Identify and Discuss Direct Tax

Terms related to direct tax

 A direct tax: It is paid by a person on whom it is levied. In direct taxes, the impact and Incidence fall
on the same person. If the impact and incident of a tax fall on the same person, it is called as direct
tax. It is borne by the person on whom it is levied and cannot be passed on to others. For example,
when a person is assessed to income tax, he has to pay it and he cannot shift the tax burden to
anybody else.

 “Income” means every sort of economic benefit including gains in cash or in kind, from
whatever source derived and in whatever form paid, credited or received.
 “Taxable income” means the amount of income subject to tax after deduction of all expenses and
other deductible items allowed under this Proclamation 286/2002 and Regulations 78/2002 issued.
 “Employee” means any individual, other than a contractor, engaged (whether on a permanent or
temporary basis) to perform services under the direction and control of the employer.

Sources of Income

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

a) Income from employment;

b) Income from business activities;

c) Income derived by an entertainer, musician, or sports person from his personal activities;

d) Income from entrepreneurial activities carried on by a non-resident through a permanent

establishment in Ethiopia;

e) Income from immovable property and appurtenances thereto, income from livestock and inventory
in agriculture and forestry, and income from usufruct and other rights deriving from immovable
property is much property is situated in Ethiopia;

f) Dividends distributed by a resident company;

g) Profit shares paid by a resident registered partnership;

h) Interest paid by the national, a regional or local Government or a resident of Ethiopia, or paid by a
non-resident through a permanent establishment that he maintains in Ethiopia;
The above sources of income are grouped under the following four Schedules:

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

1) Schedule 'A' Income from employment;

2) Schedule 'B' Income from rental buildings;

3) Schedule 'C' Income from business;

4) Schedule 'D' Income from other sources including:

1. Employment Income (Schedule ‘A’)

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

Taxable income

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

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

According to Article 10 of income tax proclamation, the employers have an obligation to withhold the
tax from each payment to an employee and to pay to the tax authority the amount withheld during each
calendar month. In applying the procedure, income attributable to the months of Nehassie and pagume
shall be aggregated and treated as the income of one month.
Exemptions: The following categories of income shall be exempted from payment of income tax.

I. Income from casual employment

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

II. Contribution of retirement benefits by employers:

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

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

IV. Payments as compensation

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

(i) Personal injuries suffered by that person;

(ii) The death of another person.

V. Allowable Deductions
The following payments, made to an employee by an employer, are allowed as deductions to determine
taxable income.
 Reimbursed medical expenses
 Transportation allowance (if it fulfills the criteria for tax exemption) 25% of basic salary or not
more than Br 2,200
 Hardship Allowance
 Desert Allowance (if it fulfills the criteria for tax exemption)
 Reimbursed traveling expense (incurred on duty)
Overtime

Overtime is the work done in the excess of the normal daily hours work. If a worker beyond stipulated
working hours during the weak day, i.e., 8 hours a day and 48hours a weak, he/she is entitled to an
overtime income as follows:

 125% of normal hourly rate for overtime work b/n 06a.m to 10p.m
  150% of normal hourly rate for overtime work b/n10 pm to 06 am
 200% of normal hourly rate for work on a weekly rest day;
 250% of normal r hourly rate for work on public holyday

Overtime income is calculated as follows:

Basic salary/hours*rate* duration of overtime worked

Tax Rate

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

No. Taxable monthly income (Birr) Rates of tax (%) Deduction (Br.)

1 < 600 Exemption 0

2 (600 – 1,650] 10% 60

3 (1,650 – 3,200] 15% 142.5

4 (3,200 – 5,250] 20% 302.5

5 (5,250 – 7,800] 25% 565

6 (7,800-10,900) 30% 955

7 over 10,900 35% 1,500

Methods of employment income tax computations

There are two methods

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

B. Deduction methods

Income tax= taxable income * tax rate – deduction

Deduction is computed by this formula: -

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

Example: Assume Mr. Tesfaye earned an amount of birr 6,750 subject to income tax
Req. calculate employment income tax.
 Method 1: Progression method
Income Tax Payable= 0- 600=0
600 - 1,650=10%= 105
1,650 - 3,200=15%=232.5
3200 – 5250=20%=410
6,750 – 5,250=25%=375
Income Tax= 105+232.5+412+375= 1,122.5
Method 2: Deduction Method
Income tax= taxable income x tax rate – deduction
= 6,750 x 25% - 565 = 1,122.5

Example2: The following data were taken from the records of Abraham Co. for July 2005 E.C. that
pays payroll to its employees according to Ethiopian payroll system.

Name Basic salary allowance Overtime worked Duration of overtime work

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

Additional information:
1. All employees are expected to render services of 160hrs per month and all of them did except
Sara Chala who has served only 150hrs.
2. All employees are permanent employees except Abel Tena.
3. The allowance of Nega Girum is not taxable.
4. All employees promised to contribute 10% of their basic salary to the credit association of the
company
Required:
a. Determine the gross earnings, taxable income, total deductions and net pay of all employees and.
Solution:
Abel Tena
Gross earnings
Gross earnings=basic salary+ overtime+ allowance
Ordinary rate=3,400/160= Br.21.25/hr
Overtime earnings= 30hrsx1.25xBr.21.25= Br.796.88
Gross earnings=3,400+796.88+250=Br. 4,446.88
Taxable income
Taxable income=Br. 4,446.88

Total deductions

Pension =0(not a permanent employee)

Payable to credit association=10%x3, 400=Br.340

Income tax payable= 4446.88*20% -302.5=586.88

Total deductions=340+586.88= Br.926.88

Net pay

Net pay=gross earnings-total deductions=4,446.88-926.88=Br.3,520

Sara Chala

Gross earnings

Gross earnings=basic salary+ overtime+ allowance

Ordinary rate=6,200/160= Br 38.75/hr.

Overtime earnings= 20hrsx1.5xBr.38.75= Br.1,162.5

Gross earnings=5,812.5 +1,162.5+500=Br.7,475

Taxable income

Taxable income=Br.7,475

Total deductions

Pension =7%xBr.6, 200= Br.434

Payable to credit association=10%x6, 200=Br.620

Income tax payable= 7475 x 25% - 565= 1,303.75

Total deductions=434+620+1,303.75= Br 2,357.75

 Net pay
Net pay=gross earnings-total deductions=7,475-2,357.75=Br 5,117.25
Nega Girum
Gross earnings
Gross earnings=basic salary+ overtime+ allowance
Ordinary rate=1,600/160= Br.10/hr
Overtime earnings= 10hrsx2xBr.10 +18hrsx2.5xBr.10= Br.650
Gross earnings=1,600 +650+100=Br.2,350
Taxable income
Taxable income=Br.2, 350-100 = Br.2,250
Total deductions
Pension =7%xBr.1, 600= Br.112
Payable to credit association=10%x1, 600=Br.160
Income tax payable= 0-600=0%
600-1,650=10%=105
2,250-1,650=15%=90
Income tax=0+105+90 =Br.195
Total deductions=112+160+195= Br.467
Net pay
Net pay=gross earnings-total deductions=2,350-467=Br.1,883