Processing Business Tax Requirements

Processing Business Tax Requirements Notes

Module Overview

This module focuses on processing business tax requirements, covering:

• Accounting records for taxation purposes.
• Managing business tax returns.
• Tax returns and lodgments.

The goal is to maintain accounting records, manage tax returns, and understand tax return processes.

Unit One: Records for Taxation Purposes

1.1. Accounting System for Tax Purposes

Tax accounting is a method focused on taxes, governed by the Internal Revenue Code, applicable to individuals, businesses, and corporations. It tracks funds coming in and going out.

Tax accounting is a subsector dealing with tax returns and payments. For individuals this involves income, deductions, donations, and investment gains/losses. For businesses, it is more complex, focusing on how funds are spent and what is taxable.

1.1.1 Tax Accounting Principles vs. Financial Accounting (GAAP)

In the U.S., tax accounting principles differ from Generally Accepted Accounting Principles (GAAP). GAAP involves common standards for financial statements. Companies can use FIFO for financial statements but LIFO for tax, reducing current year's taxes. Tax accounting focuses on transactions affecting tax burden and is regulated by the IRS.

1.1.2 Types of Tax Accounting

• Tax Accounting for Individuals: Focuses on income, deductions, investment gains/losses.
• Tax Accounting for Businesses: Tracks earnings and outgoing funds, including business expenses and shareholder payments.
• Tax Accounting for Tax-Exempt Organizations: Requires filing returns, reporting incoming funds (grants, donations), and fund usage.

1.2 Manage Business Tax Returns

1.2.1 Accounting for Business Income Tax

Business income tax is imposed on taxable business income/net profit from entrepreneurial activities. Taxable income is determined by the profit and loss statement, complying with accounting standards. Financial statements include:

• Income statement.
• Balance sheet.
• Cash flow statement.

These statements provide financial information to stakeholders. The income statement shows profitability, the balance sheet shows assets, liabilities, and equity, and the cash flow statement shows cash movements.

1.2.1 TAX RATE

Corporate businesses pay a flat rate of 30% business income tax. Individual businesses have tax rates ranging from 10% - 35% (Table 1).

Table.1 Business Profit Tax (Schedule C)

Example 1: ABC enterprise reports taxable income of birr 30,000.

A. Determine business income tax using the deduction method.
B. Record journal entries for the income tax liability.

Solution

Business income tax = (taxable income) x tax rate - deduction

$= (30,000) \times 15\% - 1,710$

$= 4,500 – 1,710$

$= 2, 790$

Income tax payable 2,790
Cash 2,790

Tax Compliance and Evasion

Tax compliance means adhering to tax laws. Tax evasion is illegally avoiding taxes. Tax avoidance is legally minimizing tax liability.

Individual Tax Compliance: Reporting accurate yearly income. Failure to report income is tax evasion.

Business Tax Compliance: Reporting accurate yearly income, paying state and federal taxes, tracking charitable donations, and having an employee identification number.

Importance of Tax Compliance: Funding government revenue, balancing the budget, and providing goods and services.

Savings = Tax Revenue − Government Spending

Increased tax compliance helps balance the budget.

3.1 Business tax returns and lodgments

1.3.1. Invoice requirement

An invoice includes the products/services delivered, the total amount due, and the preferred payment method.

Invoice format requirements:

• Business name and contact details.
• Customer's name and contact details.
• The label 'Invoice'
• Unique invoice number.
• Invoice date and supply date.
• Description of goods/services and prices.
• VAT (if applicable).
• Subtotals and totals.

1.3.2. Goods and service tax requirements

Taxes on imported goods include:

• Import duty.
• Withholding tax (3%).
• Excise tax (if applicable).
• Value-added tax (15%).
• Surtax (10%).

1.3.3. Fringe Benefits Tax (FBT)

FBT is a tax on benefits provided to employees, not exceeding 10% of the employee's salary income. This includes work vehicles for personal use, gym memberships, and discounted goods/services. It doesn't apply to salary, wages, cash bonuses, or allowances.

1.3.4. Luxury Car Tax

Car importers pay various taxes:

• VAT (15%).
• Excise tax (up to 100% depending on engine size).
• Surtax (10%).
• Withholding tax (3%).
• Income tax.

Customs tax is 15% for fully assembled vehicles, 5% for semi-assembled. CKD vehicles are not taxed.

Excise Tax (Amendment) Proclamation, 2023

• Effective April 27, 2023.
• Provides new tax rates for excisable goods and reduces the number of goods exempt from excise tax.
• The Amendment clarifies the difference between new and used vehicles and also gives rates for excisable goods andservices.

New definitions

• Ethyl alcohol with purity of 80% or more
• New vehicle, which hasn't been used, imported in SKD or CKD, to be assembled locally
• Used vehicle, not covered under the definition of a new vehicle

Changes to First Schedule of Excisable Goods

New items have been added, excise rates for some items have been reduced, and one item has been excluded from the First Schedule.

Telecommunication service of mobile and wireless telephone (internet, voice, and SMS), new rate is 5%, was previously 0%

Reduction in excise tax rate

Edible animal/vegetable fats or oils, saturated fat >= 40g per 100g, was 40%, is now 30%
Any type of sugar, excluding molasses, maple sugar and maple syrup, 20% to 10%
Chewing Gum, 20% to 10%
Edible chocolates and Sweets, 20% to 10%
Ethyl alcohol, 60% to 10%
Salt, 25% to 10%
Fuel, 30% to 15%
Textile fabrics, 8% to 5%
Carpets, 30% to 15%

Exclusion from Excise Tax

Video recording or reproducing, TV broadcasting receivers, apparatus, photo or video camera; old rate was 10%, now none.

Reduction of Exempt Excisable Items

• Excisable goods for passengers/crew of aircraft on international flights.
• Excisable goods for diplomatic/consular missions.
• Imported consignments for emergency relief.
• Goods imported/purchased locally for official use by the Ethiopian Defense force and Federal and State Police Commissions.
• Excisable goods except vehicles imported by a passenger subject to limitation in the appropriate law

UNIT TWO: MANAGING BUSINESS TAX RETURNS

Accounting System to Manage Taxation Lodgments
An accounting system organizes financial information, manually or computerized, tracking expenses, income, and activities. It helps manage financial transactions like sales, purchases, assets, and liabilities and generates reports for decision making. Computerized systems simplify data storage, changes, and interpretation.

1.3.5. Deductible and Non-Deductible Expenses in Calculating Taxable Income

Allowable Deductions (Deductible Expenses)
In accordance with income tax proclamation 979/2016 and regulation Article 8 the following expenses shall be deductible for gross income in calculating taxable income.

• Direct costs of producing income.
• General and administrative expenses.
• Insurance premiums.
• Business promotion expenses (subject to limits).
• Commissions.
• Manager salaries (may be reduced if exaggerated).
• Salaries to proprietor's children (if qualified).
• Deductible interest (if interest tax is paid).
• Conditions for deducting gifts and donations.
• Depreciation allowance.
• Reinvestment of profit.
• Deductible bad debts.
• Special reserves for finance institutions.
• Trading stock.

2.1.2 Non-Deductible Expenses (Non-Allowable Deductions)

The following expenses are not deductible:

A. Costs of business asset acquisition, improvement, renewal, etc.
B. Increases in share capital.
C. Voluntary pension contributions above 15% of monthly salary.
D. Declared dividends and profit shares.
E. Interest exceeding NBE rate + 2%.
F. Damages covered by insurance.
G. Punitive damages and penalties.
H. Creation/increase of reserves.
I. Income tax and recoverable VAT.
J. Representation expenses over 10% of employee salary.
personal consumption expenses.
K. Entertainment expenses.
L. Donations/gifts not to welfare organizations.
M. Salary to proprietor/partner.
N. Private purpose expenditures.
O. Losses not connected to the business.

Exemptions

The following categories are exempt from business income tax hereunder:

a. Awards for adopted/suggested innovations and cost saving measures.
b. Public awards for outstanding performance in any field.
c. Income specifically exempted form income tax by the law in force in Ethiopia, by international treaty or by an agreement made or approved by the Minister.
d. The revenue obtained by:
i. The Federal, regional and local Governments of Ethiopia;
ii. The National Bank of Ethiopia. From activities that are incidental to their operations shall be exempt from tax on Schedule C income.

22.2. Records to Comply with Lodgments

Every entity must keep accounting records that support financial reporting. Tax returns depend on the business structure.

22.3. Lodgment Schedule

The lodgment program allows progressive lodgment of client obligations. Tips to prepare include updating client lists and lodge prior year tax return etc. The lodgment due date for tax returns for taxable large and medium entities is set in different times. This includes the associated schedules and reports. There is no change to the payment due date.

Participation deduction: If the taxpayer transfers the share or capital contribution in respect of which deduction was allowed, the amount deducted shall be part of the taxable income of the accounting year in \ which the transfer was affected and shall be taxed as such.
Purchase of shares and capital contributions made between related persons shall not be Allowed as deductions.

Loss carry forward: Depreciation shall be transferred when the Tax Authority accepts the described book account. If the determination of taxable business income results in a loss in a tax period, that loss may be set of against taxable income in the next three periods, earlier losses being set off before later losses. A net operating loss may be carried forward and deducted only for two periods of three years.

Depreciation: As time passes, all plant assets with the exception of land lose their capacity to yield services. The acquisition or construction cost, and the cost of improvement, renewal and reconstruction, of intangible assets shall be amortized individually on a straight-line basis at then percent (10%).

For Tax Purpose in Ethiopia, pooling method is used for computer and ICT related equipment’s, straight-line method for buildings and intangibles. Depreciation for Income Tax
The acquisition or construction cost, and the cost of improvement, renewal and reconstruction, of buildings and constructions shall be depreciated individually on a straight-line basis at five percent (5%).

The following two categories of business assets shall be depreciated according to pooling system at the following rates:
a. Computers, information systems, and software products and data storage equipment: twenty- five (25%)
b. All other business assets: twenty percent (20%)

Depreciation base used for pulling system is as follows:

Example #1 The following information is obtained from Almaz Private Limited Company.
The book value of a pool of computer in the opening balance sheet of the tax period as of Hamle 1,1997 was birr 150,000 During the year 1998: Almaz bought data storage equipment for birr 75,000, software products for birr 50,000. The existing computer was upgraded and renewed for birr 12,000. Almaz has also received birr 15,000 as compensation from Haron computer, supplier, since some of the storage equipment is non-functional. Almaz sold two old computers and received birr 8,500.
Beginning book value: Br. $150,000$
Add: Additions during the period: Storage equipment: $75,000$ Software products: $50,000$ Upgrading cost: $12,000$ $137,000$
Subtotal $287,000$
Less: Compensation: $15,000$ Cash proceeds from selling $8,500$( $23,500$ )
Depreciation base for taxation: $263,500$

Computers and its accessories depreciated according to a pooling system at 25% tax rate. Therefore, depreciation expense for the year 1998 would be 25% x 263, 500 = birr 65,875
Journal entry to record depreciation expense for the year is:

Depreciation expense 65,875
Accumulated depreciation 65,875

UNIT THREE: TAX RETURNS AND LODGEMENTS

3.3 Required Returns and lodgments

Lodgment Management is a sub-domain of Obligation Management (OBLMGT). This page contains information and art effects for Digital Service Providers (DSPs). Services are only deployed on the SBR ebMS3 platform.

Services have been organized into the following business processes:

• Lodgment obligations – Allows users to notify the ATO that an income tax return is not necessary for a given year or into the future.
• Seek a ruling – Allows users to submit a request for a Private Ruling on a tax matter.
• Lodgment progress and outcome – Allows users to view the progress of return(s)/lodgment(s), with details for issued individual assessments.

3.4 Processing accounting data

Processing accounting data involves calculations, classification, summarization, and consolidation.

Six stages of data processing:

1. Data collection.
2. Data preparation.
3. Data input.
4. Processing.
5. Data output/interpretation.
6. Data storage.

HOPE Share Company prepared income statement for the year ending Sene 30, 1998 for financial accounting purpose. The company used accrual basis of accounting and LIFO method of inventory costing.
Hope Share Company Income statement For the year ending sene 30, 1998
Net sales Br. $450, 000$
Less: cost of sales $150, 000$
Gross profit $300,000$
Operating expenses:
Salaries and employee’s benefits $83,000$
Representative expenses $2,500$
Donation $25,000$
Promotion expenses $15,000$
Amortization expenses $6,000$
Stock obsolescence expense $4,500$
Court fines (penalties) $2,500$
Depreciation expense – building $10,000$
Depreciation expense – machinery $8,500$
Total operating expenses $157,000$
Earnings before interest and income $143,000$
Interest expense $93,000$
Earning before tax 50,000$
Income tax (30 %) 15,000$<br /> Net income$35,000$$

Additional information

Donation includes birr 20,000 given as a gift to the emergency called by the government to protect epidemic diseases; and birr 3000 given for political parties; birr 2,000 given for Ato Abebe, who has been guest in television talk show.

• The cost of goods sold would have been birr 110,000 if the weighted average methods of inventory costing method is used.
• Amortization expense includes; 2,000 birr for amortization of patent; and birr 4,000 for good will.
• Salaries and employee’s benefits include an employer 20% provident fund contribution to all it permanent employees. The total basic salary of permanent employees for the given tax year is birr 60,000.
• The company is paid birr 500 for each day to the chief accountant, Ato Bekele as a representation fee while he attends meeting 5 days held in Hilton Addis. His basic salary is birr 3,500.
• The company had a bad debt expense of birr 2,000, which is written off to the debtor and legal action to collect the debt has been taken but the debt is not recoverable. The company did not consider it in determination of income by considering it as un -deductibles.
• The company incurred a loss of birr 5,000 in the year ended 1997.
• Promotion expense includes: birr 5,000 for television advertisement, birr 2,500 for billboard advertisement and birr 7,500 for personal entertainment expense. The company is paying its bank loan that obtained from commercial bank of Ethiopia at an average of 7.5% annual interest rate. The unpaid outstanding bank loan at the beginning of the period was birr 600,000. The company has also paid interest expense for Ato melaku Belay, one of shareholders, at 12% annual interest on loan of birr 400,000.
• Depreciation expense for buildings and machinery is calculated in harmony with Ethiopian tax provisions.
• The total amount of share capital is birr 2,000,000.

Example 1
Dr. Mesafint Abera, a resident in Black lion hospital who specialized in Bio chemistry, teaches medical students for 12 lecture hours in Kenya and Botswana and derives the following income in the month of Tikmet 1998. His monthly basic salar in Black lion Hospital is birr 3,500.

The average exchange rates during the period were as follows: 1Birr = 8 Kenya shilling and 1 Birr = Botswana 0.7 Pula Required: How much tax is expected from him on income brought from abroad?
Total gross income for the month is calculated his basic salary birr 3,500 plus gross Income obtained from Kenya birr 1875. The total gross income is birr 5,375.
Total Income tax = (Gross taxable income) x Tax rate - deduction
= (5,375 x 25%) – 565
= 778.75
Income tax on his basic salary = (Basic salary) x Tax rate - deduction
= (3,500 x20%) – 302.5
= 397.5

3.2. Review Returns and Lodgments

Income tax Proclamation 286/2002

• If during the tax period a resident derives foreign source income, the Income Tax payable by that resident in respect of that income shall be reduced by the amount of foreign tax payable on such income. The amount of foreign tax payable shall be substantiated by appropriate evidence such as a tax assessment, a withholding certificate or any other similar document accepted by the Tax Authority.
• The reduction of the Income Tax provided in (1) shall not exceed the tax payable in Ethiopia that would otherwise be payable on the foreign source income.
• In the case of a taxpayer subject to Income Tax on Schedule C income, any reduction of tax prescribed in (1) shall be limited to the tax that would otherwise be payable in Ethiopia computed as if Article 28 (loss carry forward) of Proclamation 286/2002 applied separately to each foreign country in respect of profit and losses derived from sources therein.
• The reduction of tax prescribed shall be calculated separately in respect of each foreign country from which income or profit is derived