Public Finance and Taxation Chapter Four

CHAPTER FOUR
ACCOUNTING FOR DIRECT TAXES IN ETHIOPIA
4. Introduction
This chapter deals with the accounting for direct taxes under the Ethiopian tax system. Especially a
discussion will conducted on the accounting treatment for employment income tax, business income tax,
rental income tax, and other income taxes.

4.2. Basic Concept of the Ethiopian Tax system

The Ethiopian tax system follows scheduler tax system, in which the tax liability of a taxpayer is
determined based on the schedule of each income. This implies the loss incurred in one schedule is not
allowed to compensate from the income generated in the other schedule. Accordingly as it is depicted in
article 8 of the income tax pro 979/16, direct taxes are classified in to five schedules.
 Schedule ‘A’, income from employment;
 Schedule ‘B’, income from rental of buildings;
 Schedule ‘C’, income from business;
 Schedule ‘D’, other income;
 Schedule ‘E’, exempt income.
Ethiopia levies tax on residential jurisdiction basis. As per the income tax proclamation, every resident
of Ethiopia who gets income from within the country or abroad is charged under the act on transferring
the amount to Ethiopia. That is the income tax is applied to the Ethiopian resident taxpayer on their
world wide income. According to the Income Tax Proclamation, residence of Ethiopia includes resident
individual; resident body; and the Government of the Federal Democratic Republic of Ethiopia, and any
Regional State or City Government in Ethiopia.
 A resident of individual is an individual who has a domicile in Ethiopia; is a citizen of
Ethiopia who is a consular, diplomatic, or similar official posted abroad; and is present
in Ethiopia, and continuously or intermittently, for more than 183 days in a one-year
period.
 A resident body is a body that is incorporated or formed in Ethiopia; or has its place
of effective management in Ethiopia.
Moreover, the tax system of the country is also applied to non-residents with respect to their Ethiopian
source of income. That is foreign resident is liable to pay tax to Ethiopian tax authority for its income
generated in the territory of the country.
Residential tax levy jurisdiction can create double taxation problem and thus double taxation avoidance
treaty is required between countries. Foreign tax credit is allowed by the income tax proclamation for a

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resident that derives foreign source of during a given tax period. However, the tax credit will not exceed
the tax payable in Ethiopia.

4.2. ACCOUNTING FOR EMPLOYMENT INCOME TAX

4.2.1. Employment Income Tax in Ethiopia

Income as defined in the proclamation includes every sort of economic benefit including non recurring
gains in cash or in kind from whatever source derived and in whatever form paid, credited or
received. Taxable income shall mean the amount of income subject to tax after deduction of all expenses
and other deductible items allowed as per the law.
“Employee” means an individual engaged, whether on a permanent or temporary basis, to perform
services under the direction and control of another person, other than as an independent contractor, and
includes a director or other holder of an office in the management of a body, and government appointees
and elected persons holding public offices;
4.2.2. What is Employment Income Tax?
Employment income includes any payment or gain in cash or in kind received from employment by the
employee subject to certain exemptions.
According to Pro 979/16 of Art 12 Employment income includes the following excluding the exempted
incomes under schedule ‘’E’’
a) Salary, wages, an allowance, bonus, commission,
b) The value of fringe benefits received by an employee in respect of a past, current, or future
employment*;
c) Employees termination compensation
*As it is indicated in the income tax regulation No 410/2017 Article 8 the list of fringe benefit includes
the following:
 debt waiver;  private expenditure;
 household personnel;  property or service;
 housing or accommodation  an employee share scheme;
 discounted interest loan;  vehicle;
 meal or refreshment;  residual fringe benefit
However, the amounts of tax the aggregate tax liability on fringe benefit shall not exceed 10% the basic
salary of the employees (for detail refers the regulation).
4.2.3. The Employment Income Tax Rate: Article 11

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The employee's income tax system divides taxable income into different tax brackets. These are a range
of income bands with different tax rates. The tax payable on income from employment shall be charged,
levied and collected at the following rates:

Employment Income Employment Income Deductions for short

(per month) Birr cut method
Tax Rate
0 –600 0% 0
601-1,650 10% 60
1,651-3,200 15% 142.50
3,201-5,250 20% 302.50
5,251-7,800 25% 565
7,801-10,900 30% 955
Over 10,900 35% 1500
Employment income tax (EIT) = (Taxable income)* the tax rate in which the taxable income falls-
deduction allotted for the given rate
Taxable income= Gross income less Direct Exemption except the Common Exemption that is 600 birr

4.2.4. Employment Income Exemption Indicated in Schedule “E”

List of exempted employment income allowances indicated in the proclamation (Art 65) and income tax
regulation (Art 54) and relative directives includes the following:

 The first six hundred birr (600 birr) of monthly income tax of the employees
 An allowance in lieu of means of transportation granted under a contract of employment
with limit that will be issued by the ministry directive. Currently 25% of the basic salary but
not exceeded 2,200 birr is free from tax
 Transport expenses and per diem payments to an employee travelling on a tour of duty
subjected to limit currently per diem payment is exempted up to 4% of the basic salary of
the employee or 225 birr which is the higher
 a cash indemnity allowance paid by an employer to an employee, but only to the extent that
the allowance compensates the employee for shortfalls on money counts;
 Employment income of not exceeding five years paid to expatriate professionals recruited
for transfer of knowledge by investors engaged in export business in accordance with a
directive to be issued by the Minister;
 Income from employment received by unskilled employee working for the same employer
whether continuously or intermittently for not more than thirty (30) days within any twelve
m.nth period.

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 An amount paid by an employer to cover the actual cost of medical treatment of an

employee including Premium payments made by an employer on behalf of an employee
under employees, medical insurance scheme
 Hardship allowance subject to limit issued by the ministry directive
 Food and beverages provided for free to an employee by an employer conducting a mining,
manufacturing, or agricultural business subjected to limit issued by the ministry
 Allowances paid by the Government of the Federal Democratic Republic of Ethiopia to
employees engaged in public service in a foreign country
 Allowances paid to members and secretaries of boards of public enterprises, public bodies,
or study groups established by the Federal or a State Government or City administration;
 contributions by an employer to a pension, provident, or other retirement fund for the benefit
of an employee provided the monthly total of contributions does not exceed 15% of the
monthly employment income of the employee;
 an amount exempt from tax to the extent provided for under an international agreement
example remuneration of diplomatic personnel of foreign countries
 a public award for outstanding performance in any field or an award granted under Article
135 of the Tax Administration Proclamation
 an amount as compensation for personal injury or the death of another person
 a scholarship or bursary for attendance at an educational institution
 maintenance or child support payments
 salaries paid to domestic servants
4.2.5. Declaration and Payment of Employment Income Tax

As it is indicated in article 88 of the income tax, proclamation the obligation to fill employment income
tax is given to employer. That is the employer shall withhold tax from the gross amount of each payment
of employment income made to the employee at the rate applicable to the employee. In addition, if an
employer is aware that an employee has more than one employer and that the other employer, or none of
the other employers, is withholding tax based on the aggregated employment income, the employer shall
withhold tax based on the aggregated employment income and shall file the withholding employment
income tax declaration within 30 days after the end of months in which the withholding income was paid.
However; if an employee has more than one employer for a calendar month or a self withholding
obligation, the employee shall file a tax declaration within 30 days from the end of every three months
(Art.96). That is an employee employed by an international organization or working in an embassy,
diplomatic mission, or other consular establishment in Ethiopia of a foreign government or employed by

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an entity exempt by law from tax withholding obligations shall withhold tax from the employment
income received from such entities.
The statement shall be in the form and furnished in the manner prescribed by the Tax Authority

4.2.6. Payroll Records and Preparation

Payroll register: - this is a multi column register (form) for the payment of salaries at the end of the
payroll period. The source document for preparing the payroll register includes, Letter of employment,
Letter of Promotion, Letter of Demotion, Attendance list, Time card and Relevant payroll and labor
proclamation.
Payroll Components includes: Employee Name and Employee ID, Earning Columns (parts),
Deductions, Net pays, Signature
1. Earning
A. Basic Earning /Salary/: Monthly salary of an employee that is paid for carrying out the normal
work of employment. Basic earning refers to the amount agreed between the employer and the employee
at a time of employment, and will be clearly stated in the letter of employment. Basic salaries are the
bases for making other calculation in relation to earning like bonus, compensations, severance pay,
overtime…etc..
B. Allowance: - Additional monthly payment to the employee for one of the following reasons
 Position allowance or Acting allowance: - Sum paid for a person for assuming a certain
position.
 Housing allowance: - a monthly allowance paid to an employee to cover for house facility,
when the employer is obliged to provide house but falls to do so and taxable income.
 Transportation /fuel/ allowance: - an allowance paid to an employee for to cover the cost of
transposition from office-home-office or work related transportation costs.
 Cash indemnity allowance: - allowance paid for cashiers to cover the risk of possible cash
shortage. Cash indemnity is used to cover accidental shortage not intentional shortages,
 Hardship allowance: - an allowance paid to an employee for in convenience caused by the
employer in the form of unexpected transfers, hazardous working areas …etc.
 Desert Allowance: - a monthly allowance given to an employee assigned to a relatively hot
region. All hot regions (places) may not entitle an employee to a desert allowance.
 Representation allowance: - Allowance paid to employees whose work requires them to
entertain customers and gusts..
C. Over time payment: - is a payment for extra hours worked beyond the regular working hours

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Labor Proclamation Number 42/1985 E.C. (1993G.C.): Defines the basic legal frame work for contract
of employment, regular working hours limit, overtime rates, compensation pay, leave benefits,
employment termination procedures …etc.
 Maximum regular working hour’s 8hrs/day, or forty eight hours a week, but the current
practice is maximum 44 hours per week and 192 hours per month. i.e.:
o Monday to Friday 8hours per day X 5 = 40hours
o Saturdays 4 hours per day = 4hours
44 hours
Or there are 22 days in a month; 22 X 8hours /day = 176 hours
There are 4 Saturdays in a month; 4 X 4 hours/day = 16 hours
192 hours
Over time payment = regular hourly salary rate* rate for the duration of overtime work
Regular hourly rate = monthly basic salary divided by normal working hours per month
Overtime rate
Ordinary time: from 6 in the morning (AM) to o’clock to 10 o’clock in the evening (PM)
Over time rate =1.25 * Regular hourly rate
Late hours: from 10PM up to 6 AM, Over time rate =1.5 * Regular hourly rate
Weekly rest days: Over time rate =2 * Regular hourly rate
Public holydays: Over time rate =2.5 * Regular hourly rate

D. Bonus: - is a material (money) reward for better or best performance by managers or other
employees. Bonus could be based on net income for managers or based on monthly salary (basic
salary) for other employees. Bonus to top manager is most of the time based on annual income of the
business enterprise.
2. Gross /earning/ Salary: - is computed by totaling all the earning i.e. Basic Salary + Allowances, if any +
Overtime payment, if any + Severance pay, if any + compensation, if any + bonus, if any + … etc.
3. Taxable income: - includes all earning except for non taxable incomes as specified under exemption
discussed above.
4. Deduction: - These are subtractions form the gross earning, so as to identify the net pay of an employee.
a. Statutory deduction: - deduction enforced or imposed by low.
Currently, Pension contribution in Ethiopia applies to both public & private employees as per of the
following rate (Proc. No. 714/2011)
 7% (of the basic salary) by the employee
 11% (of the basic salary) by the employer.

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Voluntary deduction: - these are not imposed but are voluntary deductions Example: Credit association,
credit purchase …etc.
b. Others: - Like court order, fines, absence …etc.
5. Net pay: - the net pay is the difference between the gross earning of an employee and the total of the
deductions.
6. Signature: - When an employee receives his/her pay he will sign to confirm that he have received the
net pay.
4.2.7. Computation of Employment Income Tax
Employment income tax payable by an employee is determined by multiplying the employee’s monthly
taxable income by prescribed employment income tax rates. Even if there are different methods used to
calculate employment income tax payable, for the sake of this course we will use the short cut method.
Employment income tax = (Taxable income)* the tax rate in which the taxable income falls- deduction
allotted for the given rate
Taxable income= gross income less direct exemption except the common exemption that is 600 birr
Example 1: suppose ABC Company has the following employees and assume that the normal working
hours per week are 44 hours.
No Employees name Basic salary Over time work Transportation
allowance

1 Tadesse Abate 4500 - -

2 Tedros Ephrem 6000 4 hours in the ordinary time -
and 10 hours in the late
time

3 Adane Tesfaye 12,000 12 hours in the weekly rest 2,500

days

Required:
A. Compute the gross earning
B. Compute the taxable income
C. Compute the pension fund contribution by the employee and employer
E. Compute the employment income tax
F. Compute the net payee
G. Prepare the payroll
Solution:
1. Tadesse Abate
A. Gross earning =4500
B. taxable income is also =4500
Deductions
C. Pension contribution

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By the employee: 7%* of basic salary=0.07*4500=315

By the employer: 11% of the basic salary=0.11*4500= 495
D. EIT=taxable income * tax rate- deduction(adjustments)
4500*0.20-302.50= 597. 50
E. Red Cross society contribution 20 birr
F. Net pay= gross earning - pension contribution- income tax- Red Cross society contribution:
4,500-315-597.50 -20 = 3,567.50
2. Tedros Ephrem
A. Gross earning =basic salary+ over time
Over time per hour = basic salary/monthly working hours
=6000/ (192hours) = 31.25
Ordinary over time = 10*31.25*1.25=390.625
Late time overtime = 15*31.25*1.5=703.125
Total over time payment= 1,093.75
Gross earning = 6,000+1,093.75= 7,093.75
B. Taxable income is also =7,093.75
C. Pension contribution
By the employee: 7%*of basic salary=0.07*6000=420
By the employer: 11% of the basic salary=0.11*6000= 660
D. EIT=taxable income * tax rate- adjustments
7093.75*0.25-565= 1208.44
G. Net pay= gross earning- pension contribution- income tax- Red Cross society contribution:
7093.75 – 420 - 1208.44 - 20= 5445.31
3. Adane Tesfaye
A. Gross earning =basic salary+ over time+ fuel allowances+ position allowance
Over time per hour = basic salary/monthly working hours
=12,000/ (192hours) = 62.50
Weekly rest days over time payment = 12*62.50*2=1,500
Gross Earning = 12,000+1,500+2,500 +500 = 16,500
B. Taxable income =Gross earning – fuel allowances exemption
C. The fuel allowance is exempted up to 25% of the basic salary but not exceed 2,200 birr.
0.25*12,000=3000 this is higher than the maximum limit 2,200
D. Therefore only 2,200 birr is exempted while the rest of transport allowance (2500-2000=300) is
taxable.
Taxable income= 16,500 - 2,200=14,300
Deduction
E. Pension contribution : By the employee: 7%*of basic salary=0.07*12,000=840
By the employer: 11% of the basic salary=0.11*12,000= 1320
F. EIT=taxable income * tax rate- adjustments 14,300*0.35-1,500= 3,505
G. Credit association contribution = 12,000*0.10= 1,200

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Payroll Register
for the month ended Jan. 30/2009 E.C
Earning
Basic Allowance Over Time Deduction
Tax pensi credit Re
on Ass. d
Cont. Cro
Ty Amou Amo Durati
I Type ss
pe nt unt on
SE d. Gross Taxabl Soc.
R. N Employe Amo Earnin e Con Net Signat
NO O e Name Salary unt g Income t Total Pay ure
Tadesse
10 Abate 4,500.0 4,500.0 4,500.0 20.0 3,567.5
1 1 0 - _ - 0 - 0 0 597.50 315.00 - 0 932.50 0
Tedros
Ephrem Ordinar
y and
10 6,000.0 late 1,093. 7,093.7 7,093.7 1,208. 20.0 1,648. 5,445.3
2 2 0 - _ - time 75 5 5 44 420.00 - 0 44 1
Adane weekly
10 Tesfaye 12,000. 2,500. positi rest 1,500. 16,500. 14,300. 3,505. 1,200. 20.0 5,565. 10,935.
3 3 00 fuel 00 on 500.00 days 00 00 00 00 840.00 00 0 00 00

22,500. 2,500. 2,593. 28,093. 25,893. 5,310. 1,575. 1,200. 60.0 8,145. 19,947.
TOTAL 00 00 500.00 75 75 75 94 00 00 0 94 81

2200 of the fuel allowance for Adane Tesfaye is exempted

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Computation Employment income Tax on Bonus

Computation of bonus has the following steps:
A. Determine the amount of bonus to be paid for the employees
B. Calculate the monthly tax amount using the basic salary
C. Divided the bonus amount in 12 months because bonus is paid for outstanding performance that
employees achieved in the year. However if the employees have service duration of less than 12
months the amount of bonus should divided to the numbers of months in which the employees
serves in the year.
D. Calculate the monthly income tax using the taxable income you get in “C”
E. Find the difference of the monthly income tax you get in step “D” and “B” and multiply by 12
months or by the service duration of the employees in the year expressed in months. This is the total
tax to be paid from the bonus.
F. Net pay= total bonus-tax amount on the bonus
Example two: Consider the employees of the ABC plc. The management of the company decided
to give bonus two months’ salary for permanent employs worked more than six month and 1 month
basic salary for theses that are hired after January1 for the year 2008 E.C.
No Employees Name Date of Employment Basic Salary Total Bonus
1 Tadesse Abate Jan 30/2008 EC 4500 4500
2 Tedros Ephrem Sep 11/2007 EC 6000 12,000
Required:
A. Compute the total tax that must be paid from the bonus of the employees
B. Compute the net bonus paid to each individual
Solution
1. Tadesse abate
A. Taxable income using the basic salary
4500*0.20-302.50=597.50
B. The total bonus is divided to the service duration during the year that is 4500/5=900
By adding to the basic salary you will get (4500+900=5400)
C. The income tax after bonus is 5400*.25-565=780
D. Total tax from bonus (780-597.50)*5=937.50
The net pay =bonus-tax (4500-937.50=3562.50
2. Tedros Efrem
A. Taxable income using the basic salary
6000*0.25-565=935

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B. The total bonus is divided to 12 months 12,000 /12=1000

By adding to the basic salary you will get (6000+1000=7000)
C. The income tax after bonus is
7000*.25-565=1185
D. Total tax from bonus (1185-935)*12=3000
The net pay =bonus-tax (12,000-3000=9000
4.2.8. Accounting Treatment for Employment Income Tax
To explain the journal entries consider the above ABC plc payroll register and recorded in the general
journal as follows.
Date Items post ref. Debit Credit
salary expenses 28,093.75
Cash 19,947.81
Employees Pension cont. payable 1,575
Employment income tax payable 5,310.94
Credit association contribution payable 1,200.00
Red cross society contribution payable 60
To record the employees’ pension contribution and employment income tax
Date post ref. Debit Credit
Payroll expenses 2,475
Employer Pension cont. payable 2,475
To record the employer pension contribution
Date post ref. Debit Credit
Employees Pension cont. payable 1,575
Employer Pension cont. payable 2,475
Employment income tax payable 5,310.94
Credit association contribution payable 1,200.00
Red cross society contribution payable 60
Cash 10,620.94
When it is declared and paid to tax authority

4.3. Accounting for Rental Income Tax

Rental income tax includes all forms of income arising from rent of building and rent of furniture and
equipments if the building is furnished. In Ethiopia the rules for rental income tax is indicated in the
income tax pro. 979/16 from Art 13 up to Art 17. The income tax proclamation classifies income from
renting of building as Schedule B income.
There are different parities that involve in renting of the building: the lessor and lessee. The lessor is the
owners of the building and provides rental service to another person. The lessee is an individual or an

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entity who rents the building directly from the lessor. The lessee is the physical processor and users of the
building.
However there may be sub-lessor that is a third party who leases a building directly from the a lessee for
residential, business or any other use. In this circumstance the lessee becomes a sub-lessor is a person or
entity who further leases the whole or part of the building with the permission of the lessor.

4.3.1. Taxable Rental Income Tax

According to the income tax, proclamation taxable income from renting of building includes the gross
amount of income derived by the taxpayer from the rental of a building for the year reduced by the total
amount of deductions allowed to the taxpayer for the year. The gross income from rental of building
includes:
 All amounts derived by the taxpayer during the year under the lease agreement, including any
lease premium or similar amount;
 All payments made by the lessee during the year on behalf of the lessor according to the lease
agreement;
 The amount of any bond, security, or similar amount that, during the year, the taxpayer is entitled
to retain as a result of damage to the building and that has not been used by the taxpayer in
repairing the damage to the building;
 The value of any renovation or improvement made under the lease agreement to the building
when the cost was borne by the lessee in addition to the rent payable to the taxpayer.
More over if, a taxpayer leases a furnished building, the gross amount of income derived by the taxpayer
from the lease of the building shall include any amount attributable to the lease of the furniture or
equipment. The taxable rental income does not include exempted incomes.
4.3.2. Rental Income Tax Rates
The rental income tax rates are two types. The first rate is applicable to bodies at flat rates of 30% of their
rental income tax. The second rate is applicable to individual taxpayers in the following manner.

Deduction or
Taxable Rental Income Rental Income
Adjustments for
(per year) Birr Tax Rate short cut method
0 -7,200 0% 0
7,201-19,800 10% 720
19,801-38,400 15% 1,710
38,401-63,000 20% 3,630
63,001-93,600 25% 6,780

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93,601-130,800 30% 11,460

Over 130,800 35% 18,000
Rental income tax (RIT) =Taxable income*Tax rate-Adjustments
4.3.3 Computation of Rental Income Tax
The computation of rental income tax is two types for these who do not have an obligation to maintain
books of accounts and for theses who maintains books of accounts (category A and B tax payers).
In computing the taxable rental income for a tax year of a taxpayer who does not maintain books of
account, a deduction (rental expenses) shall be allowed for the following amounts:
a) any fees and charges, but not income tax, levied by a State or City Administration in respect of the
land or building leased and paid by the taxpayer during the year;
b) an amount equal to fifty percent (50%) of the gross rental income derived by the taxpayer for the
year as an allowance for the repair, maintenance, and depreciation of the building, furniture, and
equipment.
In computing the taxable rental income for a tax year of a taxpayer who maintains books of account, a
deduction shall be allowed for any expenditures to the extent necessarily incurred by the taxpayer in
deriving rental income and paid during the year including:
a) The cost of the lease of land on which the building is situated;
b) Repairs and maintenance;
c) Depreciation of the building, furniture and equipment;
d) Interest and insurance premiums; and
e) Fees and charges, but not income tax, levied by a State or City Administration in respect of
the land or building leased.
Here if the allowable deduction exceeds the gross income earned from renting of the building, there is a
Rental Loss. Hence loss carry forward is allowed for the tax payers and the detail of loss carry forward
scheme is discussed in section 4.4 of this chapter.
The taxable rental income of a sub-lesser of a building for a tax year shall be the difference between the
total rental income received by the sub-lesser during the year and the total rental income paid to
the lesser of the building plus other expenses to the extent necessarily incurred by the sub lesser to
generate the income. Here, the owner of a building who allows a lessee to sub-lease the building shall be
liable for the rental income tax payable by the lessee if the lessee fails to pay the tax.
Gross Income from leasing activities XXX
Less: Allowable deductions XX
Taxable income XXX

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Rental Tax = Taxable income X Tax rate less Adjustments

4.3.4. Rental Income Tax on Advance Collection

The amount of rent income received or receivable by a lessor for the rental service of the tax year is
normally a basis to compute the rental income tax due for that tax year. In certain circumstances a lessor
may receive from the lessee rent payments in advance that covers a period longer than one year. The
computation of rental income tax due on advance payment depends up on the category of tax payers.

If the lessor maintains books of account (category A and B tax payers), accrual basis of accounting is
applied recognize the transaction of the rental activities. According to accrual basis of accounting if a
lessor receives advance rent payment that cover more than one year from the lessee, the lessor rental
income tax such receipts is computed in the tax year in which the rent services is actually rendered. In
other words the unearned rental income is differed to the tax year that the rental service will be rendered.
If the lessor does not maintains books of account (category C tax payers), cash basis concept is
applied for his rental operation. The amount of rental income tax liability is computed in the period in
which the advance payment is received. Here, the advance payment covers more than one year tax period;
the tax is calculated for each year by perorating the advance collection to the number of the years that
covers it.

4.3.5. Declaration and Payment of Rental Income Tax

The time allowed for declaration of taxable income and payment of taxes the same as that of schedule ‘C’
tax. Remember that a taxpayer who has taxable income from rent shall declare the income (Art 83).
 Category A taxpayers Within 4 months after the end of fiscal year
 Category B taxpayers Within 2 months after the end of fiscal period
 Category C taxpayers Within 1 month after the end of the fiscal period
4.3.6. Record Keeping Obligations Related to Rental Income: the income tax proclamation 979/2016
clearly indicates the record keeping obligation related to Category of “A” and “B” taxpayers engaged in
renting of buildings. That is these taxpayers who are liable for tax under Schedule “B” shall keep the
following record of accounts:
 Rental income received;
 Fees and charges paid to a State or City Administration in relation to the building;
 Any expenditures incurred in relation to the building;

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 A register of rental buildings showing the acquisition date, the cost of acquisition, any costs of
improvement in relation to the building, and the current net book value of the building;
 Any sub-lease arrangement in respect of the building.
4.3.7. Journalizing Transaction Related to Rental Income Tax
Transaction related to the payment of rental income tax is recognized as follows:
General Journal
Date Description Items post ref. Debit Credit
Rental income tax expenses Xxxxxxx
Rental income tax payable Xxxxx
If there is withholding rental income tax the transaction is
recognized as follows

Date Description Items post ref. Debit Credit

Rental income tax expenses Xxxxxxx
Prepaid withholding rental income tax Xxxxx
Rental income tax payable Xxxxx
Illustration1: suppose w/ro Abeba has rented her building in Julay8, 2007 E.C. for monthly rent of birr
10,000 and leases on land paid to A.A city administration during the year was birr 3,000. In addition, she
was category “C “tax payer.

Required: Compute the annual rental income tax of w/o Abeba for the year ended July7, 2008 E.C

Solution: Gross rental income: ……………………….10,000*12= 120,000

Less allowable deductions
Lease on land…………………………….…………………….. (3000)
Repair, maintenance and Depreciation
(50%of the gross rental income)……….0.5*1200,000……….(60,000)
Taxable Income ………………………………………………. 57, 000
Tax payable …………… (57,000*0.20-3630)………………….7,770
Illustration 2: Suppose Abay PLC has rented his building found in AA, Arada Sub-city for
monthly rental of Birr 120,000 in July, 2007 EC. The company also provides the following
financial information in relation to the building:
 Cost leases paid on land………………………………...12,0000
 Book value of the building at the end of fourth year…….6,000,000
 Insurance premiums paid on the building ………………..30,0000
 Outstanding loans taken for construction(at 9.5% interest)….2,000,000
 Wages of building administrators and cleaning expenses……..70,0000

Required: Compute the Rental income tax paid at the end of the year 2008 E.C and journalize the rental
income tax at july 7, 2008.

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Solution: Gross rental income ……………..( 120,000*12)…………………………..1,440,000

Less allowable Deductions:

 Leases paid on land…………………………12,0000

 Depreciation expenses on building………….300,000
(.05*6,000,000)
 Insurance premium………………………….30,0000
 Interest expenses(.095*2,000,000)…………..190,000
 Wages and general expenses…………………70,000………………………….(602,000)
Taxable Income …………………………………………………………………………838,000
Since the taxpayer is Body the rental income tax rate applied is 30%
Rental Income tax (838,000*0.30) ……………………………………………………251,400

Journal entry
Date Description Items post ref. Debit Credit
251,40
Sense 30,2008 Rental income tax expenses 0
Rental income tax payable 251,400

When the rental income tax is declared and paid to the tax authority within the four months after the end
the year, the transaction will be recorded as follows:
Date Description Items post ref. Debit Credit
OCT. 20, 2008 Rental income tax payable 251,400
Cash in bank 251,400

4.4. ACCOUNTING FOR INCOME TAXES FROM BUSINESS

One of the major tax revenue sources to the Ethiopian government is undoubtedly business income tax
(business profit tax) that the government charges from the annual gross of business. Currently the tax
which, is collected from business income is computed per schedule “C”. Accordingly this section is
devoted to indicate the basic concept, computation and accounting treatment of transactions related to
Ethiopian business income tax law in accordance to the new income tax proclamation of 979/2016, tax
administration proclamation 983/2016 and income tax regulation No 410/17 and Tax Administration
Regulation 407/2017.

4.4.1. Category of Taxpayers, and Tax Reporting period

For the purposes of payment of business tax, taxpayers are categorized in to three namely, Category A,
Category B, and Category C.

Category ‘A’ includes any company incorporated under the laws of Ethiopia or in a foreign country
(Bodies) and individual tax payers having annual Sales turnover of Birr 1,000,000.00 and above. Those

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who are categorized under ‘A’ have to maintain all records and accounts which will enable them to
submit a balance sheet and profit and loss account disclosing the gross profit, general and administrative
expenses, depreciation, and provisions and reserves (together with the supporting vouchers). Pay tax
within 4-month period starting from end of their tax year (from Hamle 1 to tikimit 30).

Category ‘B’ includes those individual taxpayers having annual sales turnover of more than Birr
500,000.00 and less than Birr 1,000,000.00. They have to submit the profit and loss statement together
with the supporting vouchers. Pay tax with in 2 month period of time starting from end of their tax
year (from Hamle 1 to Nehasie 30).

Category ‘C’ includes all taxpayers who are not classified under the other two categories and whose
annual turnover is estimated at Birr 500,000.00 or less. Pay tax with in 1 month period of time starting
from end of their tax year (from Hamle 1 to 30). They pay tax based on standard assessment schedule
annexed to the income tax regulation Here theses tax payer engaged in business transport service shall
pay the withholding tax from employment income together with their business income tax.

4.4.2. Preservation of Books and Accounts

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 for category “A” tax Payer and For 3 Years for
category “B” tax Payer after the year of income to which such books and documents relate.
Particularly in accordance the income tax proclamation (ITP) of article 59, Category ‘A’ tax payers liable
for business income tax shall keep books of account prepared in accordance with the financial accounting
reporting standards and, in particular shall keep the record of:

 business assets and liabilities of the taxpayer,

 all daily income and expenditures;

 all purchases and sales of trading stock, and services provided;

 trading stock on hand at the end of the taxpayer’s tax year,;

 Any other document relevant in determining the tax liability of the taxpayer

On the other hand Category ‘B’ taxpayers liable for business income tax shall keep the following: a
record of daily income and expenditures; all purchases and sales of trading stock; salary and wages
register and any other document relevant in determining the tax liability of the taxpayer.
Category ‘C’ taxpayers may keep a record of gross income and other records that category B taxpayers
required to maintain. In addition, if these taxpayers are employing a worker shall keep documents
showing any amount of employment income paid to the employee and any amount withheld in tax from

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such income (Income tax regulation Art 59). Category C tax payer that maintains books of accounts may
pay their tax accordingly if the books of account maintained are accepted by the tax authority.
4.4.3. Methods of Tax Accounting (Article 64)

The period of tax assessment is one fiscal year. 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’.
Category “A” taxpayers are required to use international financial reporting standards (IFRS)
particularly accrual basis of accounting to record their business transactions.
Category “B” shall follow simplified methods of accounting that is cash basis of accounting to account
for business income and deductible expenditures. The rate of depreciation applicable to the depreciable
assets and business intangibles of the taxpayer shall be 100%; and deduction is allowed for the cost of
trading stock acquired during the year. However, as per the income tax regulation Art 58 these taxpayers
can voluntary account on accrual basis of accounting provided that they comply with the requirement
set under international financial reporting standards.
Long-term Contracts (Art 32): A taxpayer accounting for business income tax on an accrual basis shall
include amounts in business income and claim deductions for expenditures arising under a long-term
contract for a tax year based on the percentage of the contract completed during the year. The
computation will be made based on cost to cost method.
Change in Accounting Method: A taxpayer may apply to the Authority, in writing, for a change in the
taxpayer’s method of accounting and the Authority may, by notice in writing, approve the application but
only when satisfied that the change is necessary to properly compute the taxable income of the taxpayer.
If a taxpayer’s method of accounting changes leads to the change in the Category of the taxpayer, the
taxpayer shall make adjustments in the tax year of change to items of income, deduction, and credit, and
to any other items affected by the change, so that no item is omitted and no item is taken into account
more than once.
4.4.4. Depreciation of Business Asset and Business Intangible

Depreciable asset means tangible movable asset or a structural improvement to immovable asset that:
(1) Has a useful life exceeding one year;
(2) Is likely to lose value as a result of normal wear and tear, or obsolescence; and
(3) Is used wholly or partly to derive business income
As it is stipulated in the income tax regulation of Art 36 to 41, both diminishing value (declining
balance method) and straight line method is allowed to compute the depreciation amount. The

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Business intangible and structural improvement should be depreciated only under straight line method.
Here structural improvement means a building or any other addition or alteration to immovable asset that
becomes part of, or is permanently affixed to, the immovable asset including a road, driveway, car park,
fence, or wall.

Rate of Depreciation

Depreciable Tangible Asset Straight line rate Diminishing value rate

Computer, software and data storage equipment 20% 25%

Green house 10% Not allowed
Structural improvement other than greenhouse 5% Not allowed
Any other depreciable assets 15% 20%
Depreciable assets used in mining and petroleum 25% 30%
development operation

Here under diminishing value method depreciation is computed by applying the rate on the Net book
value of the asset at the beginning of the year.
The rate of depreciation applicable for business intangible includes the following:
 Preliminary expenditure (25%): an expenditure that provides an advantage or benefit for a
period of more than one year, incurred before the commencement of a business but not including
expenditure incurred to acquire any tangible movable or immovable asset.
 Business intangible useful life more than 10 year except preliminary expenditure= 10%
 Any other business intangible 100% divided by the useful life of the intangible
If the balance of depreciable asset of the taxpayer is not more than two thousand birr the amount shall be
fully allowed deductable from the income of the tax year.

Repair and improvement expense allowable as deduction if it is not exceeded 20% of the net book value
of the asset at the end of the tax year. However, if the improvement made to the fixed asset exceeds 20%
of the net book value of the asset at the end of the tax year, the whole cost of improvement or repair shall
be added to the net book value of the asset.

Depreciation on assets such as fine art, antiques, jewelry, trading stock etc (which are not subject to wear
and tear) are not allowed. Likewise, gain obtained as a result of revaluation of assets shall not use as a
basis for determining depreciation base.

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

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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.

4.4.5. Taxable Business Income

The taxable business income of a taxpayer for a tax year shall be the total business income of the taxpayer
for the year reduced by the total deductions allowed per the tax law.
1. Allowable Deductions

In order to determine taxable income under Schedule ‘C’, the following items of expenditures are
permissible.
A) Direct cost of producing the income such as the direct cost of manufacturing, purchasing,
importation, selling and such other similar costs.
B) General and administrative expenses incurred for earning, securing and maintaining the
income
C) Depreciation expense computed in accordance the income tax regulation
D) Bad Debt Expenses To be a deductible item, the amount must have been included
previously in income, the debt must have been written off in the books, and legal actions have
been taken for the collection of the debt
E) Insurance Premium payable on insurance directly connected with the business activity.
F) Expense incurred for the promotion of business. The maximum limit for this expense will
be set by directives to be issued by ERCA.
G) Commission paid for services rendered, provided that the amount shall not exceed the
normal rates provided by other similar businesses or persons.
H) A loss on disposal of a business asset (other than trading stock) disposed of by the taxpayer
during the year
I) Representation expense not exceeding 10% the income of the employees
J) Medical expense incurred for employees including premium payments under employees
health insurance scheme
K) Expenditures incurred in the provision of food and beverage services by Hotels, restaurants,
or other similar establishments for their employees, to the extent limit sated by the ministry
directives

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L) Lease payment made for business asset held under a capital goods lease agreement is
deductable business expenditure
M) Head Office Expenses: Payment made by a permanent establishment doing business in
Ethiopia to its parent non- resident body in reimbursement of actual expenses incurred by the
parent non-resident. Body for the benefit of the permanent establishment shall be deducted to
the extent that such expense was incurred in deriving, securing or maintaining business
income.

N. Interest expense: A deduction for any interest incurred by the taxpayer in a tax year is
allowed to the extent that the taxpayer has used the proceeds or benefit of the debt or other
instrument or agreement to derive business income.
Here deduction is not allowed if Interest paid or payable by a taxpayer in excess of the rate
used between the National Bank of Ethiopia and commercial banks increased by 2 percentage
points; unless the interest is paid or payable to a financial institution recognized by the
National Bank of Ethiopia; or a foreign bank permitted to lend to persons in Ethiopia.
Moreover, interest paid or payable by a taxpayer to a related person who is a resident of
Ethiopia except when the interest is included in the schedule ‘D’ of the related person is not
allowed as deduction from business income.
O. Charitable Donations under the following conditions.
a. If they are given to welfare organizations that have a record of outstanding
achievement and have a good accounting system showing the utilization of resources.
b. If the payments are made under emergency call issued by Gov’t to defend
sovereignty and integrity and to prevent manmade or natural catastrophe, epidemic or
any other similar cause
c. If the donation is made in support of education, health, environment protection or
provided in the form of humanitarian aid other than for the taxpayer owns employees.
(Note: Grants and donation will be allowed as deduction only if it does not exceed
10% of the taxable income)
P. Special Reserves: Financial institutions are permitted to deduct special reserves from
taxable income in accordance with the directives issued by NBE.

Q. Reinvestment of Profit: A Regulation by the Council of Ministers allows a deduction of

reinvestment of profit (of a resident company or registered partnership) not exceeding 5% of
the taxable income every year.

2. Non - allowable deductions and losses

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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:
a) An expenditure of a capital nature
b) An increase in the share capital of a company or the basic capital of a registered partnership;
c) Voluntary pension or provident fund contributions in respect of an employee in excess of 15%
of the monthly employment income of the employee;
d) Dividends and paid-out profit shares;
e) An expenditure or loss to the extent recovered or recoverable under a policy of insurance, or a
contract of indemnity, guarantee, or surety;
f) A fine or penalty imposed, or punitive damages awarded, for violation of any law, regulation,
or contract;
g) An amount that a person has transferred, in its financial accounts, to a reserve or provision for
expenditures or losses not yet incurred but expected to be incurred in a future tax year;
h) Income tax paid under this Proclamation or under a foreign tax law, or recoverable value added
tax;
i) Representation expenditures of an employee in excess of 10% of the employment income of
the employee;
j) Expenditure incurred in the provision of entertainment, except:
(1) When the person’s business involves the provision of entertainment; or
(2) to the extent that the expenditure is allowed as a deduction under a Directive issued by the
Minister relating to food provided for free to employees by an employer conducting a
mining, manufacturing, or agricultural business;
k) A donation or gift except as provided for in Article 24 of this Proclamation;
l) Personal consumption expenditure;
m) A loss on the disposal of a business asset by a taxpayer to a related person;
n) Expenditure to the extent disallowed under Regulations to be issued by the Council of
Ministers.
4.4.6. Business Income Tax Rates
The rate of business income tax applicable to a body is [30%]. While, The rates of business income tax
applicable to an individual are:

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Taxable Business Income Business Income Deductions for Short

(per year) Birr Tax Rate cut method

0 - 7,200 0% 0
7,201-19,800 10% 720
19,801-38,400 15% 1710
38,401-63,000 20% 3630
63,001-93,600 25% 6780
93,601-130,800 30% 11460
Over 130,800 35% 18000
Business Income Tax = Taxable business income* tax rate less deductions
4.4.8. 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. They are required to submit statement of financial
position and profit loss statements.
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. . They are required to submit profit loss
statements.
C) Category C taxpayers shall declare taxable income together with the annual turnover, and
the amount derived from the sources other than the main operation, within one month after
the end the tax year. The taxable income of category C taxpayers will be determined
through a standard assessment. The presumptive business tax to be paid by category 'C"
taxpayers shall be calculated in accordance with the SCHEDULE attached to the income tax
regulation

Declarations are to be made in prescribed forms prescribed by the tax authority accompanied by the
required supporting evidences. If a taxpayer engages in business in more than one region, taxable income
shall be declared in the respective regions.

4.4.8. 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. The procedure

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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&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 within the time required. Tax, of those taxpayers who have different sources of
income, will be assessed on the aggregate of all income.

4.4.9. Loss Carry forward (Article-26):

If the total amount of deductions allowed to a taxpayer for a tax year exceeds the total business income of
the taxpayer for the year, the amount of the excess shall be the taxpayer’s loss for the year. In such case
the taxpayer can carry the amount of the loss forward to the next following tax year to be deducted in
computing the taxpayer’s taxable income for that following year. The loss will be carried forward for a
maximum of five consecutive years after the year in which the loss is incurred. The taxpayer is allowed to
carry forward only two tax period losses. Here the loss earliest year shall be deducted first and loss carry
forward is allowed only if the taxpayer maintains books of accounts showing the loss are audited and
acceptable by the tax authority.

Loss Carry Back: When, at the end of the final tax year of a long term contract, a taxpayer has a final
year loss in relation to the contract that the taxpayer is permitted to carry forward under Article 26 but if it
is unable to do so for the reason that the taxpayer ceases to carry on business in Ethiopia at the end of the
contract, the taxpayer may carry the loss back to the preceding tax year and the loss shall be allowed as a
deduction and carried back ward till the loss is fully deducted. .
If during a tax period the direct or indirect ownership of the share capital or the voting rights of body
changes more than fifty percent (50%), by value or by number, loss carry forward and back is not
allowed.
4.4.10. Foreign Tax Credit
If a resident taxpayer has foreign income taxable under “Schedule C” in respect of, which the resident has
paid foreign income tax, the taxpayer shall be allowed a tax credit (referred to as a “foreign tax credit”).
The amount foreign tax credit is equal to the foreign income tax paid; or the business income tax payable
under Schedule ‘C’ in respect of the foreign income. Here, foreign tax credit shall be allowed when:
 The resident taxpayer has paid the foreign income tax within 2 years after the end of the
tax year in which the foreign income was derived by the taxpayer or within such further
time as the Authority allows and
 The resident taxpayer has a receipt for the tax from the foreign tax authority.

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If a foreign tax credit of a resident taxpayer for a tax year is not fully credited for the year, the excess
credit shall not be refunded, carried back to the preceding tax year, or carried forward to the following tax
year.
Foreign Business Losses (Art 46): in relation to a resident taxpayer for a tax year, means the amount by
which the deductible expenditures incurred by the taxpayer in deriving foreign income taxable under
Schedule “C” exceeds the amount of that income for the year. If a resident taxpayer has a foreign loss for
a tax year, the amount of the loss can carried forward to the next five consecutive tax year and allowed as
a deduction against the taxpayer’s foreign income taxable under “Schedule C” for these years. The tax
payer is allowed only to carry forward losses foreign income only two tax period losses.
4.4.11. Withholding Income Tax (Art 88 to 93)
In theory withholding tax is defined as the amount of tax to be with held by the party making payment to
another party and to be transferred or paid to the tax authority as per the tax law. The purpose of
withholding tax could be to accelerate tax collection of the government. Withholding income tax
indicated in the Ethiopian tax law includes the following.
A. Withholding tax from imported goods: A taxpayer under Schedule ‘C’ importing goods for
commercial use shall make an advance payment of business income tax to the Authority equal to 3%
of the CIF value of the goods.
B. Withholding of Tax from Domestic Payments (Art 92): Except micro enterprises, bodies having
legal personality, government agencies, non-profit organizations, or non-governmental organizations
and other tax payers required to withhold tax by a directive of the authority, shall withhold tax at the
rate of 2% of the gross amount of a payment made for the following:
 The supply of goods in Ethiopia involving more than 10,000 Birr in one transaction or
supply contract;
 The supply of services involving more than 3,000 Birr in one service contract

Here if the supplier of the transaction has failed to provide their TIN and trade license to the withholding
agent, the withholding agent shall withhold tax at the rate of 30% of the gross amount of the payment
made.
The withholding agent has the obligation to issue serially numbered receipts to persons from whom the
tax is withheld. The agent shall supply the name and TIN of the taxpayer, the amount withheld and the
total amount of payment made. For this purpose, the records showing the payment made and the tax
withheld on payment should be maintained by withholding agent in his office. It is also required that such
records should be kept for a period of 5 years and should be submitted to the tax authority as and when
required by them.

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C. Withholding of Tax from Employment Income: An employer paying employment income to an

employee who is subject to employment income tax shall withhold tax from the gross amount of each
payment of employment income made to the employee

D. Withholding of Tax from Payments to Non-residents: indicated in schedule D

E. Withholding of Tax from Dividends, Undistributed profit, repatriated profit, Interest, and
Royalties:

F. Withholding of Tax from Games of Chance Income

G. Self-withholding: for employees who works in organization that don’t have withholding obligation

Payment of Withholding Tax: Tax that a withholding agent is required to withhold from withholding
income shall be paid to the tax authority within 30 days after the end of the month in which the
withholding income was paid

4.4.12. Method of Preparing Tax Returns

Business normally prepares business income tax returns (that is profit and loss statements for tax purpose)
to determine and report their taxable business income per the income tax legislation. There are two
methods used to prepare the tax returns.
Independent approach: business prepares a separate income statement for income tax reporting. The
preparation of business tax return ignores the tax exempted business income and non deductable expenses
as indicated in the tax law in the following format.
Names of the taxpayer
Business income tax return
For the tax period ending June 30, 20xx
Admissible business income
Net Sales……………………………………………………………………..……xxxx
Less cost of goods sold……………………………………………………………xxxx
Gross profit…………………………………………………………………………xxxx
Add other admissible incomes
Income from lease of business……………………………………………..…..…….xxx
Gain on foreign exchange ………………………………………..………….……..xxxx
Commission income ……………………………………………………………….xxxx
Recovery of bad debt expenses previously write off……………………………….xxxx
Gross taxable profit………………………………………………………………....xxxx
Less tax deduction expenses
Selling and distribution expenses………………………….xxxx
Utility expenses………………………………………..…..xxxx
Salary and fringe benefit expenses…………………….…..xxxx
Interest expenses ………………………….………………xxxx

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Depreciation expenses ………………....…….………..….xxxx

Advertizing expenses ……………………..…….………...xxxx
Donation expenses………………………….….………..…..xxxx
Tax business income ……………………………………………………………...xxxx
Less provision for tax………………………………..…………xxxx
Net profit tax after tax………………………………………………………………xxx
Dependence approach: in the dependence approach the annual accounting profit determined for
financial reporting purpose abased on IFRS or GAAP is taken as the primary basis for the determination
of taxable business income subjected to adjustments per the relevant provision of the tax law. This
approach does not require keeping a separate set of record for income tax reporting purpose.

Name of the taxpayer

Business income tax Return
For the tax period ending June 30/ 20xx
Pre tax accounting income in the income statement…………………………..xxxx
Adjustments
Add back
Non deductable expenses but deducted in the income statement..............….xxxx
Admissible income but no include in the income statement…………..……...xxxx
Deduct
Deductable expenses but not charged in the income statement….……….…..xxxx
Exempted incomes but included in the income statement………….….….….xxxx
Tax business income ……………………………………………………..……...…xxxx
Less : provisions for income tax of the period ……………………………….…….xxxx
Net profit after tax ……………………………………………………….…………xxxx
Illustration
1. Mr. James is a foreign citizen neither domicile nor a habitual residence in Ethiopia. He comes to
Ethiopia for the first time on Ginbot 11, 2008 E.C for three months to give training in connection with
the shooting of cinematography film in. A.A. For this, he has been paid remuneration of Br 50,000 by
master company, an Ethiopian company. Mr. James comes to Ethiopia for the second time on
Meskerm 7, 2009 E.C. for the same job and left Ethiopia on Tir 30, 2009 E.C. During this time, he
has been paid birr 85,000 by master company.

Required:
A. Determine the residential status of Mr James for the tax year 2008 E.C.
B. Is his income chargeable to income tax in Ethiopia? And if your answer is yes under what
schedule he is liable to pay tax?
C. What would the residential status of Mr James for the tax year of 2009?
Solution

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A. During the tax year of 2008 E.C. Mr James stayed only for 50 days only (Ginbot 11 to
Sene 30, 2008 E.C). This implies he did not satisfy the condition for resident taxpayer
indicated in the income tax proclamation. Therefore, Mr James is non- resident for the tax
year of 2008 E.C.
B. Yes, he is liable to pay a tax based on source of income principle, which is taxed under
schedule “D”. That is income on non-resident’s generated through providing technical
services by nonresident to Ethiopian taxpayer subjected to tax at rate of 15% in the form
of withholding tax.
C. In the tax year 2009 E.C Mr James stayed in Ethiopia for184 days implying that he is a
resident for the tax year of 2009 E.C. and his worldwide income is subjected for tax.
2. Adane merchandise enterprise PLC has the following buildings
 Office building acquired in July, 2005 E.C. at the cost of birr 1,500,000
 Factory building acquired in September 1, 2008E.C at the cost of birr 10,000,000
birr
Required: Compute the depreciation expense for the tax year ending June, 30/ 2008 E.C.
Solution
Deprecation of building is 5% straight line.
Depreciation expense for office building is 1,500,000*0.05= 75,000 and Factor building is
10,000,000*0.05=500,000 per year. So depreciation expense of building for the year 2008 E.C is
birr 575,000.
3. XYZ plc financial statement shows the following information (the company diminishing value)
 The cost of computers birr 185,000 and accumulated depreciation in June, 30/ 2007 E.C birr
120,000.
 During the 2008 E.C tax period the company under takes the following transactions.
 Three computer and printer was purchased at the cost of Birr 30,000
 Software products costing Br 10,500 was purchased
 Seven used computers with cost of Br 48,000 and accumulated depreciation Br 45,000 was
sold for Br 18,000
 Compensation of Br 3,000 was received from the vender since two of the computers acquired
during the current tax year were slightly damaged during in transit. The company incurred Br
1,000 to maintain the computer and place them in workable condition.
Solution
Depreciation Base
Beginning Book value balance of the pool (185,000-120,000)………………………….Br 65,000

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Plus
 Purchase of cost of computer, printer and maintenance cost………Br 30,000
 Purchase cost of software product……………………………… Br10,500 40,500
Aggregate value of the pool ………………………………………………………………105,500
Less
 Sales Proceeds ………………………………………………………(18,000)
 Compensation received ……………………………………… (3,000) (21,000)
Depreciation base for the tax Year ending June 30, 2008 E.C ……………………………84,500
Depreciation expense = 84,500*0.25= 21125

4. The following was extracted from HM plc fixed asset record maintained for financial reporting
purpose for the tax years ended June, 30 2007 E.C (use diminishing value)
 The cost of pool machines at the beginning of tax year 2007 E.C. was 1,800,000 and accumulated
depreciation Br 500,000
 The company acquired new machine costing Br 50,000 in the tax year 2007 E.C
 The company had sold two used machines during the tax year, 2007 as follows
Acquisition cost Accumulated depreciation Selling proceeds
200,000 170,000 83,800
95,000 90,000 48,000
Required: compute the depreciation expenses deductable from gross business income of the tax year 2007
E.C.
Solution
Book value of the pool machinery at the beginning of tax year (1,800,000-500,000)………..1,300,000
Plus: acquisition cost during the year………………………………………………..……50,000
Aggregate value of the pool……………………………………………………………1,350,000
Less: sales proceeds from disposal during the year…………………………………… (131,800)
Depreciation Base at end of tax year 2007 E.C…………………………………………1,218,200
Depreciation expense for the tax year (1,218,200*0.20)…………………………………243,640

5. On January 2008 E.C. Belaye General Importer was imported trading goods costing Br 1,000,000,
fright incurred Br 310,000 and insurance charges Br 120,000. Determine the amount withholding tax
paid by the tax payer.
Withholding tax on import= 3% of CIF 0.03*(1,000,000 + 310,000+ 120,000) = Br 42,900

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6. During the tax year ended 2008 E.C Glorious PLC under takes the following transaction and
determine whether or not the transaction are subjected to withholding income tax
A. On Jan 1, 2008 sold electronic items to XYZ plc for one transaction Br 9,000
There is no income tax to be with hold because the transaction is less that Br 10,000
B. On march 15, sold electronic items on account Br 20,000 with term 3/30,n/120 to XYZ plc in a
single transaction.
There is no income tax to be with hold because payment has not been effected.
C. On April 10, the company collected the outstanding receivables for sales made in March 15, the
entity receives Br 19,000 in cash after deduction of the withholding tax Br 400 (0.02*20,000)
and cash discount 3% 0f 20,000 Br 600.
Here the withholding tax is 2% of the gross amount does not affected by sales discount.
D. on April 30, the company sold electronic items to HM plc for cash of Br. 20,000 in one invoice.
The company receives Br 19,600 after deduction of WIT of Br 400.
E. On June, 25 the company provided maintenance service to XYZ plc for cash of Br 5,000. In this
case the payer with holds 2% of the gross payment Br 100.
If we assume that the taxable business income of Glorious PLC is Br 50,000 the total business income
tax liability of the taxpayer will be (0.30*50,000) less WIT paid during the tax year(500) = Br 14,100.
7. Suppose X Bank Ethiopia Share Company has its head office located in A.A and its financial
statement for the tax year ended June 30, 2008 E. C shows the following information.
Particulars Head Office Kenya South Sudan Tanzania
Taxable Business income (in Br) 100,000 100,000 30,000 60,000
Tax rate of respective countries 30% 20% 30% 40%
Required: compute the business income tax payable to the Ethiopian tax authority.
Solution
Particulars Head Office Kenya South Sudan Tanzania
Taxable Business income (in Br) 100,000 100,000 30,000 60,000
Tax rate of respective countries 30% 20% 30% 40%
Income tax liability to respective countries 30,000 20,000 9,000 24,000
Income tax liability to the Ethiopian tax
authority on foreign source of income (A) _ 30,000 9,000 18,000
Less foreign tax credit (B) _ 20,000 9,000 18,000
Business income tax payable to Ethiopian tax
authority 30,000 10,000 _ _
That is Br 40,000 business income tax payable to the Ethiopian Tax authority.
8. The HM plc financial statement for the tax year ending June 30, 2008 E.C shows the financial
information.
HM PLC

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Income Statement
For the year ended, June 30, 2008 E.C
Net Sales Br.327, 000
Less: Cost of Goods Sold 155,000
Gross Profit 172,000
Less: Operating Expenses:
Salaries and Wages Br.22, 000
Representation 6,000
Utilities 3,100
Supplies 1,200
Advertising 9,100
Entertainment 2,200
Depreciation 20,000
Interest 2,500
Miscellaneous 1,300 67,400
Operating Income Br.104,600

Additionally the following information was obtained for tax reporting purpose.
 The Br.55, 000 ending inventory cost was determined based on the FIFO method. If the LIFO or
Average Cost method had been used, the amount would have been Br.58, 000 and Br.52, 000,
respectively.
 Salaries and wages comprise Br.1, 000 disallowable provident fund of employer’s contribution.
 Representation expense calculated at 25% of basic salaries of the employees.
 The Br.15, 000.00 depreciation was reported on the original cost of the Br.120, 000.00 building; and
the Br.5, 000.00 depreciation was also reported on the original cost of the Br.50, 000 vehicles. The
accumulated depreciation at the beginning of the tax year for Building and vehicle was Br 45,000 and
Br 30,000 respectively. The company used straight line method for Building and declining balance
method for depreciating the vehicle.
 The interest is on Br.25,000, and 10% simple annual interest borrowed from a recognized financial
institution By NBE in 2008 E.C. The highest interest rate by NBE and commercial banks for the
current year was 6%.
Required: Compute the business income tax payable for the tax year using independent and
dependent approach.
Solution:
1. In accordance to the tax law taxpayer should use weighted average for inventory valuation as a result
the cost of goods sold is understated by 3,000 birr
2. The salaries and benefit are overstated by 1,000
3. Since only 10% of the basic salaries of the employees are allowable as representation allowance to
be deducted from the gross income, that is only 2,400 are allowable deductions, as a result the
representation allowance is overstated by 3,600.

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4. For building the depreciation rate is 0.05 and using straight line method the annual depreciation will
be 120,000*0.05= 6000 and the depreciation rate for vehicle is 20% if we use the diminishing value
method and the depreciation expense of the year will be (50,000-30,000)*0.20= 4,000. This implies
the total depreciation allowable as deduction will be 6000+4000=10,000 and hence the depreciation
is overstated by 10,000.
5. The full interest expense is allowed as deduction because it is paid to financial institutions
recognized by NBE.
6. Entertainment expense is not allowed as deduction
Independent approach
HM PLC
Tax Return
For the year ended, June 30, 2008
Net Sales Br.327, 000
Less: Cost of Goods Sold 158,000
Gross Profit 169,000
Less: Operating Expenses:
Salaries and Benefits Br.21, 000
Representation 2,400
Utilities 3,100
Supplies 1,200
Advertising 9,100
Depreciation 10,000
Interest 2,500
Miscellaneous 1,300 (50,600)
Taxable Income Br.118,400
less Provision for business income tax (118,400*0.30)………..…………….…………(35,520)
Profit after tax……..……………………………………………………………………….82,880

Using dependent approach

HM PLC
Tax Return
For the year ended, June 30, 2008
Accounting profit ………………………………………………………………….Br 104,600
Add back
Salaries and Benefits Br.1, 000
Representation 3,600
Depreciation 10,000
Entertainment expenses 2,200
Deduct Cost of goods sold (3,000)
Taxable business income 118,400
Less Provision for business income tax (118,400*0.30) ……………………………... (35,520)

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Profit after tax………………………………………………………………………………82,880

4.5. Other Income (Schedule “D” Tax)

Incomes which are not specifically included under Schedule “A”, Schedule B and Schedule C is
categorized under this schedule. Schedule D income includes;
4.5.1. INCOME OF NON-RESIDENTS
A non-resident who has derived an Ethiopian source dividend, interest, royalty, management fee,
technical fee, or insurance premium shall be liable for non-resident tax at the rate specified as follows:
 For an insurance premium or royalty , 5% of the gross amount of the premium or royalty;
 For a dividend or interest, 10% of the gross amount of the dividend or interest;
 For a management or technical fee, 15 % of the gross amount of the fee
However, the income generated by non-residents through permanent establishment cannot be taxed under
this category. Rather, it is taxed under schedule “C” or “D”.
4.5.2. Taxation of Non-resident Entertainers
A non-resident entertainer or group of non-resident entertainers who has derived income from the
participation by the entertainer or group in a performance-taking place in Ethiopia shall be liable for
income tax at the rate of 10% on the gross income derived from the performance without deduction of
expenditures.. Here, entertainer” includes musician and sports person; “group” includes a sporting team;
and “performance” includes a sporting event.
4.5.3. Taxation of Royalties
Royalty refers to 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 film, and films or tapes for
radio or television broadcasting, any patent, trademark, 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.
Royalties is subject to a tax at a flat rate of 5%. The withholding agent who effects royalty’s payments,
withholds the foregoing tax and accounts to the Tax Authority. However, if the payer resides abroad and
the recipient is a resident, the recipient must pay the tax on royalty income. This tax is final in lieu of
income tax.

4.5.4. INCOME FROM GAMES OF CHANCE

This form of income is derived from winning at games of chance (lotteries, Tom bolas, and other similar
activities). This income is subject to tax at the rate of 15%, except for winnings of less than Br. 100

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similar to income from rendering technical activities the payer must withhold or collect the tax and
account to the Tax Authority. This tax is final in lieu of income tax

4.5.5. DIVIDENDS

The taxable Income is income received in the form of dividend from a share company or withdrawals of
profits from a private limited company. Resident of Ethiopia who derives dividend and non resident who
derives Ethiopian sources dividend that is attributable to a permanent establishment are liable to pay
dividend income tax. Dividend Income is subject to tax at the rate of 10% of the gross amount of the
dividend. The withholding agent (payer) shall withhold or collect the tax and account to the tax Authority.
This tax is final in lieu of income tax.

4.5.6. INCOME FROM CASUAL RENT

The taxable income under this category is income derived from casual rental of property (land, building,
or moveable asset) not related to a business activity. This type of income is subject to tax at a flat rate
15% of the annual gross income. This tax is a final tax in lieu of a net income tax.
tax.
4.5.7. INTEREST INCOME
A resident of Ethiopia who derives interest and non resident who derives Ethiopian source interest that is
attributed to permanent establishment, are liable for income tax at the rate of:
 5% of the gross amount of the interest derived from savings deposit with a financial
institution that is a resident of Ethiopia,; or
 10% of the gross amount of the interest in any other cases
The payer must withhold the tax and account to the Tax Authority. This tax is a final tax in lieu of income
tax.
4.5.8. Windfall Profit: windfall profit” means any unearned, unexpected, or other non-recurring gain.
The directive issued by ministry of finance and economic cooperation determines the tax rate imposed on
windfall profit.
4.5.9. GAINS ON TRANSFER OF CERTAIN INVESTMENT ASSESTS
Gains obtained from the transfer (sale or gift) of building held for business, factory, and office and a share
of companies is taxable under this category. Such income is taxable at the following rates:-
- Building held for business, factory, and office at the rate of 15%, and
- Shares and Bonds at the rate of 30%
Nonetheless, Gains obtained from the transfer of building held for residence is exempted from tax
provided that such building is fully used for dwelling for two years prior to the date of transfer.

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Computation of Capital Gain Tax

In computing capital gain tax, you should follow the following procedures;
STEP 1.Determine
1.Determine the historical cost of the building or the par-value of the Share, as appropriate.
STEP 2 Determine allowable deductions which includes
- taxes paid for the land and the buildings
STEP 3 Determine proceeds from the transfer of capital assets
STEP 4 capital gain taxes equals tax rate mentioned above times the amount obtained after deducting the
sum of step1 and step 2 from step 3.
Example
ABC Co. sold a building, which is held for business for Br. 1,000,000, which is acquired at a cost of Br.
1, 200,000. Depreciation until time of sale amounts Br. 500,000 and property tax paid for the building
Birr 50, 000.
Calculate the capital gain tax payable by ABC Co.

Solution
■ Book value of the Building = Cost – Accumulated Depreciation
= 1,200,000 – 500, 000
= 700, 000
■ Property tax on the building is allowable deduction. Br. 50, 000
Capital gain tax =( Br. 1000, 000 – (Br. 700,000 + Br. 50,000)) 15%
= Br. 250,000 X 15% = Br. 37500
4.5.10. Undistributed profit

Tax shall be paid at the rate of 10% on the net undistributed profit of a body in a tax year to the extent
that it is not reinvested, in accordance with the directive to be issued by the ministry of finance and
economic cooperation.
4.5.11. Repatriated Profit

A non-resident body conducting business in Ethiopia through a permanent establishment shall be liable
for tax at the rate of 10% on the repatriated profit of the permanent establishment.
4.5.12. Other Income
A person who derives any income that is not taxable under Schedule A, B, C, or D is liable for income tax
at the rate of 15% on the gross amount of the income.

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