Professional Documents
Culture Documents
Accounting
Chapter One
Introduction to Taxation and Tax Accounting
Chapter Outline:
1. What is taxation?
2. Definition of tax and duty
3. Tax accounting
4. Interdisciplinary Nature of Taxation
5. Objectives of taxation
6. History of taxation
7. Basic Elements of Tax Systems
8. Tax Related Terms
9. Basic characteristics of tax
10. Types of Tax Rates
11. Taxation Systems (Tax Rate Structures)
12. Principles of taxation
13. Canons of taxation
14. Effects of Taxation
15. Classification of taxes
Chapter Objectives:
After completing this chapter, you would be able to:
Define taxation, tax, duty, and tax accounting
Understand why government levies taxes on citizens
Discuss the evolution and history of taxation in the world and in Ethiopia
Define different tax related terms
Comprehend basic characteristics of taxes
Identify and Calculate Different Types of Tax Rates
Grasp the basic principles and canons of taxation
See the effect of taxation on Economy
Classify taxes on the basis of different dimensions
Time Required: 4 Hours
1.1) Taxation
Taxation is one of the systems that government uses to collect public revenues from various
sources. However, taxation is the most important system of collecting public revenue in modern
economic system. Taxation is the most powerful instrument in the hands of the government for
transferring purchasing power from individuals to government. The money collected through
taxation – tax revenue – is used to finance government operations. That is, the money required
by the government to undertake different functions –taxes– is collected from the citizens.
Without taxes to fund its activities, government could not exist. Thus, a government uses
taxation as a system of raising the lion share of its revenue. Government uses the money
collected through taxation:
To pay soldiers and police;
To build dams and roads;
To operate schools and hospitals;
To provide food to the poor and needy;
To provide medical care to the elderly people; and
To finance other hundreds of operations
Taxation is used as a system of raising the lion share of public revenue in modern economic
system to fulfill the requirement of the goods and services. Taxation depends on concepts from
law, accounting, economics, public financial management, politics, behavioral sciences, etc.
Thus, taxation can be considered as a part of special fields of study such as law (specifically tax
law), accounting (specifically tax accounting), public financial management, economics, politics,
etc. The scope of taxation includes tax policies, tax theories, tax decisions, and tax administration
Duties are also taxes. Duties are distinguished from taxes by their strictly economic
characteristic. For example, any government imposes a compulsory levy on the goods imported
from a foreign country. This compulsory levy is called Custom Duty. Custom duty is
compulsory a levy on individuals and companies importing goods to the country and its purpose
is to protect the domestic market and economy. When goods are imported from abroad while the
same goods can be produced within the country, it affects the domestic market and economy in
number of ways as follows:
It reduces demand for domestic products
It discourage production within the county
It discourages Foreign Direct Investment in the country
It results in negative balance of payment (BOP)
It increases the unemployment rate
Tax returns are government declaration forms filled and then filed with the Federal, State, or
Local tax authorities. Tax returns are forms filed with the tax authority containing information
used to calculate tax base and taxes (e.g. taxable income and the related income tax).
Examples of tax returns (tax declarations), in Ethiopia, are:
Business Income Tax Declarations
VAT Declaration
Tax accountant is an individual who assists a taxpayer in preparation of tax returns and who
undertakes tax planning and other related activities.
In 1944 - Proclamation No 60/1944 (1936 E.C) was enacted and issued to be used as a
tax code in collecting tax from all individuals and their jobs
In 1949 - Proclamation No 107/1949 (1941 E.C) amended Proclamation No 60/1944.
This second proclamation excluded agricultural income from taxes and made a tax
holiday of 5 years for persons or businesses with a capital balance of less than Br
200,000.
In 1954, Proclamation No 19/1954 (1946 E.C) was enacted and amended Proclamation
No 107/1949.
In 1961 - Proclamation No 173/1961 (1953 E.C) repealed Proclamation No 19/1954
Since then, there were few amendments to improve the tax proclamations and involved in
changing tax rates from 35% up to 89%
In the post-revolution period (1974 – 91) - significant major changes were made on the
tax rate and structure of all types of taxes
In 2002 - Proclamation No 173/1961 was repealed by Proclamation No 286/2002 (1994
E.C) after it served nearly 40 years. Proclamation No 286/2002 is currently in use in
Ethiopia regarding income taxes
Example 2.1: assume that income is taxed on a Schedule “Exempt from Br 0 up to 150, 10%
over Br 150 to 650, 15% over Br 650 to 1400, 20% over Br 1400 to 2350, 25% over Br 2350 to
3550, 30% over Br 3550 to 5000 and 35% over Br 5000”. Instruction: Determine the Marginal
Tax Rate, Statutory Average Tax Rate and Effective Average Tax Rate for a taxpayer with a
basic salary of Br 5300 and with no special allowances.
30%
25%
20%
15%
10%
Tax Base in Birr
150 650 1400 2350 3550 5000
20%
15%
10%
25%
15%
Chapter Two
Employment Income Tax Accounting
Chapter Outlines:
Components of Employment Income
Employment Income Tax Rates
Employment Income Tax Exemptions
Computation of Taxable Employment Income
Computation of Employment Income Tax
Employment Income Tax Declaration
Chapter Objectives
After completing this chapter, you would be able to:
Differentiate benefits that are included in employment income
Understand the basic legal provisions (tax laws) applicable on employment income in Ethiopia
Calculate taxable employment income
Determine employment income tax as per the tax law of the country
Determine employment income tax on severance pay, bonus and other employment benefits
Account for employment income tax related transactions
Complete Employment Income Tax Declaration (FIRA Form 1103)
Complete Personal Income Tax Declaration (FIRA Form 1105)
Time Required: 4 Hours
o.Representation allowance
p.Transportation allowance (fuel allowance)
q.Entertainment allowance (guest accommodation expenses)
r.Stress allowance: a special payment made to employees whose job is stressful. E.g. air
traffic controllers
s. License allowance: a special payment made to licensed employees. E.g. air traffic
controllers
4. Bonus: payment made to employees of businesses as acknowledgment of employees’ hard
work and effort in generating beyond expected amount of profit.
5. Employment Termination Payment
a. Severance Pay- the severance pay shall be thirty times his or her daily wages of the
last week of service for the first year of service; for the service less than one year,
severance pay shall be calculated in proportion to the period of service. If the worker
has served for more than one year, payment shall be increased by one-third of the
previous sum for every additional year of service, within the limit of a total amount of
twelve months salary
b. Job Search Payment
c. Compensation Payment
d. Annual Leave Payment
e. Job Termination Bonus
B. Deduction Method
• EIT = Taxable Employment Income @ Marginal Tax Rate – Deduction
Table 2:1 Employment Income Tax under Deduction Method
TB Range of TEI Tax Rate Deduction EIT Calculation
1st 0 – 150 Exempt 0.00 No Tax Payment
2nd 150 – 650 10% 15.00 EIT = TEI @ 10% – 15
3rd 650– 1,400 15% 47.50 EIT = TEI @ 15% – 47.50
4th 1,400 – 2,350 20% 117.50 EIT = TEI @ 20% – 117.50
5th 2,350 – 3,550 25% 235.00 EIT = TEI @ 25%n – 235
6th 3,550 – 5,000 30% 412.50 EIT = TEI @ 30% – 412.50
7th Over 5,000 35% 662.50 EIT = TEI @ 35% – 662.50
C. Addition Method
• EIT = Addition + [(TEI – Lower Tax Bracket) @ Marginal Tax Rate]
• The “Addition” is equal to the EIT amount payable on the Previous Tax Bracket
Table 2.2: Employment Income Tax under Addition Method
TB Range of TEI Tax Rate Addition EIT Calculation
1st 0 – 150 Exempt 0.00 No Tax Payment
2nd 150 – 650 10% 0.00 EIT = 0.00 + (TEI – 150) @ 10%
3rd 650– 1,400 15% 50.00 EIT = 50.00 + (TEI – 650) @ 15%
4th 1,400 – 2,350 20% 162.50 EIT = 162.50 + (TEI – 1,400) @ 20%
5th 2,350 – 3,550 25% 352.50 EIT = 352.50 + (TEI – 2,350) @ 25%
6th 3,550 – 5,000 30% 652.50 EIT = 652.50 + (TEI – 3,550) @ 30%
7th Over 5,000 35% 1,087.50 EIT = 1,087.50 + (TEI – 5,000) @ 35%
If there is any remainder after determining the full number of months, the severance pay is treated
separately as one month taxable income for tax purposes.
Example 3.7: Assume that the contract of employment is terminated when the basic salary of the
employee is Br 2,000. Determine the Employment Income Tax on the Severance Pay of Br 12,000
Reading Assignment:
Employment Income Tax on Ordinary Annual Bonus
Employment Income Tax on Weekly and Bi-Weekly Salary and other employment benefits
Exercise: You are given the following: basic Salary, Overtime Hours, Overtime Duration,
Allowances of Employee of SHINA Plastic Factory Pvt. Ltd. Co. for the Month of September
1999 E.C.
Employee Basic Normal Overtime Overtime
S. No. Allowances
Name Salary Working Hours Hours Duration
1 ABY Br 3,200 160 20 6:00A.M -10:00 PM 1000 (PA)
2 CAM 4,800 160 5 10:00PM -6:00 AM 500(TA)
3 GFD 1,600 160 8 Weekly Rest Days 500 (TA)
4 KKK 2,400 160 12 Public Holidays 500 (TA)
5 LMA 2,880 160 10 Weekly Rest Days 500 (TA)
6 WZB 1,760 160 – – 500 (TA)
7 ZFW 2,080 160 10 Weekly Rest Days 500 (TA)
8 SBH 1,080 160 – – –
Required:
A. Determine the Gross Employment Income, Taxable Employment Income and the Employment
Income Tax
B. Prepare the Employment Income Tax Return i.e. Complete Form 1103 (Employment Income Tax
Declaration) to be filed with FIRA.
C. Show all the accounting entries
Chapter Three
Rental Income Tax Accounting
Chapter Outlines:
Overview of Rental Income Tax
Basic Legal Provisions for Rental Income Tax as per the tax law of the country
Accounting for rental income tax
Chapter Objectives
After completing this chapter, you would be able to:
Understand the concepts of Rental Income Tax in Ethiopia
Identify the lessee, lessor, and sub-lessor and understand who should pay rental income tax
Determine Gross Rental Income and Taxable Rental Income
Know deductible expenses for Rental Income Tax purposes
Calculate Rental Income Tax for taxpayers maintaining books of accounts and not maintaining
books of accounts
Understand briefly the Rental Income Tax Declaration (FIRA Form 1201)
Time Required: 2 Hours
3.1) Introduction to Rental Income Tax
Rental Income is taxed under Schedule “B” of Income Tax Proclamation No. 286/2002
Income generated by renting either Residential or Business Buildings is taxable
There are two parties to the lease contract in buildings: The Lessor and Lessee.
Sometimes the third party called Sub-lessor may part of it
The leased building can be empty or furnished
Advance Payments: income that covers a period longer than one year shall be prorated
over the number of years covered by the amount paid for tax purposes.
Responsibility of the Local Administration: Informing to the Tax Authority
Taxable Rental Income for those Taxpayers not maintaining Books of Accounts
Rental Income Received....................................................................... xxxxx
Add: The Following Amounts
Amount on the lease of furniture.......................................................... xxxxx
Amount on the lease of equipments...................................................... xxxxx
Payments made by the lessee on behalf lessor ..................................... xxxxx
Cost renovation or improvement paid by the lessee............................. xxxxx
Gross Rental Income............................................................................. xxxxx
Less: Rental Payment............................................................................ (xxxxx)
Net Rental Income (NRI) ..................................................................... xxxxx
Less: Deductible Expenses
Land and building tax, if any................................................................xxxx
x
Allowance for repairs, maintenance & depreciation (20%@NRI).......xxxx
x
Total deductible expense (xxxxx)
Taxable rental income........................................................................... xxxxx
Deduction Method
RIT = Taxable Rental Income @ Marginal Tax Rate – Deduction
Addition Method
Under this method, Rental Income Tax is determined by multiplying any Taxable Rental Income
above the minimum level of the Tax Bracket by the tax rate and adding the given addition for
each tax bracket as follows:
TB Over To Tax Rate Addition
st
1 0 1,800 0% Exempt
2nd 1,800 7,800 10% 0.00
rd
3 7,800 16,800 15% 600.00
4th 16,800 28,200 20% 1,950.00
5th 28,200 42,600 25% 4,230.00
6th 42,600 60,000 30% 7,830.00
th
7 60,000 ***** 35% 13,050.00
Example 3.2: WELINEGUDENA SHARE COMPANY leased its building for Br 200,000 for
cash per month. The lessor is responsible to make renovation and improvement in the building
by incurring Br 100,000 per year as per the lease term. The cost of building is Br 10,000,000 the
Share Company paid Br 100,000 for the lease hold Land.
Required: Determine Gross Rental Income, Taxable Rental Income and Rental Income Tax
Liability
Example 3.3: ATO ZINABU leased his furnished building for Br 2,000 per month and the
equipments and furniture were leased for Br 1,000 per month. He paid Br 1,200 land and
building tax to Addis Ababa Municipality. Determine Gross Rental Income, Taxable Rental
Income and Rental Income Tax Liability assuming that the house was vacant for four months
during tax year 1999
Chapter Four
Business Income Tax / Business Profit Tax
Chapter Outlines:
Overview of Business Income Tax
Legal form businesses and taxable entities
Categories of Business taxpayers in Ethiopia
Tax accounting methods
Business profit tax rate and other legal provisions on Business Profit Tax
Deductible Expenses
Non-Deductible Expenses
Exemptions from Business Profit Tax
Accounting for business income tax
Chapter Objectives
After completing this chapter, you would be able to:
Understand what business income tax is
Identify taxable entities as per the tax law of the country
Know the three different categories of business taxpayers
Apply tax accounting methods allowed by the Tax Law currently enforce
Differentiate items that are allowed to be deducted from gross income
Identify non-deductible expenses
Know revenues of incomes exempted from business profit tax
Determine taxable business income for different categories of business taxpayers and body and
non-body
Compute business income tax for small, medium and large businesses
Understand the concepts of foreign tax credit, withholding income tax, investment tax credit and
loss carry back and carry forward
Time Required: 10 Hours
The legal provisions are taken form Income Tax Proclamation No. 286/2002 and
Income Tax Regulation No. 78/2002.
4.1) Legal Forms of Businesses and Taxable Entities
According to Commercial Code of Ethiopia, there are seven forms of business organizations in
Ethiopia:
Sole Proprietorship – It is a taxable entity but not legal entity
General Partnership – it is both taxable and legal entity
Limited Partnership – it is both taxable and legal entity
Joint Venture - It is a taxable entity but not legal entity
Private Limited Company - it is both taxable and legal entity
Share Company - it is both taxable and legal entity
Co-operative - it is a legal entity but it may or may not be a taxable entity
3) Presumptive Tax – is a predetermined amount of tax paid by small businesses whose annual
sales is less than Br 100,000. The tax is estimated by estimating annual sales (daily sales)
16. Trading Stock Disposed (Cost of Goods Sold) - The cost of trading stock disposed during a
tax period is determined on the basis of the Average Cost Method
Example 4.1: BIRTY Share Company has the following beginning and purchased of
merchandise Inventory during the Tax Year 1998 (Assume a tax year from Hamle 1 to Sene 30)
Date Particulars Quantity Unit Cost
Hamle 1, 1997 Beginning Inventory 2,000 100
Tikmet 16, 1998 Purchased Inventory 2,600 110
Megabit 22, 1998 Purchased Inventory 3,000 105
Sene 13, 1998 Purchased Inventory 2,500 106
Required: determine cost of trading stock disposed during the tax assuming that 2,700 units were
on hand as of the end of the tax year
Example 4.2: Assume ABC Spare Parts Pvt. Ltd. Co. uses the Tax Year Hamle 1 to Sene 30
and has the following plant assets: Computers, Information System, Software and Data Storage.
Date of Purchase Acquisition Cost
Yekatit 10, 1996................................ 16,000
Ginbot 01, 1996................................. 6,000
Nehase 07, 1996................................ 7,000
Tahsas 19, 1997................................. 3,500
Instruction: Compute Depreciation Base and Depreciation Expense for Tax Year Ending Hamle
30, 1996, 1997 and 1998 assuming that ABC Spare Parts Pvt. Ltd. Co. sold old Computer at Birr
3000 on Megabit 23, 1996
Example 4.3: The following data were obtained from the accounting records of ZENA Pvt.
Ltd. Co. On Hamle 1, 1997, beginning of the current tax year, the Store Equipment account
shows a book value of Birr 170,000. At the beginning of the tax period, the company sold one of
the equipments for Birr 25,000 cash and acquired a new one for Birr 85,000 on account.
Determine the amount of Depreciation Expense to be recognized on the store equipment and the
depreciation base for the store equipment for the tax year ending Sene 30, 1998 as per Art.23 of
Income Tax Proclamation No.286/2002
4.7) Exemptions
The following categories of income shall be exempt from payment of business income tax
hereunder:
Awards for adopted or suggested innovations and cost saving measures
Public awards for outstanding performance
Income specifically exempted from income tax by the law in force in Ethiopia, by
international treaty or by an agreement made or approved by the Ministry of Revenue
The revenue obtained by the Federal Government, Regional State Governments and
Local Governments of Ethiopia; and the National Bank of Ethiopia from activities that
are incidental to their operations
3. Addition Method
BPT = TBI – Lower Tax Bracket @ Marginal Tax Rate + Addition
Directives issued by the Tax Authority. Accordingly, the Taxable Business Profit is the can be
determined by subtracting costs & expenses from annual revenues.
• Taxable Business Profit = Annual Revenues – Cost of goods sold – Operating Expenses
Example 4.4: SHALA Merchandising Enterprise is a Category “B” taxpayer but not a
body. The enterprise reported Br 300,000.00 sales revenue; Br 200,000 Cost of goods sold and
Br 62,000 operating expenses during the tax year ending Sene 30, 1997. Determine the Taxable
Business Income and Business Profit Tax to be paid.
Example 4.6: Assume Oromia Cooperative Bank Share Company made Br 10,000,000
loans and advances during the tax year ending Sene 30, 1998. Assume also the bank has the
following income and expenses for the same Tax Year:
Interest Income...........................................................Br 12,000,000
Service Charge Income.............................................. 1,600,000
Interest Expense......................................................... 10,050,000
Administrative and General Expenses....................... 1,600,000
Advertising Expenses................................................. 400,000
Instruction: Determine the Taxable Business Profit of the Bank for the tax year ended Sene 30,
1998 if the technical reserve on the loan and advance was Br 1,300,000.00 and five year tax
holiday period for the business.
Expenses of Br 1,200,000.00. Required: Determine the Taxable Business Income and Business
Profit Tax during the tax year ended June 30, 2002 and Record the necessary transaction
2. Withholding Income Tax (Withholding Profit Tax)
A. Collection of withholding Income Tax on Imports
3% of the sum of cost, insurance, and freight (“CIF value”)
B. Withholding of Income Tax on Payments
Organization having Legal Personality, Government Agencies, Private Nonprofit
Institutions, and Non-Governmental Organizations (“NGOs”) shall withhold
income tax on payments
The amount withheld shall be two per cent (2%) of the gross amount of the
payment.
C. Withholding Scheme
Supply of goods involving more than Birr 10,000 in any one transaction or one
supply contract;
Rendering of the certain services involving more than Birr 500 in any one
transaction or one service contract.
Example 4.8: TENKER Pvt. Ltd. Co. purchased Birr 200,000 Stationary Materials from
HALEHA Stationary Materials Import and Distribution Pvt. Ltd. Co. on Tikmet 18, 1997
Instruction: Record the above transaction for both the seller (withholdee) and buyer (withholder)
Withholding Tax Declaration – the withholder is required to declare Withholding Income Tax
Declaration on monthly basis. Withholding Tax Declaration Form has the following Four
Sections: Taxpayer Information; Declaration Details; Tax Declaration Summations; and
Taxpayer Certification
Illustration on Business Profit Tax: from GAAP Based Income statement to Tax based
Profit and Loss Account
A number of small spare part businesses established a business named Excellent Spare Parts
Share Company. The GAAP based Profit & Loss Account for the financial year ended June 30,
2004 is as follows:
Excellent Spare Parts S.C.
Profit and Loss Account
For the Tax Period 1st July 2003 to 30th June 2004
Sales....................................................................................... 32,976,200
Less: Cost of Goods Sold....................................................... (20,126,457)
Gross Profit............................................................................ 12,849,743
Less: Operating Expenses
Administrative expenses........................................................ 100,068.65
Selling and distributing expenses........................................... 2,000,322.0
0
Depreciation and amortization expense................................. 42,000.56
Bank interest and charges ..................................................... 34,217.44
Audit fees............................................................................... 27,000.35
Provision for Stock Obsolescence......................................... 41,985.00
Total Operating Expenses...................................................... 2,245,594
Taxable Business Profit for the Year..................................... 10,194,272
Provision for Profit tax at 30%.............................................. * (3,058,282)
Net Income or Profit.............................................................. 7,135,990
Legal Reserve......................................................................... (356,799)
Balance Carried Forward to Balance Sheet........................... 6,779,191
* Such amounts are rounded to the nearest birr amount
Additional Information: The following information was available from the records of the firm.
Required: Find out the taxable business income and business income tax liability of the firm for
the tax year ending June 30, 2004 according to Proclamation No 286/2002 and Regulation No
78/2002.
Required:
A. Prepare profit and loss statement for tax purposes assuming that the enterprise is a body
and use accrual basis of accounting for tax purpose for tax year ending Sene 30, 1998 as per
Proclamation No. 286/2002 and Regulation No. 78/2002
B. Prepare profit and loss statement for financial year ending Sene 30, 1998 for financial
accounting purposes assuming that the same cost and depreciation method as “A” above
Chapter Five
Other Income Tax Accounting
Chapter Outlines:
Legal provisions for other income taxes
Accounting for other income taxes
Chapter Objectives
After completing this chapter, you would be able to:
Comprehend other incomes in Ethiopian Context
Discuss the tax rates applicable on other incomes
Calculate taxable other income
Compute Royalty income tax, interest income tax, dividend income tax, capital gain tax and other
income taxes
Account for other income taxes
Declare other income taxes
Time Required: 2 Hours
5.1) Introduction to Other Income Tax
Other Income is taxed under Schedule “D”.
Other income includes the following types of income:
Royalty Income;
Technical Service Income;
Income from Game of Chance;
Dividend Income;
Income from Casual Rental of Property;
Interest Income; and
Capital Gains
All sort of these incomes are taxable under the law in force in Ethiopia: the Income Tax
Proclamation No. 286/2002 and the Income Tax Regulation No. 78/2002.
5.2) Withholding of Schedule “D” Income Tax on Payments
The Payer of any payment subject to tax under Schedule “D” shall withhold from the
payment the amount of tax required by Schedule “D”
Every Taxpayer who has Schedule D Income, not subject to withholding at source
constituting a final tax, shall prepare a declaration of that income in a form prescribed by the
Tax Authority. Taxpayers shall submit this declaration to the Tax Authority within two (2)
months from the end of the Ethiopian Fiscal Year
The tax calculated in accordance with the declaration, after the Foreign Tax Credit has been
reduced from the related Schedule D income subject to taxation during the year, shall be
transferred by the taxpayer to the Tax Authority simultaneously with the Declaration Form
tax in Kenya. Determine the Tax Liability of Dr. Engineer Tibebu assuming it was not deducted
at source and the exchange rate for a dollar was Br 8.75 on the Date of Declaration of this
Income.
Example 5.3: Assume Mr. Prajnan Goswami, an Indian Engineer, is consulting Gilegel Gibe
Hydro-Electric Project. The annual payment is 80,000 USD. Required: Calculate other income
tax on this technical service income
Example 5.4: Ato Bedelu won Birr 100,000 from the lottery drawn on April 25 th 2006.
Determine the Tax Liability to be withheld by the National Lottery Administration.
Example 5.8: SI Business Enterprise sold its building which has a cost of Br 85,000 at Br
185,000. The Building was held for 10 years and Br 11,000 Land and Building tax was paid on
the building during the 10 years period. If the average inflation rate is 5%, determine the Taxable
Capital Gain and the Capital Gain Tax.
Example 5.9: Ato Jara sold his personal home at Birr 150,000 in 1996 E.C. The home was
accomplished with the cost of Birr 95,000 in 1993 E.C. Determine the Capital Gain Tax
assuming that the person paid Br 2,200.00 Land and Building Tax and the applicable Prince
Index is 1.25 in this regard.
Example 5.10: Ato Abebe Purchased 100 Shares from NIB International Bank S. Co. at Birr
1100 per share when the par value is Birr 1000 per share on January 1, 2003. Ato Abebe sold the
shares at Birr 1700 per share on February 20, 2005. Taking year 2003 as a base year, the price
index is 1.15 in 2005. Determine the tax on the Capital Gain
Chapter Six
Value Added Tax (VAT) Accounting
Chapter Outlines:
Overview of Value Added Tax
Components of Value Added Tax
Valued Added Tax when the tax element is included and excluded
Basic Legal provisions of VAT in Ethiopia
Accounting for VAT
Computation of VAT
VAT Declaration
Chapter Objectives
After completing this chapter, you would be able to:
Describe Value Added and Value Added Tax
Understand Input Tax and Output Tax
Compute Input Tax and Output Tax when the tax element is included in the price
Discuss the basic legal provisions such taxable goods, zero-rated goods, standard rated
goods, Registration for Value Added Tax, etc
Account for transaction with value added tax
Compute VAT Payable or VAT Refund
Complete VAT Declaration on monthly basis
Time Required: 4 Hours
Chapter Pre-Requisite: Acct 202
6.1) Overview Value Added Tax
VAT was invented by a French economist Maurice Laura in 1954. It is a government tax that is
charged at each stage of production. For instance, when a company buys parts, then buys more
parts - for each purchase, a separate VAT is paid. When a company exports into a VAT country,
that company (or the company purchasing the products) must pay a VAT based on the value of
the goods. There are nearly 140 countries that use the VAT system, with the average percentage
being 15%
Value Added Tax (herein after VAT) is a tax on the Value Added
It is an indirect tax on the value added
A VAT may be defined as "a tax to be paid by the manufacturers or traders of goods and
services is on the basis of value added by them".
The value added by them is the difference between the receipts (from the sale) and payments
made to various factors of production (land, labor, capital and organization)
Manufacturer or Trader is not liable to pay the tax on the entire value of the commodity
because the tax base for VAT is the Value Added.
In Canada, VAT is known as “goods and service tax” or GST; and in Japan it is known as
"Consumption Tax".
VAT is an indirect tax, in that it is a tax collected from someone other than the person who
actually pays the tax.
Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011 41
Tax Accounting (ACCT-332)
Output Tax: – is the Value Added Tax collected on the sale of taxable supplies (goods and
services). It is the VAT collected on sales.
Input Tax: - is the value added tax paid on purchases of taxable goods and services. It is the
VAT paid on purchases
Vat Payable Or Liability = Output Tax is greater than Input Tax
Vat Refundable/Credit = Output Tax is less than Input Tax
6.3) VAT Exclusive and VAT Inclusive Price and Determination of VAT
VAT Exclusive Price – In this case, purchases and sales are made Exclusive of VAT. When a
VAT Return is prepared, the Output and Input Tax are determined by multiplying Sales and
Purchases Price by the existing VAT Rate.
VAT = VAT Exclusive Price @ VAT Rate
VAT Inclusive Price – In this case, purchases and sales are made inclusive of VAT. When a
VAT Return is prepared, the Output and Input Tax is determined by multiplying sales and
purchases by the Ratio of VAT Rate to 1 Plus VAT Rate; For example if the VAT Rate is 15%,
Sales and Purchases Price which are VAT Inclusive are multiplied by 15/115 which is the same
as 0.15/1.15)
VAT = [VAT Inclusive Price] @ [VAT Rate / (1 + VAT Rate)]
Mandatory Registration
Any person conducting a commercial enterprise or intending to conduct a commercial
enterprise may apply to get registered for VAT. The term any person for purposes of VAT
registration includes: Sole proprietor, Company, Partnership, Estate of the Deceased, Trust,
Incorporated Body or Unincorporated Body or Club or Association, etc.
If the gross sales value or turnover of the enterprise, which is gross income for 12 calendar
months, exceeds or is likely to exceed Br 500,000, the person conducting the enterprise
must register for VAT with VAT Department of the FIRA. It is calculated ongoing basis.
Turnover related to exempt supplies is not to be included in compulsory VAT registration.
Voluntary Registration
A person who carried on taxable activity and is not required to get registered for VAT, may
voluntarily apply to the Authority for such registration, if the person regularly is supplying or
rendering at least 75% of his goods and services to registered persons
2. Imposition of Tax
Subject to the provisions of the VAT proclamation, there shall be levied and paid tax to
be known as Value Added Tax, at the rate of 15 % of the value of:
Every taxable transaction by a registered person; and
Every import of goods, other than an exempt import
An import of goods takes place when the goods are entered into the customs declaration. The
value of a taxable import is the customs value of the goods, determined in accordance with
the customs legislation of Ethiopia, plus the sum of duties and taxes (Custom Duty and
Excise Tax) payable upon the import of the goods into Ethiopia, excluding VAT and income
tax withholding.
3. Zero-Rated Supplies
The following taxable transaction shall be charged with tax at a rate of Zero percent:
The export of goods or services to the extent provided in regulations;
The rendering of transportation or other services directly connected with international
transport of goods or passengers,
The supply of gold to the National Bank of Ethiopia; and
A supply by a registered person to another registered person in a single transaction 0f
substantially all of the assets of a taxable activity or an independent functioning part of a
taxable activity
Note: on Zero Rated supplies the registered person can claim the Input Tax Credit on purchases
either it is domestic or import. The input VAT will be recovered but no Output Tax will be
reported for the sales.
4. Exempt Supplies (Transactions)
The following types of supplies of goods (other than by way of export) or rendition of services,
as well as the following types of imports of goods, are exempt from payment of VAT to the
extent provided by regulation:
1. The sale or transfer of a used dwelling, or the lease of a dwelling
2. The rendering of financial services
3. The supply or import of National Or Foreign Currency (except for that used for
numismatic purposes), and of securities
4. The import of gold to be transferred to the national bank of Ethiopia
5. The re. The import or supply of prescription drugs and medical services
6. The rendering of educational services provided by educational institutions,
7. The supply of goods and rendering of services in the form of humanitarian aid,
8. The supply of electricity, kerosene, and water
9. Goods imported by the government
10. Supplies of services by the post office
11. The provision of transport be it public or freight
12. Permits and License Fees
Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011 43
Tax Accounting (ACCT-332)
In respect of a supply or import received which is used both for the making of taxable
and exempt transactions, the rules of apportionment of the credit shall be determined
by a directive to be issued by the Minister or Revenue,
No Credit is allowed for VAT:
On a taxable transaction to, or import by, a person of a passenger vehicle
Unless the person is in the business of dealing in, or hiring of, such vehicles
Unless the person is engaged in the business of transporting passengers
On a taxable transaction, or import by, a person of goods or services acquired for the
purposes of entertainment or providing entertainment
Unless the person is tin the business of providing entertainment
The person is in the business of providing taxable transactions involving
transportation services
9. VAT Refund
If at least 25 percent of the value of a registered person's taxable transactions for the
accounting period is taxed at a zero rate, the tax authority shall refund the amount of VAT
applied as a credit in excess of the amount of VAT charged for the accounting period within
a period of two months after the registered person files an application for refund,
accompanied by documentary proof of payment of the excess amounts.
In the case of other registered persons, the amount of VAT applied as a credit in excess of the
amount of VAT charged for the accounting period is to be carried forward to the next five
accounting periods and credited against payments for these periods, and any unused credits
shall be refunded by the tax authority within a period of two months after the registered
person files an application for refund, accompanied by documentary proof of payment of the
excess amounts
The Authority is not obliged to refund excess credits if the amount to be refunded is not more
than 50 Birr. This amount can be carried forward and credited against tax due in the
subsequent accounting period
Record Keeping
A record refers to accounting records, accounts, books, computer-stored information, or any
other documents. A registered person or any other person liable for tax under VAT proclamation
shall maintain for 10 years in Ethiopia the following:
Original tax invoices received by the taxable person,
A copy of all tax invoices issued by the taxable person,
Customs documentation relating to imports and exports by the person,
Accounting records; and
Any other records as may be prescribed by the Ministry of Revenue and useful to
determine the VAT Liability
The amount of tax payable or VAT Liability for any accounting period by a person who is
registered or is required to register is the difference between the amounts of tax charged on
taxable transactions i.e. the VAT charged on sales and the VAT paid on purchases of goods
and services applying the Zero Rate or the Standard Rate.
Example 6.1: if a taxable person purchases birr 200,000 goods and services and sales Birr
300,000 taxable supplies during the month of Nehase, the VAT liability will be as follows:
Output Tax:
300,000 @ 15 % .....................................45,000
Input Tax:
200,000 @ 15%.......................................30,000
VAT Liability..........................................15,000
Example 6.3: Kombolcha Textile Factory Share Company made taxable sales of Birr 80,000
during the month of June 2006. It also made taxable purchases of Birr 50,000 and imported Birr
10,000 during the same month. Required: Determine the VAT Liability or VAT Refund
assuming all the prices are VAT Exclusive and the VAT Rate is 15%
Example 6.4: Tabor Ceramics Share Company made taxable purchases of Birr 230,000 and Birr
138,000 taxable import. It also made taxable sales of Birr 345,000. Required: Determine the
VAT Liability or VAT Refund assuming that the prices are VAT inclusive and a VAT rate is
15%.
Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011 47
Tax Accounting (ACCT-332)
Chapter Seven
Turnover Tax Accounting
Chapter Outlines:
Introduction to Turnover Tax
Basic legal provisions such as Rate of TOT, Base of Computation of TOT, Exemptions,
Computation of tax
Accounting for TOT
Chapter Objectives
After completing this chapter, you would be able to:
Define Turnover and Turnover Tax
Calculate TOT Base and TOT according the tax law
Account for Turnover Tax
File Turnover Tax as per the filling time
Time Required: 2 Hours
Chapter Pre-Requisite: Acct 202
7.1) Introduction To Turnover Tax
What is Turnover?
Turnover refers to total revenue or Sales
Turnover Tax (TOT)
It is a tax imposed on almost all goods and services on the total turnover rather than on
the Value Added. Turnover tax is a sales tax. A reduced tax rate is applied for Turnover
Tax as compared to the VAT in most of the countries of the world
Filing of Turnover Tax Return and Payment
Tax payers subject to Turnover Tax shall:
Pay the tax for every accounting period by the deadline for filing the Turnover Tax
return. The Accounting period for the purposes of Turnover tax shall mean:
For Category "A" taxpayers but are not required to register for VAT, the calendar month;
For category "B" taxpayers, each three months period commencing from the first day of
the Ethiopian fiscal year (tax year);
For Category "C" taxpayers, the fiscal year is the accounting period. A Presumptive
Turnover Tax shall be payable by Category "C" taxpayers who are not required to keep
records. The base for the presumptive turnover tax shall be the total turnover used as base
for the income tax.
Base of computation of the Turnover tax shall be the Gross Receipt in respect of goods
supplied or services rendered
Obligation to Collect and Transfer the Turnover Tax (Article 6)
A person who sells goods and services has the obligation to collect the Turnover Tax
from the buyer and transfer it to the Tax Authority. Hence, the seller is principally
accountable for the payment of the tax.
Exemptions (Article 7)
The following transactions of goods and services shall be exempted from Turnover Tax:
1. The sale or transfer of a dwelling use for a minimum of two years, or the lease of
a dwelling:
2. The rendering of financial services;
3. The supply of National or Foreign Currency (except for that used for numismatic
purposes) and of securities;
4. The rendering by religious organizations of religious or other related services:
5. The supply of prescription drugs specified in directives issued by the relevant
government agency, and the rendering of medical services;
6. The rendering of educational services provided by educational institutions, as well
as child care services for children at pre-school institutions:
7. The supply of goods and rendering of services in the form of humanitarian aid:
8. The supply of electricity, kerosene, and water;
9. The provision of transport;
10. Permits and license fees;
11. The supply of goods or services by a workshop employing disabled individuals if
more than 60%of the employees are disabled; and
12. The supply of books
13. Bread, Injera and Milk are exempted by the Ministry of Finance and Economic
Development.
Turnover Tax liability at the time each taxable transaction occurs. This may have the highest
burden of Record keeping and Compliance cost on the taxpayers. The second is to make
adjustment for all the transactions of the Tax period at the end of tax period by recording the
transactions initially as sales
Example 7.3: A Category “B” Taxpayer Named NUFTANA Furniture PLC made the
following transactions during a Calendar Month Meskerem, Tikemit and Hidar 1998:
Meskerem 1998: Birr 32,000 tables, chairs and beds were sold
Tikemit 1998: Birr 27,000 Sofa, Computer Desk, And Tables were sold
Hidar 1998: Birr 30,000 Office Furniture was sold
Instruction: Determine the transactions and Prepare and File the Turnover Tax Return for the
three months ended Hidar 1998 under both separate and adjustment recording method.
Example 7.4: PHOTO KEJELA, A Category “C” Taxpayer, had a gross receipts of Birr
86,000 for the Tax Year ended 30th of Sene 1998. Determine the Turnover Tax Payable for this
Business.
Chapter Eight
Excise Tax Accounting
Chapter Outlines:
Introduction to Excise Tax
Basic Legal Provisions of Excise Tax in Ethiopia such as Excise Tax Rate and Base of Excise
Tax, Payment of Excise Tax (Article 6)
Accounting for Excise Tax
Chapter Objectives
After completing this chapter, you would be able to:
Understand what excise tax is
Identify and excisable goods and Know the excise tax rate applicable on each good
Compute excise tax base for goods imported and locally produced
Calculate excise tax as per Schedule “E”
Account for excise tax
In Ethiopia Excise Tax was introduced in 1993 under Sales and Excise Tax Proclamation No.
68/1993 and this proclamation was repealed in 2002 through Excise Tax Proclamation No. 307/
2002. Excise tax is payable either on production of goods listed in Excise Tax Rate Schedule or
on the importation of the same goods from foreign countries. For Excise Tax purposes, the
Taxpayer is either a person who is importing the goods or producing the goods. This person is
liable to pay excise tax according to the Excise Tax Proclamation.
Every taxpayer shall:
Maintain books of accounts and supporting documents in accordance with proper
accounting principle and in a manner acceptable to the Tax Authority;
Submit every 30 Days to the Tax Authority, in a form which shall be supplied by said
Authority, a declaration containing such information as may be necessary for proper
collection of the tax.
Comply fully with requirements of the inspection of his premises by the delegate of the
Tax Authority in accordance with Sub-Article 3 of Article 9 of this Proclamation.
Comply fully with requirements of the inspection of taxpayer’s premises by the delegate
of the Tax Authority if The Tax Authority wants to inspect the taxpayer.
Immediately communicate to the Tax Authority the type and address as well as the
commencement and termination date of his business;
Pay in full the tax due Within 30 Days from the date of termination where such business
is terminated.
SCHEDUL "E"
S. No. Types of Product Tax Rate
1. Any type of sugar (in solid form) Excluding Molasses 33%
2. Drinks:
2.1. All types of soft drinks (Except Fruit Juices) 40%
2.2. Powder Soft Drinks 40%
2.3. Water Bottled Or Canned In A Factory 30%
2.4. Alcoholic Drinks1
2.4.1. All Types Of Beer & Stout 50%
2.4.2. All Types Of Wine 50%
2.4.3. Whisky 50%
2.4.4. Other Alcoholic Drinks 100%
3. All types of pure Alcohol 75%
4. Tobacco & Tobacco Products
4.1. Tobacco Leaf 20%
4.2. Cigarettes, Cigar, Cigarillos, Pipe Tobacco, Snuff and Other Tobacco Product 75%
5. Salt 30%
6. Fuel-super Benzene, regular Benzene, Petrol, Gasoline and other Motor spirits 30%
7. Perfumes and Toile Waters 100%
8. Textile and Textile products
8.1. Textile fabrics, knitted or woven of natural silk, rayon, nylon, wool
or other similar materials 10%
8.2. Textile of any type partly or wholly made from cotton, which is
gray, white, dyed or printed, in piece of any length or width (except Mosquito
net and "Abudgedi") and including blankets, bed sheets, counterpanes, towels, 10%
table clothes and similar articles
8.3. Garments 10%
9. Personal Adornment made of Gold, Silver or Other materials 20%
10. Disk washing machines of a kind for domestic use 80%
11. Washing machines of a kind for domestic purposes 30%
12. Video decks 40%
13. Television and Video Cameras 40%
14. Television Broadcast Receivers Whether Or Not Combined With
Gramophone, Radio, Or Sound Receiver And Reproducers 10%
15. Motor passenger cars, station wagons, utility cars, and land rovers, jeeps
pickups, similar vehicles (including motorized caravans), whether assembled,
together with their appropriate initial equipment:
A. Up to 1,300 C.C (C.C = Cylinder Capacity) 30%
B. From 1,301 C.C up to 1800 C.C 60%
C. Above 1,800 C.C 100%
16. Carpets 30%
17. Asbestos And Asbestos Products 20%
18. Clocks And Watches 20%
19. Dolls And Toys 20%
1
“Alcohol” means Ethyl Alcohol. “Pure Alcohol” means Alcohol of purity of 80 degree or more;
Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011 52
Chapter Eight: Excise Tax Accounting
Time of Payment:
Unless decided otherwise, the excise tax on goods specified under the Schedule “E” shall be
payable.
When imported at the time of clearing the Goods from Customs area;
When produced locally, not later than 30 days from the date of production;
If the total amount FOH Cost that includes the Factory Depreciation (either depreciation on
factory building or production machineries) is given, the factory depreciation shall be deducted
to compute the base of computation of Excise Tax Payable as follows:
Computation of Excise Tax Payable
Raw Materials.................................................................. xxxxx
Labor Cost..............................................................................
xxxxx
FOH Costs..............................................................................
xxxxx
Total Production Cost............................................................ xxxxx
Less: Factory Depreciation.................................................... xxxxx
Tax Base for Excise Tax........................................................ xxxxx
Tax Rate from Schedule “E”.................................................. xx%
Excise Tax Payable................................................................xxxxx
Example 8.1: META Brewery used Birr 850,000 malt; Birr 250,000 Direct Labour Cost and
Birr 400,000 FOH to produce 1,400,000 bottles of Beer during the month of Sene 1998.
Required: Determine the Excise Tax Liability of the month of Hamle 1998 assuming that the
FOH cost includes a factory depreciation of Birr 100,000.
Example 8.2: Assume SIRARA General Trading PLC imported Br 12,000,000.00 merchandise
from China. Br 480,000.00 and Br 120,000.00 Freight cost and Insurance cost was incurred,
respectively in respect of goods imported. Required: Determine the Excise Tax Base and Excise
Tax Liability
Chapter Nine
Accounting for Customs Duty
Chapter Outlines:
Overview of Customs Duty
Basic Legal Provisions of Ethiopian Customs Duty
Customs Valuation Systems
Calculate Customs Duty on Goods Imported
Chapter Objectives
After completing this chapter, you would be able to:
Understand Customs duty
Determine Duty Paying Value as per the customs law in the country
Determine the value of imported goods using different valuation systems
Understand duties and taxes collected at customs station
Compute Customs Duty on Imported Goods
Account of Customs Duty in the books of accounts
Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011 55
Tax Accounting (ACCT-332)
Ad-valorem Taxes – are taxes or duties levied as a percentage of the Value of Goods and
Services.
Specific Tax – are the taxes levied at a fixed amount, irrespective of the Value of the goods
and services.
1. Transaction Value
The transaction value method is the first method to be applied in customs valuation.
Transaction value means the price actually paid or payable by the buyer for the goods
when sold for export to the country of importation.
2. Transaction Value of Identical Goods
If the customs value of the imported goods cannot be determined under the Transaction
Value Method above, the customs value shall be the transaction value of identical goods
sold for export to the same country of importation and exported at or about the same time
as the goods being valued. "Identical goods" means goods, which are the same in all
respects, including physical characteristics, quality and reputation.
9.4) Duty and Taxes Collected at the Customs Station from Businesses
From businesses or commercial organizations, the following duty and taxes are collected at time
of clearing from customs station:
Customs Duty (Article 52 of Proclamation No 60/1997);
Excise Tax (Article 6 (2) of the Excise Tax Proclamation No 307/2002);
Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011 57
Tax Accounting (ACCT-332)
Value Added Tax (Article 5 of the VAT Proclamation No. 285/2002); and
Withholding Tax (Article 52 of the Income Tax Proclamation No 286/2002)
Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011 59
Tax Accounting (ACCT-332)
Chapter Ten
Taxable Income and Book Income
Chapter Outlines:
Taxable Income versus Book Income (Accounting Income)
Specific Differences
Accounting for inter-period tax allocation
Accounting for operating losses
Chapter Objectives
After completing this chapter, you would be able to:
Understand differences between accounting standards and tax laws
Understand differences between taxable income and book income
Discuss Specific differences
Identify permanent differences between taxable income and book income and discuss accounting
treatments of permanent differences
Discuss temporary differences and discuss accounting treatment for inter-period tax allocations
Compute deferred tax assets and deferred tax credits
Account for both deferred tax assets and credits
Time Required: 4 Hours
Chapter Pre-Requisite: Acct 202
10.1) Taxable Income versus Book Income
In computing income tax payable, businesses must complete tax returns including a
statement showing the amount of income subject to Tax. In general, the form and contents of
the income statements for tax purposes are similar to the form and contents of the Income
Statement for Financial reporting purposes.
The Taxable Income in the Tax Return however, is computed with prescribed tax regulations
or rules (tax code or laws). Where as, Before Tax Accounting Income or Income as per the
Book or merely Accounting Income (Before Tax Financial Income) is measured in
accordance with GAAPs. differences arise from some of the following reasons:
Depreciation may be computed on Sum of the years Digit method for the Book Purposes but
on Straight Line Method for Tax Purposes.
Revenue is recognized on accrual basis at the time of Sale for Book purposes or financial
reporting purposes but may be recognized on cash basis at the time of cash receipts
Expenses are recognized on accrual basis for Financial Reporting purposes but may be
recognized on the cash basis for the tax purposes
Permanent Differences
Some of the differences between Taxable Income and Before Tax Accounting Income are
permanent. Permanent differences are items that enter into in the determination of Before
Tax Accounting Income but never into Taxable Business Income and item that inter Taxable
Income but never into Before Tax Accounting Income.
There are a variety of Tax Law provisions. Some of the provisions exclude certain
revenue from taxation; limit the deductibility of certain expenses and permit the deduction of
certain expenses on excess of costs incurred. Permanent Differences affect only one period in
which they occur so that they do not give rise to future reversible amount.
Temporary Differences (Timing Differences)
It is a difference between a tax basis of an asset or a liabilities and Book Basis of assets and
liabilities that will result in reversible amount in some future years when the reported amounts of
assets are recovered and liabilities are settled. Examples of temporary differences are:
Revenues are Taxable (are recognized in the Tax Returns) after they are recognized to
determine Accounting Income. That is cash basis of revenue recognition for tax purposes but
accrual basis of revenue recognition for accounting purposes
Expenses are recognized or deductible after they are recognized for Financial Reporting
purposes. That is accrual basis of expense recognition for accounting purposes but cash basis
of expense recognition for tax purposes
Revenue is taxable before they are recognized to determine Accounting Income. For
Example; Advance Collection may be recorded as revenue.
Expenses are deductible before they are recognized for Financial Accounting Income
Purposes. For example; expenses are recognized when cash is paid
Illustration 10.2: Assume that in the year ended June 30, 2004 Ethio Trading Enterprise
(PLC) reported Br 270,000 revenues for both the tax purposes and financial accounting purposes.
It also reported expenses of Br 206,000 for both the tax purposes and financial reporting
purposes excluding insurance expense. Required: Determine the taxable income and before tax
accounting income and calculate the deferred tax credit for the year ended June 30, 2004
assuming a flat tax rate of 30%.
Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011 61
Tax Accounting (ACCT-332)
Illustration 10.3: Assume that BETA Book Publishing (PLC) earned and collected Br
150,000 book publishing fee in 2003 for both the book purposes and tax purposes. The business
incurred book publishing expenses of Br 140,000 out of which Br 90,000 is paid in cash. The
company uses cash method of accounting for tax purposes and accrual method of accounting for
financial accounting purposes. Required: Determine the Taxable and Accounting Income
assuming a tax rate is 30%.
Illustration 10.4: Continuing with the above illustration, revenue earned and collected cash
for tax purposes and book purposes is the same Br 180,000. The Book publishing company
incurred book publishing expenses 120,000 but paid expenses of Br 160,000 in the tax year
2004. This indicates that Br 40,000 accrued liabilities are paid during the year which is an
expense of the year 2003. Required: Determine taxable income and book income assuming 30%
flat tax rate in the tax year 2004.
Chapter Eleven
Business Tax Planning
Chapter Outlines:
What is Tax Planning
Tax Minimization Methods: Tax Evasion, Tax Avoidance and Tax Planning
Tax Planning Techniques
Tax Planning Skills
Tax planning and Corporate Financing
Chapter Objectives
After completing this chapter, you would be able to:
Define tax planning
Compare and Contrast Tax Planning with Tax Avoidance and Tax Evasion
Understand and apply tax planning techniques
Grasp the tax planning skills
Apply tax planning on corporate financing
Time Required: 4 Hours
Chapter Pre-Requisite: Acct 202
11.1) What Is Tax Planning?
Nobody likes paying taxes. Thus, everybody tries to minimize taxes. This shall be legal. To
become more tax efficient year round, taxpayers have to know the spelled out implications;
warning about consequences; plenty of useful tips and others. Tax Planning has become an
important feature of all business enterprises, new or old, small or big, public or private.
Tax Planning is an arrangement of one’s financial affairs in such a way that, without
violating in any way the legal provisions full advantage is taken of all tax exemptions,
deductions, concessions, rebates, allowances and other relief or benefits permitted under the
tax laws so that the incidence of tax is reduced to minimum thereby ensuring that the money
remaining after payment of tax is kept as high a level as possible. Tax Planning is a
legitimate arrangement of one’s financial activities in a manner that reduces or defers
(postpones) the related Income Tax Expenses
Tax Planning is a systematic way of organizing and planning for taxes. Effective business tax
planning should be a year-round effort.
Business Tax Planning means estimates and programmes that a company carries to minimize
the Tax Liability apart from fulfilling legitimate expectations and aspiration of the people.
Business Tax Planning demands a through examination of all laws of taxation as failure to
recognize the tax implications of business decisions can have serious consequences for the
survival and growth of the business, while a step in the right direction could mean a
considerable saving of sources; a wrong step will bring disaster to the enterprise. Thus, to
avoid uncertainties in future in regard to the tax liability and to avoid harassment at the hands
of tax authorities in the matter of assessment, the company should resort to tax planning in its
own interest.
11.2) Tax Minimization Methods: Tax Evasion, Tax Avoidance, and Tax Planning
Three methods of saving taxes have been developed in most countries of the world in the past
few decades: Tax Evasion, Tax Avoidance and Tax Planning. A great deal of confusion prevails
Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011 63
Tax Accounting (ACCT-332)
in the Business Sector about the correct connotation of these terms. Hence we shall attempt to
explain these terms to show that Tax Planning is absolutely legal.
Tax Evasion
Tax evasion is by no means a tax planning because it is a criminal act or offence. It is a
commission or omission of an act with the intention to deceive the tax authority. The taxpayer is
evading and trying to escape a legally matured tax liability or obligation by dishonest and
fraudulent means. Tax evasions might involve simply failing to report income or trying to create
excess deductions or False Deductions. The Failure to report income can also be broken down
into two subcategories: (A) Evasion of tax on income that is legally earned; and, (B) Evasion
of tax on income that arises from an illegal activity such as trafficking in narcotics and other
drugs. An example of tax fraud on legally earned income would be the formation of sales
companies that appear to deal only with unrelated parties, but in fact deal with related parties,
hiding the fact that one owns a particular tax haven corporation. These tax haven corporations
are also used to hide corporate receipts or slush funds. It is dubious way of attempting to solve
tax problems. Hence tax evasion is illegal, unethical and uneconomical as well. Thus, it should
be condemned not only by the Government but by the Businesses as well.
Tax Avoidance
Tax Avoidance is not the same as the tax planning even though the transactions undertaken seem
legal and with the spirit and intentions of the tax proclamations and regulations. Tax Avoidance
is taken to refer to arrangements by which a person acting within the tax laws reduces his true tax
liability, infringing in the process both the spirit and the intention of law. In other words tax
avoidance is the art of dodging Tax Authority without breaking the law. It means acting within
the framework of law or acting as per the language of law only in form, but murdering the very
spirit of tax law and thus acting against the intention of tax laws and defeating the purpose of
particular legal enactment. In short, tax avoidance is taking advantage of loopholes in tax laws.
Taking advantage of tax loopholes provides a short run benefit because when the loopholes are
made public, legislative step will be taken by the Tax Authority.
Tax Planning
Tax planning is a method of planning business affairs by considering the incentives and benefits
provided by the legislature. Tax planning takes the maximum advantages of the exemptions,
deductions, rebates, relief and other tax concessions allowed by taxation statutes leading to the
reduction of the tax liability of the taxpayer. As compared to Tax Avoidance, tax Avoidance is
viewed with displeasure by the tax authority as it is an art of escaping the a matured burden of
tax without breaking the law and this provides only a short term benefit. On the contrary, tax
planning by businesses cannot be called a crime or illegal activity or an immoral action. What
constitutes a crime is tax evasion or what is undesirable is tax avoidance, but tax planning
benefits the company as well as community. It enables a company to save a good deal of tax and
also avoid unwarranted harassment, worry and tension.
Example 11.1;
Assume you need to raise Br 100,000 and your company is in the 30% tax bracket. The dividend
paid on the shares will be 10% (assume they are common shares) and the interest that must be
paid is also the same 10%
Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011 65
Tax Accounting (ACCT-332)
Chapter Twelve
Tax Administration
Chapter Outlines:
Overview of Tax Administration
Structure of Tax Administration in Ethiopia
Development of Tax Administration in Ethiopia
Problems of Tax Administration in Ethiopia
Chapter Objectives
After completing this chapter, you would be able to:
Define Tax Administration
Understand criteria used to evaluate good tax administration
Discuss types of taxes collected by Federal government and State governments
Comprehend revenue sharing between Federal Government and State Governments in Ethiopia
Differentiate Federal Taxpayers and State Taxpayers in Ethiopia
Identify measures taken to improve tax administration in Ethiopia
Understand the existing problems in tax administration
Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011 67
Tax Accounting (ACCT-332)
They shall collect rent income on houses and other properties they own.
States shall levy and collect profit, sales, excise and personal income taxes on income of
enterprises owned by the States.
States shall levy and collect taxes on income derived from mining operations, and
royalties and land rentals on such operations.
They shall determine and collect fees and charges relating to licenses issued and services
rendered by State organs.
They shall fix and collect royalty for use of forest resources
Compiled By: KASSAHUN BORESSA, Lecturer, AAU, School of Commerce, Revised in 2011 69