Tax Accounting

Chapter One: Introduction to Taxation and Tax Accounting

Chapter One Introduction to Taxation and Tax Accounting
Chapter Outline:
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. What is taxation? Definition of tax and duty Tax accounting Interdisciplinary Nature of Taxation Objectives of taxation History of taxation Basic Elements of Tax Systems Tax Related Terms Basic characteristics of tax Types of Tax Rates Taxation Systems (Tax Rate Structures) Principles of taxation Canons of taxation Effects of Taxation Classification of taxes

Chapter Objectives:
After completing this chapter, you would be able to:
         Define taxation, tax, duty, and tax accounting Understand why government levies taxes on citizens Discuss the evolution and history of taxation in the world and in Ethiopia Define different tax related terms Comprehend basic characteristics of taxes Identify and Calculate Different Types of Tax Rates Grasp the basic principles and canons of taxation See the effect of taxation on Economy Classify taxes on the basis of different dimensions

Time Required: 4 Hours

1.1) Taxation
Taxation is one of the systems that government uses to collect public revenues from various sources. However, taxation is the most important system of collecting public revenue in modern economic system. Taxation is the most powerful instrument in the hands of the government for transferring purchasing power from individuals to government. The money collected through taxation – tax revenue – is used to finance government operations. That is, the money required by the government to undertake different functions –taxes– is collected from the citizens. Without taxes to fund its activities, government could not exist. Thus, a government uses taxation as a system of raising the lion share of its revenue. Government uses the money collected through taxation:  To pay soldiers and police;  To build dams and roads;  To operate schools and hospitals;  To provide food to the poor and needy;  To provide medical care to the elderly people; and  To finance other hundreds of operations
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Tax Accounting (ACCT-332)

Taxation is used as a system of raising the lion share of public revenue in modern economic system to fulfill the requirement of the goods and services. Taxation depends on concepts from law, accounting, economics, public financial management, politics, behavioral sciences, etc. Thus, taxation can be considered as a part of special fields of study such as law (specifically tax law), accounting (specifically tax accounting), public financial management, economics, politics, etc. The scope of taxation includes tax policies, tax theories, tax decisions, and tax administration

1.2) Tax and Duty
Tax is defined as an amount of money levied by a government on its citizens and used to run the country. A tax is an involuntary fee or more precisely "unrequited payment" made by individuals or businesses to a government without quid pro quo. Human beings need four types of goods and services:  Private goods – consumed individually, for payment  Toll goods – consumed jointly, for payment  Common pull goods – consumed individually, for free  Collective goods – consumed jointly, for “free” Tax is an indirect payment for collective goods and services Duties are also taxes. Duties are distinguished from taxes by their strictly economic characteristic. For example, any government imposes a compulsory levy on the goods imported from a foreign country. This compulsory levy is called Custom Duty. Custom duty is compulsory a levy on individuals and companies importing goods to the country and its purpose is to protect the domestic market and economy. When goods are imported from abroad while the same goods can be produced within the country, it affects the domestic market and economy in number of ways as follows:  It reduces demand for domestic products  It discourage production within the county  It discourages Foreign Direct Investment in the country  It results in negative balance of payment (BOP)  It increases the unemployment rate

1.3) Tax Accounting
Tax accounting is one of the specialized fields of accounting that encompasses activities such as:  recording of tax related transactions;  continuous follow-up of tax laws affecting a taxpayer i.e. individual or organizations;  analyzing the consequences of tax on alternative business transactions/courses of actions  determination of taxes and tax liabilities;  preparation of tax returns or tax reports; and  providing tax related information to assist decision makers Tax returns are government declaration forms filled and then filed with the Federal, State, or Local tax authorities. Tax returns are forms filed with the tax authority containing information used to calculate tax base and taxes (e.g. taxable income and the related income tax). Examples of tax returns (tax declarations), in Ethiopia, are:  Business Income Tax Declarations  VAT Declaration
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter One: Introduction to Taxation and Tax Accounting

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Employment Income Tax Declarations Turnover Tax Declaration Excise Tax Declaration Withholding Tax Declaration Other Income Tax Declarations

Tax accountant is an individual who assists a taxpayer in preparation of tax returns and who undertakes tax planning and other related activities.

1.4) Interdisciplinary Nature Taxation
A. Taxation and Economics Economics used taxation as one of the tools of fiscal policy and other economic measures B. Taxation and Public Financial Management Taxation is used as one of the systems of raising public revenue and it is one of the items that public financial management is concerned with. C. Taxation and Law Law provides rules and regulations that are used to guide taxation system so that the taxation system can be streamlined. D. Taxation and Politics Political decisions on tax related issues directly or indirectly affect the environment of taxation. E. Taxation and Accounting Accounting is concerned with regulation, control, and reporting of taxes from both sides: taxpayers and tax office F. Taxation and Behavioral Sciences Taxation is one of the things that highly affect human behavior. When a government increases or decreases taxes, taxpayers may react negatively or positively which could be subject of discussion in sociology and psychology

1.5) Objectives of Taxation
The objectives of taxation are: 1. To Raise public revenue 2. To Remove inequalities income and wealth 3. To Ensure economic stability 4. To Reduce regional imbalances 5. To Create employment opportunities 6. To Prevent harmful consumption 7. To Divert resources beneficially 8. To Encourage exports 9. To Enhance standard of Living

1.6) History of Taxation
History of taxation is concerned with these four questions:  Who paid tax?  What was taxed?  Who collected taxes?  In what form taxes were paid?
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Tax Accounting (ACCT-332)

1) History of Taxation in the World
A. Ancient Period (up to 5th Century AD)
 Palestine, Egypt, Assyria, and Babylonia

 Individual property rights did not exist  The king was sole owner of everything in his domain  Confiscated property and tribute payment from conquered peoples (additional source of finance)  Ancient Athens (Greece)  Relied on publicly owned silver mines  Tribute from conquered countries  Few custom duties, and  Voluntary contributions from citizens.  Poll tax - on slaves and aliens  Eisphora - a tax imposed during war times  Metoikion – a poll tax on foreigners (people who did not have both an Athenian Mother and Father)  Ancient Roman Republic  Poll Tax – on all roman citizens  Roman military victories brought large amount of Foreign Tribute  5% Inheritance Taxes – by Emperor (Caesar) Augustus  Wheat and Salt tax  1 % sales tax for most goods and 4% sales tax for slaves – by Emperor Julius and the sales tax on slaves was increased to 5% by Emperor Augustus  Portoria – The earliest custom duty in Rome on imports and exports

B. Medieval Period (5th to 15th Century AD)
 Europeans were subject to many forms of taxation:

 Land taxes  Poll taxes  Inheritance taxes,  Tolls (payments for the use of bridges, roads, or seaports), and  Miscellaneous fees and fines.  Many people paid taxes in the form of money or crops. Taxes were paid directly to the local lords. An important development toward the end of the feudalism was taxes on Property Under the system of feudalism in Western Europe (11th Century):  Kings, nobles, and church rulers all collected taxes.  Kings derived income from their lands, from import and export duties, and from the various feudal dues and services owed by their vassals.  Scutages - payments made in lieu of military service under King Edward of England  Feudal nobility refused to pay scutages  In 1215, Feudal nobility forced the king to sign the Magna Carta -the king agreed to collect scutages only with the “common consent”  The Roman Catholic Church was a major tax collector during the middle ages – Tithe. The church also collected various fees, fines, and tolls.
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter One: Introduction to Taxation and Tax Accounting

C. Modern Period (16th Century AD to Date)
 Strong centralized states emerged in Europe  During the 16th and 17th centuries, these states relied heavily on revenues generated by the king’s own estates and by taxes on land.  In England, the power of Parliament grew steadily - in 1689 the English Bill of Rights guaranteed that the king could not tax without Parliament’s consent.  In 18th century, England started imposing various taxes on transactions. Taxes on imported goods (tariffs) assumed great importance. It also stated imposing income taxes.  In 1799 Britain enacted the first national income tax - to finance the Napoleonic Wars. The war was ended up in 1815. The tax was discontinued after the war and revived in 1842.  In the late 19th Century AD and early 20th Century AD, concerns about both fairness and the ability of tax systems to generate sufficient revenue led governments to enact income taxes.  In 1853 - the first progressive income tax was used by Prussia. Other countries introduced progressive income taxation subsequently:  Great Britain in 1907,  United States in 1913, and  France in 1917

2) History of Taxation in Ethiopia
A. Ancient Ethiopia
 History of taxation in Ethiopia comes with the establishment of the government.  The Aksum Kingdom minted coins in 500 AD which facilitated internal trades, external trades, and collection of taxes, which tells us that taxation was used starting from the Aksum Kingdom in Ethiopia

B. Medieval Ethiopia
 During medieval period, in Ethiopia, taxation greatly varied from region to region and was often arbitrary  There had been different obligations that were considered to be taxes including compulsory labor and compulsory hospitality  This was evident during 15th century AD at the time of Emperor Zarayakobe  Form 15th to 19th century AD taxation was carried out in haphazard manner  It was also dependent on the will of the chief or the tax collector  During Emperor Tewdros, as per Walter Plowden who was friend and consultant of the emperor, “The taxes are numerous but varied according to the traditional customs of each village." C. Modern Ethiopia  Emperor Menilik II carried out first important reform in taxation - a fixed tenth (tithe) was established rather than the undefined and arbitrary systems of agricultural taxes.  The second major reform was the steady monetarization (monetization) of agriculture and other taxes.  Emperor Haileselassie I continued the tax reforms started by Emperor Menilik II  Modern tax collection procedure, tax schedules and the development of trained responsible bodies and regularly paid civil service came into existence.  In 1943 (1935 E.C.) - a government body was established to collect taxes
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Tax Accounting (ACCT-332)

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In 1944 - Proclamation No 60/1944 (1936 E.C ) was enacted and issued to be used as a tax code in collecting tax from all individuals and their jobs In 1949 - Proclamation No 107/1949 (1941 E.C) amended Proclamation No 60/1944. This second proclamation excluded agricultural income from taxes and made a tax holiday of 5 years for persons or businesses with a capital balance of less than Br 200,000. In 1954, Proclamation No 19/1954 (1946 E.C) was enacted and amended Proclamation No 107/1949. In 1961 - Proclamation No 173/1961 (1953 E.C) repealed Proclamation No 19/1954 Since then, there were few amendments to improve the tax proclamations and involved in changing tax rates from 35% up to 89% In the post-revolution period (1974 – 91) - significant major changes were made on the tax rate and structure of all types of taxes In 2002 - Proclamation No 173/1961 was repealed by Proclamation No 286/2002 (1994 E.C) after it served nearly 40 years. Proclamation No 286/2002 is currently in use in Ethiopia regarding income taxes

3) Taxation and Some Holy Books
A. The Bible and Taxation  There are many evidences of taxation in the holy book bible. Different types of taxes were collected by the then governments in the holy book bible.  These include Income Tax (Genesis 47:26), Property Tax (II Kings 23:35), Special Assessment Tax (II Chronicles 24:5), Poll Tax (Exodus 30:12) and Indirect taxes (Ezra 4:20) B. The Koran and Taxation  In Koran, there are different contributions which are considered to be taxes. For examples, Khums, Jizya and Zakat are common contributions which can be considered taxes.  Khums is one fifth of any item which a Muslim acquires as wealth, income and property and which must be paid as an Islamic tax.

1.7) Basic Elements of a Tax System
The five pillars or basic elements of tax system are taxpayer, tax base, tax rates, tax period, and tax administration. 1. Taxpayer refers to any individual or organization that is obligated to pay tax 2. Tax Base is the value of everything which is subject to taxation 3. Tax Rate is the amount of taxes expresses as a percentage of the tax base 4. Tax Period is the period for tax assessment. It can be a year (tax year), month, week, etc 5. Tax Administration refers to any government office mainly with a responsibility of tax collection and other related activities

1.8) Tax Related Terms
1. 2. 3. 4. 5. Delinquent Tax refers to taxes remaining unpaid on and after the date of penalty Fiscal Year refers to the twelve month period used by the government Gross Income is the total income of individual or business Tax Abatement refers to a complete or partial cancellation of imposed taxes Tax Assessment is the determination of the amount subjected to tax 6

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

Chapter One: Introduction to Taxation and Tax Accounting

6. Tax Avoidance refers to the practice of paying as little tax as possible 7. Tax Bracket is a range of income subject to tax at the same tax rate. It is the band of taxation in which a taxpayer is in. 8. Tax Cut is the act of reducing taxes for certain reason 9. Tax Credit is an investment activity which directly minimizes the tax to be paid 10. Tax Deed is a written instrument by which title to property sold for taxes is transferred unconditionally to the purchaser 11. Tax Deduction is the amounts legally permitted to be subtracted from gross income 12. Tax Evasion is an illegal activity in which a taxpayers seek to hide taxable income by overstating expenses or understating revenues 13. Tax Exemption is a legal provision that permits to deduct specified amount from gross income as a tax free income. The term tax exempt income can be used interchangeably with tax free income. 14. Tax Exile refers to somebody who leaves a country in order to avoid paying taxes 15. Tax Favored Investment refers to an investment whose profits are taxed lower tax rate 16. Tax Function is a function of tax accountant 17. Taxable Income refers to the amount of an Individual or business income which is subject to taxation 18. Tax Heaven means a country with favorable tax rates 19. Tax Holiday is period of no taxation 20. Tax Liability is the legal obligation of a taxpayer to the government 21. Tax Liens is claim for unpaid taxes 22. Tax Levy is the total amount of taxes imposed on an individual or corporation 23. Tax Method is a method of recording trading of plant assets for tax purposes with no gain or loss 24. Tax Penalties are fines or punishments imposed on a taxpayer 25. Tax Refund an amount that a government gives back to a taxpayer 26. Tax Relief is tax savings in the form of special allowable deduction. E.g. Capital Gain loss, Business Loss 27. Tax Return is a government tax collection form 28. Tax Schedule is the official list of tax rates matched with different level of incomes 29. Tax Shelter is an investment activity that protects some of a taxpayer's income form taxes. E.g. Investment in Treasury Bills 30. Tax Subsidy refers to a government subsidy to a particular company in the form of reduced tax

1.9) Basic Characteristics of Tax
Tax has the following basic characteristics: 1. Tax is a compulsory payment 2. Benefits are not the basic condition in tax payment 3. It is a personal obligation 4. It is used for Common interest 5. It is a Legal collection 6. Element of Sacrifice is seen in tax 7. It is a periodic and regular payment 8. It has Wide Scope 9. No discrimination exists in tax payment

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Tax Accounting (ACCT-332)

1.10) Types of Tax Rates There are four different types of tax rates: statutory tax rate, marginal tax rate, average tax rate, and effective tax rate, which are discussed as follows:
 Statutory Tax Rates (STRs): all the tax rates applicable to a particular type of tax. They are

legally imposed tax rates on a taxpayer. Statutory tax rates are those percentages appearing in the tax law.  Marginal Tax Rate (MTR): is the tax rate that applies to the taxpayer’s last birr of taxable Income. It is the ratio of change in tax to taxable income  Average Tax Rate (ATR): is the ratio of the amount of taxes paid to taxable income  Effective Tax Rate (ETR): is the ratio of the amount of taxes paid to the total income Example 2.1: assume that income is taxed on a Schedule “Exempt from Br 0 up to 150, 10% over Br 150 to 650, 15% over Br 650 to 1400, 20% over Br 1400 to 2350, 25% over Br 2350 to 3550, 30% over Br 3550 to 5000 and 35% over Br 5000”. Instruction: Determine the Marginal Tax Rate, Statutory Average Tax Rate and Effective Average Tax Rate for a taxpayer with a basic salary of Br 5300 and with no special allowances.

1.11) Tax Rate Structures (Tax Systems)
Tax rate structure expresses the relationship between the tax rate and tax base in a country. Currently nations are using four different types of tax systems: progressive tax system, proportional tax system, regressive tax system, and degressive tax system.

1. Progressive Tax System
Tax Rate
35% 30% 25% 20% 15% 10% Tax Base in Birr 150 650 1400 2350 3550 5000

Tax Rate Structure

2. Proportional Tax System

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter One: Introduction to Taxation and Tax Accounting
Tax Rate

10%

Tax Rate Structure

1500

6500

14000

23500

35500

50000

Tax Base in Birr

3. Regressive Tax System
Tax Rate

20%

15%

10%

5%

Tax Rate Structure

4000

6000

12000

15000

Tax Base in Birr

4. Degressive Tax System
Tax Rate

25%

15% 10% Tax Rate Structure

500

1000

3000

5000

7000

Tax Base in Birr

5. Government Tax Revenue and Taxation System

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Tax Accounting (ACCT-332) Tax Rate Progressive Taxation System Proportional Taxation System Degressive Taxation System

Regressive Taxation System

Tax Base in Birr

1.12) Principles of Taxation
1. Principle of Economic Neutrality The taxation system of a country must be economic neutral. Taxation should not have unneutral effects. Taxation must not create economic distortion. Taxation may the following unneutral effects: A. Affecting the Consumer Choice B. Affecting the supply of Factors of Production 2. Principle of Equity The tax burden should be fair and equal. There are two approaches how a government could be fair. The government may use one of the following to be fair: A. Benefit Received Approach B. Ability - to - Pay Approach  Horizontal Equity – means persons in like circumstances should be treated equally.  Vertical Equity – means persons in unlike circumstances should get relative treatment 3. Principle of Efficiency According to this principle, a Taxation System a country should be economically and administratively efficient. A. Economic Efficiency - taxation system of a country should be economical B. Administrative Efficiency – taxation system of a country should have sufficient number and competent staffs.

1.13) Canons of Taxations
1. Canon of Equality - every person ought to contribute toward the support of the Government, as nearly as possible, in proportion to their abilities 2. Canon of Certainty – tax which each individual is required to pay should be certain and not arbitrary. 3. Canon of Convenience – mode and timings of tax payment should be, so far as possible, convenient to the taxpayer. 4. Canon of Economy - recommends that cost of collection of taxes should be the minimum possible.
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter One: Introduction to Taxation and Tax Accounting

5. Canon of Productivity (Canon of Adequacy) - the tax system should be productive enough. It should enable to collect sufficient tax revenue. 6. Canon of Elasticity (Canon of Flexibility) - this canon implies that taxes should be increased or decreased according to the needs of the government. 7. Canon of Diversity-the tax system should be diverse in nature. 8. Canon of Simplicity-a tax system should be easily understood by the Taxpayer 9. Canon of Expediency-taxes should be levied after considering all favorable and unfavorable factors from different angles such as economical, political and social. 10. Canon of Buoyancy–the tax revenue should have an inherent tendency to increase along with an increase in national income even if the rates and coverage of taxes are not revised. 11. Canon of Co-ordination: according to this canon, there should be a proper co-ordination between various authorities (Federal, State and Local Tax Collecting Agencies) while imposing taxes so as to avoid double and triple taxation.

1.14) Classification of Taxes
1. Classification Based on the Tax Bases A. Income Taxes: are taxes levied on income of persons or businesses B. Property Taxes: are levied on a property of Persons or businesses C. Commodity Taxes: are taxes levied on commodities and services 2. Classification Based on ultimate burden of taxes (Based on Tax Impact, Tax Shifting and Tax Incidence)  Tax Impact refers to the person who bears the money burden of tax in the first instance  Tax Incidence refers to the person who ultimately bears the money burden of a tax  Tax Shifting refers to the process by which the money burden of a tax is transferred from one person to another person. Based on ultimate burden, taxes are classified into two: Direct Taxes and Indirect Taxes described as follows: A. Direct Taxes: are taxes the impact and incidence of which fall on the same person. Direct taxes are taxes which can not be shifted on to the others. E.g. Employment income tax B. Indirect Taxes: these are taxes the impact and incidence of which fall on different persons. The impact fall on one person and the incidence fall on another person. E.g. VAT 3. Classification Based on Tax Determinant A. Ad-valorem Taxes: taxes are determined based on the value of the item to be taxed. B. Specific Tax: are the taxes levied at a fixed amount, irrespective of the value of the goods and services 4. Classification Based on Number of Taxes A. Single Tax: using only one tax in the country. It is a tax on one thing B. Multiple Taxes: using many kinds of taxes in the country. The government of modern state uses diversified taxes to use advantage of it 5. Classification based on Taxing Authority Taxes are classified into three based on taxing authority or taxing hierarchy: Federal Taxes, State Taxes and Local Taxes A. Federal Taxes: are taxes collected by Federal government tax agency B. State Taxes: are taxes collected by Regional State governments C. Local Taxes: are taxes collected by local tax authorities

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Tax Accounting (ACCT-332)

1.15) Effects of Taxation
Taxation might have different effects in an economy. Taxation has a positive or adverse effect on production, distribution of income, and economic stabilization 1. Effects of Taxation on Production Taxation may affect either adversely or positively production in an economy. Increasing or decreasing the tax rate affects the ability to work, save and invest and will to work, save and invest. Thus, it affects production 2. Effects of Taxation on Distribution of Income Taxation is used in most countries to distribute fairly the income generated in a country. 3. Effects of Taxation on Stabilization of Economy During abnormal prices rises (inflation), taxation can be used as a tool to stabilize the economy. Inflation is results of either demand pull or cost push. In demand pull inflation, the government should increase the tax so as to reduce the capacity of the people to purchase. In cost push inflation, the government uses taxation to minimize and control cost of production so as to reduce the price of goods and services

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter Two: Employment Income Tax Accounting

Chapter Two Employment Income Tax Accounting
Chapter Outlines:
      Components of Employment Income Employment Income Tax Rates Employment Income Tax Exemptions Computation of Taxable Employment Income Computation of Employment Income Tax Employment Income Tax Declaration

Chapter Objectives
After completing this chapter, you would be able to:
        Differentiate benefits that are included in employment income Understand the basic legal provisions (tax laws) applicable on employment income in Ethiopia Calculate taxable employment income Determine employment income tax as per the tax law of the country Determine employment income tax on severance pay, bonus and other employment benefits Account for employment income tax related transactions Complete Employment Income Tax Declaration (FIRA Form 1103) Complete Personal Income Tax Declaration (FIRA Form 1105)

Time Required: 4 Hours

2.1) What is Employment Income? (Components of Employment Income)
As per Article 12 of Income Tax Proclamation No. 286/2002, employment income shall include any payments or gains in cash or in kind received from employment by an individual from all the employers. These include: 1. Basic salary or wages 2. Overtime (OT) Income a. For OT jobs between 6:00 AM to 10:00 PM, OHR=RHR @ 1.25 b. For OT jobs between 10:00 PM to 6:00 AM, OHR=RHR @ 1.5 c. For OT jobs on weekly rest day, OHR=RHR @ 2.0 d. For OT jobs on public holiday, OHR=RHR @ 2.5 3. Allowances a. Acting allowance b. Board allowance c. Cash indemnity allowance (cash fault allowance) d. City compensation allowance e. Educational allowance f. Hardship allowance (desert allowance) g. Cell phone allowance (mobile allowance) h. Disturbance allowance i. House rent allowance (house subsidy) j. Meal allowance (lunch allowance) k. Medical allowance l. Per-diem allowance (daily allowance) m. Position allowance n. Computer allowance
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Tax Accounting (ACCT-332)

Representation allowance Transportation allowance (fuel allowance) Entertainment allowance (guest accommodation expenses) Stress allowance: a special payment made to employees whose job is stressful. E.g. air traffic controllers s. License allowance: a special payment made to licensed employees. E.g. air traffic controllers 4. Bonus: payment made to employees of businesses as acknowledgment of employees’ hard work and effort in generating beyond expected amount of profit. 5. Employment Termination Payment a. Severance Pay- the severance pay shall be thirty times his or her daily wages of the last week of service for the first year of service; for the service less than one year, severance pay shall be calculated in proportion to the period of service. If the worker has served for more than one year, payment shall be increased by one-third of the previous sum for every additional year of service, within the limit of a total amount of twelve months salary b. Job Search Payment c. Compensation Payment d. Annual Leave Payment e. Job Termination Bonus

o. p. q. r.

2.2) Basic Legal Provisions of EIT The legal provisions are taken form Income Tax Proclamation No. 286/2002 and Income Tax Regulation No. 78/2002. Employment Income Tax Rates
Article 11 of Income Tax Proclamation No. 286/2002 provides that the following tax rate schedule shall be applied on employment income

Schedule “A”
Employment Income per Month TB Over Birr To Birr st 1 0 150 2nd 150 650 rd 3 650 1,400 th 4 1,400 2,350 5th 2,350 3,550 th 6 3,550 5,000 7th 5,000 xxxxx Tax Liability Tax Rate Exempt (0%) 10% 15% 20% 25% 30% 35%

Employment Income Tax Exemptions
Art 13 of Proclamation No 286/2002 exempts the following employment income from taxation: a. Income from employment received by casual employees b. Pension contribution, provident fund contributions and all forms of retirement benefits – not more 15% of basic salary c. Income from employment received by diplomatic and consular representatives; and other persons employed in any Embassy d. Income specifically exempted from income tax by any law in Ethiopia
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Chapter Two: Employment Income Tax Accounting

e. Payments made to a person as compensation or gratitude in relation to personal injuries; or the death of another person. Art 3 of Regulation 78/2002 exempts the following allowances from taxation: a. Medical Allowance b. Transportation Allowance c. Hardship Allowance d. Per-diem Allowance (Daily Allowance) e. Traveling Expenses f. Board Allowances of public enterprises’ board members g. Income of persons employed for domestic duties

2.3) Computation of Taxable Employment Income (TEI)
Every person deriving income from employment is liable to pay tax on that income at the rate specified in Schedule "A", set out in Article 11. But the entire employment income is not taxable as some the employment benefits are non taxable. Taxable employment is the sum of all taxable employment benefits. Taxable income shall mean the amount of income subject to tax after deduction of all expenses and other deductible items as per Article 2 of Proclamation No. 286/2002. The first Birr 150 employment income exclusion from taxable income should be considered as a taxable employment income at the rate of zero percent. TEI = Gross Employment Income – Special Tax Exemption – Tax Allowances 1. Gross Employment Income –refers to any income earned from employment sources regardless of the way it is earned 2. Tax Exemptions – are employment incomes exempted from EIT. Tax Exemptions are classified into two: Special Exemptions and Personal Exemption A. Special Tax Exemptions – are income directly exempted by the income tax proclamation in Ethiopia for special reasons. B. Personal Exemption – is a non-taxable income for each employee under Schedule “A” per month. It is common to all employees regardless of their employment income, which is Br 150 per month. It is considered an income taxable at rate of 0%. 3. Tax Allowances – are amounts which are allowed or permitted to be deducted from Gross Employment Income for different reasons However, there is no tax allowance in Ethiopia so that the formula for calculating taxable Employment income can be modified to the following form: TEI= Gross Employment Income – Special Tax Exemptions. The detail calculation can be in one of the following two ways Alternative 1: When all payments are made at the end of the month

Determination of Taxable Employment Income
Basic salary.............................................................................................. Xxxxx Overtime Pay .......................................................................................... Xxxxx Transport allowance................................................................................ Xxxxx Other allowances..................................................................................... Xxxxx Gross Employment Income..................................................................... Xxxxx Less: Special Tax Exemptions ................................................................ (xxxxx) Taxable Employment Income ................................................................. Xxxxx
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Tax Accounting (ACCT-332)

Alternative 2: Special Exemptions can be paid any time

Determination of Taxable Employment Income
Basic salary.............................................................................................. xxxxx Overtime pay .......................................................................................... xxxxx Taxable Transport allowance.................................................................. xxxxx Other Taxable allowances....................................................................... xxxxx Tax Employment Income........................................................................ xxxxx

Adding Tax on Income
If the tax on income from employment instead of being deducted from the salary or wage of the employee is paid by the employer in whole or in part, the amount so paid shall be added to the taxable income and shall be considered as part thereof (Article 4, Regulation No 78/2002).

Illustrations on calculating TEI
Example 2.1: Ato Hizkiyas is an employee of Excel Pvt. Ltd. Co. The basic salary of Br 3,200 is

meant for 160 normal working hours. He worked 170 hours during the month of Hamle 2006. Assuming that all overtime work is done on employee rest days and the employee received Br 300 transportation allowance according to the employment contract, determine the taxable employment income. Required: determine taxable employment income
Example 2.2: Ato Daniel is a loan officer at Awash International Bank. Determine the Taxable

Employment Income of Ato Daniel if his monthly salary of Br 2,800 is for 176 Normal Working Hours and the Employer’s Contribution to Provident Fund is 20% of Daniel’s basic salary.
Example 2.3: Ato Samuel is head of Human resource department of BB Family Pvt. Ltd. Co.

Assume the following  He gets a monthly salary of Br 2,640 for 176 normal working hours;  He worked 186 hours during the month of Sene 2006 and all overtime work is done from 6:00 A.M. to 10:00 P.M.  He is entitled to receive a Transportation Allowance of Br 1000 Required: determine the Taxable Employment Income of Ato Samuel
Example 2.4: the employment contract between Ato XY and his employer stated that Ato XY will receive a basic salary of Br 940 net of tax (after the tax is deducted) and the employer agreed to pay Br 110 tax to the tax authority on the basic salary amount. The normal working hours are 150. Determine the taxable income for the month of Nehase and Pagumen assuming that Ato XY worked 170 Hours and all overtime work was done on employee rest days

2.4) Accounting For Employment Income Tax
Accounting for employment income tax is concerned with determination of Taxable Employment Income as we discussed earlier. Accounting is also concerned with: A. Determination EIT Base i.e. Taxable Employment Income B. Calculation of Employment Income Tax; C. Preparation of Employment Income Tax Declaration; and D. Recording Employment Income Tax Related Transactions Recording transactions is an overlapping activity with payroll accounting but the tax accountant need not consider other transactions on the payroll

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter Two: Employment Income Tax Accounting

2.4.1) Calculation of Employment Income Tax (EIT)
A. Progression Method – the EIT is computed progressively applying the tax rates in Schedule “A” Example: take example 3.1 to 3.4 and calculate Employment Income Tax under progression method

B. Deduction Method
• EIT = Taxable Employment Income @ Marginal Tax Rate – Deduction

Table 2:1 Employment Income Tax under Deduction Method
TB 1st 2nd 3rd 4th 5th 6th 7th • • Range of TEI 0 – 150 150 – 650 650– 1,400 1,400 – 2,350 2,350 – 3,550 3,550 – 5,000 Over 5,000 Tax Rate Exempt 10% 15% 20% 25% 30% 35% Deduction 0.00 15.00 47.50 117.50 235.00 412.50 662.50 EIT Calculation No Tax Payment EIT = TEI @ 10% – 15 EIT = TEI @ 15% – 47.50 EIT = TEI @ 20% – 117.50 EIT = TEI @ 25%n – 235 EIT = TEI @ 30% – 412.50 EIT = TEI @ 35% – 662.50

C. Addition Method
EIT = Addition + [(TEI – Lower Tax Bracket) @ Marginal Tax Rate] The “Addition” is equal to the EIT amount payable on the Previous Tax Bracket

Table 2.2: Employment Income Tax under Addition Method
TB 1st 2nd 3rd 4th 5th 6th 7th Range of TEI 0 – 150 150 – 650 650– 1,400 1,400 – 2,350 2,350 – 3,550 3,550 – 5,000 Over 5,000 Tax Rate Exempt 10% 15% 20% 25% 30% 35% Addition 0.00 0.00 50.00 162.50 352.50 652.50 1,087.50 EIT Calculation No Tax Payment EIT = 0.00 + (TEI – 150) @ 10% EIT = 50.00 + (TEI – 650) @ 15% EIT = 162.50 + (TEI – 1,400) @ 20% EIT = 352.50 + (TEI – 2,350) @ 25% EIT = 652.50 + (TEI – 3,550) @ 30% EIT = 1,087.50 + (TEI – 5,000) @ 35%

Example 2.5: Assuming a Taxable Employment Income of Br 1,000, determine employment income tax under Progression, Deduction, and Addition Method Example 2.6: Determine the Employment Income Tax to be paid by Ato Girma for taxable employment income of Br 3,600 for the month of Hamle 1999 under the three Employment Income Tax calculation methods

Employment Income Tax on Job Termination Payments EIT on Severance Pay
The EIT on Severance Pay is computed as follows:  Determine the total severance pay  Determine number of months with severance pay - the total Severance Pay is divided by the basic salary of the employee at the time the Employment of Contract is terminated  Determine the EIT on Severance Pay per month using Schedule “A”  Determine the EIT on the total Severance Pay
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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If there is any remainder after determining the full number of months, the severance pay is treated separately as one month taxable income for tax purposes. Example 3.7: Assume that the contract of employment is terminated when the basic salary of the employee is Br 2,000. Determine the Employment Income Tax on the Severance Pay of Br 12,000

Reading Assignment: Employment Income Tax on Ordinary Annual Bonus Employment Income Tax on Weekly and Bi-Weekly Salary and other employment benefits

2.4.2) Preparation of Employment Income Tax Declaration
The Federal Inland Revenue Authority (FIRA) introduced Employment Income Tax Declaration (Form 1103) as of July 2006. The Employer is required to file Form 1103. Form 1103 has five sections:
1. 2. 3. 4. 5. Taxpayer Information Declaration Details Calculation of Tax Due Employees Removed From Payroll Taxpayer Certification

2.4.3) Recording Employment Income Tax Related Transactions
At the time of payment of Employment Income, the appropriate income tax liability should be recorded. The Withheld EIT should be credited to liability account. This Withheld EIT (EIT deducted at source) should be submitted to the tax authority within the time frame set in the income tax proclamation. At time of submission the related liability account should debited.

Exercise: You are given the following: basic Salary, Overtime Hours, Overtime Duration, Allowances of Employee of SHINA Plastic Factory Pvt. Ltd. Co. for the Month of September 1999 E.C.
S. No. 1 2 3 4 5 6 7 8 Employee Name ABY CAM GFD KKK LMA WZB ZFW SBH Basic Salary Br 3,200 4,800 1,600 2,400 2,880 1,760 2,080 1,080 Normal Working Hours 160 160 160 160 160 160 160 160 Overtime Hours 20 5 8 12 10 – 10 – Overtime Duration 6:00A.M -10:00 PM 10:00PM -6:00 AM Weekly Rest Days Public Holidays Weekly Rest Days – Weekly Rest Days – Allowances 1000 (PA) 500(TA) 500 (TA) 500 (TA) 500 (TA) 500 (TA) 500 (TA) –

Required:
A. Determine the Gross Employment Income, Taxable Employment Income and the Employment Income Tax B. Prepare the Employment Income Tax Return i.e. Complete Form 1103 (Employment Income Tax Declaration) to be filed with FIRA. C. Show all the accounting entries

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter Two: Employment Income Tax Accounting

Federal Democratic Republic of Ethiopia Ministry of Revenue Federal Inland Revenue Authority

Schedule A
Employment Income Tax Declaration Form (Income Tax Proclamation No.286/2002 & Income Tax Regulation No. 78/2002 3. TIN
0000121361

Section 1: Taxpayer Information
A) Taxpayer’s Name (Company Name, Father’s Name, Grandfathers Name) SHEENA Consultancy Pvt. Ltd. Co. 2A. Region - Addis Ababa 2B. Zone / Kifle Ketema - Kirkos 2C. Woreda 2D. Kebele /Farmers Association 2E. House Number 14/53 1534
A) Seq. No. 1 2 3 4 5 6 7 B) Employee TIN S000121 S000122 S000123 S000124 S000125 S000126 S000127 C) Employee Name ABY CAM GFD KKK LMA WZB ZFW D) Date of Employmen t E) Basic Salary

4. TAN 000112

5. Tax Center - Kirkos 6. Telephone 7. Fax Number
011 – 125 3434 011 – 125 4141

8. Tax Period Page 1 of _2__ Month Year Sep. 1999 Document Number (Official Use Only)

Section 2: Declaration Details
F) Total Additional Benefit Transportation G) Taxable H) OT allowance Transportation Income Allowance Sep. 2004 3200 –– –– 500 July 2003 4800 500 –– 225 August 2004 1600 500 100 160 Dec. 2004 2400 500 –– 450 January 2005 2880 500 –– 360 January 2005 1760 500 60 –– January 2005 2080 500 –– 260 Transfer totals from the last continuation sheets to the Line I) Other Taxable Benefits 1000.00 –– –– –– –– –– –– Total
J) Taxable Income (sum columns E, G, H and I

K) Tax WH 997.50 1096.25 254.50 477.50 575.00 246.50 350.50 114.50 4112.25 (Line 30)

I) Cost Shari ng

M) Net Pay

N) Emp. Sign

4700.00 5025.00 1860.00 2850.00 3240.00 1820.00 2340.00 1080.00 22915.00 (Line 20)

–– –– –– –– –– –– ––

3702.50 4428.75 2005.50 2872.50 3165.00 2013.50 2489.50 20677.25

Section 3: Calculation of Tax Due
10 20 30 Number of Employees on Your Payroll for this Tax Period Total Taxable Income (From Column J Above) Total Tax Withheld (From Column K Above) 8 Br 22,915.00 Br 4,112.25
Seq. No. –– –– –– ––

Section 4: Employees Removed from Payroll
Employee TIN –– –– –– –– Employee’s Name –– –– –– –– Use OnlyFor Office Date of Payment Receipt No. Amount Payment Cheque No. Cashier’s Sign.

Section 5: Employer’s Certification
I declare that the above declaration and all information provide here with (Including continuation sheets) is correct and complete. I understand that any misrepresentation is punishable as per the Tax Laws and the penal Code
Taxpayer or Authorized Agent Name: Signature: Date: Employer Seal For Tax Office: Authorized Tax Officer Name: Signature: Date:

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Ethiopian Revenues and Customs Authority (ERCA) Continuation Sheet

FORM 1103
Employment Income Tax Declaration (Continuation Sheet for Form 1103)(Form 1104) (Income Tax Proclamation No. 286/2002 & Income Tax Regulation No. 78/2002) 2. TIN 3. Tax Period

Federal Democratic Republic of Ethiopia Ministry of Revenue Federal Inland Revenue Authority
1. Taxpayer’s Name (Company Name) SHEENA Consultancy Pvt. Ltd. Co.

Section 1: Taxpayer Information
0000121361 Month Sep.
J) Taxable Income (Sum Columns E, G, H, And I) K) Tax Withheld

Year 1999
L) Cost Sharing

Page _____2_____ Of _______2_____

Section 2: Calculation of Payments to Employees
A) Seq Num B) Employee TIN C) D) E) Employee Date Of Basic Name Employment Salary F) Transport Allowance Additional Benefits G) H) I) Taxable Over Other Transport Time Taxable Allowance Benefits –– –– –– M) Net Pay N) Employee Sign

8

S000127

SBH

January 2005

1,080

––

1,080

114.50

––

965.50

Totals from Previous Continuation Sheet(s) if Used Carry Totals from Final Continuation Sheet to Page 1 of EIT Declaration, Form 1103

––

––

1,080 (Line 20)

114.50 (Line 30)

Name of taxpayer/Authorized Agent: Ethiopian Revenues and Customs Authority (ERCA)

Signature :

Employer Seal
FORM 1104

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter Three: Rental Income Tax Accounting

Chapter Three Rental Income Tax Accounting
Chapter Outlines:
 Overview of Rental Income Tax  Basic Legal Provisions for Rental Income Tax as per the tax law of the country  Accounting for rental income tax

Chapter Objectives
After completing this chapter, you would be able to:
Understand the concepts of Rental Income Tax in Ethiopia Identify the lessee, lessor, and sub-lessor and understand who should pay rental income tax Determine Gross Rental Income and Taxable Rental Income Know deductible expenses for Rental Income Tax purposes Calculate Rental Income Tax for taxpayers maintaining books of accounts and not maintaining books of accounts  Understand briefly the Rental Income Tax Declaration (FIRA Form 1201)     

Time Required: 2 Hours

3.1) Introduction to Rental Income Tax
 Rental Income is taxed under Schedule “B” of Income Tax Proclamation No. 286/2002  Income generated by renting either Residential or Business Buildings is taxable  There are two parties to the lease contract in buildings: The Lessor and Lessee.

Sometimes the third party called Sub-lessor may part of it
 The leased building can be empty or furnished  Advance Payments: income that covers a period longer than one year shall be prorated

over the number of years covered by the amount paid for tax purposes.  Responsibility of the Local Administration: Informing to the Tax Authority

3.2) Basic Legal Provisions for Rental Income Tax (RIT) The legal provisions are taken form Income Tax Proclamation No. 286/2002 and Income Tax Regulation No. 78/2002. 3.2.1) Taxable Rental Income (TRI) Taxable Rental Income = Gross Rental Income –– Deductible Expenses Determination of Gross Rental Income
Gross Rental Income shall include:  All payments in cash and all benefits in kind received by the lessor (owner of the building) from the lessee;  All payments made by the lessee on behalf of the lessor according to the contract of lease; for example if the lessee agreed to pay brokerage cost on behalf of the lessor.  The value of any renovation or improvement made under the contract of lease to the land or building, where the cost of such renovation or improvement was borne by the lessee in addition to rent payable to the lessor;  If the tax payer leased furnished quarters the amounts received attributable to the lease of furniture and equipment shall be included in Gross Rental Income in addition to the above rental incomes.
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Deductible Expenses from Gross Rental Income
The following amounts shall be deducted from income in computing taxable income:  Taxes paid with respect to the land and buildings being leased; except Rental Income Taxes; and  For taxpayers not maintaining books of account, one fifth (1/5) 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 in Proclamation No.286/2002, 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 Art 23 of Proclamation No 286/2002 as well as interest on bank loans, insurance premiums

3.2.2 Tax Rate
 On rental income of body thirty percent (30%) of Taxable Rental Income  On income of persons according to the Schedule B (hereunder)

Schedule “B”
TB 1st 2nd 3rd 4th 5th 6th 7th Range of Rental Income 0 1800 1,800 7,800 7,800 16,800 16,800 28,200 28,200 42,600 42,600 60,000 ***** 60,000 T RI ––– 6,000 9,000 11,400 14,400 17,400 ––– Tax Rate Exempt (0%) 10% 15% 20% 25% 30% 35%

3.3) Accounting for Rental Income Tax
In this case, accounting is involved with the following tasks:  Determination of Gross Rental Income and Taxable Rental Income  Calculation of Rental Income Tax  Preparation of Rental Income Tax Return

3.3.1) Determination of Gross Rental Income and Taxable Rental Income
Taxable Rental Income for those Taxpayers Maintaining Books of Accounts Rental Income Received................................................................ Add: the following amounts Amount on the lease of furniture................................................... Amount on the lease of equipments.............................................. Payments made by the lessee on behalf lessor ............................. Cost renovation or improvement paid by the lessee...................... Gross Rental Income..................................................................... Less: Rental Payment.................................................................... Net Rental Income......................................................................... xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx (xxxxx) xxxxx 22

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

Chapter Three: Rental Income Tax Accounting

Less: deductible expenses Land and building tax....................................................................xxxxx Annual lease payment on land.......................................................xxxxx Cost of repairs and maintenance....................................................xxxxx Depreciation of building................................................................xxxxx Depreciation of furniture and equipment......................................xxxxx Interest on bank loans....................................................................xxxxx Adverting expense to call tenant...................................................xxxxx Other expense, if any incurred to generate rental income.............xxxxx Insurance premiums.......................................................................xxxxx Total deduction.............................................................................. (xxxxx) Taxable rental income................................................................... xxxxx

Taxable Rental Income for those Taxpayers not maintaining Books of Accounts
Rental Income Received....................................................................... Add: The Following Amounts Amount on the lease of furniture.......................................................... Amount on the lease of equipments...................................................... Payments made by the lessee on behalf lessor ..................................... Cost renovation or improvement paid by the lessee............................. Gross Rental Income............................................................................. Less: Rental Payment............................................................................ Net Rental Income (NRI) ..................................................................... Less: Deductible Expenses Land and building tax, if any................................................................xxxx x Allowance for repairs, maintenance & depreciation (20%@NRI).......xxxx x Total deductible expense Taxable rental income........................................................................... xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx (xxxxx) xxxxx

(xxxxx) xxxxx

Calculation of Rental Income Tax (RIT)
• • Sub-lessor shall pay the tax on the difference between income from sub-leasing and the rent paid to the lessor, provided that the amount received from the sub-lessor is greater than the amount payable to the lessor In the computation of Rental Income Tax, the taxpayers can use the progressive method using Schedule B or Deduction Method

Deduction Method
RIT = Taxable Rental Income @ Marginal Tax Rate – Deduction TB 1st 2nd 3rd 4th Over 0 1,800 7,800 16,80 0 To 1,800 7,800 16,800 28,000 Tax Rate Exempt 10% 15% 20% Deduction 0.00 180.00 570.00 1,410.00

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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5th 6th 7th

28,20 0 42,60 0 60,00 0

42,600 60,000 *****

25% 30% 35%

2,820.00 4,950.00 7,950.00

Addition Method
Under this method, Rental Income Tax is determined by multiplying any Taxable Rental Income above the minimum level of the Tax Bracket by the tax rate and adding the given addition for each tax bracket as follows: TB Over To Tax Rate Addition st 1 0 1,800 0% Exempt 2nd 1,800 7,800 10% 0.00 rd 3 7,800 16,800 15% 600.00 4th 16,800 28,200 20% 1,950.00 5th 28,200 42,600 25% 4,230.00 6th 42,600 60,000 30% 7,830.00 th 7 60,000 ***** 35% 13,050.00

Rental Income Tax (RIT)
The Rental Income Tax is computed as follows under Addition Method:

RIT = Addition + [(TRI – Lower Tax Bracket) @ Marginal Tax Rate] Illustrations on Rental Income Tax Example 3.1: Assume ATO AYELE, the owner of AYU BUILDING, let out (leased) the
Building at Br 2,000,000 per annum. In addition to this, the lessee will incur Br 100,000 cost for repair and maintenance of the building. Assume further that Ato Ayele maintains books of Accounts and the cost of the building is Br 20,000,000 and the following expenses are incurred by the lessor: Cost of Lease payments on Land.......................... Br 100,000 Land and Building Tax.......................................... 4,800 Other Deductible Expenses................................... 5,200 Required: Determine the Gross Rental Income, Taxable Rental Income, and Rental Income Tax

Example 3.2: WELINEGUDENA SHARE COMPANY leased its building for Br 200,000 for
cash per month. The lessor is responsible to make renovation and improvement in the building by incurring Br 100,000 per year as per the lease term. The cost of building is Br 10,000,000 the Share Company paid Br 100,000 for the lease hold Land. Required: Determine Gross Rental Income, Taxable Rental Income and Rental Income Tax Liability

Example 3.3: ATO ZINABU leased his furnished building for Br 2,000 per month and the
equipments and furniture were leased for Br 1,000 per month. He paid Br 1,200 land and building tax to Addis Ababa Municipality. Determine Gross Rental Income, Taxable Rental Income and Rental Income Tax Liability assuming that the house was vacant for four months during tax year 1999

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter Three: Rental Income Tax Accounting

Rental Income Tax Declarations
RIT Declaration with books of accounts (FORM 1201) RIT Lessee Details Declaration and Continuation Sheet (FORM 1202 and FORM 1203) RIT Declaration for taxpayers not maintaining Books of Accounts (FORM 1205 & FORM 1206)

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter Four Business Income Tax / Business Profit Tax
Chapter Outlines:
         Overview of Business Income Tax Legal form businesses and taxable entities Categories of Business taxpayers in Ethiopia Tax accounting methods Business profit tax rate and other legal provisions on Business Profit Tax Deductible Expenses Non-Deductible Expenses Exemptions from Business Profit Tax Accounting for business income tax

Chapter Objectives
After completing this chapter, you would be able to:
Understand what business income tax is Identify taxable entities as per the tax law of the country Know the three different categories of business taxpayers Apply tax accounting methods allowed by the Tax Law currently enforce Differentiate items that are allowed to be deducted from gross income Identify non-deductible expenses Know revenues of incomes exempted from business profit tax Determine taxable business income for different categories of business taxpayers and body and non-body  Compute business income tax for small, medium and large businesses  Understand the concepts of foreign tax credit, withholding income tax, investment tax credit and loss carry back and carry forward        

Time Required: 10 Hours

The legal provisions are taken form Income Tax Proclamation No. 286/2002 and Income Tax Regulation No. 78/2002. 4.1) Legal Forms of Businesses and Taxable Entities
According to Ethiopia:        Commercial Code of Ethiopia, there are seven forms of business organizations in Sole Proprietorship – It is a taxable entity but not legal entity General Partnership – it is both taxable and legal entity Limited Partnership – it is both taxable and legal entity Joint Venture - It is a taxable entity but not legal entity Private Limited Company - it is both taxable and legal entity Share Company - it is both taxable and legal entity Co-operative - it is a legal entity but it may or may not be a taxable entity

4.2) Categories of Taxpayers
The categorization of taxpayers depends upon of the following points: a. Annual turnover or annual sales b. Maintenance of accounting records or books of accounts
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter Four: Business Income Tax Accounting

c. d. e. f.

Requirements for registered vouchers, etc Number and types of financial statements to be prepared for tax purposes Tax Year Declaration of Income and time of payment of tax liability

1. Category ‘A’ Taxpayers a. Category ‘A’ Taxpayers shall include the following persons and bodies:  Any business having an annual turnover of Br 500,000 (Five Hundred Thousand Birr) or more;  Any company incorporated under the laws of Ethiopia or in a foreign country – Share Companies b. They have to maintain accounting records c. They have to use registered vouchers d. Category “A” taxpayers shall submit to two statements to the Tax Authority: a balance sheet and a profit & loss statement (income statement) e. The tax year can be either the government fiscal year or the accounting year of the body f. They shall submit the Tax Declaration Form to the Tax Authority within 4 months 2. Category ‘B’ Taxpayers a. Category ‘B’ shall include any business having an annual turnover of Br 100,000 and above (100,000 to 499,999.99). b. They have to maintain accounting records c. They have to use registered vouchers d. Category “B” taxpayers shall submit only a profit and loss statement to the Tax Authority e. The tax year can be either the government fiscal year or the accounting year of the body f. They shall submit the Tax Declaration Form to the Tax Authority within 2 months 3. Category ‘C’ Taxpayers a. Category “C” Taxpayers include, unless already classified in Categories “A” and “B”, Taxpayer whose annual turnover is estimated by the Tax Authority as being up to Birr 100,000. Category “C” taxpayers shall pay tax in accordance with Schedule “1” and “2” attached with Regulations No. 78/2002 b. Maintaining books of accounts is encouraged by the Tax Authority for Category “C” Taxpayers but not mandatory c. They are not required to use registered vouchers d. They are not required to submit any financial statement to the tax authority e. The tax year is the government fiscal year f. Category “C” taxpayer shall, within the period of 7th day of July to the 6th day of August every tax year, declare to the Tax Authority. One month from the end of the tax year.

4.3) Tax Accounting Methods
A taxpayer shall account for tax purposes on a Cash or Accrual Basis . But, for the purposes of ascertaining a person’s income accruing or derived during a tax period, the Timing of Inclusions and Deductions shall be made according to GAAPs and a Company shall account for tax purposes only on an accrual basis. • Cash-Basis Accounting – revenue is recognized when received and expense is recognized when paid for tax purposes • Accrual-Basis Accounting - revenue is recognized when it is earned and expense is recognized when it is incurred.
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Tax Accounting (ACCT-332)

4.4) Business Profit Tax Rate
Business Profit Tax is a tax on income from business activities in Ethiopia. Business Profit is taxed under Schedule C, 30% Flat Tax Rate or Presumptive Tax Assessment 1) Taxable Business Profit of body is taxable at the rate of 30 %. “Body” shall mean any Company (Pvt. Ltd. Co. and Share Company), Registered Partnership, Any Public Enterprise or Public Financial Agency that carries out business activities 2) Taxable business income of other taxpayers whose annual turnover is Br 100,000 or more shall be taxed in accordance with Schedule “C” hereunder

Schedule “C”
Taxable Business Income per Year TB Over Birr To Birr st 1 0 1,800 2nd 1,800 7,800 rd 3 7,800 16,800 4th 16,800 28,000 th 5 28,200 42,600 6th 42,600 60,000 th 7 60,000 ***** Business Income Tax Tax Rate Exempt (0%) 10 15 20 25 30 35

3) Presumptive Tax – is a predetermined amount of tax paid by small businesses whose annual sales is less than Br 100,000. The tax is estimated by estimating annual sales (daily sales)

4.5) Deductible Expenses (Allowable Deductions)
Any Direct Costs and expenses of producing the Income is deductible – General Concept of deductible expenses. It includes: 1. Insurance Expense 2. Promotional Expense 3. Commissions Expense 4. Payment to Holding or Parent Company 5. General and administrative expenses 6. Salary Expense A. Salary paid to employees B. Salary paid to Management of the Company C. Salary paid to children of business owners 7. Interest Expense – Shall not exceed Inter-Bank Interest Rate + 2% A. To lending institutions recognized by the national bank of Ethiopia, B. To foreign banks permitted to lend to enterprises in Ethiopia; C. To shareholders of Companies 8. Donations and Gift Expense 9. Maintenance and Improvement Expense – 20% of Depreciation Base 10. Bad Debts Expense (Uncollectible Accounts Expense) 11. Participation deduction (Deduction for Reinvestment of Profit) 12. Special Reserves for Finance Institutions – provisions for NPLs 13. Transportation Allowance paid to Employees not exceeding the limit 14. Retirement Benefits – less or equal to 15% of the basic salary of the employee 15. Representation Expense – 10% of basic salary of employee
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Chapter Four: Business Income Tax Accounting

16. Trading Stock Disposed (Cost of Goods Sold) - The cost of trading stock disposed during a tax period is determined on the basis of the Average Cost Method Example 4.1: BIRTY Share Company has the following beginning and purchased of merchandise Inventory during the Tax Year 1998 (Assume a tax year from Hamle 1 to Sene 30) Date Particulars Quantity Unit Cost Hamle 1, 1997 Beginning Inventory 2,000 100 Tikmet 16, 1998 Purchased Inventory 2,600 110 Megabit 22, 1998 Purchased Inventory 3,000 105 Sene 13, 1998 Purchased Inventory 2,500 106 Required: determine cost of trading stock disposed during the tax assuming that 2,700 units were on hand as of the end of the tax year 17. Depreciation Expense (Article 23) Method of Depreciation for Tax Purposes 1. Fine Art, Antiques, Jewelry, Trading Stock and Other Business shall not be depreciated. 2. The Acquisition or Construction cost, and the cost of Improvement, Renewal and Reconstruction, of buildings and constructions shall be depreciated individually on a straight-line basis at five per cent (5%) 3. The Acquisition or Construction cost, and the cost of Improvement, Renewal and Reconstruction, of intangible assets shall be depreciated individually on a straight-line basis at ten percent (10%) 4. The following two categories of business assets shall be depreciated according to a Pooling System at the following rates: A. Computers, information systems, software products and data storage equipment at twenty five percent (25%) B. All other business assets at twenty percent (20%) Depreciation Base under Pooling Method Depreciation Base during the Tax Year = Book Value at the Beginning + Cost of Assets Acquired – Disposal of Assets • If the depreciation base is a Negative Amount, that amount shall be added to taxable profit and the depreciation base shall become zero. • If the depreciation base does not exceed Br 1,000, the entire depreciation base shall be a deductible business expense

Example 4.2: Assume ABC Spare Parts Pvt. Ltd. Co. uses the Tax Year Hamle 1 to Sene 30
and has the following plant assets: Computers, Information System, Software and Data Storage. Date of Purchase Acquisition Cost Yekatit 10, 1996................................ 16,000 Ginbot 01, 1996................................. 6,000 Nehase 07, 1996................................ 7,000 Tahsas 19, 1997................................. 3,500 Instruction: Compute Depreciation Base and Depreciation Expense for Tax Year Ending Hamle 30, 1996, 1997 and 1998 assuming that ABC Spare Parts Pvt. Ltd. Co. sold old Computer at Birr 3000 on Megabit 23, 1996

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Tax Accounting (ACCT-332)

Example 4.3: The following data were obtained from the accounting records of ZENA Pvt.
Ltd. Co. On Hamle 1, 1997, beginning of the current tax year, the Store Equipment account shows a book value of Birr 170,000. At the beginning of the tax period, the company sold one of the equipments for Birr 25,000 cash and acquired a new one for Birr 85,000 on account. Determine the amount of Depreciation Expense to be recognized on the store equipment and the depreciation base for the store equipment for the tax year ending Sene 30, 1998 as per Art.23 of Income Tax Proclamation No.286/2002

4.6) Non-Deductible Expenses
1. The cost of the acquisition, improvement, renewal and reconstruction of business assets that are depreciated pursuant to Article 23 of EITP No. 286/2002 2. An increase in the share capital of a company or the basic capital of a registered partnership 3. Voluntary pension or provident fund contributions over and above 15% of the monthly salary of the employee 4. Declared dividends and paid-out profit shares 5. Interest in excess of the rate used between the National Bank of Ethiopia and the commercial banks increased by two (2) percentage points 6. Damages covered by insurance policy 7. Punitive damages and penalties 8. The creation or increase of reserves, provisions and other special-purpose funds unless otherwise allowed by this Proclamation; 9. Income Tax paid on Schedule C income and Recoverable or Refundable Value-Added Tax; 10. Representation expenses over and above 10% of basic salary; 11. Personal consumption expenses; 12. Expenditures exceeding the limits set forth in Proclamation No 286 13. Entertainment expenses 14. Donation or gift to other entities not listed in the EITP No 286 15. Sum paid as salary, wages or other personal emoluments to the proprietor or partner of the enterprises and to their spouses 16. Expenditure for maintenance of other private properties of the proprietor or partner of the enterprises 17. Losses not connected with or not arising out of the actively of the enterprise;

4.7) Exemptions
The following categories of income shall be exempt from payment of business income tax hereunder:  Awards for adopted or suggested innovations and cost saving measures  Public awards for outstanding performance  Income specifically exempted from income tax by the law in force in Ethiopia, by international treaty or by an agreement made or approved by the Ministry of Revenue  The revenue obtained by the Federal Government, Regional State Governments and Local Governments of Ethiopia; and the National Bank of Ethiopia from activities that are incidental to their operations

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Chapter Four: Business Income Tax Accounting

4.8) Accounting for Business Profit Tax
Accounting for Business Profit Tax is concerned with the following tasks: 1. Computation of Business Profit Tax 2. Determination of Taxable Business Income according the legal Provisions 3. Preparation of Tax Returns i.e. Profit and Loss Account and Balance Sheet 4. Adjusting Business Profit Tax 5. Recording Transactions Related to the Business Tax Liability

4.8.1) Calculation of Business Income Tax
1. Progression Method 2. Deduction Method BIT = Taxable Business Profit @ Marginal Tax Rate – Deduction TB 1st 2nd 3rd 4th 5th 6th 7th Over Br 0 1,800 7,800 16,800 28,200 42,600 60,000 To Br 1,800 7,800 16,800 28,000 42,600 60,000 ***** Tax Rate Exempt 10% 15% 20% 25% 30% 35% Deduction 0.00 180.00 570.00 1410.00 2820.00 4950.00 7950.00

3. Addition Method BPT = TBI – Lower Tax Bracket @ Marginal Tax Rate + Addition TB 1st 2nd 3rd 4th 5th 6th 7th Over Br 0 1,800 7,800 16,800 28,200 42,600 60,000 To Br 1,800 7,800 16,800 28,000 42,600 60,000 ***** Tax Rate Exempt 10% 15% 20% 25% 30% 35% Addition 0.00 0.00 600.00 1950.00 4230.00 7830.00 13050.00

4.8.2) Determination of Taxable Business Income (Taxable Business Profit)
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 Ethiopian Income Tax Proclamation and the
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Tax Accounting (ACCT-332)

Directives issued by the Tax Authority. Accordingly, the Taxable Business Profit is the can be determined by subtracting costs & expenses from annual revenues. • Taxable Business Profit = Annual Revenues – Cost of goods sold – Operating Expenses Example 4.4: SHALA Merchandising Enterprise is a Category “B” taxpayer but not a body. The enterprise reported Br 300,000.00 sales revenue; Br 200,000 Cost of goods sold and Br 62,000 operating expenses during the tax year ending Sene 30, 1997. Determine the Taxable Business Income and Business Profit Tax to be paid.

4.8.3) Preparation of Tax Returns
When a business is required to prepare tax returns i.e. profit and loss account and balance sheet, it shall apply the income tax law regarding deductible and non-deductible expenses. The tax returns shall be accompanied by:  the amount of business profit tax payable in check or in cash,  tax vouchers and documents, and  any other relevant information Example 4.5: Assume that the revenue from SAMARITAN Share Company is Br 2,000,000 during Tax Year ended Sene 30, 1997. Cost and Expense were Br 1,000,000 and Br 560,000, respectively. Determine the Taxable Business Profit and Compute the Business Profit Tax Liability of this Share Company preparing a tax return i.e. Profit and Loss Statement.

Example 4.6: Assume Oromia Cooperative Bank Share Company made Br 10,000,000
loans and advances during the tax year ending Sene 30, 1998. Assume also the bank has the following income and expenses for the same Tax Year: Interest Income...........................................................Br 12,000,000 Service Charge Income.............................................. 1,600,000 Interest Expense......................................................... 10,050,000 Administrative and General Expenses....................... 1,600,000 Advertising Expenses................................................. 400,000 Instruction: Determine the Taxable Business Profit of the Bank for the tax year ended Sene 30, 1998 if the technical reserve on the loan and advance was Br 1,300,000.00 and five year tax holiday period for the business.

4.9) Special Items that Reduces Business Profit Tax
There are tax provisions to pay taxes in advance under tax withholding system of the country and tax benefit as a result of loss carry forward and loss carry back. Thus, the business profit tax is adjusted for factors such as Loss Carry Forward and Loss Carry Back; Withholding of Business Profit Tax; Foreign Income Tax Credit and Investment Income Tax Credit.

1. Loss Carry Forward and Loss Carry Back
Loss Carry Back is a tax provision that allows operating losses to be used as a tax shield to reduce taxable income in prior. • Loss Carry-Forward is a tax provision that allows operating losses to be used as a tax shield to reduce taxable income of the future years In some countries losses can be carried back and/or forward Example 4.7: MOTERA Trading Share Company reported net sales and Cost & Expense of Birr 1,000,000 and 1,200,000 during the year ended June 30, 2001, respectively. During the year ended June 30, 2002, the same Share Co. reported net sales of Birr 1,500,000 and Cost and •

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Chapter Four: Business Income Tax Accounting

Expenses of Br 1,200,000.00. Required: Determine the Taxable Business Income and Business Profit Tax during the tax year ended June 30, 2002 and Record the necessary transaction

2. Withholding Income Tax (Withholding Profit Tax)
A. Collection of withholding Income Tax on Imports  3% of the sum of cost, insurance, and freight (“CIF value”) B. Withholding of Income Tax on Payments  Organization having Legal Personality, Government Agencies, Private Nonprofit Institutions, and Non-Governmental Organizations (“NGOs”) shall withhold income tax on payments  The amount withheld shall be two per cent (2%) of the gross amount of the payment. C. Withholding Scheme  Supply of goods involving more than Birr 10,000 in any one transaction or one supply contract;  Rendering of the certain services involving more than Birr 500 in any one transaction or one service contract. Example 4.8: TENKER Pvt. Ltd. Co. purchased Birr 200,000 Stationary Materials from HALEHA Stationary Materials Import and Distribution Pvt. Ltd. Co. on Tikmet 18, 1997 Instruction: Record the above transaction for both the seller (withholdee) and buyer (withholder) Withholding Tax Declaration – the withholder is required to declare Withholding Income Tax Declaration on monthly basis. Withholding Tax Declaration Form has the following Four Sections: Taxpayer Information; Declaration Details; Tax Declaration Summations; and Taxpayer Certification

3. Foreign Tax Credit and Investment Tax Credit
Both foreign tax credit and investment tax credit are direct reduction from business profit tax to be paid.  Foreign tax credit refers to reduction of business profit tax for income tax paid in foreign country from foreign source income.  The investment tax credit refers to immediate reduction of business profit tax for some investment made during the tax period. In Ethiopia, there is no tax provision relating to investment tax credit. Businesses can take advantage of foreign tax credit as per Art. 7 or Proclamation No.286/2002

4.10) Computation of TBI from GAAP Based Financial Statements
Amount Amount Particulars In ETB In ETB Taxable Business Profit from GAAP Based Income Statement xxxxx Add: Non-Deductible Expenses (If they are deducted) Depreciation on revalued assets........................................................................................................ xxxxx Above 15% of the basic salary retirement contribution.................................................................... xxxxx Declared dividends and paid-out profit Shares................................................................................. xxxxx Interest in excess of the rate of specified in Proclamation No 286.................................................... xxxxx Damages covered by insurance policy.............................................................................................. xxxxx Punitive damages and penalties........................................................................................................ xxxxx Unallowed provisions and reserves................................................................................................... xxxxx Income tax paid on Schedule “C” income......................................................................................... xxxxx Recoverable value-added tax............................................................................................................ xxxxx
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Tax Accounting (ACCT-332)

Representation Expense above 10% of the Basic Salary................................................................... xxxxx Personal Consumption Expenses...................................................................................................... xxxxx Entertainment Expenses.................................................................................................................... xxxxx Donation or gift made to organizations not listed............................................................................. xxxxx Other expense if any......................................................................................................................... xxxxx Total Non-Deductible Expenses....................................................................................................... xxxxx Less: Allowable Expenses (If not claimed) Expenses incurred for earning business income................................................................................ xxxxx Deprecation Expense........................................................................................................................ xxxxx Irrecoverable Bad Debts Expense..................................................................................................... xxxxx Total Deductible Expense................................................................................................................. (xxxxx) Taxable Business Profit for tax purpose........................................................................................... xxxxx

 For income tax purposes the taxpayer files the returns of income (statement of income in the prescribed Form) along with accounts. The statement furnished may not be correct in all respects. Hence, the taxable income is calculated in the following manner:  If the tax payer has deducted any expense which is non-deductible, then such amount is to be added back with his net profit given in the furnished return of income. Likewise if the tax payer has not claimed any expense that is deductible, then such amount is to be deducted from the net profit shown in the accounts Illustration on Business Profit Tax: from GAAP Based Income statement to Tax based Profit and Loss Account A number of small spare part businesses established a business named Excellent Spare Parts Share Company. The GAAP based Profit & Loss Account for the financial year ended June 30, 2004 is as follows:

Excellent Spare Parts S.C. Profit and Loss Account For the Tax Period 1st July 2003 to 30th June 2004
Sales....................................................................................... Less: Cost of Goods Sold....................................................... Gross Profit............................................................................ Less: Operating Expenses Administrative expenses........................................................ 100,068.65 Selling and distributing expenses........................................... 2,000,322.0 0 Depreciation and amortization expense................................. 42,000.56 Bank interest and charges ..................................................... 34,217.44 Audit fees............................................................................... 27,000.35 Provision for Stock Obsolescence......................................... 41,985.00 Total Operating Expenses...................................................... Taxable Business Profit for the Year..................................... Provision for Profit tax at 30%.............................................. Net Income or Profit.............................................................. Legal Reserve......................................................................... Balance Carried Forward to Balance Sheet........................... * Such amounts are rounded to the nearest birr amount Additional Information: The following information was available from the records of the firm.
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

32,976,200 (20,126,457) 12,849,743

2,245,594 10,194,272 * (3,058,282) 7,135,990 (356,799) 6,779,191

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Chapter Four: Business Income Tax Accounting

 Loss Br 18,491 on Consignment sales was not included  Vehicle rent expense was overstated by Br 6,700  Administrative and general expense of Br 22,500 of the sister company was included in the income statement  Advertising expense include Br 8,700 expense of the Sister Company  Amortization expense includes Br 7000 amortization in exceeding the limit Required: Find out the taxable business income and business income tax liability of the firm for the tax year ending June 30, 2004 according to Proclamation No 286/2002 and Regulation No 78/2002.

General Illustration on Business Profit Tax
The following transactions are given for the tax year Hamle 1 st, 1998 to Sene 30th, 1999 for Amantha General Trading Pvt. Ltd. Co.: 1. Sales during the tax year is Br 2,320,000 2. The inventory account shows a balance of Br 520,000 (26,000 units @ Br.20 a unit) at the beginning of tax year and the enterprise purchased Br 1,080,000.00 (50,000 units @ Br.21.60 a unit) and Br 464,000.00 (20,000 units at Br.23.20 a unit) during Hidar and Yekatit 1998, respectively. The enterprise uses periodic inventory system and 26,600 units are remaining on hand as of Sene 30, 1999 3. Promotional expense of Br 83,000 was incurred which comprises Br 38,000 advertising expense; Br 25,000 trading coupons and Br 20,000 entertainment expense. 4. Salary expense of Br 165,000 was incurred and composed of Br 100,000 basic salary; Br 25,000 provident fund contribution; Br 20,000 representation expense and Br 20,000 overtime payment 5. Store Rent Expense of Br 240,000 was also incurred 6. Br 21,000 interest is paid on Br 100,000 principal amount of loan where the interest rate between NBE and Commercial Banks is 9% 7. Penalties paid by the business is Br 1,360 8. Building has a cost of Br 500,000 and not fully depreciated during tax year 1999 9. Truck has a carrying amount of Br 120,000 on Hamle 1st, 1998. 10. Computers, Information System, Data Storage and Software have a balance of Br 69,000 on Hamle 1st, 1998. During tax year the business enterprise acquired and disposed Br 32,000 and 39,000 assets, respectively 11. Br 80,000 award for outstanding performance was received from the government 12. the business incurred Br 100,000 expenses on behalf of the owners 13. Donation of Br 50,000 was made by the business to charity organization with successful achievement and transparent system. 14. Withholding income tax receivable has a balance of Br 23,800 at the end of tax year 1998 15. Br 50,000.00 loss was carried forward to tax year 1999

Required:
A. Prepare profit and loss statement for tax purposes assuming that the enterprise is a body and use accrual basis of accounting for tax purpose for tax year ending Sene 30, 1998 as per Proclamation No. 286/2002 and Regulation No. 78/2002 B. Prepare profit and loss statement for financial year ending Sene 30, 1998 for financial accounting purposes assuming that the same cost and depreciation method as “A” above
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Tax Accounting (ACCT-332)

C. Determine the non-deductible items and the related amounts

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter Five: Other Income Tax Accounting

Chapter Five Other Income Tax Accounting
Chapter Outlines:
 Legal provisions for other income taxes  Accounting for other income taxes

Chapter Objectives
After completing this chapter, you would be able to:
Comprehend other incomes in Ethiopian Context Discuss the tax rates applicable on other incomes Calculate taxable other income Compute Royalty income tax, interest income tax, dividend income tax, capital gain tax and other income taxes  Account for other income taxes  Declare other income taxes    

Time Required: 2 Hours

5.1) Introduction to Other Income Tax
 Other Income is taxed under Schedule “D”.  Other income includes the following types of income:

 Royalty Income;  Technical Service Income;  Income from Game of Chance;  Dividend Income;  Income from Casual Rental of Property;  Interest Income; and  Capital Gains  All sort of these incomes are taxable under the law in force in Ethiopia: the Income Tax

Proclamation No. 286/2002 and the Income Tax Regulation No. 78/2002. 5.2) Withholding of Schedule “D” Income Tax on Payments
 The Payer of any payment subject to tax under Schedule “D” shall withhold from the

payment the amount of tax required by Schedule “D”  Every Taxpayer who has Schedule D Income, not subject to withholding at source constituting a final tax, shall prepare a declaration of that income in a form prescribed by the Tax Authority. Taxpayers shall submit this declaration to the Tax Authority within two (2) months from the end of the Ethiopian Fiscal Year  The tax calculated in accordance with the declaration, after the Foreign Tax Credit has been reduced from the related Schedule D income subject to taxation during the year, shall be transferred by the taxpayer to the Tax Authority simultaneously with the Declaration Form

5.3) Basic Legal Provisions on Other Income Tax The legal provisions are taken form Income Tax Proclamation No. 286/2002 1. Royalty Income (Article 31)
 It is taxable at the rate of 5% - flat tax rate  This tax is a final tax in lieu of a net income tax
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Tax Accounting (ACCT-332)

2. Technical Service Income (Article 32)
 It is taxable at the rate of 10%

3. Income from Games of Chance (Article 33)
 Income from winning at games of chance shall be subject to tax at the rate 15%, except for

winnings of less than 100 Birr
 This tax is a final tax in lieu of income tax

4. Dividend Income (Article 34)
 Dividend distributed by S. Co. or withdrawals of profits from PLC shall be subject to tax at

the rate of ten percent (10%).  This tax is a final tax in lieu of income tax

5. Income from Rental of Property (Article 35)
 Income from the casual rental of property is taxable at the rate of fifteen percent (15%).  This tax is a final tax in lieu of a net income tax

6. Interest Income on Deposits (Article 36)
 Income from interest on deposits is taxable at the rate of five percent (5%)  The payer shall withhold the tax  This tax is a final tax in lieu of income tax

7. Capital Gain Tax (Article 37)
 Gain on Transfer of Certain Investment Property is taxable.  Income Tax shall be payable on gains obtained from the transfer (sale or gift) of property at

     

the following rates: A. Building held for business, factory, office 15% B. Shares of companies 30% Gains from transfer of residential building is exempt The basis of calculation of the tax is the historical cost of the building or the par-value of the share, as appropriate Inflation adjustment at a rate determined by the appropriate authority, in respect of buildings, taxes paid for the land and the building shall be allowed as deduction The cost registered with the appropriate government body Shares given in exchange under reorganization is not disposal of Shares Loss on the transfer shall be recognized and be available to offset gain for indefinite periods

5.4) Accounting for Other Income Tax 1. Other Income Tax on Royalty (Royalty Income Tax)
Royalty Income Tax = Royalty Income @ 5% Example 5.1: assume that the Famous Ethiopian musician Tewderos Kassahun (Teddy Afro) sold his album called “Jaha Yastesryal” at Birr 1,000,000 to Electra Music Studio. Required: Determine the amount of other income tax and record the tax liability at the time of payment to the artist and to the tax authority

2. Other Income Tax on Income from Rendering of Technical Services
   

Technical Service is provided to a resident person in Ethiopia Other Income Tax = Technical Service Income @ 10% Technical Service is Provided by Resident Person to person outside Ethiopia Other Income Tax = Technical Service Income @ 10% – Foreign Tax Credit

Example 5.2: Assume Dr Engineer Tibebu Bekele was a consultant to the Kenyan HydroElectric Project at Mombassa. He received $100,000 form this technical service and paid $ 2000
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Chapter Five: Other Income Tax Accounting

tax in Kenya. Determine the Tax Liability of Dr. Engineer Tibebu assuming it was not deducted at source and the exchange rate for a dollar was Br 8.75 on the Date of Declaration of this Income.

Example 5.3: Assume Mr. Prajnan Goswami, an Indian Engineer, is consulting Gilegel Gibe
Hydro-Electric Project. The annual payment is 80,000 USD. Required: Calculate other income tax on this technical service income

3. Other Income Tax on Income from Games of Chance
 The Tax Liability is determined as follows:  Other Income Tax = Income form Game of Chance @ 1 5%

Example 5.4: Ato Bedelu won Birr 100,000 from the lottery drawn on April 25 th 2006.
Determine the Tax Liability to be withheld by the National Lottery Administration.

4. Dividend Income Tax
 Dividend Income Tax = Dividend Paid @ 10%

Example 5.5: BURQAGUDINA Share Company distributes 50% of the Net Income to
Share Holders each year. During the tax year ended June 30, 2005 the business had a Net Income of Br 500,000. Required: Determine the Dividend Income Tax on the Dividend Distributed and record the necessary tax related transactions

5. Other Income Tax on Income from Casual Rental of Property
 The tax liability is determined as follows:

Other Income Tax = Casual Rental Income @ 15% Example 5.6: Ato Nahome Hunduma rented his Land Cruiser Toyota at Br 15,000 for three months to SS Tour and Travel Pvt. Ltd. Co. Required: Determine the income tax to be withheld by the Payer SS Tour and Travel Pvt. Ltd. Co. and record the tax related transactions

6. Income Tax on Interest Income
The Tax liability is: Interest Income Tax = Interest Income @ 5% Example 5.7: Ato XX deposited Birr 200,000 at prevailing Deposit rate (4%) at Commercial Bank of Ethiopia at the beginning of the tax year 1997. If the deposit is in the account for two years, determine the tax amount to be withheld by Commercial Bank of Ethiopia and record the withdrawal of the sum after two years at the end tax year June 1998.

7. Capital Gain Tax A. For Business Buildings
Capital Gain Tax = Taxable Capital Gain @ 15% Selling Price of the building..................................................... Less: Cost of Building.............................................................. Gross Capital Gain.................................................................... Less: Inflation Adjustment........................................................ xxxx x Taxes paid for the land xxxx ....................................................................................... x
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

xxxxx (xxxxx) xxxxx

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Tax Accounting (ACCT-332)

Taxes Paid for the Building ....................................................................................... Loss carried on the Sale of Building ....................................................................................... Total Deduction........................................................................ Taxable Capital Gain................................................................ Capital Gain Tax (Taxable Capital Gain @ 15%)....................

xxxx x xxxx x (xxxxx) xxxxx xxxxx

B. For Shares of Stock
Capital Gain Tax = Taxable Capital Gain @ 30% Selling Price of the Share.......................................................... Less: Par Value or Cost of Shares............................................. Gross Capital Gain.................................................................... Less: Inflation Adjustment........................................................ xxxxx xxxxx (xxxxx) xxxxx

Loss carried on the Sale of Shares xxxxx ........................................................................................ Total Deduction......................................................................... (xxxxx) Taxable Capital Gain................................................................. Capital Gain Tax (Taxable Capital Gain @ 30%)..................... xxxxx xxxxx

Example 5.8: SI Business Enterprise sold its building which has a cost of Br 85,000 at Br
185,000. The Building was held for 10 years and Br 11,000 Land and Building tax was paid on the building during the 10 years period. If the average inflation rate is 5%, determine the Taxable Capital Gain and the Capital Gain Tax.

Example 5.9: Ato Jara sold his personal home at Birr 150,000 in 1996 E.C. The home was
accomplished with the cost of Birr 95,000 in 1993 E.C. Determine the Capital Gain Tax assuming that the person paid Br 2,200.00 Land and Building Tax and the applicable Prince Index is 1.25 in this regard.

Example 5.10: Ato Abebe Purchased 100 Shares from NIB International Bank S. Co. at Birr
1100 per share when the par value is Birr 1000 per share on January 1, 2003. Ato Abebe sold the shares at Birr 1700 per share on February 20, 2005. Taking year 2003 as a base year, the price index is 1.15 in 2005. Determine the tax on the Capital Gain

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter Six: Value Added Tax Accounting

Chapter Six Value Added Tax (VAT) Accounting
Chapter Outlines:
      

Overview of Value Added Tax Components of Value Added Tax Valued Added Tax when the tax element is included and excluded Basic Legal provisions of VAT in Ethiopia Accounting for VAT Computation of VAT VAT Declaration

Chapter Objectives
After completing this chapter, you would be able to:  Describe Value Added and Value Added Tax  Understand Input Tax and Output Tax  Compute Input Tax and Output Tax when the tax element is included in the price  Discuss the basic legal provisions such taxable goods, zero-rated goods, standard rated goods, Registration for Value Added Tax, etc  Account for transaction with value added tax  Compute VAT Payable or VAT Refund  Complete VAT Declaration on monthly basis

Time Required: 4 Hours Chapter Pre-Requisite: Acct 202

6.1) Overview Value Added Tax
VAT was invented by a French economist Maurice Laura in 1954. It is a government tax that is charged at each stage of production. For instance, when a company buys parts, then buys more parts - for each purchase, a separate VAT is paid. When a company exports into a VAT country, that company (or the company purchasing the products) must pay a VAT based on the value of the goods. There are nearly 140 countries that use the VAT system, with the average percentage being 15%  Value Added Tax (herein after VAT) is a tax on the Value Added  It is an indirect tax on the value added  A VAT may be defined as "a tax to be paid by the manufacturers or traders of goods and services is on the basis of value added by them".  The value added by them is the difference between the receipts (from the sale) and payments made to various factors of production (land, labor, capital and organization)  Manufacturer or Trader is not liable to pay the tax on the entire value of the commodity because the tax base for VAT is the Value Added.  In Canada, VAT is known as “goods and service tax” or GST; and in Japan it is known as "Consumption Tax".  VAT is an indirect tax, in that it is a tax collected from someone other than the person who actually pays the tax.

6.2) Components of Value Added Tax
 There are two principal components of VAT: Output Tax and Input Tax.
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Output Tax: – is the Value Added Tax collected on the sale of taxable supplies (goods and services). It is the VAT collected on sales.  Input Tax: - is the value added tax paid on purchases of taxable goods and services. It is the VAT paid on purchases  Vat Payable Or Liability = Output Tax is greater than Input Tax  Vat Refundable/Credit = Output Tax is less than Input Tax


6.3) VAT Exclusive and VAT Inclusive Price and Determination of VAT
VAT Exclusive Price – In this case, purchases and sales are made Exclusive of VAT. When a VAT Return is prepared, the Output and Input Tax are determined by multiplying Sales and Purchases Price by the existing VAT Rate. VAT = VAT Exclusive Price @ VAT Rate VAT Inclusive Price – In this case, purchases and sales are made inclusive of VAT. When a VAT Return is prepared, the Output and Input Tax is determined by multiplying sales and purchases by the Ratio of VAT Rate to 1 Plus VAT Rate; For example if the VAT Rate is 15%, Sales and Purchases Price which are VAT Inclusive are multiplied by 15/115 which is the same as 0.15/1.15) VAT = [VAT Inclusive Price] @ [VAT Rate / (1 + VAT Rate)]

6.4) Legal Provisions on VAT in Ethiopia The legal provisions are taken form Value Added Tax Proclamation No. 285/2002 and Value Added Tax Regulation No. 79/2002. Most transactions involve supplies of
goods and services. VAT is payable on taxable supplies made in Ethiopia by a taxable person in the course or furtherance of the taxable activity during an accounting period. The Analysis of this legal point is as follows: A. Taxable Supplies made in Ethiopia B. Taxable person – refers to a taxpayer for VAT Purposes C. Course or furtherance – an activity undertaken to develop, advance and progress the taxable activity by a taxable person is assumed to be undertaken in the course or furtherance of taxable activity. The supply of goods or rendering of services by an employer to his employees, including gratuitously, is a supply of goods or services in the course or furtherance of a taxable activity D. Taxable Activity - any activity, which is carried regularly by any taxable person in Ethiopia whether or not for a pecuniary profit as long as it involves or is intended to involve in whole or in part the supply of goods or services to another person for consideration. E. Accounting Period – is a calendar month. 1. VAT Registration in Ethiopia VAT Registration is classified into two: Mandatory and Voluntary Mandatory Registration  Any person conducting a commercial enterprise or intending to conduct a commercial enterprise may apply to get registered for VAT. The term any person for purposes of VAT registration includes: Sole proprietor, Company, Partnership, Estate of the Deceased, Trust, Incorporated Body or Unincorporated Body or Club or Association, etc.  If the gross sales value or turnover of the enterprise, which is gross income for 12 calendar months, exceeds or is likely to exceed Br 500,000, the person conducting the enterprise

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Chapter Six: Value Added Tax Accounting

must register for VAT with VAT Department of the FIRA. It is calculated ongoing basis. Turnover related to exempt supplies is not to be included in compulsory VAT registration. Voluntary Registration A person who carried on taxable activity and is not required to get registered for VAT, may voluntarily apply to the Authority for such registration, if the person regularly is supplying or rendering at least 75% of his goods and services to registered persons 2. Imposition of Tax  Subject to the provisions of the VAT proclamation, there shall be levied and paid tax to be known as Value Added Tax, at the rate of 15 % of the value of:  Every taxable transaction by a registered person; and  Every import of goods, other than an exempt import  An import of goods takes place when the goods are entered into the customs declaration. The value of a taxable import is the customs value of the goods, determined in accordance with the customs legislation of Ethiopia, plus the sum of duties and taxes (Custom Duty and Excise Tax) payable upon the import of the goods into Ethiopia, excluding VAT and income tax withholding. 3. Zero-Rated Supplies The following taxable transaction shall be charged with tax at a rate of Zero percent:  The export of goods or services to the extent provided in regulations;  The rendering of transportation or other services directly connected with international transport of goods or passengers,  The supply of gold to the National Bank of Ethiopia; and  A supply by a registered person to another registered person in a single transaction 0f substantially all of the assets of a taxable activity or an independent functioning part of a taxable activity Note: on Zero Rated supplies the registered person can claim the Input Tax Credit on purchases either it is domestic or import. The input VAT will be recovered but no Output Tax will be reported for the sales. 4. Exempt Supplies (Transactions) The following types of supplies of goods (other than by way of export) or rendition of services, as well as the following types of imports of goods, are exempt from payment of VAT to the extent provided by regulation: 1. The sale or transfer of a used dwelling, or the lease of a dwelling 2. The rendering of financial services 3. The supply or import of National Or Foreign Currency (except for that used for numismatic purposes), and of securities 4. The import of gold to be transferred to the national bank of Ethiopia 5. The re. The import or supply of prescription drugs and medical services 6. The rendering of educational services provided by educational institutions, 7. The supply of goods and rendering of services in the form of humanitarian aid, 8. The supply of electricity, kerosene, and water 9. Goods imported by the government 10. Supplies of services by the post office 11. The provision of transport be it public or freight 12. Permits and License Fees
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Tax Accounting (ACCT-332)

13. Rendering by religious organizations of religious or church related services 14. The import of goods to the extent provided under Schedule 2 of the customs tariffs regulations 15. The supply of goods or services by a workshop employing disabled individuals; 16. The import of supply of books and other printed materials; 17. The Ministry of Finance and Economic Development exempted the following by directive after the proclamation: Bread, Injera and Milk 18. Grains and their flours (As of March 2008) Note: in the case of exempt supplies, there is neither Input Tax nor Output Tax. This is to say that:  No tax is collected when a person sells exempt goods and services  No tax is paid when a person purchase exempt supplies. 5. Standard Rated Supplies These are supplies of goods or provisions of services which are neither exempt nor zero-rated and taxable at the standard rate of 15% 6. Mixed Supplies  A supply of goods or rendering of services, which is incidental to a (main) supply of goods or rendering of services, is treated as part of the latter.  The rendering of services incidental to an import of goods is part of the import of goods.  A taxable transaction involving independent elements, on or more of which involves the separate supply of goods or rendering of services, which would be exempt from tax, is treated as separate transactions. An exempt transaction, which involves the separate supply of taxable goods or rendering of taxable services, is treated as separate transactions. 7. Adjustment of the value of a Taxable Transaction In relation to a taxable transaction made by a registered person Adjustment of the value of a Taxable Transaction is allowed where:  The transactions cancelled;  The nature of the transaction is changed;  The previously agreed consideration for the transaction is altered, whether due to a reduction of prices or for any other reason; or  The goods or services are returned in full or in part to the registered person. 8. Input Tax Credit  The amount of VAT that is creditable is the amount of VAT paid by a registered person in respect of tax invoices or Customs Declarations issued to the person for:  Imports of good that take place during the current accounting period; and  Taxable transactions involving the supply of goods or rendering of services that are considered to take place during the current or preceding accounting  Where only a part of the supplies made by a registered person during a tax period are taxable transactions, the amount of tax creditable for that period is determined as follows:  In respect of a supply or import received to make taxable transactions, the full amount of tax paid on the supply or import shall be allowed as a credit;  In respect of a supply or import received to make exempt transaction, no amount of tax payable in respect of the supply or import Shall be allowed as a credit; or

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter Six: Value Added Tax Accounting



In respect of a supply or import received which is used both for the making of taxable and exempt transactions, the rules of apportionment of the credit shall be determined by a directive to be issued by the Minister or Revenue,

No Credit is allowed for VAT:  On a taxable transaction to, or import by, a person of a passenger vehicle  Unless the person is in the business of dealing in, or hiring of, such vehicles  Unless the person is engaged in the business of transporting passengers  On a taxable transaction, or import by, a person of goods or services acquired for the purposes of entertainment or providing entertainment  Unless the person is tin the business of providing entertainment  The person is in the business of providing taxable transactions involving transportation services 9. VAT Refund  If at least 25 percent of the value of a registered person's taxable transactions for the accounting period is taxed at a zero rate, the tax authority shall refund the amount of VAT applied as a credit in excess of the amount of VAT charged for the accounting period within a period of two months after the registered person files an application for refund, accompanied by documentary proof of payment of the excess amounts.  In the case of other registered persons, the amount of VAT applied as a credit in excess of the amount of VAT charged for the accounting period is to be carried forward to the next five accounting periods and credited against payments for these periods, and any unused credits shall be refunded by the tax authority within a period of two months after the registered person files an application for refund, accompanied by documentary proof of payment of the excess amounts  The Authority is not obliged to refund excess credits if the amount to be refunded is not more than 50 Birr. This amount can be carried forward and credited against tax due in the subsequent accounting period

6.5) Accounting for VAT
Accounting for VAT is concerned with the following activities. A tax accountant shall:  Identify the records to be kept for VAT purposes  Determine the VAT Liability  Record VAT Related Transactions in the Books of Accounts  Preparation of VAT Return

Record Keeping
A record refers to accounting records, accounts, books, computer-stored information, or any other documents. A registered person or any other person liable for tax under VAT proclamation shall maintain for 10 years in Ethiopia the following:  Original tax invoices received by the taxable person,  A copy of all tax invoices issued by the taxable person,  Customs documentation relating to imports and exports by the person,  Accounting records; and  Any other records as may be prescribed by the Ministry of Revenue and useful to determine the VAT Liability

Determination of the VAT Liability
Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011

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Tax Accounting (ACCT-332)

 The amount of tax payable or VAT Liability for any accounting period by a person who is

registered or is required to register is the difference between the amounts of tax charged on taxable transactions i.e. the VAT charged on sales and the VAT paid on purchases of goods and services applying the Zero Rate or the Standard Rate.  Example 6.1: if a taxable person purchases birr 200,000 goods and services and sales Birr 300,000 taxable supplies during the month of Nehase, the VAT liability will be as follows: Output Tax: 300,000 @ 15 % ..................................... 45,000 Input Tax: 200,000 @ 15%....................................... 30,000 VAT Liability.......................................... 15,000

Recording VAT Related Transactions in the Books of Accounts
Recording Purchases  The accounting entry is to credit the amount owed to the purchaser for the purchase plus VAT.  Purchases are charged as an expense to the trading account exclusive of VAT.  The VAT element is debited to the VAT Account representing the Tax Authority as a debtor.  VAT on inputs and outputs should offset one against the other. Some input tax cannot be recovered. Recording Sales  The sales are debited to Debtor or Cash Account for the amount of the sales plus VAT  The sales amount is credited to sales account exclusive of VAT  The VAT element is credited to the VAT Account representing FIRA-VAT Department as a creditor. Example 6.2: Record the following transactions for DMX Trading Pvt. Ltd. Co. for the month Hidar 1998 assuming all prices are VAT exclusive: 1. It purchased merchandise of Br 300,000 on cash from SYB Trading 2. It purchased merchandise of Br 230,000 on account 3. It sold merchandise of Br 465,000 4. It incurred telephone expenses of Br 2,000 5. A Minibus is acquired at Br 200,000 Preparation of VAT Return  Preparation of VAT Return is compulsory. When filling of VAT Return, it should be accompanied by payment of VAT. Every registered person is required:  To file VAT return with the Authority for each accounting period, whether or not tax is payable in respect of that period;  To pay the tax for every accounting period by the deadline for filing the VAT return.  The VAT return for every accounting period shall be filed no later than the last day of the calendar month following the accounting period. For the accounting period Meskerem, the VAT Return must be filed till 30th of Tikmet.

Example 6.3: Kombolcha Textile Factory Share Company made taxable sales of Birr 80,000
during the month of June 2006. It also made taxable purchases of Birr 50,000 and imported Birr 10,000 during the same month. Required: Determine the VAT Liability or VAT Refund assuming all the prices are VAT Exclusive and the VAT Rate is 15%
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter Six: Value Added Tax Accounting

Example 6.4: Tabor Ceramics Share Company made taxable purchases of Birr 230,000 and Birr 138,000 taxable import. It also made taxable sales of Birr 345,000. Required: Determine the VAT Liability or VAT Refund assuming that the prices are VAT inclusive and a VAT rate is 15%.

Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011

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Tax Accounting (ACCT-332)

Chapter Seven Turnover Tax Accounting
Chapter Outlines:
 Introduction to Turnover Tax  Basic legal provisions such as Rate of TOT, Base of Computation of TOT, Exemptions, Computation of tax  Accounting for TOT

Chapter Objectives
After completing this chapter, you would be able to:
    Define Turnover and Turnover Tax Calculate TOT Base and TOT according the tax law Account for Turnover Tax File Turnover Tax as per the filling time

Time Required: 2 Hours Chapter Pre-Requisite: Acct 202

7.1)

Introduction To Turnover Tax

What is Turnover?  Turnover refers to total revenue or Sales Turnover Tax (TOT)  It is a tax imposed on almost all goods and services on the total turnover rather than on the Value Added. Turnover tax is a sales tax. A reduced tax rate is applied for Turnover Tax as compared to the VAT in most of the countries of the world Filing of Turnover Tax Return and Payment Tax payers subject to Turnover Tax shall:  Pay the tax for every accounting period by the deadline for filing the Turnover Tax return. The Accounting period for the purposes of Turnover tax shall mean:  For Category "A" taxpayers but are not required to register for VAT, the calendar month;  For category "B" taxpayers, each three months period commencing from the first day of the Ethiopian fiscal year (tax year);  For Category "C" taxpayers, the fiscal year is the accounting period. A Presumptive Turnover Tax shall be payable by Category "C" taxpayers who are not required to keep records. The base for the presumptive turnover tax shall be the total turnover used as base for the income tax.

7.2) Legal Provisions on Turnover Tax The legal provisions are taken form Turnover Tax Proclamation No. 308/2002
Rate of Turnover Tax (Article 4) The Turnover Tax shall be:  2% (two percent) on Goods Sold Locally  For Services Rendered Locally;  2 % (Two percent) on Contractor, Grain Mills, Tractors and Combine-Harvesters.  10% (Ten percent) on others; these include services such as Consultancy, Training, Legal advice, Auditing, etc Base of Computation of the Turnover Tax (Article 5)
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Chapter Seven: Turnover Tax Accounting

 Base of computation of the Turnover tax shall be the Gross Receipt in respect of goods

supplied or services rendered Obligation to Collect and Transfer the Turnover Tax (Article 6)  A person who sells goods and services has the obligation to collect the Turnover Tax from the buyer and transfer it to the Tax Authority. Hence, the seller is principally accountable for the payment of the tax. Exemptions (Article 7) The following transactions of goods and services shall be exempted from Turnover Tax: 1. The sale or transfer of a dwelling use for a minimum of two years, or the lease of a dwelling: 2. The rendering of financial services; 3. The supply of National or Foreign Currency (except for that used for numismatic purposes) and of securities; 4. The rendering by religious organizations of religious or other related services: 5. The supply of prescription drugs specified in directives issued by the relevant government agency, and the rendering of medical services; 6. The rendering of educational services provided by educational institutions, as well as child care services for children at pre-school institutions: 7. The supply of goods and rendering of services in the form of humanitarian aid: 8. The supply of electricity, kerosene, and water; 9. The provision of transport; 10. Permits and license fees; 11. The supply of goods or services by a workshop employing disabled individuals if more than 60%of the employees are disabled; and 12. The supply of books 13. Bread, Injera and Milk are exempted by the Ministry of Finance and Economic Development.

7.3) Accounting for Turnover Tax Computation of Turnover Tax Liability
The computation of turnover tax is straight forward. The Gross receipt is multiplied by the tax rate either 2% or 10% to determine the Turnover Tax Liability. Example 7.1: ABC Stationery Materials Sold Birr 3000 Papers, Pens, Pencils and Others on June 30, 2006. Determine the Turnover Tax Liability on this transaction But sometimes the turnover tax may be included in the selling price. In such a case the turnover tax is computed by multiplying the selling price by R / (100 + R) as follows: Turnover Tax Liability = Selling Price @ R / (100 + R) Where: R= the Turnover Tax Rate. Example 7.2: NICE Furniture Enterprise Sold Birr 5,100 Sofa and Other Furniture to UKK Tour and Travel Business. Determine the Turnover Tax Payable on this Transaction assuming that the price includes the TOT amount.

Recording Transactions with TOT
For Category “A” and “B” Taxpayers who are required to keep the accounting records, the transactions can be recorded in two different ways. The first way is to record separately the
Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011

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Tax Accounting (ACCT-332)

Turnover Tax liability at the time each taxable transaction occurs. This may have the highest burden of Record keeping and Compliance cost on the taxpayers. The second is to make adjustment for all the transactions of the Tax period at the end of tax period by recording the transactions initially as sales

Example 7.3: A Category “B” Taxpayer Named NUFTANA Furniture PLC made the
following transactions during a Calendar Month Meskerem, Tikemit and Hidar 1998:  Meskerem 1998: Birr 32,000 tables, chairs and beds were sold  Tikemit 1998: Birr 27,000 Sofa, Computer Desk, And Tables were sold  Hidar 1998: Birr 30,000 Office Furniture was sold Instruction: Determine the transactions and Prepare and File the Turnover Tax Return for the three months ended Hidar 1998 under both separate and adjustment recording method.

Example 7.4: PHOTO KEJELA, A Category “C” Taxpayer, had a gross receipts of Birr
86,000 for the Tax Year ended 30th of Sene 1998. Determine the Turnover Tax Payable for this Business.

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

50

Chapter Eight: Excise Tax Accounting

Chapter Eight Excise Tax Accounting
Chapter Outlines:
 Introduction to Excise Tax  Basic Legal Provisions of Excise Tax in Ethiopia such as Excise Tax Rate and Base of Excise Tax, Payment of Excise Tax (Article 6)  Accounting for Excise Tax

Chapter Objectives
After completing this chapter, you would be able to:
     Understand what excise tax is Identify and excisable goods and Know the excise tax rate applicable on each good Compute excise tax base for goods imported and locally produced Calculate excise tax as per Schedule “E” Account for excise tax

8.1) Introduction to Excise Tax
Different Governments levy excise taxes, which are sales taxes on specific goods and services. Excise taxes are also called selective sales taxes. Goods subject to excise taxes are mostly luxury items and harmful products. Excise taxes are applied either on a Per Unit Basis, such as per package of cigarettes or per litter or gallon of gasoline, or a fixed percentage of the sales price. In Ethiopia Excise Tax was introduced in 1993 under Sales and Excise Tax Proclamation No. 68/1993 and this proclamation was repealed in 2002 through Excise Tax Proclamation No. 307/ 2002. Excise tax is payable either on production of goods listed in Excise Tax Rate Schedule or on the importation of the same goods from foreign countries. For Excise Tax purposes, the Taxpayer is either a person who is importing the goods or producing the goods. This person is liable to pay excise tax according to the Excise Tax Proclamation. Every taxpayer shall:  Maintain books of accounts and supporting documents in accordance with proper accounting principle and in a manner acceptable to the Tax Authority;  Submit every 30 Days to the Tax Authority, in a form which shall be supplied by said Authority, a declaration containing such information as may be necessary for proper collection of the tax.  Comply fully with requirements of the inspection of his premises by the delegate of the Tax Authority in accordance with Sub-Article 3 of Article 9 of this Proclamation.  Comply fully with requirements of the inspection of taxpayer’s premises by the delegate of the Tax Authority if The Tax Authority wants to inspect the taxpayer.  Immediately communicate to the Tax Authority the type and address as well as the commencement and termination date of his business;  Pay in full the tax due Within 30 Days from the date of termination where such business is terminated.

8.2) Basic Legal Provisions of Excise Tax In Ethiopia
Excise Tax Rate and Excisable Goods in Ethiopia
The Excise tax shall be paid, when imported or produced locally, on the goods mentioned in Schedule “E”
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Tax Accounting (ACCT-332)

SCHEDUL "E"
S. No.

1. 2.

3. 4. 5. 6. 7. 8.

Types of Product Any type of sugar (in solid form) Excluding Molasses Drinks: 2.1. All types of soft drinks (Except Fruit Juices) 2.2. Powder Soft Drinks 2.3. Water Bottled Or Canned In A Factory 2.4. Alcoholic Drinks1 2.4.1. All Types Of Beer & Stout 2.4.2. All Types Of Wine 2.4.3. Whisky 2.4.4. Other Alcoholic Drinks All types of pure Alcohol Tobacco & Tobacco Products 4.1. Tobacco Leaf 4.2. Cigarettes, Cigar, Cigarillos, Pipe Tobacco, Snuff and Other Tobacco Product Salt Fuel-super Benzene, regular Benzene, Petrol, Gasoline and other Motor spirits Perfumes and Toile Waters Textile and Textile products

Tax Rate 33% 40% 40% 30% 50% 50% 50% 100% 75% 20% 75% 30% 30% 100%

9. 10. 11. 12. 13. 14. 15.

16. 17. 18. 19.

8.1. Textile fabrics, knitted or woven of natural silk, rayon, nylon, wool or other similar materials 8.2. Textile of any type partly or wholly made from cotton, which is gray, white, dyed or printed, in piece of any length or width (except Mosquito net and "Abudgedi") and including blankets, bed sheets, counterpanes, towels, table clothes and similar articles 8.3. Garments Personal Adornment made of Gold, Silver or Other materials Disk washing machines of a kind for domestic use Washing machines of a kind for domestic purposes Video decks Television and Video Cameras Television Broadcast Receivers Whether Or Not Combined With Gramophone, Radio, Or Sound Receiver And Reproducers Motor passenger cars, station wagons, utility cars, and land rovers, jeeps pickups, similar vehicles (including motorized caravans), whether assembled, together with their appropriate initial equipment: A. Up to 1,300 C.C (C.C = Cylinder Capacity) B. From 1,301 C.C up to 1800 C.C C. Above 1,800 C.C Carpets Asbestos And Asbestos Products Clocks And Watches Dolls And Toys

10%

10% 10% 20% 80% 30% 40% 40% 10%

30% 60% 100% 30% 20% 20% 20%

1

“Alcohol” means Ethyl Alcohol. “Pure Alcohol” means Alcohol of purity of 80 degree or more; 52

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

Chapter Eight: Excise Tax Accounting

Base of Computation of Excise Tax (Article 5)
The basis of computation of Excise Tax varies for goods produced locally and goods imported. In respect of goods produced locally, the Base of Computation is Cost of Production. Cost of Production means direct labor and raw material cost incurred in the production process, cost of indirect inputs and overhead costs, but does not include Depreciation Costs of Machineries. In respect of goods imported, the tax base is C.I.F Value of the import (Cost, Insurance and Freight)

Payment of Excise Tax (Article 6)
The Excise tax shall be paid  In respect of goods produced locally, by the producer; or  In respect of goods imported, by the importer

Time of Payment:
Unless decided otherwise, the excise tax on goods specified under the Schedule “E” shall be payable.  When imported at the time of clearing the Goods from Customs area;  When produced locally, not later than 30 days from the date of production;

8.3) Accounting For Excise Tax
Accounting for Excise Tax is concerned with the following activities:  Computation of Excise Tax  Recording Transaction with Excise Tax  Preparation of Excise Tax Declaration Form

Computation of Excise Tax
The base of computation for Excise Tax is discussed above. Excise Tax Payable is computed differently for goods produced locally and goods imported. Computation of Excise Tax for Locally Produced Goods Excise Tax Payable = Cost of Production @ the Tax Rate in Schedule “E”

Computation of Excise Tax Payable
Raw Materials................................................................. Labor Cost....................................................................... Factory Overhead Costs: Indirect Labor xxxxx Indirect Materials xxxxx ..................................................................... Factory Insurance xxxxx Factory Supplies xxxxx ..................................................................... Factory Utilities xxxxx ..................................................................... Other Indirect Costs xxxxx .....................................................................
Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011

xxxxx xxxxx

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Tax Accounting (ACCT-332)

FOH Costs....................................................................... Tax Base for Excise Tax................................................. Tax Rate from Schedule “E”........................................... Excise Tax Payable.........................................................

xxxxx xxxxx xx% xxxxx

If the total amount FOH Cost that includes the Factory Depreciation (either depreciation on factory building or production machineries) is given, the factory depreciation shall be deducted to compute the base of computation of Excise Tax Payable as follows:

Computation of Excise Tax Payable
Raw Materials.................................................................. xxxxx Labor Cost.............................................................................. xxxxx FOH Costs.............................................................................. xxxxx Total Production Cost............................................................ xxxxx Less: Factory Depreciation.................................................... xxxxx Tax Base for Excise Tax........................................................ xxxxx Tax Rate from Schedule “E”.................................................. xx% Excise Tax Payable................................................................ xxxxx

Computation of Excise Tax for Imported Goods
The Ethiopian Customs Authority collects Excise Tax at Custom Station at the time of clearing. Excise Tax is a responsibility of FIRA. But The ECuA (Ethiopian Customs Authority) serves as an agent to Federal Inland Revenue Authority as far Excise Tax on imported Goods is concerned.  Excise Tax Payable = C.I.F @ the Tax Rate in Schedule “E”

Example 8.1: META Brewery used Birr 850,000 malt; Birr 250,000 Direct Labour Cost and
Birr 400,000 FOH to produce 1,400,000 bottles of Beer during the month of Sene 1998. Required: Determine the Excise Tax Liability of the month of Hamle 1998 assuming that the FOH cost includes a factory depreciation of Birr 100,000.

Example 8.2: Assume SIRARA General Trading PLC imported Br 12,000,000.00 merchandise
from China. Br 480,000.00 and Br 120,000.00 Freight cost and Insurance cost was incurred, respectively in respect of goods imported. Required: Determine the Excise Tax Base and Excise Tax Liability

Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011

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Chapter Nine: Accounting for Customs Duty (Tariff)

Chapter Nine Accounting for Customs Duty
Chapter Outlines:
    Overview of Customs Duty Basic Legal Provisions of Ethiopian Customs Duty Customs Valuation Systems Calculate Customs Duty on Goods Imported

Chapter Objectives
After completing this chapter, you would be able to:
      Understand Customs duty Determine Duty Paying Value as per the customs law in the country Determine the value of imported goods using different valuation systems Understand duties and taxes collected at customs station Compute Customs Duty on Imported Goods Account of Customs Duty in the books of accounts

Time Required: 4 Hours Chapter Pre-Requisite: Acct 202

9.1) Introduction to Custom Duty
 Customs Duty is a duty or tax levied on Import and Export goods by the Ethiopian

Government.
 Goods shall mean any commodities, personal effect and animals including money.  Importation of goods shall mean bringing or cause to be brought, goods through the first







 

custom station into Ethiopia and Exportation goods shall mean taking or cause to be taken out, goods through the final port of departure from Ethiopia. Thus, Importation and Exportation indicates that goods are crossing Customs Area of Ethiopia. The Customs Area refers to the territory of Ethiopia or boundary of Ethiopia. The goods are crossing the Ethiopian border to outside or inside. The Duty is payable at Customs Stations. Customs station shall mean any place designated as customs office at the port of entry or exit of goods, transit routes or at customs area for the control of import and export goods, collection of duties and taxes; Customs Duty is the responsibility of Ethiopian Customs Authority. The Ethiopian Customs Authority has either a branch offices or customs stations in different part of the Customs Areas to collect the Customs Duty while the head office in Addis Ababa. It has also a police force called Customs Police to enforce the Customs Laws and the Collection of Customs Duty or Tariffs and to Control the Contraband. Customs Police shall mean an armed police force assigned by the Federal Police Commission to enforce customs laws under the command of the Authority. The Ethiopian Customs Authority shall have the following powers and duties: Customs Declaration is a Form prepared by the Customs Authority in which the details of import, export or transit goods are described for the accomplishment of customs formalities.

Customs Duty: Specific Duty and Ad valorem Duty
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Tax Accounting (ACCT-332)

Ad-valorem Taxes – are taxes or duties levied as a percentage of the Value of Goods and Services. Specific Tax – are the taxes levied at a fixed amount, irrespective of the Value of the goods and services.

9.2) Basic Legal Provisions of Ethiopian Customs Duty
The Basis of Computation of Customs Duty – The basis of computation is the Duty Paying Value. Sometimes the Duty Paying Value can be the same as CIF Value Duty Paying Value (Article 47) – The duty paying value of any import or export goods shall be the Actual Total Costs of the goods. Duty Paying Value of Imports (Article 48) - For the purpose of customs, the Duty Paying Value (DPV) for imported goods shall be the sum of the Transaction Value (Cost), Freight Cost and Insurance Premium that is paid to deliver the goods upped a prescribed customs port. Deductibles from Import Value (Article 49) The following adjustment costs shall be deducted from import values:  Costs for damages in routes;  Costs for damages in customs warehouse.  The value of destroyed goods by Customs Authority Value of Export Goods: For customs purpose the value of export goods shall be the transaction value of the goods and the cost of transportation up to the port of exit. Exchange Rate or Conversion of Currency The conversion of currency is necessary for the determination of the customs value. The rate of exchange to be used shall be that duly published by the National Bank of Ethiopia every Monday and shall be applicable from Tuesday up to the next Monday. Commodity Classification & Tariff Rate  Any goods imported or exported shall be subject to:  Pay duties and taxes according to the tariff of Harmonized Commodity Description and Coding system; Duty Free Imports  Goods may be imported or exported free from any duties and taxes in accordance with law or international agreement to which Ethiopia is a party or by an agreement made and permission given by the government.  Any goods imported duty free may be sold or disposed to any person who enjoys similar privileges, or exported, without paying duties and taxes; or subject to pay customs duties and taxes at the rate and value prevailing during the time of sales or disposal, be transferred to any person.  Where duty free imported goods are lost or damaged due to force major the importer shall report forthwith to the Authority, and if it is proved to the satisfaction of the Authority the whole or part of the duties and taxes may be cancelled.

9.3) Customs Valuation System
According to the new customs law, the primary basis for customs value in Ethiopian Customs Authority is "transaction value" as defined in Article 1 below

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Chapter Nine: Accounting for Customs Duty (Tariff)

1. Transaction Value
 The transaction value method is the first method to be applied in customs valuation.  Transaction value means the price actually paid or payable by the buyer for the goods

when sold for export to the country of importation.

2. Transaction Value of Identical Goods
 If the customs value of the imported goods cannot be determined under the Transaction

Value Method above, the customs value shall be the transaction value of identical goods sold for export to the same country of importation and exported at or about the same time as the goods being valued. "Identical goods" means goods, which are the same in all respects, including physical characteristics, quality and reputation. 3. Transaction Value of Similar Goods If the customs value of the imported goods cannot be determined under the Transaction Value of the Goods and Transaction Value of the Identical Goods above, the customs value shall be the transaction value of similar goods sold for export to the same country of importation and exported at or about the same time as the goods being valued. "Similar goods" means goods which, although not alike in all respects, have like characteristics and like component materials which enable them to perform the same functions and to be commercially interchangeable. 4. The Deductive Method If the imported goods or identical or similar imported goods are sold in the country of importation in the condition as imported, the customs value of the imported goods under the provisions of this method shall be based on the wholesale unit price at which the imported goods or identical or similar imported goods are so sold in the greatest aggregate quantity, at or about the time of the importation of the goods being valued less all local costs incurred and taxes paid by the buyer. 5. The Computed Value Method  The customs value of imported goods at this stage shall be based on a computed value. Computed value shall consist of the sum of:  The cost or value of materials and fabrication or other processing employed in producing the imported goods;  An amount for profit and general expenses equal to that usually reflected in sales of goods of the same class or kind as the goods being valued which are made by producers in the country of exportation for export to the country of importation;  The cost or value of all other expenses.  If the customs value of the imported goods cannot be determined under the methods above, the customs value shall be determined using reasonable means consistent with the principles and general provisions of this procedure and on the basis of data available from free sources.  With regard to Used Goods the procedure issued by the Federal Government Revenues Board shall be applicable

9.4) Duty and Taxes Collected at the Customs Station from Businesses
From businesses or commercial organizations, the following duty and taxes are collected at time of clearing from customs station:  Customs Duty (Article 52 of Proclamation No 60/1997);  Excise Tax (Article 6 (2) of the Excise Tax Proclamation No 307/2002);
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 Value Added Tax (Article 5 of the VAT Proclamation No. 285/2002); and  Withholding Tax (Article 52 of the Income Tax Proclamation No 286/2002)

Computation of Duty Paying and Taxable Value
Cost, Freight Cost and Insurance...................................................... Add: The Following Items Commissions and brokerage costs incurred by the buyer ................................................................................................. The cost of container and cost of packing the goods ................................................................................................. The value of free goods and services ................................................................................................. Royalties and license fees related to the goods ................................................................................................. Loading, unloading and handling charges ................................................................................................. Total Addition................................................................................... Less: The Following Items Costs for damages in routes ................................................................................................ Costs for damages in customs warehouse ................................................................................................ Value of the goods destroyed or disposed ................................................................................................ Total Deduction................................................................................ Duty Paying Value and Taxable Value............................................ xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx

Duty and Taxes Collected at the Customs Station from Individuals
 From Individuals, the following duty and taxes are collected at time of clearing from customs

station:  Customs Duty (Article 52 of Proclamation No. 60/1997)  Excise Tax (Article 6 (2) of the Excise Tax Proclamation No. 307/2002)  Value Added Tax (Article 5 of the VAT Proclamation No. 285/2002) – this is 15% of the CIF plus Customs and Excise Duty

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Chapter Nine: Accounting for Customs Duty (Tariff)

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Chapter Ten Taxable Income and Book Income
Chapter Outlines:
    Taxable Income versus Book Income (Accounting Income) Specific Differences Accounting for inter-period tax allocation Accounting for operating losses

Chapter Objectives
After completing this chapter, you would be able to:
Understand differences between accounting standards and tax laws Understand differences between taxable income and book income Discuss Specific differences Identify permanent differences between taxable income and book income and discuss accounting treatments of permanent differences  Discuss temporary differences and discuss accounting treatment for inter-period tax allocations  Compute deferred tax assets and deferred tax credits  Account for both deferred tax assets and credits    

Time Required: 4 Hours Chapter Pre-Requisite: Acct 202

10.1) Taxable Income versus Book Income
 In computing income tax payable, businesses must complete tax returns including a



  

statement showing the amount of income subject to Tax. In general, the form and contents of the income statements for tax purposes are similar to the form and contents of the Income Statement for Financial reporting purposes. The Taxable Income in the Tax Return however, is computed with prescribed tax regulations or rules (tax code or laws). Where as, Before Tax Accounting Income or Income as per the Book or merely Accounting Income (Before Tax Financial Income) is measured in accordance with GAAPs. differences arise from some of the following reasons: Depreciation may be computed on Sum of the years Digit method for the Book Purposes but on Straight Line Method for Tax Purposes. Revenue is recognized on accrual basis at the time of Sale for Book purposes or financial reporting purposes but may be recognized on cash basis at the time of cash receipts Expenses are recognized on accrual basis for Financial Reporting purposes but may be recognized on the cash basis for the tax purposes

10.2) Specific Differences
There are numerous items that create differences between taxable income and book income. These differences are called Specific Differences and for purposes of accounting recognition, they are classified into two:  Permanent Differences  Temporary Differences

Permanent Differences
 Some of the differences between Taxable Income and Before Tax Accounting Income are

permanent. Permanent differences are items that enter into in the determination of Before
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Chapter Ten: Taxable Income and Book Income

Tax Accounting Income but never into Taxable Business Income and item that inter Taxable Income but never into Before Tax Accounting Income.  There are a variety of Tax Law provisions. Some of the provisions exclude certain revenue from taxation; limit the deductibility of certain expenses and permit the deduction of certain expenses on excess of costs incurred. Permanent Differences affect only one period in which they occur so that they do not give rise to future reversible amount.

Temporary Differences (Timing Differences)
It is a difference between a tax basis of an asset or a liabilities and Book Basis of assets and liabilities that will result in reversible amount in some future years when the reported amounts of assets are recovered and liabilities are settled. Examples of temporary differences are:  Revenues are Taxable (are recognized in the Tax Returns) after they are recognized to determine Accounting Income. That is cash basis of revenue recognition for tax purposes but accrual basis of revenue recognition for accounting purposes  Expenses are recognized or deductible after they are recognized for Financial Reporting purposes. That is accrual basis of expense recognition for accounting purposes but cash basis of expense recognition for tax purposes  Revenue is taxable before they are recognized to determine Accounting Income. For Example; Advance Collection may be recorded as revenue.  Expenses are deductible before they are recognized for Financial Accounting Income Purposes. For example; expenses are recognized when cash is paid

10.3) Accounting for Temporary Differences and Inter-Period Tax Allocations
Inter-period Tax Allocation is an allocation of income tax of one period over a period of two or more years. The Inter-Period Tax Allocation is expressed in terms of Deferred Tax Credit and Deferred Tax Assets.

Temporary Differences and Deferred Tax Credit
A deferred tax credit is a result of deferred tax consequences that are attributable to payable temporary differences. In other words a deferred tax credit represents the increase in taxes payable in future years as a result of payable temporary differences existing at the end of current tax period or tax year. It is resulted when book basis asset is different from tax basis asset.

Illustration 10.1:
Assume that Ethio Trading Enterprise (PLC) has revenue of Br 240,000.00 for tax purposes and financial accounting purposes during tax year ended June 30, 2003. It has also expenses of Br 140,000.00 for both the tax purposes and financial accounting purposes excluding insurance expense. The enterprise also purchased insurance policy of Br 36,000 on July 1, 2002 that will be allocated to the next three years evenly for financial accounting purposes but immediately deductible for tax purposes. Required: Determine the taxable business income and before tax accounting income and calculate deferred tax credit for the tax year ended June 30, 2003 assuming a flat tax rate of 30%.

Illustration 10.2: Assume that in the year ended June 30, 2004 Ethio Trading Enterprise
(PLC) reported Br 270,000 revenues for both the tax purposes and financial accounting purposes. It also reported expenses of Br 206,000 for both the tax purposes and financial reporting purposes excluding insurance expense. Required: Determine the taxable income and before tax accounting income and calculate the deferred tax credit for the year ended June 30, 2004 assuming a flat tax rate of 30%.
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Temporary Differences and Deferred Tax Assets
A deferred tax asset is a result of deferred tax consequences that are attributable to deductible temporary differences. In other words a deferred tax asset represents the increase in taxes refundable in future years as a result of deductible temporary differences existing at the end of current tax period or tax year. It is resulted from differences in book basis liability and tax basis liability.

Illustration 10.3: Assume that BETA Book Publishing (PLC) earned and collected Br
150,000 book publishing fee in 2003 for both the book purposes and tax purposes. The business incurred book publishing expenses of Br 140,000 out of which Br 90,000 is paid in cash. The company uses cash method of accounting for tax purposes and accrual method of accounting for financial accounting purposes. Required: Determine the Taxable and Accounting Income assuming a tax rate is 30%.

Illustration 10.4: Continuing with the above illustration, revenue earned and collected cash
for tax purposes and book purposes is the same Br 180,000. The Book publishing company incurred book publishing expenses 120,000 but paid expenses of Br 160,000 in the tax year 2004. This indicates that Br 40,000 accrued liabilities are paid during the year which is an expense of the year 2003. Required: Determine taxable income and book income assuming 30% flat tax rate in the tax year 2004.

10.4) Accounting For Operating Losses
Operating Loss may be Carried Backward and Carried Forward. An operating loss is used to offset either the Taxable Future Income or Taxable Past Income. An operating loss occurs for tax purposes in a year when tax deductible expenses exceed or greater than the taxable revenues in certain countries where the tax laws permit tax payers to use the losses of one year to offset the profits of other years by carrying losses forward or backward. Loss Carry Backward and Carry forward can also create a difference in taxable income and accounting income as discussed in unit four.

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Chapter Eleven: Tax Planning and Tax Minimization Methods

Chapter Eleven Business Tax Planning
Chapter Outlines:
     What is Tax Planning Tax Minimization Methods: Tax Evasion, Tax Avoidance and Tax Planning Tax Planning Techniques Tax Planning Skills Tax planning and Corporate Financing

Chapter Objectives
After completing this chapter, you would be able to:
     Define tax planning Compare and Contrast Tax Planning with Tax Avoidance and Tax Evasion Understand and apply tax planning techniques Grasp the tax planning skills Apply tax planning on corporate financing

Time Required: 4 Hours Chapter Pre-Requisite: Acct 202

11.1) What Is Tax Planning?
 Nobody likes paying taxes. Thus, everybody tries to minimize taxes. This shall be legal. To



  

become more tax efficient year round, taxpayers have to know the spelled out implications; warning about consequences; plenty of useful tips and others. Tax Planning has become an important feature of all business enterprises, new or old, small or big, public or private. Tax Planning is an arrangement of one’s financial affairs in such a way that, without violating in any way the legal provisions full advantage is taken of all tax exemptions, deductions, concessions, rebates, allowances and other relief or benefits permitted under the tax laws so that the incidence of tax is reduced to minimum thereby ensuring that the money remaining after payment of tax is kept as high a level as possible. Tax Planning is a legitimate arrangement of one’s financial activities in a manner that reduces or defers (postpones) the related Income Tax Expenses Tax Planning is a systematic way of organizing and planning for taxes. Effective business tax planning should be a year-round effort. Business Tax Planning means estimates and programmes that a company carries to minimize the Tax Liability apart from fulfilling legitimate expectations and aspiration of the people. Business Tax Planning demands a through examination of all laws of taxation as failure to recognize the tax implications of business decisions can have serious consequences for the survival and growth of the business, while a step in the right direction could mean a considerable saving of sources; a wrong step will bring disaster to the enterprise. Thus, to avoid uncertainties in future in regard to the tax liability and to avoid harassment at the hands of tax authorities in the matter of assessment, the company should resort to tax planning in its own interest.

11.2) Tax Minimization Methods: Tax Evasion, Tax Avoidance, and Tax Planning
Three methods of saving taxes have been developed in most countries of the world in the past few decades: Tax Evasion, Tax Avoidance and Tax Planning. A great deal of confusion prevails
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in the Business Sector about the correct connotation of these terms. Hence we shall attempt to explain these terms to show that Tax Planning is absolutely legal.

Tax Evasion
Tax evasion is by no means a tax planning because it is a criminal act or offence. It is a commission or omission of an act with the intention to deceive the tax authority. The taxpayer is evading and trying to escape a legally matured tax liability or obligation by dishonest and fraudulent means. Tax evasions might involve simply failing to report income or trying to create excess deductions or False Deductions. The Failure to report income can also be broken down into two subcategories: (A) Evasion of tax on income that is legally earned; and, (B) Evasion of tax on income that arises from an illegal activity such as trafficking in narcotics and other drugs. An example of tax fraud on legally earned income would be the formation of sales companies that appear to deal only with unrelated parties, but in fact deal with related parties, hiding the fact that one owns a particular tax haven corporation. These tax haven corporations are also used to hide corporate receipts or slush funds. It is dubious way of attempting to solve tax problems. Hence tax evasion is illegal, unethical and uneconomical as well. Thus, it should be condemned not only by the Government but by the Businesses as well.

Tax Avoidance
Tax Avoidance is not the same as the tax planning even though the transactions undertaken seem legal and with the spirit and intentions of the tax proclamations and regulations. Tax Avoidance is taken to refer to arrangements by which a person acting within the tax laws reduces his true tax liability, infringing in the process both the spirit and the intention of law. In other words tax avoidance is the art of dodging Tax Authority without breaking the law. It means acting within the framework of law or acting as per the language of law only in form, but murdering the very spirit of tax law and thus acting against the intention of tax laws and defeating the purpose of particular legal enactment. In short, tax avoidance is taking advantage of loopholes in tax laws. Taking advantage of tax loopholes provides a short run benefit because when the loopholes are made public, legislative step will be taken by the Tax Authority.

Tax Planning
Tax planning is a method of planning business affairs by considering the incentives and benefits provided by the legislature. Tax planning takes the maximum advantages of the exemptions, deductions, rebates, relief and other tax concessions allowed by taxation statutes leading to the reduction of the tax liability of the taxpayer. As compared to Tax Avoidance, tax Avoidance is viewed with displeasure by the tax authority as it is an art of escaping the a matured burden of tax without breaking the law and this provides only a short term benefit. On the contrary, tax planning by businesses cannot be called a crime or illegal activity or an immoral action. What constitutes a crime is tax evasion or what is undesirable is tax avoidance, but tax planning benefits the company as well as community. It enables a company to save a good deal of tax and also avoid unwarranted harassment, worry and tension.

11.3) Techniques of Tax Planning
The mechanics of tax planning demonstrate basic techniques that can be used to help make more efficient tax planning. The following tax planning techniques can be used to minimize taxes: 1. Shifting income of one period to another period (Timing Decisions) 2. Transferring income of one entity to another entity (Income Shifting) 3. Converting one type of income to another type of income (Conversion of Income) 4. Keep track of business interest expense deductions
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Chapter Eleven: Tax Planning and Tax Minimization Methods

5. 6. 7. 8. 1. 2. 3. 4. 5. 6.

Change the structure of business Invest in tax-wise ways Use of opportunities in foreign Countries Use of losses among a related group of companies

11.4) Skills Required for Good Tax Planning
Anticipation skills – ability to predict the future accurately Speculation – speculative activities that minimizes taxes Flexibility – watching the Tax Situations of a country Understanding time Value of money – in terms of interest Risk Assessment – tax related risks Common Sense – familiar knowledge and intelligence in tax saving. Common factors in all tax planning are Cash flows (Inflow and Outflow) and fluctuation in Tax Rates 7. Perspective (tax is only one consideration)

11.5) Tax Planning and Corporate Financing
There are three usual methods of financing a business: Debt (Borrowing from others), Equity (Investment by Shareholders or owners) and Leasing.  The real cost of debt is the after-tax cost of interest payment  The Real Cost of Leasing is the After-tax cost of Rental payments  The Real Cost of Equity payment of dividend which is not deductible and which must be paid for using after tax Birr amount. Example 11.1; Assume you need to raise Br 100,000 and your company is in the 30% tax bracket. The dividend paid on the shares will be 10% (assume they are common shares) and the interest that must be paid is also the same 10%

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Chapter Twelve Tax Administration
Chapter Outlines:
    Overview of Tax Administration Structure of Tax Administration in Ethiopia Development of Tax Administration in Ethiopia Problems of Tax Administration in Ethiopia

Chapter Objectives
After completing this chapter, you would be able to:
       Define Tax Administration Understand criteria used to evaluate good tax administration Discuss types of taxes collected by Federal government and State governments Comprehend revenue sharing between Federal Government and State Governments in Ethiopia Differentiate Federal Taxpayers and State Taxpayers in Ethiopia Identify measures taken to improve tax administration in Ethiopia Understand the existing problems in tax administration

Time Required: 4 Hours Chapter Pre-Requisite: Acct 202

12.1)

Overview of Tax Administration

Tax administration refers to the systematic organization and arrangement of elements to collect taxes from taxpayers and to undertake other similar activities by the Tax Authorities of the Federal Government, State and Local Governments. A good tax administration has:  Management system through which it carries out its activities  Tax Laws or Codes that guide the tax management system  Knowledgeable Administrator All governments give much attention to Tax Administration. Tax Experts suggest a number of requirements or criteria for an effective and efficient Tax Administration. These include:  Simplification of the Tax Procedures  Establishment of separate units to support and develop new tax proposals and to analyze the revenue and economic aspects of changes  Provision of training to employees who engages in tax assessment and estimation. There are two types of assessment: Statutory Assessment or Government Assessment and SelfAssessment  Development of a good accounting system  Monitoring closely the behaviour of taxpayers  Numbering of taxpayers  Provisions of relief to industries facing difficulty  Viewing taxpayers more as a clients than as enemies  Encouraging self assessment  Educating taxpayers by distributing booklet, public notices, explanations, etc  Decentralizations of tax Administration  Encouraging Tax Withholding and Record Keeping

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Chapter Twelve: Tax Administration

12.2) Tax Collection Structure in Ethiopia
 Ministry of Revenue: Ethiopian Customs Authority, National Lottery Administration and

Inland Revenue Authority (Federal or Regional). The Inland Revenue Authority is classified into two: Federal Inland Revenue Authority and Bureaus of Regional Inland Revenue Authorities.  Federal Inland Revenue Authority and Bureaus of Regional Tax Authorities collect the all the direct costs (Employment Income Tax, Business Profit Tax, Rental Income Tax and Other Income Tax) and three of the four indirect taxes (Value Added Tax, Turnover Tax and Excise Tax).  The Ethiopian Customs Authority is responsible for Collecting Customs Duty. But the responsibility for collecting is not mutually exclusive. Even though the main responsibility of the Ethiopian Customs Authority is collecting Customs Duty, it has to collect Excise Tax, Value Added Tax and Withholding Tax on imported goods on behalf of the Federal Inland Revenue Authorities and Bureaus of Regional Inland Revenue Agencies.  The Ethiopian Federal Democratic Republic Constitution has separated the tax revenue to be collected by the Federal Government and State Governments (Article 95 to 100)

Federal Power of Taxation
 The Federal Government shall levy and collect custom duties, taxes and other charges on

imports and exports.
 It shall levy and collect income tax on employees of the Federal Government and

       

international organizations. But now, the case of international organizations is given to the Addis Ababa Region. It shall levy and collect income, profit, sales (VAT and Turnover Tax) and excise taxes on enterprises owned by the Federal Government. It shall tax the income and winnings of national lotteries and other games of chance. It shall levy and collect taxes on the income of air, rail and sea transport services. It shall levy and collect taxes on income of houses and properties owned by the Federal Government; It shall fix rents and services rendered by organs of the Federal Government. It shall levy and collect taxes on monopolies. It shall levy and collect Federal stamp duties. The Federal Government using the two offices FIRA and Ethiopian Customs Authority collect the above taxes

State Power of Taxation
 States shall levy and collect income taxes on employees of the State and employees of

   

private enterprises within States shall determine and collect fees for land usufractuary rights (Land Taxes) States shall levy and collect taxes on the incomes of private farmers and farmers incorporated in cooperative associations States shall levy and collect profit and sales taxes on individual traders carrying out a business within their territory States shall levy and collect taxes on income from transport services rendered on waters within their territory They shall levy and collect taxes on income derived from private houses and other properties within the State.
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Tax Accounting (ACCT-332)

 They shall collect rent income on houses and other properties they own.  States shall levy and collect profit, sales, excise and personal income taxes on income of

enterprises owned by the States.
 States shall levy and collect taxes on income derived from mining operations, and

royalties and land rentals on such operations.
 They shall determine and collect fees and charges relating to licenses issued and services

rendered by State organs.
 They shall fix and collect royalty for use of forest resources

Concurrent Power of Taxation
 The Federal Government and the States shall jointly levy and collect profit, sales, excise

and personal income taxes on enterprises they jointly establish.  They shall jointly levy and collect taxes on the profits of companies and on dividends due to shareholders.  They shall jointly levy and collect taxes on incomes derived from large-scale mining and all petroleum and gas operations, and royalties on such operations. Types of Joint Revenue 1. Jointly Established Companies  Profit Tax  Employee Income Tax  Indirect Taxes 2. Private Companies  Profit Tax  Indirect Taxes  Dividends 3. Minerals and Petroleum  Profit Tax  Royalty Revenue Sharing Ratio Federal Government State Governments As per Capital Share As per Capital share 50% 50% 70% 30% Federal Government State Governments 50% 50% 70% 30% 50% 50% Federal Government State Governments 50% 50% 60% 40%

Undesignated Powers of Taxation The House of the Federation and the House of Peoples’ Representatives shall, in a joint session, determine by a two-thirds majority vote on the exercise of powers of taxation which have not been specifically provided for in the Constitution. Directives on Taxation  In exercising their taxing powers, Sates and the Federal Government shall ensure that any tax is related to the source of revenue taxed and that it is determined following proper considerations.  They shall ensure that the tax does not adversely affect their relationship and that the rate and amount of taxes shall be commensurate with services the taxes help deliver.  Neither States nor the Federal Government shall levy and collect taxes on each other’s property unless it is a profit-making enterprise

12.3)

Development of Tax Administration in Ethiopia

The following are the notable steps taken by the government of Ethiopia to enhance efficiency in tax administration:  Establishing of a separate unit – FIRA
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Chapter Twelve: Tax Administration

Performance of tax audit Confidentiality of taxpayers’ information Code of conduct for tax authority employees Cooperation of other entity TIN (Taxpayer Identification Number) Introduction of Tax withholding system Record Keeping Requirement for Taxpayers Establishment of Review Committee and Tax Appeal Court Provision for Tax Relief Reward for outstanding performance Convenience of Tax Payment System – Businesses can directly remit the amount of tax to banks with which the FIRA is doing.  Taxpayers’ information series – the tax authority is providing information to the tax payers through leaflets and other publications  Automation of the Tax Collection System
          

12.4)

Problems of Tax Administration in Ethiopia

 Tax Declaration Forms – there are problems to declare in prescribed forms until July,

2006. still there is no declaration form (Tax Return) for Rental Income Tax, Turnover Tax, other Income Tax and Business Profit Tax  Unskilled Employees – when withholding system is introduced into the taxation system of the country even the tax officers are not aware of the system. Still the officers are not well trained and educated. This may relate to the ability to employ and retain highly qualified professionals because of low salary scale.  Lesser Probability of Tax Audit by the Tax Authority – Event though Tax Audit is introduced to the taxation system of the country, the Tax Audit is not performed in the required manner to find out tax evaders  TIN is not given to all taxpayers. Employees of either government or private organizations are not given Tax Identification Number (TIN)

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