Rate of Depreciation

Depreciable Tangible Asset Straight line rate Diminishing value rate

Computer, software and data storage equipment 20% 25%

Green house 10% Not allowed

Structural improvement otherthan greenhouse 5% Not allowed

Any other depreciable assets 15% 20%

Depreciable assets used in mining and petroleum 25% 30%

development operation

5.4.12. Method of Preparing Tax Returns

Business normally prepares business income tax returns (that is profit and loss statements for tax purpose)
to determine and report their taxable business income per the income tax legislation. There are two
methods used to prepare the tax returns.
Independent approach: business prepares a separate income statement for income tax reporting. The
preparation of business tax return ignores the tax exempted business income and non deductable expenses
as indicated in the tax law in the following format.
Names of the taxpayer
Business income tax return
For the tax period ending June 30, 20xx
Admissible business income
Net Sales……………………………………………………………………..……xxxx
Less cost of goods sold……………………………………………………………xxxx
Gross profit…………………………………………………………………………xxxx
Add other admissible incomes
Income from lease of business……………………………………………..…..…….xxx
Gain on foreign exchange ………………………………………..………….……..xxxx
Commission income ……………………………………………………………….xxxx
Recovery of bad debt expenses previously write off……………………………….xxxx
Gross taxable profit………………………………………………………………....xxxx
Less tax deduction expenses
Selling and distribution expenses………………………….xxxx
Utility expenses………………………………………..…..xxxx
Salary and fringe benefit expenses…………………….…..xxxx
 Interest expenses ………………………….………………xxxx
Depreciation expenses ………………....…….………..….xxxx
Advertizing expenses ……………………..…….………...xxxx
Donation expenses………………………….….………..…..xxxx
Tax business income ……………………………………………………………...xxxx
Less provision for tax………………………………..…………xxxx
Net profit tax after tax………………………………………………………………xxx
Dependence approach: in the dependence approach the annual accounting profit determined for
financial reporting purpose abased on IFRS or GAAP is taken as the primary basis for the determination
of taxable business income subjected to adjustments per the relevant provision of the tax law. This
approach does not require keeping a separate set of record for income tax reporting purpose.
Name of the taxpayer
Business income tax Return
For the tax period ending June 30/ 20xx
Pre tax accounting income in the income statement…………………………..xxxx
Adjustments
Add back
Non deductable expenses but deducted in the income statement..............….xxxx
Admissible income but no include in the income statement…………..……...xxxx
Deduct
Deductable expenses but not charged in the income statement….……….…..xxxx
Exempted incomes but included in the income statement………….….….….xxxx
Taxabe business income ……………………………………………………..……...…xxxx
Less: provisions for income tax of the period ……………………………….…….xxxx
Net profit after tax ……………………………………………………….…………xxxx
Illustration

1. The HM plc financial statement for the tax year ending June 30, 2008 E.C shows the financial
information.
HM PLC
Income Statement
For the year ended, June 30, 2008 E.C
Net Sales Br.327, 000
Less: Cost of Goods Sold 155,000
 Gross Profit 172,000
Less: Operating Expenses:
Salaries and Wages Br.22, 000
Representation 6,000
Utilities 3,100
Supplies 1,200
Advertising 9,100
Entertainment 2,200
Depreciation 20,000
Interest 2,500
Miscellaneous 1,300 67,400
Operating Income Br.104,600

Additionally the following information was obtained for tax reporting purpose.

 The Br.55, 000 ending inventory cost was determined based on the FIFO method. If the LIFO or
Average Cost method had been used, the amount would have been Br.58, 000 and Br.52, 000,
respectively.
 Salaries and wages comprise Br.1, 000 disallowable provident fund of employer’s contribution.
 Representation expense calculated at 27.27% of basic salaries of the employees.
 The Br.15, 000.00 depreciation was reported on the original cost of the Br.120, 000.00 building; and
the Br.5, 000.00 depreciation was also reported on the original cost of the Br.50, 000 vehicles. The
accumulated depreciation at the beginning of the tax year for Building and vehicle was Br 45,000 and
Br 30,000 respectively. The company used straight line method for Building and declining balance
method for depreciating the vehicle.
 The interest is on Br.25,000, and 10% simple annual interest borrowed from a recognized financial
institution By NBE in 2008 E.C. The highest interest rate by NBE and commercial banks for the
current year was 6%.
Required: Compute the business income tax payable for the tax year using independent and
dependent approach.

Solution:

1. In accordance to the tax law taxpayer should use weighted average for inventory valuation as a result
the cost of goods sold is understated by 3,000 birr
2. The salaries and benefit are overstated by 1,000
3. Since only 10% of the basic salaries of the employees are allowable as representation allowance to
be deducted from the gross income, that is only 2,400 are allowable deductions, as a result the
representation allowance is overstated by 3,800.
4. For building the depreciation rate is 0.05 and using straight line method the annual depreciation will
be 120,000*0.05= 6000 and the depreciation rate for vehicle is 20% if we use the diminishing value
method and the depreciation expense of the year will be (50,000-30,000)*0.20= 4,000. This implies
the total depreciation allowable as deduction will be 6000+4000=10,000 and hence the depreciation
is overstated by 10,000.
5. The full interest expense is allowed as deduction because it is paid to financial institutions
recognized by NBE.
6. Entertainment expense is not allowed as deduction
Independent approach
HM PLC
Tax Return
For the year ended, June 30, 2008
Net Sales Br.327, 000
Less: Cost of Goods Sold 158,000
Gross Profit 169,000
Less: Operating Expenses:
Salaries and Benefits Br.21, 000
Representation 2,200
Utilities 3,100
Supplies 1,200
Advertising 9,100
Depreciation 10,000
Interest 2,500
Miscellaneous 1,300 (50,400)
Taxable Income Br.118,600
less Provision for business income tax (118,600*0.30)………..…………….…………(35,580)
Profit after tax……..……………………………………………………………………….83,020
 Using dependent approach

HM PLC
Tax Return
For the year ended, June 30, 2008
Accounting profit ………………………………………………………………….Br 104,600
Add back
Salaries and Benefits Br.1, 000
Representation 3,800
Depreciation 10,000
Entertainment expenses 2,200
Deduct Cost of goods sold (3,000)
Taxable business income 128,600
Less Provision for business income tax (118,600*0.30) ……………………………... (35,580)
Profit after tax………………………………………………………………………………83,020

5.5. Other Income (Schedule “D” Tax)

Incomes which are not specifically included under Schedule “A”, Schedule B and Schedule C is
categorized under this schedule. Schedule D income includes;

5.5.1. INCOME OF NON-RESIDENTS

A non-resident who has derived an Ethiopian source dividend, interest, royalty, management fee,
technical fee, or insurance premium shall be liable for non-resident tax at the rate specified as follows:
 For an insurance premium or royalty , 5% of the gross amount of the premium or royalty;
 For a dividend or interest, 10% of the gross amount of the dividend or interest;
 For a management or technical fee, 15 % of the gross amount of the fee
However, the income generated by non-residents through permanent establishment cannot be taxed under
this category. Rather, it is taxed under schedule “C” or “D”.
5.5.2.Taxation of Non-resident Entertainers
A non-resident entertainer or group of non-resident entertainers who has derived income from the
participation by the entertainer or group in a performance-taking place in Ethiopia shall be liable for
income tax at the rate of 10% on the gross income derived from the performance without deduction of
expenditures. Here, entertainer” includes musician and sports person; “group” includes a sporting team;
and “performance” includes a sporting event.
5.5.3. Taxation of Royalties
Royalty refers to a payment of any kind received as a consideration for the use of or the right to use any
copyright of literary, artistic or scientific work, including cinematography film, and films or tapes for
radio or television broadcasting, any patent, trademark, design or model, plan, secret formula, or process,
or for the use or for the right to use of any industrial, commercial or scientific equipment, or for
information concerning industrial, commercial or scientific experience.

Royalties is subject to a tax at a flat rate of 5%. The withholding agent who effects royalty’s payments,
withholds the foregoing tax and accounts to the Tax Authority. However, if the payer resides abroad and
the recipient is a resident, the recipient must pay the tax on royalty income. This tax is final in lieu of
income tax.

5.5.4. INCOME FROM GAMES OF CHANCE

This form of income is derived from winning at games of chance (lotteries, Tom bolas, and other similar
activities). This income is subject to tax at the rate of 15%, except for winnings of less than Br. 100
similar to income from rendering technical activities the payer must withhold or collect the tax and
account to the Tax Authority. This tax is final in lieu of income tax

5.5.5. DIVIDENDS

The taxable Income is income received in the form of dividend from a share company or withdrawals of
profits from a private limited company. Resident of Ethiopia who derives dividend and non resident who
derives Ethiopian sources dividend that is attributable to a permanent establishment are liable to pay
dividend income tax. Dividend Income is subject to tax at the rate of 10% of the gross amount of the
dividend. The withholding agent (payer) shall withhold or collect the tax and account to the tax Authority.
This tax is final in lieu of income tax.

5.5.6. INCOME FROM CASUAL RENT

The taxable income under this category is income derived from casual rental of property (land, building,
or moveable asset) not related to a business activity. This type of income is subject to tax at a flat rate
15% of the annual gross income. This tax is a final tax in lieu of a net income tax.

5.5.7. INTEREST INCOME

A resident of Ethiopia who derives interest and non resident who derives Ethiopian source interest that is
attributed to permanent establishment, are liable for income tax at the rate of:
  5% of the gross amount of the interest derived from savings deposit with a financial
institution that is a resident of Ethiopia,; or
 10% of the gross amount of the interest in any other cases
The payer must withhold the tax and account to the Tax Authority. This tax is a final tax in lieu of income
tax.

5.5.8. Windfall Profit: windfall profit” means any unearned, unexpected, or other non-recurring gain.
The directive issued by ministry of finance and economic cooperation determines the tax rate imposed on
windfall profit.

5.5.9. GAINS ON TRANSFER OF CERTAIN INVESTMENT ASSESTS

Gains obtained from the transfer (sale or gift) of building held for business, factory, and office and a share
of companies is taxable under this category. Such income is taxable at the following rates:-

- Building held for business, factory, and office at the rate of 15%, and
- Shares and Bonds at the rate of 30%
Nonetheless, Gains obtained from the transfer of building held for residence is exempted from tax
provided that such building is fully used for dwelling for two years prior to the date of transfer.

COMPUTATION OF CAPITAL GAIN TAX

In computing capital gain tax, you should follow the following procedures;

STEP 1.Determine the historical cost of the building or the par-value of the Share, as appropriate.

STEP 2 Determine allowable deductions which includes

- taxes paid for the land and the buildings

STEP 3 Determine proceeds from the transfer of capital assets

STEP 4 capital gain taxes equals tax rate mentioned above times the amount obtained after deducting the
sum of step1 andrr step 2 from step 3.

Example

ABC Co. sold a building, which is held for business for Br. 1,000,000, which is acquired at a cost of Br.
1, 200,000. Depreciation until time of sale amounts Br. 500,000 and property tax paid for the building
Birr 50, 000.
Calculate the capital gain tax payable by ABC Co.
5.5.10. Undistributed profit
Tax shall be paid at the rate of 10% on the net undistributed profit of a body in a tax year to the extent
that it is not reinvested, in accordance with the directive to be issued by the ministry of finance and
economic cooperation.
5.5.11. Repatriated Profit

A non-resident body conducting business in Ethiopia through a permanent establishment shall be liable
for tax at the rate of 10% on the repatriated profit of the permanent establishment.

5.5.12. Other Income

A person who derives any income that is not taxable under Schedule A, B, C, or D is liable for income tax
at the rate of 15% on the gross amount of the income.