Wollela AbehodieYesegat (PhD) is an academic staff at the College of Business and Economics of the Addis Ababa University. She teaches taxation related courses at the graduate level. Wollela has conducted a good number of researches on the Ethiopian tax system. In addition, she is a short term consultant to the International Finance Corporation (IFC) (a part of the World Bank Group). She has been involved in and isleading Ethiopian Revenue and Customs Authority (ERCA)- IFC’s tax simplification project, of which the current income tax reform thatwas initiated by both ERCA and the Ministry of Finance and Economic Cooperation(MoFEC), is one component. This project has had contributions to bring light to the newly drafted tax laws which are currently under discussion.The draft laws quickly grabbed public attention as there was much expectation for nearly fifteen years. Wollela argues that beyond some employment tax savings, there are considerable changes the new draft tax laws havebrought. She argues that the tax system has to reflect new developments internationally without losing the reality in Ethiopia.
BirhanuFikade of The Reporter sat down with Wollela at her office located at EshetuChole Building,the College of Business and Economics, Addis Ababa University and grasped what the new tax system has brought to the public. Excerpts:
The Reporter: can you take us to the backgrounds of the process of undertaking the recent tax reform?
WollelaAbehodieYesegat (PhD):. The income tax reform program was initiated by MoFEC and ERCAabout two years ago. They reviewed the existing income tax law, identifying issues and problems, and prepared a draft income tax law on their own. Following this, MoFEC sought IFC’s support in getting the draft income tax law reviewed in light of experiences internationally. In response to this and as part of the tax simplification project, IFC has been providing support. An international consultant was commissioned by MoFEC (with the support of IFC)to review and draft income tax law covering all areas except tax rate brackets and thresholds. The consultant reviewed the existing income tax law, and drafts prepared by ERCA and MoFEC in light of the experience internationally and the real circumstances in Ethiopia. The initial assessment report prepared by the consultant was reviewed by MoFEC and ERCA. In addition, the report was reviewed by colleagues at the IFC/ World Bank Group and others like the IMF. Having considered comments given on the review report, the results and recommendations of different studies conducted by ERCA with the financial and technical support of IFC (the tax compliance costs and perception survey, a review of dispute resolution system and others) the consultant has drafted these laws.
What are the rationales behind the new income tax amendment which took nearly fifteen years to happen?
There are a number of rationales to reform the existing income tax law in Ethiopia. Among others, the first reason that, I think, necessitated this reform is that the tax laws particularly the income tax legislation has been in place for nearly fifteen years without significant changes. It was enacted back in the year 2002. However, no earlier attempts were made to look back and assess whether the law remained effective in achieving its policy objectives. Things are changing quickly and the business environment is getting more dynamic. Inflation has eroded tax rate brackets and thresholds since 2002. As a result taxpayers were forced to bear unnecessarily heaviertax burden. Addressing these and other issues,and keeping pace with the changing environment in Ethiopia and internationally was essential. You can’t leave everything to remain there forever. You have to revisit what is there to make it up-to-date. This is one explanation in, my view. Secondly, there areproblems in the tax systemitself. We often hear taxpayers complaining about the tax administration practices and procedures and aspects of the tax system. For instance, in the current system, a taxpayer has to pay 50 percent of the disputed amount in advance to file an objection with the appeal commission. The disputed amount in this case includes the net tax due, late payment interest and penalties. If you add up all, and apply 50 percent onthe resulting amount, the advance payment, sometimes, would accumulate to multiple/hundredtimes the original tax. In addition, interpretational difference between taxpayers and tax administrators has remained a challenge. Even among tax administrators the interpretation for certain provisions in tax laws varies from one individual to the other. From the side of tax payers, this is quite a burden. These and other problems encountered by taxpayers necessitated the current income tax reform. Thirdly, the increase in the flow of foreign capital into Ethiopia is another impetus for the current income tax reform. The tax system has to be ready to deal with the complexity in the nature of operations of multinational businesses that are flowing into the country. The tax system, both the legal framework and the administration, needs to be prepared to deal with such a changing businessenvironment. Fourthly,in the existing system both the substantive provisions and administrative procedures related provisions are contained in one income tax proclamation. If you look at the existing income tax proclamation, it provides the substantive aspects of the tax i.e. the rates, the base and the like. In addition,the proclamation provides for the administration procedures which are mostly common with the administration procedures of other type of taxes. The administration procedures we use for the income tax are very similar to those of VAT, excise tax, turn over tax etc. In the existing system, as far as administrative procedures are concerned, each tax law provides for similar rules. As part of this reform, therefore, containing all administration procedures related provisions in one law was sought.
Finally, the legal framework governing taxation of income in Ethiopia is scattered across three income tax laws. These are the ordinary income tax, mining operations’ income tax and petroleum operations income taxlaws. These different laws in some situations might have sustained some inconsistent provisions. It was important to bring them together because they all deal with income taxation and to address inconsistencies in any form. While bringing these different laws into one legal document, however, we shouldn’t forget the special nature of the extractive industries. Hence, the tax regime designed for that sector has to reflect the nature of mining and petroleum operations.
Generally, in my view, these could be mentioned as some of the reasons for the current income tax reform in Ethiopia.
When you say there are contradictory in the laws, can you mention in what ways they are contradictory?
I think, there are some inconsistencies between the ordinary income tax law and the other two that sometimes cause confusion from the side of taxpayers. For instance, in the case of mining the reporting time is provided to be 90 days. But, when you look at the regular income tax legislation the reporting time is given to be four months (for large businesses). This seems minor but in order to create certainty, it’s essential to maintain consistency and avoid contradictions wherever possible. There may be also other issues similar to this
How does the new income tax amendment address the challenges of the costs of living in the country? We assume that employees somehow are burdened with taxation. Therefore, in your view, does, the new reform address that?
Before answering this,I should note the importance of looking at the income tax reform in Ethiopia as a package. The reform is not just about rates; there are other components. When we try to evaluate the reform, we should considerthe overall changes the reform tries to bring in. In this context, when we see the benefits out of the reform, I would say it has several advantages for both taxpayers and the government. When I say tax payers, I am referring to all types of tax payers that include employment income taxpayers, business tax payers, rental income taxpayers and others.
For taxpayers, in addition to revising the tax brackets and thresholds, the reform has brought many changes entirely in the income tax system which I will mention specifically later on. The reform has clarified many ambiguous areas. It tries to address most concerns taxpayers were out crying for. Clarifying different provisions and directly addressing problems, devising a mechanism to address the issue of lack of consistency in the administration process are some of the aspects the reform has looked at. Some of the measures taken, I think, will help in reducing the burden of taxes on payers. Excessive burden of taxes (including the tax burden of the tax itself and the burden of compliance requirements; the latter one translates into tax compliance costs) may deter taxpayers from fulfilling the requirements imposed on them. Therefore, apart from reducing the burden of taxes themselves, it is important to work on reducing tax compliance costs. I believe, measures taken in this reform, in addition, to the tax savings, they will help in reducing the burden of tax compliance (tax compliance costs).
From the government’s side, I would say there are a number of benefits. The reform attempts to broaden the tax base. Some of the incomes which are not taxed as income in the existing situation have now been included as incomes and are due to taxation. But, as far as cost of living is concerned, freeing up some income would help but as you might know the amount is not that big. I can’t say there won’t be any benefit at all. There is benefit in it though it’s small. We need to see the reform holistically by considering the negative and the positive outcomes. We need to bear in mind that the government is also losing revenue. .
The tax savings were expected to benefit tax payers a lot. Top level government officials have made us expect much out of the reform. That was one of the factors that made many despair against the reform.
You are right, what matters is the expectation we have. But, as I said it’s important to see the reform with its new packages. The reform, in my view, has brought many benefits to taxpayers.
Is it possible to judge who is most likely to benefit a lot out of the new reform? Is it employment income tax payers or is it business income tax payers or else mostly benefiting out of the reform?
At this stage I think it is very difficult to come to that kind of firm conclusion. You need to carefully look at the overall benefits coming to employees and the overall benefits coming to business taxpayers. Hence, at this stage it will be very difficult for me to compare and contrast the benefits segmenting across tax payers.
The progressive tax rate for employees amounts to 35 percent and there are VAT payments related to consumption taxpayers should bear. Just from this point of view itself, is it possible to assume that there is a tendency for employees to be more burdened than businesses?
I think, it is important to exercise caution in comparing these two types of incomes – employment and business income. If you take a business (in this case owned by individuals), the tax is imposed on the taxable income (the net taxable income) after excluding various costs incurred in the process of earning the income. Costs/ expenses deductible from business income are business expenses (not personal expenses of the owner/ owners). This is in accordance with the accepted accounting principles, which are also guiding business taxation. Now, if we want to compare business owners and employees, I think the comparison should be based on the employment income and taxable business income of individuals for the deductions given are only business related expenses (not the personal expenses of the owner(s)). If there are concessions needed to be given to taxpayers in order to enhance the fairness of the tax system (like for example dependence allowance etc), I believe that has to be given to both individual business income and employment income earners.
In terms of VAT, when you see the burden to these groups (employees and business owners), they both bear the burden on their consumption and I do not see difference in that regard.Regarding tax rates, as you mentioned the (maximum) marginal tax rate for employees and individual business ownersis 35 percent, while the income tax rate for companiesis 30 percent. If you look at the tax at company shareholders’ level, the tax rate goes up to 40 percent (the sum of 30 percent business profit tax and 10 percent dividend tax) which is even higher than the marginal rate for employment income and individuals’ business income tax.
Can you mention some of the incomes which will be considered as taxable now?
For example, management fees and similar other payments by a resident company in Ethiopia to a non-resident company are not part of the existing income tax proclamation. In addition, the draft laws contain a residual income tax provision. In the existing system if there is income which doesn’t fall under either of the schedules A (employment income tax), B (building rental income tax) or C (Business profit tax), there is no legal basis to tax that income. But now in the draft laws, there is a residual income section that gives the tax authority a legal basis in reaching out to those income types and imposing income tax. I believe, the drafts provide for similar things which can broaden the tax base.
Do management fees have considerable amount to be considered as taxable incomes?
I mentioned management fees as one and a simple example; considering this and the other new aspects of the draft laws, a considerable amount of tax revenue might be there, I think.
There is an emerging public outcry against the new reform. Could you mention additional benefits from the reform that can substantiate the outcry?
I have reflected on most of the things. The reform tries to free up some income but as I said it is not that much. In addition to the tax saving (though small) the reform has brought a good level of clarity and certainty which are very important in a tax system. These and other aspects of the reform coupled with other investment climate related measures that the government is trying to take can influence the locational choice of investors and attract investment into the country.
The draft tax lawsalso attempt to be fair. For example, fringe benefits according to the draft laws are expected to be taxed for the drafts provide that income in kind will be taxed using a scheme to be determined in the regulations. In fact, if you look at the existing income tax proclamation, it provides for the same thing; however, the income tax regulations issued by the Council of Ministers are silent on this. I hope this time the Council of Ministers’ regulations following these new draft laws will provide for the mechanism for taxation of fringe benefits. Doing so, I think, will help in enhancing the fairness of the tax system in Ethiopia.
What were the considerations when producing the matrices of the new income tax?
I was not part of this segment of the reform. I came up with the points I mentioned so far, during my assignment as a coordinator of the tax simplification project at the IFC. As I mentioned earlier IFC’s support in this reform covers all aspects of the income tax law with the exception of rate brackets and thresholds. Hence, I don’t think I am in a position to answer this question.
It is feared that price escalation might exacerbate following the introduction of the new taxation law. Does that concern you?
The change is not that big and I think the problem might not be that serious. If you look at the theory you might say this will lead to inflation. But, to me the tax saving is not that big although it’s very hard to rule out that it won’t cause any increase in prices of goods and services. In any case, if there happens to bea price escalation caused by this reform, I think, the government may need to try to address the problem.
Can you consider the new reform as a real change to the existing tax system of the country?
Yes, to me it is a real change. There are a number of changes introduced which I have explained. But, further we can say that the draft laws recognizeInternational Financial Reporting Standards (IFRS) as the main guiding principles for the overall tax accounting with some exceptions. The new law will address one of the major issues in the existing tax legislation. As you might know according to the existing income tax legislation, tax officers can reject the financial statements of tax payers on their own discretion, subjectively. In the new draft laws, however, this is not going to be the case anymore. Unless they have valid reasons, they can’t reject financial reports prepared by taxpayers.
The draft tax laws contain provisions, which are expected to reduce the compliance cost burden of category “B” taxpayers (in the proposed law, category B taxpayers are unincorporated taxpayers who have annual gross income from birr 500,000 to one million). For this category of taxpayers the compliance requirement has been made less than that of larger taxpayers. Large taxpayers in this case are those in category “A” (all incorporated taxpayers and others with annual gross income of over a million birr). Hence, in the proposed laws, category B taxpayers are allowed to use cash basis of accounting. In addition, category B taxpayers are required to maintain books and documents only for two years as opposed to the five years period in the existing law. These changes are expected to reduce the compliance burden on this segment of taxpayers. For category “C” taxpayers the proposed legislation provides that the scheme for taxation will be determined in the regulations. I hope much simplified taxation system will be designed for this category of taxpayers.
The proposed law helps to strengthen the international tax regime. Many foreign companies are coming into the country, which is good. But, from taxation point of view, the existing tax regime seems to be focusing on domestic business taxpayers.As part of enhancing the international tax system, these proposed laws, try to tighten the definition of permanent establishment, which will help in closing up the opportunities for transfer mispricing. Related companies try to shift profits from one jurisdiction to others. Hence, the draft laws attempt to strengthen the mechanisms so as to reduce the problem of transfer mispricing.
Mispricing or in general form, illicit financial outflow is the central issue in Africa and beyond. Finding ways to fight multinationals which easily shift with shadow banking and the likes is causing countries like Ethiopia lose billions of dollars. Therefore you are saying that the new law is to address this challenge?
Yes, it will mitigate the incidence of transfer mispricing significantly, if the legal framework is buttressed by enhancement in the capacity of revenue authorities in Ethiopia and also good access to information about taxpayers, among others.
Regarding transfer pricing, the existing income tax proclamationhas one provision stating that transactions between related parties have to be priced according to Arm’s Length Principle. The proclamation further provides that the manner of applying the Arm’s Length Principle would be determined according to a directive to be issued by MoFEC. This directive was ratified in October 2015 and is now under implementation. In addition to the directive, in the draft laws efforts are made to provide for the relevant provisions considering the situations in Ethiopia. However, in order to achieve the desired outcomes of this draft laws in all areas, not just transfer pricing related matters, among others, capacitating the tax administration is crucial.
How is the 50 percent in advance payment requirement in case of dispute treated in the draft tax law?
The dispute resolution system has long been the major concern for tax payers. Now in the draft laws there are a number of changes. In the existing system, there are steps in resolving disputes. There is an internal committee (administrative review committee) within ERCA. If the dispute remains unsettled at this stage, the tax payer will go to the tax appeal commission then to the courts. The administrative review committee is like an ad hoc committee whose members are drawn from different directorates of ERCA. Members of the administrative review committee review disputed cases on top of their regular duties. As a result they may not decide on cases on time. Usually decisions made by them are contentious and end up being unaccepted by tax payers. Unsatisfied tax payers will proceed to the next level which requires them to pay 50 percent (of the assessed tax, and late payment interest and penalty) in advance. To address these and other problems in resolving tax disputes, the proposed lawshave made the following changes:
According to the proposed laws the administrative review committee will be instituted as a department/unit within ERCA; and the department will be fully responsible for reviewing disputed tax cases; further, the new proposed laws require ERCA to assign capable and experienced members to the administrative review unit/ department.
The existing law gives ten days to establish a case and file an objectionwith the administrative review committee. Now, that has been increased to 21 days. Additional ten days could be given to those who may not be able to file their objection in 21 days for valid reasons (some unforeseen occurrences). The draft lawsalso require decisions to be made by the administrative review unit/ department within 180 days. If the review department fails to decide within 180 days, the tax payer can proceed to the appeal commission by paying only 25 percent of the disputed amount instead of 50 percent. .
In the determination of the advance payment, the proposed laws require the 50 percent or 25 percent to be applied on the disputed tax amount instead of the sum of the disputed tax, and late payment interest and penalty. In addition, the proposed drafts reduce the late payment interest rate and put a cap for the maximum interest not to exceed the tax amount.
According to the draft laws, the tax appeal commission will be accountable to the Prime Minister; the composition of members excluding officials from ERCA is provided in the drafts. This measure I think will enhance the independence of the commission.
The other change that these drafts bring in is the introduction of Advance rulings. The draft laws provide for both public and private advance rulings. Private ruling is when MoFEC provides interpretation of a certain law upon the request of a taxpayer, while public ruling is when MoFEC issues interpretation of a certain provision in tax laws which apply to all taxpayers. These advance rulings (both private and public) are binding on the part of MoFECand ERCA. This system, I believe, will help in reducing problems due to interpretational differences substantially and hence tax compliance costs.
Finally, the draft laws provide for the licensing of tax agents in Ethiopia. This also will help improve the quality of tax advisory environment and also facilitate the tax administration process, although immediate implementation of the relevant rules, in this regard, will be highly constrained by the lack of sufficient number of qualified tax advisors in Ethiopia. In general, I would say that the draft laws in so many ways have bought light to the tax system of the country.
