VAT and Banks

To Tax or Not To Tax: Is that Really the Question?
VAT, Bank
Foreclosure Sales, and the Scope of Exemptions for Financial
Services in Ethiopia
Taddese Lencho∗
To tax and to please, no more than to love and to be wise, is not given to men
Edmund Burke
Abstract
The Ethiopian Value Added Tax of 2002 follows the standard approach of exempting financial
services from VAT. Not all ‘financial services’ are, however, exempted from VAT. A number of
services provided by the financial institutions are made taxable by the VAT laws of Ethiopia –raising
nagging questions about the scope of exempted ‘financial services’ vis-à-vis those of taxable ‘financial
services’. No subject in this regard has probably attracted as much attention and controversy as that
of sale by foreclosure of property held as security by banks. Both sides (i.e., members of the financial
industry and the tax authorities) seemed locked in their conviction over the treatment of foreclosure
sales in VAT. Members of the financial industry (in particular banks) are convinced that foreclosure
sales enjoy the privilege of exemption in VAT while some in the Tax Authorities are equally
convinced that foreclosure sales should be chargeable with VAT. These controversies have played
out in the courtrooms, the press and a number of communications between the Tax Authorities and
the members of the financial industry. This article investigates these controversies and analyzes the
scope of exemptions for financial institutions under Ethiopian VAT laws.
Key words:
VAT, exemptions, zero-rating, foreclosure sales, financial services, taxable transactions,
taxable activity
Introduction
Ethiopia joined what is now a large chorus of nations in the world by introducing the
value added tax (VAT) in 2002 (effective January 2003). 1 The VAT laws of 2002 replaced
∗
Addis Ababa University, LL.B (AAU), LL.M (University of Michigan Law School, Ann Arbor), PhD
candidate (University of Alabama Law School, Tuscaloosa); I am grateful to members of the informal
colloquium (Seyoum Yohannes and Yazachew Belew) for their comments on the earlier drafts of this article. I
am also grateful to the DLA Piper Foundation for providing me with funds for research on the Ethiopian tax
system in general.
1
The value added tax has become one of the most remarkable fiscal phenomena of the modern times. All but
one (i.e., the USA) of the industrial nations have adopted the VAT as one major source of government
revenue, and more than 150 nations have now adopted VAT as their favorite indirect tax. In Africa, Ethiopia
was the 36th African nation to catch the VAT-bug; see Alan Schenk and Oliver Oldman, Value Added Tax: A
1
the then general sales tax law (in force since 1993), which was a single-stage sale tax whose
application was limited to manufacturers or producers and/or importers.2 The VAT which
replaced this tax is a multiple-stage sales tax with the ability to reach all levels of economic
distribution (manufacture, wholesale and retail). Although VAT has the potential to reach
all levels of economic distribution, the reach of VAT in Ethiopia was limited for
administrative reasons to those businesses whose annual volume of trade exceeded half a
million Ethiopian Birr (ETB). For those businesses whose annual volume of trade did not
reach the half – a – million ETB, another tax was introduced along with the VAT, namely
the turnover tax. 3 The novelty as well as structural complexity of the VAT is such that
small and medium-sized businesses could not be immediately brought within the fold of
the VAT system.
Although VAT is generally recognized as a broad-based general sales tax, the VAT laws of
Ethiopia issued in 2002 (the Proclamation and Regulations) came out with a fairly long list
of exemptions for certain transactions in goods and services. The public policies (to the
extent public policies could be inferred from the laws) that produced the exemptions vary
from one exemption to another. We may, however, generalize the policies into two.
There are, on the one hand, lists of exemptions which seem to be motivated by the desire
on the part of the government to encourage consumption of certain goods and services.
Many of the exemptions fall in this category. The social policy of the government to
encourage consumption drives the exemption for merit goods like education, health and
medical services, as well as those for books and transportation.
There are also exemptions in VAT which are not really motivated by the desire of the
government to encourage consumption. Certain types of transactions in goods and services
have proved difficult for conventional VATs to apply because of the technical challenges
involved in levying VAT on these transactions. In this category of exemptions, we place the
Comparative Approach, with Materials and Cases, Transnational Publishers, Inc, New York, 2001, at 1;
Richard Krever (ed., 2008), VAT in Africa, Pretoria University Law Publications (PULP), at 3; even in the
United States, there are serious debates about the possible introduction of VAT to the United States; see
Michael J. Graetz, 100 Million Unnecessary Returns, Yale Law Journal, vol. 112, No. 2 (Nov. 2002); N.
Gregory Mankew, Much to Love, and Hate, in a VAT, the New York Times, May 1, 2010; Lori Montgomery,
Once Considered Unthinkable, U.S. Sales Tax Gets Fresh Look, the Washington Post, May 27, 2009
2
See Sales and Excise Tax Proclamation No. 62/1993, Negarit Gazeta, 52nd year, No. 61
3
See Turnover Tax Proclamation No. 308/2002, Federal Negarit Gazeta, 9th year, No. 21
2
exemptions granted for the supply of residential houses, investment instruments like shares
and bonds and the supplies of financial services.4
Whatever the motivations for exemptions may have been, exemptions for various types of
goods and services are mainly to be found in the VAT Proclamation (hereinafter VATP)
and VAT Regulations (hereinafter VATRs) – both issued in 2002.5 The Ministry of
Finance is empowered by the VATP to grant exemptions to additional lists of goods and
services not listed in the VATP and VATRs. 6 The Ministry has since then added its own
list of exemptions to the catalogue of exempted goods and services under the Ethiopian
VAT regime. The exemptions for supplies of bread, injera, milk and agricultural inputs are
some of the lists of goods added by the Ministry.7
The existence of exemptions in any tax law often leads to disputes over the nature and
extent of the exemptions, and VAT is not an exception in this regard. Of the long list of
exemptions, nothing has so far attracted as much attention from the Ethiopian tax
authorities as the exemption of financial institutions.8 This is hardly surprising. Financial
institutions, in particular banks, generate huge sums of revenue and it might at first be
galling to think that these services are not affected by VAT when the tax has reached
cafeterias and restaurants and small consumption items like tea and coffee.
The first sign of interest in taxation of financial institutions came in a case involving the
sale through foreclosure of a debtor’s property (collaterals) by Abyssinia Bank S.C. In FIRA
4
See Value Added Tax Proclamation No. 285/2002, Federal Negarit Gazeta, 8th year, No. 33, Article 8(2)(a)
(b) (c); and Council of Ministers Value Added Tax Regulations No. 79/2002, Federal Negarit Gazeta, 9th year,
No. 19, Articles 19, 20, and 21
5
See VAT Proclamation 2002, supra note 4; VAT Regulations 2002, supra note 4
6
See VAT Proclamation 2002, supra note 4, Article 8 (4)
7
See FDRE, Ministry of Finance and Economic Development, 1995 E.C., in Amharic, unpublished; see also
T. Lencho, the Ethiopian Tax System, Michigan State Journal of International Law (upcoming)
8
See Getahun Worku, Do Banks really need Register for VAT for Collection of Loans? Reporter, vol. 16,
No. 22/1126, Yekatit 6, 2003 E.C. in Amharic (translation mine); see also Kirubel Tadesse, Unpredictable
Tax Measures will Hurt Investments, Capital, vol. 13. No. 626, Sunday December 12, 2010;Mahlet Mesfin,
Financial Institutions, Tax Authority Disagree Over VAT, Addis Fortune, Vol. 11, No. 552, November 28,
2010; Shimelis Abebe, the Application of VAT on Sales Upon Foreclosure, Addis Ababa University, Faculty
of Law Library Archives, unpublished, May, 2009; ØLG<” ›¡K=K< “v”¢‹ ¨Å ¡e S[u< ŸMÑu< `UÍ
”¨eÇK”” ÔÓM Ò²?× Ide 29 2003 ¯.U. Ñ° 10-11 ÃSMŸ~
3
vs. Abyssinia Bank S.C.,9 a dispute arose over whether the sale of collaterals in a
foreclosure by the Bank constituted a taxable transaction for VAT purposes. Abyssinia
Bank S.C. (lender) took tires from Tana International Trading PLC (the borrower –
hereinafter simply Tana International) as security for the payment of loans it extended to
the latter. Tana International defaulted on its payment, and Abyssinia Bank sold the tires
(collaterals) in a foreclosure sale for a total price of 4 million ETB. The Tax Authority
assessed that VAT was due on the sales, to which the Bank objected. Abyssinia Bank
argued that the sale was exempted from VAT as Abyssinia Bank is a financial institution.
Federal Inland Revenue Authority (FIRA - the predecessor of ERCA) argued that the sale
was not an exempt transaction although the Bank was a financial institution.
Abyssinia Bank appealed against the decision of the Tax Authority to the Tax Appeal
Commission. The Commission decided by a majority opinion that the sales of tires by
Abyssinia Bank S. C. constituted taxable transactions. The case went to the High Court on
appeal, which reversed the decision of the Tax Appeal Commission. The High Court ruled
that the sale did not constitute a taxable transaction as the sale by the Bank was not a
continuous or regular activity of the Bank. Both the parties and the Tax Appeal
Commission as well as the High Court dwelt on whether foreclosure constituted ‘a
continuous or regular activity’ of the Bank because it seemed to them that the attachment
of VAT on the sales turned on whether this requirement is met in the case or not.
Although the results went against the Tax Authority in the Abyssinia Bank case, the issue
has since then lingered with some in the Tax Authority convinced that VAT should be
payable upon foreclosure sales. As early as 2005, the Ministry of Revenues issued a
Directive regarding the imposition of VAT upon some ‘difficult-to-tax’ transactions like the
provision of lottery and gambling, travel agency services and purchase of used goods by
used-goods-dealers.10 This rather generic ‘directive’ has a provision which states that ‘the
scope of exemptions for financial services does not cover the sale by foreclosure of goods
9
See Abyssinia Bank vs. Federal Inland Revenue Authority, Federal Tax Appeal Commission, File No. 543,
in Amharic, unpublished; Abyssinia Bank S.C. vs. Federal Inland Revenue Authority, Federal High Court,
File No. 31952, in Amharic, unpublished
10
See Federal Democratic Republic of Ethiopia, Ministry of Revenues, Directive No. 23/1997 (In Amharic,
unpublished).
4
held as security by financial institutions’. The ‘directive’ goes on to instruct banks to charge
foreclosure sales with VAT. 11
However, it appears that the said ‘directive’ was not properly communicated to all the
parties involved (it certainly was not implemented) as banks and the Tax Authorities are
still arguing – six or seven years later - over the taxability (or otherwise) of foreclosure
sales. 12
Banks seemed convinced that their foreclosure sales were insulated from any form of tax
claims.13 In a letter written in 1994 E.C (2002), the Ministry of Finance and Economic
Development seemed to have given them assurance against the threat of taxes.14 The letter
relieved banks from any duty to obtain tax clearance in respect of any property the banks
took as security for loans – with the obvious view to facilitating foreclosure sales by banks.
And more importantly, the letter conceded the priority of secured claims of banks over the
collaterals against the competing tax claims of the government.15 Banks referred to this
letter in support of their position that the sales of collaterals in foreclosure sales are
exempted from the payment of VAT.
Well those were perhaps different times! Although the Tax Authority suffered a set back in
the courts as shown in the Abyssinian Bank case, recent developments within the
Authorities show that they are determined to collect VAT on foreclosure sales by banks.
In 2010, Ethiopian Revenues and Customs Authority (ERCA – hereinafter simply the Tax
Authority) – sent a circular letter to Banks reminding them of their duty to register for
VAT for their services which are taxable under the VAT laws.16 The Authority bases its
position on a provision in the VATR which mentions ‘debt collection services’ by financial
11
See id, Article 16(1) and (2)
12
See Mahlet Mesfin, supra note 8
13
Even in their latest communications with the Tax Authority, Banks were quick to draw the attention of the
Authority to the much favorable circular letter written by the Ministry of Finance and Economic
Development; see Ethiopian Bankers Association, Hidar 8, 2003 E.C., in Amharic, unpublished
14
See Ministry of Finance and Economic Development, Circular Letter, Sene 1994 E.C., in Amharic
(unpublished)
15
The priority rights of banks and all other secured creditors was already asserted in the tax laws that came
out in 2002 – see Income Tax Proclamation No. 286/2002, Federal Negarit Gazeta, 8th year, No. 34, Article
82; Value Added Tax Proclamation, supra note…, Article 32; the Turnover Tax Proclamation, supra note…,
Article 14; the Excise Tax Proclamation No. 307/2008, Federal Negarit Gazeta, 9th year, No.20, Article 11
16
See Ethiopian Revenues and Customs Authority, Tikimt 3/2003 EC, in Amharic, unpublished
5
institutions as taxable services17 and Directive No. 23/1997, which declares that
foreclosure sales are chargeable with VAT.18
The Banks were predictably opposed to the idea of registration for VAT and expressed
their objection to the move through their association – Ethiopian Bankers’ Association.
They expressed their concerns by a letter written to the Tax Authority urging the latter to
reconsider its position on this matter. The Tax Authority wrote a reply essentially insisting
that they register for VAT for collection of the tax from foreclosure sales.19 In its reply, the
Tax Authority drew the attention of banks to the taxation of debt collection services again,
which is clearly indicated in the VATRs as a taxable service.20
Recent developments have in general signaled the hardening of stance on the part of the
government in its position on the payment of taxes on property held as security. The most
recent income tax amendment law, for example, included a provision that requires banks
to verify if borrowers have any outstanding tax claims against them before taking their
property as security for loan – in effect reversing the policy of the government in place
since 1994 E.C.21
The status of foreclosure sales under the VAT laws in particular and the scope of
exemptions for financial services in general has divided opinions ever since. We have, on
the one hand, people (mostly from the Tax Authority) who argue that foreclosure sales
should be subject to VAT and there are, on the other hand, people who have argued that
foreclosure sales are financial services and should not become subjects of VAT.
This article will explore the controversies surrounding the status of foreclosure sales in
VAT and will use the controversies to explore the nature and scope of exemption for
financial services under Ethiopian VAT laws. The article is not confined to finding answers
to the question of whether VAT should attach to foreclosure sales, although it is inspired
by it.
17
See id, citing VAT Regulations 2002, supra note 4, Article 20 (8)
18
See id, citing Article 16(1) and (2) of Directive No. 21/1997
19
See Ethiopian Bankers Association, Hidar 8, 2003 E.C., in Amharic, unpublished
20
See VAT Regulations 2002, supra note 4, Article 20(8)
21
See Article 2(3) of Income Tax (Amendment) Proclamation No. 693/2010, Federal Negarit Gazeta, 17th year,
No. 3
6
1. The Nature of Financial Institutions and Services: A Brief Overview
It is impossible to capture the essence of all financial services that financial institutions
offer, so bewilderingly diverse and complex these services have become. The financial crisis
of 2008 amply demonstrated how complex and protean financial services have become.
The aim here is to grasp the general features of financial services that have made them
something of a challenge for VAT systems in the world. For our purposes, we shall confine
ourselves to the two well-known financial institutions: banks and insurance companies.
The banking industry offers various types of services. Many of us are familiar with
commercial banks that perform the classic function of accepting deposits and making
loans.22 Depending on the degree of financial freedom in a given country, banks may also
perform other functions in the economy, like that of investment banking.23 Financial
institutions – those that provide intermediation services, among others – vary from country
to country. The major ones may include commercial banks (of course), what Meir Kohn
calls ‘near banks’ (saving institutions, credit unions and finance companies), insurance
companies (life and non-life), investment intermediaries (pension funds, mutual funds),
securities’ firms (e.g. brokerage firms), government intermediaries (national/central banks)
and non-financial companies that supply financial services.24 The Ethiopian Banking
Business Proclamation lists as financial institutions ‘insurance companies, banks, micro-
finance institutions, postal saving institutions, money transfer institutions and ‘other
similar institutions to be determined by the National Bank’.25
One of the core functions of a financial institution (in particular banks) is the provision of
indirect lending.26 This function is probably the best illustration (for our purposes) of what
a financial intermediary like a bank does. The existence of a financial intermediary removes
most of the barriers to lending in the market. The depositor’s great worry of ‘default’ by
borrowers is greatly reduced by the bank’s intercession as a party obligated to pay the
22
Stephen Valdez (5th edition, 2007), An Introduction to Global Financial Market, (Palgrave Macmillan), at
65
23
Ibid
24
Meir Kohn (2004), Financial Institutions and Markets, (Oxford University Press), at 124
25
See Banking Business Proclamation 592/2008, Federal Negarit Gazeta, 14th year, No. 57, Article 2(9)
26
Meir Kohn, supra note 24, at 28
7
depositor on demand.27 Since the financial intermediary specializes in the lending, it has
the capacity to cut down the risks of default by collecting a wealth of information about its
customers – something which is not available to the depositor as such.28 The financial
intermediary also takes advantage of the benefits of pooling (to make large loans),
specialization, continuing relationships, diversity and liquidity to supply financial services
at a much lower cost than would be available otherwise.29
Meir Kohn has captured the core functions of a financial institution in four words:
delegation, credit substitution, pooling and netting.30 Through the devices of ‘delegation’, a
depositor delegates to an intermediary the works of making a loan (thereby reducing the
transaction costs associated with lending).31 Through the devices of ‘credit substitution’,
the financial intermediary substitutes its own credit for the credit of the borrower;
depositors lend to the bank rather than to the ultimate borrower.32 An insurance company
substitutes its own credit for that of members of an insurance pool.33 The device of pooling
makes the financial intermediary safer and more liquid.34 And finally netting makes it
possible for the financial intermediary to offset one transaction against another.35 These
operations of a financial intermediary all involve intermediation of borrowers and
depositors (in the case of banks) or insurance policy holders and insurance claimants (in
the case of insurance companies).
The Banking Business Proclamation places the intermediate services banks perform in the
first order in its definition of ‘banking business’.36 Article 3(2) of the Banking Business
Proclamation emphasizes the intermediate nature of ‘banking business’ when it states:
“banking business” means any business that consists of [among others]:
a) receiving funds from the public through means that the National Bank has declared to be an authorized
manner of receiving funds;
27
Ibid
28
Ibid
29
See id, at 28-30
30
Id, at 37-40
31
Id, at 38
32
Id, at 38
33
Id, at 38-39
34
Id, at 39
35
Id, at 39-40
36
See Banking Business Proclamation, supra note 25
8
b) using the funds referred to under paragraph (a) … in whole or in part, for the account and at the risk of
the person undertaking banking business, for loans or investments in a manner acceptable by the National
Bank;
We have sufficient authority from the Banking Business Proclamation to place the accent
of banking business on ‘intermediation’. It is, however, well-known that while the primary
functions of many financial institutions is financial intermediation, most financial
institutions are not confined to just providing intermediation services. This is what
complicates the application or otherwise of VAT upon financial institutions and other
institutions that provide financial services. In addition to intermediation, financial
institutions (in particular banks) are involved in the provision of a range of so-called ‘direct
services’. Some banking services are offered in exchange for the payment of direct fees (for
more on these direct services by Ethiopian banks, see below). One of these is custody
services. Customers who wish to deposit some high-value goods (e.g., precious metals) or
burglar-prone goods like negotiable securities (e.g. shares and bonds) may do so with banks
upon payment of some fees for safe keeping and related services of banks.37 Banks may also
be involved in consultancy and/or advisory functions in exchange for the payment of fees
like all consultancy firms.
Whatever these other services may be, the great challenge in VAT is one of distinguishing
them from intermediation services, for on that depends whether to impose VAT on the
services or not. We shall have occasion to deal with some of these services later under the
section on the scope of exemptions for financial services.
2. Why Financial Services are Exempted from VAT

Most VAT systems in the world exempt financial services from VAT primarily because of
the technical difficulties involved in identifying and isolating the service charges in
financial services like the provision of loans, insurance services, sale of stocks, bonds and
foreign currency exchanges.38 The technical difficulty involved, as Yolanda Henderson
noted, is that ‘financial intermediaries provide a service by channeling funds of persons
37
Stephen Valdez, supra note 22, at 71
38
Yolanda Henderson, ‘Financial Intermediaries Under Value-Added Taxation’, (2001), in Schenk and Oldman,
supra note 1, at 372ff
9
with certain preferences regarding risk and liquidity [i.e., depositors] to other persons with
different preferences’.39 For most of their intermediation services, financial institutions
make profits by spreading the service charges between or among their various customers,
thus concealing the value added from the reach of VAT. Banks spread the value added in
loans between borrowers and depositors, by charging the former higher interest rates and
paying a lower interest rate to the latter. The value added is spread between borrowers and
depositors. Similarly, insurance companies spread the risk of insurance coverage among
thousands, sometimes millions of policy holders and pay out insurance compensation
when the risk materializes with some of their customers. The value added by insurance
companies is more than the premiums they charge policy holders.40
Harry Huizinga drew the differences between most other supplies and financial services
when he wrote:
The value added created by a business is the value of its sales minus the value of its purchased capital and intermediate
inputs. For most businesses, calculating total sale and purchases is straightforward. The problem with financial services… is
that a major input is financial capital, and pricing such capital is difficult.
Banks, for example, do not ‘buy’ capital, so it is difficult for them to document how much they paid for this particular input.
…banks raise capital by taking in deposits or by accessing the capital markets. This difference implies many problems for
value-added calculations. First, determining the price that banks pay for capital is difficult. The interest rate banks pay to
depositors, for example, understates the cost since a whole array of services are tied to bank deposits and these are typically
‘paid’ for by offering depositors a lower interest rate. But even if it were possible to determine the price banks paid for the
capital they use in providing financial services, this would not be enough. The loan interest rate charged to any particular
business accounts for some default risk. And while banks surely evaluate such risks, their evaluations are not verifiable.
Consequently, the amount of value added created by any given loan is very hard to calculate. The crux of the problems is that it is
virtually impossible for tax authorities to determine whether a high rate of interest on a loan represents big profits, which constitutes value
added and thus should be taxed, or a big risk premium, which constitutes a cost and thus should not be taxed. Analogous difficulties arise
for a wide range of financial services, including foreign exchange transactions and insurance.41 (Italics mine)
Related to the difficulty of figuring out the value added in financial services is the difficulty
in identifying the customers of intermediation services.42 Because borrowers pay interest in
exchange for the extension of loans to them, we may be inclined to believe that borrowers
are the customers of banks.43 But the interest paid by the borrowers does not reflect the
39
Id, at 372
40
Alan Schenk (Rep, 1989), Value Added Tax: A Model Statute and Commentary, American Bar Association
Section of Taxation, at 170-171
41
Harry Huizinga, (Oct., 2002), Economic Policy, vol. 17, No. 35, 497-534, at 500
42
Yolanda Henderson, supra note 38, at 374
43
Ibid
10
price charged by financial institutions. Banks connect their relationships with borrowers
with their relationships with depositors in ways that make it impossible to know how much
value they have added in their services to individual borrowers and depositors.
While technical difficulties stand as the primary reason for exemption of financial
intermediation services, it must be remembered that other reasons have also been cited to
strengthen the exemption of financial services. These ‘ancillary’ justifications or
ratiocinations are offered in resignation over the inevitable arising from the difficulty of
taxing financial intermediation services. Some have argued that the nature of financial
services justifies their exemption from VAT –or at least makes the exemption more
acceptable than otherwise. Financial services (in particular loans) are often provided as
inputs to investments, which are relieved from VAT anyway through the tax credit
mechanism of the value added tax.44 It is argued that even if financial services were to be
subject to VAT, the recipient of the services would obtain full credit for the VAT paid on
the financial services. The borrowers who obtain loans from banks will use the proceeds for
investments and, in an ideal world, they should receive tax credits for their inputs,
including taxes paid on financial services. The depositors who obtain interest on their
loans may use the money to consume goods and services in the market, by which time they
should pay VAT on their consumption. The borrowers of loans will use the proceeds either
for investment or consumption. Their spending on consumption goods is subject to VAT
when they purchase goods and services from the market (assuming the universal coverage
of VAT). If they use the proceeds for investment, they will pay VAT for inputs of their
business and these will also be chargeable with VAT, subject to the regular rules of input
tax crediting. Hence, the argument runs, little is lost by exemption of financial services
from VAT. But these arguments have been developed after it is realized that conventional
VAT systems have insurmountable technical challenges in reaching intermediation
services. If the technical problems did not exist in the first place, few governments would
extend exemptions to provision of financial services.
44
Id, at 374-375
11
3. Approaches to VAT treatment of Financial Institutions
Many different approaches have been proposed to the conundrum of financial services,
some of which have been put in place in actual legislations.45 The most dominant approach
has been that of the European Union, which is followed by many countries in the world.46
The EU Directive on the Harmonization of VAT (also known as the VAT Directive)
requires member states to exempt a wide range of financial services, such as those relating
to the provision of loans, credit, credit guarantees, and transactions involving money,
deposit, saving and current accounts.47 The EU Directive is not of peremptory character as
it authorizes member states to allow taxpayers to treat most of the ‘exempted’ financial
services as taxable.48 In general, the EU approach is one of exempting financial services and
zero-rating49 those financial services connected with zero-rated supplies (e.g., financial
services rendered in connection with export of goods are zero-rated).50
The consequence of exemption for financial services in the EU approach is that input tax
credits are denied to exempt financial services. Under the EU Directive, input taxes
attributable to exempt financial services are as a rule not entitled to credit.51 Where input
taxes relate to both taxable and exempt financial services, the EU VAT Directive employs
an allocation formula, the numerator of which is the VAT exclusive turnover for the year
45
See Schenk and Oldman, supra note 1, at 361-372;
46
Id, at 361
47
See Alan Schenk, ‘Financial Services’, in Richard Krever, supra note 1, at 37
48
Id, Schenk quoting VAT Directive, Article 137(1)(a), footnote 12, at 37
49
VAT has a list of technical terms and jargons which baffle novice readers of VAT literature. One of these
technical lingoes is the term ‘zero-rated’. Often used along with ‘exemptions’ –which is more familiar – zero-
rated treatment is perhaps the most exalted and beneficial treatment in VAT. Zero-rated transactions enjoy a
zero-rated treatment, which means that not only is no VAT chargeable on the output (sale), all the VAT paid
on the inputs is fully creditable as well. Exemptions in VAT are often misleading. They convey the
impression that VAT is not chargeable on exempted goods and services. That is not really the case. Exempted
goods and services are exempted from the output VAT due on sales only. Exempted goods and services are
not entitled to a tax credit for the VAT paid on inputs (a privilege reserved for zero-rated transactions) –
which means that exempted goods and services carry a hidden VAT, i.e., VAT paid on inputs; see Michael
Keen and Stephen Smith (2007), VAT Fraud and Evasion: What Do We Know and What Can be Done?
IMF Working Paper WP/07/31, International Monetary Fund.
50
Schenk, supra note…, foot note 13, at 37, quoting S Cnossen ‘VAT Treatment of Financial Services’ in
Lindocrona et al (eds.) International Studies in Taxation: Law and Economics (1999) 91
51
Schenk, supra note 47, at 37
12
attributable to taxable (including zero-rated) transactions, and the denominator of which is
the VAT exclusive turnover for the year attributable to taxable and exempt supplies.52
Other approaches have also emerged, which, while resembling the EU approach in
essential features, also depart in some respects. The Indonesian and Australian Goods and
Services Taxes (GST)53 – analogous to VAT – are, for example, distinguished for allowing
some input taxes attributable to exempt financial services, in effect zero-rating some
financial services even when these services are destined for the domestic market.54
Somewhat similar to these approaches is that of New Zealand Goods and Services Tax
(GST). New Zealand’s GST has an elective scheme that zero-rates financial intermediation
services rendered to certain qualified registered persons.55 A recipient is deemed qualified if
its taxable supplies amount to 75% or more of its total supplies.56
South Africa has emerged as another model country for expanding the tax base for
financial services beyond the conventional approach of the EU.57 South Africa has
adopted a VAT regime which imposes tax on financial services rendered for explicit fees.58
South Africa has gone farther than many countries in expanding the reach of VAT on
financial services,59 and the South African approach is spilling over to the neighboring
countries of Namibia and Botswana.60 South Africa imposes VAT on currency exchange
transactions, transactions involving cheques, letters of credit, debt, equity or participatory
securities and some credit transactions.61 South Africa also imposes VAT upon fee-based
services on checking and saving accounts, money transfers, off-site or electronic banking,
52
Ibid; foot note 16, quoting EU Directive, Article 174
53
GST – like VAT- is a multi-stage consumption tax on each point of supply in a production chain, with
suppliers entitled to refunds of GST incurred on inputs; see P R Hill et al (2006,), Australian GST
Handbook: 2006-2007, (Thomson), at 4; some countries have used other names to designate taxes analogous
to VAT. VAT is known simply as a ‘consumption tax’ in Japan, and GST (Goods and Services Tax) in
Canada, New Zealand and Australia; the acronyms for VAT obviously vary across languages: TVA in France,
IVA in Spanish, NDS in Russian, and DRG in Georgian, see Victor Thuronyi (2003), Comparative Tax Law,
Kluwer Law International, at 305
54
Schenk, supra note 47, at 38-39; see also P R Hill et al, supra note 53
55
56
Ibid
57
Id, at 41
58
Schenk & Oldman, supra note 1, at 361
59
60
Id, at 42
61
Id, at 41
13
credit and debit cards, foreign exchange transactions, mortgage loans, rental agreements,
documentation and similar motor finance services, brokerage and underwriting
transactions, registration of shares, custody of securities, investment advice, and safety
deposit boxes.62 The tax authorities in South Africa have developed a list of taxable, exempt
and zero-rated financial services after consultation with representatives of the financial
sector.63
Upon closer examination, we notice that the South African approach is a variant of the EU
approach, with the important difference that South Africa has developed a long list of fee-
based financial services as taxable financial services. The South African VAT limits
exemption to interest charges or discounts that serve as interest charges or interest
penalties.64
A country that has truly departed from the EU approach both in form and content is
Israel. Israel taxes intermediation services through the addition method VAT,65 and taxes
their inputs through the regular VAT.66 In effect, Israel imposes VAT on financial
institutions in two ways. First, it charges VAT on inputs purchased by banks and these
input VATs are not creditable (this is incidentally the case in all those countries which
exempt financial services from VAT). In addition, Israel imposes VAT on the total of
profits of financial institutions and wages paid by financial institutions to their
employees.67 The second VAT, for which Israel claims exception, is administered along
with the income tax – in fact, the information collected for income tax purposes is used for
application of VAT on banks.68
The Ethiopian VAT law falls squarely within the EU approach, as aptly conceded by the
drafter of Ethiopian VAT laws.69 The VATP of 2002 curtly states that financial services are
62
63
Schenk, supra note 47, at 41-42
64
65
The addition method VAT adds the components of value added, namely, interest on loans, rent paid,
wages and salaries, and net profit to calculate the VAT due; see Schenk & Oldman, supra note 1, at 39-40
66
67
Id, at 362
68
Ibid; the Israeli VAT system is not without its critics; some argue that this form of tax imposes double
taxation on financial services as no input tax credit is available to business borrowers; the tax is imposed after
the fact; see ibid
69
See Schenk, supra note 47, at 34
14
exempted from VAT, without going into details of what these services might be. The
VATRs, issued along with the VATP, however, deal with this issue in some details. The
VATRs list a number of financial services that are exempted from VAT (whether rendered
for explicit fees or not).70 The VATRs also list the services that are taxable even when they
are provided by financial institutions.71 We shall analyze the scope of VAT exemptions
under Ethiopian law below.
4. The Scope of Exemptions for Financial Services and Taxable Financial
Services
Exemptions of whatever nature inevitably lead to disputes over the scope and nature of
exemptions. The VATP of 2002 lists financial services as one of the services exempted from
VAT but neither defines nor describes what these services are.72 It was left to the VATRs to
list (if not define) the types of financial services that are exempted and those that are
taxable.73 The Regulations give a fairly extensive list of financial services that are exempted
from VAT ‘whether provided for explicit or implicit fees’.74 The Regulations give an
equally extensive list of financial services that are taxable ‘whether or not they are rendered
in connection with an exempt financial service’.75
The list of ‘exempt financial services’, which incidentally does not seem to be exhaustive,
includes in its ranks the familiar list of financial services provided by, among others, banks
and insurance companies. Provision of loans or credits and foreign exchange transactions
by banks is, for example, exempted from VAT.76 Similarly, provision of insurance and
reinsurance by insurance companies is exempted from VAT.77 In addition, provision of
provident funds, pension or retirement annuity funds by mutual fund companies, is also
exempted from VAT.78
70
See VAT Regulations 2002, supra note 4, Article 20(2); see also Schenk, supra note 47, at 35
71
See VAT Regulations 2002, supra note 4, Article 20(6)
72
See id, Article 8(2)(b)
73
See id, Article 20
74
See id, Article 20(1)
75
76
See id, Article 20(2) (a) and (b)
77
See id, Article 20(2)(d)
78
See id, Article 20 (2)(e)
15
Contrary to what some financial institutions (in particular banks) have come to believe, the
exemptions are not granted because of what the institutions are but because of the nature
of the services. VAT exemption for financial services is not to be interpreted as a privilege
of the financial industry but of certain services provided by the industry. There are a
number of provisions which emphasize this. First of all, the financial services that are
granted exemption are exempted even when the services are rendered in connection with
supplies of goods.79 For example, banks enjoy exemptions for loans they extend in
connection with the acquisition of goods in hire-purchase or finance lease cases, as long as
the loans as well as the charges and interests for the loans are shown separately in the
transactions and this is disclosed to the recipients of the goods.80 The privilege of
exemption also extends to suppliers that are not financial institutions if the suppliers
provide loans with interest in connection with the acquisition of goods and services.81
Hence, suppliers of goods or services that provide loans to customers in connection with
the acquisition of goods or services in hire-purchase agreements or finance lease
agreements are also covered by the privilege of exemption. Even suppliers that sell goods
on installment payment arrangements are covered by the privilege of exemption as long as
they are able to insulate the loan transactions from the underlying sales transactions.82 The
interest charged for installment (deferred) payments is exempted as a financial service while
the underlying sales transactions are subject to VAT like all regular transactions.83
The lists of exempted financial services are illustrative. We have no general provision that
gives the common thread that connects all exempt financial services, which is a challenge
when we are faced with new types of financial services that are not mentioned in the lists.
We are therefore compelled to extrapolate from the illustrative list a common thread that
characterizes all exempt financial services. That common thread is ‘intermediation’, which,
as alluded to before, makes it difficult for VAT systems throughout the world to apply
conventional VAT upon these services.84 The last item in the list of exempt financial
79
See id, Article 20(2) (c )
80
See ibid,
81
82
See id, Article 7(4)(b) and Article 20(5)
83
84
See above
16
services in the VATRs makes a reference to ‘provision of intermediation services by a buy-
aid society or medical aid fund’, which seems to indicate the nature of financial services
which compelled exemption in the first place.85 It is intermediation that put financial
services beyond the reach of conventional VAT and it is intermediation which should
extend exemption to those services that are not mentioned in the list.
The VATRs also list taxable financial services.86 The list includes ‘legal, accounting, record
keeping services’, ‘ safe custody services’, ‘data processing and payroll services’, ‘debt
collection and factoring services’, ‘management services’ and ‘trustee, financial, advisory
and estate planning services’.87 Even a cursory reading of the list and prior knowledge of
the range of services provided by financial institutions in Ethiopia will indicate that the list
is forward-looking. There are many services in the list which are either entirely unknown in
the lexicon of Ethiopian financial industry or not yet put in place. As in the case of exempt
financial services, the list is additional evidence that the exemptions are not granted to the
financial industry as such but due to the nature of certain services which happen to be
commonly offered by financial institutions. While intermediations services are the core
functions of financial institutions, financial institutions are not confined to providing just
intermediation services.
Even in the limited range of functions provided by financial institutions in Ethiopia, some
of the taxable services are well known practices. Some banks are known to provide payroll
services for other businesses and the government.88 The Tax Authorities themselves are
increasingly relying upon banks for processing tax payments.89 Many taxpayers particularly
in the capital – Addis Ababa – remit taxes through banks. Banks also offer safe custody
services to customers. One of the well-publicized services of banks in recent times is the sale
of shares on behalf of companies that are about to be established, and banks offer these
services in exchange for the payment of commissions.90 While these services are well-known
85
See VAT Regulations 2002, supra note 4, Article 20(2)(g)
86
87
See id, Article 20(6) (a-g))
88
Interview with Ato Eshetu Erana, Oromia International Bank, formerly a legal advisor to the National
Bank of Ethiopia, May 9, 2011
89
Ibid
90
Ibid
17
in the financial industry, other services in the list are not so well known. Banks and
insurance companies in Ethiopia are seldom involved in the provision of the so-called
‘legal, accounting, management, estate planning and financial advisory services’. Debt
collection and factoring services are probably unknown in the Ethiopian financial industry
– a factor which partly accounts for the confusion that surrounds these concepts in the
VAT. The list of ‘taxable’ financial services, like that of exempt services, is taken from the
laws of mature financial and tax systems and is not illustrative of the practice in Ethiopia.
The challenge here is distinguishing and characterizing certain transactions as ‘exempt’ and
others as ‘taxable’. While this problem is not of financial institutions and services per se, it
is more pronounced here. There are of course clear cases on both sides. Supplies of loans
and acceptance of deposits (the classic banking transactions) should remain exempted even
when banks appear to charge explicit or implicit fees for these services. Similarly, the
provision of insurance coverage by insurance companies (including re-insurance) should
remain exempted regardless of how these services are structured between insurance
companies and policy holders.
There are also clear cases on the side of ‘taxable’ financial services. The provision of payroll
services, the collection of taxes on behalf of tax authorities, rental of safe boxes for valuable
items are clearly taxable even if these services are provided by financial institutions. These
services are typically provided in exchange for the payment of direct fees or commissions.
There is therefore little or no difficulty in reaching these types of transactions through
conventional VAT systems.
The less common practices in the list have led to mis-constructions in practice. Some
within the Tax Authority have, for example, considered foreclosure sales to be ‘debt-
collection’ services, which, as we saw above, are included in the list of taxable services. In
Abyssinia Bank case, the counsel for the Tax Authority argued that foreclosure sales
constitute ‘debt collection’ services in the VATRs literally understanding debt collection to
mean any action of the bank to collect its own debt. This sentiment was echoed in the
letters written by the Tax Authorities requiring banks to account for VAT in respect of
foreclosure sales (see above). This is clearly a misunderstanding. The Tax Authorities need
go no farther than the VATRs to understand what ‘debt collection’ and ‘factoring services’
18
might mean for VAT purposes. Debt collection and factoring services are described in sort
of suggestive way in Article 20(8) of the VATRs as ‘services related to debt-recovery,
litigation and the management of the recovery of the debtors’. If the Regulations are not
sufficiently suggestive, recourse may be made to the mature practices of the range of
financial and other services in other countries.
We need to define and fix the meaning once and for all time of ‘debt collection and
factoring services’, which the VATRs mention among those services taxable if and when
they are provided by financial or non-financial institutions. It is doubtful if any financial
institution in Ethiopia provides ‘debt collection’ services. The VATRs refer to debt
collection of a different order. Debt collection services are typically provided by financial
and non-financial institutions in other countries to persons who do not want to spend time
and money collecting debts from their debtors. Many companies in the developed world
outsource debt collection to specialized agencies or companies in order to cut down on the
administrative costs of debt collection. Debt collection agencies or companies typically
charge their customers fees or commissions for their services. They pursue defaulting
debtors and collect debts on behalf of their clients.
Factoring is also probably entirely unknown in Ethiopian financial practice. Factoring
companies or enterprises purchase trade debts (accounts receivables) from clients at a
discount before the debts are due.91 Factoring involves the sale of accounts receivable at a
discount to factoring companies in order to improve cash flows.92 It is one of the great
devices created to increase liquidity of otherwise illiquid assets, namely accounts
receivables. ‘Factor’ companies may be independently established to provide factoring
services or financial institutions like banks may create units or subsidiaries to provide
factoring services to customers who need these services.93
In any event, it may be seen that the ‘debt collection’ and ‘factoring’ services mentioned in
the VATRs have nothing to do with foreclosure sales. Foreclosure sales may be understood
91
See Ross Cranston (2nd ed., 2002), Principles of Banking Law, (Oxford University Press), at 260
92
See id, at 354-355
93
Factoring services may be ‘recourse’ or ‘non-recourse’ services. In a non-recourse factoring services, the
provider (called the factor) bears the risk of losses on bad debts, while in a recourse factoring, the factor
reserves the right of recourse in case the factor is unable to collect the debts; id, at 355
19
colloquially as debt collection actions, but they are not ‘debt collection’ services in the
technical language of these services. Anyone who knows one or two things about bank
foreclosures can tell that foreclosure sales are anything but.
Apart from the real problem of delimitation, there is also a problem of unbundling taxable
services from exempt services when the two are provided by financial institutions in
undifferentiated manner. Financial institutions may make the task of unbundling difficult
by providing both services in undifferentiated fashion. Financial institutions may choose to
provide taxable services along with exempt financial services without charging explicit fees,
concealing the value added in the range of services they provide as a whole to a customer.
If a bank provides investment advisory services to a borrower as a package of services it
provides to the latter, how are we going to separate the fees for the investment advisory
from the interest chargeable on the loans when the bank has not done so in its
transactions?
If financial institutions know how VAT operates, it is in their best interest to un-bundle
exempt financial services from taxable services. Financial institutions obtain the right to
claim input tax credit in respect of the taxable services, and they are able to claim input tax
credits only if they un-bundle the taxable services from the exempt services.
5. Why Foreclosure Sales is Missing from the List
Both sides have tried to make a point out of the absence of foreclosure sales in the list of
either exempted financial services or taxable financial services. Those who wished to press
for the taxation of foreclosure sales pointed to the absence of foreclosure sales among the
list of exempted financial services as evidence of the intention of the lawmakers to exempt
foreclosure sales from the payment of VAT. Those who wished to see foreclosure sales
exempted pointed to the absence of foreclosure sales in the list of taxable supplies as
evidence that these sales are exempted from the payment of VAT. Which begs the
question: why is foreclosure sales not mentioned in the list of either exempted or taxable
financial services?
The speculation that foreclosure sales did not appear in the list because these forms of sales
were unknown or even uncommon banking practices must be dismissed immediately.
Foreclosure sales are fairly common practices of banks even in Ethiopia where the financial
20
sector is not as developed and certainly not as diverse and complicated as in some other
countries. The Proclamation which authorizes banks to foreclose debtors’ property
precedes the VAT legislations by at least four years.94 The list of exempt and taxable
financial services in the VAT laws of Ethiopia includes some uncommon and even non-
existent financial services in Ethiopia, no doubt in anticipation of the development and
diversification of financial services in that direction in the future. How is this rather
expansive and forward-looking list said to be missing foreclosure sales by banks?
There is one plausible explanation which may at first sound counter-intuitive but true in
retrospect. Foreclosure sales by banks are not services in the strict sense of the term
‘services’ under the VAT laws. They are self-help actions by banks. Banks resort to
foreclosure sales to enforce the payment of loans in the event of the loans remaining
unpaid by debtors upon the expiry of due dates. When loans are paid on time by
borrowers, the security agreement is terminated and the collaterals are redeemed to the
borrowers. The payment of the loan by borrowers occasions no VAT whatsoever as there
are no taxable transactions between the borrowers and the bank. As the extension of the
loan was exempted from VAT, so is the payment of the loan by the borrowers.
The absence of foreclosure sales by banks from the list of either ‘exempt’ or ‘taxable’
financial services is, therefore, not a result of oversight by the drafter but a recognition that
foreclosure sales are not even distinct financial services. Foreclosure sales typically occur in
order to enforce the terms of a contract of loan. The bank which seeks enforcement
through foreclosure is not providing any service to any person, but helping itself to
repayment of the loan. While foreclosure sales appear as transactions between banks and
bidders, they are in reality actions taken by banks to enforce the terms of a loan contract –
in other words, self-help services. As we shall explore below, the mere fact that foreclosure
sales are self-help actions does not exempt them from VAT. While from the vantage point
of the banks, foreclosure sales are self-help actions, they also conceal another layered
transaction, which may make them eligible for VAT.
94
See Property Mortgaged or Pledged with Banks Proclamation No. 97/1998, Federal Negarit Gazeta, 4th year,
No. 16; a Proclamation to Provide for Business Mortgage Proclamation No. 98/1998, Federal Negarit Gazeta,
4th year, No. 17
21
6. The Nature of Bank Sale Foreclosures
Foreclosure sales are not different from other conventional sales. Foreclosure sales exhibit
all the attributes of a typical sales transaction. There are typically two parties involved, the
seller and the buyer. There is an express price and an object of sale. The only thing peculiar
about foreclosure sales is the circumstances under which the sales occur. Foreclosure sales
invariably occur to enforce a payment of debt, which is expressed in a separate contract or a
judgment of a court.95 Another peculiarity (if we can call it that) of foreclosure sales is that
these sales typically occur in auction sales. But that does not change the nature of
foreclosures as sales.
The Civil Code of Ethiopia treats ‘sale by auction’ as one type of sale.96 The Civil Code
describes the peculiar circumstances in which auctions occur. One of these is the fact that
the sale is made to the highest bidder.97 Whoever participates in a public auction is bound
by his offer on the terms or conditions of the sale unless a higher bid is made or his offer is
not accepted immediately after the usual calls.98 Once auction sales are consummated, they
assume the conventional attributes of a typical sale, with obligations on the part of the
seller to deliver the goods and of the buyer to pay the price.99
Since the sales transactions accompanying foreclosure procedures are nothing out of the
ordinary, they are not really difficult to tax. Foreclosure sales are thoroughly accessible to
VAT on technical grounds. Foreclosure sales meet the profile of ‘supply of goods or
services’ (for the meaning of supply of goods or services, see below).100 They also meet the
requirement of consideration, the price at which the goods are foreclosed and sold
constituting consideration for the supply of goods in foreclosure sales.101 We do not even
95
See Property Mortgage Proclamation, supra note 94, Article 3; Business Mortgage Proclamation, supra note
94, Article 13; Civil Procedure Code of Ethiopia (1965), Negarit Gazeta – Extraordinary Issue No. 3 of 1965,
Articles 394ff
96
See the Civil Code of Ethiopia (1960), Negarit Gazeta, Gezette Extraordinary, 19th year, No. 2, Articles
2403-2407
97
See id, Article 2404
98
99
See id, Article 2403
100
See VAT Proclamation 2002, supra note 4, Article 4(1)(a)
101
See id, Articles 6 and 12
22
have to resort to one of the presumptive rules of VAT in order to figure out the value of
the supplies. Those who vociferously argue for taxation of foreclosure sales can therefore be
forgiven if they mingle foreclosure sales with ordinary sales transactions, which attract
VAT. The only thing different about foreclosure sales is the circumstances in which the
sales occur. Foreclosure sales occur typically to enforce a debt, whether that debt is
expressed in a separate contract or in a judgment of courts.
Both the Property Mortgage and Business Mortgage Proclamations furnish all the necessary
elements we need to characterize foreclosure sales for VAT purposes. Since both
Proclamations are virtually identical in every respect except the underlying property subject
to sale, we use the two pieces of legislation interchangeably for purposes of this article.
Both laws emphasize the agency character of foreclosure sales. Although banks are in
charge of foreclosure sales, both laws emphasize that foreclosure sales are ‘executed on
behalf of the debtor’.102 Banks are not regarded as owners of the property they foreclose. In
fact, banks are ‘liable for any damage they cause to the debtor in the process of selling the
property through foreclosure procedures.103
Only in exceptional cases are banks authorized by law to have the debtor agree in a
contract of loan for banks ‘to take over the property in consideration of its estimated value
as specified in the contract of loan’.104 But the transfer of the property even then occurs
from the debtor to the bank, which effectively prevents foreclosure sales from happening.
In all circumstances, the transfer of property occurs from the debtor to third parties, and in
exceptional circumstances, the transfer occurs from the debtor to a creditor bank. We have
therefore established conclusively that banks are involved in foreclosure sales as agents of
debtors, not as owners of the property foreclosed. The proper characterization of the
foreclosure sales sets the stage for the next question: should VAT apply to foreclosure sales.
The next section will try to find answers to that question.
102
See Property Mortgage Proclamation, supra note 94, Article 5; Business Mortgage Proclamation, supra
note 94, Article 15
103
See Property Mortgage Proclamation, supra note 94, Article 7; Business Mortgage Proclamation, supra
note 94, Article 1
104
See Corrigendum to Property Mortgaged or Pledged with Banks Proclamation No. 97/1998 No. 1/1998,
Federal Negarit Gazeta, 4th year, No. 17
23
7. VAT and Bank Foreclosures: Setting the Scenarios
In order to properly understand the nature of foreclosure sales and their VAT
implications, there is no better place to start than from the opinions of the drafter of the
Ethiopian VAT laws: Professor Alan Schenk. Professor Schenk was also a Reporter for the
Committee on Value Added Tax of the American Bar Association Section of Taxation.105
As a member of the said Committee, Professor Schenk helped draft a Model Value Added
Tax Statute suitable for adoption by the United States (incidentally the US is the only
industrialized nation which does not have a national Value Added Tax). The Model
Statute has a special section devoted to the transfer in satisfaction of debts, to which
reference is here made for its instructive points on VAT and foreclosure sales.106 Section
4039 of the Model Statute provides that ‘the transfer of property or services by a debtor to
a creditor in payment or reduction of debt is a sale of such property or services.’ In his
explanatory text to this section, Professor Schenk charts different scenarios of transfer of
property or services from a debtor to a creditor.
The first scenario is where the debtor transfers ownership (title) of the property to a
creditor in payment of the debt.107 In this instance, writes Professor Schenk, a transfer
occurs from the debtor to a creditor. The second scenario is where the property (collateral)
is sold by or on behalf of the debtor to a third party in a foreclosure or similar sale and the
proceeds are used to pay the debt.108 In this second instance, too, the debtor is regarded as
the seller of the collateral.109 In both instances, the transfers or sales may be taxable,
depending on whether the debtor is a registered VAT payer. If the debtor is not registered
for VAT (for example, if the debtor is selling his/her residential property in a foreclosure),
the transfer or sale is not chargeable with VAT, because the debtor (as a supplier) is not a
registered person. In all instances involving dealings between debtors and creditors, the
105
See Alan Schenk, supra note 40
106
See Section 4039, in Alan Schenk, supra note 40, at 181
107
Ibid
108
Ibid
109
Ibid
24
only situation where the creditor (e.g., the bank) may be required to account for the VAT is
where the ‘creditor has control over the remittance of the proceeds to the debtor’.110
If we transpose the scenarios established by professor Schenk in the abstract to the concrete
situation of the Abyssinian Bank case, the following scenarios will emerge.
The first and most likely turn of events in these kinds of situations is that Tana
International (debtor) would pay back the loan it owed to the Bank along with the interest
due thereon. In so doing, Tana International redeems the collateral. The repayment of the
loan as well as the interest due thereon is an exempt financial transaction. Under
Ethiopian VAT laws, neither the transfer of the collaterals as security nor the redemption
of the collaterals attracts VAT.111 The redemption of property leads to taxation only where
the original transfer of the property constitutes a supply of goods under the VAT law. That
occurs in a finance lease or hire-purchase (hiring sale) agreements.112 The granting of
security interest by a debtor to a creditor is non-taxable transaction and the redemption of
the collateral upon payment of the debt (the loan) does not lead to taxation either.
The second scenario is that Tana International (the debtor) agrees to surrender the
collaterals to the Bank in payment of the loan. This is regarded as a supply of goods by
Tana International to Abyssinia Bank. The fact that the supply occurs in the context or
against the background of payment of the loan does not change the nature of the supply
for VAT purposes. It is taxable. Tana International is required to issue VAT invoices and
collect the VAT due upon the transfer of the collaterals just as it would be required to if
the collaterals were sold in the market.
The third scenario, as actually happened in the Abyssinia Bank case, is the case of the Bank
foreclosing the collaterals as it is authorized by Property Mortgage and Business Mortgage
Proclamations. Here the characterization of the transaction is important. The law casts the
transaction as one occurring between the debtor and a winning bidder, the Bank acting
merely as an agent. In essence, therefore, the transaction is not different from the second
scenario above, except that the transfer now occurs from the debtor to a third party bidder,
110
Ibid
111
Article 3 (10) of VAT Regulations states that ‘the provision of goods on consignment and the transfer of
goods to a person in a representative capacity is not a supply’; VAT Regulations 2002, supra note 4
112
25
instead of the Bank. This transfer carries VAT as in the second scenario. It fulfills all the
requirements of VAT. We shall go over these requirements just to clarify. Since those who
object to taxation of foreclosure sales doubted whether these sales are taxable transactions
within the meaning of the VAT laws, it may be in order to review the notion of ‘taxable
transactions’ and cognate VAT concepts to assess whether foreclosure sales meet this basic
requirement in VAT.
7.1. The Notion of “Taxable Transactions”

The key to the application of VAT to domestic supplies of goods and services is the notion
of ‘taxable transactions.113 Every supply of goods or services must be a taxable transaction
before VAT attaches to it. Article 7(3) of the VATP defines a taxable transaction as:
… a supply of goods or a transaction of services in Ethiopia in the course or furtherance of a taxable activity other than an
exempt supply…
The notion of taxable transaction is relevant to all transactions that attract VAT. We shall
examine this notion for purposes of understanding ‘foreclosure sales’ in VAT. We can
deduce from a cursory reading of the definition above that the notion of taxable
transactions consists of at least three elements. A taxable transaction is:
a) a supply of goods or services;
b) that occurs in Ethiopia;
c) in the course or furtherance of a taxable activity.
Since there is little doubt that foreclosure sales that have become a matter of some debate
all occur in Ethiopia, we shall easily dispense with the second element (b) and focus upon
elements (a) and (c) instead.
a. Supply of Goods or Services
Both the VATP and the VATRs contain definitions that will help us unlock the meaning
of the first element for application of VAT: supply of goods or services. Goods are defined
in the VATP expansively as ‘all kinds of corporeal movable or immovable property’,
including ‘thermal, electrical energy, heat, gas, refrigeration, air conditioning and water’
113
See VAT Proclamation 2002, supra note 4, Article 7(1)(a)); see also, Article 3 of the VAT Proclamation
which prescribes the scope of application of VAT; taxable transactions, imports of goods and import of
services; for imports, it is not at all necessary for the imports to be taxable transactions
26
but excluding ‘money’.114 And services are defined as ‘work done for others, which does
not result in the transfer of goods’.115 Between them, the notions of goods and services
share all types of goods and services imaginable, except money, which is excluded from
VAT because of its unique role in the market as a medium of exchange.116 The meanings
ascribed by the VATP and the VATRs to ‘supply of goods’ and ‘supply of services’ is a mere
expansion of the meaning of goods and services. Supplies of goods or services are therefore
understood as ‘sale’, ‘grant’ ‘transfer’ or ‘rendition’ of goods or services.117
With respect to foreclosure sales, few would doubt that foreclosure sales represent supplies
of goods within the meaning given to these terms in the VAT laws. The only question over
which the opposing camps have parted company is whether foreclosure sales constitute
exempt supplies, which we shall examine later in this article. Foreclosure sales represent
conventional sales of goods and easily qualify as supplies of goods for purposes of VAT.
b. In the course or furtherance of a taxable activity

This requirement, a subject of much debate in the Abyssinian Bank case, actually consists
of two elements: ‘taxable activity’ and ‘in the course or furtherance of…’. It will be seen that
a separate analysis of the two elements is necessary for proper understanding of the
application of VAT upon domestic supplies of goods and services.
i. ‘Taxable Activity’
This requirement in particular has been a subject of intense debate among the opposing
camps as well as in the Tax Appeal Commission and the Courts. Like the notion of
‘taxable transactions’, of which it is a part, the notion of taxable activity is defined in the
VATP and elaborated in the VATRs. Article 6 of the VATP defines ‘taxable activity’ as ‘an
activity which is carried on continuously or regularly by any person’ ‘in Ethiopia or partly
in Ethiopia’ involving or intending to involve… the supply of goods or services to another
114
115
Id, Article 2(16)
116
117
Compare the terms used in the definitions with VAT Proclamation, Article 4(1)(a)&(b)
27
person for consideration’.118 The notion of ‘taxable activity’ consists of at least three
elements, as can be readily inferred from the definition. The activity must:
i) be continuous or regular;
ii) involve or be intended to involve a supply for consideration; and
iii) be carried on in Ethiopia or partly in Ethiopia.
In connection with foreclosure sales, elements (ii) and (iii) were never contested. For
whatever it is worth, it is element (i) that has become a subject of some debates. In the
Abyssinia Bank case, the counsel for the Bank argued that foreclosure sales are not
‘continuous or regular’ activities of banks, their regular activity being the business of
banking. For our purposes, we shall concentrate upon the issue of ‘continuity’ or
‘regularity’ in VAT and explore why it is placed as one of the requirements for application
of VAT in domestic transactions.
In the Abyssinia Bank case, it is aptly shown that the parties as well as the tribunals have
tended to confuse ‘taxable activities’ with ‘taxable transactions’. The two expressions, while
related, are not the same. The requirement of ‘continuity’ or ‘regularity’ is an attribute of a
taxable activity, and not of a ‘taxable transaction’. It may be helpful to remember that other
countries use phrases like ‘economic activity’, ‘enterprise’ or ‘business’ to refer to what the
Ethiopian VAT calls ‘taxable activity’.119 A taxable activity must be a continuous or regular
activity to be subject to the regime of VAT. VAT, contrary to the conventional
misconception, is not a transactional tax like stamp duties or even customs duties. VAT
requires some regularity in the activity of the taxpayer and imposes certain ‘recurrent’
obligations upon taxpayers. Taxpayers in VAT must be registered for VAT.120 Taxpayers
must maintain books and records for purposes of complying with the regime of VAT.121
118
For more on the notion of taxable activity, see Schenk and Oldman, supra note 1, at 96-98; P.R. Hill et al,
supra note 53, at 61-64
119
The Australian GST law, for example, uses the word ‘enterprise’ to refer to the same thing; see P.R. Hill,
supra note 53, at 61; Professors Schenk and Oldman use the expression ‘taxable business activity’ to refer to
what is known in Ethiopian VAT legislation simply as ‘taxable activity’; see Schenk and Oldman, supra note
1, at105
120
See Schenk and Oldman, supra note 1, at 90
121
See VAT Proclamation 2002, supra note 4, Article 16
28
Taxpayers must file returns on a regular basis, every month in Ethiopian case.122 There are
regular communications between taxpayers and the government, involving transactions
such as input tax credits, refunds and payment of VAT on outputs.123 For those taxpayers
who have installed ‘sales register machines’, these ‘communications’ now occur in real
time.
All these attributes of VAT indicate that the regime of VAT applies to those taxpayers who
exhibit certain attributes, regularity or continuity of activity being one of them. Certain
transactions may nominally meet the registration threshold (e.g., one time transactions
involving millions of Birr) but they do not attract VAT because they do not meet the
profile of a taxable activity as a ‘continuous’ or ‘regular’ activity. A one-time supplier of
goods or services cannot become a taxpayer for VAT purposes, although that person may
become a taxpayer for purposes of transactional taxes like stamp duties.
In practice, there is a tendency to confuse a taxable activity with taxable transactions, as
amply shown in the Abyssinia Bank case. The counsel for the Bank argued that the sale of
collaterals in foreclosure sales does not constitute a ‘continuous’ or ‘regular’ activity of the
bank. This argument arises from the confusion of taxable transactions with taxable
activities. For application of VAT, the transaction does not have to be continuous or
regular to attract VAT as long as the transaction is carried in the context of a taxable
activity. Setting aside for the moment the argument of whether a bank is exempted from
VAT or not, transaction of foreclosure sales by the bank does not have to be continuous or
regular for it to attract VAT as long as it is supplied by a continuous or regular activity, i.e.,
the bank. The phrase ‘taxable activity’ refers to the bank, and the phrase ‘taxable
transactions’ refers to, among others, foreclosure sales of collaterals. The transaction itself
may be rare or unique in the life cycle of a taxable activity, but that is of no consequence
for VAT. As long as the transaction occurs in the context of a regular or continuous
activity, it is chargeable with VAT no matter how rare.
This distinction was not heeded in the arguments of the parties in the Abyssinia Bank
case, although there is sufficient authority in the VAT laws showing how the two phrases
122
See id, Articles 37-39
123
See id, Articles 20, 21, 26, 27 and 28
29
are different. The VATRs make this distinction abundantly clear. Article 4 of VATRs
seems to anticipate the possible confusions that might arise between taxable activities and
taxable transactions. It states that ‘anything done in connection with the commencement
or termination of a taxable activity’ is also a taxable activity. Sales during liquidations may
be rare or even unique for that business, but they constitute taxable transactions since they
are carried on in connection with a taxable activity, in this case in connection with its
termination. The rarity of the transactions themselves is of no consequence for VAT.
Unfortunately, the confusion is not limited to the Abyssinia Bank case. Apparently stung
by the set back in the Abyssinia Bank case, the Tax Authorities pushed through an
amendment of the provisions in this regard in a bid to do away with the requirement of
‘continuity’ or ‘regularity’ for application of VAT.124 This, we submit, is totally unnecessary.
The requirement of ‘regularity’ or ‘continuity’ is an essential, nay, indispensable attribute
of a taxable activity in all VAT systems, Ethiopia unexcepted. Doing away with the
requirement of ‘regularity’ or ‘continuity’ might mean in the future (if the amendments are
to be taken seriously) that VAT in Ethiopia would apply to one-time transactions by
consumers – turning VAT into transactional taxes like stamp duties. This is contrary to the
nature of VAT. What the Tax Authorities did not realize in pushing through this
amendment is the difficulties involved in bringing consumers into the network of a regular
activity of VAT – registration, input tax credits, etc.
ii. ‘In the course or furtherance of….’

Another requirement in VAT which might engender disputes particularly in the context of
foreclosure sales is the phrase ‘in the course or furtherance of….’. The parties in the
Abyssinian Bank case alluded to this phrase in defending their respective positions. The
counsel for Abyssinia Bank suggested that foreclosure sales are not ‘in the course or
furtherance of’ a banking activity.
The VAT laws do not furnish a general definition for the phrase ‘in the course or
furtherance of…’. Instead, we have several provisions in the VAT laws that enumerate
124
See Value Added Tax (Amendment) Proclamation No. 609/2008, Federal Negarit Gazeta, 15th year, No.
6, Article 2(3).
30
specific instances in which supplies of goods or services might or might not constitute ‘in
the course or furtherance of a taxable activity’. The phrase ‘in the course or furtherance
of…’ might at first be puzzling until we realize that the phrase is intended to capture all the
multifarious forms of supplies ‘in connection’ with a taxable activity. In fact, some laws use
a more genial phrase ‘in connection with…’ to refer to the same requirement.125 Registered
taxpayers may supply goods or services in various circumstances, some of which are
regarded as ‘in the course or furtherance of…’ and others are not regarded as such.
Obviously, supplies of goods or services to customers for value in arm’s length transactions
constitute ‘in the course or furtherance of a taxable activity’. VAT laws are not limited,
however, to the conventional supplies of goods or services to presume that supplies
constitute ‘in the course or furtherance of…’.
The provisions pertaining to the requirement of ‘in the course or furtherance of…’ depart
from our preconceived notions of what might constitute as supplies of goods or services ‘in
the course or furtherance of a taxable activity’. Withdrawals of business goods for personal
consumptions of the taxpayers or family members are considered to be in the course or
furtherance of a taxable activity although we are wont to regard these conventionally as ‘not
in the course or furtherance of a taxable activity’.126 Similarly, the VAT laws presume that
supplies of goods to employees at a discount or for free are supplies ‘in the course or
furtherance of a taxable activity’.127 The only supplies that are not considered to be ‘in the
course or furtherance of a taxable activity’ are those supplies that are not related to or
connected with the business activity, such as sales of personal property by a taxpayer. For
example, if a hotel owner sells his personal vehicle, the supply does not attract VAT even
though the deal may have been struck with a customer of the hotel. Whether a supply is in
the course or furtherance of a taxable activity, of course, depends on the facts and
circumstances of each case.
125
See Section 4003 of the Model Act, in Alan Schenk, Reporter, supra note 40
126
See VAT Proclamation 2002, supra note 4, Article 4(2)
127
See id, Article 4(4); VAT Regulations 2002, supra note 4, Article 3(2); but payment by employers for goods
purchased from third parties does not constitute a supply by the employer in the course or furtherance of a
taxable activity; see VAT Regulations 2002, supra note 4, Article 3(3)
31
Given the expansive meaning proffered to the phrase ‘in the course or furtherance of a
taxable activity’, it is difficult to argue that foreclosure sales by banks are not in the course
or furtherance of a taxable activity. Foreclosure sales easily meet the requirement of ‘in the
course or furtherance of a taxable activity’ both from the vantage point of borrowers (who
as we shall see later on are the real suppliers of goods in foreclosure sales) and banks. VAT
laws are indifferent to the purposes for which or the circumstances under which supplies
are made. As we saw above, even personal consumption of business goods (called
withdrawal of goods for personal consumption) constitutes a supply in the course or
furtherance of a taxable activity. It is of no consequence to VAT that the supplies are made
to pay debts, as foreclosure sales are. Even if we assume that foreclosure sales are supplies
of goods by banks, we can argue that foreclosure sales are ‘in the course or furtherance of
taxable activity’ of banks. But that argument is not necessary at all, for it is the result of the
mis-location of the supply in foreclosure sales.
Apart from the common misunderstanding surrounding the notions of taxable activities
and taxable transactions, we submit that the confusion surrounding foreclosure sales also
arises from the mis-location of the route of the supplies. Both Abyssinia Bank and the Tax
Authorities viewed the transaction as something occurring between banks and third party
bidders. Surprisingly, both the Tax Appeal Commission and the High Court seemed to be
in agreement with the parties in spite of the opposite conclusions they reached. They all
seemed to view foreclosure sales as sales by banks to third parties. That is clearly a
misunderstanding of foreclosure sales. Although banks carry out foreclosure sales, the
transactions occur between debtors and third party bidders, not between banks and third
party bidders. Both the Property and Business Mortgage Proclamations cast the
transactions as occurring between debtors and third party bidders, banks acting merely as
agents.128 The focus of attention for purposes of meeting the requirement of a taxable
activity should therefore be not banks but the business of the debtor. If the activity of the
debtor is a taxable activity, the sale of property in foreclosure sales is a taxable transaction
regardless of whether banks are registered or not, exempted or not. Conversely, if the
128
See Property Mortgage Proclamation, supra note 94, Articles 3 and 5; Business Mortgage Proclamation,
supra note 94, Articles 13 and 15
32
activity of the debtor is not a taxable activity, the sale of property in a foreclosure sale does
not transform the sale into a taxable transaction. Both Abyssinia Bank and the Tax
Authorities were led astray in their arguments because they mischaracterized and mis-
located the route of the transaction as something occurring between banks and third
parties. The Tax Appeal Commission and the High Court joined the chorus of confusion
in characterizing the transactions as occurring between banks and third parties.
This of course does not mean that sales transactions never occur between banks and third
party bidders. In some cases, banks may become direct suppliers (and not mere agents) of
goods. Banks may take over the collaterals as payments of loans and later on sell the
collaterals in public auctions. Both the Property and Business Mortgage proclamations
authorize banks to take ownership of collaterals if the public auctions fail to fetch the price
indicated in bids the second time around.129 These transactions are not foreclosure sales.
Banks sometimes sell their used inventory and stocks (e.g., vehicles) as well as property
claimed from debtors as collaterals. These are taxable transactions too, although they are
not as such related to foreclosure sales.
We recall that Professor Schenk made one exception for cases in which banks (as creditors)
may be said to be suppliers in foreclosure sales (see above). That exception is where banks
as creditors have ‘control over the remittance of the proceeds to the debtor.130 Ethiopian
laws that authorize banks to foreclose debtors’ collaterals do not provide for instances
where banks may control remittances of the proceeds to debtors, but they do provide for
cases in which banks may take over the collaterals in payment of the loan (debt). Even
then, the route of the transaction is not altered. The supply occurs from debtors to banks.
The taxation of this supply, as alluded to before, depends on whether the debtor is a
taxpayer under VAT. If the bank sells the collateral in a public auction, the supply will now
become a supply by the bank to a third party. This sale in a public auction or for that
matter any type of sale is a taxable supply. The argument that the banks are exempted for
their financial services does not have much traction in such cases.
129
See Corrigendum, supra note 104 and Business Mortgage Proclamation, supra note 94, Article 13
130
See Alan Schenk, supra note 40, at 181
33
8. Banks as Agents in Foreclosure Sales and Application of VAT to Agents
We have concluded so far that supply of goods in foreclosure sales is a case of banks acting
as agents of borrowers to sell goods to third parties. This does not let banks completely off
the hook of VAT obligations. We need to examine a few more provisions of the VAT laws
of Ethiopia to check whether banks are obligated as agents to collect VAT on foreclosure
sales.
Both the VATP and VATRs deal with cases of supplies of goods by agents. An agent is
defined in the VATP as ‘any person who acts on behalf of and on instruction from another
person’.131 Unless we argue that the agency function of banks in foreclosure sales does not
square with the strict definition of agents in VAT law, we must be prepared to apply the
rules of VAT pertaining to agents to banks as agents.132
The VATP presumes that supplies by agents are supplies made by principals except in two
cases.133 The first case involves ‘services rendered by an agent to the principal’.134 Here the
VAT law presumes that the supply is made by an agent. It is not hard to imagine why that
is the case. In truth, the supply is made by the agent, not qua agent but as principal. Hence,
if an agent charges the principal for her service as agent, the supply is made by the agent to
the principal, not qua agent but as principal.
The second exception involves an agent who supplies goods or services on behalf of a
principal who is not a resident of Ethiopia.135 Here, too, the VATP presumes that the
supply is made by the agent in Ethiopia. Again, it is not difficult to imagine why there is
this exception. The presumption that a supply by an agent is a supply by the principal is
unworkable in such cases. Since the principal is not a resident of Ethiopia, it is pointless to
stipulate that the principal is a supplier when it is known that Ethiopian tax jurisdiction
cannot reach the principal. It is the agent who is accessible to Ethiopian tax jurisdiction
131
VAT Proclamation 2002, supra note 4, Article 2(2)
132
While banks may be said to act on behalf of borrowers in foreclosure sales, they do not do so on the
instructions of borrowers. Foreclosure sales typically occur against the interests or in the face of objections of
borrowers.
133
134
135
34
and it is therefore the agent who should remain answerable for all obligations arising from
VAT in such cases.
In any event, we have established the general rule that supplies by agents are considered to
be supplies by principals. That being the case, we need to figure out what that means for
both the principal and the agent, and what their respective obligations are in transactions
chargeable with VAT. Whatever obligations agents may assume in VAT, we must
remember that the obligations of agents are contingent upon the obligations of principals.
In general, it may be stated that where principals have no obligations, nor should agents.
Where principals have obligations in VAT, agents qua agents have a number of obligations
in VAT. One of these obligations is the obligation to issue VAT invoices for the supplies.
Article 13 of VATRs authorizes (in effect obligates) agents to issue a VAT invoice to
purchaser of goods where the purchaser is a registered person.136 Since both the principal
and the agent are required to issue invoices, this may lead to the issuance of double VAT
invoices. The VATRs anticipate this problem and prohibit the principal from issuing VAT
invoices where the agent has issued one, and vice versa.137 Where no invoice is issued for
the supply either by the principal or the agent, the agent and the principal will be held
liable (probably jointly and severally). In practice, the proximity of the agent to the
purchaser of the goods means that it is the agent who should issue VAT invoice for the
supply. In any event, it is clear that the agent has an obligation of issuing VAT invoices for
the supply that s/he makes for the principal. Foreclosure sales by banks are transactions by
banks as agents on behalf of principals – borrowers. Banks have all the obligations
incumbent upon agents in VAT. Whether banks should register for VAT in order to
account for VAT in foreclosure sales is quite another matter, and we shall explore below
whether that is necessary.
9. Should Banks Register for VAT for Foreclosure Sales?
Registration performs certain administrative functions in VAT. It is primarily designed to
provide government with the necessary information needed to assess and collect VAT from
136
See VAT Regulations 2002, supra note 4, Article 13(1); the phrase ‘where the purchaser is a registered
person’ appears to be superfluous.
137
See ibid
35
taxpayers.138 Registration is what brings businesses within the network of VAT
administration. Those businesses that are registered for VAT are required to perform
certain duties from time to time, like issuing invoices on transactions, collecting the VAT
due and transmitting the proceeds to the government.139 Those who are registered are also
entitled to certain privileges not available to unregistered persons. The most important
privilege is the right to obtain tax credits for VAT paid on purchases or inputs.140
Even if we agreed that VAT is due on foreclosure sales, it is by no means settled that banks
should therefore register for VAT – despite the clamor to get the banks registered for VAT
on account of the sales they conduct in foreclosures.141 Thankfully, the answer to this
question of registration is made considerably easier by the characterization of foreclosure
sales as supplies of goods by debtors through the agency of banks to third party bidders
(this is a typical route of foreclosure sales). As already emphasized, VAT is due if debtors
are registered taxpayers or required to be registered for VAT. Conversely, VAT is not due
upon foreclosure sales, if the debtor involved is not registered or required to be registered
in the first place. This contains with in it the solutions we are to seek on the question of
registration.
If debtors are registered for VAT, there is no reason why banks are to register for VAT to
account for VAT in foreclosure sales. Banks should use the registration identity and
certificate of debtors to account for VAT during foreclosure sales. They should use the
VAT invoices of debtors to collect VAT and account for the proceeds to the government.
We have already asserted that banks are agents in foreclosure sales. To be sure, agents may
be required to have their own registration in VAT,142 but we submit that registration is not
required of banks in order for them to account for VAT during foreclosure sales. The
circumstances under which banks operate in foreclosure sales make registration pointless.
Banks represent disparate numbers of debtors (some registered and others not) in
138
See Schenk and Oldman, supra note 1, at 90-91
139
See VAT Proclamation 2002, supra note 4, Articles 20 and 22
140
See id, Article 21
141
See Mahlet Mesfin, Kirubel Tadesse, Getahun Worku and Tilahun Aklilu, supra note 8
142
See VAT Proclamation 2002, supra note 4, Article 2(11), where a person is defined as any natural person,
sole proprietor, body, joint venture, or association of persons (including a business representative residing and
doing business in Ethiopia on behalf of the principal) (italics mine)
36
foreclosure sales and it does not make any administrative sense to require them to register
for VAT when they act as agents for multiple debtors in different foreclosure sales.
Requiring banks to register for VAT complicates the administration of VAT in foreclosure
cases. As we shall examine below, the imposition of VAT upon foreclosure sales is not a
simple affair of slapping the sales with the VAT rates (15% in Ethiopian case). There are
additional tasks involved, such as the computation of input tax credits. Since the supplies
in foreclosure sales occur from borrowers to purchasers, it makes little sense to require
registration of banks, when all we need (and should care about) is the registration of
borrowers by whom the supplies are made.
The tax authorities may be worried about possibilities of tax evasion or tax avoidance by
banks and borrowers. But the conventional registration is a not a solution to these
problems. The tax authorities may use other administrative devices to hold both banks and
borrowers accountable for charging VAT on foreclosure sales. We have already seen that
banks and borrowers are jointly and severally liable for issuing VAT invoices on foreclosure
sales. There are severe penalties in the VAT laws against those who fail to issue VAT
invoices when they are required to do so.143If these are not deterrent enough, the Tax
Authorities may use well-known administrative devices to ensure that VAT is effectively
chargeable on bank foreclosure sales. One commonly used device is to require banks to
furnish detailed information to tax authorities on foreclosure sales and the names of
borrowers whose securities have been sold in foreclosure sales. These additional
precautionary measures are in reality not necessary because banks should be motivated to
charge foreclosure sales with VAT for fear of the penalties that attach in the event of their
default.
In sum, the tax authorities may hold banks to account using other administrative devices,
but the conventional registration should not be one of them. The clamor for registration of
banks for accounting for VAT in foreclosure sales is yet again another misunderstanding of
the nature of VAT, the scope of VAT exemptions for financial services and the nature of
foreclosure sales.
143
See VAT (Amendment) Proclamation, supra note 124, Article 50(b)
37
While registration of banks is clearly neither a solution nor necessary for purposes of
taxation of foreclosure sales, this should not be seen as a blanket exemption of banks and
other financial institutions from the obligation of registration for VAT. As pointed out
above, banks and other financial institutions may supply a number of taxable services
which require registration for VAT. Banks may provide payroll, accounting, auditing,
management, advisory and trust services for fees. Banks may also provide safe keeping
services, again for fees. These services are taxable under the VAT laws. It is therefore
paramount that banks and other financial institutions are registered for VAT in order for
them to account for VAT on these services. Banks and other financial institutions may
contest or resist moves for registration on the ground that the value of these services do not
exceed the registration threshold (currently 500, 000 ETB). Many in the past have resisted
registration on this ground before (in fact, most of the disputes between tax authorities and
taxpayers have arisen from those taxpayers who believed that their annual turnovers do not
reach the registration threshold).144
But in the case of financial institutions, this argument should have no traction whatsoever.
The basic rationale for VAT registration threshold is administrative. It is generally assumed
that those businesses whose annual turnovers exceed a certain threshold possess the
administrative capacity to comply with the recording and accounting requirement of VAT,
such as the capacity to issue VAT invoices. The threshold is set at a fairly high turnover
solely on this ground. In the case of financial institutions, few would dispute that these
institutions have the capacity to comply with VAT, regardless of the total volume of taxable
supplies in a year. Given the high capital requirements for financial institutions in this
country, it should be presumed that all financial institutions possess the capacity for
complying with VAT obligations regardless of whether their core financial services are
exempted from VAT.
144
The Tax Authorities have resorted to presumptive registration schemes in the past in part in order to
forestall the arguments of some taxpayers that their annual turnovers would not cross the registration
threshold. Many businesses were ordered to register for VAT based on a presumption that the volume of
transactions in these types of businesses exceeds the half a million ETB threshold. These business include:
jewelry stores, computer stores, flour factories, etc; see Ministry of Revenues, FDRE, Ref. No.
01/A29/306/45, Sene 17, 1995 E.C, in Amharic, unpublished; see also Mahlet Mesfin, Ambiguous VAT
Registration Leaves Bitter Taste, Addis Fortune, vol. 12, No. 575, May 8, 2011
38
If they know anything about how VAT operates, financial institutions should not resist
calls for registration at all; in fact, they should call for it. Although they should collect VAT
on their taxable supplies, they should also realize that they are entitled to tax credits on
inputs attributable to their taxable supplies.145 Financial institutions will be entitled to tax
credits only if they are registered for VAT. The entitlement to tax credits should provide
them with incentive enough for registration.
10. VAT Invoicing in Foreclosure Sales: VAT Exclusive or Inclusive
Invoices?
As they contemplate collecting VAT on foreclosure sales, banks are confronted by twin sets
of problems or challenges. The first is how to apply VAT on foreclosure sales that have
already occurred without or prior to the knowledge that these sales carry VAT. The second
is how to apply VAT on foreclosure sales after the knowledge that these sales carry VAT.
Although the (political) will of the Tax Authorities to enforce VAT upon foreclosure sales
that have already occurred is yet to be seen, the circular letter cited above clearly indicates
the intention of the Authorities to collect VAT from foreclosure sales that have already
happened (over the past eight years if we start from the beginning).
It is necessary to keep the two situations apart for purposes of analyzing how VAT may be
imposed on foreclosure sales. Before we examine how VAT applies to the two sets of
situations, we need to review how VAT is computed in general.
VAT can be computed exclusive or inclusive of the tax itself.146 We are accustomed to the
VAT exclusive of the price, with tax invoices showing the price of the good separately from
the VAT. So with a 15% VAT rate, a 100 ETB good will be sold for a total of 115 ETB, 15
ETB being exclusive of the price of the good. This method of computing VAT is (or should
be) followed in all transactions where VAT is clearly known to apply and where it is easy to
apply VAT this way.
VAT may also be computed inclusive of the tax, which is expressed in a formula:
145
146
See Schenk & Oldman, supra note 1, at 32
39
Hence a price inclusive of VAT in the above example would yield the following result:
This method ensures that the taxpayer who uses VAT exclusive method and the taxpayer
who is subject to the VAT inclusive method are both subject to the same tax rate (15% in
the above example) and collect the same amount of tax (15 ETB in the example).
The VAT inclusive method is not recommended on transparency grounds. However, it
may become unavoidable in some cases. There are instances where a taxpayer may not have
issued VAT exclusive invoices to buyers. In the above example, a taxpayer may have sold
the good for 115 ETB inclusive of VAT. In that situation, it will be unfair to the taxpayer
(and an over taxation) to impose 15% VAT upon the 115 ETB as if 115 ETB were
exclusive of VAT.147 Imposing a VAT 15% upon an already sold good yields in this
example 17.25% ETB, requiring the supplier to remit to the government 2.25 more than
he could have collected from the purchaser. The VAT inclusive method of calculation
ensures that the VAT remains the same whether the goods are sold exclusive or inclusive of
VAT.
We have reason to contemplate applying VAT inclusive method in foreclosure sale cases.
There are two compelling reasons why VAT inclusive method becomes the preferred
method of computation in the context of foreclosure sales. The first is for foreclosure sales
that have already occurred. For these sales, it is too late to apply VAT exclusive method for
the simple reason that the sales have already happened. We cannot expect banks to recall
the winners of the bids in foreclosure sales and account for the VAT due on the sales. To
require banks to pay the VAT as if they collected the VAT from the sales would be to
assume that VAT is a direct tax obligation of the banks (which it is not). On a 100 ETB
good, a 15% VAT is not 15 ETB (as the VAT exclusive method would indicate) but about
147
If penalties are to be imposed, they should be calculated separately
40
13 ETB, which comes as a result of the application of the VAT inclusive method of
computation.
In the practices of the Ethiopian Tax Authorities, there is a tendency to apply the VAT
exclusive method regardless of the circumstances of the case. This is clearly a
misunderstanding of how VAT operates and what the tax means. In foreclosure sales that
have already occurred we cannot apply (without grievous injustice) the VAT exclusive
method. The VAT inclusive method is the only fair method that should apply in such
instances.
Even in foreclosure sales that have occurred after banks realize that these sales carry VAT,
we may need to employ the VAT inclusive method if the bidders are not informed in
advance that the bid prices are exclusive of the VAT. Otherwise, slapping the sales with
VAT will constitute an unwelcome surprise, something that the bidders have not bargained
for. Since foreclosures typically occur in public auctions, the application of VAT upon the
bid price may depress the bid market and discourage bidders from bidding up to the full
price of the goods sold. In anticipation of the VAT, bidders may be forced to underbid in
public auctions. Of course, all attempts must be made to inform bidders in advance that
the bid prices are exclusive of the VAT, in which case the VAT exclusive price would be
appropriate.
The VAT inclusive method encourages bidders to bid without restraint in expectation that
what ever price they bid for, that price includes the VAT in it. It frees the bidding process
from the fear of VAT being applied after the auction has been closed. Tax invoices may
still be issued in the VAT inclusive method, by putting the price separately from the VAT,
with the price now lower than the whole bid price. There is nothing extraordinary about
this practice. Even in the VAT exclusive world, we are accustomed to being informed the
VAT inclusive price when we shop for goods and services in the market. When we eat at
restaurants, the menus at the restaurants usually show the VAT inclusive price of the food
even though when the invoice arrives, we are able to see the VAT exclusive price.
In sum, the VAT inclusive method of VAT computation is the only way out if banks are to
be asked to pay VAT on foreclosure sales they conducted before they realized VAT was
due. We cannot apply the VAT exclusive method of computation on sales that have
41
already occurred. We cannot also, without distorting the very notion of VAT, apply the
VAT exclusive method of computation in a foreclosure sale where the bidders are not in
advance informed that the bid price is exclusive of VAT. The imposition of VAT after the
foreclosure sales have been closed will obviously take bidders by surprise and might even
derail the process of foreclosure sales in the future.
11. Input Tax Credits in Foreclosure Sales
An argument for taxation of foreclosure sales is only the beginning of the process. Even if
we were to agree that foreclosure sales attract VAT (in cases where the debtor is a registered
person), we must permit credits for input taxes paid on the acquisition of the goods now
being sold through foreclosures. The VAT laws require full credits for input taxes paid on
taxable supplies, and foreclosures sales should be no different. Even if banks are collecting
VAT on the outputs (foreclosure sales), they are not under obligation to transmit the whole
to the government. They are entitled (or the debtor is) to claim input tax credits for VAT
paid on the acquisition of the property now being sold through foreclosures. Now that
banks realize VAT may be due on foreclosure sales, they should adjust their business
transactions with borrowers and insist on getting the input VAT paid on goods they hold
as collaterals, for their capacity to obtain input tax credits depends on this. Let’s take an
example to illustrate this point. Suppose ABC Bank foreclosed a taxable supply of goods
for a bid price of 4 million ETB exclusive of VAT. The Bank, as an agent, is required to
issue invoice on behalf of the debtor on the sale price. The output tax on the foreclosure
sale is 15% x 4 million ETB, which is 600,000 ETB. Suppose the debtor acquired the
goods for 3 million ETB, exclusive of VAT. The input tax paid on the goods is therefore
15% of 3 million ETB, which is 450,000 ETB. The Bank is required to pay the difference
to the government, which is 150, 000 ETB. 148
148
Sometimes, a bank may sell a business as a going concern. In VAT, the sale of a business as a going
concern is zero-rated. A transaction which is zero-rated when a debtor sells his business directly is also zero-
rated when the bank sells the business as a going concern. When that happens, the bank is entitled to a full
refund of the input tax paid on the business being sold as a going concern. Of course, the bank charges zero
on the output of the sale of the business as a going concern; see VAT Proclamation 2002, supra note 4,
Article 7(2)(d)
42
In order to expedite the process of input tax crediting, banks should make it their business
to require borrowers to surrender input VAT invoices along with the collateral or the title
to the collateral. Otherwise, banks risk delays in their bid to obtain input tax credits upon
the properties they sell in foreclosure proceedings. Or even worse, borrowers may manage
to obtain input tax credits while the collateral is in the possession of banks. Once tax
credits have already been claimed by borrowers, the Tax Authorities will be hard put to
grant tax credits to banks upon sale of collaterals by banks.
Now that banks are aware of the VAT consequences of foreclosure sales, they should insist
on surrender of VAT invoices showing evidence of payment of VAT upon collaterals now
held as security.149 Where the property involved has a separate VAT invoice when it was
acquired or purchased by the borrower, the computation of VAT is a simple affair of
calculating VAT upon output and deducting the input tax from the VAT due on the
output. In the Abyssinian Bank case, for example, the input VAT invoices consisted of the
input VAT paid on tires when they were imported by Tana International (the borrower).
All that Abyssinia Bank could have done was to deduct the input VATs paid on the
importation of tires from the output VATs due on the sale of the tires in foreclosure
proceedings.
However, it is not often that separate invoices are issued for acquisition of goods. What if,
for example, the borrower manufactured the collaterals, not purchased or imported them?
Ordinarily, we should not be concerned about this issue in other sales because the taxpayer
who sells the goods is also the taxpayer who requests the tax credits in respect of the goods.
In the case of sale of goods in foreclosure proceedings, however, we have a situation where
the bank and the borrower may concurrently request input tax credits.
The difficulty of allocation should not lead to denial of the input tax credits altogether.
Instead, some solutions must be sought – solutions that are acceptable to all parties
involved: the Tax Authorities, borrowers and banks. One solution is the application of
allocation formula that is applicable in cases where taxpayers make mixed supplies of
149
Of course, the sale of the collateral may be exempt because the property in question is exempted from
VAT even when it is sold directly by the borrowers. In that case, banks need not worry about VAT invoices as
the foreclosure sales of such collateral would also be exempted from VAT.
43
taxable and exempt goods.150 To the extent practicable, this solution should be pursued as
it entails little or no additional administrative requirements upon the parties.
Another solution is to impose some administrative duties upon borrowers and banks to
ensure that no double tax credits are obtained. Borrowers that give merchandise or any
other property as security may be required to furnish the Tax Authorities with information
regarding the granting of property as security so that input tax credits in respect of the
collaterals are suspended until such time the collaterals are sold in bank foreclosures or
redeemed to borrowers upon payment of the loan. This solution prevents the taking of
input tax credits by borrowers prior to the sale of the collaterals. It also ensures that banks
and not borrowers take input tax credits in respect of properties sold through foreclosure
proceedings.
12. Priority Issues in Bank Foreclosure Sales

Even after taxation of foreclosure sales is settled, banks may claim priority of payment over
the collaterals sold in foreclosure sales. One of the arguments the counsel for Abyssinia
Bank raised was that the Bank had priority of payment even if it were conceded that
foreclosure sales carried VAT. The claim of priority of payment is strictly speaking not an
argument against taxation of foreclosure sales. As shown in the Abyssinia Bank case, banks
may raise ‘priority’ of secured creditors in the event that the argument against taxation of
foreclosure sales fails. Since the claim of priority is likely to persist in future cases, it is
appropriate to address the question of priority in the context of foreclosure sales. Once the
government has made a case for taxation of foreclosure sales, it is still confronted with the
burden of overcoming issues of priority of tax claims vis-à-vis the claims of other creditors,
particularly creditors secured by the collateral.
Before we address the issue of priorities in the context of foreclosure sales, we shall review
briefly the issue of priorities of tax claims under Ethiopian laws. The priority of tax claims
vis-à-vis other claims (including the claims of secured creditors) was a staple of controversy
in a number of court cases pitting especially secured creditors (e.g., banks) and tax
150
See VAT Proclamation 2002, supra note 4, Article 21(2)(c)
44
authorities.151 The tax laws of Ethiopia issued in 2002 partly put the controversies to rest by
clarifying the position of tax claims vis-à-vis secured creditors.152 The tax laws of Ethiopia
distinguish two types of taxes for purposes of priorities.
There are, on the one hand, taxes which are required to wait in line in the order of
priorities among competing claims of creditors. We may call these ‘priority-prone’ taxes.
These are taxes which are directly claimed from taxpayers in which the taxpayers stand as
debtors. These taxes are mostly the so-called direct taxes. Taxes like profit taxes claimed
from the income of businesses are directly claimed from businesses as debtors. The
taxpayers are at once taxpayers and debtors. The government in these instances is required
to stand in line and wait until creditors with superior rank are paid. The tax laws of
Ethiopia accord priority to tax claims but subordinate these claims to the claims of secured
creditors over their collaterals.153
There are, on the other hand, tax claims which taxpayers are assumed to collect from
others and hold in trust for the account of the government. We may call these ‘priority-
immune’ taxes. These are mostly indirect taxes and direct taxes collected through
withholding schemes. These types of taxes are not subject to competition with the claims of
other creditors of the taxpayer. In other words, the tax authorities enjoy absolute priority
rights in respect of these taxes.
Ethiopian tax laws are not consistent in this regard, but at least in one respect, there is a
specific reference to some of these taxes and the language of the law is emphatically for
exception of ‘priority-immune’ taxes from the rules of priorities. The Income Tax
Proclamation (of 2002) provides that taxes withheld for the account of the government by
taxpayers are not subject to the rules of competition and must be paid to the government
151
See Taddese Lencho, Ethiopian Bankruptcy Law: Commentary, Part II, J. Eth. L., vol. 24, No. 2, at 61-72;
see also Inland Revenue Authority vs. Fissehaye W/Gebriel, Housing and Thrift Bank and Addis Ababa Abattoirs,
(Supreme Court, Civ/App. No. 13/1984), in Supreme Court Cases, Vol. 3, in Amharic, at 595-598;
Commercial Bank of Ethiopia vs. Inland Revenue Authority,(Supreme Court, Civ./App. No. 562/69), in Supreme
Court Cases, Vol. 1, in Amharic), at 17-18
152
See VAT Proclamation 2002, supra note 4, Article 32(1); the Turnover Tax Proclamation, supra note 3,
Article 14, and the Excise Tax Proclamation No. 307/2002, Federal Negarit Gazeta, 9th year, No. 20, Article
11(1)
153
See ibid
45
no matter how many other creditors the taxpayer might have.154 In these instances, it is as if
the tax authorities have already appropriated the tax proceeds, the only thing remaining
being the collection of these taxes from the taxpayer. Different organizations or institutions
(e.g., government bodies, NGOs, etc) are required by income tax laws to withhold taxes
from payments these organizations or institutions make for purchase of goods and
services.155 Similarly, most employers are required to withhold income taxes from salaries,
wages and other emoluments of employees.156 These withholding agents hold the taxes
withheld in trust and for the account of the government. The taxes are neither theirs to
keep nor for other creditors to claim. They are, in other words, not subject to competition
of priority by other creditors of employers or other withholding organizations.
The tax laws only make specific mention of withholding taxes, but an equally strong case
can be made for indirect taxes like VAT, which are after all collected from consumers by
businesses in trust and for the account of the government. Particularly with respect to
VAT, there are a number of provisions which support the idea that the taxpayers in VAT
are mere collection/withholding agents.157
The businesses that charge VAT whenever they make supplies are withholding the VAT
from purchasers on behalf of and for the account of the government. In that sense, it may
be argued that the VAT collected in foreclosure sales (or for that matter of any sales)
should never be subject to the rules of priority no matter how anxious banks are to cast
these taxes as such to obtain superior advantage over the tax claims of the government over
foreclosure sales.
Unfortunately, due to the mindless and careless reproduction of certain rules of the
income tax in other taxes like VAT, we have rules which lump VAT with direct income
taxes in this regard, contrary to the real nature of VAT. The rules which assert the priority
of secured claims against tax claims are reproduced verbatim in the VATP and other
154
See Income Tax Proclamation No. 286/2002, Federal Negarit Gazeta, 8th year, No. 34, Article 82
155
Id, Articles 52, 53, and 54; see also Council of Ministers Income Tax Regulations No. 78/2002, Federal
Negarit Gazeta, 8th year, No. 37, Articles 24 and 25
156
See Income Tax Proclamation, supra note 156, Articles 51 and 65
157
See VAT Proclamation 2002, supra note 4, the preamble which states that VAT is a consumption tax; see
also Articles 21(5) and 22
46
indirect tax Proclamations of Ethiopia.158 If Banks raise these arguments of priority,
therefore, they cannot be blamed for the laws actually support their arguments in this
regard. The income tax rules of priority are reproduced in VAT and other indirect tax laws
of Ethiopia without proper understanding the real differences between these taxes.
Properly speaking, however, the collection of VAT by banks from foreclosure sales should
never become a subject of priority battles. Banks, like all other sellers, hold the VAT in
trust and for the account of the government and should transmit what they collect without
any question of priority.
13. Other Forms of Foreclosure Sales and VAT: Judicial Foreclosure, Tax
Foreclosures
The debate over taxation of foreclosure sales is not confined to bank foreclosures, although
the Tax Authorities have so far focused on this type of sale, presumably because of the
sheer volume of the sales in this regard. Courts are also involved in foreclosure sales during
execution of judgments (judicial foreclosure) and there is no reason why attention may not
be drawn to these sales as well, now that we know the status of foreclosure sales in VAT.
The situation may even come home to roost, as the tax authorities are also empowered by
various tax laws to enforce taxes, if need be, by foreclosing upon the property of defaulting
taxpayers.159 The tax authorities have so far used this power (of foreclosure) sparingly, but
they should remember to impose VAT upon these sales when the debtor happens to be a
registered VAT payer.
So while attention has so far been drawn to bank foreclosure sales, it is important to
remember that the insights developed in bank foreclosure sales may be extended with
equal force to all other forms of foreclosure sales: judicial foreclosure sales, tax foreclosure
sales, and others.
14. Is Exemption a Good Thing for Financial Institutions?
The exemption of financial services is often painted in black and white terms by opposing
camps to the argument for or against taxation of foreclosure sales, and, as often happens in
158
Id, Article 32; Excise Tax Proclamation, supra note 154, Article 11; Turnover Tax Proclamation, supra
note 3, Article 14
159
See Income Tax Proclamation, supra note 156, Article 77
47
such cases, the real issues involved are often lost in the din of arguments. Those who
oppose taxation of foreclosure sales are convinced that the imposition of VAT upon these
sales will depress the foreclosure market and even eat into the secured transactions
currently protecting banks against risks of defaulting borrowers. In one newspaper article
opposing the taxation of foreclosure sales, one writer suggested a number of ‘negative’
consequences of taxation of foreclosure sales.160 He expressed fear that banks might not be
able to recover loans from defaulting borrowers now that they have to share the proceeds
(the spoils) with the government. He also feared that the taxation will force banks to let
borrowers sell the property through private sale arrangements.
We submit that these fears are exaggerated and unfounded. The fears assume a static world
in which banks remain indifferent to the changing situation around them. No one can or
should underestimate the ability of banks to assess the risks of non-payment and default.
Their core specialization consists of risk assessment and little else. It would be difficult to
believe that banks will fail to assess the risk properly because some foreclosure sales are
now slapped with VAT. It is likely that banks will factor the VAT into their pricing of the
collaterals they accept in exchange for extension of loans to borrowers. They will probably
cushion themselves against risks of under-security by requiring borrowers to give collateral
with a value greater than the basic loan owed by borrowers so as to cover the additional
costs of VAT. We can be certain that banks will adjust to the imposition of VAT upon
foreclosure sales. In stead of VAT depressing and disrupting foreclosure markets, therefore,
we must expect the markets to internalize new information and function as normally as
ever before.
If banks understand the nature of VAT, they will not revert to requiring borrowers to sell
collaterals through private sale arrangements, as some have suggested. This suggestion is
based on a false premise that those private sale arrangements are beyond the reach of VAT.
As we saw previously, regardless of how the sales are carried out – private sale or public
sale, foreclosure sale or no foreclosure sale, the sales attract VAT. In fact the sales attract
VAT precisely because they are carried out by borrowers, and not banks. The conclusion
160
See Getahun Worku, supra note 8
48
that private sales are beyond the reach of VAT arises from the misconception that the sales
are carried out by banks.
Since many of the negative reactions to VAT arise from the misconception about the
nature of VAT exemptions, we shall examine the impact of VAT exemptions upon
financial institutions in general to clear up some of the common misconceptions that
persist in the debates about taxation or exemptions of financial services.
The exemption of some financial services is not as positive as it is sometimes supposed.
The exemption means that banks and other financial institutions are not entitled to tax
credits on their inputs (purchases of computers, etc),161 something they could have claimed
as a matter of right if their supplies were taxable supplies. As result, financial institutions
provide most of their financial services loaded with un-creditable input taxes, which puts
the recipients of these services at a competitive disadvantage. Businesses that purchase
financial services are not entitled to tax credits for VAT embedded in financial services, as
these taxes are not even allowed to be shown in the transactions. Businesses which receive
their inputs from taxable sectors are entitled full tax credits for VAT paid on their inputs.
That puts those businesses which use financial services as inputs at a competitive
disadvantage. Banks and other financial institutions may vociferously object to applications
of VAT to their services, but they should realize that exemption is not necessarily to their
advantage.
The current VAT treatment of financial institutions forces financial institutions to be
excluded from the benefits of VAT (input credits) while requiring them to register for VAT
on their taxable supplies. The fact that some of their services are exempted from VAT has
not exempted them from the requirement of registration. Financial institutions are
required to register and account for VAT on their taxable supplies. Financial institutions
are required to maintain detailed records on their taxable supplies. Because financial
institutions are exempted on some of their supplies, they are required to maintain more
detailed records than otherwise in order to be able to distinguish their taxable supplies
from exempted supplies.162 Input taxes related to the production of regularly taxed
161
See Harry Huizinga, supra note 41, at 499
162
Ibid
49
financial services are creditable while input taxes paid on exempt financial supplies are not
creditable.163 This is administratively burdensome to financial institutions. They have to
determine which inputs are used for what – track the actual use of inputs in their
production processes. Since most inputs are used to produce both exempt and taxable
supplies, it is difficult to track them separately, making the VAT regime more of an
onerous requirement to financial institutions than is normally the case.164
Another negative consequence of exemption of financial services in VAT has been
litigation. The extent of the exemption has already generated considerable litigation in EU
member states.165 Some of the disputes relate to the status of services outsourced by
financial institutions while others are about the proper allocation of a business input tax
between taxable and exempt supplies.166 We shall look no farther than some of the
controversies outlined in this article to demonstrate that exemption of financial services
and taxation of some other services of financial institutions leads to controversies. The
controversies so far generated in Ethiopia regarding the scope of VAT exemption are
indicative of the level of disputes that might arise in the future.
Exemption of some financial services (with the denial of input tax credits) has also been
said to encourage vertical integration of operations.167 A financial institution is denied
input tax credits for taxes paid on its purchases from other businesses (including
importers). If the financial institution is able to supply these purchases from its in-house
operations (in other words, self-supply some of its inputs), it will not be subject to tax on its
inputs. A bank may, for example, choose to hire its own security staff, in stead of
outsourcing (which brings with it the danger of VAT, if we can regard VAT as a danger)
from the firm that provides security services. The Bank may also choose to create its own
‘IT services unit’ instead of outsourcing the service to an outside IT firm which will then
charge VAT on its IT supplies. If the bank is able to self-supply these services, it will escape
taxation of some of its inputs. This is of course not desirable as it will distract banks and
163
Id, at 509; see also VAT Proclamation 2002, supra note 4, Article 21(2)
164
See Harry Huizinga, supra note 41, at 509
165
166
Ibid
167
Id, at 43
50
other financial institutions from their core operations and force them to engage in some
tax planning activities which are not productive to the economy.
Conclusion and Recommendations

The question of whether foreclosure sales are taxable transactions turns on whether the
debtor/borrower is a registered person. The context in which the sale occurs (i.e., loans)
remains exempted from the reach of VAT as the underlying relationship between a bank
and a borrower is not changed or affected by the enforcement of the debt through
foreclosure. Foreclosure sale constitutes a continuum of actions that a bank takes to
enforce the terms of the financial contract. As a bank takes action to collect the debt
directly, a bank also takes action to foreclose on collaterals. In both cases, a bank is simply
enforcing the terms of the financial contract and remains within the confines of
intermediation. The intermediation nature of the transaction is not changed because a
bank has resorted to or has been forced to sell property in order to enforce the payment of
the loan along with the interest.
All the arguments marshaled so far to find exception for taxation of foreclosure sales
constitute varying levels of misunderstanding regarding the real nature of the transactions
involved and their relationship with the underlying financial services provided by banks.
The disputes, however, point to the possible escape routes by debtors from VAT when
collaterals are sold through foreclosures: judicial or contractual. The Tax Authorities
should watch out for these escape routes, for it is not often that people think of these
transactions are supplies taxable under the VAT regimes. Many of the bank foreclosures
probably involve the sale of business assets by debtors who are registered taxpayers. These
must be pursued vigorously. If the businesses themselves sell these assets, they are subject to
VAT. There is no reason why they should escape taxation simply because the business
assets are sold through bank foreclosure.
At the same time, bank foreclosures may also involve sale of assets which are not subject to
VAT under normal circumstances. Borrowers give all kinds of property as security for
payment of loans, including their personal property. A bank that sells a residential property
is not selling a property that is subject to VAT if the sales were made by the owner directly.
51
There is no reason why a sale that is exempted when made by the owner should be taxable
when it is made by the intermediary (the bank). A bank may also sell business assets of a
borrower who is not registered or who ought not to have been registered for VAT. The sale
would not have attracted VAT had the borrower herself sold the assets, and there is no
reason why the mere sale of the same assets by the intermediary should attract VAT. As the
Tax Authority should watch out for the possible avoidance of tax in foreclosure sales, it
should also be careful not to slap a transaction with VAT otherwise non-taxable or
exempted under ordinary circumstances.
In general, we must cast foreclosure sales as transactions between borrowers and winning
bidders, with banks acting merely as agents. Placing the locus of the supply in that of
borrowers sets the stage for whether VAT attaches at all and how VAT is to be chargeable
upon foreclosure sales. If a transaction is chargeable with VAT when borrowers supply the
goods, banks should ensure that VAT is charged upon foreclosure sales. The obverse is also
true. If the transaction is not chargeable with VAT when borrowers supply the good (e.g.,
where the supply pertains to collateral by a borrower who is not or should not be registered
for VAT), banks that sell the good in foreclosure sale need not charge the transactions with
VAT.
As agents, banks are required to discharge certain obligations under Ethiopian VAT laws.
They are required to issue VAT invoices for the foreclosure sales chargeable with VAT.
Their identity as agents persists when banks perform certain obligations on behalf of
borrowers in foreclosure sales. As agents, banks should issue VAT invoices in the name
and on behalf of borrowers. If they are not in possession of the requisite invoices, it is
incumbent upon them to get those invoices from borrowers, preferably at the time of
taking possession of the collaterals as security.
Their identity as agents persists also for purposes of registration. In spite of all the clamors
for registration, it must be clear by now that banks should not be required to register for
VAT in order to collect VAT on foreclosure sales. Banks should use the registration
identity of borrowers in the course of charging foreclosure sales with VAT. While
registration is the gateway to obligating suppliers to charge their supplies with VAT, it is
unnecessary for foreclosure sales. The tax authorities are understandably wary of any
52
prescription that dispenses with registration – their way of keeping track of what registered
taxpayers do. In lieu of registration of banks (which is clearly not a solution for foreclosure
sales), the tax authorities may use other schemes to ensure that banks (along with
borrowers) charge foreclosure sales with VAT. One solution suggested in the body of this
article is requiring banks to report their foreclosure sales – including those that do not
attract VAT. The tax authorities may use these reports to keep track of the activities of
banks in this regard and hold them to account for VAT whenever they fail to do so. This,
it must be remembered, is in addition to the deterrent measures already in place in the tax
laws, i.e., penalties.
It is, however, important to caution against reading too much into this exemption from
registration. As a general matter, banks and other financial institutions should be required
to register for VAT (regardless of the volume of their annual taxable transactions), but this
is quite a different matter from requiring them to register for VAT in order for them to
account for VAT on foreclosure sales. As suggested in the body of this article, financial
institutions make a number of taxable transactions for which registration for VAT is
absolutely necessary. Given the size of financial institutions in this country, it is not even
necessary to establish the minimum threshold of registration in the case of financial
institutions.
As the tax authorities eye foreclosure sales as objects of VAT, they should remember that
all aspects of VAT are applied with full force, not just the selective and rather superficial
arguments so far made in this regard. The full force of VAT means that banks are entitled
to tax credits as are borrowers. The full force of VAT also means that for some types of
supplies, the conventional VAT exclusive method of computation is a distortion of the
notion of VAT. For foreclosure sales that have already occurred and for those sales in
which bidders are not informed in advance about VAT, the proper method of
computation of VAT is the VAT inclusive method of computation.
53

VAT and Banks

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To Tax or Not To Tax: Is that Really the Question?

2. Why Financial Services are Exempted from VAT

7.1. The Notion of “Taxable Transactions”

b. In the course or furtherance of a taxable activity

ii) involve or be intended to involve a supply for consideration; and

iii) be carried on in Ethiopia or partly in Ethiopia.

ii. ‘In the course or furtherance of….’

12. Priority Issues in Bank Foreclosure Sales

Conclusion and Recommendations

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