OROMIA STATE UNIVERSIY

SCHOOL OF LAW

LLM PROGRAM IN COMMERCIAL AND INVESTMENT LAW

ADAMA CENTER

Advanced Tax Law Course

Term Paper Assignment

Title: Taxation of Foreign Companies Income under Ethiopian Tax Law

Submitted By Abdulbasit Ahmede

ID No: PGP/LLM/W/14/0403
May 2023, Adama, Oromia, Ethiopia

Table of Contents…………………………………………………………………………..pages
 CHAPTER ONE

INTRODUCTION

1.1 Background of the Study……………………………………………………………………..2

1.2 Statement of the Problems…………………………………………………………………….3
1.3 Study Objectives………………………………………………………………………………3
1.4 Methods……………………………………………………………………………………….4

CHAPTER TWO
TAXATION OF FOREIGN COMPANIES INCOME UNDER ETHIOPIAN TAX LAW
2.1 Introduction……………………………………………………………………………………4
2.2 The Taxation of Corporate/Companies Income defined……………………………………...4
2.3 The Rules of Taxation of Foreign Company Income in General……………………………...5
2.3.1 Residence Principle………………………………………………………………………….6
2.3.2. Source Principle……………………………………………………………………………6
2.3.2.1. Taxation of Business Income of Foreign Companies through Permanent Establishment..7
2.3.2.2. Taxation of Investment Income of Companies…………………………………………...9
2.3.3 Relief from Double Taxation Rule………………………………………………………….9
2.4 The Rule of Taxing Foreign Companies Income Tax under Ethiopian Tax Law…………...11
2.4.1 Residence Rule………………………………………………………………………….11
2.4.2 Source Rule……………………………………………………………………………..12
2.4.2.1 Taxation of Business Income (Profit) Through Permanent Establishment……………...12
2.4.2.2 Taxation of Investment (Passive) Income of Foreign Company………………………...15
2.4.3 Relief from Double Taxation under Ethiopian Tax Rule…………………………………..16

CHAPTER THREE

CONCLUIONS AND RECOMMENDATIONS

3.1 Conclusions………………………………………………………………………………….17
3.2 Recommendations……………………………………………………………………………18
Bibliographies ……………………………………………………………………………..19
CHAPTER ONE

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 INTRODUCTION

1.1 Background of the Study

Century ago, commerce and investments were predominantly territorial. Corporations were
incorporated and did their businesses within the national jurisdiction of registration. In those
days, corporate taxation did not have many challenges as these companies were subject to one
jurisdiction where income was generated, declared, and taxed. However, the growth of the
international trade and investment, just after the First World War, has created a vast expansion of
business across borders. With the advent of globalization and the flourishing of commercial
ventures, corporations started to expand their business overseas outside of their place of
incorporation. Companies have become more and more multinational with head office in one
jurisdiction while having subsidiaries, associates, or branches in other parts of the world. This
expansion poses a new challenge in the taxing power of governments because their source
income is not restricted to only their country of incorporation but also other country in which
they operate while the power to tax is essentially bound to one's territory. As a result, numerous
tax model treaties/conventions have been signed between the countries to make sure that
incomes generated by those companies in foreign country are subjected to tax 1. International tax
law has its own sets of generally recognized norms such as the single tax (no double taxation),
the benefits principle (that active business income should be taxed primarily at source, and
passive investment income primarily at residence) and the principle of non-discrimination.
However, such international tax law, themselves does not provide all rules. Countries Provides
rules of taxation in their domestic laws which have its own objectives. Ethiopia has amended its
Income Tax Proclamation in 2016. It has also come up with Tax Administration Proclamation
which is a new introduction in the country’s tax regime. One of the defining features of those
amendments made in the 2016 tax legislation was that there is a better articulated rule purported
to curb taxing problems related to taxing income of Multinational Companies-foreign companies.
However, the gist of those rules has some gaps when evaluated particularly in-light with
international standards. This term paper attempts to see the gaps of the current income tax laws
regarding rules of taxation of income of MNCs operating in Ethiopia and will try to recommend
what should has be done to fulfill the gaps.
1 The OECD and UN Tax Model laws are among internatonal law made to overcome issues of taxaton of cross
border companies

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 1.2 Statement of the Problems

The existence of the delicate need to balance between the norms of international taxation and the
general tax policy objectives of Ethiopia complicates the income taxation of foreign owned
businesses which are nowadays playing a significant role in Ethiopia’s economy by engaging in
different works. Although the Federal Income Tax Proclamation no.979/2016 has remedied some
ills of the previous income tax law in treating their activities, there still lingers a significant
difficulty in the identification of Ethiopian source income of these businesses. Absence of
definition for the elements of a permanent establishment, total disregard of permanent
establishment concerning E-Commerce, failure to provide a list of auxiliary or preparatory
activities that cannot be considered as PE, and absence of any clarification concerning a place of
management and effective place of management, which is provided as a requirement for
determining whether a foreign enterprise has a permanent establishment or a resident
respectively are among the major problems. Furthermore, the absence of clarity in rules of
double taxation is posed as problems on which this research is based.

1.3 Study Objectives

The main (general) objective of this study is to closely examine Ethiopian tax rules crafted to
regulate taxation of foreign company income. In doing so it will assess the rules instilled under
relevant international model tax laws. Consequently, the specific objectives of the study are:

• It will illuminate on the concept of corporate income tax in general;

• It will define and explore its rules of taxation of non-resident Companies income in
international model tax laws and current tax laws of Ethiopia;

• Showing how income of foreign company is attributed to tax law of Ethiopia and weighing it
against the international tax law and finally,

• Identifying the major gaps in the tax laws of Ethiopia regarding taxation of foreign company,
and pointing to possible ways of improvements are the expected objectives of the study.

1.4 Methods

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This research has doctrinal features. It is doctrinal in that it examines the rules of taxation of
non-resident companies as provided under the Ethiopian income tax law, identifies its
shortcomings and explores opportunities for proper regulation. To this end, it employed doctrinal
legal research method to investigate the pertinent provision of income tax law.

CHAPTER TWO

TAXATION OF FOREIGN COMPANIES INCOME UNDER ETHIOPIAN TAX LAW

2.1 Introduction

Multinational Companies(MNCs here in after) are established to engage in business activities

thereby generating income (profit) which is subject to tax unless relieved otherwise. When
companies become multinational with head office in one jurisdiction while having subsidiaries,
associates, or branches in other parts of the world, their source of income is not restricted to only
their country of incorporation but also other country in which they operate which brought the
issue of tax rules on their income sourced in foreign countries. This issue of taxation of foreign
companies’ income concerns have been addressed at the national level by each state (unilateral
measures), and internationally through bilateral treaty means, as well as multilateral measures.
Internationally, numerous tax model treaties have also been signed between the countries to
make sure that incomes generated by those companies in foreign country are not subjected to tax
twice. However, such tax treaties, themselves does not provide all rules. Countries Provides rules
of taxation in their domestic laws. This paper will try to discuss the rules of taxing foreign
companies’ income in Ethiopia tax law with general highlight to the concept of taxation of
companies’ income and its treatment under international tax law.

2.2 The Taxation of Corporate/Companies Income defined

Defining the concept of taxing companies’ income will take us to defining the concept of
corporate taxation in general. A corporate tax, also called corporation tax or company tax, is a
type of direct tax levied on the income or capital of corporations and other similar legal entities2.
It is a tax imposed on the net profit of a corporation that is taxed at the entity level in a particular

2 https://en.wikipedia.org/wiki/Corporate_tax).

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jurisdiction3. Net profit for corporate tax is generally the financial statement net profit with
modifications, and may be defined in great detail within each country's tax system4.

Many countries have tax laws that require corporations to pay taxes on their worldwide income,
regardless of where the income is earned5. However, some countries have territorial tax systems,
which only require corporations to pay taxes on income earned within the country's borders6.

Corporations may also be subject to withholding tax obligations upon making certain varieties of
payments to others7. These obligations are generally not the tax of the corporation, but the
system may impose penalties on the corporation or its officers or employees for failing to
withhold and pay over such taxes8. A company has been defined as a juristic person having an
independent and separate existence from its shareholders9. Income of the company is computed
and assessed separately in the hands of the company 10. In certain cases, distributions from the
company to its shareholders as dividends are taxed as income to the shareholders11

2.3 The Rules of Taxation of Foreign Company Income in General

All nations of the world currently assert their jurisdiction to tax income that is sourced in their
territories. However, for a state to assert its power of taxation over the tax payer, it has to
establish the legal relationship between itself and the taxpayer which could be personal or
objective. This question of the nexus between taxing state and taxpayer is particularly relevant in
the context of international taxation which could, potentially, bring two or more states on board.
The connecting factors to exercise taxing power are created either on the relationship of the
income (tax object) to the taxing state, commonly known as the source principle, or the
relationship of the taxpayer (tax subject) to the taxing state based on residence or nationality12.

2.3.1 Residence Principle

3 ibid
4 Ibid
5 Ibid
6Ibid
7 Ibid
8 Ibid
9 Ibid
10 Ibid
11 Ibid
12 Tibebe Zewdu, Business Income Taxaton of Foreign Owned Constructon Enttes in Ethiopia: Gaps in the
Internatonal Tax Laws of Ethiopia and their Enforcement in Practce, 2017, p.14

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The concept of residence as a nexus for taxation originated in the context of natural person vis-a-
vis state and its application in the context of multinational corporations could lead to some
difficulties. However, it is ascertained that almost all states in the world use the residence nexus
to tax juridical persons too and hence MNCs. To determine the residence of companies or legal
entities various connecting factors are applied. The most common determinants are the place of
incorporation or legal seat, and/or the location of management or real seat 13. In this regard, tax
residence based on the statutory seat is almost obvious, but there exist different perceptions and
legal definitions for the location of management or real seat14. Management can signify either the
central management and control (which is the ultimate level of policy decision-making or
supervision) or operational management (which denotes the day-to-day management or effective
management) of the business15. Countries apply either of the dimensions of management16.

2.3.2. Source Principle

The other major nexus for exercising taxing right is the source of income. Unlike the residence
nexus that somehow establishes personal attachment; the source principle establishes economic
attachment. It deals with where certain taxable income is generated rather than where the
taxpayer resides. Generally, source-based taxation is justified because the state has invested in
creating economic opportunities for these MNCs for them to make those profits. Therefore, it is
fair for the source state to exercise a taxing right over the income generated by such company
using the resources availed to it.

In determining the income tax jurisdiction the source rule identifies the place where the income
arises (source of income) and the country which has a tax right over it 17. That is based on the
ability to identify income and its recipient, quantify it, and enforce its taxing rights18.

The source rule applies in determining the income tax jurisdiction of business income of non-
resident companies through association with the permanent establishment under the model
Convention of UN and OECD rules.

13 Richard J. Vann, supra 33, p.696; Roy Rohatgi, supra 31, p.200-209
14 Tewachew Molla Alem and Yibekal Tadesse Abate, Examining the Income Tax Jurisdicton Rules of the Federal
Income Tax Law of Ethiopia vis-a-vis the Doctrines of Income Taxaton Power of States, 2022
15 Supra note 13
16 Ibid
17 Roy Rohatgi, supra 31, p.222.
18 Ibid

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Source of income is usually determined for tax purposes on factors such as the location of the
assets and the activities that generated the income19. In determining source this way, business
(active) income is usually differentiated from investment (passive) income and net basis taxation
is applied to the former (i.e. deductions are allowed to be made to reach at taxable income) while
gross basis taxation is applied to the latter by a withholding tax mechanism 20. In order to tax
active or business income of foreign company, the activity has to have a permanent
establishment in that country.

2.3.2.1. Taxation of Business Income of Foreign Companies through Permanent

Establishment

It is internationally agreed principle that tax on profits of multinational companies in non-foreign

country should be based on the permanent establishment rule. The income tax jurisdiction over
business income of non-resident enterprise is determined through the rule of permanent
establishment21. The permanent establishment is the concept to refer to active business operation
in a given country and giving the source country the primary right to tax the profits from that
operation of non-resident company22. Its existence in the form for instance, an office or a branch
gives the country in which the business entity is situated (the source country) the right to tax its
income, notwithstanding the fact that the PE has no separate legal existence 23. The existence of a
permanent establishment is a requirement for a country to tax non-resident's business profits
derived from sources in that jurisdiction24. Both the OECD and UN Model Conventions provide
that, a source country should tax profits derived by a foreign business if and only if the enterprise
maintains a PE and only to the extent that the profits are attributable to the PE in that country 25.

19 United Natons, Manual for the Negotaton of Bilateral Tax Treates (n 22) 9, para 2
20 Hugh J. Ault and Brian J. Arnold, Comparatve Income Taxaton, A Structural Analysis (Aspen Publishers 2010 3rd
ed) 495
21 The business income of a company refers to an actve income of companies derived from the provision of labor
or business (i.e. actvites. See Tibebe supra note 12
22 UN Model Double Tax Conventon artcles 4, 5, 7; The U.S. Treasury Department United States Model Income
Tax Conventon, Artcles 4, 5, 7 [Hereinafer U.S. Model Treaty]; OECD Model Tax Conventon (2003) [Hereinafer
OECD MTC], Artcles. 4, 5, 7; Reuven S. Avi-Yonah, The Structure of Internatonal Taxaton: A Proposal for
Simplifcaton (1996)74 Texas Law Review pp1301-1307
23 Annet Wanyana Ogutu; Sebo Tladi, E-Commerce: A Critiue on the Determinaton of a Permanent
Establishment for Income Tax Purposes from a South African Perspectve, 20 Stellenbosch L. Rev. (2009)
24 Alemu Balcha Adugna, Major Problems Associated with Rules on Permanent Establishment under Ethiopian
Income Tax Law
25 Ibid

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Thus, defining PE is crucial in determining tax power of certain state over business profit of non-
resident companies.

There is no a universally accepted definition so far in the literature for PE. In international law, a
permanent establishment is defined as “a fixed place of business through which the business of
an enterprise is wholly or partly carried on” 26. The phrase “a fixed place of business…” in the
above general definition is the first test for the existence of a PE which requires there being a
facility such as premises, machinery, equipment or simply a space at a distinct place with a
certain degree of permanence27. Besides, article 5(2), 5(3), 5(4), 5(5) and 5(6) of both the OECD
and UN Model Conventions have provided for the list of activities that constitutes permanent
establishment, list of activities that cannot be deemed to be permanent establishment, conditions
when construction or building project by non-resident constitutes permanent establishment, and
agency permanent establishment, respectively. Two types of a permanent establishment are
contemplated by Article 5 of both OECD and UN Model Tax Conventions 28. The first type of a
permanent establishment is associated with the permanent establishment which is part of the
same enterprise and under common ownership and controls like an office and branch29. The
second type of a permanent establishment is an unassociated permanent establishment. This type
of permanent establishment involves an agent who is legally separate from the enterprise but is
nevertheless dependent on the enterprise to the point of forming a permanent establishment30.

Once, it has been established that a permanent establishment exists; it gives an assurance for
hosting countries that non-resident enterprise is subject to tax within their territory. The profits of
the permanent establishment are calculated based on the arms-length principle 31. Rule of
deduction, net bas taxation is applied to i.e. deductions are allowed to be made to reach at taxable
income32.

It is also provided that a resident business in the source country that is owned or largely
controlled by a non-resident, i.e. a subsidiary, is a subject of international taxation for the foreign

26 paragraph 1 of Artcle 5 of both OECD and UN Model Tax Conventon

27 Supra note 12, p.15
28 Supra note 24
29 Ibid
30 Ibid
31 Supra note 24
32 Supra note 12

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element it holds (i.e. its non-resident parent). In this regard, Article 9 of the OECD Model treaty
entitled “Associated Enterprises” becomes relevant as it applies where “an enterprise of a
Contracting State participates directly or indirectly in the management, control or capital of an
enterprise of the other Contracting State,” i.e., where there is a parent-subsidiary relationship33.

2.3.2.2. Taxation of Investment Income of Companies

Investment (passive) income is that which is derived from the use of assets, and hence highly
mobile, and include capital gains, interest, dividends, rents and royalties 34. They are income not
earned through a PE in the source jurisdiction. Source states generally impose taxation on
dividends, interest and royalties derived from their country by non-resident taxpayers by means
of obliging the payer of the income to withhold tax at a certain percentage from the gross amount
of the payment35. The payer, or withholding agent, is then obliged to transfer the tax withheld to
the appropriate tax authority. No tax return needs to be filed by the taxpayer and the tax withheld
represents a final tax due in that country36.

Generally, under the source rules the active business income follows the place of operations from
which the income or profits arise while passive income is sourced in the country of the payer
unless it is effectively connected with the business activity in the State.

2.3.3 Relief from Double Taxation Rule

When a company expands its business activities to another jurisdiction by establishing a physical
presence there to manage the local market, the company may become liable to pay tax on the
business profits which arise in or are derived from that host (source) jurisdiction 37. Thus, the
same income may be taxed twice, once by the source jurisdiction where the income arose, and
again by the jurisdiction where the entity resides38. This will, at least, lead to the conflict on the
taxing power of the source country and the resident country. To avoid such double taxation took
measures at international level through bilateral treaty means, as well as multilateral measures,

33 Ibid
34 Ibid
35 Jan de Goede, Taxaton of Investment Income and Capital Gains,2013 p.8
36 Ibid
37 WONG, Antonieta Pui-Kwok, A comparatve study of the taxaton of business profts – especially ‘onlineL profts – in
Australia and the Hong Kong Special Administratve Region of the PeopleLs Republic of China, 2008,p.19
38 Ibid

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and at the national level by each state (unilateral measures). At an international level, countries
enter into double tax treaties (‘DTT’) that limit the rights of one of the contracting states to levy
tax in a particular situation39. There are two major standard models used in negotiating double
tax treaties (‘DTT’) – the OECD Model Tax Convention on Income and on Capital (‘OECD
MTC’) and the United Nations Model Double Taxation Convention between Developed and
Developing Countries (‘UN MTC’) both of which include the same compromise between the
country of source and country of residence. They allocate taxing rights over income between the
residence and the source jurisdiction (that are parties to the DTT) and specify what forms of
income are subject to tax and who may tax it40.

The unilateral measures (domestic law measures) to avoid double taxation include a foreign tax
credit, exemption rule or a deduction system. Under a foreign tax credit, a resident taxpayer will
be credited to the extent that he can prove that he has paid for foreign governments on his foreign
source41. The other unilateral means to avoid double taxation is the exemption rule. In this case,
the residence country excludes income derived in another state from the taxable base which
essentially means that its taxing right will be limited to source only 42. It simply excludes foreign
source income (or of a listed type) from the tax base in the residence country 43. A deduction
system proceeds by treating a paid amount of foreign tax as an expense and as such giving a
taxpayer a deduction for the tax paid abroad in the source country in calculating its worldwide
income in the residence country44.

2.4 The Rule of Taxing Foreign Companies Income Tax under Ethiopian Tax Law

The current income tax proclamation of Ethiopia no 979/2016 put its scope of application clearly
under art 7. As per this provision of the law, the income tax proclamation will apply in the two
scenarios. First, the proclamation applies to residents of Ethiopia with respect to their worldwide
income. Secondly, the proclamation applies to non-residents with respect to their Ethiopian

39 Id, p20
40 Ibid
41Andrew Lymer (ed) The Internatonal Taxaton System, Kluwer Academic Publishers, (2002), p. 10
42 Michael Langa, Introducton to the Law of Double Taxaton Conventons, Linde Publishing, (2nd ed. 2013), pp 1-
2
43 Supra note 12, p.19
44 Ibid

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source income. Hence, the income tax jurisdiction of Ethiopia has recognized two bases of
jurisdiction; i.e. the residence and the source jurisdiction.

2.4.1 Residence Rule

The tax laws lists down two standards in order to determine the residence of taxpayers. The first
standard is used to determine residence in case of juridical person while the other is used to
determine the same matter in case of physical persons. Since the aim of this paper is about the
taxation of foreign companies’ income, our discussion focuses only on the residence of legal
(juridical) person.

With regard to the residence of legal entities, the place of incorporation or place of effective
management is applicable rule. That is a resident body or company is that incorporated or formed
in Ethiopia or its place of effective management is in Ethiopia45. It seems that these elements
should be satisfied alternatively. This is because if we require these elements to be satisfied
cumulatively, the purpose of the tax proclamation cannot be met. Legally speaking, the place
where the legal person got its personality is called a place of incorporation. Accordingly, that
entity will be regarded as the resident of the State where the incorporation is hosted.

Although the test of formation or incorporation is fairly easy, the problem arises in the
determination of the place of ‘effective management’. Determining the place of management
would be difficult unless there is a specific rule as to the type of management and the frequency
of management to be held in the country in question. The law does not provide its meaning.
Though the meaning of effective management is not clearly provided in the law, it is said that the
effective management test include a place where the high level management, commercial and
financial decisions necessary for the operation of the business as a whole is taken 46. For example,
in determining the residence of a company, the ‘effective management’ test should be considered
in light of the place of the meeting of its board members, since the management of a company is
made through its board of directors47. Thus, for a body to be considered as Ethiopian resident, the
body should either be incorporated or formed in Ethiopia or it’s the place of its effective
management should be in Ethiopia. Non-resident legal person (company) on the other hand is the
45 Federal Income Tax Proclamaton No. 979/2016 Fed. Neg. Gaz. Extra Ordinary Issue, Year 22, No. 104, Artcle
5(5, 6)
46 Federal Income Tax Proclamaton Technical Notes, 17
47 Ibid

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company who is not resident of Ethiopia48. That means the company which is neither
incorporated nor its’ place of effective management is in Ethiopia.

2.4.2 Source Rule

In a similar fashion with the UN and OECD Model Conventions, the Ethiopian income tax
proclamation has provided permanent establishment as a benchmark in determining when and
how the business profits of the non-resident enterprises sourced in Ethiopia are subjected to tax.
Investment or passive income of non-resident sourced in Ethiopia on the other hand is taxed
through withholding tax system.

2.4.2.1 Taxation of Business Income (Profit) Through Permanent Establishment

Business income of foreign company sourced in Ethiopia is taxed through permanent

establishment. Article 6(3) of the proclamation provides that the business income of non-resident
company sourced in Ethiopia is taxed through PE. This provision extends tax jurisdiction to
foreign firms operating in Ethiopia on the income attributable to operations inside Ethiopia. A
permanent establishment is defined in Article 4(1) of the income tax proclamation as “a fixed
place of business through which the business of an enterprise is wholly or partly carried on’’.
From this article, we can easily understand that the definition given to the term permanent
establishment under the Ethiopian income tax law is similar to that of the OECD and UN Model
Conventions. This article states the basic notion of a permanent establishment, namely a fixed
place of business through which the business of a person is conducted. This means that there
must be: (i) a place of business; (ii) the place of business must be fixed (i.e. have a degree of
permanency); and (iii) a business activity must be conducted through the place of business (for
example, it cannot just be a vacant office). The requirement, therefore, is that a place of business
must be established. There is no time limit for a place of business to constitute a permanent
establishment, although the 183-day time period in sub-articles (2)(c) and (3) may provide some
guidance on this to avoid very short-term operations from being a permanent establishment 49.
Besides, article 4(2) of the proclamation provides for a list of activities that constitutes
permanent establishment while article 4(3) provides for when construction or building project by
nonresident enterprises constitutes a permanent establishment. Furthermore, Article 4(4) and 4(5)
48 Proc.No.979/2016, Artcle 5(7)
49 Federal Income Tax Proclamaton Technical Notes, p.34

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of the proclamations have provided for agency permanent establishment. From the
aforementioned facts, we can easily understand that both associated and unassociated types of
the permanent establishment are recognized under article 4(2), and article 4(4) (5) of income tax
proclamation number 979/2016, respectively50. The income tax regulation of Ethiopia has also
provided some issues on PE.

Under the current income tax law of Ethiopia, the PE rule is relevant in determining whether
income is Ethiopian source income (Article 6), the taxation of certain payments made to non-
residents (Article 51), the transfer pricing rules (Article 79), the withholding of tax (including
self-withholding) from certain payments (Articles 89, 90, and 93).

With regard to determining whether income is Ethiopian sourced income, article 6 of the income
tax proclamation provides the conditions in which the active business income to source in
Ethiopia. Accordingly, business income of a non-resident (foreign) company is
considered Ethiopian-source income to the extent that it is attributable to:

 business conducted by the non-resident through a PE in Ethiopia

 disposals in Ethiopia by the non-resident of goods of same or similar
kind as those disposed by the non-resident through a PE in Ethiopia, or
 any other business activity conducted by the non-resident through a PE
in Ethiopia.(Tax on Corporate income)

However, the way current income tax law of Ethiopia defined PE has its own shortcoming. One
is absence of definition for the elements of a permanent establishment. Though Ethiopian income
tax proclamation has defined permanent establishment as a fixed place of business through
which business of person is wholly or partially carried on, it does not provide for what
constitutes fixed, place of business and condition for determining whether the business is carried
on through place of business or not. The second absentee is a provision that would specifically
list those activities not deemed to constitute a PE (i.e. auxiliary activities).This could have been
helpful for avoiding unnecessary quarrel between taxpayers and the tax authority over the

50 Alemu Balcha Adugna, Major Problems Associated with Rules on Permanent Establishment under Ethiopian
Income Tax Law,p.4

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treatment of some activities as PEs51. The reason why the proclamation avoided such a provision
is not clear especially when witnessing that it used to appear in its predecessor, the repealed
Income Tax Proclamation52. Moreover, the law does not provides that a parent-subsidiary
relationship does not constitute a PE in itself, as the UN and OECD Models do and as used to
appear in the FITP’s predecessor53. In the absence of such a provision, there remains a chance for
a subsidiary to be mistakenly taken as a PE of its parent without it engaging in activities that
would make it fall in the normal definition given for a PE54. This is because differentiating
between a subsidiary and a PE is not as easy as suggested and the problem has also actually
happened in practice55. Furthermore, such differentiation is crucial because the effects in taxation
of income derived from the two entities are very much different. One consequence is the fact that
a limited force of attraction rule is applied when a foreign enterprise engages in a business
activity through a PE in Ethiopia, while that does not apply in case of a subsidiary. This brings a
more burdensome tax liability to a foreign enterprise engaged in a business through a PE as the
income from the provision of the same or similar goods and services by it will be attributed to
the PE even if not directly made by the latter56.

The current income tax proclamation is also not clear as to whether permanent establishment
may be created via E-Commerce or not, and how the taxation of business profits that are
attributed to E-Commerce ought to be regulated. Among the elements of the definition of a
permanent establishment, a place of the business test requires some physical existence in the
source country. Accordingly, since the website is not a tangible object, it cannot be a place of
business. Besides, the concept of "fixed place" in Permanent establishment is difficult to apply in
E-Commerce as companies located anywhere can conduct business everywhere 57. Hence, it is
quite difficult to apply the notion of a permanent establishment in the case of E-Commerce, and
it can be argue that the definition of permanent establishment as envisaged under the income tax
proclamation of Ethiopia did not extend to E-Commerce. Furthermore, absence of any

51 Supra note 12, p.36

52 Income Tax Proc. No. 286/2002, Artcle 2(9)(b)
53 UN, Model Tax Conventon of 2011, Artcle 5(8); OECD, Model Tax Conventon of 2014, Artcle 5(7); and Artcle
2(9)(e) of the previous Income Tax Proc. No. 286/2002
54 Supra note 12, Tibebe, p.37
55 Ibid
56 Ibid
57 Rifat A., E-Commerce Taxaton and Cyberspace Law: The Integratve Adaptaton Model, Virginia Journal of Law
&Technology, Vol. 12, No. 5, (2007), P. 9.

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clarification concerning a place of management and effective place of management, which is
provided as a requirement for determining whether a foreign enterprise has a permanent
establishment or a resident respectively are other problems of Ethiopian income tax law. As
provided under article 4(2) (a) of proclamation number 979/16, ‟place of management’’ is one
element to determine whether the non-resident enterprise has a permanent establishment status or
not.114 At the same time, article 5(5) (b) of the same proclamation provides an “effective place
of management” as a requirement in determining whether a certain body is resident or not. Here,
it is difficult to put a line of demarcation between the place of management and effective place of
management which in turn creates controversy in determining whether a foreign enterprise is
resident enterprise or just operating through a permanent establishment.

2.4.2.2 Taxation of Investment (Passive) Income of Foreign Company

Non-residents without a permanent establishment in Ethiopia are taxed through a withholding

scheme. When a non-resident person without permanent establishment derives income in
Ethiopia the tax shall be paid by the payer of the income58. This is the case with regard to passive
income derived if the payer is in the country of Ethiopia, it is Ethiopian source income. Passive
income which is effectively connected with business activity in Ethiopia is an Ethiopian source
of income59. Accordingly, under the FITP, interest, a royalty, management fee, technical fee, or
other income is subject to tax via withholding schemes. As regulated under Art 6 of the ITP,
non-residents without permanent establishment are required to pay tax on the interest, a royalty,
management fee, technical fee, or other income if the following pivots have occurred
cumulatively. First, if the income is paid to the person by a resident or nonresident with the
permanent establishment for its business operating in Ethiopia; and secondly, if the income, paid
to the non-resident person, is regarded as expenditure of the payer in relation to its business in
Ethiopia60. They are taxed according to schedule D tax payer category, and the hubs for tax
jurisdiction are diverse depending on the type of income

2.4.3 Relief from Double Taxation under Ethiopian Tax Rule

58 Proc.No.979/2016, Artcles 6, 51
59 Supra note 14, p.11
60 Proc.No.979/2016, Artcles 6, 51

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Among the three methods of relieving double taxation, the Ethiopian tax law recognizes the
foreign tax credit (FTC) method as provided under Article 45 of the income tax proclamation.
Unlike other jurisdictions, it is not clear whether the deduction and exemption methods are given
a residual place in Ethiopian tax law for relieving other types of foreign taxes paid which are not
deemed “income tax” under the provision, as the FTC applies only for “income taxes” paid
abroad61. But it should be noted that the payment of taxes other than income tax or recoverable
value added tax in a foreign country is not listed as a non-deductible expense unlike the latter
two in Article 27(1)(h) of the FITP, thus leaving the door open for its deductibility.

In addition, the FTC rule in the income tax proclamation does not have a provision covering the
issue of multiple foreign taxes paid in different countries, unlike its predecessor, which used to
incorporate a “per country limitation” rule 62. The absence of such rule may defeat the limited
crediting rule in Article 45(1) by enabling taxpayers to credit excess foreign taxes (i.e. greater
than the Ethiopian tax payable on the foreign income) by averaging them with another foreign
tax which is lesser than the Ethiopian tax payable in respect of the foreign income 63. Or it may at
least create a ground for disagreement between taxpayers and the tax authority64.

Business losses incurred in a foreign country are also allowed to be deductible in the FITP, but
only against foreign income, by carrying the losses forward up to 5 years 65.Here too, there is no
provision, unlike the FITP’s predecessor, that makes it clear as to whether such foreign loss is to
be treated with a “per country limitation” rule 66. That is, the prohibition placed by Article 46(1)
(especially the Amharic version) is only against deducting foreign losses against Ethiopian
source income, and not against foreign income from another, third, foreign country 67. This is
another gap in the Federal Income Tax law of Ethiopia which might breed uncertainty in the tax
administration and become a source for disagreement between the tax authority and taxpayers.

61 See the defniton given for “foreign income tax” in Federal Income Tax Proclamaton No. 979/2016, Artcle
45(6)(b)
62 Supra note 12, P.30
63 Ibid
64 Ibid
65 Federal Income Tax Proclamaton No. 979/2016, Artcle 46(1 - 3)
66 Supra note 12. P.30
67 Ibid

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 CHAPTER THREE

CONCLUIONS AND RECOMMENDATIONS

3.1 Conclusions

The taxing jurisdiction of a State stands on a legally relevant connecting factor or nexus between
the State and the tax subject (the taxpayer) or the taxable event (the tax object), which links the
subject or object to that particular fiscal jurisdiction. These connections, which are contained in
the international the UN and OECD Model Conventions, include factors such as the tax
residence of the taxpayer referred to as residence rule and the source of income referred to as
source principle.

With regard to taxation of foreign company as indicated under UN and OECD Model tax treaties
the permanent establishment principle is decisive in determining a non-resident enterprise's tax
obligation due to business activities with economic allegiance to more than one country– through
a branch office, representative, project office or even the simple signing of a contract.
Accordingly, existence of PE entitled a country to exercise taxing jurisdiction over business
income of non-resident company income sourced in its jurisdiction.

In a similar fashion with the UN and OECD Model Conventions, the Ethiopian income tax
proclamation has provided permanent establishment as a benchmark in determining when and
how the business profits of the non-resident enterprises sourced in Ethiopia are subjected to tax.
The Ethiopian income tax proclamation has defined permanent establishment as a fixed place of
business through which the business of a person is wholly or partially carried on. Non-resident
companies are required to pay tax under the schedule of business income if and only if they have
generated income through a permanent establishment. Yet, it has various problems. Though
Ethiopian income tax proclamation has defined permanent establishment as a fixed place of
business through which business of person is wholly or partially carried on, it does not provide
for what constitutes fixed, place of business and condition for determining whether the business
is carried on through place of business or not. Besides, its failures to define elements of the
permanent establishment, absence of clarification in relation to the place of management and
effective place of management that are provided as requirements for determining permanent

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establishment, and conditions for determining whether a certain body is resident or not,
respectively, are among the major problems of the Ethiopian tax system in relation to the
permanent establishment. Complete absence of rules on permanent establishment in relation to
E-Commerce, absence of a list of activities that cannot constitute PE, lack of clarity with respect
to double taxation rule are also the main problems of the Ethiopian tax system.

3.2 RECOMMENDATIONS

1. The Ethiopian income tax proclamation should incorporate the definition for the controversial
elements of permanent establishment.

2. Since the traditional concepts contained in the definition of a permanent establishment are
inadequate to deal with the ever-increasing growth of E-Commerce in the digital era; the rules
governing the taxation of E Commerce should be added under Article 4 of the Federal Income
Tax Proclamation No.979/2016.

3.The issues of “place of management’’ under 4(2) (a) of proclamation number 979/16, and
“effective place of management’’ under article 5(5) (b) of the same proclamation should be
clarified as it creates controversy in determining whether a foreign enterprise is resident
enterprise or just operating through a permanent establishment.

4. It is better if a list of activities that cannot constitute PE is added to article 4 of the income tax
proclamation. Moreover, it would have also been better if there was a sub-article in Article 4 of
the FITP providing that a parent-subsidiary relationship does not constitute a PE in itself, as the
UN and OECD Models do and as used to appear in the FITP’s predecessor.

5. The tax law has to be also made clear with respect to double taxation rule in line with
international standards.

Bibliographies

Legislations

1.Income Tax Proclamation, 2002, Proc. No. 286, Neg. Gaz., year 8, no. 34 [Repealed]

2.Federal Income Tax Proclamation, 2016, Proc. No. 979, Neg. Gaz., year 22, no. 104

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3.Federal Tax Administration Proclamation, 2016, Proc. No. 983, Neg. Gaz., year 22, No. 103

Articles

1. Tibebe Zewdu, Business Income Taxation of Foreign Owned Construction Entities in

Ethiopia: Gaps in the International Tax Laws of Ethiopia and their Enforcement in Practice,
2017, p.14(12)
2. A Technical Notes on the Income-tax proclamation No. 979/2016, 2016
3. Rifat A., E-Commerce Taxation and Cyberspace Law: The Integrative Adaptation Model,
Virginia Journal of Law &Technology, Vol. 12, No. 5, (2007), P. 9.(57)
4. Tewachew Molla Alem and Yibekal Tadesse Abate, Examining the Income Tax Jurisdiction
Rules of the Federal Income Tax Law of Ethiopia vis-a-vis the Doctrines of Income Taxation
Power of States: Jimma University Journal of Law (JUJL) Volume 14, (December, 2022)
2022(14)
5. Alemu Balcha Adugna, Major Problems Associated with Rules on Permanent Establishment
under Ethiopian Income Tax Law(24)

Books

1. Richard J. Vann, supra 33, p.696; Roy Rohatgi, supra 31, p.200-209(13)
2. Hugh J. Ault and Brian J. Arnold, Comparative Income Taxation, A Structural Analysis
(Aspen Publishers 2010 3rd ed) 495(20)
3. Annet Wanyana Oguttu; Sebo Tladi, E-Commerce: A Critique on the Determination of a
Permanent Establishment for Income Tax Purposes from a South African Perspective, 20
Stellenbosch L. Rev. (2009)(23)
4. Jan de Goede, Taxation of Investment Income and Capital Gains,2013 p.8(35)
5. WONG, Antonietta Pui-Kwok, A comparative study of the taxation of business profits –
especially ‘online’ profits – in Australia and the Hong Kong Special Administrative Region of
the People’s Republic of China, 2008,p.19(37)
6. Andrew Lymer (ed) The International Taxation System, Kluwer Academic Publishers, (2002),
p. 10(41)
7. Michael Langa, Introduction to the Law of Double Taxation Conventions, Linde Publishing,
(2nd ed. 2013), pp 1-2(42)

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8. Reuven S. Avi-Yonah, The Structure of International Taxation: A Proposal for Simplification
(1996)74 Texas Law Review pp1301-1307-22
International Instruments and Reports of International Organizations

1. OECD, Model Tax Convention on Income and on Capital 2014 (Full Version), (OECD
Publishing 2015)

2. United Nations, United Nations Model Tax Convention between Developed and Developing
Countries (United Nations 2011)

3. United Nations, Manual for the Negotiation of Bilateral Tax Treaties (n 22) 9, para 2(19)

4. OECD Model Tax Conventon (2003)

Websites

https://en.wikipedia.org/wiki/Corporate_tax).

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