HARAMBEUNIVESITYCOLLEGE

FACULITYOFBUSINESSDEPART
MENTOFACCOUNTING

PROPOSAL ON AN ASSESSMENT ON THE

VAT COLLECTION PROBLEM IN THE CASE
OF AFAR REGION REVENUE BEAURO OF
AWASH 07 TOWN
BY:-

1.EbrahimAwole 40/07
2.HareguaKasaye 4050
3.MohammedkedirAli
4.EredatGetachew 4007
5.MuluneshSamuael 4022

Advisor: Wendessen feleke

May, 2019
Awash, Ethiopia
Table of Content

Page

ACKNOWLEDGMENTS.....................................................................................................................................i
ABSTRACT....................................................................................................................................ii
TABLEOFCONTNTE....................................................................................................................iv
LIST OF TABLES & LISTOFFIGURES.....................................................................................vi
CHAPTER ONE..............................................................................................................................1

1. Introduction............................................................................................................1

Background of the Organization......................................................................................................................2

Statement of the problem........................................................................................................3
Research Questions.........................................................................................................................................3
Objective of the study......................................................................................................................................4
Significant of the study....................................................................................................................................4
Scope and delimitation of the study.................................................................................................................4

2. Review of related literature....................................................................................................................7

2. 1 Theoretical Literature review....................................................................................................................7

Definition of Tax…..........................................................................................................................................7

Definition of VAT..................................................................................................................8

Ethiopian values Added Tax Administrative and collection..........................................................................10

What is value added Tax as proclamation.....................................................................................................10

Supplies and rates forVATcomputation.........................................................................................................13

Seizure of property tocollectVAT..................................................................................................................15

Filling to Tax return and paymentofVAT.......................................................................................................16

VATrefund 16

VATAssessment 16

VATinvestigation 17

Advantage and DisadvantageofVAT..................................................................................17

AdvantageofVAT.............................................................................................................17

DisadvantageofVAT........................................................................................................18
 TheVATexemption.............................................................................................................19

TheVATsystem...................................................................................................................20

ComputationofVAT............................................................................................................20

VATAdministrative............................................................................................................21

Modernization VATcollectionsystem...............................................................................21

2.2. EmpiricalLiteraturereview.....................................................................................................22

3. ResearchDesignandMethodology
3.1 Research Design and Methodology................................................................................................24
3.2 Organization of the paper...............................................................................................................25
 List of Tables & Figures

Table 3.1.Background information of branch staff....................................................................................24

Table 3.2. Background information of tax payers.....................................................................................25

Fig 3.1. Response on importance of VAT.................................................................................................26

Fig 3.2. Effectiveness of vat collection practice........................................................................................27

Fig 3.3. Tax payers level of awareness......................................................................................................28

Fig 3.4. Response on importance of Tax...................................................................................................30

Fig 3.5. Response on level of awareness among Tax payers...................................................................30

Fig 3.6. Sources of information for awareness..........................................................................................31

Fig 3.7. Effectiveness of vat collection practice........................................................................................32

Fig 3.8. The impact of inefficient VAT Collection practice.......................................................................32

 CHAPTER ONE

INTRODUCTION

Background of the Study

Currently, one of the priorities of the Ethiopian government is to bring rapid and sustainable
development in the country. The achievement of this rapid and sustainable development requires
mainly sustained and dependable domestic revenue mobilization which otherwise be a dream to
realize government vision depending only on external finance sources, which is subject to
uncertainty. In order to realize domestic revenue mobilization objectives, the role of taxation is vital.
The newly implemented overall tax reform program of Ethiopia consists of Direct and Indirect
taxation scheme. Direct tax includes employment income tax, business income tax, rental income
tax and other income tax. On the other hand, indirect tax includes VAT, excise tax, customs duty
and sur-tax is the heads of indirect taxes in Ethiopia (Misrak,2008:303).
Ethiopian government has introduced Value Added Tax (VAT) in 2003GC as a replacement to sales
tax. Currently VAT is the principal source of revenue for the government. For example, in 2006-
2007GC fiscal year, federal VAT revenue accounted for about 41 percent of total federal tax
revenues from domestic sources (wollelaA, 2008). According to wollela, VAT has been more
productive than sales tax since its introduction. To sustain VAT’s revenue role in government’s
finance it is important to ensure that revenue collection through should be as effective as possible.
However, in Ethiopia revenues generated through VAT is usually garnered at the expense of erosion
in its salient features. This may be caused by factors including poor VAT administration, i.e., the
incapability of tax authorities to implement the attributes of the tax in practice. A good tax
administration is essential in fully implementing the design feature of VAT and achieving
government‘s policy objectives at large (Wollela A, 2008).
VAT collection as the main part of VAT administration. It should be given a great concern for it.
This is due to the fact that an overall VAT administration effectiveness of any tax collection office
measured by its’ capability to collect what it have to. ERCA currently collects at different level and
collection center. Among these small scale tax payers office collect and administrate VAT at sub
city level. Problems associated with the collection of VAT should be study to find possible solution
thatgiveustheoverallpictureofVATadministration.therefore,ThisstudywillfocusonVAT

collection problems of Addis Ketema Sub City small scale tax payers office merkato N.O 1 branch
office and forward possible solution for it.
Background of theOrganization
The Ethiopian revenues and customs authority (ERCA) is the body responsible for collecting
revenue from customs duties and domestic taxes. In addition to raising revenue, ERCA is
responsible to protect the society from adverse effects of smuggling. It seizes and takes legal
action on the people and vehicles involved in the act of smuggling while it facilitates the
legitimate movement of goods and people across the border. The ERCA traces its origin to July
7,2008 as a result of the merger of the ministry of revenues, the Ethiopian customs authority and
the Federal Inland revenues into one giant organization. According to article 3 of the
proclamation No. 587/2008, the authority is looked upon as “an autonomous Federal agency
having its own legal personality”. The authority came into existence on 14 July 2008, by the
merger of the ministry of revenue, Ethiopian customs authority and the federal Inland revenue
authority who formerly were responsible to raise revenue for the Federal government and to
prevent contraband. Reasons for the merge of the foregoing administrations into a single
autonomous authority are varied and complex. Addis Ababa as the capital city of Ethiopia was
established in 1986 Addis Ababa has 10 sub cities and each sub city is divided in to Woredas,
which are the smallest administrative, unites of city Addis ketema sub city, which is one of the
sub cities in central part of Addis Ababa and the branch which understudy. Until December
2010, Addis Ketema sub city revenue office was one of the offices in the Adds ketema sub city
administration. According to ERCA (2011), due to the agreement concluded between the Addis
Ababa city Administration and ERCA after December 2010 the Addis Ababa Revenue
Authority and ERCA Have merged and four tax payer’s branch office emerged. Micro tax
payers’ Branch include those taxpayers whose annual turnover is not greater than Br 100,000
and administrate in Woreda level, small tax payer’s branch include those tax payers whose
annual turnover is greater than Br 1,000,000 and not more than one million Birr and minister at
sub city level; medium tax payers Branch include tax payers whole annual turnover is greater
than one million but not more than 15 million and administrate city level and large tax payers
branch include tax payer whole annual turnover at Federal level. Therefore, Addis Ketema Sub
City revenue called Addis Ketema Sub City small scale tax payers’ branch under ERCAonly
interms of administration and transfer the tax collected to the Addis Ababa city treasury including
VAT.

Statement of theproblem
Value Added Tax (VAT) is abroad tax imposed on consumption of goods and services. It is
collected at all stages in the production and distribution process. Ethiopian Revenue and
 Customs Authority (ERCA) have an authority to administer the VAT .It uses small scale branch
offices as the main collection center of VAT and other types of taxes. The branch offices have a
number of problems related with assessing, collecting and administrating VAT that makes
ERCA not to collect the potential tax which the authority can generate. Among the problems
characterized in most small scale tax payers branch office related with VAT are huge refund,
weak audit and enforcement of the tax office and low level of voluntary compliance.
Addis Ketema sub city small scale tax payers Merkato No. 1 branch office faced similar
problems as other small scale branch of the city that makes it not effective in collecting the
potential tax from registered tax payers as well as unregistered potential tax payers in the sub
city. These problems were needed to be studied and solved to establish effective VAT collection
process for the branch. Therefore this study assessed VAT collection system of the Merkato
small scale taxpayers’ branch office and identify the real causes of the branch is VAT related
problems mentioned above, and it recommend some possible solution.
ResearchQuestions
This study has answered the following research questions
1. What procedure used by the branch (Merkato NO 1.Small scale tax payers office) for
VAT assessment andcollection?

2. How is the VAT payers’ level of awareness about VAT and its complianceadequate?

3. How the branch is VAT administration is proper andefficient?

Objective of theStudy
GeneralObjective
The general objective of this research was to assess VAT collection problem in the case of

Merkato No 1 small scale tax payer’s office and to recommend for some possible solution to

minimize the problem.

Specific Objectives of the study

To achieve above general objective, the following Specific objectives are formulated to be

performed:-

 To assess effectiveness of VAT assessment mechanisms in Merkato No .1

branchoffice,

 To assess VAT payer’s level of awareness and their compliances,

  To evaluate the conformability of VAT collectionmechanisms
Significance of theStudy
 Improve tax administration by identifying thegap

 Enhance the research skill of the students involved in theresearch

 To have a clear picture on how the VAT collection and assessment are taking
place

 It could be used as major reference/secondary source for those who want to

perform further study on the same subjectmatter.
Scope and delimitation of theStudy
Our study was encompassed to carrying out a detail examination, especially on the VAT
collection problems of the merkato No. 1 small scale tax payers office on the basis VAT
administration of aspect of ERCA . In order to describe the current status of the office and to
make the scope manageable the study will use the most recent five years data from the fiscal
year 2001EC up to 2005 EC.

CHAPTER TWO

2. REVIEW OF RELATED LITERATURE

This section presents a brief review of existing theoretical and empirical literature of Value
Added Tax (VAT) Collection. At the end of the review, an attempt is made to summarize the
major drawbacks of the existing empirical studies and to identify the knowledge gap to be filled
in by further investigation.
Theoretical LiteratureReview
Definition ofTax,
Tax is a compulsory contribution or unrequited payment by the people to the government for
which there is no direct return to taxpayers. A tax is a generalized exaction which may be levied
on one or more criteria upon individuals, groups of individuals, or other legal entities (Bhatia,
2002).Taxation is a system of rising money to finance government. All governments require
payments of money –taxes- from people. Without taxes to fund its activities, government could
not exist.
Throughout history, people have debated the amount and kinds of taxes that a government
should impose, as well as how it should distribute the burden of those taxes across society.
Unpopular taxes have caused public protests, riots, and even revolutions. In political campaigns,
candidates’ views on taxation may partly determine their popularity with voters.
The Ethiopia tax system classifies taxes in to two major categories as direct and indirect taxes.
In indirect tax both incident and tax impact lies on the taxpayers. It mostly known by four
schedules as schedule A-income from employment, schedule B- income from rental of building,
schedule C-income from business profit and schedule D-otherincome.
Income from employment excluded the first Birr 150 per month of taxable employment income
and its minimum and maximum rate is 10% and 35% respectively. Income from rental of
building excluded the first birr 1,800 per year of rental income from taxable income. The
minimum range of income tax is 10% and the maximum is 35%. Income from business profit
depends on whether the taxpayer is incorporated or unincorporated. For unincorporated entity
the first birr 1,800 per year of business profit income is excluded from taxable income. The
minimum range of income tax is 10% and the maximum is 35%. The tax rate for incorporated
ones is 30%. Schedule D (commonly known as other income) includes income from
royalties,income paid for services rendered outside of Ethiopia, income from games of chance,
dividends, income from casual rental of property, interest income, gains on transfer of certain
investment property and income from agricultural activities. It executed the rate by applying
proclamation set by House of People Representatives, Regulation set by council of Ministers
and Directives set by tax Authority.

Unlike direct taxes, indirect taxes are not directly paid by individuals and enterprises from
income derived. Indirect taxes collected from customers. Indirect taxes are levied on locally
produced and imported goods and services rendered. In Ethiopia, the government has given due
attention to indirect taxes. The main reason for the shift in emphasis is that about 75% of the
Federal Government revenue is collected from indirect tax. Indirect taxes include Value Added
Tax (VAT), Turnover Tax (TOT), Excise Tax, Stump Duty and Custom Duty. VAT obliged to
those who register as VAT payers and their taxable annual turnover is above Birr 500,000 the
standard VAT rate is 15%, while exported goods are treated as zero rate. TOT is payable on
domestically produced and sold goods; including on services rendered by a person not
 registered for VAT and whose annual turnover is below 500,000 Birr. 2% and 10% are rates for
goods services respectively even if there are specific goods and services exempted from TOT.
Tax imposed on limited number of imported and/ or locally produced goods refers to excise tax.
It is imposed on luxury goods and basic goods, whose demand is inelastic. The computation of
excise tax is based on cost of production and Cost, Insurance and Freight (CFI) value for locally
produced and imported goods respectively. But, the rate differs accordingly the type of goods.
The two duties stump and customs are among the types of indirect taxes. Stump duty is
chargeable on instrument with stump duty in respect of any amount expressed in any currency,
other than Birr. However, custom duty paid when goods imported in to the country based on the
criteria specified by law on tradable goods for individual or organization service (ERCA
Statistical Bulletin, VOL 11,2011).

Definition of VAT
Value Added Tax (VAT) a tax on consumption levied whenever the value of goods and services
increases as they change hands in the course of production, distribution, and final sales to the
consumer. For example, a manufacturer pays a VAT on the materials it buys to make a product,
a wholesaler pays one on the price it pays a manufacturer for a good, and a retailer pays one
onthe price it pays a wholesaler. Price paid by consumers also includes VATs, reflecting the
cost of providing goods and services for sale. VAT work on the assumption that value is added
at every stage, and taxes should be levied on amounts of value added. This distinguished VATs
from sales taxes, which are based simply on the retail price of goods. (“Value-Added Tax”
Encarta 2009)
In this system the seller pays the government a percentage of the value added to goods or
services at each stage of production. The value added at each stage of production is the
difference between the seller’s costs for materials and the selling price. In essence, a VAT is
just a general sales tax that is collected at multiple stages. VAT is belongs to the family of sales
taxes and a tax not on the total value of the goods being sold, but only on the value added to it
by the last seller (Bhatia,1994:152-153).
According to Rosen (1988), Value Added Tax (VAT) is a percentage tax on a value Added
applied at each stage of production. It is a type of indirect tax, nowadays found in More than
130 countries and has become the principal source of revenue for many Countries (Keen and
Lockwood, 2007). In Ethiopia, according to IMF (2003), one of the Focuses of the tax policy
reforms is reforming indirect taxation. The main reform to Indirect taxation was the introduction
of VAT in January 2003. However, weak tax Administration, particularly in developing and
 transitional economies is the principal Impediment to the successful implementation of VAT.
The same is true in Ethiopia as well in Addis Ababa (Yesigat, 2008). In Addis Ababa, according
to BoFED (2009), lack of capital expenditure for public investment has hindered sustained
economic Development. Therefore improving tax administration, particularly VAT
administration helps the Addis Ababa city to improve its revenue through voluntary
compliance. Almost unknown in 1960, VAT is now found in more than 130 countries, raises
around 20% of the world’s tax revenue (Keen and Lockwood, 2007). According to Ulbrich
(2003) it was a surprisingly popular revenue tool in South America, Asia andAfrica.
In Ethiopia, one of the focuses of the tax area is indirect tax The main reform to indirect
taxation was the introduction of a VAT in January, 2003 as a replacement to Sales Tax.
Compared with the replaced sales tax, the new VAT have the advantages, (1) taxes services in
addition to production, (2) grants zero rating to exports and (3) gives exemptions to fewer basic
products.
In order to make up sufficient revenue from VAT it needs efficient and effective tax administration.
However, developing countries like Ethiopia, where there is a large number of informal sector, low tax
moral, rampant evasion, and total distrust between tax administration and taxpayers may not make the
tax successful. One of the reasons is lack of simplified procedures. In VAT administration, there should
be a concern for small businesses because as compared to the burden of VAT administration on large
businesses, the cost of administering VAT is proportionally high for small businesses.
To that effect, many countries adopt simplified procedures for small and medium businesses
like, allowing accounting for VAT on a cash basis rather than accrual basis and filling within
reasonable accounting period, however this is not the case in Ethiopia.
According to Yesegat (2008) the VAT administration is poor due to many factors, particularly
incapacity of tax authorities to implement the attributes of the tax to practice.
Ethiopian Values Added Tax Administration andcollection
What is Value Added Tax AS perproclamation?
As the student researcher tried to mention earlier that VAT replaces the sales tax on
manufactured and imported goods and services in Ethiopia January 2003 (FDRE VAT
Proclamation No. 285/2002). According to this proclamation, VAT in Ethiopia is payable if
they are: supplies make in Ethiopia, made by a taxable person, made in the course of
furtherance of a business, are not specifically exempted or zero rated. Supplies, which are made
in Ethiopian, not exempt known as taxablesupplies.
As it was also tried to mention earlier that, VAT is an indirect tax type, which is imposed on
consumption or spending. VAT is collected from sales of the value added of goods and services,
starting form importers and producers ending with consumers through the conditions of whole
selling and retailing.

VAT applied on the value added meaning a producer for example provides final product to sell,
performs different activities like spending direct and indirect costs and administrative cost
except VAT and prepaid income tax. Doing that, value is created. This value is liable to tax,
(FDRE VAT Proclamation No. 285/2002).
VAT is imposed only on the value created up on production and distribution but not on the
cumulative return. Therefore, it avoids tax cascading burden using this method. This tax follows
the procedures of refunding or credit input tax that is paid on purchasing inputs for productionof
goods or provision of services. Again, it is paid for the sales of output. It is based on invoice in
order that it reconciles the input tax against output tax.
Thus, record processing is mandatory to balance them. Therefore, modern accounting method of
business system is being practical as the result of VAT introduction, (Misrak Tesfaye, Msc,
2008).

INPUT TAX: The VAT charged on creditors for VAT charged on business purchases and
recollect on sales .not only the VAT on the purchases of raw materials or on goods purchased
for resale, but also the VAT on things like, office equipment of the business, commercial
vehicles used in the business for the carriage of goods, the telephone bill for the business, and
payments for services in connection with thebusiness,
Accountants, Lawyers fee’s. It does not include VAT paid on goods or services for someone
else’s business or VAT on private purchases, such as furnishings for the home of the proprietor.
VAT charged in these circumstances is not considered as input tax, (FDRE VAT Proclamation
No. 285/2002).
Input tax are credited, however there are cases of purchasing which cannot be allowed as credit
passenger automobiles, the repair and maintenance of passenger automobiles unless the
business is dealing in or hiring such automobiles entertainment. Credit for input tax needs
supporting documents original copy of a tax invoice, or certified customs import declaration-
warehousing entry to substantiate a claim for input tax credit. FDRE VAT Proclamation No.
285/2002)

Output Tax: The VAT charged on customers. It is only the taxable person who charges VAT
in the course of effecting supplies. It is applied on taxable supplies. The rate, which is used for
calculating for VAT on output, is standard rate. In Ethiopian case, standard rate is 15%, as the
 proclamation stated, (FDRE VAT Proclamation No.285/2002).
Taxable supplies: According to VAT proclamation, VAT is chargeable on all taxable supplies.
The sales of goods or service in the businesses for which are tax paid on them are taxable
supplies. It is possible to supply goods and service in the reference of VAT, if supplier has right
to make such activities.
Rate of VAT: There are two rates of VAT, which are standard rate and zero rates 15% and 0%
respectively. Tax rates are applied to tax base to determine a taxpayer’s liability, (Willis,
Eugene et.al,2007).

Gifts: The proclamation also stated that VAT is accounted on any gift of goods or services form the
business based on the fair market value of the goods or services at the time the supply is made.
Cascading of the tax, tax on tax, is avoided by providing credit the tax paid at the preceding level. Unlike
the current sales tax system, where by relief is granted only to raw materials used directly in the
production of goods, under a VAT, relief is granted for tax paid on capital goods, distribution and
administration inputs. Sales of exported are not subjected to the VAT, (FDRE VAT Proclamation No.
285/2002).
Benefit: VAT removing the tax content, on input, from exported goods makes the goods more
competitive in international markets, domestically produced will be more competitive with
imported goods. In addition, relief from tax on capital goods will encourage investment;
potential investors consider VAT legislation as one of the factors in making favorable
investment decisions. VAT is less easily evaded, and the minimizing of tax avoidance supports
the maintenance of equality and fairness in the application of tax legislation, (Misrak Tesfaye,
Msc, 2008).VAT reduces unfair burden, has not been placed on the lower burden like the sale
and transfer or lease or immovable property the rendering of medical services, the rendering of
educational services, the supply of electricity and water and post office and the provision of
public transport permits and license fees. VAT includes concessions to small-scale business to
lessen the administrative burden, such as relief from the requirement to register, to collect VAT,
(FDRE VAT Proclamation No. 285/2002).

Registration forVAT
Registration for VAT is categorized in to three. These are obligatory, voluntary and special
business categories. The first category obligatory registration is made for any person conducting
a commercial enterprise or intending to conduct a commercial enterprise may apply to be
registeredforVAT.Howeverifthetaxableturnoveroftheenterprise,thatisgrossincomefor
12 calendar months exceeds or is likely to exceed birr 500,000 in Ethiopia, the person
conducting the enterprise must register for VAT, (proclamation No 285/2002 Article 8). sole
proprietor, company, partnership, trust, incorporate persons, unincorporated body, club or
association. Authority determine whether a person obligatory registrant if it makes (Ethiopia
VAT proclamation No.285/2005 Art. 16) birr 500,000 taxable turn over within 12 months of a
year. If one reasonably expects that during 12 months the total value of taxable supplies
excluding tax is likely to exceed birr 500,000, in Ethiopia, then the person needs to
beregisteredfor VAT. A registrant, the turnover on an ongoing basis, makes calculation of VAT.
Two periods need to be considered the past 12 calendar months and the next 12 calendar months
on a month-by-month basis. There is the need to estimate at the end of each trading calendar
month the total value of taxable goods and services supplied by all the business for the past 12
months. Where the total exceeds Birr 500,000, in Ethiopia, then there is the requirement to
register for VAT. The second category of registration is voluntary registration the total of
twelve months business transaction turnover may not necessarily be birr 500,000 in Ethiopia
case, however, if customers of a registrant are at least 75 % for supplies provided, a person is
allowed to be registered voluntarily. Things to be recognized in voluntary registration are those
who are involved in export advised to be registered voluntarily in order to get refund. This is
practical through zero rated purchases that enable the person to ask credit on input tax.
Otherwise, the person voluntarily registered, there may be the loss of customers who are VAT
registrants that nee invoice from their provider in order to claim input tax Credit. Therefore,
voluntary registration here is compulsorily required. Revenue Authority needs prerequisites like:
Permanent residential; proper accounting records; Bank account and; the one who obeys tax law
and that must have capacity to do what the Authority requires. The third category of
registration, special business categories that also have the following features: Those who are
involved in export are advised to be registered voluntarily in order to get refund. This is
practical through zero rate purchases that enable the person to ask credit on inputtax.
2.1.3.3 Supplies and Rates for VAT Computation

For VAT administration purposes in Ethiopia, the rates are computing in the following ways:
a). Taxable Supplies
VAT is collected from taxable supplies, which are imported or sold domestically Transactions
on which the tax is paid up on are where supplies: Made in the territory and produced or
provided by VAT registrants that are not exempted or zero-rated. Aid or exchanging similar
supplies from the business are liable to VAT. These values of derived from market price. In
case the value increases, tax should be adjusted in the form of aid or exchanging, (Abebe
Worku,2008).
b). VAT on Import

According to VAT proclamation of Ethiopia, all goods imported in to country are liable to
VAT, except zero-rated goods and exempt goods. The imported goods regardless of the goods
are private or for business purposes, and whether or not the importer is registered for VAT.
The VAT for importation is paid at the point of clearing the goods in the customs division of
ERCA of Ethiopian case.
VAT is paid that is due. However, VAT and TIN number should be provided on customs import
entry and declared if the goods imported are for the given business. If they are imported for
taxable business purpose, credit is claimed for the tax paid on the VAT tax return. The value on
which the VAT will have to be paid at importation is in accordance with the VAT law as the
CIF (cost, Insurance and Freight) duty plus the customs duty plus the cost of any service
supplied incidental to the delivery of the goods. The customs division will give the basis of
value for VAT purposes, as proclamation stated. Import credits are claimed for the VAT paid on
imports are applicable if, client is VAT registrant, the import must be for the business and not
for private use, the copy of the customs bill must of entry certified by customs as to the amount
VAT paid. This amount must entered in appropriate box on the VAT return and claim it as a
credit. A copy of customs bill of entry must beretained.
Service business conduct to give service in the country and registered for VAT then pays VAT.
If the service supplied by foreign who is not registered for VAT in Ethiopia, then Ethiopia
registrant must be accounted for VAT of service received from abroad. (Misrak Tesfaye, Msc,
2008).
c). Zero ratedSupplies
Supplies of zero-rate goods or services are business transaction, which VAT is chargeable as
0% (Zero rate). Supplies are taxable although no VAT is charged and the value of these supplies
forms part of the taxable turnover for registration purpose. Input tax could be claimed in full,
tax paid on purchases, credit related to zero ratedsupplies.
The supplies of export of goods or services treated by zero-rate. Goods are treated as exported
from Ethiopia if the goods are delivered to or made available at all address outside Ethiopia as
evidenced by documentary proof from customs acceptable by the concerned official of ERCA.
Services are treated as exported of the services are supplies for use or consumption outside
Ethiopia as evidenced by documentary proof from customs by concerned official of ERCA.
The rendering or supply of transaction or other services directly connected with international transport of
goods or passengers, as well as the supply of lubricants and other consumable technical supplies taken
on aboard for consumption during international flights. International transport of goods or passengers
occur where the goods or passengers are transported by road, rail, water, transportation from a place
outside
Ethiopia or another place outside Ethiopia where the transport or port of the transport is across
the territory of Ethiopia, or outside to a place of Ethiopia, the Ethiopia to outside.In addition,
supply of gold to the National Bank of Ethiopia from abroad. (Misrak Tesfaye, Msc, 2008).
d). VAT onExports
Exports are subjected to VAT at zero rates. VAT has no to be charged for the goods and service
would be exported, however, credit or input tax is claimed upon those supplies purchased to
produce the exports.
The one who is making taxable supplies even if it a nil rate and law requires that it will be
registered if the turnover exceeds the registration limits. Secondly if will be entitled to refund of
VAT from the authority if it exports, goods or services, and it will therefore be its interest to
register regardless of the level of turnover, to be able to claim VAT refunds, (Proclamation No.
285/2002).
e). ExemptSupplies
Supplies of exempt goods and services are business transactions on which VAT is not
chargeable at either the standard or zero-rate. Exempt supplies are not taxable supplies
2.1.3.4. Seizure of Property to Collect VAT
A person who has liability to pay VAT imposed by the law has to pay properly. However, this
may not be implemented as per expected. During this Authority is lawful to collect the tax by
seizing property equivalent to tax and administrative cost of managing seizure of property, as
per theproclamation.
Seizure extends only to property possessed and an obligation existing at the time the seizure is
made. Whenever the seizure properties are sold, the procedure to be followed is with public
auction or any other approved method by Authority after ten days of the seizure. However, for
perishable goods the authority decides appropriate time to sell.The person, whose property to
the seized should be notified before 30 days of seizure. However, if the Authority makes a
finding that the collection of the tax is in jeopardy, it does not necessarily to keep 30 days
period.
2.1.3.5 Filling of Tax Return and payment of VAT
Every registered person is required to file a VAT return with the Authority for each accounting
period, whether or not tax is payable in respect of that period; and to pay the tax for every
accounting period by the deadline for filing the VAT return.The VAT return for every
accounting period is filed no later than the last day of the calendar month following the
 accounting period. VAT on taxable imports is collected by the ERCA accordance with VAT as
per the customs legislation of Ethiopia under the procedure contemplated for customs duty,
(FDRE VAT Proclamation No.285/2002, Art.26).

VAT Refund
As of the official proclamation, VAT refund is practical 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
Authority refunds 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 excess
remaining after the end of this five-month period is refunded by the
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.
VAT Assessment
After review by the Authority, it appears that a person has understood his tax obligation. The
Authority issues an additional assessment within 5 years after the end of the accounting period
concerned; and in the case of fraud or willful negligence, not withstanding any limitation in any
other law, assessment make at any time. If the Authority makes an additional assessment within
30 days of the notice and demand, the person assessed does not pay the additional assessment
orappeal the assessment as provided in VAT proclamation, the person is in default,
(Proclamation No.285/2002, Art.29).
2.1.4.2.. VAT Investigation
Authority gets to mitigate VAT evasion through investigation activities. This is done through
qualified professionals in different disciplines. These help to investigate various tax offences
easily because most activities are identified through diverse expertise capacity. Tax evasions
mainly made by high taxpayers who are involved with VAT, such activities are due to deep
understanding of corruption seeking and supported by well experienced and skilled workers
capable to fraud the system.
VAT evasion offence can be treated with criminal penalty. The ordinal court treats the offence
made by taxpayers through the prosecuting. Such activities are processing with layers of the
 Authority. Offenders of tax evasion penalized in money as well by imprisonment as per the
criminal law states. Their names with offence they commit also publicized through mass media.
Exposing such offenders pertains to aware others keep the tax law as stated to be implemented.
Therefore, the Authority focuses investigations of VAT evasions in order to reduce corruption
in this sector. Ethiopia is treating such problem with VATproclamation.

Advantages and Disadvantages ofVAT

Advantages of VAT
As started Bhatia, 1994:148-150, the following are advantage of VAT.
1. VAT is a major source ofrevenue.

2. Domestically produced goods will be more competitive with importedgoods.

3. Relief from tax on capital good will encourageinvestment.

4. Literacy is noticeably higher in countries that adapted and VAT reduce tax distortions,
encourage investment by allowing input credits, broadens the tax base and ultimately raised
the revenuepotential.
5. Lesser tax evasion. Firstly this happens because the tax is divided into parts and therefore the
incentive to evade tax by any firm is reduced. Secondly, it is in the interest of a firm to
account for the taxes paid by earlier firms through which the inputs have come otherwise,
this firm pays that tax itself. It may firms, therefore understates its output, it will be
caughtbythe disclosure of the firm buying inputs from it. This type of cross-auditing enables the
authorities to plug the tax leakage.

6. VAT is conductive to efficiency since a firm is not exempted from its tax liability even if it
runs into a loss. It pays a tax not on its profits but on the value produced. It, therefore, tries to
improve its performance and reduce the cost ofproduction
7. Some goods should enjoy a tax exemption (zero tax rate) while the remaining ones need not be
subjected to uniform tax rate so multiple (including zero) rates are new commonly found in VAT
systems. A multiple tax rate variety can also easily accommodate credit system (that is, deducting
tax liabilities of a firm by the amount of taxes paid by other firms on itspurchases.
Disadvantages ofVAT
VAT, however, is not just a bundle of advantages. Rather it has serious limitations especially
for under developed countries because of which it has not yet become popular. As stated By
Bhatia, 1994:155-158, the following are disadvantages ofVAT.
1. VAT is complicated system and needs honest and efficient government machinery to do the
cross checking and link up various production activities and the resulting tax liability of each
 firm. It is, therefore, necessary that the country adopting it should also be sufficiently
advanced its financial and economic structure and the firm should be in the habit of keeping
properaccount.

2. VAT system depends a lot up on the cooperation of the tax-payers each firm itself calculates
its tax liability to begin with and also finds out the taxes paid by the earlier firms. Once
however, the sellers realties that the administrative machinery of government is in-equipped
to do all the necessary cross-checking, they will resort to the creation of false purchase
invoices showing taxes paid by others, to the extent this happens, tax evasion becomes a
major possibility and commonpractice.

3. Unless the rates of VAT are extraordinary high, the state would end up with smaller tax
revenue as against the collection from salestax.

4. Even if the taxpayers are fully honest, this system of taxation forces them to maintain
elaborate and costly accounts. This becomes uneconomical especially for the smallerfirms.

5. Critics of VAT doubt that it induces efficiency. They claim that is shortage economically like
ours speculative hoarding non-competitive price rise and similar practices are quite common.
In a seller’s market, producers and sellers have no incentive of their quality and highprices.

6. VAT requires a highly efficient administration and Competitivemarket.

The VAT Exemption
The following type of supplies of good or rendering of service are exempted:-(Misrak,
2008:375).
• Insurance and bankingoperation

• (http://www.conseco.ru/eng/abc/tax/small/vat3.htm) the seller or transfer ofused

dwelling or the lease of adwelling

• The rendering of financialservice

• The supply or import national or foreign currency (except for that usednumismatic
purpose) and ofsecurities

• The import of gold to be transferred to national bank ofEthiopia

• The rendering of religious organization or church relatedservice

• The import or supply of prescription drugs specified in directive issued by theminister

of health and rendering of medicalservice

• The supply of electric city, resource andwater

 • Good imported by the government organization, situation or projected exemption from
duties and other import tax to be extent provided by low or byagreement

• Supply by post office authorized under the Ethiopian Postal Service proclamation,other
than service rendered for free orcommission

• Some R&Doperation.

• Sale of companies employeddisabled

• Gratuitous aid

• Transfer of participatory share in limited liabilitycompanies.

The VAT
SystemHow does
VATwork?
The VAT due on a taxable sale is a percentage of the sales price but from this the taxable person
(VAT registered person) is entitled to deduct all the tax already paid at the preceding stage.
Therefore, double taxation is avoided and tax is paid only on the value added (incremental
value) at each stage of production and distribution. As the final price of a supply to consumer is
the sum of value added at each stage of the production and distribution chain, the final VAT
paid by the consumer is also made up of the sum of the VAT paid at each stage. (Misrak,
2008:316)

When the vendor is applied with goods or services by another vendor, VAT will be levied by
the supplier of those good or services the VAT on those goods or services received, is the Input
tax of the vendor who received those goods and services. When the vendor in turn supplies
goods or services to other persons (or vendors) VAT must be included in the output tax of the
vendor.
Output tax minus Input tax = VAT payable When input tax exceeds output tax, a taxpayer may
be allowed to carry the credit forward and a refund made after 5 months if inputs tax still
exceeds output tax.
Input tax minus Output tax = VAT refundable/credited
Computation ofVAT
Calculation of Net VAT Liability/Payable toFIRA
Though value added (VAT base) is often thought as the difference between a firm’s sales and its
purchases, VAT liability on sales may be calculated by three different methods; by subtraction,
credit or addition.(Misrak,2008:372)
a) SubtractionMethod
 Under this method, a taxpayer calculates its VAT liability by subtracting its cost of purchases
from other firms from its sales and applying the tax rate to the difference. With a
consumption VAT, the deduction for purchases would include any capital equipment brought
during the period. (ibid)

b) Credit/Invoice Method

Under the credit method, a firm’s tax liability is determined by allowing the firm to subtract
VAT paid on purchases from VAT due on its sales. The amount of deductible tax paid on
purchases would include the full amount of tax paid on any capital equipment purchase in the
case of a consumption type VAT.(ibid)

c) AdditionMethod
Though value added is equal to the difference between a firm’s sales and its purchases, it is
also equal to the payments for the labor and capital that generate the value added. Under the
addition method, a taxpayer’s VAT liability is calculated by adding together the components
of value added such as various production factors like wage, rent, interest etc and profit
(markup) and then applying the tax rate to that sum.

VATAdministration
Administration of value added tax does not require firm to calculate value added. The most
common means of administering the tax is the invoice method developed in France and used in
European Union nation to collect the tax. Under the invoice method, all transaction are taxed at
fixed proportion rate regardless of whether they are final or intermediate transaction tax payer
then are allowed to deduct the terming their tax liability. This is called the invoice method
because payment of the merely required firm to maintain invoice on sales and purchased for
each tax payment period (usually monthly or quarterly). Tax liability is simply by applying the
fixed rate of taxation to total sales invoice and then deducting the amount of VAT paid
previously on intermediate purchased invoice. (Misrak, 2008:228)

Modernizing VAT Collection System

Modernizing tax system mainly consists of computerizing the tax collection system using well
trained human power and drafting proper tax rules and regulations that enhance tax
administration effectiveness. As it has been mentioned reputedly, tax collection is not
functioning properly without an effective and efficient tax administration. To that end, a well
designed computer system is an important tool of tax administration. Naturally computerization
is useful to improve efficiency and reduce cost in the current information technology age,
computers and their wide spread application allow tax collectors to provide efficient, timely and
accurate services. A computers application is equally important to save tax payers time and
promote tax equity (Semegn: 2002).
In administering VAT in Ethiopia tax authorities use computer programs, namely: Standard
Integrated Government Tax Administration System (SIGTAS) and Automated System for
Customs Data Management (ASYCUDA). The computer programs are used to maintain
taxpayer register and process VAT returns. Detection of non-filers seems to be carried out
mainly manually. In addition, tax authorities endeavor to follow-up non-filers identified by the
computer programs. However, because of shortage of manpower, such follow-ups are usually
carried out once in a 3 to 6 month period. The above practices pertaining to controlling VAT
filing and payment delay the collection of the tax and jeopardize the government’s revenue.
Hence, suggested that to ameliorate the potential impact of non-filers on the revenue
performance of the tax, strengthening the administration capacity of the tax authorities, and
effectively using the computer programs coupled with timely follow-up of non-filing taxpayers
are worthwhile to consider (Wollela Abehodie, 2008).

Empirical Literature Review

A study made by Wollela Abehodie (2008) examines VAT administration in Ethiopia and
identifies key problems including lack of sufficient number of skilled personnel and gaps in the
administration in such areas as refunding, invoicing and filing requirements. The paper suggests
that in Ethiopia attempting to implement what is legislated in the main areas (such as refunds)
deserves the government’s due attention. The study also emphasizes the need to strengthen the
administration capacity in general and the tax audit program in particular.
Furthermore, the paper assesses the assignment of VAT revenue to regional governments and
the decentralization of its administration. This paper examined how VAT administrators in
Ethiopia perform their duties and how the effective taxation requirements differ from the
legislation (focusing on the key administration tasks).
In addition, the outcomes showed a paucity of tax awareness among the society and strong
education programs as well as lack of trust between taxpayers and administrators as major
challenges to the VAT system in the country. The gaps and problems identified in the study
were partly because of under staffing of the tax authority. This, in turn, is attributable to limited
tax
administrationresources.Itishencesuggestedthatthegovernmentwouldbetterlookatthepossibility of
making sufficient resources available for the administration of VAT. However, considering the
role of VAT administration in the overall financial system of the Ethiopian government,
allocating reasonably sufficient resources is worthwhile to consider. Generally, one can see that
empirical studied under taken the above researcher not to account specific area of the tax
administration and specific area of tax payers. So that this Study focuses on VAT collection
problem of vat payers particularly small scale taxpayers.

CHAPTER THREE

Research Design and Methodology

Research Design
This search was conducted in a descriptive and explanatory approach. The reason for using
descriptive approach is to describe the current status of the branch office and for explaining
reasons for existence of some facts by focusing on VAT collection problems. The study adopted
mixed research design inorder to achieve the stated research objective and to answer research
questions. Specifically, the study used quantitative survey and qualitative in-depth interview
and documentary analysis. The survey was conducted with employees of the branch office and
VAT payers while the in-depth interviews were conducted with the branch office staffs.
Inaddition, documentary analysis was made referring annual reports of the branch office which
relevant for the conduct of the study. To answers the research question we prepared
aquestionnaire and conducted an interview that enables us to get information about VAT
collection practice and its effectiveness. The primary data obtained from the questionnaire and
unstructured interview was analyzed and discussed. Finally the research concluded the findings
of the study and forwarded the possible solution.
Population and Sampling Technique
Employees, managers and VAT payers of small scale tax payer’s branch office are the target
population of the study. As it is impossible to collect from the whole population because the
numbers are not manageable so, the required data will be collected from the sample respondent
of employees and VAT payers.
From all employees of the branch office 15 respondents was taken as a sample size. The study
has taken a sample of 15 respondents as a sample size for the research purpose out of all tax
payers within the branch VAT payers. Simple random sampling will be used to select a sample
from the employees of the
branchofficeandconvenientsamplingtoselectasamplefromVATpayersasthemainsamplingtechniq
ues.Simplerandomsamplingwillbeusedasthemaintechniquebecausetogivetherespondentequalcha
ncebeingselectedandconvenientsamplingsbecauseithelpstheresearchereasilyreachthesamplerespo
ndents.
Sources of Data Collection
Bothprimaryandsecondarydatawereusedforthisresearch.Primarydatawascollectedfrommanagers’
interviewandquestionnairedistributedtoemployeesofthebranchofficeandVATpayers.Secondaryda
tawascollectedfromtheorganizationdocuments,relevantliteratureandotherprintedmaterials.

Method of Data Collection

Theresearcherswillemploythesurveymethodasamaindatacollectiontoolinthisstudybecauseitisthe
maintypeofdatagatheringindescriptiveresearchexplanatoryresearch.
Therefore,thesurveymethodquestionnaireandin-
depthinterviewwillbeexpectedtosupplytherequireddataforthisresearch.Questionnaireshavebeendi
stributedtothesampleemployeesandVATpayersofthebranchoffice.Thequestionnairedevelopedfor
customershasbeentranslatedtoAmharictoavoidlanguagebarriers.
Data Analysis Method
Thedatathroughquestionerandinterviewwascategorizedandanalyzedbasedontheresponseofthesam
plerespondents.CollecteddatawastabulatedtosummarizetherespondofemployeesandVATpayersa
ndanalyzedusingwordstatements,descriptivestatisticsandgraphs.Descriptivestatisticswasbeusedb
ecauseitisappropriatetoanalyzequantitativedatafrequencycountandpercentage.
 Reference

 Bhatin, H,L.(1994). Public Finance (18th Revised Edition). New Delhi: Viskas
Publishing House PVT Ltd.

 Council of ministers, 2002, value added tax proclamation no 79/2002, Negarit

Gazetta,FDRE.

 Council of ministers, 2002, value added tax proclamation no 285/2002, Negarit

Gazetta,FDRE.

 Warnest and Young (1995) VAT and sales Taxes World Wide: A guide to
practice and proclamation is 61 Countries, John will and Sons, England Ebrill L,
Keen M, Bodin J, and Summers V, (2001) The Modern VAT, IMF, Washington.

 ERCA (2010) revenue performance reports during 2007-2010) (Unpublished

Encarta (2009), “Value Added Tax”

 IMF (2003) Social impacts of a tax Reform: The Case of Ethiopia, Working
Paper, and WP/03/232: Washington.

 MOR (2004) Ministry of Revenue Working Paper, Implementation of VAT in

Ethiopia, Addis AbabaAddis Ababa City Gov.

 Misrak Tesfay (2008) Ethiopia Tax Accounting Theory and Practice ( 1st
Edition) Addis Ababa, Ethiopia

 Representatives, value Added Tax proclamation No 285/2002, Birhanina Selam

Printing press, Addis Ababa

 Rosen H, S, (2011) Challenges of VAT administration in Arada Sub city of

Addis Ababa city administration

ANNEX
Questioner