Business and finance

Accounts and budget support level III

Unit of competency፡- Process Payroll

MODULE TITL: - Processing Payroll
Module code: BUF ACB3 11 0812

2011 E.C

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 LEARNING OUTCOMES:

LO1: Record payroll data

LO2 Prepare payroll
LO3: Handle payroll enquiries

TABLE OF CONTENTS PAGE

LO 1: Record payroll data……………………………………………………………………….1

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1.1 Introduction to Payroll Accounting..............................................................................................2
Matching Principle.........................................................................................................................3
1.2 Salaries, Wages, & Overtime Pay................................................................................................4
Salaries.......................................................................................................................................4
Wages.........................................................................................................................................4
1.3 Bonuses & Commissions Paid to Employees..............................................................................5
Overtime Pay..............................................................................................................................5
Overtime Premium.....................................................................................................................5
Payroll Withholdings: Taxes & Benefits Paid by Employees.......................................................5
1.4 Net Pay.........................................................................................................................................8
LO2 Prepare payroll........................................................................................................................9
2.1 Payroll Taxes, Costs & Benefits Paid by Employers...................................................................9
2.2 Major Types of Taxes existing in Ethiopia................................................................................14
2.3 Business Profit Tax....................................................................................................................15
2.4 Tax on Income from Rental of Buildings.................................................................................17
2.5 Tax on Interest Income on Deposits...........................................................................................18
2.6 Agricultural Income Tax............................................................................................................19
2.7 Indirect Taxes.............................................................................................................................20
2.8 Tax Evasion................................................................................................................................20
2.9 Value Added Tax (VAT)...........................................................................................................23
LO3: Handle payroll enquiries...................................................................................................32
3.1 Record Keeping Requirement....................................................................................................32
3.2 Penalty for Failure to keep proper Records................................................................................33
3.3 Duty Draw-Back Scheme...........................................................................................................35
3.4 Voucher Scheme........................................................................................................................36
3.5 Purposes for which the Tax Revenue is utilized.......................................................................37
3.6 Views of the Business Community...........................................................................................38
3.7 Personal Income Tax in Ethiopia...............................................................................................38
3.8 Manual Payroll Vs Computerized Payroll Systems...................................................................40

LO1: Record payroll data

 Checking and clarifying payroll data and discrepancies with designated persons
 Entering employee pay period details and any deductions and allowances in payroll
system in accordance with source documents

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  Calculating payment due to individual employees to reflect standard pay and variations in
accordance with employee source data

1.1 Introduction to Payroll Accounting

It's a fact of business—if a company has employees, it has to account for payroll and fringe
benefits.
In this explanation of payroll accounting we'll introduce payroll, fringe benefits, and the payroll-
related accounts that a typical company will report on its income statement and balance sheet.
Payroll and benefits include items such as:

Payroll Tax Rate in Ethiopia and calculations

What does the term "Payroll" Mean?

 The distribution of paychecks (physical or electronic) to employees each payday, as in "I finished
doing payroll yesterday."
 The financial records for employee wages/salaries, withholding, deductions, bonuses, pay for time
not worked (holidays, vacations, sick time, etc.) and other items on employee paychecks.
 It can also mean the record of total earnings of all employees for a company in a fiscal year.

Payroll processing describes the preparation of paychecks (including withholding and

deductions), distribution of paychecks, and payment and porting of payroll taxes. Options for
payroll processing include doing it yourself with accounting software, hiring a bookkeeper, or
engaging a payroll service. It is the financial record of employees' salaries, wages, bonuses, net
pay, and deductions
Payroll is
1. Total amount required to pay workers and employees during a week, month or other period.
2. Pay sheet which records wage rates, deductions, and net pay.

Matching Principle
As we proceed with our explanation of payroll accounting, it will be helpful to recall
the matching principle of accounting. This principle will guide us to better understand how
payroll and fringe benefits are reported on financial statements. (We're assuming that a company
follows the accrual method of accounting.)
The matching principle requires a company to match expenses to the accounting period in which
the related revenues are reported. If a direct connection between revenues and an expense does not
exist, then the expense should appear on the income statement for the accounting period in which
it was incurred. Keep in mind that expenses are often incurred (or occur) in a different
accounting period than when they are paid.
Let's use three payroll examples to illustrate this point:

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 1. A company employs a student to work a total of five days—from December 26 through
December 30, 2013. On December 30 the student submits her time card. The company
issues her payroll check on the next scheduled payday, January 5, 2014.
Even though the check is dated January 5, 2014, the matching principle requires that the
company report the expense and the liability in December 2013 when the work was
performed (and the company incurred the liability). Because the student was only
employed for the last five days of December, the company would not have any wage or
fringe benefits expense for her during January. The paycheck issued on January 5
merely reduces the company's liabilities and cash.
2. Let's assume that a company gives its sales manager an annual bonus of 1% of sales, to
be paid on January 15, 2014. The bonus amount is calculated by multiplying the sales
from January 1 through December 31, 2013 times 1%.
The matching principle requires that the company report 1% of sales as a Bonus
Expense on its income statement (and a liability for the total amount owed must be
reported on its balance sheet) in every accounting period in which sales occurred in
2013. If the company violates the matching principle by ignoring the bonus expense
throughout the year 2013 (when sales actually occurred) and reports the entire bonus
amount as an expense for just one day (January 15, 2014), every income statement
pertinent to 2013 will report too much net income and the income statement that
includes January 15, 2014 will report too little net income. The matching principle
requires that the bonus expense pertinent to the 2013 sales be matched with the 2013
sales on the 2013 income statement.
If the entries are recorded properly, the balance sheet dated December 31, 2013 will
report a current liability for the total bonus amount owed to the sales manager. On
January 15, 2014 (when the company pays the bonus) the company will not have an
expense; rather, the payment will reduce the company's cash and reduce the current
liability that was established when the bonus was recorded as an expense in 2013.
3. A company has a vacation plan that will provide two weeks of vacation in the year 2014
if the employee worked the entire year of 2013. In the year 2013 (when the employee is
working) the company reports the vacation expense on its 2013 income statement. The
company's December 31, 2013 balance sheet will report a current liability for the two
weeks of vacation pay that was earned by each employee but not yet taken. In 2014
(when employees take the vacations that were earned and expensed in 2013), the
company will reduce its cash and its vacation liability.
As you learn about accounting for payroll and fringe benefits, keep the matching
principle in mind. As the above examples show, the date on which a company pays
wages or fringe benefits is not necessarily the date on which the company reports the
expense on its financial statements.

1.2 Salaries, Wages, & Overtime Pay

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In this section of payroll accounting we focus on the gross amounts earned by the employees of a
company.
Salaries
Salaries are usually associated with "white-collar" workers such as office employees, managers,
professionals, and executives. Salaried employees are often paid semi-monthly (e.g., on the 15th
and last day of the month) or bi-weekly (e.g., every other Friday) and their salaries are often stated
as a gross annual amount, such as "$48,000 per year." The "gross" amount refers to the pay an
employee would receive before withholdings are made for such things as taxes, contributions to
United Way, and savings plans.
Since salaried employees earn a specified annual amount, it is likely that their gross pay for each
pay period is the same recurring amount. For example, if a manager's salary is $48,000 per year
and salaries are paid semi-monthly, the manager's gross pay will be $2,000 for each of the 24 pay
periods. (If the manager is paid bi-weekly, the gross pay would be $1,846.15 for each of the 26
pay periods.) A salaried employee's work period usually ends on payday; for example, a paycheck
on January 31 usually covers the work period of January 16-31. This is convenient for accounting
purposes if the company prepares financial statements on a calendar month basis.
Wages
Wages are often associated with production employees (sometimes referred to as "blue-collar"
workers), non-managers, and other employees whose pay is dependent on hours worked. The pay
for these employees is generally stated as a gross, hourly rate, such as "$13.52 per hour." Again,
the "gross" amount refers to the pay an employee would receive before withholdings are made for
such things as taxes, contributions, and savings plans.
Employees receiving wages are often paid weekly or biweekly. To determine the gross wages
earned during a work period, the employer multiplies each employee's hourly rate times the
number of work hours recorded for the employee during the work period. Due to the extra time
needed to make calculations for each employee, hourly-paid employees typically receive their
paychecks approximately five days after the work period has ended.

When the hourly-paid employees have work periods that are weekly or biweekly, but the
company's financial statements cover calendar months, the company will likely have to prepare an
accrual-type adjusting entry at the end of the month. If hourly wages are a significant portion of a
company's expenses, it is critical that the company report the correct amount of wages expense
that pertains to the 30 or 31 days in the month, not the 28 days in a four-week work period.

1.3 Bonuses & Commissions Paid to Employees

Throughout our explanation, bonuses paid to employees and sales commissions paid to employees
will be considered to be part of salaries.
Overtime Pay
Overtime refers to time worked in excess of 40 hours per week. Whether or not employees are
paid for overtime depends on each employee's job responsibilities and rate of pay—some

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employees are exempt from overtime pay and some are not. For example, executives are
considered to be "exempt"; their employers are not required to pay them for their overtime hours
because (1) their compensation is high, and (2) they can control their work hours. Executives do
not need state or federal wage and hour laws to protect them from company abuse.
On the other hand, a design technician earning an annual salary of $18,000 per year is probably
not in control of her work hours. If she works for an executive who decides to work 60 hours per
week, the design technician needs to be protected from having to work 60 hours per week for no
more pay than she would receive for 40 hours of work. This employee is considered a
"nonexempt" employee—she is not exempt from being paid overtime compensation. Some
unethical companies have been known to classify "hourly wage" employees as "salaried" in hopes
of making them exempt from overtime pay—federal and state laws exist to prevent such unfair
treatment of employees.

When processing payroll, don't assume that it's only the hourly paid employees who receive
overtime pay—state and federal laws require overtime payments to lower—paid salaried
employees. It is also possible that some generous employers will give overtime pay to employees
who are not required by law to receive it.
Overtime Premium
An overtime premium refers to the "half" portion of "time-and-a-half" or "time-and-one-half"
overtime pay. For example, assume an employee in the production department is expected to work
40 hours per week at $10 per hour. If the employer requires the employee to work 42 hours in a
given week, the extra two hours are paid at time-and-a-half and the employee earns a total of $430
for the week (40 hours x $10 per hour, plus 2 overtime hours x $15 per hour). It can also be
computed as 42 hours at the straight-time rate of $10 per hour plus 2 hours times the overtime
premium of $5 per hour.
Payroll Withholdings: Taxes & Benefits Paid by Employees
This section of payroll accounting focuses on the amounts withheld from employees' gross pay.
The U. S. income tax system—as well as most state income tax systems—requires employers to
withhold payroll taxes from their employees' gross salaries and wages. The withholding of taxes
and other deductions from employees' paychecks affects the employer in several ways: (1) it
reduces the cash amount paid to employees, (2) it creates a current liability for the employer, and
(3) it requires the employer to remit the withheld taxes to the federal and state government by
specific deadlines. Failure to remit payroll taxes in a timely manner results in interest and penalties
levied on the employer; flagrant violations trigger more severe consequences.
Payroll withholdings include:
1. Employee portion of Social Security tax
2. Employee portion of Medicare tax
3. Federal income tax
4. State income tax
5. Court-ordered withholdings
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 6. Other withholdings
1. Employee portion of Social Security tax
A key component of payroll accounting is the Social Security tax. (The Social Security tax along
with the Medicare tax makes up what is referred to as FICA.) Social Security tax is withheld from
an employee's salary or wages and the employer is also required to pay a Social Security tax. In
other words, the employer is responsible for remitting to the federal government both the
employee and the employer portions of the Social Security tax. As a result, Social Security tax is
both an employee withholding and an employer expense. (The official title for the system financed
by the Social Security tax is Old Age, Survivors and Disability Insurance, or OASDI. As the name
indicates, this system pays retirement, disability, family, and survivors' benefits.)
In 2014, the amount of Social Security tax that an employer must withhold from an employee is
6.2% of the first $117,000 of the employee's annual wages and salary; any amount above
$117,000 is not subject to Social Security tax withholdings. For example:
 If an employee earns $40,000 in wages in 2014, the entire $40,000 is subject to
withholdings at 6.2%, for a total annual withholding of $2,480.
 If an employee earns $200,000 in salary in 2014, only the first $117,000 of the salary is
subject to the Social Security tax of 6.2%, for a total annual withholding of $7,254. (The
amount of salary that is greater than $117,000 is not subject to Social Security tax
withholdings, although it will be subject to the Medicare tax discussed in the next section.)
The amount withheld—and the employer’s portion—is reported as a current liability until the
amounts are remitted to the government by the employer.
2. Employee portion of Medicare tax
Medicare tax is also withheld from an employee's salary or wages and the employer is also
required to pay a Medicare tax. In other words, the employer is responsible for remitting to the
federal government both the employee and the employer portions of the Medicare tax. As a result,
Medicare tax is both an employee withholding and an employer expense. (The Medicare program
helps pay for hospital care, nursing care, and doctor's fees for people age 65 and older as well as
for some individuals receiving Social Security disability benefits.)
The combination of the Social Security tax and the Medicare tax is referred to as FICA (an
acronym for Federal Insurance Contribution Act).
An employer must withhold 1.45% of each employee's annual wages and salary for Medicare tax.
Unlike the Social Security tax, this percentage is applied on every employee's total salary no
matter how large the salary might be—an employee's salary of $200,000 will require Medicare tax
withholdings of $2,900 (the entire $200,000 times 1.45%).

Also, there is a Medicare surtax of 0.9% that is withheld from the employee on wages and salaries
that are in excess of certain amounts.
The employee's Medicare tax withholding plus the employer's Medicare tax are reported as a
current liability until the amounts are remitted to the government by the employer.
3. Federal income tax

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Another part of payroll accounting involves the employees' federal income tax. An employer is
required to withhold the federal income tax that an employee is expected to owe based on salaries
or wages. The amount withheld, however, is rarely the exact amount of income tax that the
employee will owe to the government. The employee's year-end income tax return will dictate the
exact amount owed for the year, meaning the employee will either pay in a little more in taxes, or
will receive a tax refund.
The amount withheld for federal income tax is based on the employee's salary or wages as well as
personal information that the employee is required to provide the employer on federal form W-4
(including marital status and the number of dependents claimed as exemptions). In cases where an
employee is paid low wages and/or has a large number of personal exemptions, it may not be
necessary for the employer to withhold any federal income tax. Unlike FICA, there is no employer
contribution for federal income tax.

Amounts withheld from employees for federal income taxes are reported on the employer's
balance sheet as a current liability. When the employer remits the amounts to the federal
government, the current liability is reduced.
4. State income tax
In most states payroll accounting will involve a state income tax. In those states an employer is
required to withhold the state income tax that an employee is expected to owe based on salaries or
wages. Like its federal counterpart, the amount withheld is rarely the exact amount of income tax
that the employee will owe to the state government. (It should be noted here that some states do
not levy a personal income tax.)
The amount withheld for state income tax is based on the employee's salary or wages as well as
personal information that the employee is required to provide the employer on a state version of
federal form W-4 (including marital status and the number of dependents claimed as exemptions).
In cases where an employee is paid low wages and/or has a large number of personal exemptions,
it may not be necessary for the employer to withhold any state income tax. Like the federal income
tax (and unlike the FICA tax), there is no employer contribution for state income tax.

Amounts withheld from employees for state income taxes are reported on the employer's balance
sheet as a current liability. When the employer remits the amounts to the state government, the
current liability is reduced.
5. Court-ordered withholdings
Payroll accounting also involves withholdings for items other than payroll taxes. For example,
courts of law may order employers to garnish (withhold money from) an employee's salary or
wages for purposes such as paying child support or repaying debts.
The amounts withheld from employees for court-ordered withholdings are reported on the
employer's balance sheet as a current liability. When the employer remits the amounts to the
designated parties, the liability is reduced.

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Some court orders may include a small fee to be withheld from the employee in order to reimburse
the employer for administrative expenses. For example, the court order might direct the employer
to withhold $101 from the employee and to remit $100 to a designated agency. The $1 difference
will be a credit to the company's administrative expenses or to a miscellaneous revenue account.
6. Other withholdings
In addition to the mandatory withholdings that an employer makes for taxes and court orders,
payroll accounting often includes amounts that employers may be willing to withhold at the
direction of its employees. These voluntary withholdings can include such things as:
 union dues
 charitable contributions
 insurance premiums

 401(k) and 403(b) contributions

 U.S. savings bonds purchases
 payments owed to the company for the purchase of company merchandise
If the voluntary withholdings are to be remitted to places outside of the company (a local charity,
for example), the amounts withheld are reported on the employer's balance sheet as a current
liability. When the employer remits the withholdings, the current liability will be reduced.

If the withholdings are for amounts that are due the company (such as employees' share of
insurance premiums or amounts owed by employees for company merchandise), no remittance is
required. Rather, the journal entry reflects a credit that reduces the company's insurance expense
or reduces the company's receivables from employees.

1.4 Net Pay

Net pay is the amount that remains after withholdings are deducted from an employee's gross pay.
Net pay is also referred to as "take home pay" or the amount that an employee "clears." From the
company side of the transaction, it is the amount of cash the company will pay directly to the
employees on payday.

LO2 Prepare payroll

 Identifying types of payroll systems
 Preparing payroll within designated time lines in accordance with organizational policy
and procedures
 Reconciling total salary/wages for pay period

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  Making arrangements for payment in accordance with organizational and individual
requirements
 Obtaining authorization of payroll and individual pay advice in accordance with
organizational requirements
 Producing, checking and storing payroll records in accordance with organizational policy
and security procedures
 Following security procedures for processing payroll and for maintaining payroll records

2.1 Payroll Taxes, Costs & Benefits Paid by Employers

In addition to salaries and wages, the employer will incur some or all of the following payroll-
related expenses:
1. Employer portion of Social Security tax
2. Employer portion of Medicare tax
3. State unemployment tax
4. Federal unemployment tax
5. Worker compensation insurance
6. Employer portion of insurance (health, dental, vision, life, disability)
7. Employer paid holidays, vacations, and sick days
8. Employer contributions toward 401(k), savings plans, & profit-sharing plans
9. Employer contributions to pension plans
10. Post-retirement health insurance
1. Employer portion of Social Security tax
Understanding the Social Security tax and the Medicare tax is critical for payroll accounting. In
this section we discuss the employers' portion of the Social Security tax.
In addition to the amount withheld from its employees for Social Security taxes, the employer
must contribute/remit an additional amount, which is an expense for the employer. In the year
2014, the employer's portion of the Social Security tax is 6.2% of the first $117,000 of an
employee's annual wages and salary.

For example, if an employee earns $40,000 of wages, the entire $40,000 is subject to the Social
Security tax. This means that in addition to the withholding of $2,480, the employer must also pay
$2,480. The combined amount to be remitted to the federal government for this one employee is
$4,960 ($2,480 of withholding plus the employer's portion of $2,480).

For an employee with an annual salary of $200,000 in the year 2014, only the first $117,000 is
subject to the Social Security tax. This means that in addition to the withholding of $7,254, the

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employer must also pay $7,254. The combined amount to be remitted to the federal government
for this one employee is $14,508 ($7,254 + $7,254).

The employer's share of Social Security taxes is recorded as an expense and as an additional
current liability until the amounts are remitted.
2. Employer portion of Medicare tax

In addition to the employee's Medicare tax there is also an employer's Medicare tax. The
employer's Medicare tax is considered to be an expense for the employer. For the year 2014, the
employer's portion of the Medicare tax is the same rate as the employee's withholding—1.45% of
every dollar of each employee's annual wages and salary.

Unlike the Social Security tax, there is no cap (ceiling or limit); if an employee earns a salary of
$200,000, the employer must pay a Medicare tax of $2,900 in addition to the $2,900 that was
withheld from the employee. The combined amount to be remitted to the federal government for
this one employee is $5,800.

The employer's share of Medicare taxes is recorded as an expense and as an additional current
liability until the amounts are remitted.
3. State unemployment tax

State governments administer unemployment services and determine the state unemployment tax
rate for each employer. (Some not-for-profit organizations—such as churches without schools—
may not be required to pay state unemployment taxes. You should check with your state
unemployment office to learn the specifics for your organization.)

Generally, states require that the employers pay the entire unemployment tax. Often, employers
that have built up a large reserve in the state's unemployment fund will have lower unemployment
tax rates. Employers with a small reserve (or no reserve at all) will have higher unemployment tax
rates.

The state unemployment tax rate is applied to a wage base that is determined by each state. (The
wage bases range from $7,000 to more than $30,000.) If a state's unemployment wage base is
$14,000 then the state unemployment tax rate is applied only to the first $14,000 of each
employee's annual salary and wages. If we also assume that an employer's state unemployment tax
rate is 4%, then the employer's state unemployment tax cost will be a maximum of $560 per year
for each employee ($14,000 x 4%).
To illustrate, let's assume that a company has three employees. In 2014, Employee #1 earns
$19,000, Employee #2 earns $40,000, and Employee #3 earns $4,000. If the 2014 state
unemployment tax rate is 4% and the wage base is $14,000, the employer will pay a tax of $1,280
to the state government:

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Even though the state unemployment tax is based on employee salaries and wages, the entire tax is
paid by the employer. There is no withholding from an employee's salary or wages for the state
unemployment tax.
You should contact your state to get the rates that apply to your company.

4. Federal unemployment tax

The federal government oversees the state unemployment programs and requires employers to pay
a federal unemployment tax of 6.0% minus a credit if the employer has paid into a state
unemployment fund. If an employer is allowed the maximum credit of 5.4%, then the federal
unemployment tax rate will be 0.6%. This rate is then applied to each employee's first $7,000 of
annual salaries and wages.
Using the example of three employees with annual 2014 earnings of $19,000, $40,000, and
$4,000; with a federal unemployment tax rate of 0.6%, the employer will pay a tax of $108 to the
federal government:

Even though the federal unemployment tax is based on employee salaries and wages, the entire tax
is paid by the employer. There is no withholding from an employee's salary or wages for the
federal unemployment tax.
5. Worker compensation insurance
Worker compensation insurance provides coverage for employees who are injured on the job.
State law usually requires that employers carry this insurance. Worker compensation
insurance rates are a function of at least three variables: (1) the type of business or industry, (2)
the type of job being performed, and (3) the employer's history of claims.
For example, statistics show that a production worker in a meat packing plant has a greater-than-
average chance of suffering job-related cuts or back injuries. Because of this, worker
compensation insurance rates for these employees can be as high as 15% of wages. On the other
hand, the office staff of the meat packing plant—provided that they do not venture out into the
production area—may have a rate that is less than 1% of salaries and wages.

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The worker compensation insurance rates are then applied to the wages and salaries of the
employees to arrive at the worker compensation insurance premiums or costs. Although the
insurance premiums are based on employee salaries and wages, the entire premium cost is likely
to be paid by the employer and is considered an expense for the employer. (Contact your state's
worker compensation office for the specifics in your state.)
If the employer pays the premium in advance, a current asset such as Prepaid Insurance is used.
The account balance will be reduced and Worker Compensation Insurance Expense will
increase as the employees work.
If the employer does not pay the premiums in advance, the company must accrue the expense with
an adjusting entry that increases Worker Compensation Insurance Expense along with increases in
a current liability such as Worker Compensation Insurance Liability. In this situation the current
liability will be reduced when the employer pays the worker compensation insurance premiums.

Worker compensation insurance is a significant expense for the employer and therefore we
consider it an important part of payroll accounting.
6. Employer portion of insurance (health, dental, vision, life, disability)

In the past, many companies included group health, dental, vision, disability, and life insurance in
the benefit package provided to employees. Over the past few decades, however, the cost of these
group policies has risen significantly. Today the insurance premium for family coverage could be
more than $10,000 per year per employee. As a result of these escalating costs, most companies
now require employees to pay a portion of the premium cost; this amount is usually collected by
means of employee-directed payroll withholding.

The employers' net cost (or expense) is simply the total amount of premiums paid to the insurance
company minus the portion of the cost the employer collects from its employees.
7. Employer paid holidays, vacations, and sick days
Many companies pay their permanent employees for holidays such as New Year's Day, Memorial
Day, July 4th, Labor Day, Thanksgiving, and Christmas. It is not unusual for employees to be paid
for 10 holidays per year. It is also common for employees to earn one week of vacation after one
year of service. Many employers give their employees two weeks of vacation after three years of
service, with more weeks given after 10 years of service.

Paid sick days are also a common benefit given to employees. If an employee is absent from work
due to such things as illness or surgery, the company will pay the employee for the time missed.
Employers generally set policies as to how sick days are to be used, and as to whether or not an
employee is permitted to carry over unused sick days into subsequent years.

The matching principle requires that the cost of compensated (or paid) absences (holidays,
vacations, and sick days) be recognized as an expense during the time the employee is present and
working. In other words, the cost is expensed when the benefit is being earned by the employee,
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not when the benefit is being used by the employee. (However, the Financial Accounting
Standards Board generally allows for sick days and holidays not to be accrued.)
To illustrate, assume that an employee works full-time for the entire year 2013 and as a result
earns one week of vacation to be taken any time during the year 2014. During the year 2013 (when
the employee is working), the employer records the vacation expense and the vacation liability. In
2014, when the employee takes the vacation earned in the previous year, the employer records the
cash payment by crediting Cash and reduces the company liability by debiting Vacation Payable.
8. Employer contributions toward 401(k), savings plans, and profit-sharing plans

If an employer is required to contribute company money into an employee's savings program or

profit-sharing plan, the contribution should appear as an expense in the period when the employee
earned the company contribution. It is also likely that the company will have the expense and the
liability before the company actually pays the amount. This situation requires the company to
record an adjusting entry in order to match the expense to the proper accounting period.
9. Employer contributions to pension plans

Some companies provide pensions for their employees. This means their employees will receive
ongoing monthly payments after they retire from the company. The matching principle requires
that the cost of the benefit should be recognized during the years that the employees are working
(earning the benefit), and not when the employee is retired.

The concept is that in the years that the employee works, the company will charge Pension
Expense and will credit either Pension Payable or Cash. For more specifics on pensions, you are
referred to an Intermediate Accounting text or to the Financial Accounting Standards Board's
website www.fasb.org.
10. Post-retirement health insurance

Some companies continue to provide health insurance coverage to employees after they have
retired. This retiree benefit is considered to be part of the compensation package earned by
employees while they are working. Again, accrual accounting and the matching principle require
that the cost of this future insurance coverage be expensed (or assigned to manufactured products)
during the years the employees are working by debiting an expense and crediting a liability.
During the employees' retirement years, the company's payment for insurance will reduce the
company's liability and will reduce its cash.

2.2 Major Types of Taxes existing in Ethiopia

Direct Taxes
Tax on Income from Employment / Personal Income Tax
Every person deriving income from employment is liable to pay tax on that income at the rate
specified in Schedule ‘A’ as follows:

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 Schedule ‘A’

Employment Income (per month) Tax Rate (in %) Deduction (in Birr)

over Birr to Birr

0 Exempt threshold
150
151 650 10% 15.00

651 1 400 15% 47.50

1 401 2 350 20% 117.50

2 351 3 550 25% 235.00

3 551 5 000 30% 412.50

over 5 000 35% 662.00

Example: Computation of Personal Income Tax

Monthly Salary of 500.00 Birr
- Personal Income Tax = 500 Birr x 10% tax rate = 50 Birr
- Deduction = 50 Birr - 15 Birr deduction fee
- Tax payment = 35 Birr
Employment income shall include any payments or gains in cash or in kind received from
employment by an individual. Employers have an obligation to withhold the tax from each
payment to an employee, and pay the Tax Authority the amount withheld during each calendar
month. In applying the procedure, income attributable to the months of Nehassie and Pagume
shall be aggregated and treated as the income of one month.
If the tax on income from employment, instead of being deducted from the salary or wage of the
employee, is paid by the employer in whole or in part, the amount so paid shall be added to the
taxable income and shall be considered as part thereof.
The following categories of income shall be exempt from payment of personal income tax:
 Income from employment received by casual employees who are not regularly employed
provided that they do not work for more than one month for the same employer in any twelve
months;
 Pension contribution, provident fund and all forms of retirement benefits contributed by
employers in an amount that does not exceed 15% of the monthly salary of the employee;

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 Subject to reciprocity, income from employment, received for services rendered in the exercise
of their duties by diplomatic and consular representatives, and other persons employed in any
Embassy and who are national of that state and bearers of diplomatic passports;
 Payments made to a person as compensation or gratitude in relation to personal injuries
suffered by that person or death of another person;
 Amounts paid by employers to cover the actual cost of medical treatment of employees;
 Allowances in lieu of means of transportation granted to employees under contract of
employment;
 Hardship allowance;
 Amounts paid to employees in reimbursement of traveling expenses incurred on duty;
 Amounts of travelling expense paid to employees recruited from elsewhere than the place of
employment on joining and completion of employment or in case of foreigners travelling
expenses from or to their country, provided that such payments are made pursuant to specific
provisions of the contract;
 Allowance paid to members and secretaries of board of public enterprises and public bodies as
well as to members and secretaries of study groups set up by the Federal or Regional
Government;
 Income of persons employed for domestic duties.

2.3 Business Profit Tax

This is the tax imposed on the taxable business income / net profit realized from entrepreneurial
activity. Taxable business income would be determined per tax period on the basis of the profit
and loss account or income statement, which shall be drawn in compliance with the generally
accepted accounting standards. Corporate businesses are required to pay 30% flat rate of business
income tax. For unincorporated or individual businesses the business income tax ranges from 10%
- 35%.
Unincorporated or individual businesses are taxed in accordance with the following schedule
below:
Schedule ‘C’

Tax Rate (in %) Deduction (in Birr)

Taxable Business Income /
Net Profit per year
over Birr to Birr

0 1,800 Exempt threshold

1,801 7,800 10% 180.00
7, 801 16,800 15% 570.00
16, 801 28, 200 20% 1410.00
28, 201 42,600 25% 2520.00
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 42, 601 60,000 30% 4950.00
over 60, 000 35% 7950.00
Example: Computation of business profit tax
Business Net Profit per year/Taxable Income = 70,500.00 Birr
- Business Profit Tax = 70,500 Birr x 35% tax rate = 24,675 Birr
- Deduction = 24,675 Birr - 7,950 Birr deduction fee
- Tax payment = 16,725.00 Birr
In the determination of business income subject to tax in Ethiopia, deductions would be allowed
for expenses incurred for the purpose of earning, securing, and maintaining that business income
to the extent that the expenses can be proven by the taxpayer.
The following expenses shall be deductible from gross income in calculating taxable income:
 The direct cost of producing the income, such as the direct cost of manufacturing,
purchasing, importation, selling and such other similar costs;
 General and administrative expenses connected with the business activity;
 Premiums payable on insurance directly connected with the business activity;
 Expenses incurred in connection with the promotion of the business inside and outside the
country, subject to the limits set by the directive issued by the Minister of Revenue;
 Commissions paid for services rendered to the business;
 Sums paid as salary, wages or other emoluments to the children of the proprietor or
member of the partnership shall only be allowed as deduction if such employees have the
qualifications required by the post.
The following categories of income would be exempted from payment of business income tax:
 Awards for adopted or suggested innovations and cost saving measures;
 Public awards for outstanding performance;
 Income specifically exempted from income tax by the law in force in Ethiopia, by
international treaty or by an agreement made.
Penalty for understatement of tax:
 If the amount of tax shown on a declaration understates the amount of tax required to be
shown, the taxpayer is liable for a penalty in the amount of 10% of the understatement or
50% if the understatement is considered substantial. The understatement is considered
substantial if it exceeds 25% of the tax required to be shown on the return or 20,000 Birr;
 The penalty shall continue to apply until, the Appeal Commission or a Court, as the case
may be shall have rendered its final decision.
Penalty for late payment:
A taxpayer who fails to pay tax liability on the due date is subject to:
 A penalty of 5% of the amount of unpaid tax on the first day after the due date has passed;
and
 An additional 2% of the amount of tax that remains unpaid on the first day of each month
thereafter.

2.4 Tax on Income from Rental of Buildings

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This is the tax imposed on the income from rental of buildings. If the taxpayer leased furnished
quarters, the amounts received attributable to the lease of furniture and equipment would be
included in the income and taxed. The tax payable on rented houses would be charged at the
following rates:
 On income of bodies 30% of taxable income
 On income of persons according to the following schedule next page:
Taxable Income from Rental of Buildings Income Tax Payable Deduction (in Birr)
(per year) (in %)

over Birr to Birr

0 Exempt threshold
1,800
1,801 7,800 10% 180.00
7, 801 16,800 15% 570.00
16, 801 28, 200 20% 1410.00
28, 201 42,600 25% 2520.00
42, 601 60,000 30% 4950.00
over 60, 000 35% 7950.00
Example: Computation of Rental Income Tax
Net profit per-year/Taxable Income 38, 000.00 Birr
- Rental Income Tax = 38,000 Birr x 25% tax rate = 9,500 Birr
- Deduction = 9,500 Birr -2,820 Birr deduction fee
- Tax payment = 6,680 Birr
Conditions of payment:
 The owner of a building who allows a lessee to sub-lease is liable for the payment of the
tax for which the sub-lessor is liable, in the event the sub-lessor fails to pay;
 When the construction of a rental building is completed or when the building is rented, the
owner and the builder are required to notify the administration of the Kebele in which the
building is situated about such completion and the name, address, and tax identification
number of the person or persons subject to tax on income from rental of building;
 The Kebele administration has the obligation to communicate the information obtained to
the appropriate tax authority.

2.5 Tax on Interest Income on Deposits

Every person deriving income from interest on deposits shall pay tax at the rate of 5%. The payers
are required to withhold the tax and account to the Tax Authority.
Dividend Income Tax
Every person deriving income from dividends from a share company or withdrawals of profits
from a private limited company shall be subject to tax at the rate of 10%. The withholding agent
shall withhold or collect the tax and account to the Tax Authority.
Tax on Income from Royalties
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‘Royalty income’means 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 films,
and films or tapes for radio or television broadcasting. Royalties income shall be liable to tax at a
flat rate of 5%. The withholding agent who effects payment shall withhold the foregoing tax and
account to the Tax Authority. Where the payer resides abroad and the recipient is a resident, the
recipient shall pay tax on the royalty income within the time limit set out.
Tax on Income from Games of Chance
Every person deriving income from winning of games of chance (e.g., lotteries, tombolas, and
other similar activities) shall be subject to tax at the rate of 15%, except for winning of less than
100 Birr. The payer shall withhold or collect the tax and account to the Tax Authority.
Tax on Gains of Transfer of Certain Investment Property
This is the tax payable on gains obtained from the transfer (sale or gift) of building held for
business, factory, office, and shares of companies. Such income is taxable at the following rates:
 Building held for business, factory, and office at the rate of 15%;
 Shares of companies at the rate of 30%.
Gains obtained from the transfer of building held for residence shall be exempted from tax
provided that such building is fully used for dwelling for two years prior to the date of transfer.
Any person authorized by law to accept, register or in any way approve the transfer of capital
assets shall not accept, register or approve the transfer before ascertaining that the payment of the
tax has been duly effected.
Tax on Income from Rental of Property
The taxable income under this category is income derived from casual rental of property
(including any land, building, or moveable asset) not related to a business activity. This type of
income is subject to tax at a flat rate of 15% of the annual gross income.
Rendering of Technical Services outside Ethiopia
All payments made in consideration of any kind of technical services rendered outside Ethiopia to
resident persons in any form shall be liable to tax at a flat rate of 10% which shall be withheld and
paid to the Tax Authority by the payer. The term “technical service “means any kind of expert
advice or technological service rendered.

2.6 Agricultural Income Tax

According to Proclamation No. 152 of 1978 individual farmers and agricultural producer-
cooperatives earning up to Birr 600 per annum are required to pay 10 Birr. The tax rates on every
additional income vary from 10% to 89% for income above 600 Birr.
In line with the economic policy and structural set up of the Federal
Democratic Republic of Ethiopia, the former tax on income from agricultural activities and the
land use rent was revised in 1995. Since income tax from this source is allocated to Regional
States in consonance with the provisions of the new constitution of 1994, each Regional State is
entitled to issue a Proclamation providing for such a tax and rent.

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Accordingly, the Oromia Regional State has promulgated Proclamation No. 8/1995 that revised
agricultural income tax rates schedule and rural land use fee. As for the payment of income tax
from agricultural activities other taxpayers, except state farms, shall pay at the following rate.
Agricultural Income Tax per Proclamation No. 8/1995, Oromiya

No Annual Taxable Income Tax Rate

1 up to 1,200 Birr Birr 15

2 1,201 - 5,000 5%
3 5,001 - 15,000 10%
4 15,001 - 30,000 20%
5 30,001 - 50,000 30%
6 over 50,000 40%

A state farm shall pay 40% of the taxable income it realizes from its agricultural activities. Income
from agricultural activities is said to be determined by estimating the price, in the area, of the crop
before harvest.
If the crop is sold, the price declared shall be the basis for the assessment of income.
Land Use Tax
According to Proclamation No. 77/1976 and No. 152 /1978 individual farmers, who are not
members of producer’s cooperatives, are required to pay a land use fee of Birr 10 per hectare per
annum. Whereas government agricultural organizations are paying 2 Birr per hectare per annum.
Presently regional states have their own land use rent systems. For instance, according to the
Proclamation No. 8/1995 of Oromiya, rural land held for agricultural activities is subject to land
use rent payment on annual basis. The annual land use rent payable by a farmer shall be Birr 10
for the first hectare and Birr 7.50 for each extra hectare of land. Meanwhile statefarming
enterprises shall pay Birr 15 for each hectare of their land holdings.
Land use rent is to be collected between the 1st of Hidar and the 30th of Miazia of the year.

2.7 Indirect Taxes

Turnover Tax
The Turnover Tax would be payable on goods sold and services rendered by persons not
registered for Value Added Tax. The rate of Turnover Tax is
 2% on goods sold locally;
 for services rendered locally:
 2% on contractors, grain mills, tractors and combine-harvesters;
 10% on others.
The base of computation of the Turnover Tax is the gross receipts in respect of goods supplied or
services rendered. A person who sells goods and services has the obligation to collect the
Turnover Tax from the buyer and transfer it to the Tax Authority. Hence, the seller is principally

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 accountable for the payment of the tax. In accordance with the Turnover Tax Proclamation No.
308/2002, the following would be exempted:
 Sale or transfer of dwelling used for a minimum of two years, or the lease of a dwelling;
 Rendering of financial services;
 Supply of national or foreign currency and of securities;
 Rendering by religious organizations of religious or other related services;
 Supply of prescription drugs specified in directives issued by the relevant government agency,
and the rendering of medical services;
 Rendering of educational services provided by educational institutions;
 Supply of goods and rendering of services in the form of humanitarian aid;
 Supply of electricity, kerosene and water;
 Provision of transport;
 Permits and license fees;
 Supply of goods or services by a workshop employing disabled individuals (if more than 60%
of the employees are disabled);
 Supply of books..

2.8 Tax Evasion

A person who evades the declaration or payment of tax, commits an offence and in addition to any
penalty may be prosecuted and be subject to a term of imprisonment of not less than five (5) years.
If any amount of tax is not paid by the due date, the person liable is obliged to pay interest on such
amount for the period from the due date to the date the tax is paid. The interest rate is set at 25%
over and above the highest commercial banks lending interest rate that prevailed during the
preceding quarter.
A person who fails to file a timely return is liable for a penalty equal to 5% of the amount of tax
underpayment for each month (or portion there of) during which the failure continues, up to 25%
of such amount. The penalty is limited to 50, 000 Birr for the first month in which no return is
filed
Excise Tax
It is believed that this tax should be imposed on luxury goods and basic goods, which are demand
inelastic. It is also believed that imposing the tax on goods that are hazardous to health and which
are causes to social problems will reduce the consumption thereof.
Rate of Excise tax:
The excise tax would be imposed on goods imported or either produced locally in accordance with
the following schedule, given in Excise Tax Proclamation No. 307/2002.
Goods to be liable to Excise Tax (produced locally or imported)

Ser. No. Type of Product Excise Tax Rate

1 Any type of sugar (in solid form) excluding molasses 33%

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2 Drinks:
2 2.1 - All types of soft drinks (except fruit juices) 40%
2.2 - Powder soft drinks 40%
2.3 - Water bottled or canned in a factory 30%
2.4 Alcoholic Drinks:
2.4.1 - All types of beer + stout 50%
2.4.2 - All types of wine 50%
2.4.3 - Whisky 50%
2.4.4 - Other alcoholic drinks 100%
3 All types of pure alcohol 75%
4 Tobacco + tobacco products
4 4.1 - Tobacco leaf 20%
4.2 - Cigarettes, cigar, cigarillos, pipe tobacco, 75%
snuff and other tobacco products
5 Salt 30%
6 Fuel-Super Benzene, Regular Benzene, 30%
Petrol, Gasoline and other Motor Spirits
7 Perfumes and toilet waters 100%
8 Textile and textile products
8 8.1 - Textile fabrics, knitted or woven of natural silk, rayon, nylon, wool 10%
or other similar materials
- Textile of any type partly or wholly made from cotton, which is 10%
8.2 grey, white, dyed or printed, in pieces of any length or width (except
Mosquito net and Abudgedid) and including, blankets, bed-sheets,
counterpanes, towels, table clothes and similar articles
8.3 - Garments 10%

9 Personal adornment made of gold, silver or 20%

other materials
10 Dish washing machines of a kind for domestic use 80%
11 Washing machines of a kind for domestic purposes 30%
12 Video decks 40%
13 Television and video cameras 40%
14 Television broadcast receivers whether or not combined with 10%
gramophone, radio, or sound receivers and reproducers
15 Motor passenger cars, StationWagons, utility cars, and Land Rovers,
15.1 jeeps pickups, similar vehicles (including motorized caravans),
15.2 whether assembled, together with their appropriate initial
15.3 equipment: 30%
- up to 1,300 c.c. 60%

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 - from 1,301 c.c. up to 1,800 c.c. 100%
- above 1,800 c.c.
16 Carpets 30%
17 Asbestos and asbestos products 20%
18 Clocks and watches 20%
19 Dolls and toys 20%
The base of computation of Excise Tax is the cost of production for goods produced locally;
whereas for goods imported the base of computation would be the cost of production, insurance
and freight costs.
Obligations of the taxpayer:
 Maintaining books of accounts and supporting documents in accordance with proper
accounting principles and in a manner acceptable to the Tax Authority;
 Submit every 30 days to the Tax Authority, in a form which would be supplied by the
Authority, a declaration containing the necessary information for the proper collection of the
tax;
 Comply fully with the requirements of inspection of his premises by the delegates of the Tax
Authority;
 Immediately communicate to the Tax Authority the type and address as well as the
commencement and termination date of his business;
 Pay in full the tax due within 30 days from the date of termination where such business is
terminated.
Regarding goods imported the Tax Authority can sell such goods where the tax in respect of them
is not paid within six months from the day of deposit within the premises of government
warehouse, or in the case of perishable goods.

2.9 Value Added Tax (VAT)

VAT is a tax on consumer expenditure. It is collected on business transactions and imports. A
taxable person can be an individual, firm, company, as long as such a person is required to be
registered for VAT.
Most business transactions involve supplies of goods or services. VAT is payable if they are:
 Supplies made in Ethiopia;
 Made by a taxable person;
 Made in the course or furtherance of a business;
 Are not specifically exempted or zero-rated.
The Value Added Tax would be levied at the rate of 15% of the value of:
 Every taxable transaction by a registered person;
 Every import of goods, other than an exempt import; and
 Import of services.
A person who carries on taxable activity and is not registered is required to file an application for
VAT registration with the Authority if:

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 At the end of any period of 12 calendar months the person made , during that period, taxable
transactions the total value of which exceeded 500,000 Birr; or
 At the beginning of any period of 12 calendar months there are reasonable grounds to expect
that the total value of taxable transactions to be made by the person during that period will
exceed 500,000 Birr.
Registration procedure:
 A person applying to register for VAT is required to do so in such a form as is established by
the implementation directives issued by the Ministry of Revenue;
 When a person carrying out taxable transactions files an application to be registered for VAT,
the Authority is required to register the person in the VAT register, and to issue a certificate of
registration within 30 days of the registration;
 A person registered for VAT is required to use his taxpayer identification number on all VAT
invoices, and on all tax returns and official communications with the Authority.
There is a VAT invoice prepared by the Ministry of Revenue containing the following
information:
 Full name of the registered person and the purchaser, and the registered;
 Person’s trade name, if different from the legal name;
 Taxpayer identification number of the registered person and the purchaser;
 Number and date of the VAT registration certificate;
 Name of the goods shipped or services rendered;
 Amount of the taxable transaction;
 Amount of the excise on excisable goods;
 Sum of the VAT due on the given taxable transaction;
 Issue date if the VAT invoice, and
 Serial number of the VAT invoice.
The registered person is required to issue the VAT invoice to the purchaser of goods or services
upon the supply or rendering, but not later than 5 days after the transaction.
Record Keeping Requirement:
A registered person or any other person liable for VAT under the proclamation shall maintain for
10 years in Ethiopia:
 Original tax invoices received by the person;
 Copy of all tax invoices issued by the person;
 Customs documentation relating to imports and exports;
 Accounting records; and
 Any other records as may be prescribed by the Minister of Revenue by directive.
Administrative Penalties:
The following penalties are imposed for violations of the VAT Proclamation:
 Where any person engages in taxable transactions without VAT registration where VAT
registration is required – 100%of the amount of tax payable for the entire period of operation
without VAT registration;

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 Where any person issued incorrect tax invoice resulting in a decrease in the amount of tax or
increase in accredit or in the event of the failure to issue a tax invoice –100%of the amount of
tax for the invoice or the transaction;
 Where a person who is not registered for VAT issues a tax invoice – a penalty of 100%of the
tax which is indicated in the tax invoice and is due for transfer to the budget but has not been
transferred; and
 Where a person fails to maintain records required – 2,000 Birr for each month or portion
thereof that the failure continues.
A person who fails to file a timely return is liable for a penalty equal to 5% of the amount of tax
underpayment for each month (or portion thereof) during which the failure continues, up to 25%
of such amount. The penalty is limited to 50,000 Birr for the first month (of portion thereof) in
which no return is filed. If any amount of tax is not paid by the due date, the person liable is
obliged to pay interest on such amount for the period from the due date to the date the tax is paid.
The interest is set at 25% over and above the highest commercial lending interest rate that
prevailed during the preceding quarter. The following types of supplies of goods (other than by
way of export) or rendering of services, as well as the following types of imports of goods are
exempt from payment of VAT:
 Sale, transfer or the lease of a used dwelling;
 Rendering of financial services;
 Supply/import of national/foreign currency and of securities;
 Import of gold to be transferred to the National Bank;
 Rendering of religious organizations or church services;
 Import or supply of prescription drugs specified in directives issued by Minister of health,
rendering of medical services;
 Educational services provided by educational institutions, or child care services for children at
pre-school institutions;
 Supply of goods and rendering of services in the form of humanitarian aid, as well as import of
goods transferred to state agencies of Ethiopia and public organizations for the purpose of
rehabilitation after natural disasters, industrial accidents, and catastrophes;
 Supply of electricity, kerosene, and water;
 Goods imported by the government, organizations, institutions or projects exempted from
duties and other import taxes to the extent provided by law or by agreement;
 Supplies by the post office authorized under the Ethiopian Postal Services Proclamation, other
than services rendered for a fee or commission;
 Provision of transport; Permits and license fees;
 Supply of goods or services by a workshop employing disabled individuals if more than 60 %
of staff are disabled;
 Import or supply of books and other printed materials.
Customs Duty
Any good imported or exported would be subject to:

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  Payment of duties and taxes according to the tariff of Harmonized Commodity Description
and coding system;
 Payment of duties and taxes according to the preferential tariff rate where goods are
imported from the preferred country;
 Payment of duties and taxes at the rate in force on the day the declaration of the goods are
presented to, and accepted by the customs office.
Duty Paying Value
The duty paying value of any import or export goods shall be the actual total costs of the goods.
Duty Paying Value of Imports:
1) For the purpose of customs the duty paying value for imported goods would be the sum of the
transaction value, freight cost and insurance premium that is paid to deliver the goods up to a
prescribed customs port;
2) Transaction value and other related costs given by a supplier who is associated in business with
the importer shall be considered genuine unless the given price is influenced by their relationship;
3) Where a document which show the correct freight cost up to the first customs port is not
produced or the document produced is rejected by the Authority; the freight cost of identical goods
transported at or about the same time with the same means of transport would be taken to calculate
the cost of freight;
4) Goods imported without insurance coverage or transported under insurance coverage but the
bill produced is rejected by customs, the insurance cost paid for identical goods transported at or
about the same time with the same means of transport would be taken to calculate the cost of
insurance;
5) To determine the accurate value of the goods the following additional costs shall be considered
A. commission and brokerage costs incurred by the buyer;
B. cost of container and cost of packing the goods be it for labor or material;
C. value of goods and services supplied by the buyer free of charge or at reduced cost, to the
extent that such value has not been included in the price actually paid or payable;
D. royalties and license fees related to the goods that is paid directly or indirectly by the buyer;
E. loading, unloading and handling charges paid up to the port of importation.
6) Where documents necessary to determine duty paying value of the goods are not presented, or
rejected by the Authority, the transaction value of identical goods imported from the same country
at or about the same time shall be taken to determine the value of the goods;
7) Where the value of the goods cannot be determined the transaction value of similar goods
imported from the same country at or about the same time shall be taken to determine the value of
the goods.
Deductibles from Import Value:
1) The following adjustment costs shall be deducted from import values
a) Costs for damages in routes;
b) Costs for damages in customs warehouse.
2) When it is requested and agreed upon by the customs office to destroy or dispose any dangerous
goods deposited in the warehouse, the goods shall be destroyed or disposed at the presence of

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customs officer and other officials concerned, and the value of the goods destroyed or disposed
should be deducted proportionally from the duty paying value of the goods.
For customs purpose the value of export goods shall be the transaction value of the goods and the
cost of transaction up to the port of exit.
Requirements for Customs transit goods:
1) For commercial goods
 original bill of lading;
 original or copy Performa invoice;
 original receipt of pre-shipment inspection fee;
 original and copy of bank permit;
 deposit for goods imported with guarantee bond or certificate for goods imported without
guarantee bond.
2) For duty free goods
2.1 Goods which do not require pre-shipment inspection
 bill of lading (goods to be imported with bank permit);
 copy of the original bill of lading (for goods to be imported without bank permit);
 permit letter for duty free privilege or certificate for the transportation of goods without
guarantee;
 document showing quality and quantity of transit goods;
2.2 Goods requiring pre-shipment inspection
 original bill of lading;
 original or copy of the Performa invoice;
 original receipt of the pre-shipment inspection fee;
 Original and copy of the bank permit.
3) For goods to be imported on government budget
 original and copy of bill of lading;
 original or copy Performa invoice;
 original receipt of the pre-shipment inspection fee or copy of the receipt bearing the seal of
customs offices;
 original bank permit with its copy;
 Undertaking letter for a guarantee or permit for transiting goods without guarantee.
4) For transit of donation or gift goods
 original bill of lading or the fax copy of the original;
 original or copy document stating the type, the amount, and the value of goods;
 Letter of guarantee or permit for goods to be transited without guarantee.
Customs Control
For the implementation of the objectives of customs, the following goods shall be under the
supervision and control of customs:
 Imported goods from the time at Customs port until the completion of customs formalities and
received by the importer;
 Goods under drawback procedure from the time of drawback claim until exportation;

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 Goods entered into customs warehouse until removed from the warehouse;
 Goods of export from the time they entered into customs port until the completion of customs
formalities and be exported;
 Goods in transit, from the time their movement is allowed until the completion of transit
procedure;
 Goods found without owner, abandoned, forfeited or contraband goods until they are sold or
disposed otherwise.
The Customs Authority would be responsible for the damage on goods under its control and
supervision caused by its employees while discharging their official duties.
Duty Free Privilege
Ethiopians enjoying duty free privilege are classified in to five categories based on the special
rank, responsibility, mission and the length of their stay in abroad. People in these categories and
goods imported without paying duties and taxes are the following.
Category 1
Ethiopian diplomats returning from abroad up on completion of their mission. These diplomats
are:
a) Ethiopians who were working in Ethiopian Embassies abroad;
b) Ethiopians who were assigned by the government with the rank of diplomat to work at
international and regional organizations where Ethiopia is a member;
c) Ethiopians competitively employed by their own in the above organizations and have got a
diplomatic status;
d) Ethiopians who are issued diplomatic passport and were working in foreign institutions
recognized by the Ministry of
Foreign Affairs of Ethiopia;
e) Ethiopian returnees on special call made by the government.
People under this category can import automobile; personal effects and house hold goods without
paying duties and taxes. However, those who are under “E”of category 1 are not allowed to import
automobile on duty free.
Category 2
Ethiopians who are included in this category are:
a) Those who have been working in any Ethiopian government office for more than three years;
b) Those who returned to invest their capital in their country and who have got investment
certificates;
c) Students who have been attending higher education for one or more academic year;
d) Students who have been abroad for higher education and who returned home for research
during academic seasons may bring with them part of what they are allowed to import when they
return home after graduation;
e) Returnees/refugees stayed for more than three years abroad;
f) Ethiopians employed in international regional organizations on competitive basis served for
more than three years abroad.

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People under this category are allowed to import automobile, personal effects and household
goods without paying duties and taxes. Whereas those people mentioned under “E”are not allowed
to import automobile on duty free.
Category 3
Ethiopian refugees, returnees, staff of international and regional organizations who do not have a
diplomatic status and employees of government branch offices abroad who stayed for more than
one year and less than three years. People in this category are allowed to import household goods
and personal effects on duty free but not automobile.
Category 4
This category includes Ethiopians who stayed abroad for more than three months and less than one
year. These are refugees, returnees, employees of government branch offices abroad, staff of
international and regional organizations as well as Ethiopians who were out on business, seminar,
education, visiting and medical reasons. Ethiopians under this category are allowed to import
household goods and personal effects on duty free excluding automobile.
Category 5
Ethiopians who were abroad for less than three months for government business education,
visiting and medical reasons. People in this category are also allowed to import household goods
and personal effects on duty free except automobile. Diplomatic and Consular Missions and their
officials are entitled duty free rights. UN Organizations, international and regional organizations
and their officials and staff members are granted exemptions from all customs duties and taxes for
articles imported by them with in the permitted time frame.
Organizations established by foreign governments to render economic, technical and cultural
assistance and their expatriates are granted exemption from all customs duties and taxes for
articles imported by the organizations and their respective officials. Expatriates working in
nongovernmental organizations are entitled duty free rights for articles imported for their personal
use. Investors of foreign nationals are also entitled to a duty free right for articles imported for
their personal use.
Any goods imported duty free may be sold or disposed to any person who enjoys similar
privileges without paying duties and taxes. Whereas, if the goods imported duty free are to be sold
or transferred to any other person not having the privilege it would be subjected to customs duties
and taxes at the rate and value prevailing during the time of sales or disposal.
Stamp Duty
The following instruments shall be chargeable with stamp duty:
 Memorandum and articles of association of any business organization, cooperative or any
other form of association;
 Award; Bonds; Warehouse bond;
 Contract and agreements and memoranda;
 Security deeds;
 Collective agreement;
 Contract of employment;
 Lease, including sub-lease and transfer of similar rights;

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  Notaries acts;
 Power of attorney;
 Documents of title to property.
Time and Manner of Payment
1) The stamp duty would be paid:
 On memorandum and articles of association, before or at the time of registration;
 on awards, before or at the time of issuance of the award;
 on contracts or agreements, before or at time of signature;
 on leases or sub-leases, before or at the time of signature;
 on notaries acts, at the time of issuance;
 on security deeds, before or at the time of signature;
 on documents of title to property, before or at the time issuance is effected.
2) The payment of stamp duty
 Under Birr 50 would be effected by affixing stamp of appropriate value to the instrument;
 when the stamp duty exceeds Birr 50 or where the type and nature of instrument so
requires, the Federal Government Revenue Board may by directive provide;
 That stamp duty is paid by means other than affixing stamp.
3) Whoever executes or receives an instrument bearing an adhesive stamp shall at the time of
execution cancel the same, so that it cannot be used again.
Rate of Stamp Duty:
The stamp duty on each instrument to be charged levied and collected at the following rates:
No. No. Instruments chargeable Basis of Rates of
with Stamp Duty Valuation Stamp Duty

1 Memorandum and articles of association

of any business organizations, or any
association: flat Birr 350
a) upon 1st execution flat Birr 100
b) upon any subsequent execution
2 Memorandum and articles of
association of cooperatives
a) upon 1st execution flat Birr 35
b) upon any subsequent execution flat Birr 10
3 Award on value a) determinable value 1%
b) undeterminable value Birr 35
4 Bonds on value 1%
5 Warehouse bond on value
6 Contracts and agreements and memoranda flat Birr 5

7 Security deeds on value 1%

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8 Collective agreement
a) on 1st execution flat Birr 350
b) on any subsequent execution flat Birr 100
9 Contract of employment salary 1%
10 Lease including sub-lease and transfer on value 0.5 %
thereof
11 Notaries act flat Birr 5
12 Power of attorney flat Birr 35
13 Register title to property on value 2%
Right to Appeal
Persons dissatisfied with the decision of the Federal Inland Revenue Authority in respect of the
amount of Stamp Duty may, within 21 days from the date of notification of the decision rendered
in writing, make an appeal against the decision to the Federal High Court.
Penalty
Any person:
 Executing or signing, otherwise than as a witness, a document chargeable with stamp duty
without the same being stamped,
 Who, with intent to defraud the appropriate payment of duty, conceals facts bearing on the true
nature of any instrument, shall be liable on conviction to a fine not less than Birr 25,000 and
not exceeding Birr 35,000 and to rigorous imprisonment for a term not less than 10 years and
not more than 15 years.
Any person who:
 Appointed to sell stamps or stamped papers, disobeys regulations issued under this
proclamation; or
 Not so appointed, sells or offers for sale stamps or stamped papers; shall be liable on
conviction to a fine not less than Birr 5,000 and not exceeding Birr 20,000 and to rigorous
imprisonment for a term not less than 5 years and not more than 10 years.
Exemptions:
 The Ministry of Revenue may for good cause grant exemption from payment of stamp duty;
 Public bodies on which the Federal Government of Ethiopia Financial Administration
Proclamation No. 57/1996 applies shall be exempt from payment of stamp duties;
 Goods imported for sale by traders having import license shall be exempt from payment of
stamp duty when first registered in the name of the trader;
 Documents may be exempted from the payment of stamp duty in accordance with international
agreements and conventions approved by the Government;
 Subject to reciprocity, the Minister may grant embassies, consulates and missions of foreign
states exemption from payment of stamp duty;
 Share certificates shall be exempt from stamp duty payable on the register of title of property.
2. Categories of Taxpayers
Taxpayers are classified into the following three major categories:

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1) Category “A “Taxpayers
2) Category “B”Taxpayers
3) Category “C”Taxpayers
2.1 Category “A “Taxpayers
This category of taxpayers includes:
a) Any company incorporated under the laws of Ethiopia or in a foreign country;
b) Any other business having an annual turnover of Birr 500,000 or more.
Category “A “taxpayers are required to submit to the Tax Authority, at the end of the year, a
balance sheet and a profit and loss statement and the following details:
a) Gross profit and the manner in which it is computed;
b) General and administrative expense;
c) Depreciation expense; and
d) Provisions and reserves.
In addition, these taxpayers should register with the Tax Authority the type and quantity of
vouchers they use before having such vouchers printed.
Any printing press before printing vouchers of taxpayers shall ensure that the type and quantity of
such vouchers is registered with the Tax Authority.
2.2 Category “B”Taxpayers
Unless already classified in category “A”, any business having an annual turnover of over Birr
100, 000 would be classified under Category “B” taxpayers. This category of taxpayers should
submit to the Tax Authority profit and loss statement at the end of the year.
2.3 Category “C”Taxpayers
Unless classified in Categories “A” and “B”, those businesses whose annual turnover is estimated
up to Birr 100, 000 are classified under this category of taxpayers.
3. Declaration of Income and Assessment of Taxes
Taxpayers shall submit the tax declaration to the Tax Authority at the time of submitting the
balance sheet, and the profit and loss account for that tax year within the time prescribed below:
a) Category “A”taxpayers within four months from the end of the taxpayers tax year;
b) Category “B”taxpayers within two months from the end of the taxpayers tax year.
A standard assessment method should be used to determine the income tax liability of category C
taxpayers. The taxpayer should pay the tax determined in accordance with standard assessment
from the 7th day of
July to the 6th day of August every year, unless, the taxpayer requested and is allowed to make
installment payments.
If no records and books of accounts are maintained by the tax payer, or if, for any reason, the
records and books of accounts are unacceptable to the
Tax Authority, or if the taxpayer fails to declare his or its income within the time prescribed by the
proclamation, the Tax Authority may assess the tax by estimation. Unless and otherwise provided,
the period for tax assessment is the one-year period from 1st Hamle to 30th Sene. A body shall not
change its accounting year unless it obtains prior approval, in writing, from the Tax Authority and
compiles with any condition that may be attached to the approval.

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If a taxpayer has submitted a declaration of income within the time and manner as prescribed in
the proclamation, the Tax Authority has five years to amend the assessment. The five years
assessment period runs from the due date of the declaration. In case where the taxpayer has not
declared his income or has submitted a fraudulent declaration, no time limit provided in any other
law shall bar the assessment of the tax by the Tax Authority.

LO3: Handle payroll enquiries

 Responding payroll enquiries
 Providing information in accordance with organizational and legislative requirements
 Ensuring all enquiries outside area of responsibility and knowledge are referred to
designated persons for resolution
 Completing additional information or follow-up action within designated time lines in
accordance with organizational policy and procedures

3.1 Record Keeping Requirement

All persons who are engaged in a business or trade or who own buildings held all or in part for
rental, except for Category “C”taxpayers shall keep books and records. Those businesses that are
required to keep books of accounts and records are also required to keep the following
information:
a) Record of the business assets and liabilities, including a register of fixed assets showing the date
of acquisition, the cost of acquisition, and the current book value of each asset;
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b) Record of all daily income and expenses related to the business activity and the matter to which
they relate;
c) Record of all purchases and sales of gods and services to the business activity showing:
- The particular goods and services sold;
- The name of the buyers and sellers or providers in such a manner that they can be identified by
the Tax
Authorities;
- Pre-numbered invoices containing the vendor’s tax identification number;
d) Record of trading stock on hand at the end of the accounting period, including the type, quantity
and cost of that stock as well as the method of valuation of that stock;
e) Any other document relevant for the determination of the tax liability;
f) If a taxpayer has certain books or records in a foreign language, the Tax Authority may require
that they be translated into one of the official languages of Ethiopia at the taxpayer’s expense.

3.2 Penalty for Failure to keep proper Records

The taxpayer shall be liable for a penalty of 20% of the tax assessed if he failed to keep proper
books of account, records, and other documents regarding a certain tax year. If the Tax Authority
finds that a taxpayer has failed for two consecutive years, to keep proper books of account,
records, and other documents the licensing authority would suspend the taxpayer’s license on
notification by the Tax Authority.
Tax Evasion: A tax payer who evades the declaration or payment of tax commits an offense and,
in addition to the penalty for the understatement of income may be prosecuted and be subjected to
imprisonment for a term of not less than five (5) years.
4. Tax Incentives
To encourage private investment and promote the inflow of foreign capital and technology into
Ethiopia, the following incentives are granted to both domestic and foreign investors engaged in
areas eligible for investment incentives:
Customs Import Duty
 100% exemption from the payment of import customs duties, and other taxes levied on
imports is granted to an investor on all investment capital goods, such as plant machinery and
equipment, construction materials, as well as spare parts worth up to 15% of the value of the
imported investment capital goods, provided that the goods are not produced locally in
comparative quantity, quality and price;
 Investment capital goods imported without the payment of import customs duties and other
taxes levied on imports may be transferred to another investor enjoying similar privilege;
 Exemptions from customs duties or other taxes levied on imports are granted for raw materials
that are necessary for the production of export goods.
Areas of Investment not eligible for Exemption from Payment of
Customs Duty

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 Hotels (other than those star-designated), motels, tea rooms, coffee shops, bars, night club and
restaurants that do not have international standards;
 Wholesale, retail and import trade;
 Maintenance services;
 Commercial road transport and car-hire services;
 Postal and courier services;
 Real estate development;
Income Tax Holiday
Profit tax holiday is granted in accordance with the Council of Ministers
Regulation No. 84/2003 as follows:
Conditions for profit tax holiday eligibility, for investors engaged in a new manufacturing or agro-
industry activity:
A) If at least 50% of its production is to be exported, profit tax exemption is for 5 years. In
addition, if the investment is made in relatively under-developed regions the profit tax exemption
is for 6 years;
b) If at least 75% of its production will be input for the production of export items there is also a
profit tax exemption for 5 years. If the investment is made in relatively underdeveloped region the
exemption would be for 6 years;
c) If the project is evaluated under a special circumstance by the BOI the profit tax exemption
would be given up to 7 years. If the investment is made in relatively underdeveloped regions the
profit tax exemption would be given up to 8 years. However, the granting of income tax
exemption for a period longer than 7 years requires the decision of the Council of Ministers;
d) If less than 50% of the production is to be exported the profit tax exemption would be given for
2 years. If the investment is made in relatively under-developed regions the exemption would be
given for 3 years;
e) If the production is for the local market there is a profit tax exemption for 2 years; and if the
investment is made in relatively under-developed regions the exemption would be given for 3
years;
f) If the production mentioned above under (d) and (e) is considered by the BOI to be a special one
the profit tax exemption would be given up to 5 years. If the investment is made in relatively
under-developed regions the exemption would be given up to 6 years.
It is to be noted that for expansion or upgrading of the above projects which would increase the
existing production by 25% in value and if 50% of the production is to be exported, a profit tax
exemption would be given for 2 years.
In order to improve the foreign currency reserve of the country enhancing export trade has become
necessary. Among the measures taken to achieve this, the setting up of the following export trade
incentive schemes is of worth mentioning:
 Duty Draw-Back Scheme;
 Voucher Scheme;
 Bonded Manufacturing Warehouse Scheme.

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3.3 Duty Draw-Back Scheme
“Duty Draw-back “means a scheme by which duty paid on raw materials used in the production of
commodities is refunded upon exportation of the commodity processed and shall include refund of
duties paid on goods re-exported in the same condition.
Beneficiaries of the scheme are persons or organizations wholly, partially or occasionally engaged
in exporting their products; re-exporting commodities, or raw materials they have imported upon
payment of duties.
Where raw materials equivalent in price and quality to those they imported are locally available it
would not apply. Duties paid on commodities or raw materials shall not be refunded where the
amount of duty paid is less than Birr 1000.
The commodity produced with the raw material should be exported within one year from the date
on which such raw material has been imported or purchased locally. Before exporting the
commodity or raw material, the beneficiary of the Drawback Scheme should declare to the Tax
Authority upon presentation of supporting documents that he intends to claim drawback. The
declaration presented shall include the following:
 The name and address of the claimant;
 The date of importation and the import transaction documents;
 The document proving the amount of duty paid;
 The type and quantity of the commodity or raw material on which draw-back is claimed;
input output coefficient;
 The type and detailed description of the manner of exportation of the commodity to be
exported;
 If the commodity or raw material is re-exported in the same condition, the damage that
could be caused by not being re-exported;
 The burden of proof that the duty claimed and the raw material and commodity presented
for draw-back are in accordance with the proclamation.
If duty drawback is claimed for an export of commodity or raw material, the rate is 100%
assuming that the items in question are processed and exported. The rate is 95% if the raw material
or commodity is re-exported in the same condition.

3.4 Voucher Scheme

“Voucher” means a document having monetary value, printed by the Ministry of Finance, to be
used as deposit for duties and taxes payable on imported raw materials. The Ministry of Finance
upon request of the
Customs Authority shall issue vouchers, in the amount of taxes and duties to be paid on raw
materials they may import, to producers who are legible to become beneficiaries upon satisfying
the conditions required.
On arrival of the imported raw materials at the Customs post, the raw materials shall directly be
transferred to the private warehouse in the premises of the production site after the exporter has

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deposited with the Customs Authority the vouchers in the amount of taxes and duties to be paid.
Raw materials imported under the Voucher Scheme must be fully utilized within one year from
the date of their importation. However, taking into consideration the nature of the raw material, the
Customs Authority may extend this period for an additional one year. Export commodities
produced from raw materials imported under the Voucher Scheme should be declared and
exported in accordance with Customs Procedure Code issued for this purpose by the Customs
Authority.
Raw materials imported under the Voucher Scheme should not be sold in the local market. Any
producer who in violation of the prohibitions provided sells the raw materials imported under the
Voucher Scheme in the local market forfeit his right to use the Scheme. If the producer because of
events beyond his control has terminated his export activity, after securing the consent of the
Customs Authority, can sell the raw materials upon payment of duties and taxes together with
interest thereon.
If the Ministry of Trade and Industry accepts the input-output coefficient submitted by the
producer the Customs Authority would assess the taxes and duties payable on the raw materials
imported under the Voucher
Scheme on the basis of the input-output coefficient and settle the voucher on the basis of such
assessment. Beneficiaries of the Voucher Scheme, in addition to input-output coefficient are
required to submit a memorandum showing the amount of raw material wasted in the course of
production process, the input used out of the raw material imported in the production of the by-
product, in percentage, during the execution of the annual production plan.
Beneficiaries of the Voucher Scheme are persons and organizations who have obtained eligibility
certificate issued by the Ministry of Trade and Industry. To become beneficiaries of the Scheme
persons and organizations are required to:
 Have manufacturing license;
 Submit their annual business and export plan;
 Submit input-output coefficient;
 Supply information concerning raw materials wasted in the process of production;
 Submit evidence of export performance in the last two years, if they are not new to the sector;
 Sign an agreement with the Customs Authority undertaking to fulfill obligations enabling them
to become beneficiaries of the Scheme;
 Submit evidence confirming that the commodity has demand and the demand is confirmed.

3.5 Purposes for which the Tax Revenue is utilized

The best instrument which the governments can use as a source of revenue is taxation. It can be
said, therefore, that a major function of taxation is to marshal the necessary funds to finance the
ever-expanding level of public expenditures.
As in all other countries, one of the purposes of taxation in Ethiopia is the raising of as much
revenue as possible to meet the ever-expanding public expenditure for the supply of public goods
and services which otherwise would not be available to the general public by the market. The

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central aim of the tax system in Ethiopia is to collect sufficient money to finance the
administrative machinery of the government as well as to finance the fulfillment of basic
infrastructures like roads, telecommunication, electricity and other basic social services like
education, health and water supply facilities. In developing countries personal savings are usually
low. This is because the per capita income of the population in these countries is very low.
Moreover, the population in these countries is so high that it demands their governments to spend
much of their limited revenues on public goods such as infrastructure, education and health. Thus
the governments of these countries normally have to look into various sources of finance, one of
which is tax revenue, so that public goods and services which in turn positively impact
development are supplied in reasonable quantities.
The tax system in Ethiopia is not only meant to raise revenue for current expenditures but also
aims at directing economic agents to the development goals foreseen by the government through
the incentive schemes embedded within the prevailing tax laws. If the investments are of high
priority in-terms of the country’s overall development goals, then they are entitled to better tax
incentives like tax holidays and the vice versa if otherwise. By doing so the government can direct
the allocation of resources into areas of its priority
Through the tax system, government can protect domestic industries from competing imported
goods through levying high tariff on the later.
Taxation is also used for non-fiscal purposes such as reducing the inequalities in income
distribution; encouraging certain industries and discouraging others depending on how useful and
appropriate they are at that particular economic stance.
Hence, some of the specific purposes of taxation in Ethiopia can be summarized as follows:
 Raising of as much revenue as possible to finance the country’s social and economic
development programs and to alleviate poverty;
 Promotion of capital investment and trade;
 Ensuring equity, fairness and consistency in the administration of tax laws;
 Encouraging certain industries which are held important in developing the country; and
 Discouraging other industries which are likewise not important to the long-run development of
the country.

3.6 Views of the Business Community

The business community comprises many different enterprises with partly diverging interests.
Public enterprises, parastatals, micro, small, medium and large enterprises are part of it. So the
views differ according to the size of the enterprise in terms of turnover, paid-up capital and
employment records and according to the sector. Also do regional aspects play a role, since the
regions have gained more autonomy? Last but not least the municipal taxes may complicate the
picture and make transparency difficult. The latter two aspects raise issues of regional equity,
since it was observed that the tax-burden for the very same business might differ according to the
geographical area of operation.
In general, the organized business community is unanimous about some basic principles:

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 Tax policy should promote investment and production so as to broaden the economic tax base
of the country and not only aim at over imposing taxes on existing incomes
 Taxes must be fair, i.e., citizens should be taxed in proportion to their abilities to pay “in
proportion to the benefit they derive from the government “(principle of equity) 1);\
 The possibilities and mechanisms to appeal should be improved and entrepreneurs be regarded
as partners who contribute their share to the national revenue (and not as objects that need to
be controlled first with a general suspicion that they are evading their civic duty);
 Tax penalties should be aimed at correcting and guiding the business community and not be
regarded as a source of additional revenue for the government. The prevailing tax penalties are
considered to be beyond the common businesses ability to pay, which makes it very hard for
government as well to enforce payment and leads to the closure of enterprises, which
otherwise could have continued to provide income and jobs to the national economy.
Customs Reform Program
The Ethiopian Customs Authority (ECuA) is planning to modernize its operational systems. The
modernization of ECuA would involve effective use of computerized systems. The modernization
would support the faster release of goods, post-release verification and audit programs and the
development of effective commercial intelligence and anti-smuggling programs. Moreover, ECuA
needs to develop its internal training capacity through the establishment of a training school.
The Customs Reform Program is organized into the following subprograms:
 Customs Automation; Headquarters and Station Buildings; Training School; Customs
Laboratory; Enforcement; Management and Operational Staff Training.

3.7 Personal Income Tax in Ethiopia

We have compiled here the rates and exemptions on personal income tax or tax on income from
employment in Ethiopia.
Payroll Tax Rate in Ethiopia and calculations
Every person having income from employment in any government or other private organization or
non Governmental organization, such as NGOS, and if his/her is income from employment
includes any payments or gain in cash or in kind which he/she receives from employers is
supposed to pay income tax as per the following table.

No Employment Income /Per- Tax Rate (%) Deduction In

months/ Birr

From Birr To Birr None

1 0 150 Exempted (Non-

taxable)

2 151 650 10% 15

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 3 651 1400 15% 47.5

4 1401 2350 20% 117.5

5 2351 3550 25% 235

6 3551 5000 30% 412.5

7 Over 5000 35% 662.5

Examples of Calculation on Payroll Tax Rate in Ethiopia

Example 1
Gross Salary = Br. 500
Tax: 500 x 10% - 15 = Br. 35
Net: 500-35 = Br. 465
Net Salary = Br. 465
Income Tax = Br. 35

Example 2
Gross Salary = Br. 5200
Tax: 5200 x 35% - 662.50 = Br. 1157.50
Net: 5200-1157.50 = Br. 4042.50
Net Salary = Br. 4042.50
Income Tax = Br. 1157.50

This part is adapted from the Ethiopian Revenues and Customs Authority
website: http://www.erca.gov.et/
Exempted Tax of an Employee's Transport Allowance
Transportation allowance of an employee is exempted from income tax when an employee and an
employer have an agreement between them, which their agreement is clearly defined on the
contract agreement that the allowance is applied only for transportation purpose.
The exempt transportation allowance from tax doesn't include if the employer arrange or give a
vehicle to employee when a person use the vehicle from house to work and from work to house.
The maximum Transportation Allowance Exempted from Tax
Tax exempted for transportation allowance to the employee shall be not more than 800 birr. Also
the transportation allowance paid to the employee should be not more than ¼ of his /her salary.
Exempted Tax on an employee's Per Diem and Weather Allowance
According to Directive No. 21/2001 (Download) issued by ERCA, Per Diem allowance and
Weather allowance can be free from Income Tax subject to the following conditions:
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  Weather allowance paid for employees who work in places that are clearly marked as
arid/desert.
 Per Diem allowance can be exempted from income tax when the employee and the employer
have an agreement between them, which their agreement is clearly defined on the contract
agreement that the allowance is applied only for Per Diem purpose.
 The Per Dime allowance doesn't include expenses incurred when an employee commutes to
and returns from office. It doesn't include expenses incurred by those who have company
vehicle or expenses incurred on transportation service provided by the company to
employees.
 The maximum Per Diem allowance - exempted from income tax - paid to an employee if
he/she travels farther than 25km from his/her place of work is Br. 150 per day and should not
exceed 4% of the employee's monthly salary.
 The maximum Per Diem allowance - exempted from income tax - paid to an employee per
month is Br. 1000 and should not exceed 1/4th or 25% of the employee's monthly salary.
 Transport expense incurred while an employee is on travel for work related purposes should
be based on documents/evidences and should be in line with (should not exceed) the
prevailing land or air transport fares.
 Transport expense incurred when and expatriate worker leaves the country - having
terminated his/her contract - should be as per the agreement specified in the contract and
should be in line with (should not exceed) the prevailing land or air transport fares with
his/her luggage not exceeding 300 kg.
3.8 Manual Payroll Vs Computerized Payroll Systems
Not so long ago, all payrolls used to be calculated manually, without any help from a computer.
Professional accountants invested a lot of time and energy into keeping track of all employee data,
files and information, calculating monthly salaries, hourly remunerations, bonuses, sick leaves,
benefits, taxes, deductions and so on. And they did this all by keeping numerous files filled with
track records for each and every person employed.

Nowadays, however, thing are far more simple than they used to be. Because technology is always
dedicated to making things easier and better, quite a wide variety of computerized payroll systems
is available to save us from this tedious task. Now, instead of keeping dozens of files and spending
endless hours calculating, all you have to do is get a payroll software system and let it do all the
nasty work.

So what manual vs. computerized payroll system? It really bares no comparison. A manual payroll
system means doing everything by hand, while a computerized one will enable its users to store
unlimited data, keeping track of everything. While with a manual payroll system you'd have to
keep track of all employees' time by hand, with payroll software you can automatically transfer all
punches or swipes directly into the system, which will store them instantly. It can even separate
regular work hours from overtime, and calculate the different remunerations according to set
parameters. And if human error sneaks in even with the most organized manual payroll system,

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 computerized payroll software will provide accurate calculations regardless of the amount of data
stored.
Automatic Calculations
 If employee time is imported into the computerized payroll system, the latter rounds the employee
time up and down appropriately, such as to the nearest quarter hour. It calculates the total hours
worked and to be paid. This saves on time spent manually calculating the hours and reduces errors.
If the payroll person enters the hours into the system herself, it calculates the wages automatically,
based on her input. The system calculates all pay frequencies, such as weekly, biweekly, and
semimonthly.

A computerized payroll system automatically calculates employee statutory deductions, such as

taxes and wage garnishments, and voluntary deductions, such as parking fees, 401k contributions
and medical benefits. The payroll person simply enters the data upon which the deductions are
based, such as Form W-4 information for federal income tax withholding.

Paycheck Processing
 A manual payroll system requires you to print paychecks on a typewriter or by hand. A
computerized payroll system has direct-deposit capability, which saves money spent on live
checks and reconciliation. Additionally, paycheck and pay stub generation occurs quickly,
regardless of volume.
Examples of Payroll Journal Entries for Wages
NOTE: In the following examples we assume that the employee's tax rate for Social Security is
6.2% and that the employer's tax rate is 6.2%. (During the years 2011 and 2012 only, the
employee's rate was reduced to 4.2%.)
In this section of payroll accounting we will provide examples of the journal entries for recording
the gross amount of wages, payroll withholdings, and employer costs related to payroll.

Let's assume that a distributor has hourly-paid employees working in two departments: delivery
and warehouse. The company's workweek is Sunday through Saturday and paychecks are dated
and distributed on the Thursday following the workweek.

For the workweek of December 18-24, the gross wages are $1,000 for hourly employees in the
delivery department and $1,300 for employees in the warehouse. Tax withholdings are determined
by consulting government payroll guidelines; other withholdings are based on agreements with
employees and court orders. Paychecks are dated and distributed on December 29.

The journal entry to record the hourly payroll's wages and withholdings for the work period of
December 18-24 is illustrated in Hourly Payroll Entry #1. In accordance with accrual accounting
and the matching principle, the date used to record the hourly payroll is the last day of the work
period.

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Hourly Payroll Entry #1: To record hourly-paid employees' wages and withholdings for the
workweek of December 18-24 that will be paid on December 29.

In addition to the wages and withholdings in the above entry, the employer has incurred additional
expenses that pertain to the above workweek. These are shown next in Hourly Payroll Entry #2,
which is also dated the last day of the work period. The items included are the employer's share of
FICA, the employer's estimated cost for unemployment tax, worker compensation insurance,
compensated absences, and company contributions for the company's 401(k) plan. The company is
recognizing these additional expenses and the related liability in the period in which the
employees are working and earning them. Later, when the company pays for them, it will reduce
the liability and reduce its cash. (Our journal entry assumes that this company does not provide
post-retirement benefits—like pensions or health insurance—to its employees.)
Hourly Payroll Entry #2: To record the company's additional payroll-related expense for
hourly-paid employees for the workweek of December 18-24.

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On payday, December 29, the checks will be distributed to the hourly-paid employees. The
following entry will record the issuance of those payroll checks.
Hourly Payroll Entry #3: To record the distribution of the hourly-paid employees' payroll
checks on Dec. 29. (These checks reflect the net pay for the wages earned during the
workweek of Dec. 18-24).

Some withholdings and the employer's portion of FICA were remitted on payday; others are not
due until a later date. Some withholdings, such as health insurance, were recorded as reductions of
the company's expenses in Hourly Payroll Entry #1. We will assume the amounts in the following
Hourly Payroll Entry #4 were remitted on payday.
Hourly Payroll Entry #4: To record the remittance of some of the payroll withholdings and
company matching pertaining to the hourly-paid workweek of Dec. 18-24.

End of Month and End of Year

Let's continue with our example of the payroll for the hourly-paid employees. We'll assume that
this distributor's accounting month and accounting year both end on Saturday, December 31.
The matching principle requires the company to report all of its December expenses (not simply
its cash payments) on its December financial statements. This means the company must report on
its income statement the hourly wages and other payroll expenses that the company incurred (and
the employees earned) through December 31.
Recall that the paychecks issued on December 29 covered the work done by hourly employees
through December 24. The company must now record the cost of work done during the week of
December 25-31 (a week that includes a Christmas holiday plus a number of employees taking
vacation days).

Let's assume that during the workweek of December 25-31, delivery department employees took
$300 worth of their holiday and vacation days. Since a portion of the employer's estimated cost of
holiday and vacation days was recorded as an expense and liability via each week's Hourly Payroll
Entry #2, the $300 associated with the days actually taken this week will not be recorded as an

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expense—rather, the $300 associated with the days taken this week will reduce the liability that is
recorded with each week's Hourly Payroll Entry #2. In other words, only $700 of the delivery
department's employee gross wages of $1,000 is for the work performed this week. The warehouse
department had a similar situation. Of the warehouse department's $1,300 of weekly wages, only
$1,050 is the expense for the work performed this week. The wages associated with the "days off
with pay" reduces the company's liability that was provided for each week in Hourly Payroll Entry
#2. Except for the holiday and vacation days, the workweek payroll for December 25-31 is similar
to the previous week.
Hourly Payroll Entry #1: To record hourly-paid employees' wages and withholdings for the
workweek of December 25-31 that will be paid on January 5.

In addition to the wages and withholdings in Hourly Payroll Entry #1, the employer has incurred
additional expenses that pertain to the above workweek. These are shown next in Hourly Payroll
Entry #2, which is also dated the last day of the work period. The items included are the
employer's share of FICA, the employer's estimated cost for unemployment tax, worker
compensation insurance, compensated absences, and company contributions for the company's
401(k) plan. The company is recognizing these additional expenses and the related liability in the
period in which the employees are working and earning them. Later, when the company pays for
them, it will reduce the liability and reduce its cash. (Our journal entry assumes that this company
does not provide post-retirement benefits-like pensions or health insurance-to its employees.)
Hourly Payroll Entry #2: To record the company's additional payroll-related expense for
hourly-paid employees for the workweek of December 25-31.

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On payday, January 5, the checks will be distributed to the hourly-paid employees. The following
entry will record the issuance of those payroll checks.
Hourly Payroll Entry #3: To record the distribution of the hourly-paid employees' payroll
checks on Jan 5. (These checks reflect the hourly-paid employees' take home pay from their
wages earned during the workweek of Dec. 25-31).

Some withholdings and the employer's portion of FICA were remitted on payday; others are not
due until a later date. Some withholdings, such as health insurance, were recorded as reductions of
the company's expenses in Hourly Payroll Entry #1. We will assume the amounts in the following
Payroll Entry #4 were remitted on payday.
Hourly Payroll Entry #4: To record the remittance of some of the payroll withholdings and
company matching pertaining to the hourly-paid workweek of Dec. 25-31.

Additional Accrual of Wages

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In our example above, the workweek ended on the same day as the calendar month and year:
December 31. In other months and in some years, the last full workweek might end on the 28th of
the month. In that case, the employer will need to estimate the payroll and payroll-related
expenses for the 29th, 30th, and 31st days of the month. Those estimates will be used to record
an accrual-type adjusting entry on the 31st. This is required so that all of the expenses actually
occurring during the month are matched with the revenues of the month. Recording wages
expense in the proper period is critical for accurate financial statements and therefore a very
important part of payroll accounting.
Examples of Payroll Journal Entries for Salaries
Note: In the following examples we assume that the employee's tax rate for Social Security is
6.2% and that the employer's tax rate is 6.2%. (During 2011 and 2012 only, the employee's rate
was reduced to 4.2%.)
Let's assume our company also has salaried employees who are paid semimonthly on the 15th and
the last day of each month. The pay period for these employees is the half-month that ends on
payday. There is one salaried employee in the warehouse department with a gross salary of
$48,000 per year, or $2,000 per pay period. There are four salaried employees in the Selling &
Administrative Department with combined salaries of $9,000 per pay period.

Because the salaried employees are paid on the last day of the month and their pay period ends
right on payday, there is no need to accrue for salaries at the end of December (or any other
calendar month). The salaried payroll entry for the work period of December 16-31 will be dated
December 31 and will look like this:
Salaried Payroll Entry #1: To record the salaries and withholdings for the work period of
December 16-31 that will be paid on December 31.

In addition to the salaries recorded above, the company has incurred additional expenses
pertaining to the salaried payroll for this semi-monthly period of December 16-31. These expenses
must be included in the December financial statements, as shown in the next journal entry:
Salaried Payroll Entry #2: To record additional payroll-related expense for salaried
employees for the work period of December 16-31.

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On payday, December 31, the checks will be distributed to the salaried employees. The following
entry will record the issuance of those payroll checks.
Salaried Payroll Entry #3: To record the distribution of the salaried employees' payroll
checks on Dec. 31. (These checks reflect the take-home pay for the salaries earned during the
work period of Dec. 16-31).

Some withholdings and the employer portion of FICA were remitted on payday; others are not due
until a later date. Some withholdings, such as health insurance, were recorded as reductions of the
company's expenses in Salaried Payroll Entry #1. We will assume the amounts in the following
Payroll Entry #4 were remitted on payday.
Salaried Payroll Entry #4: To record the remittance of some of the payroll withholdings and
company matching pertaining to the salaried employees during the work period of Dec. 15-
31.

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