Abstract

Presumptive tax system is introduced in our country to provide category ‘C’ tax payers with
equitable, efficient, quality services and bringing more firms to the tax net by promoting tax
payers voluntarily discharge their tax obligations. However, when the daily presumed income
is estimated the questions of fairness just arisen that lead the authority and the business to
dispute. So, the aim of this study is to examine the perceptions of category ‘’C’’ tax payers
towards pillars of presumptive tax system (simplicity, administrative capacity and fairness)
and its related challenges. To achieve the intended objectives quantitative research approach
and explanatory research design will be employed. In addition, the study will also use
primary data source collected through questionnaire. The questionnaire will be distributed to
presumptive tax payers after selecting sample. The sampling technique in this study is
multistage stratified sampling. As a result, a total of 400 self-administered, closed-ended
questionnaires will be distributed to category “C” taxpayers found in Gamo Zone city
administrations and woredas. Given the logical ordering of the alternatives (presumptive tax
application) the study will employ an Ordinal logistic regression model. As part of the
process, the Statistical Package for Social Science (SPSS) Version 24 will be used.

Key Words: Perceptions; Challenges; Presumptive Taxation; Category ‘C’ Tax Payers.

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 CHAPTER ONE: INTRODUCTION

This chapter introduces briefly about the background of the study, problems from theories
and past studies. The problem statement is given and research objectives have been clearly
described. Apart from this, this chapter also identifies the significance, scope, and structure
of the study.

1.1. Background of the Study

The capacity of any government to mobilize domestic resources is a crucial factor in the
process of poverty reduction and its overall economic development. This domestic resource
mainly includes tax collection, non- tax revenues, domestic borrowing, and from other
domestic income sources. Among these sources, taxation is considered to be the most reliable
way of financing government expenditure in both developed and emerging economies. In
order to avoid excessive foreign debt financing and strengthen domestic revenue
mobilization, developing countries were expected to broaden their tax bases and improve
their tax administration systems. However, many of them, including Ethiopia, experience a
chronic gap between actual and desirable levels of tax revenue (International Monetary Fund
[IMF], 2015).

In the past decades Ethiopia has made encouraging progress in mobilizing more revenues
from domestic sources, particularly in tax revenue. Tax collection increased from Birr12.4
billion in 2005 to Birr 165.3 billion in 2015 indicating over thirteen fold increase in the
decade. Similarly the share of domestic revenue in the total public revenue increased from 77
percent to 94 percent in the same period, and the share of tax revenue stands at 83 percent in
2015. However, there is a challenge in increasing the tax revenue proportionate GDP; the tax
to GDP ratio remained low at 13.4percent in 2015 which is below the Sub Saharan Average
of about 18percent, over 20percent for emerging economies and above 30percent for
developed economies (Geda, 2014).

As a way of compensating for the revenue shortfalls, small business tax regimes are now the
focus of many tax systems in developing countries including Ethiopia. Such taxes are usually
targeted at the self-employed and small to medium-sized businesses in the informal or
unregistered sector, and commonly take the form of presumptive taxes (Wallace, 2002 &

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Benjamin & Mbaye, 2012). Presumptive tax is a typology of simplified tax regimes levied on
SMB and self-employed taxpayers. Such policy tools represent a methodology of assessment
of tax liability alternative to the regular method used to compute actual taxable income,
based on taxpayers’ accounts as defined by law (Slemrod & Yitzhaki, 1994; Martins & S´a,
2018). As per Loeprick (2009) presumptive taxes are generally favored for their
administrative simplicity and economic efficiency. They are simpler to administer than direct
taxes on income as informal sector of the economy are not required to keep the detailed
records necessary under the standard tax regime and the authorities can avoid the costs
associated with the conventional verification and assessment procedures.

In the context of the above discussion, Memon (2010) noted that developing countries use
presumptive tax to supplements the normal income tax because these countries do not meet
the pre-requisites of successfully administering the normal income tax, which include
literacy, a documented economy and an efficient tax administration. Moreover, a large
population of taxpayers in these countries are small businesses which cannot afford the
compliance costs of income tax. Presumptive tax is therefore used in these countries to
control non-compliance of small business.

Even though presumptive tax is preferred over the conventional income tax with respect to
cost avoidance and simplicity, in Ethiopia the micro business tax payers frequently
complains. Because the tax assessment methods are based on subjective estimation, the lack
of book of records by micro business taxpayers and the tax estimation committees focused on
observations to estimate tax liability. As a result of these they are subjected to over taxation
(ERCA, 2017). Since business owners do not have simplified access to and clarification on
information of the tax laws, they lack awareness on tax rules and regulations, so this has an
impact on the practicability of the regulations (Ethiopian chamber of commerce, 2005).
Accordingly, the aim of this study is to empirically investigate the perceptions and challenges
in the application of presumptive business tax in Gamo Zone for the period covering 2021.

1.2. Statement of the Problem

The developing countries economy is cash based and is dominated by a significantly large
number of micro and small businesses. Like many tax regimes of different countries, taxes
are levied on various segments of businesses depending on the amount of income derived by

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the taxpayers in Ethiopia. Small businesses, sometimes called hard-to-tax (HTT) sectors, are
an integral part of these groups. Hence, taxing this sector assists the growth of the economy
by raising government revenue and increasing the number of taxpaying firms. It is for this
reason that the simplified tax system of presumptive taxation is designed as a transition for
micro businesses to introduce them to the standard tax regime in many growing economies.
(Benjamin & Mbaye, 2012).

As such presumptive tax is a system for ascertaining the tax liabilities of small businesses
using an indirect method of assessment that differs from the regular tax assessment
mechanism based on the taxpayer’s account. Currently, Ethiopia employs the presumptive
tax method in respect of category “C” taxpayers, with the aim of collecting an adequate
amount of tax revenue. According to the new income tax proclamation No. 979/2016,
taxpayers are divided into three categories, namely “A”, “B”, and “C”, based on their sales
volumes and the ways in which their businesses are set up. As per the income tax
proclamation 979/2016 and regulation 410/2017, Article 60 (FDRE, 2017) presumptive tax is
employed in two ways. These are the turnover-based presumptive system and a system based
on indicators.

Like most developing countries, Ethiopia has a very large number of taxpayers in category
“C” (small and medium-sized taxpayers). When compared to the other taxpayer categories,
category “C” is an important source of revenue for the government (Megnaka & Devi, 2014).
However, this category is the most problematic one in terms of levying and collecting taxes
in Ethiopia. Research conducted by Gezahegn, Desta and Adane (2014), and Mengesha and
Ashebir (2013) indicated that frequent frictions and controversies are observed between
taxpayers and tax administrators, which causes widespread complaints about unfairness and
overstated tax by the majority of category “C” taxpayers. Recently, presumptive income
taxpayers across Ethiopia contended that the tax authority had violated the existing standard
assessment procedures with its practical application of them, and that the revenue offices did
not conduct sufficient and appropriate tax research into category “C” taxpayers in order to
levy taxes. As a result, many small and medium-sized businesses closed in protest against the
tax authority’s assessment and collection procedures (Getachew, 2019).

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This particular study uniquely will use econometrics model to examine the tax payers’
perceptions towards simplicity, administrative capacity and fairness which are the pillars of
presumptive taxation. In addition to this, even though, there were a few researches conducted
on factors affecting tax compliance on micro business tax payers, there is no study directly
on perception towards in the application of presumptive taxation and its challenge in case of
Gamo Zone. This research gap together with the problem statement presented above
necessitated the conduct of this study. Therefore, this study will focus on presumptive tax
payers in Gamo Zone.

1.3. Research Questions

Based on the above statement of the problems the researchers develops the following
pertinent research questions.

1. Are aspects of the tax system simple to understand for presumptive tax payers?
2. Is the tax administration good enough on the eyes of the presumptive tax payers?
3. Does the presumptive tax payers perceive the tax as fair?
4. What are the challenges in securing tax revenue from the presumptive tax?

1.4. Objective of the Study

1.4.1. General objective of the Study

The general objective of this study is to assess the perception and challenges in the
application of presumptive business tax in Gamo Zone.

1.4.2. Specific Objective the Study

Specifically, this study intends:

 To explore if the tax payers find the presumptive business tax is simple?
 To find out if the tax payers find the tax administration is efficient and if it handles
the job properly?
 To examine if there is fairness in the presumptive tax regime?
 To investigate challenges associated with the perception and if this has any effect on
the tax revenue generation?

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1.5. Significance of the Study

This study believed to shed more lights on the practical application of presumptive business
tax in Gamo Zone. The issues to be addressed in this study will have of significance to the
following stakeholders:

Gamo Zone Revenue Authority: The finding of the present study will help Gamo Zone
ministry of revenue to understand different challenges related to micro business taxation and
minimizing the observed tax collection challenges faced by the authority and tax payer’s
complaints to increase tax revenue. It also helps to improve the tax system and tax law in
order to increase the size of formal sectors and archive the tax reforms of the country.

Presumptive Tax Payers: This study will provide category ‘C’ tax payers to get better
understanding of the culture of taxation and on the design of the current presumptive tax
system of the Gamo zone.

Academic Community: Last but not least the study would contribute more updated
empirical evidence regarding to the existing work on the study of perception towards in the
application of presumptive business tax and its challenges and would be of great benefit to
the academic field as it will serve as a reference material for students and future researchers
who want to research more on the topic.

1.6. Scope of the Study

This study is delimited in terms of topic and cross-section units concerned. Thus, the study
will focus on examining perception towards in the application of presumptive business tax
and its challenge in Gamo zone. As it is difficult to cover the whole category ‘C’tax payers in
Gamo zone whose annual turnover is less than 500,000 birr and since the application of
presumptive taxation follows nearly the same procedure, emphasis is given to Gamo zone
micro business tax payers after selecting a sample.

1.7. Structure of the Study

The final report of this study is organized in five chapters. The first chapter states
introduction of the study including elements, such as back ground of the study, statement of
the problem, objectives of the study, significance of the study, scope of study and structure of
the paper and the second chapter includes related literature reviews ( theoretical as well as
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empirical), research gap and conceptual framework. The third chapter deals with research
methodology that will be used in conducting the study and this is followed by the results and
analysis of data in chapter four. The last chapter presents conclusions and recommendation of
the study. Finally, references and appendix were enclosed herewith.

CHAPTER THREE: RESEARCH METHODOLOGY

The previous chapter presented the problem statement along with the existing research gap
which this study intends to address. The purpose of this chapter is to present the research
methodology (a way to systematically solve the research problem) that the researcher will
apply in this study in order to examine the perception towards in the application of
presumptive taxation and its challenges in Gamo Zone. This chapter includes the research
design, research approach, target population and research instruments, description of
variables and measurements, model specification and methods of data analysis.

3.1. Research Design

Research design is the structures that guide the researcher in their investigation of a
phenomenon (Kothari et al., 2005). A choice of research design is based on the objective of
the research; the objective of this research is to examine perceptions towards in the
application of presumptive taxation and its challenge in Gamo Zone. So, this study will use
explanatory research design in order to understand the perception of the presumptive tax
payers in the key aspects of presumptive tax (simplicity, administrative capacity and
fairness). This is because it aims at, explaining relations or events, advancing knowledge
about the structure, process and nature of events, linking factors and elements of issues into
general statements and building, testing or revising a theory (Adams et al., 2007).

3.2. Research Approach

As per Creswell (2009) in an investigative study, there are three common approaches to
business and social researches, and among them, quantitative approach will be employed for
this study. If the research problem is wants to identify factors that influence an outcome, or
understanding the best predictors of outcomes, then a quantitative research approach is the
best choice. Quantitative research approach also raised the positivist perspectives. Positivist
reflects a deterministic philosophy in which a need to examine causes that influence an

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outcome, this provide a chance to the researcher to examine perceptions towards in the
application of presumptive taxation and its challenges. Therefore, for this study quantitative
research approach will be used to investigate the relationship between perceptions and
presumptive taxation and its challenges.

3.3. Target Population and Sampling Technique

3.3.1. Target Population

A population is defined as a complete set of individuals, case or objects with some common
observable characteristic (Mugenda & Mugenda, 2003). The target population considered in
this study is presumptive tax payers in Gamo zone. According to the current income tax
proclamation number 979/2016, presumptive taxpayers are small businesses with an annual
turnover of less than 500,000 Birr (equivalent to $12,500).

3.3.2. Sampling Technique and Sample Size

This study will use purposive and multistage sampling techniques for collecting data from
presumptive tax payers. Currently, there are 4 city administrations and 14 woredas in Gamo
zone. So, this study will be conducted on these city administrations and woredas after
selecting a sample. For this study, purposive sampling was first applied to deliberately select
sample Cities and Woredas based on qualities the participant possesses and the selection
criteria set by the researchers. As a result, the researchers purposively selected these city
administrations and Woredas (Arbaminch, Geresse, Arbaminch Zuria Woreda, Mirab Abaya
woreda, Ditta and Selamber). These cities and woredas were selected by taking in to account
the number of total category ‘C’ tax payers they have and based on their relative business
transactions. According to Mugenda & Mugenda (2003) a sample of 10-30% of the total
population is adequate if the sample is properly selected. The sample of cities and woredas
category ‘C’ tax payers included in the study covers 69% of the total population in terms of
number of tax payers included in the sample.

After selecting the city administrations and woredas purposely multistage sampling
techniques will be employed to select sample respondents in each strata. The sample tax
payers from each stratum were then selected through a proportional sampling method.
According to Gamo Zone Revenu Authority (2020), there were about 13801 Category ‘C’ tax

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payers in all selected cities and woredas. From this 389 individual samples were determined
by using (Yemane, 1967) formula.

Where: n = Sample size

N = Total population size

e = Level of precision.

Hence, the sample size is equal to: n = 13801/ (1+13801(.05)2) = 388.73 ≈ 389

So, samples of 389 individual tax payers will be selected. The number of tax payers and their
addresses will be obtained from Gamo Zone Revenue Authority.

No. Cities Total Sample size determination Samples

presumptive by proportion taken
tax payer

1 Arba Minch 8,069 Arba Minch = 8069*389 227

13801

2 Mirab Abaya Woreda 1,633 Mirab Abaya = 1633*389 46

13801

3 Arba Minch zuria 1,359 Zuria Woreda = 1359*389 38

woreda 13801

4 Geresse Woreda 1,147 Geresse = 1147*389 32

13801

5 Ditta Woreda 777 Ditta Woreda = 777*389 22

13801

6 Selamber 816 Selamber = 816*389 23

13801

Total 13801 389

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Source: Own source and computation, 2021

3.4. Data Source, Type and Collection Instrument

In order to achieve the stated objectives and to investigate the research questions, primary
sources of data will be used in this study. The primary data for this study will be collected by
surveying presumptive taxpayers in Gamo Zone. In this regard, a self-administered structured
questionnaire will be used. The questionnaire will be divided into two sections: the first
section contained questions pertaining to the respondents’ businesses and demographic
information, while the second section comprised closed-ended questions regarding the
taxpayers’ perceptions towards in the application of presumptive tax and its challenges. With
regard to this study’s independent variables, respondents were asked to indicate their level of
agreement on five-point Likert scale, as follows: 1 = Strongly disagree; 2 = Disagree;, 3 =
Neutral; 4 = Agree; 5 = Strongly agree. The data collection instrument was prepared in the
Amharic language first and then translated into English. In addition to primary source of
data, this study will be conducted by using cross-sectional data type. According to Gujarati
(2004) cross-sectional data are data on one or more variables collected at the same point in
time.

3.5. Variable Description, Measurement and Formulation of Hypothesis

This study intends to examine perception of category ‘C’ tax payers towards in the
application of presumptive taxation and its challenges in Gamo zone. Specific to the research
objective which is to investigate the cause of complains due to the effect of perceptions, the
researchers’ classified perception of the tax payers towards (simplicity, administrative
capacity and fairness). The definition and measurement of these variables are described as
follows. Finally, as per the theoretical and empirical literature review, in this study statistical
hypotheses will be formulated for each independent variable to guide the researcher so as to
address the stated objectives.

3.5.1. Dependent Variable: Presumptive Tax

Presumptive taxation is the applications of indirect means to ascertain tax liability, which
differ from the usual rules based on tax payer’s account’s (Thuronyi, 1996). The term
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"presumptive" is used to indicate a legal presumption that the taxpayer's income is no less
than the amount resulting from application of the indirect method. Presumptive techniques
may be used for a variety of reasons. I.e. for simplification of a compliance burden on tax
payers with very low gross income, to prevent tax avoidance and evasion. Presumptive
method may lead to a more equitable distribution of the tax burden by providing objective
indicators for tax assessment, when normal accounts based are unreliable because of
problems of tax payer’s compliance or administrative corruption (Victor, 2003). A number of
different types of presumptive methods exist in different countries (Thuronyi, 1996). In
Ethiopia, presumptive tax is employed in two ways according to the proclamation 979/2016
(House of Peoples Representatives, 2016) and regulation 410/2017, Article 60 (FDRE,
2017). These are the turnover-based presumptive tax system and a system based on indicators
like, business location, the floor space of business premises, number of employees, value of
inventory, capacity of machinery, number of years of operation of the business and data
obtained from third parties like electricity and water consumption.

3.5.2. Independent Variables: Perception towards Pillar of Presumptive Tax

In this subsection, the independent variables used in the model to examine the relationship
between perceptions and presumptive taxation will be described. Based on prior studies and
from the research topic and to get results that are more descriptive and analytical, the
researchers separated perceptions in terms of (simplicity, fairness and administrative
capacity) and the description and measurements of each variables with statistical hypothesis
were stated as follows:

3.5.2.1 Simplicity

Simplicity refers to the simplification of the tax structure with regards to administrative and
compliance costs. Tax simplification is achieved through the simplification of (a) the tax
system, (b) the tax legislation, and (c) the application of the tax rules (Glenn and Edwin,
1993).

3.5.2.2 Administrative capacity

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Administrative capacity refers to various issues that can be divided along the lines of a
functional classification, registration, payment, information access, assessment, audit,
litigation and the appeal system, sanctions and penalties.

3.5.2.3 Fairness

Fairness should be viewed in the general tax system and not just from the presumptive tax
point of view as it can be offset by social security and other form of taxes. As one of the
major objectives of this study is to assess the perception of fairness, it is worth discussing the
different dimensions of fairness in this section. According to the American Institute of
Certified Public Accountants, there are seven dimensions of tax fairness (AICPA, 2007).
These includes, exchange fairness, procedural fairness, horizontal fairness, vertical fairness,
time-related fairness, inter-group fairness and compliance fairness.

3.6. Model Specification

An ordered response model can only be applied if there exists a logical ordering of the
alternatives. The reason is that there is assumed to exist one underlying latent variable that
drives the choice between the alternatives. In other words, the results will be sensitive to the
ordering of the alternatives, so this ordering should make sense. To estimate relationships
between an ordinal dependent variable and a set of independent variables ordered logit
models are used (Verbeek, 2004). Commonly chosen models are logit model and probit (or
normit) model. Because of its mathematical convenience, given the scaled ranking
information of the dependent variable (presumptive tax application), ordered logistic
estimation will be applied. The ordered logistic have the following form:

ci*= α + β1X1i + β2X2i…+ βkXki + ei…………………………… (1)

ci*= βXi + ei ……………………………………………………..... (2)

c* is the dependent variable (levels of presumptive tax application). ; β is the vector of

estimated parameters and is the vector of explanatory variables ; ei is the error term, which is
assumed to be normally distributed (zero mean and unit variance). ci, the observed ordinal
variable, takes on values 0 through m according to the following scheme:

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ci = j if γj−1 < ci*≤ γj ………………………………………….. (3) Where j=0, ..……. 4 and
yj’s are cut off points (boundaries). Therefore, the order response categories can be rewritten
as follows:

ci=1 if ci* ≤ u1

ci=2 if u1< ci* ≤ u2

ci=3 if ci* > u2

Consequently, the probability that alternative j is chosen is the probability that the latent
variable yi* is between two boundaries γj-1 and γj. P(ci = j | Zi) = P(γj−1 < ci*≤ γj) = Λ(γj-
Ziβ) - Λ(γj−1-Ziβ) ………………………….(4)

Hence, the probability of each level of presumptive tax application (low, medium, and high)
will be computed and rewritten as follows:

P(ci = 1 | Zi) = P(ci*≤ γ1 | Zi) = Λ(-Ziβ)

P(ci = 2 | Zi) = P(γ1 < ci* ≤ γ2 | Zi) = Λ(γ2- Ziβ) - Λ(-Ziβ)

P(ci = 3 | Zi) = P(ci* > γ2 | Zi) = 1 - Λ(γ2- Ziβ)

Since the equation of the dependent variable (ci) in an ordered logit model is nonlinear, only
the signs of the coefficients can be directly interpreted and not their size. To interpret the
influences of the explanatory variables on compliance level of tax payers, the marginal
effects were calculated. This can also control the violation of parallel lines assumption or
proportional odds assumption. According to Wooldridge (2013), the direction of the effect of
explanatory variable, say Xk, only on the probabilities P(y = 0 | x) and P(y = j | x) is
unambiguously determined by the sign of βk. Whereas, the intermediate categories, 1, 2…j-
1, are ambiguous. Therefore, for the interpretation of the study results, it is plausible to focus
on the values of either the lowest (Low application) or highest (High application) category of
the marginal effects.

3.7. Method of Data Analysis

Once the required data is obtained, data computations and entries will be made with the help
of Microsoft Excel. Then, having entered and computed the values of the variables, data was
regressed by using SPSS version 24 software program for meaningful analysis. Descriptive

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and econometric analyses will be used in this study to analyze the survey data. Although
there is considerable debate in literature on the issue of whether Likert scale data should be
analyzed as an ordinal or interval measurement scale, the authors of this research is
convinced that it should be analyzed as an ordinal measurement scale. A similar descriptive
analysis method was employed by Megnaka and Devi (2014) and Abate (2018). Moreover,
an ordered logistic regression model will be used in order to discover whether direct
relationships exist between the perception proposed as independent variables and the
likelihood of presumptive tax application. As he dependent variable (i.e., presumptive tax
application) is an ordinal variable ordered logistic models will be used. A similar data
analysis technique was utilized by Gezahegn et al. (2014). As part of due process, the
Statistical Package for Social Science (SPSS) Version 24 will be used.

3.8. Ethical Considerations

The authors of this study believe that this study is subject to ethical dilemmas. The data
retrieved is gathered from a primary source which is not available to the public and does
contain sensitive information. The primary data is derived from category ‘C’ tax payers
which the tax payers are not obligated to disclose. This study has engaged in a questionnaires
that involve personal information or opinions which may be considered sensitive. As the tax
payer’s genuine response is highly important for the achievement of this research work, their
responses will be recorded anonymously and strict confidentiality will be maintained.

3.9. Dissemination of the Final Output

This is a final step in research process. If it isn’t communicated nobody knows. The research
output will be disseminated through presentations and publications. The disseminated
research output will contain four major sections: introduction, methods, results and
discussions of the findings. Once the research report is prepared, there are nine separate steps
the researchers should consider in developing a dissemination strategy.

Step 1: Review past dissemination efforts

Step 2: Devising dissemination objectives

Step 3: Determining primary and secondary audiences

Step 4: Developing messages

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Step 5: Deciding on dissemination approaches

Step 6: Determining dissemination channels

Step 7: Reviewing available resources

Step 8: Considering timing and windows of opportunity

Step 9: Evaluating dissemination effor

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