OROMIA COLLEGE

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OROMIA COLLEGE

Basic Account Works Level II

Learning Guide
UNIT OF COMPETENCIES: DEVELOP UNDERSTANDING OF TAXATION
MODULE TITLE: DEVELOPING UNDERSTANDING OF TAXATION
LG Code: EIS BAW2 07 0812 TTLM
Code: EIS BAW2 07 0812

LO1: IDENTIFY AND DISCUSS THE ROLE OF TAXATION IN THE ETHIOPIAN

ECONOMY
LO2: IDENTIFY AND DISCUSS DIRECT TAX
LO3: IDENTIFY AND DISCUSS INDIRECT TAX
LO4: IDENTIFY AND DISCUSS STAMP DUTY TAX
LO5: MANAGE TAX LIABILITY

Basic Account Works Level II

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Develop Understanding of Taxation

Meaning of taxation
Taxation is a system of raising revenue of government by collecting tax. It is a system of
collecting money by a government to finance the government operations.

Every government is expected to finance at least three functions;

A. defense of the country
B. maintenance of law and order
C. socio – economic development
Meaning of tax
Tax is a compulsory contribution (levy) payable by an economic unit to a government without
expectation of direct and equivalent return from government for the contribution made. From this
definition, we can understand that tax:-

 Is not a voluntary contribution but a mandatory contribution

 Is contributed by an a economic unit which is also called a tax payer who is liable to pay
tax in accordance with the rules and regulations prescribed by law

 Is contributed without expectation of direct and equivalent return from the government
for the contribution made means no direct relationship between compulsory contribution
and the amount of service received from the government for the contribution made. Basic
characteristics of taxation

1. Tax is a compulsory contribution

2. Tax is levied only by the government
3. Tax is a legal collection
4. Tax imposes personal obligation
5. Tax is for the common benefit
6. Tax is based on taxable person income, item and /or activity

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7. certain taxes have special objectives (such as discouraging consumption of harmful

products, to stabilize an economy)
8. Tax system recognize the rights of tax payer
Lo1. Identify and discuss the role of taxation in the Ethiopian economy
1.1. The purpose of taxation in the Ethiopian economy The
purpose of taxation may include:

• Raising revenue for the government

• Removal of inequalities in income and wealth
• Reduce regional imbalances
• Ensuring economic stability
• To create employment opportunities/minimize unemployment
• Discourage the consumption harmful products
• Encouragement of exports
• To support the functions of the government
1.2. The various ways that tax is collected and from whom is analyzed and discussed Ways
that tax is collected include:

1. Direct tax – if both the impact and incidence fall on the same person, the tax is considered to
be direct tax. It is a tax that cannot be shifted to another person.

Direct taxes include:

• Employment income tax
• Business profit/income tax
• Rental income tax
• Tax on other incomes which includes:
 Tax on income from rental of property
 Tax on interest income on deposits
 Dividend income tax
 Tax on income from royalties

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 Tax on gain of transfer of certain investment property

 Tax on Income from Games of Chance
Royalty – a sum of money paid to a patentee for the use of a patent or to an author or composer
for each copy of a book sold. A payment made by a producer of minerals, oil, or natural gas to
the owner.
• Tax on gain of transfer of certain investment property
• Tax on income from games of chances
• Agricultural income tax
• Land use tax
2. Indirect tax – the impact and incidence fall on different persons. The tax is not born by the
person on whom it is levied and can be passed on to others.

Indirect taxes include:

• Turnover tax – is levied by the government on the sales which are not covered under
VAT (value added tax).

• Value Added Tax (VAT) – is levied by the government on the commodities sold at
specified percentage (15%) on the value of sales.

• Excise duty – are levied on the commodities imported & produced in the country.
• Customs duty – includes both import and export duties. These duties are levied when
the goods cross the boundaries of the country.

• Stamp duty tax – a duty levied on the legal recognition of certain documents.
Instruments shall be chargeable with stamp duty include:
• Memorandum and articles of associations of any business (sole proprietorship,
partnership, private limited company (P.L.C) and share company (S.C))

• Contracts and agreements

• Collective agreements – means an agreement relating to conditions of work concluded in
writing between one or more representatives of trade unions and one or more employers
or agents of employer’s organizations.

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• Contract of employment – means an agreement formed where a person agrees, directly or

indirectly, to perform, work for a definite or indefinite period in return for remunerations.

• Document of title to property

• Power of attorney (legal representative) – a legal document giving power of attorney to
someone

• Notorious acts – a person authorized to perform certain legal formalities

1.3. The role of the Ethiopian Revenue and Customs Authority (ERCA)
The authority shall have the roles to:
• Establish and implement modern tax assessment and collection system
• Provide quality and efficient service within the sector
• Properly enforce incentives of tax exemptions given to investors and ensure that such
incentives are used for the intended purposes

• Implement awareness creation programs to promote a culture of voluntary compliance of

taxpayers in the discharge of their tax obligations.

• Carry out valuation of goods for the purpose of tax assessment and determine and collect
the taxes

• Conduct study and research to improve the enforcement of custom and tax laws and
regulations; and implement the same upon approval

• Collect and analyze information necessary for the control of import and export goods and
the assessment and determination of taxes

• Compile statistical data on criminal offences relating to the sector and disseminate the
information to others as may be necessary

1.4. What taxation revenue is used for is explained and related to the well-being and
lifestyle of Ethiopian citizens

Taxation revenue may be used to provide:

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 Defense and boarder protection, Education, Environment protection 

Essential infrastructures such as:

 Roads, Transport systems, Public buildings, Sport and recreation, Public housing
 Health care, Justice systems, Public safety, Scientific and other research

LO.2. Identify and discuss direct tax

2.1. Key terminology used in direct taxation is identified and discussed Terminology
used in taxation may include:

• Interest on deposits, Allowances

• Deductions such as:
 Travel expense, Medical cost, Transportation allowance
 Hardship allowance, Depreciation expense, Commission expense
 Promotion expense, Cost of sales, Insurance expense, Interest on loan
• Exempt threshold – income level free from tax
• Capital gain/appreciation - gain of transfer of certain investment property
• Dividends – distribution of profits by corporate bodies to shareholders/owners
• Gross income – the total of all income received by a tax payer before exemptions
deductions.

• Tax evasion – tax concealment

• Withholding tax – a tax required to be withhold
• Taxable income – is the residual amount of income after all allowable deductions are
made from gross income.

2.2. Rates of direct tax are identified and analyzed

Direct taxes include: Personal income tax, Business profit tax

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property tax, dividend tax, capital gain tax Tax

rate for personal income tax:
Income level Tax rate Deductions
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
>10,900 35 % 1,500
E.g. Solomon earns a gross salary of Br. 4,520. Calculate the income tax.
Income tax = gross salary * tax rate - deduction

= 4,520 x 20% - 302.50

= 601.50
E.g.2. Ato Tessema gets salary of Br. 8,000 per month. He also gets hardship allowance and
transportation allowance of Br. 800 and 500 respectively. He has worked an overtime of Br.
1,000 during the month. During the month he felt sick and hospitalized and the employer paid
him medical bills amounting to Br. 600.

Required:
1. gross income
2. taxable income
3. tax amount
Solution: Gross income = basic salary + transportation allowance + medical cost + overtime +
hardship allowance

= 8,000 + 500 + 600 + 1,000 + 800

= 10,900

Taxable income = Gross income – deductions

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= Gross income – trans. Allowance – medical cost – hardship allowance

= 10,900 – 500 – 600 – 800
= 9,000
Tax amount = Taxable income * tax rate – deduction
= 9,000 * 30% - 955
= 1,745
Business profit tax
It is a tax imposed on the taxable business income realized from a business activity.
Corporate businesses are required to pay 30% flat rate of business income tax and 10% (on the
dividend amount) dividend tax if a business declares a dividend.

Corporate businesses include:

 Private limited company – is a company whose members are liable only to the extent of
their contributions. A private limited company shall not have less than two or more than
fifty members and is always commercial in any form. The capital of a private limited
company shall not be less than 15,000 Br.
 Share company - is a company whose capital is fixed and divided into shares and whose
liabilities are met only by the assets of the company and the members shall be liable only
to the extent of their shares holdings.

Deductible expenses:
 the direct cost of manufacturing, purchasing, and importations
 general and administrative expenses, promotion expense
 premiums payable on insurance, commission expense, interest on loan  depreciation
expense

Profit and loss statement

A profit and loss statement helps to determine whether a business is operating at a profit or a loss
for a given time period.

Five basic steps to calculate the profit and loss statement:

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1. sales – including sales for cash or credit

2. Cost of sales – the price paid by the business for merchandise sold.
3. Gross profit – calculated by subtracting the costs of sales from sales.
4. Expenses – this include labor costs and other costs of operating the business.
5. Net profit before tax – is the amount remaining when the expenses are deducted from
the gross profit?

6. Net profit after tax – the amount remaining when the tax amount to be paid is deducted
from the net income /net profit before tax.

Illustration
ABC P.L.C manufacturing company imported raw material by birr 900,000 and additional
purchase local materials for birr 500,000 before Vat for production of X product. The company is
charged local customs duty of birr 50,000 and paid to tax authority. The company sales were
4,000 products at birr 650 each before Vat, including 2% sales commission. Total administration
expenses of the company show birr 460,000 and withhold birr 15,000 of employment income
tax.

Required
1. Calculate net profit
2. Calculate direct and indirect tax
Solutions
Sales = sales including/1.02 Sales = 4000*650/1.02
Sales = 2,600,000/1.02 Sales = 2,549,019.61
Cost of sale = 900,000+500,000+50,000
Cost of sale = 1,450,000
Expenses = Administration expense = 460,000 Required
1.

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Supreme manufacturing company

Income statement
For the year ended of 2014
Sale -----------------------------------------------------------------------2,549,019.61
Cost of sales------------------------------------------------------------ (1,450,000)
Gross profit -------------------------------------------------------------1,099,019.61
Administrative expenses --------------------------------------------- (460,000)
Net income ---------------------------------------------------------------639,019.61
Business tax (30% of net income) -----------------------------------191,705.883
Net profit -----------------------------------------------------------------447,313.727
Required 2,
Direct tax =Business profit tax + employment income tax
=191,705.883 +15,000
=206,705.883
Indirect tax
Output VAT =15 %( 2,600,000)
=390,000
Input VAT = 15 %( 500,000)
= 75,000
Net Vat = output VAT-input VAT
= 390,000-75,000 = 315,000
Indirect tax = Net VAT + Customs duty
= 315,000+50,000
= 365,000
For unincorporated or individual businesses, the income tax ranges from 10% - 35%.
Unincorporated business includes:
 sole proprietorship – a business owned by a single owner
 partnership - a business formed by an agreement of two or more persons

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Unincorporated or individual businesses are taxed in accordance with the following schedule:
Income Business income tax Deductions
(per year) rate
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
93,601 – 130,800 30 % 11,460
>130,800 35 % 18,000
E.g. Kaleab enterprise, unincorporated business has reported a taxable income of Br. 60,000 of
the tax year ending Sene 30, 2008.

Required: Determine the amount of business income tax.

Solution:
Tax = taxable income * tax rate – deduction
= 60,000 * 20% - 3,630
= 8,370
Rental income tax
Rental income tax is a tax imposed on the income from rental of buildings.
Tax rate
The tax payable on rented houses shall be charged, levied and collected at the following rates:
a) On income of bodies (P.L.C and S.C) thirty percent (30%) of taxable income.
b) On income of persons according to the following schedule.
Income Business income tax rate Deductions
(per year)
0 -7,200 0% 0
7,201 – 19,800 10 % 720

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19,801 – 38,400 15 % 1,710

38,401 – 63,000 20 % 3,630
63,001 – 93,600 25 % 6,780
93,601 – 130,800 30 % 11,460
>130,800 35 % 18,000

c) Sub-renting shall pay the tax on the difference between income from sub-renting and the
rent paid to the renter.

d) The following amounts shall be deducted from income in computing taxable income
 Taxes paid with respect to the land and buildings being rented, except income
taxes

 For tax payers not maintaining books of accounts, fifty percent (50%) of the gross
income received as rent for buildings furniture as an allowance for repairs,
maintenance and depreciation of such buildings, furniture and equipment.

 For tax payers maintaining books of account, the expenses incurred in earning,
securing and maintaining rental income, to the extent that the expense can be
proven by the taxpayer; deductible expenses include the cost of rent of land,
repairs, maintenance, and depreciation of buildings, furniture and equipment
as well as interest on bank loans, insurance premiums, land use fees.

Illustration
Ato Markos, the owner of AZ building, constructed at Br. 5,000,000 and furnished with furniture
and equipment, which costs Br. 500,000. He rented the building with all its furniture and
equipment to W/ro Muluwork, for Br. 540,000 per year. She has also rented it to Omega primary
school for Br. 50,000 per month for one year.

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Required:
1. The amount of annual rental income tax expected from Ato Markos and W/ro Muluwork
assuming both of them do not maintaining books of account.

2. The amount of annual rental income tax expected from Ato Markos assuming he
maintained books of account and report the following expenses in relation to building and
equipment.

• Land and building ownership fee (property tax) of Br. 5,000

• Annual depreciation expense for building Br. 250,000
• Annual depreciation expense for furniture and equipment Br. 100,000 Solution 1
From Ato Markos:

Taxable rental income = (gross rental income – allowance)

= 540,000 – 270,000
= 270,000
Rental income tax = taxable rental income * tax rate – deduction
= 270,000 * 35% - 18,000
= 76,500
From W/ro Muluwork:
Gross income = 50,000 (monthly rent income) * 12
= 600,000
Taxable income = gross income - rent expense
= 600,000 – 540,000
= 60,000
Rental income tax = Taxable rental income * tax rate – deductions
= 60,000 * 20% - 3,630
= 8,370

Solution 2
Gross rental income ------------------------------------------------------------------------ 540,000

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Less: Deductibles
Land and building ownership fee ------------------------------------------- 5,000
Annual depreciation expense for building ------------------------------- 250,000
Annual depreciation expense for furniture & equipment ----------- 100,000
Total deductibles -------------------------------------------------- (355,000)
Taxable rental income ----------------------------------------------------------------------- 185,000
Rental income tax = taxable rental income * tax rate – deduction
= 185,000 * 35% - 18,000
= 46,750
Other income taxes
In addition to employment income tax, business profit tax, and rental income, tax authority levied
other tax on the following type of income.

A. Royalties
It is a payment of any kind received as a consideration for the use of or right to use, any
copyright of literary artistic or scientific work, including cinematography films, and films or
tapes for radio or television broadcasting, any patent, trademark, design or model, secret formula
or process.

Royalties shall be liable to tax at a flat rate of five percent (5%).

B. Tax on income from games
Every person deriving income from winning at games of chance (for example lotteries, tombola,
and other similar activities) shall be subject to tax at rate of fifteen percent (15%), except for
winnings of less than 1000 Br.

C. Tax on dividend
Every person deriving income from dividends from a share company or withdrawals of profit
from a private limited company shall be subject to tax rate of ten percent (10%).

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D. Tax on interest income of deposits

Every person deriving income from interest on deposits shall pay tax at the rate of five percent
(5%).In any other case, 10% of the gross amount of the interest.

E. Capital gains tax (tax on gain at transfer of certain investment property)

Income tax shall be payable on gains obtained from the transfer (sale or gift) of property at the
following rates:

I. Building held for business, factory office 15% (fifteen percent)

II. Share of companies 30% (thirty percent)
Gains obtained from the transfer of building held for residence for 2 years before the disposal of
the asset shall be exempt.

F. Income from casual rentals

A person who derives income from the casual rental of asset in Ethiopia (including any land,
building, or movable asset) shall be liable for income tax at the rate of 15%.

2.3. How direct tax is assessed, tax returns completed and paid is considered and discussed

Tax returns can be completed by:

 Accountant, an individual, tax agent, on-line or in written form

2.4. Sources of ongoing information about direct tax in Ethiopia are identified, accessed and
discussed

Sources of ongoing information may include:

• accountants and other financial services professionals  Ethiopian Revenues and
Customs Authority (ERCA)

• Industry associations and professional organisations

• Federal and Regional governments’ agencies. Taxpayers
LO.3. Identify and discuss indirect tax

3.1. Key terminology used in indirect taxation is identified and discussed

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1. Turnover tax – is levied by the government on the sales which are not covered under
VAT (value added tax).

The base of computation of the turnover tax is the gross receipts in respect of goods supplied
or services rendered. Tax rate

• 2% (two percent) on goods sold locally

• for services rendered locally
a) 2% on contractors, grain mills, tractors and combine-harvesters
b) 10% on others
2. Value Added Tax (VAT) – is levied by the government on the commodities sold at
specified percentage (15%) on the value of sales.
The following are some of the terms that are common in VAT.
• Input VAT – the VAT that your business pays over on taxable supplies made (VAT paid
on purchase) and can be recovered only insofar as your business is VAT-registered.

• Output VAT – the VAT that your business collects over taxable supplies (VAT paid on
sales)

• VAT payable – this is the net VAT to be paid to ERCA by a taxable person.
VAT payable = output VAT – INPUT vat
• VAT refundable – the net VAT that is a taxable person expected from ERCA when
input VAT exceeds output VAT.

• Zero-rating – the supply is charged with VAT at 0% but credit can be taken for VAT
paid on purchases used to make supply.

• Exemptions – the supply is exempted from VAT. No VAT is charged on supply and no
credit can be taken for VAT paid on purchases used to make the supply.

3. Excise duty – are levied on the commodities produced in the country.

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The base of computation of excise tax is the cost of production for goods produced locally;
whereas for goods imported the base of computation would be the cost of importation,
insurance and freight cost (CIF).

The excise tax rate range from 10% to textile and textile products to 100% for other alcohol
drinks, perfume and motor vehicles above 1800 c.c.

E.g. KK textile factory produced 1,500 tons of printed bed sheet in meskerem1, 2009. The unit
cost of production for a ton of printed bed sheet is as follows:
Direct labor Br. 4000
Raw material 5,500
Cost of indirect inputs 1,500
Overhead costs 500
Required:
a) Unit base of excise tax (unit cost of production per ton for tax purpose)
b) Total amount of excise tax
Total unit cost = direct labor + raw material + cost of indirect inputs + overhead costs
= 4,000 + 5,500 + 1,500 + 500
= 11,500
Total production cost = tons of bed sheet produced * total unit cost
= 1,500 * 11,500
= 17,250,000
Excise tax payable = total cost of production * tax rate
= 17,250,000 * 10%
= 1,725,000
4. Customs duty – includes both import and export duties. These duties are levied when the
goods cross the boundaries of the country.

5. Stamp duty tax – a duty levied on the legal recognition of certain documents.

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When the value of the right or obligation executed by means of an instrument can be determined,
the rate chargeable on such instrument shall be the percentage of such value. e.g. register title to
property ------------ 2% (on value) when the value of the right or obligation executed by means
of an instrument cannot be determined, the amount chargeable on such instrument is the fixed
amount specified for each such instrument.

e.g. power of attorney ---------------- Br. 35 (flat)

3.2. The structure of business and how this affects taxation are analyzed and discussed

The structure of business includes:

• sole trader: an individual trading on their own
• partnership: an association of people or entities carrying on a business together, but not
as a company

• Private limited company – is a company whose members are liable only to the extent of
their contributions. A private limited company shall not have less than two or more than
fifty members and is always commercial in any form. The capital of a private limited
company shall not be less than 15,000 Br.

• trust: an entity that holds property or income for the benefit of others
• company: a legal a legal entity separates from its shareholders
3.3. How indirect tax is assessed and paid is considered and discussed

Tax is assessed through:

• Business Activity Statements , payroll, allowable deductions, capital gains  financial
adjustments such as:

 write-offs, revaluations, profits and losses, superannuation payments 

fringe benefits assessment

3.4. Sources of ongoing information about indirect tax in Ethiopia are identified, accessed and
discussed

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LO.4. Identify and discuss stamp duty tax

4.1. Key terminology used in stamp duty taxation is identified and discussed

4.2. How stamp duty tax is assessed and paid is considered and discussed

4.3. Sources of ongoing information about stamp duty tax in Ethiopia are identified, accessed
and discussed

LO.5. Manage tax liability

5.1. How tax payers can determine their tax liability is identified and discussed

Tax payers can determine their tax liability by:

 assessing income:
 capital gains, employment, foreign , investment
 rental property income
 assessing deductions:
 allowable medical expenses and health insurance rebates
 capital losses, dependent rebates, gifts and donations
 rental property expenses, tax offsets
 work related clothing expenses
 work related education expenses
 work related travel expenses  zone and overseas forces allowances  lodging
returns and paying governments:  land tax where applicable

 payroll tax (rate varies by jurisdiction and depends on size of payroll so many small
business operators are exempt)  stamp duty on:

 hire purchase agreements

 insurance polices
 leases and mortgages
 motor vehicle purchases

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 property transfer

5.2. Under or overpayment of tax and its implications are analyzed and discussed Under
or overpayment of tax may involve:

 claiming interest on early payments that may be possible for certain tax categories such as:
 income tax
 Higher Education Contribution Scheme
 amended assessments of earlier years
 paying interest on overdue amounts

Assignment
1. Enjoy is a governmental unit established to develop tourist attractions in Addis Ababa
regional state. It has four employees whose salaries are paid according to the Ethiopian
Calendar month. The following data relates to the month of Meskerem, 2012

Name salar Position Ove Duration of OT

y allowan r work
ce time
Abebe 730 - 4 6-10 pm
Berihun 2800 - 8 Sunday
Chekol 5300 300 - -

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Dagim 8100 - - -

Additional Information
• The employees usually are expected to work for 40 hours per week
• All employees are permanent except Dagim
• Berihun agreed to contribute Br 300 to credit association Required:

1-calculate the gross earnings, deductions and net pay

2-prepare the payroll register of Enjoy for the month of Meskerem
3-Record the payment of withholding tax, pension contribution

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