURANCE EXPENSE 3309.08
Penalty paid under violation of law 5544.00
Interest expense 1224.44
Miscellaneous expenses 21105.40
159553.38
Net income before tax Birr 215149.62
Tax auditors, after a careful examination of the documents, revealed the following.
1. Expenditures without source documents amount to Birr 1876.5
2. Rent of Birr 6000 was paid for year 1996
3. Birr 1607 of insurance expense was paid for private purposes
4. Ending inventory was overstated by Birr 25370
5. The documents produced for the payment of subscription Birr 850 was not reliable.
6. Birr 1270 were incurred for the payment of membership fee for a sports club
7. Entertainment Birr 7750 (included in miscellaneous expenses)
8. Expenses of Birr 15350 were related to the sister concerns of the enterprise
9. Purchases of Birr 23718.5 were without reliable documents.
Required: Compute the taxable income of the company for the year 1992 and the tax liability of the
company for the year as per the Ethiopian income tax proclamation.
Solution:
Declared income before tax 215149.62
Audit adjustments:
ADD: EXPENDITURE WITHOUT SOURCE DOCUMENTS 1876.50
Prepaid rent 6000.00
Personal insurance expense 1607.00
Understated ending inventory 25370.00
Payment for subscription 850.00
Membership fee 1270.00
Entertainment expenses 7750.00
Expenses of sister concerns 15350.00
Purchases without source documents 23718.50
Penalty paid under violation of law 5544.00
Taxable Income 304485.62
Income tax =304485.62 X 30% = Birr 91,345.686
Assessment Notification
On completion of assessment, a notification regarding the assessment of income tax, in writing, is
provided to taxpayers in the following ways.
 To resident individuals: By registered post or in person. (In case the taxpayer is absent, to any
adult member of the family). In the absence of any person to receive the notice, it will be affixed
to the door of residence or place of business.
 To bodies: by a registered letter to the body, or to any director or employee.
 To non-residents: by a registered letter to the agent or by affixing the notice on the residence
or place of business.
Example2: The following information is obtained from Densa private limited company.
 The book value of a pool of computer in the opening balance sheet of the tax period as of
Hamle 1, 2006 was birr 150,000. During the year 2006:
 Densa bought data storage equipment for birr 75,000, software products for birr 50,000.
 The existing computer was upgraded and renewed for birr 12,000.
 Densa has also received birr 15,000 as compensation from Haron computer, supplier, since
some of storage equipment’s are not functioning.
 Densa also sold two old computers and received birr 8,500
Required:
1. Determine depreciation base of computer?
2. Determine depreciation expense of computer
3. Record necessary journal entries
Sol.
Beg B.V……………………………………………….150, 000
Add: storage equipment …..75,000
Software product…… 50,000
Upgrading……………… 12,000 --------------- 137,000
Subtotal --------------------------------------------287,000
Less: Compensation………………..15,000
Cash proceed from selling…..8,500------------- 23,500
Depreciation base for tax ……………………………. 263,500
Depreciation expense = .25x 263,500 = 65,875
Journal entries:
Dep exp ………………………..65,875
Accu. Dep ………………………………….65, 875
4.4 SCHEDULE ‘D’ INCOME: OTHER INCOMES
This is the last and residuary Schedule of income. Any income which is taxable under them Income
Tax Proclamation but does not find place under any of the remaining three Schedules of income (i.e.,
Schedules A, B and C) will be taxable under this residuary Schedule “D” Other Incomes.
Incomes chargeable under this Schedule of income:
The following incomes shall be chargeable to income tax under the Schedule-D:
4.4.1 Royalties (Article- 54):
The term “royalty” means 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 films and films
or tapes for radio or television broadcasting, any patent, trade work, 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. It is taxable
as follows:
Rate of tax:
Royalties shall be liable to tax at a flat rate of flat rate of 5%
1. The amount of tax shall be withheld and paid to the Tax Authority by the payer. That is the
withholding Agent who effects payment shall withhold the foregoing tax and account to the Tax
Authority within the time limit set out in this Proclamation.
2. Where the payer resides abroad and the recipient is a resident, the recipient shall pay tax on the
royalty income within the time limit set out in this Proclamation
3. This tax is a final tax in lieu of a net income tax
Example
The authors of the book ‘Book Keeping: A Practical View’ gave the copy right of the book to XYZ
Publishers, Ethiopia, for a royalty of Birr 75000. How much tax will XYZ Publishers withhold in this
transaction?
Solution:
Tax withheld= 75000X 5%= Birr 3750
4.4.2 Income from Rendering of Technical Services (Article- 52):
The term “technical service” means any kind of expert advice or technological service rendered.
All payments made in consideration of any kind of technical services rendered outside Ethiopia to
resident persons in any form shall be liable to tax under this Article.
Rate of tax:
It is Taxable at a flat rate of 10%
The amount of tax shall be withheld and paid to the Tax Authority by the payer.
4.4.3 Income from Games of Chance (Article- 57):
Every person deriving income from winning at games of chance (for example, lotteries, tom bolas, and
other similar activities) shall be subject to tax.
Rate of tax:
It is Taxable at the rate of 15% except for winnings of less than 1000 Birr.in computing taxable income
of taxable income under Income from Games of Chance there no deduction shall be allowed for any
loss incurred by a person from game and chance.
Example
Ato Bereket won Birr 45000 from Ethiopian National Lottery in Sene 1994. What is the amount of tax
withheld by the lottery authority?
How much did AtoBereket receive?
Solution:
Tax withheld=45000*0.15=6750
4.4.4 Dividends (Article- 55):

Every person deriving income from dividends from a share company or withdrawals of profits from a
private limited company shall be subject to tax under Article 34.
Rate of tax:
It is Taxable at the rate of 10%
1) The withholding Agent shall withhold or collect the tax and account to the Tax Authority.
2) This tax is a final tax in lieu of income tax.
Example
Ato Emmanuel, the stockholder of a share company holds 1000 shares of Birr 100 each. At the end of
a fiscal year the company declared and paid dividend of Birr 50 per share. The tax payable by the
stockholder on the dividend income is calculated as follows
Gross income from dividend = 1000 X 50 = Birr 50000
Income tax on dividend = 50000 X 10% = Birr 5000
4.4.5 Income from Rental of Property (Article- 58):
Every person deriving income from the casual rental of property (including any land, building, or
moveable asset) not related to a business activity taxable under Article 17 shall pay tax on the annual
gross income.
Rate of tax:
4.4.6 Interest Income on Deposits (Article- 56):
As per Article 56, every person deriving income from interest on deposits shall pay tax.
Rate of tax:
1) The payer shall withhold the tax and account to the Tax Authority in the manner provided in Article
67.
2) This tax is a final tax in lieu of income tax.
Example
Ato Dawit has a deposit with Commercial Bank of Ethiopia on which he is eligible to get interest of
Birr 16000 in a year. How much of this is withheld by CBE?
Solution:
Tax withheld= 16000X 5%= Birr 800
4.4.7 Gain on Transfer of Certain Investment Property (Article- 59):
Income Tax shall be payable on gains obtained from the transfer (sale or gift) of property described in
this Article at the following rates:
Rate of tax:
a) Building held for business, factory, and office 15% (fifteen percent)
b) Shares of companies 30% (thirty
Percent)
1) Gains obtained from the transfer of building held for residence shall be exempt.
2) The basis for computation of gains obtained from the transfer of properties described in this Article
shall be determined by Regulations to be issued by the Council of Ministers.
3) Any exchange of shares in a resident company which is a party to a reorganization– in exchange for
share in another resident company which is also a party is not a disposal of the shares.
4) The value of the shares given in exchange shall be equal to the value of the original shares.
5) Loss on the transfer of such property shall be recognized and be available to offset gain subject to
the following limitations:
(a) Loss on transfers under this Article may be used to offset gain on transfers under this Article, but
may not be used to offset any other income or gain. Unused losses may be carried forward indefinitely.
(b) No loss shall be recognized on transfer to associates within the meaning of Article 2(4).
6) Any person authorized by law to accept, register or in any way approve the transfer of capital assets
shall not accept, register or approve the transfer before ascertaining that the payment of the tax has
been duly effected in accordance with this Article.
(i) What is Capital?
When asked what a capital is, most people would think of money, that is, the amount invested in a new
business or the money used in buying shares or bonds. However, as some writers assert, “… for the
purpose of understanding capital gains tax, it is wrong to think of capital as just financial assets. Capital
is also physical investment – the plant, the factory… the fax machines, and the other non-labor factors
of production that make a business operate efficiently.” A fruit shop (like ET Fruit, for example) would
not be able to exist without capital – the truck and the crates of fruits are the essential capitals that
make the business operate. Other than money and physical investments, the concept of capital can also
include technological innovations and even the glimmer of an idea that leads to the creation of a new
business or product.
(ii) What are Capital Assets?
It has been asserted that almost everything one owns and uses for personal purposes or investment can
be considered as a capital asset. This is somewhat a broad definition that could include one’s home,
household furniture, jewelry, or even car. Note however that capital assets do not include supplies (i.e.,
paper and pens) or inventory (anything one regularly sells to customers during the ordinary course of
business). For capital gains tax purposes, the “scope” of capital assets becomes narrower. However,
there exists no “common list” as to what should be included under capital assets. What will be
considered as capital asset for tax purposes varies across the world. For example, in the USA, a home,
a farm or ranch and a work of art are considered capital assets. Other countries, including Ethiopia, do
not have such wide tax base. But in most, if not all countries, (including Colombia, Mexico, and
Nigeria) shares and bonds are commonly treated as capital assets. A few countries, however, only
make a half-hearted attempt to tax the capital gains arising from real estate transactions. Within
Ethiopian context, the term ‘capital assets’ refers only to (a) shares of companies and (b) urban houses
or buildings held for business, factory and office.
(1) Shares
The shares referred to in the proclamation would include those shares issued by share companies. For
bonds, Ethiopia at present issues only short-term bonds in the form of treasury bills.The use of these
instruments is still in its infancy, owing principally to an economy that is still in the midst of
transforming itself from a centrally-planned to a market-oriented economy and by extension, to a
relatively undeveloped market.
(2) Urban Houses/Buildings

Proclamation No. 47/1975 defines an urban house as “any house, whether fully constructed or under
construction intended for dwelling or business or other purposes.” According to the current
proclamation, the buildings situated within the urban range, if used for business purposes and are sold,
the gain earned by the seller is subject to tax. It is to be noted that if the sale is of a residential house,
the gain earned thereon is not taxable. The law also states that to be a residential house, the house must
have been used at least for two years for residential purposes before its sale.
(iii) What are Capital Gains?

A capital gain is the rise or increase of the price of an asset over the period in which the asset is held.
Such increase in value however is taxable only if it is realized; that is, the capital asset is sold. To
illustrate the concepts of realized and unrealized gains: “… A realized capital gain is money in your
pocket. If you bought shares at Birr 10 and sold at Birr 20, you realized a capital gain of Birr 10 per
share. An unrealized gain is a gain that you have on paper, in other words, you bought a stock at Birr
10, still hold the shares, and at some date it’s trading at Birr 20. You have an unrealized capital gain
as of that date of Birr10 per share, and because it’s unrealized, there are no tax implications.” Generally
speaking therefore, for tax purposes, a capital gain is the income derived from the sale of a capital
asset.
The capital gain from a sale is measured by the difference between the amount realized on the sale and
the basis of the asset sold. Roughly, the amount realized is the amount received on the sale (i.e., the
sales price) and the basis is the cost (i.e., the purchase price) of the asset, though it can be adjusted for
various reasons. More specifically, in our context, the cost price of the building is the cost registered
with the appropriate government body at the time of its construction. Thus, there is a capital
gain if the sales price is greater than the basis or cost. A capital loss occurs if the sales price is less
than the basis or cost. A capital gain arises from the “increase in value upon the sale of shares
and bonds and urban houses by persons or organizations.”
Due to various factors such as a limited bonds market, lack of appropriate regulating agencies, and a
still undeveloped share market, capital gains tax are computed solely for urban houses. The discussion
that follows will therefore focus only on gains arising from the sale of urban houses. Computation of
the capital gains tax shall be based on the “value of the capital asset”, and such value defined as “the
price for which the capital asset is sold,” adjusted for:
 Inflation in respect of building, and
 Taxes paid for the land and building.
These two adjustments or allowable deductions are permitted to determine the taxable income. As
mentioned in the preceding section, current practice in Ethiopia only covers computation of capital
gains for urban houses. Such computation is also more straightforward than what is stated in the
previous capital gains proclamation. For instance, indexing for inflation is a seldom occurrence and
adjustment for tax paid is practically non-existent. Thus, any gain arising from the sale of urban house
is computed by this basic formula:
Gain = Sales value of urban house - Cost of urban house
(iv) Capital Gain Tax Rates
The law provides for taxing gain from the transfer of investment properties such as building and factory
office at 15% and share of companies at 30%. Gains from sale of residential houses are exempted
from payment of tax. Building used for residential purposes shall be exempt from capital gains only if
each building is fully used for dwelling for two years prior to the date of sale. That means only if the
gain is arrived at from buildings used for business and that are located within the urban limit, it is
taxable under the provisions of the current tax proclamation. Likewise, the transfer of shares between
two companies, which are parties to reorganization, shall not be considered a disposal as per the
provisions of law.
If a loss is incurred on transfer of shares, it can be used to set off any gain on transfer of shares, it
should be noted that losses from shares couldn’t be set off any other gains earned from other activities.
The law also provides that the concerned authorities can affect the registration and approval of the
transfer of capital assets only after having confirmation about the payment of tax from the tax authority.
Non- compliance of any of the provisions of schedule ‘D’ tax will result in penalty. Penalties under
this case are similar to those of schedule ‘A’, schedule ‘B’, and schedule ‘C’ taxes.
Example I
Ato Ahmed acquired 10 shares of Trans Ethio Share Company for Birr 25000 each and sold them at
Birr 32000 each. How much does he pay as capital gains tax?
Solution
Selling price = 32000 X 10 = Birr 320000
Purchase price = 25000 X10= Birr 250000
Gain = 320000 – 250000 = 70000
Capital Gains tax = 70000 X 30% = Birr 21000
Example II
Alpha Traders sold one of its office buildings for Birr 456000, which they acquired for Birr 316000.
Compute the capital gains tax that the taxpayer pays on this transaction.
Solution
Capital Gain = 456000 – 316000 = Birr140000
Capital Gains Tax = 140000 X 15% = Birr21000

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Public Finance and Taxation Chapter Four August, 2019

CHAPTER FOUR: ETHIOPIAN TAX ACCOUNTING

4. DIRECT TAXES IN ETHIOPIA (INCOME TAXES: PROCLMATION 797/2008)

 Schedule A: Employment Income tax

4.1.1 Determination of Employment Income

 Computation of income tax on income from rental of building

4.3 INCOME FROM BUSINESS (SCHEDULE “C”)

4.3.1 Taxable Business Income

4.3.2 Category of Taxpayers

4.3.3 Tax payment Period

4.3.4 Allowable Deductions

4.3.5 Non-allowable Deductions

4.3.7 Assessment of Tax

4.3.9 Provision for Loss Carry Forward

Declared net income XXX

Gross profit 65923

Profit before tax 38921

4.4.4 Dividends (Article- 55):

(2) Urban Houses/Buildings

(iii) What are Capital Gains?

Gain = Sales value of urban house - Cost of urban house

(iv) Capital Gain Tax Rates

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