Basic account works Develop understanding of

taxation

Occupational Standard : Accounting and Account Finance Level II

Unit Title Develop Understanding of Taxation
Unit Code
Unit Descriptor This unit describes the performance outcomes, skills and knowledge required
to understand the role of taxation in the Ethiopian economy, including why
and how tax is levied and collected, types of taxes paid by business and
individuals and its impact on investment choices.
Elements Performance Criteria

1. Identify and 1.1. The purpose of taxation in the Ethiopian economy at the local, Regional
discuss the
and Federal level and how this compares with other countries is explored
role of taxation
in the and discussed
Ethiopian
 The purpose of taxation includes but is not limited to:-
economy
 financing government activity,
 maintaining equity in the national economy
 promoting efficiency where markets fail to control pollution or health
dangers, social infrastructure, social services
1.2. The various ways that tax is collected and from who is analyzed and
discussed
 Ways that tax is collected include:-
through regional and federal level taxes including:
 Direct tax
 Tax on Income from Employment / Personal Income Tax
 Business Profit Tax, Tax on Income from Rental of Buildings
 Tax on Interest Income on Deposits
 Dividend Income Tax, Tax on Income from Royalties
 Tax on Income from Games of Chance
 Tax on Gain of Transfer of certain Investment Property
 Tax on Income from Rental of Property
 Rendering of Technical Services outside Ethiopia
 Agricultural Income Tax, Land Use Tax

 Indirect tax
Basic account works Develop understanding of
taxation

 Turnover Tax , Excise Tax, Value Added Tax, Customs Duty

 Stamp duty tax: instruments shall be chargeable with stamp duty
include:
 Memorandum and articles of association of any business
 organization, cooperative or any other form of association;
 Award; Bonds; Warehouse bond;
 Contract and agreements and memoranda;
 Security deeds, Collective agreement; Documents of title to property
 Contract of employment; Notarial acts; Power of attorney;
 Lease, including sub-lease and transfer of similar rights;
1.3. The role of the Ethiopian Revenues and Customs Authority (ERCA) is
identified and discussed
 The Ethiopian Revenues and Customs Authority (ERCA) roles include:-
The Authority shall have the roles to:
 establish and implement modem revenue assessment and collection
system;
 provide, based on rules of transparency and accountability, efficient,
equitable and quality service within the sector; properly enforce
incentives of tax exemptions given to investors and ensure that such
incentives are used for the intended purposes;
 implement awareness .creation programs to promote a culture of
voluntary compliance of taxpayers in the discharge of their tax
obligations;
 Carry out valuation of goods for the purpose of tax assessment and
determine and collect the taxes.
 Conduct study and research activities with greater emphasis to improve
the enforcement of customs and tax laws, regulations and directives and the
collection of other revenues; and based on the result of the study and
research initiate laws and policies and implement the same up an approval.
 collect and analyze information necessary for the control of import and
export goods and the assessment and determination of taxes; compile
 Basic account works Develop understanding of
taxation

statistical data on criminal offences relating to the sector, and

disseminate the information to others as may be necessary;
1.4. What taxation revenue is used for is explained and related to the
wellbeing and lifestyle of Ethiopian citizens
 Taxation revenue may be used to provide:-
 assistance to business and farming, defence and border protection
 cultural and artistic resources and support
 education, environmental protection
 essential infrastructure such as:
 roads, transport systems, public building
 sport and recreation amenities, public housing
 foreign representation and trade promotion for Ethiopia
 health care, justice systems, public safety, scientific and other research
 welfare, income and community support systems
2. Identify and 2.1. Key terminology used in direct taxation is identified and discussed
discuss direct
 Terminology used in taxation may include:-
tax
 interest on deposits, allowances, deductions, Exempt threshold
 assessable income, capital gain/appreciation
 Assessment of Tax, dividends
 gross income, Higher Education Contribution Scheme
 taxable income, Tax Evasion, Withholding tax
2.2. Tax declaration forms, Tax File Number (TFN) requirements and rates of
direct tax are identified and analyzed
 Rates of tax and calculators can be accessed from:-
 Ethiopian Revenues and customs Authority (ERCA) publications and
website, accountants and tax agents
2.3. How direct tax is assessed, tax returns completed and paid is considered
and discussed
 Tax returns can be completed by:-
 Accountant, an individual, tax agent, on-line or in written form
2.4. Sources of ongoing information about direct tax in Ethiopia are identified,
 Basic account works Develop understanding of
taxation

accessed and discussed

 Sources of ongoing information may include:-
 accountants and other financial services professionals
 Ethiopian Revenues and Customs Authority (ERCA)
 Industry associations and professional organisations
 Federal and Regional governments agencies
 Taxpayers
3.1. Key terminology used in indirect taxation is identified and discussed
3. Identify and
3.2. The structure of business and how this affects taxation is analyzed and
discuss
indirect tax discussed
 The structure of the business includes:-
 sole trader: an individual trading on their own
 partnership: an association of people or entities carrying on a business
together, but not as a company
 trust: an entity that holds property or income for the benefit of others
 company: a legal a legal entity separate from its shareholders
3.3. How indirect tax is assessed and paid is considered and discussed
 Tax is assessed through:-
 Business Activity Statements, payroll, allowable deductions, capital gains
 financial adjustments such as:
 write-offs , revaluations, profits and losses
 superannuation payments, fringe benefits assessment
3.4. Sources of ongoing information about indirect tax in Ethiopia are
identified, accessed and discussed
3.1. Key terminology used in stamp duty taxation is identified and discussed
4. Identify and
3.2. How stamp duty tax is assessed and paid is considered and discussed
discuss stamp
duty tax 3.3. Sources of ongoing information about stamp duty tax in Ethiopia are
identified, accessed and discussed
 Basic account works Develop understanding of
taxation

4.1. How tax payers can determine their tax liability is identified and
5. Manage tax discussed
liability  tax payers can determine their tax liability by:-
 assessing income:
 capital gains, employment, foreign, investment, rental property income
 assessing deductions:
 allowable medical expenses and health insurance rebates
 capital losses, dependent rebates, gifts and donations
 rental property expenses, tax offsets
 work related clothing expenses, work related education expenses
 work related travel expenses, zone and overseas forces allowances
 lodging returns and paying governments:
 land tax where applicable
 payroll tax (rate varies by jurisdiction and depends on size of payroll so
many small business operators are exempt)
 stamp duty on:
 hire purchase agreements, insurance policies, property transfer
 leases and mortgages, motor vehicle purchases
4.2. Under or overpayment of tax and its implications is analyzed and
discussed
 Under or overpayment of tax may involve:-
claiming interest on early payments that may be possible for certain tax
categories such as:
 income tax, Higher Education Contribution Scheme
 amended assessments of earlier years
 paying interest on overdue amounts
Basic Account Works Level II

Develop Understanding of Taxation

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

Every government is expected to finance at least three functions;

A. defense of the country
B. maintenance of law and order
C. socio – economic development
Meaning of tax
Tax is a compulsory contribution (levy) payable by an economic unit to a government
without expectation of direct and equivalent return from government for the contribution
made. From this definition, we can understand that tax:-
 Is not a voluntary contribution but a mandatory contribution
 Is contributed by an a economic unit which is also called a tax payer who is liable to
pay tax in accordance with the rules and regulations prescribed by law
 Is contributed without expectation of direct and equivalent return from the
government for the contribution made means no direct relationship between
compulsory contribution and the amount of service received from the government
for the contribution made.
Basic characteristics of taxation
1. Tax is a compulsory contribution
2. Tax is levied only by the government
3. Tax is a legal collection
4. Tax imposes personal obligation
5. Tax is for the common benefit
6. Tax is based on taxable person income, item and /or activity
7. certain taxes have special objectives (such as discouraging consumption of
harmful products, to stabilize an economy)
8. Tax system recognize the rights of tax payer
Lo1. Identify and discuss the role of taxation in the Ethiopian economy
1.1. The purpose of taxation in the Ethiopian economy
The purpose of taxation may include:
 Raising revenue for the government
 Removal of inequalities in income and wealth
 Reduce regional imbalances
 Ensuring economic stability
 To create employment opportunities/minimize unemployment
 Discourage the consumption harmful products
 Basic account works Develop understanding of
taxation

 Encouragement of exports
 To support the functions of the government
1.2. The various ways that tax is collected and from whom is analyzed and discussed
Ways that tax is collected include:
1. Direct tax – if both the impact and incidence fall on the same person, the tax is
considered to be direct tax. It is a tax that cannot be shifted to another person.
Direct taxes include:
 Employment income tax
 Business profit/income tax
 Rental income tax
 Tax on other incomes which includes:
 Tax on income from rental of property
 Tax on interest income on deposits
 Dividend income tax
 Tax on income from royalties
 Tax on gain of transfer of certain investment property
 Tax on Income from Games of Chance
Royalty – a sum of money paid to a patentee for the use of a patent or to an author or
composer for each copy of a book sold. A payment made by a producer of minerals, oil, or
natural gas to the owner.
 Tax on gain of transfer of certain investment property
 Tax on income from games of chances
 Agricultural income tax
 Land use tax
2. Indirect tax – the impact and incidence fall on different persons. The tax is not born by
the person on whom it is levied and can be passed on to others.
Indirect taxes include:
 Turnover tax – is levied by the government on the sales which are not covered under
VAT (value added tax).
 Value Added Tax (VAT) – is levied by the government on the commodities sold at
specified percentage (15%) on the value of sales.
 Basic account works Develop understanding of
taxation

 Excise duty – are levied on the commodities imported & produced in the country.
 Customs duty – includes both import and export duties. These duties are levied
when the goods cross the boundaries of the country.
 Stamp duty tax – a duty levied on the legal recognition of certain documents.
Instruments shall be chargeable with stamp duty include:
 Memorandum and articles of associations of any business (sole proprietorship,
partnership, private limited company (P.L.C) and share company (S.C))
 Contracts and agreements
 Collective agreements – means an agreement relating to conditions of work
concluded in writing between one or more representatives of trade unions and one or
more employers or agents of employer’s organizations.
 Contract of employment – means an agreement formed where a person agrees,
directly or indirectly, to perform, work for a definite or indefinite period in return for
remunerations.
 Document of title to property
 Power of attorney (legal representative) – a legal document giving power of
attorney to someone
 Notorious acts – a person authorized to perform certain legal formalities
1.3. The role of the Ethiopian Revenue and Customs Authority (ERCA)
The authority shall have the roles to:
 Establish and implement modern tax assessment and collection system
 Provide quality and efficient service within the sector
 Properly enforce incentives of tax exemptions given to investors and ensure that such
incentives are used for the intended purposes
 Implement awareness creation programs to promote a culture of voluntary
compliance of taxpayers in the discharge of their tax obligations.
 Carry out valuation of goods for the purpose of tax assessment and determine and
collect the taxes
 Conduct study and research to improve the enforcement of custom and tax laws and
regulations; and implement the same upon approval
 Basic account works Develop understanding of
taxation

 Collect and analyze information necessary for the control of import and export goods
and the assessment and determination of taxes
 Compile statistical data on criminal offences relating to the sector and disseminate
the information to others as may be necessary
1.4. What taxation revenue is used for is explained and related to the well-being and
lifestyle of Ethiopian citizens
Taxation revenue may be used to provide:
 Defense and boarder protection, Education, Environment protection
 Essential infrastructures such as:
 Roads, Transport systems, Public buildings, Sport and recreation, Public housing
 Health care, Justice systems, Public safety, Scientific and other research

LO.2. Identify and discuss direct tax

2.1. Key terminology used in direct taxation is identified and discussed
Terminology used in taxation may include:
 Interest on deposits, Allowances
 Deductions such as:
 Travel expense, Medical cost, Transportation allowance
 Hardship allowance, Depreciation expense, Commission expense
 Promotion expense, Cost of sales, Insurance expense, Interest on loan
 Exempt threshold – income level free from tax
 Capital gain/appreciation - gain of transfer of certain investment property
 Dividends – distribution of profits by corporate bodies to shareholders/owners
 Gross income – the total of all income received by a tax payer before exemptions
deductions.
 Tax evasion – tax concealment
 Withholding tax – a tax required to be withhold
 Taxable income – is the residual amount of income after all allowable deductions
are made from gross income.
2.2. Rates of direct tax are identified and analyzed
Direct taxes include: Personal income tax, Business profit tax
 Basic account works Develop understanding of
taxation

property tax, dividend tax, capital gain tax

Tax rate for personal income tax:
Income level Tax rate Deductions
0 – 600 0% 0
601 -1,650 10 % 60
1,651 -3,200 15 % 142.50
3,201 – 5,250 20 % 302.50
5,251 – 7,800 25 % 565
7,801 – 10,900 30 % 955
>10,900 35 % 1,500
E.g. Solomon earns a gross salary of Br. 4,520. Calculate the income tax.
E.g.2. Ato Tessema gets salary of Br. 8,000 per month. He also gets hardship allowance and
transportation allowance of Br. 800 and 500 respectively. He has worked an overtime of
Br. 1,000 during the month. During the month he felt sick and hospitalized and the
employer paid him medical bills amounting to Br. 600.
Required:
1. gross income
2. taxable income
3. tax amount
Business profit tax
It is a tax imposed on the taxable business income realized from a business activity.
Corporate businesses are required to pay 30% flat rate of business income tax and 10% (on
the dividend amount) dividend tax if a business declares a dividend.
Corporate businesses include:
 Private limited company – is a company whose members are liable only to the extent
of their contributions. A private limited company shall not have less than two or
more than fifty members and is always commercial in any form. The capital of a
private limited company shall not be less than 15,000 Br.
 Share company - is a company whose capital is fixed and divided into shares and
whose liabilities are met only by the assets of the company and the members shall be
liable only to the extent of their shares holdings.
 Basic account works Develop understanding of
taxation

Deductible expenses:
 the direct cost of manufacturing, purchasing, and importations
 general and administrative expenses, promotion expense
 premiums payable on insurance, commission expense, interest on loan
 depreciation expense
Profit and loss statement
A profit and loss statement helps to determine whether a business is operating at a profit or
a loss for a given time period.
Five basic steps to calculate the profit and loss statement:
1. sales – including sales for cash or credit
2. Cost of sales – the price paid by the business for merchandise sold.
3. Gross profit – calculated by subtracting the costs of sales from sales.
4. Expenses – this include labor costs and other costs of operating the business.
5. Net profit before tax – is the amount remaining when the expenses are deducted
from the gross profit?
6. Net profit after tax – the amount remaining when the tax amount to be paid is
deducted from the net income /net profit before tax.
Illustration
ABC P.L.C manufacturing company imported raw material by birr 900,000 and additional
purchase local materials for birr 500,000 before Vat for production of X product. The
company is charged local customs duty of birr 50,000 and paid to tax authority. The
company sales were 4,000 products at birr 650 each before Vat, including 2% sales
commission. Total administration expenses of the company show birr 460,000 and withhold
birr 15,000 of employment income tax.
Required
1. Calculate net profit
2. Calculate direct and indirect tax
For unincorporated or individual businesses, the income tax ranges from 10% - 35%.
Unincorporated business includes:
 sole proprietorship – a business owned by a single owner
 partnership - a business formed by an agreement of two or more persons
 Basic account works Develop understanding of
taxation

Unincorporated or individual businesses are taxed in accordance with the following schedule:
Income Business income tax Deductions
(per year) rate
0 -7,200 0% 0
7,201 – 19,800 10 % 720
19,801 – 38,400 15 % 1,710
38,401 – 63,000 20 % 3,630
63,001 – 93,600 25 % 6,780
93,601 – 130,800 30 % 11,460
>130,800 35 % 18,000
E.g. Kaleab enterprise, unincorporated business has reported a taxable income of Br. 60,000
of the tax year ending Sene 30, 2008.
Required: Determine the amount of business income tax.
Rental income tax
Rental income tax is a tax imposed on the income from rental of buildings.
Tax rate
The tax payable on rented houses shall be charged, levied and collected at the following
rates:
a) On income of bodies (P.L.C and S.C) thirty percent (30%) of taxable income.
b) On income of persons according to the following schedule.
Income Business income tax
Deductions
(per year) rate
0 -7,200 0% 0
7,201 – 19,800 10 % 720
19,801 – 38,400 15 % 1,710
38,401 – 63,000 20 % 3,630
63,001 – 93,600 25 % 6,780
93,601 – 130,800 30 % 11,460
>130,800 35 % 18,000

c) Sub-renting shall pay the tax on the difference between income from sub-renting and
the rent paid to the renter.
 Basic account works Develop understanding of
taxation

d) The following amounts shall be deducted from income in computing taxable income
 Taxes paid with respect to the land and buildings being rented, except income
taxes
 For tax payers not maintaining books of accounts, fifty percent (50%) of the
gross income received as rent for buildings furniture as an allowance for
repairs, maintenance and depreciation of such buildings, furniture and
equipment.
 For tax payers maintaining books of account, the expenses incurred in earning,
securing and maintaining rental income, to the extent that the expense can be
proven by the taxpayer; deductible expenses include the cost of rent of land,
repairs, maintenance, and depreciation of buildings, furniture and equipment
as well as interest on bank loans, insurance premiums, land use fees.
Illustration
Ato Markos, the owner of AZ building, constructed at Br. 5,000,000 and furnished with
furniture and equipment, which costs Br. 500,000. He rented the building with all its
furniture and equipment to W/ro Muluwork, for Br. 540,000 per year. She has also rented it
to Omega primary school for Br. 50,000 per month for one year.
Required:
1. The amount of annual rental income tax expected from Ato Markos and W/ro
Muluwork assuming both of them do not maintaining books of account.
2. The amount of annual rental income tax expected from Ato Markos assuming he
maintained books of account and report the following expenses in relation to
building and equipment.
 Land and building ownership fee (property tax) of Br. 5,000
 Annual depreciation expense for building Br. 250,000
 Annual depreciation expense for furniture and equipment Br. 100,000
Other income taxes
In addition to employment income tax, business profit tax, and rental income, tax authority
levied other tax on the following type of income.
A. Royalties
 Basic account works Develop understanding of
taxation

It is a payment of any kind received as a consideration for the use of or right to use, any
copyright of literary artistic or scientific work, including cinematography films, and films or
tapes for radio or television broadcasting, any patent, trademark, design or model, secret
formula or process.
Royalties shall be liable to tax at a flat rate of five percent (5%).
B. Tax on income from games
Every person deriving income from winning at games of chance (for example lotteries,
tombola, and other similar activities) shall be subject to tax at rate of fifteen percent (15%),
except for winnings of less than 1000 Br.
C. Tax on dividend
Every person deriving income from dividends from a share company or withdrawals of
profit from a private limited company shall be subject to tax rate of ten percent (10%).
D. Tax on interest income of deposits
Every person deriving income from interest on deposits shall pay tax at the rate of five
percent (5%).In any other case, 10% of the gross amount of the interest.
E. Capital gains tax (tax on gain at transfer of certain investment property)
Income tax shall be payable on gains obtained from the transfer (sale or gift) of property at
the following rates:
I. Building held for business, factory office 15% (fifteen percent)
II. Share of companies 30% (thirty percent)
Gains obtained from the transfer of building held for residence for 2 years before the
disposal of the asset shall be exempt.
F. Income from casual rentals
A person who derives income from the casual rental of asset in Ethiopia (including any
land, building, or movable asset) shall be liable for income tax at the rate of 15%.

II.3. How direct tax is assessed, tax returns completed and paid is considered and discussed

Tax returns can be completed by:

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

II.4. Sources of ongoing information about direct tax in Ethiopia are identified, accessed and
discussed
 Basic account works Develop understanding of
taxation

Sources of ongoing information may include:

 accountants and other financial services professionals
 Ethiopian Revenues and Customs Authority (ERCA)
 Industry associations and professional organisations
 Federal and Regional governments’ agencies. Taxpayers

LO.3. Identify and discuss indirect tax

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

1. Turnover tax – is levied by the government on the sales which are not covered under
VAT (value added tax).
The base of computation of the turnover tax is the gross receipts in respect of goods
supplied or services rendered.

Tax rate
 2% (two percent) on goods sold locally
 for services rendered locally
a) 2% on contractors, grain mills, tractors and combine-harvesters
b) 10% on others
2. Value Added Tax (VAT) – is levied by the government on the commodities sold at
specified percentage (15%) on the value of sales.
The following are some of the terms that are common in VAT.
 Input VAT – the VAT that your business pays over on taxable supplies made (VAT
paid on purchase) and can be recovered only insofar as your business is VAT-
registered.
 Output VAT – the VAT that your business collects over taxable supplies (VAT paid
on sales)
 VAT payable – this is the net VAT to be paid to ERCA by a taxable person.
VAT payable = output VAT – INPUT vat
 VAT refundable – the net VAT that is a taxable person expected from ERCA when
input VAT exceeds output VAT.
 Basic account works Develop understanding of
taxation

 Zero-rating – the supply is charged with VAT at 0% but credit can be taken for VAT
paid on purchases used to make supply.
 Exemptions – the supply is exempted from VAT. No VAT is charged on supply and
no credit can be taken for VAT paid on purchases used to make the supply.
3. Excise duty – are levied on the commodities produced in the country.
The base of computation of excise tax is the cost of production for goods produced
locally; whereas for goods imported the base of computation would be the cost of
importation, insurance and freight cost (CIF).
The excise tax rate range from 10% to textile and textile products to 100% for other
alcohol drinks, perfume and motor vehicles above 1800 c.c.
E.g. KK textile factory produced 1,500 tons of printed bed sheet in meskerem1, 2009. The
unit cost of production for a ton of printed bed sheet is as follows:
Direct labor Br. 4000
Raw material 5,500
Cost of indirect inputs 1,500
Overhead costs 500
Required:
a) Unit base of excise tax (unit cost of production per ton for tax purpose)
b) Total amount of excise tax
4. Customs duty – includes both import and export duties. These duties are levied
when the goods cross the boundaries of the country.
5. Stamp duty tax – a duty levied on the legal recognition of certain documents.
When the value of the right or obligation executed by means of an instrument can be
determined, the rate chargeable on such instrument shall be the percentage of such value.
e.g. register title to property ------------ 2% (on value)
when the value of the right or obligation executed by means of an instrument cannot be
determined, the amount chargeable on such instrument is the fixed amount specified for
each such instrument.
e.g. power of attorney ---------------- Br. 35 (flat)

3.2. The structure of business and how this affects taxation are analyzed and discussed
 Basic account works Develop understanding of
taxation

The structure of business includes:

 sole trader: an individual trading on their own
 partnership: an association of people or entities carrying on a business together, but
not as a company
 Private limited company – is a company whose members are liable only to the extent
of their contributions. A private limited company shall not have less than two or
more than fifty members and is always commercial in any form. The capital of a
private limited company shall not be less than 15,000 Br.
 trust: an entity that holds property or income for the benefit of others
 company: a legal a legal entity separates from its shareholders

3.3. How indirect tax is assessed and paid is considered and discussed

Tax is assessed through:

 Business Activity Statements , payroll, allowable deductions, capital gains
 financial adjustments such as:
 write-offs, revaluations, profits and losses, superannuation payments
 fringe benefits assessment

3.4. Sources of ongoing information about indirect tax in Ethiopia are identified, accessed
and discussed
LO.4. Identify and discuss stamp duty tax

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

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

4.3. Sources of ongoing information about stamp duty tax in Ethiopia are identified,
accessed and discussed
LO.5. Manage tax liability

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

Tax payers can determine their tax liability by:

 assessing income:
 capital gains, employment, foreign , investment
 Basic account works Develop understanding of
taxation

 rental property income

 assessing deductions:
 allowable medical expenses and health insurance rebates
 capital losses, dependent rebates, gifts and donations
 rental property expenses, tax offsets
 work related clothing expenses
 work related education expenses
 work related travel expenses
 zone and overseas forces allowances
 lodging returns and paying governments:
 land tax where applicable
 payroll tax (rate varies by jurisdiction and depends on size of payroll so many
small business operators are exempt)
 stamp duty on:
 hire purchase agreements
 insurance polices
 leases and mortgages
 motor vehicle purchases
 property transfer

5.2. Under or overpayment of tax and its implications are analyzed and discussed
Under or overpayment of tax may involve:
 claiming interest on early payments that may be possible for certain tax categories
such as:
 income tax
 Higher Education Contribution Scheme
 amended assessments of earlier years
 paying interest on overdue amounts