Ethiopian Tax System

Income Tax Proclamation

Proclamation No. 286/2002

Income tax is a very important direct tax. It is an important and most significant source of
revenue of the government. The government needs money to maintain law and order in the
country; safeguard the security of the country from foreign powers and promote the welfare of
the people. It is the foremost duty of the government to bring out welfare and development
programs which will bridge the gap between the rich and the poor. All this requires mobilization
of fund from various sources. These sources may be direct or indirect.

What is Income Tax?

“Income” means every sort of economic benefit including gains in cash or in kind, from
whatever source derived and in whatever form paid, credited or
received.                                                                                                                                             

“Taxable income” means the amount of income subject to tax after deduction of all expenses
and other deductible items allowed under this Proclamation 286/2002 and Regulations 78/2002
issued.

Employee” means any individual, other than a contractor, engaged (whether on a permanent or
temporary basis) to perform services under the direction and control of the employer.

Sources of Income (Article-6):

Income taxable under this proclamation shall include, but not limited to:

1. Income from employment;

2. Income from business activities;
3. Income derived by an entertainer, musician, or sports person from his personal activities;
4. Income from entrepreneurial activities carried on by a non-resident through a permanent
establishment in Ethiopia;
5. Income from immovable property and appurtenances thereto, income from livestock and
inventory in agriculture and forestry, and income from usufruct and other rights deriving
from immovable property is much property is situated in Ethiopia;
6. Dividends distributed by a resident company;
7. Profit shares paid by a resident registered partnership;
8. Interest paid by the national, a regional or local Government or a resident of Ethiopia, or
paid by a non-resident through a permanent establishment that he maintains in Ethiopia;
9. License fees (including lease payments, and royalties paid by a resident or paid by a non
resident through a permanent establishment that he maintains in Ethiopia.
- The above sources of income are grouped under the following four Schedules:

Schedules of Income (Article-8):

The proclamation provides for the taxation of income in accordance with four schedules.

 Schedule 'A' Income from employment;

 Schedule 'B' Income from rental buildings;
 Schedule 'C' Income from business;
 Schedule 'D' Income from other sources including:

Determination of Employment Income (Schedule ‘A’)

A. Determination of Gross employment income: all type of income like Basic salary, allowance,
overtime and bonus

B. Taxable income    

1. Every person deriving income from employment is liable to pay tax on that income at the
rate specified in Schedule “A”, shown bellow. The first Birr 600 (six hundred Birr) of
employment income is excluded from taxable income.
2. Employers have an obligation (Liability) to withhold the tax from each payment to an
employee, and to pay to the Tax Authority the amount withheld during each calendar
month. In applying preceding income attributable to the months of Nehassie and
Pagumen shall be aggregated and treated as the income of one month.

Every person deriving income for employment is liable to pay tax on that income at the rate
specified in schedule `A`, set out in Article 11. The first Birr 600 (six hundred Birr) of
employment income is excluded from taxable income. If the tax on income from employment,
instead of being deducted from the salary on wage of the employee, is paid by the employee in
whole or in part, the amount so paid shall be added to the taxable income and shall be considered
as part there of 

According to Article 10 of income tax proclamation, the employers have an obligation to with
hold the tax from each payment to an employee and to pay to the tax authority the amount with
held during each calendar month. In applying the procedure, income attributable to the months of
Nehassie and pagume shall be aggregated and treated as the income of one month.

B. Exemptions

The following categories of income shall be exempted from payment of income tax.

I. Income from casual employment

Income from employment received by casual employees who are not regularly employed
provided that they do not work for more than one month for the same employer in any twelve
months period.

II. Contribution of retirement benefits by employers:

Pension contribution, provident fund and all forms of retirement benefits contributed by
employers in an amount that does not exceed 15% (fifteen percent) of the monthly salary of the
employee.

III. Income from Diplomatic and consular representatives, and Other persons employed in any
Embassy, Legation, Consulate or Mission of a foreign state performing state affairs, which are
national of that state and bearers of diplomatic passports or who are in accordance with
international usage or custom normally and usually exempted from the payment of income tax..

IV. Payments as compensation

 Payments made to a person as compensation or gratitude in relation to:

  Personal injuries suffered by that person;

 The death of another person.

V.  Allowable Deductions

The following payments, made to an employee by an employer, are allowed as deductions to

determine taxable income.

o Reimbursed medical expenses

o Transportation allowance (if provided in the contract)
o federal  25% of basic salary or not more than Br 800
o Addis Ababa 15% of basic salary or not more than Br 500
o Hardship Allowance
o Desert Allowance 
o Reimbursed traveling expense (incurred on duty)

C. Tax Rate

The tax payable on income from employment shall be charged, levied and collected at the
following rates:

Taxable monthly Rates of tax

No.
income(Birr) (10%)
1 < 600 Exemption
2 (600 – 1,650] on the next 1,050 10%
 (1,650 – 3,200] on the next
3 15%
1,550
(3,200 – 5,250] on the next
4 20%
2,050
(5,250 – 7,800 ] on the next
5 25%
2,550
( 7,800-10,900] on the next ,
6 30%
3100
7 over 10,900 35%

It can be explained as follows                    

         Schedule A  

Taxable monthly Rates of Deductio

No.
income(Birr) tax (10%) n (Br.)
Exemptio
1 < 600 0
n
(600 – 1,650] on the next
2 10% 60
1,050
(1,650 – 3,200] on the next
3 15% 142.5
1,550
(3,200 – 5,250] on the next
4 20% 302.5
2,050
(5,250 – 7,800 ] on the next
5 25% 565
2,550
( 7,800-10,900] on the next ,
6 30% 955
3100
7 over 10,900 35%  1,500

               

    Methods of employment income tax computations

There are two methods are used to compute employment income tax.

1. Progression method    
The amount of tax is calculated for each layer of tax bracket by multiplying the given
rate under schedule A For each additional income.
2. Deduction methods

           Income Tax =Taxable Income x tax rate - Deduction

        Deduction is computed by this formula

Deduction = upper taxable income pervious tax bracket tax rate of given bracket-cumulative
threshold.

 Example1: The following data were taken from the records of Abraham Co. for July 2008 E.C.
that pays payroll to its employees according to Ethiopian payroll system.

Basic Allowanc Overtim Duration of

Name
salary e e worked overtime work
Abel
Br.2,400 250 30hrs Up to 10:00pm
Tena
Sara 10:00pm-
3,200 500 20hrs
Chala 6:00am
Nega 10hrs Weekends
1,600 100
Girum 18hrs Public holiday

Additional information:

1. All employees are expected to render services of 160hrs per month and all of them did
except Sara Chala who has served only 150hrs.
2. All employees are permanent employees except Abel Tena.
3. The allowance of Nega Girum is not taxable.
4. All employees promised to contribute 10% of their basic salary to the credit association
of the company

Required:

o Determine the gross earnings, taxable income, total deductions and net pay of all
employees.

Solution:

a. Abel Tena

Gross earnings

Gross earnings=basic salary+ overtime+ allowance

Ordinary rate=2,400/160= Br.15/hr

Overtime earnings= 30hrsx1.25xBr.15= Br.562.5

Gross earnings=2,400+562.5+250=Br.3,212.5
Taxable income

Taxable income=Br.3, 212.5  

Total deductions

Pension =0(not a permanent employee)

Payable to credit association=10%x2, 400=Br.240

Income tax payable= 3,212.5*0.20-302.5

                               =340

Total deductions=0+240+340= Br.580

 Net pay

Net pay=gross earnings-total deductions=3,212.5 - 580=Br.2, 632.5

Sara Chala

Gross earnings

Gross earnings=basic salary+ overtime+ allowance

Ordinary rate=3,200/160= Br.20/hr

Overtime earnings= 20hrsx1.5xBr.20= Br.600

Gross earnings=3,000 +600+500=Br.4,100

Taxable income

Taxable income=Br.4,100      

Total deductions

Pension =8%xBr.3, 200= Br.256

Payable to credit association=10%x3, 200=Br.320

Income tax payable= 4,100*20%-302.5                       

Income tax=517.5
Total deductions=256+320+517.5= Br.1,093.5

Net pay

Net pay=gross earnings-total deductions=4,100-1,093.5=Br.3006.5

Nega Girum

Gross earnings

Gross earnings=basic salary+ overtime+ allowance

Ordinary rate=1,600/160= Br.10/hr

Overtime earnings= 10hrsx2xBr.10 +18hrsx2.5xBr.10= Br.650

Gross earnings=1,600 +650+100=Br.2,350

Taxable income

Taxable income=Br.2, 350-100 = Br.2,250   

Total deductions

Pension =8%xBr.1, 600= Br.128

Payable to credit association=10%x1, 600=Br.160

Income tax payable= 2250*15%-142.5

Income tax =Br.195

Total deductions=128+160+195= Br.483

 Net pay

Net pay=gross earnings-total deductions=2,350-483=Br.1,867

     2. Tax on Income from Rental   of Buildings (Schedule ‘B’)

 Introduction

Any income arising from rental of buildings is taxable under schedule ‘B’. Rental income
includes all form of income from rent of a building and rent of furniture and equipment if the
building is fully furnished. Income from the lease of business including goods, equipments and
building which are part of the normal operation of a business, (called business lease) are taxable
under another schedule that is in schedule ‘C’

Gross rental income also includes any cost incurred by the lessee for improvement to the land or
building all payments made by the lessee on behalf of the lessor in accordance with the contract
lease. In the lease contract there are two parties involved in renting a building, the lessor and the
lessee. The party who grants rent of the building is the lessor. The one who leases the property
for use is the lessee. In some occasions the lessor may allow the lessee to sub lease the building
for another party. In such circumstances the first lessee becomes the sub-lessor and the third
party who rents the building from the lessee is called sub-lessee. The sub lessor must pay tax on
the difference between income from the sub leasing and the rent paid to the lessor, provided that
the amount received by the sub lessor. The owner of the building who allows a lessee to sub-
lease is liable for payment of the tax for which the sub lessor is liable, in the event the sub-lessor
fails to pay.

5.2.2 Taxable Income

i. Gross income includes all payments, either in cash or benefited in kind, received by the lessor 
for instance if a computer trader rents a building for use and give computer to lessor, the market
value of the computer shall be used as gross rental income.

ii. All payments made by the lessee on the behalf of the lessor. For instance if the lessee pay
brokerage fee on behalf of the lessor, such payments are i.e ownership fee on behalf of the
lessor , such payments are include in the gross rental income.

iii. The value of any renovation or improvement to the land or the building is also part of taxable
income under this schedule if such cost is borne by the lessee in addition to rent payable.

A. Deduction

 Taxable income from schedule B income is determined by subtracting the allowable deductions
from the gross income. Allowable deductions include the following:

A. For lessor that do not maintain books of accounts

o taxes paid with respect to the land and buildings being leased; except income taxes; and
 o 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;

B. For lessor that  maintain books of accounts

o For taxpayers maintaining books of account, the expenses incurred in earning, securing,
and maintaining rental income, to the extent that the expenses can be proven by the
taxpayer and subject to the limitations specified by this Proclamation, deductible
expenses include (but are not limited to) the cost of lease (rent) of land, repairs,
maintenance, and depreciation of buildings, furniture and equipment in accordance with
Article 23 of this Proclamation as well as interest on bank loans, insurance premiums.

i.e. building 5%, computer and related asset 25%, furniture and equipment 20% and other asset
10% of depreciation base.

Tax Rate

The tax payable on rented houses shall be charged, levied and collected at the following rates:

(a) if the lessor or owners are bodies , they pay thirty percent (30%) of taxable income,

(b) On income of persons according to the Schedule B (hereunder) Schedule –B

Ta
Taxable income from rental
x
No      
rat
           (Income per year)
e
To
  Over Birr %
Birr
1 0                                   1,800  
2 1,801 7,800 10
16,80
3 7,801 15
0
28,20
4 16,801 20
0
42,60
5 28,201 25
0
60,00
6 42,601 30
0
7 Over 60,000 ***** 35
 
It can be explained as follows:

                              Schedule B                  

Taxable income from

   Tax Deductio
rental of building
No     rate n in birr
(Income per year)                 
  Over Birr         To Birr % Birr
Exempt
1 0 1,800
threshold
2 1,801 7,800 10 180
3 7,801 16,800 15 570
4 16,801 28,200 20 1410
5 28,201 42,600 25 2820
6 42,601 60,000 30 4950
Over 7,950
7 ***** 35
60,000  

i. Computation of income tax on income from rental of building

In order to compute the taxable income from rental of building we use the following approach.

Sources (income)                                                                                  Amount  in birr                                         

Amount in birr

Rental Income Received                                        xxxxx

Add: Amount received on the

                  i) Lease of furniture                              xxx

                  ii) Lease of equipment                          xxxxx                              xxxxxx

Less: Deductions:

i) Taxes paid on land and buildings

                           Leased                                           xxxx

ii) For those not maintain books of

         Accounts

     Allowance for repair, maintenance

 and depreciation (1/5 of gross income)                     xxxx

                (OR)

iii) For those maintain books of Accounts

i. Expenses on

    a) Cost of lease of land                                          xxxx

    b) Repairs                                                               xxxx

    c) Maintenance                                                          xx

   d) Depreciation of    building, furniture and

        Equipments                                                          xxx

   e) Interest on bank loans                                           xxx

   f) Insurance premiums --                                       xxxxxx                              (xxxxxx)

Taxable Income from rental of Buildings                                                            xxxxxx

Example1) Mr. X has a building that is available for rent in year 2008. The following are the
details of the property let out

i. He has  let out  for twelve month

ii. Actual rent for a month is birr 30,000
iii. He paid 15% of the actual rent received as land taxes and 3% as other taxes
iv. He spent birr 10,000 for maintenance of the building

DEPRECIATIO
       
N SCHEDULE
YEA ORGINAL ADDITIO
Type TOTAL COST
R COST N
3,000,000.0
building 2008 _ 3,000,000.00
0
Equipme
2008 150,000.00 _ 150,000.00
nt
computer
& 2008 100,000.00 60,000.00 160,000.00
accessory

 
Required : compute the taxable income and tax liability

A. He does not maintain any books of accounts in this regard

B. assumes that Mr. X has maintained books of accounts.

       Solution :

       Annual rental income (birr 30,000*12 months)---------------------------------------360,000

       Less: allowable deductions

 Land tax (15% of 360,000)-------------54,000

 Other taxes (3%of 360,000)--------------10,800
 Maintenance (1/5 of 360,000)----------72,000                                    (136,800)

           Taxable income………………………………………………     223,200

o Then tax liability should be calculated as follows

>  130,800 35% 18,000

 

              = taxable income* tax rate- deduction

               =birr223,200*35%-18,000

                =birr 60,120

      Required : compute the taxable income and tax liability

       Solution :     

     Depreciation Schedule

1. For building 300,000*0.05=15,000

2. For Equipment 15,000*.20= 3,000
3. For computer  16,000*.25 = 4,000

      Annual rental income (birr 30,000*12 months) ---------------------------------------360,000

       Less: allowable deductions

 Land tax (15% of 360,000)----------54,000

 Other taxes (3%of 360,000)---------10,800
 Maintenance ---------------------------10,000
  Dep Expense Building----------------15,000
  Dep Expense Equpment-------------3,000
 Dep Expense computer---------------4,000-------------------------- (96,800)                            

           Taxable income………………………………..………………263,200

o Then tax liability should be calculated as follows

>  130,800 35% 18,000

 

               = taxable income* tax rate- deduction

               =birr263,200*35%- 18,000

                =birr 74,120

1. Accounting for Business Income Tax

      Meaning

Business means manufacture or purchase and sale of a commodity with a view to make profit. It
includes any trade, commerce or manufacture or any other adventure or concern in the nature of
entrepreneurial activity. It is not necessary that there should be a series of transactions in a
business and it should be carried on permanently. Neither repetition nor continuity of similar
transactions is necessary. Profit of an isolated transaction is also taxable under this Schedule,
provided that it is a venture in the nature of business or trade. In this connection, it is important
that the intention of purchase or manufacture should be sell at a profit.

       Taxable Business Income

Taxable business income shall be determined per tax period on the basis of the profit and loss
account or income statement, which shall be drawn in compliance with the Generally Accepted
Accounting Standards, subject to the provisions of this Proclamation and the directives issued by
the Tax Authority.

Business income tax or business profit tax is the tax imposed on taxable business income /profit
realized from entrepreneurial activities. it is charged on the profit of business enterprises on their
activities arising each accounting period or tax year.

        Category of Taxpayers

For the purposes of payment of business tax, taxpayers are categorized into three namely:
Category “A”, Category “B”, and Category “C”.
Category “A” Taxpayer

Category “A” taxpayer includes;

a. Business that have separate legal personality (share company, PLC and  public
enterprise) regardless of their annual sales revenue.
b. Any company incorporated under the laws of Ethiopia or in a foreign country and other
entities having annual turnover of more than Br500, 000.

 Those who are categorized under “A” have to maintain all records and account which will
enable them to submit a balance sheet and profit and loss account.

The following details are included  the gross profit and the manner in which it is computed ,
general and administrative expenses, depreciation, and provisions and reserves (together with the
supporting vouchers).

Category “B” Taxpayer                                                        

 Category “B” taxpayers includes, unless already classified in Category “A” Taxpayer , business
with no legal personality and  those enterprises having annual income of more than Br 100,000
and less than Br 500,000 ( i.e. Br 100,000 < sales < Br 500,000). Category “B” taxpayers have to
submit the profit and loss statement together with the supporting vouchers.

Category “C” Taxpayer

Category “C” includes all taxpayers who are not classified under the other two categories and
whose annual turnover is estimated at Br 100,000 or less. Every businessman (except Category
“C”) is required to preserve all books of accounts and other records and documents for a period
of not less than 5 years after the year of income to which such books and documents relate.

To determine the income tax liability of such tax payer , standard assessment or presumptive
method shall be used . Assessment or presumptive tax is fixed amount of tax determined by
estimation or best judgment. However, if categories “C” tax payer maintain books of account,
they shall pay taxes on the basis of their books of account.

Moreover the tax payer who drives income from different source subjected to the same schedule
shall be assessed on the aggregate of such income. For example if the individual has barberry
and castle shop, the income of the two business are aggregated.

         Tax payment Period

The fiscal year starts on Hamle 1 and ends on Sene 30. The body can change the accounting year
only with the permission of the tax authority. When the tax period of a body is changed (with the
permission); the period between the previous tax period and the new period will be treated as a
“transitional period”.
          Allowable Deductions

In the determination of business income subject to tax in Ethiopia, deductions shall be allowed
for expenses incurred for the purpose of earning, securing, and maintaining that business
income to the extent that the expenses can be proven by the taxpayer and subject to the
limitations specified by this Proclamation. In order to determine taxable income under Schedule
“C” the following items of expenditures are allowable for deduction.

1) Direct cost of producing the income such as the direct cost of manufacturing, purchasing,
importation, selling and such other similar costs.

2) General and administrative expenses incurred for earning, securing and maintaining the
income. such costs are salary of administrative personnel , utility cost, rental cost ,repair and
maintenance and e.t.c. 

3) Bad debt

4) Premium payable on insurance directly connected with the business activity ;-  insurance
premium directly connected with business activities and against risk of damage or destruction of
business premises.

5) Expense incurred for the promotion of business

6) Commission paid for services rendered, provided that the amount shall not exceed the
normal rates provided by other similar businesses or persons

7) Any payment made by a branch, subsidiary or associated company in

Subjected to the following two conditions;

a. The payment is made for the service actually received.

b. The service was necessary for the business and could not be performed by other person or
by the business itself at lower cost.

8) Salaries, wages or other benefit paid to the children of proprietors or member of partnership.
Subjected to the following two conditions;

      a. such employees shall have the required qualification.

  b. the salary payable for such employs shall be equivalent for the post.

9) Salaries and other personal benefit paid to manager or managers of a private limited
company.

10) Interest expense, if the lending institution is recognized by NBE or a foreign bank permitted
to lend to enterprises in the country.
11) Depreciation expense

The following are the rates of depreciation permitted per the rule:

1) Building: 5% of the original cost. The cost includes the cost of acquisition, construction,
improvement, reconstruction and renewal.

2) Intangible Assets: 10% (straight-line basis).

3) Computers, information systems, software products and data storage equipment: 25% (on a
pooling system). Under pooling system the asset that has the same or similar character pooled
together and are called pooled asset. For example projector, LCD, scanner ,flash disk e.t.c.

4) All other business assets: 20% (on a pooling system)

All other depreciable business asset such as machineries, vehicles furniture is pooled together.
For assets for which the pooling method is used, the rate is applied to the depreciation base for
the determination of depreciation. Depreciation base is the book value of the asset on the opening
day of the tax period, increased by the cost of acquisition, creation, renewal, etc during the
period and reduced by the sales price of the asset disposed during the period. Loss incurred
during the period due to natural calamity and other involuntary conversion will also be
considered for the computation of depreciation base. Any compensation received for these
purposes will be deducted from the book value.

While determining the depreciation base, if it becomes negative, it will be added to the taxable
income.

On the other hand, if the depreciation base is Br 1,000 or less in any tax period, the entire amount
shall be treated as depreciation for that period. Likewise, gain obtained as a result of revaluation
of assets shall not be a basis for determining depreciation base.

For each category of assets, the actual expense incurred for the maintenance and improvement is
allowable provided it does not exceed 20% of the depreciation base at the end of the year. If such
an expense exceeds 20% of the depreciation base, the excess will be added to the depreciation
base of the category.

According to the Regulation issued by the Council of Ministers, depreciation will be allowed as
deduction only if the tax payers keep satisfactory record and submit the same to the tax authority
regarding the date and cost of acquisition and a record of the total amount of depreciation
deducted on the asset so far. However, depreciation on assets such as fine art, antiques, jewelry,
trading stock, etc (which are not subject to wear and tear) are not allowed.
Financial institutions are permitted to deduct special reserves from taxable income in accordance
with the directives issued by NBE. However, the amount drawn from such reserves will be added
to the taxable income of such institutions.

      Non-allowable Deductions

All those expenses, which are not wholly or exclusively incurred for the business activity, shall
not be allowed as deductions per the provisions of law. Such expenses include:

1) Additional investment: an increase in the share capital of a company or the original capital of
a registered partnership

2) Pension or provident fund contribution in excess of 15% of the monthly salary of

employees

3)  Business profit tax and input value added tax ;- but they can be recovered through
collection on sales.

4) Fines or penalty paid under violation of law

5) Losses that are not connected with the business activity

6) Losses recoverable by insurance

7) Entertainment expenses

8) Personal consumption expenses

9) Salary, wages, and other personal benefit paid to the partner, or proprietor of an
enterprise

    Declaration and Payment of Tax

The following is the procedures for the declaration of taxable income by taxpayers.

A) Taxpayers categorized as “A” are required to declare their taxable income within four months
from the end of the tax period

B) Those taxpayers who are categorized as “B” are required to declare their taxable income
within two months from the end of the tax period

C) Category “C” taxpayers shall declare taxable income within one month i.e. between July 07
and August each year                         

       Assessment of Tax
Assessment is a tax review by a tax official of the tax declaration and information provided by a
taxpayer and a verification of the arithmetical and financial accuracy of the declared tax liability.
Pursuant to the proclamation, each taxpayer is required to furnish the tax authority with all
information required for the assessment of income tax including information about his
operations, and relationship with other bodies that may be necessary for the declaration of
income or for supporting the books of accounts.

The procedure for the assessment of business income tax takes two forms:

          A) Assessment by books of accounts, and

          B) Assessment by estimation.

Assessment by books will be done for those who maintain books of accounts (Category A and
B). The revenue authority makes assessment by estimation when the taxpayers do not maintain
the books or when the submitted books are not acceptable. This is also done if the taxpayer fails
to declare his/her taxable income within the time required. Tax, of those taxpayers who have
different sources of income, will be assessed on the aggregate of all income.

If the taxpayers keep no records, or if the income tax authority does not accept the submitted
books, or if the taxpayer fails to declare tax within the time specified, the income tax authority
estimates tax by the use of certain indicators. Category “C” should pay tax at fixed rate on the
income estimated by the income tax authority.

Tax assessors will be assigned by the tax office to estimate the daily sales of the taxpayers. The
estimates will be done using the best of their judgment and objectivity. The estimated daily sales
will be converted to annual income using the number of working days. Tax on annual sales is
determined on the basis of presumptive value assigned to each activity.

          Business Income Tax Rates

According to the income tax proclamation, the following tax rates are used for computation of
business income tax under Schedule “C”. The Range of Taxable Business.

Taxable income from

   Tax Deductio
rental of building
No     rate n in birr
(Income per year)       
        To
  Over Birr % Birr
Birr
1 0    1,800 Exempt threshold
2 1,801 7,800 10 180
3 7,801 16,800 15 570
4 16,801 28,200 20 1410
 5 28,201 42,600 25 2820
6 42,601 60,000 30 4950
Over
7 ***** 35 7,950
60,000
 

                Provision for Loss Carry Forward

  If a business incurs a loss in a year, that loss may be set off against taxable income in the next
three years. If there is operating loss for more than one period,  earlier losses being set off before
later losses. A net operating loss may be carried forward and deducted only for two periods of
three years. However, the loss cannot be carried forward: If during a year, the direct or
indirect ownership of the share capital or the voting rights of a business changes more than
twenty-five percent, by value or by number and if the business cannot provide a books of
account showing the loss, which are acceptable by the authority.

Penalties

The following penalties are provided in the proclamation regarding business income tax.

For Non-declaration

Taxpayers who do not declare tax income within the period specified in the regulation will be
liable to pay Br 1,000 for the first 30 days of non-declaration. The penalty is Br 2,000 for the
next 30 days of non-declaration. Br 1,500 will be charged for each 30 days for failure to declare
the taxable income thereafter.

   For understatement of taxable income

Understatement of taxable income results in a penalty of 10% of the amount Understatement. If

the understatement is substantial, the penalty will be 30%.

   For late payment

When a taxpayer fails to pay tax within the due date, he/she will be required to pay a penalty of
5% of the amount unpaid. An additional 2% penalty on the amount unpaid is imposed on the first
day of each month for non-payment.

For failure to keep records

Failure to keep books of accounts, records and other documents by any taxpayer results in a
penalty of 20% of the tax assessed. If this failure continues for two consecutive years, the license
of the taxpayer will be suspended. One more year’s failure leads the tax authority to revoke the
license of the taxpayer.

For failure to withhold

A withholding agent, who fails to withhold tax per the proclamation, will be personally liable to
pay tax (which has been withheld). In addition, this failure obliges the agent to pay Br 1,000 per
case. The following individuals are also liable in this regard:

1) The manager that has known of the failure

2) The chief accountant or a senior officer who was responsible for the supervision of the
withholding activities.

Recording Business Income Tax        

Like any business transaction, profit tax payment must be properly accounted for. To record
business profit tax, Income Tax Expense will be debited and Income Tax payable will be
credited (if the tax is not paid yet) or cash will be credit (if recording is made at the time when
the tax is paid).

Example Melat enterprise, unincorporated business has reported  earnings before tax of birr
80,000 at the tax year ended Sene 30,2006.

   Required

A. Determine the amount of business income tax?

B. Record necessary journal entries?

Sol.

Deduction method:

7,200 - 19,800              10%              720

   = 80,000* 10-720

   = 8,000-720

   = 7,280

To record recognition of income tax expense

    Income tax expense ……………………7,280

               Income tax payable ………………………. 7,280

To record payment of tax

        Income tax payable…………….. 7,280

                 Cash …………………………………… 7,280

     SCHEDULE ‘D’ INCOME: OTHER INCOMES

This is the last and residuary Schedule of income. Any income which is taxable under them
Income Tax Proclamation but does not find place under any of the remaining three Schedules of
income (i.e., Schedules A, B and C) will be taxable under this residuary

Schedule “D” Other Incomes.

          Incomes chargeable under this Schedule of income:

The following incomes shall be chargeable to income tax under the Schedule-D:

        1. Royalties (Article- 31):

The term “royalty” means a payment of any kind received as a consideration for the use of ,or
the right to use, any copyright of literary, artistic or scientific work, including cinematography
films and films or tapes for radio or television broadcasting, any patent, trade work, design or
model, plan secret formula or process, or for the use or for the right to use of any industrial,
commercial or scientific equipment, or for information concerning industrial, commercial or
scientific experience. It is taxable as follows:

    Rate of tax:

Royalties shall be liable to tax at a flat rate of flat rate of 5%

1. The amount of tax shall be withheld and paid to the Tax Authority by the payer. That is the
withholding Agent who effects payment shall withhold the foregoing tax and account to the Tax
Authority within the time limit set out in this

     Proclamation.

2. Where the payer resides abroad and the recipient is a resident, the recipient shall pay tax on
the royalty income within the time limit set out in this Proclamation

3. This tax is a final tax in lieu of a net income tax.

         2. Income from Rendering of Technical Services (Article- 32):

The term “technical service” means any kind of expert advice or technological service
rendered. All payments made in consideration of any kind of technical services rendered outside
Ethiopia to resident persons in any form shall be liable to tax under this Article.

      Rate of tax:

It is Taxable at a flat rate of 10%

The amount of tax shall be withheld and paid to the Tax Authority by the payer.

         3. Income from Games of Chance (Article- 33):

Every person deriving income from winning at games of chance (for example, lotteries, tom
bolas, and other similar activities) shall be subject to tax.

       Rate of tax:

It is Taxable at the rate of 15% except for winnings of less than 100 Birr.

1. The payer shall withhold or collect the tax and account to the Tax Authority in the manner
provided in Article 67.

2. This tax is a final tax in lieu of income tax.

       4. Dividends (Article- 34):

Every person deriving income from dividends from a share company or withdrawals of profits
from a private limited company shall be subject to tax under Article 34.

        Rate of tax:

It is Taxable at the rate of 10%

1) The withholding Agent shall withhold or collect the tax and account to the Tax Authority.

2) This tax is a final tax in lieu of income tax.

       5. Income from Rental of Property (Article- 35):

Every person deriving income from the casual rental of property (including any land, building, or
moveable asset) not related to a business activity taxable under Article 17 shall pay tax on the
annual gross income.

     Rate of tax:

It is Taxable at the rate of 15%

This tax is a final tax in lieu of a net income tax.

        6. Interest Income on Deposits (Article- 36):

As per Article 36, every person deriving income from interest on deposits shall pay tax.

     Rate of tax:

It is Taxable at the rate of 5%

1) The payer shall withhold the tax and account to the Tax Authority in the manner provided in
Article 67.

2) This tax is a final tax in lieu of income tax.

SCHEDULE ‘D’ INCOME: OTHER INCOMES

 This is the last Schedule of income.

 Any income which is taxable under the Income Tax Proclamation but does not find
place under any of the remaining three Schedules of income (i.e., Schedules A, B and C)
will be taxable under this residuary Schedule “D” Other Incomes.

6. 2 importance of payroll accounting

Accounting for payroll is particularly important because:

1. Payroll often represents the largest expense that a company incurs.

2. Both federal and state governments require that detailed payroll records be kept and
3. Employees are sensitive to payroll errors or irregularities. To maintain good employee
morale payroll must be paid on a timely and accurate basis.

6. 3 definition of payroll related terms

1. Salary and Wages: Salary and wages are usually used interchangeably. However, the
term wages is more correctly used to refer to payments to unskilled-manual labor. It is
usually paid based on the number of hours worked or the number of units produced.
Therefore, wages are usually paid when a particular piece of work is completed or
weekly.
On the other hand, salaries refers to payments to employees who render managerial,
administrative or similar services, and they are usually paid to skilled labor on a monthly
or yearly basis.
Both wages and salaries related to an ‘employee’ is an individual who works primarily to
 one organization and whose activities are under the direct supervision of employer.
A self-employed person on the other hand works (gives her services) on a fee basis to
various firms.
2. The Pay Period: A pay period refers to the length of time covered by each payroll
payment.
3. The Pay Day: The pay day- is the day on which wages or salaries are paid to employees.
This is usually on the last day of the pay period.
4. A Payroll Register (sheet): is the list of employees of a business along with each
employee’s gross earnings; deductions and net pay (take home pay) for a particular pay
period. The payroll register (sheet) is prepared based on attendance sheets, punched
(clock) cards or time cards.
5. Pay Check: A business can pay payroll by writing a check for the amount of the net pay.
A check is prepared in the name of each employee and handed to employees.
Alternatively a check for the total net pay can be prepared for employees to the paid by
cash at the organization.
6. Gross Earnings: are taxes collected from the earnings of employees by t he employer
organization as per the regulations of the government. These have to be submitted (paid)
to the government because3d employer organization is only acting as an agent of the
government in collecting these taxes from employees.
7. Payroll Deductions: are deductions from the gross earnings of an employee such as
employment income taxes (with holding taxes), labor union dues, fines, credit association
pays etc.
8. Net Pay: Net Pay is the earning of an employee after all deductions have been deducted.
This is the take home pay amount collected by an employee on the payday.

6.4  Possible components of a Payroll Register

1. Employee Number

Number assigned to employees for identification purpose when a relatively large number of
employees are involved in a payroll register.

2. Name of Employees

3. Earnings

Money earned by an employee from various sources,. This may include.

a. Basic Salary- a flat monthly salary of an employee for carrying out the normal work of
employment and subject to change when the employee is promoted.
b. Allowances- money paid monthly to an employee for special reasons, like:
o Position allowance- a monthly paid to an employee of earning a particular office
responsibility.
 o Housing allowance- a monthly allowance given to cover housing costs of the
individual employee when the employment contract requires the employer to
provide housing but the employer fails to do so.
o Hardship allowance- a sum of money given to an employee to compensate for an
inconvenient circumstance caused by the employer. For instance, unexpected
transfer to aw different and distant work area or location.
o Desert allowance- a monthly allowance given to an employee because of
assignment to a relatively hot region.
o Transportation (fuel) allowance- a monthly allowance to an employee to cover
cost of transportation up to her workplace if the employer has committed itself to
provide transportation service.
c. Overtime Earning: Overtime work is the work performed by an employee beyond the
regular working hours.
Overtime earnings are the amount paid to an employee for overtime work performed.

Article 33 of proclamation No. 64/1975 discussed the following about how overtime work
should be paid:

A worker shall be entitled to the paid at a rate of

i. one and one-quarter (1 ¼) times his ordinary hourly rate for overtime work performed
before 10:00 P.M in the evening.
ii. One and one half (1 ½) times his ordinary hourly rate for overtime work performed
between 10:00 P.M and six (6:00 A.M) in the morning.
iii. Two times the ordinary hourly rate for overtime work performed on weekly rest   days
iv. two and one half (2 ½ ) times the ordinary hourly rate for overtime work performed on a
public holiday.

All in all, the gross earnings of an employee may include the basic salary, allowance and
overtime earnings.

4. Deduction: are subtractions made from the earnings of employees required by the government
or permitted by the employee himself.

a. Employment Income Tax: Every citizen is required to pay employee tax to the
government in almost all countries. In Ethiopia also, income tax is charged on the gross
earnings of the employee at the rates indicated under schedule A of the Proclamation N.
286/2002- Income tax proclamation.

OVER TIME
-150% of normal hourly rate for overtime work between 06 a.m. to 10 p.m.;
-175% of normal hourly rate for overtime work between 10 p.m. to 06 a.m.;
-200% of the normal hourly rate for work on a weekly rest day; and
-250% of the normal hourly rate for work on a public holiday.
Source: §61-68 of the Labour Proclamation No. 1156/2019