Analysis of the Proposed Amendments to the Federal Income Tax Proclamation: A Comparative Review with Proclamation No. 979-2016

Summary

The Draft Income Tax Proclamation (No. /2025) represents a comprehensive effort to modernize Ethiopia’s tax system, aiming to enhance revenue mobilization, foster fairness, broaden the tax base, and combat tax avoidance and evasion. These objectives are deemed critical for supporting the nation’s economic growth and improving the delivery of public services.  

The proposed amendments introduce several significant changes. These include a substantial adjustment to personal income tax brackets, the explicit introduction of taxation for digital economy activities, the establishment of an Alternative Minimum Tax (AMT), the imposition of stricter controls on cash transactions, and the implementation of a simplified tax regime for small businesses. These modifications are anticipated to redistribute the tax burden, capture previously untaxed revenue streams, and improve overall tax compliance.

The draft proclamation signifies a pivotal shift towards a more equitable and efficient tax system. However, the successful implementation of these reforms will depend heavily on the development of robust administrative capacity within the tax authority, the provision of clear and comprehensive regulatory guidance, and effective taxpayer education initiatives. Recommendations derived from this analysis will therefore focus on strategies to mitigate potential compliance challenges and ensure a smooth transition for all stakeholders.

1. Introduction

Purpose and Scope of the Analysis

This comparative analysis provides detailed comparison of the proposed Federal Income Tax Proclamation (Draft No. /2025) against the existing Federal Income Tax Proclamation No. 979/2016. Its primary purpose is to identify the key amendments, synthesize their implications across various taxpayer categories and economic activities, and offer strategic observations and recommendations for relevant stakeholders. The analysis aims to illuminate the policy objectives underlying these changes and their potential impact on Ethiopia’s fiscal landscape.

Background: Overview of Proclamation No. 979/2016

Proclamation No. 979/2016, enacted in 2016, established the prevailing framework for federal income taxation in Ethiopia. This foundational legislation categorized taxpayers, defined various income sources, set progressive tax rates across different schedules (including employment income, rental income, business income, and other incomes), and outlined the administrative provisions governing tax assessment, collection, and compliance. It has served as the backbone of Ethiopia’s income tax system for nearly a decade.  

Introduction to the Draft Proclamation: Objectives of the Proposed Amendments

The Ministry of Finance initiated the current amendments, recognizing that the existing law, having been in force for over nine years, contained gaps relative to the evolving economic realities, particularly the burgeoning digital economy, and inadvertently facilitated certain tax evasion practices. The overarching goals of the proposed amendments, as articulated in the explanatory note, are multifaceted and strategic :  

• To alleviate the tax burden on low-income individuals.
• To expand the national tax base.
• To address and rectify existing inequities within the tax system.
• To simplify the tax payment process for small-scale commercial activities.
• To support and encourage capital mobilization efforts for investment.
• To prevent the erosion of the tax base and combat tax evasion and avoidance.
• To resolve ambiguities in existing articles that have led to disputes and administrative complexities.

Methodology for Comparative Analysis

This analysis employs a detailed article-by-article comparison, systematically contrasting the provisions of Proclamation No. 979/2016 with those of the Draft Proclamation. The analysis is further enriched by drawing upon the insights provided in the accompanying explanatory note. Observations are derived through a multi-layered examination of direct changes, the underlying policy rationales, and the anticipated socio-economic implications. This comprehensive approach ensures a thorough understanding of the legislative shifts and their potential ramifications.  

2. Comparative Analysis of Key Changes in the Tax Framework

2.1. Fundamental Structural and Definitional Changes

Taxpayer Categories and Thresholds (Article 3)

Under the current Proclamation No. 979/2016, taxpayers are classified into three main categories based on their annual total income. Category “A” taxpayers include organizations or individuals with an annual total income of Birr 1 million or more. Category “B” taxpayers are individuals (excluding organizations) whose annual total income falls between Birr 500,000 and less than Birr 1 million. Finally, Category “C” taxpayers comprise individuals (excluding organizations) with an annual total income of less than Birr 500,000.  

The Draft Proclamation introduces a significant restructuring of these categories. It proposes to eliminate Category “C” taxpayers entirely, effectively merging them into an expanded Category “B.” Concurrently, the threshold for Category “A” taxpayers is substantially raised from Birr 1 million to Birr 2 million. Consequently, Category “A” taxpayers will now be defined as organizations or individuals with an annual total income of Birr 2 million or more, while Category “B” taxpayers will encompass individuals (excluding organizations) with an annual total income of less than Birr 2 million.  

This revision streamlines the taxpayer classification system, which is expected to simplify the tax payment process for a larger segment of small businesses. By increasing the Category A threshold and eliminating Category C, many taxpayers who previously fell under Category B or C will now be classified under a potentially less administratively burdensome Category B regime. This aligns with the policy objective of fostering small business growth by reducing compliance costs, which could encourage formalization and improve overall tax morale among smaller enterprises. The consolidation also streamlines tax administration by reducing the number of distinct categories the tax authority needs to manage.

Permanent Establishment Definition (Article 4)

The existing Proclamation No. 979/2016 defines a “permanent establishment” with specific duration thresholds for service provision and construction activities. For service provision, including consultancy, a permanent establishment is deemed to exist if the services continue for over 183 days within one year for a single or related project. Similarly, construction, assembly, or installation projects are considered a permanent establishment if they extend beyond 183 days.  

The Draft Proclamation significantly shortens these duration thresholds. Under the proposed changes, a permanent establishment will be recognized if service provision (including technical and consultancy services) or construction, assembly, or installation projects continue for more than 91 days within a tax year or any one-year period. Furthermore, the draft introduces a comprehensive definition for “technical services,” encompassing a wide range of professional activities such as accounting, auditing, financial, legal, engineering, and information technology. Professionals engaged in these fields will now be explicitly required to maintain records, irrespective of their turnover.  

The halving of the duration threshold for establishing a permanent establishment significantly expands Ethiopia’s tax jurisdiction over foreign entities. This means that foreign companies or non-residents providing services or undertaking construction projects in Ethiopia for durations between 91 and 183 days will now be deemed to have a permanent establishment, thereby becoming subject to Ethiopian tax obligations. This change is intended to capture income that previously escaped taxation due to the longer threshold, particularly in the rapidly growing service and construction sectors. The explicit and comprehensive definition of “technical services” further clarifies which activities are targeted, reducing ambiguity and improving enforcement. This legislative adjustment aligns with the broader policy objective of broadening the tax base and preventing tax avoidance, as foreign service providers might have structured their operations to avoid permanent establishment status under the previous, more lenient law.

New Income Definitions (Article 2)

The Draft Proclamation introduces several new definitions to address evolving economic activities, particularly those related to the digital economy, and to establish a new tax basis for small businesses.  

• “Tax on Annual Gross Sales” (Article 2(28)) is defined as a simplified tax regime applicable to small businesses under Article 49 (renumbered as Article 50), where tax is calculated based on their annual gross receipts.  
• “Income from Digital Content Creation” (Article 2(29)) encompasses any monetary or in-kind income derived from creating, distributing, or selling digital media or products on online platforms. This includes, but is not limited to, income from video sharing services, social media platforms, podcast services, and live transmission platforms, covering sources such as advertisements, sponsorships, affiliate marketing, fan contributions, and sales of digital or physical goods.  
• “Digital Service” (Article 2(30)) is introduced as a service involving digital content, with its specific definition to be further elaborated by a regulation issued by the Council of Ministers.  

These explicit definitions lay the legal groundwork for taxing previously untaxed or ambiguously taxed digital income streams. This demonstrates a proactive approach by the Ethiopian government to adapt its tax legislation to global trends in the digital economy, ensuring that emerging sectors contribute to the national tax base. The introduction of these definitions also signals a move towards formalizing these activities, which could lead to improved data collection and regulation of the digital space, thus enhancing the overall integrity and comprehensiveness of the tax system.

2.2. Changes in Income Tax Rates and Brackets

Employment Income Tax (Article 11)

Under Proclamation No. 979/2016, employment income tax rates began with a 0% bracket for income up to 600 Birr per month, progressing to a 10% rate for income between 601 and 1,650 Birr, and reaching the highest rate of 35% for income exceeding 10,900 Birr.  

The Draft Proclamation introduces substantial revisions to these brackets. The tax-exempt threshold for employment income is significantly increased by 300%, from 600 Birr to 2,000 Birr per month. The 10% bracket is eliminated, with the next taxable bracket commencing at 15% for income between 2,001 and 4,000 Birr. The highest rate of 35% now applies to income exceeding 14,000 Birr, an increase from the previous 10,900 Birr threshold.  

This adjustment aims to alleviate the tax burden on low-income earners, thereby increasing their disposable income. The widening of the brackets and the higher threshold for the top rate suggest an implicit attempt to account for inflation and the rising cost of living since the last adjustment in 2002 E.C. (as stated in the explanatory note, the previous rates were from 1994 E.C.). This enhances the fairness of the tax system by mitigating “bracket creep,” where inflation pushes individuals into higher tax brackets without a real increase in purchasing power. However, the explanatory note acknowledges a projected revenue loss equivalent to 0.21% of the national Gross Domestic Product (GDP) due to these adjustments, which will primarily affect regional government revenues. This highlights a delicate balance between achieving social equity and maintaining fiscal sustainability.  

Table 1: Comparison of Employment Income Tax Rates (Current vs. Draft)

Rental Income Tax (Article 14)

Under Proclamation No. 979/2016, organizations are subject to a flat 30% rental income tax rate. For individuals, the tax-exempt threshold for rental income is 7,200 Birr per year, with rates progressively increasing up to 35% for income exceeding 130,800 Birr.  

The Draft Proclamation maintains the 30% flat rate for organizations. However, for individuals, the tax-exempt threshold is significantly increased to 24,000 Birr per year, a substantial rise from the previous 7,200 Birr. The subsequent brackets are also adjusted upwards, and the 10% bracket is eliminated, similar to the changes observed in employment income tax. The top rate of 35% now applies to annual rental income exceeding 168,000 Birr.  

This adjustment harmonizes the tax relief provided to individuals across different income schedules, aligning with the broader objective of reducing the tax burden on lower-income segments. The explanatory note explicitly states that the tax-exempt annual income from rental and sole proprietorship businesses will be adjusted “in the same manner” as employment income to ensure fairness. The increased thresholds reflect the significant rise in rental prices over the years, implicitly acknowledging the market realities and adjusting the tax burden accordingly. This could potentially reduce informal rental arrangements by making formal declaration more attractive for smaller landlords who now benefit from a higher tax-free threshold.  

Table 2: Comparison of Individual Rental Income Tax Rates (Current vs. Draft)

Individual Business Income Tax (Article 19)

Proclamation No. 979/2016 stipulates a flat 30% business income tax rate for organizations. For individuals, the tax-exempt threshold is 7,200 Birr per year, with rates escalating to 35% for income exceeding 130,800 Birr.  

The Draft Proclamation maintains the 30% flat rate for organizations. However, the tax-exempt threshold for individual business income is also raised to 24,000 Birr per year, aligning with the adjustments for employment and rental income. Corresponding adjustments are made to the higher income brackets. A significant structural change introduced is the “pass-through” taxation for Limited Liability Partnerships (LLPs) and Collective Investment Funds (CIFs). These entities will no longer be subject to corporate income tax at the entity level; instead, tax will be withheld upon distribution to their members or shareholders.  

This change is designed to promote investment and modernize business structures. The explanatory note clarifies that the previous system exposed LLPs to double taxation and that CIFs are crucial for capital mobilization. By eliminating entity-level taxation for LLPs and CIFs, the draft removes a significant tax barrier, making these structures more attractive for professional services and pooled investment vehicles. This directly incentivizes the formation and operation of such entities, thereby supporting the objective of facilitating capital mobilization for investment and modernizing Ethiopia’s business landscape. The removal of this tax disincentive could lead to increased capital flow into formal investment channels, fostering economic development.  

Table 3: Comparison of Individual Business Income Tax Rates (Current vs. Draft)

2.3. New Taxation Regimes and Anti-Avoidance Measures

Taxation of Digital Content Creation Income (Article 22)

The Draft Proclamation introduces an explicit framework for taxing income derived from digital content creation. Income from digital content creation will be considered business income if the activity is regularly performed with the intention of making a profit, conducted in a professional or organized manner, and if proper business records are maintained. If these conditions are not met, the income will be classified as “other income” under Schedule D and subjected to a 15% tax, with further details to be determined by regulation. Online platforms facilitating payments to Ethiopian resident creators will be mandated to report the gross income paid to the tax authority if the annual turnover exceeds a threshold determined by the Ministry of Finance. Furthermore, digital content creators will be required to obtain a Taxpayer Identification Number (TIN), declare their income, and fulfill all relevant tax obligations.  

This new provision is a crucial step towards formalizing the digital economy and expanding the tax net. The explanatory note identifies the digital economy as a significant source of previously untaxed income. By explicitly defining and taxing these activities, the government brings a rapidly growing sector of the economy into the formal tax system. The distinction between “business income” and “other income” provides a degree of flexibility in tax treatment but also highlights the potential for disputes regarding classification, necessitating clear regulatory guidance. The reporting requirement imposed on online platforms is a critical enforcement mechanism, shifting some of the compliance burden to intermediaries. This move is essential for broadening the tax base and ensuring fairness across all economic activities, ensuring that new forms of wealth generation contribute to public revenue.  

Digital Service Tax (Article 53)

The Draft Proclamation introduces a new tax specifically targeting digital services. It stipulates that income derived from digital services provided in Ethiopia, whether by residents or non-residents, will be subject to income tax. The specific tax rate and mode of payment will be determined by Council of Ministers Regulations, with the rate not exceeding 5% of the gross income.  

This new tax aims to address the challenges of taxing cross-border digital services. The explanatory note explicitly mentions the difficulty of taxing foreign satellite television companies and other cross-border digital service providers that generate significant revenue from the Ethiopian market without a traditional physical presence. This provision is designed to capture revenue from digital services consumed within Ethiopia, regardless of the provider’s physical location. This aligns with international trends where countries are implementing Digital Service Taxes (DSTs) to address the tax challenges of the digitalized economy, especially for non-resident providers with significant economic presence but no physical permanent establishment. While the proposed 5% maximum rate is relatively modest, it establishes the legal principle and mechanism for taxing these services, thereby contributing to base broadening and ensuring greater fairness in the tax system.  

Alternative Minimum Tax (AMT) (Article 23)

The Draft Proclamation introduces an Alternative Minimum Tax (AMT) as a significant anti-avoidance measure. The AMT will be applicable to any organization or person whose tax payable from business income falls below 2.5% of their total gross income for a given tax year. The general rate for the AMT is 2.5% of the annual total gross income for bodies and persons. However, specific rates are prescribed for certain sectors: banks will pay 2.5% of their net banking income, insurance companies 2.5% of their gross premium income, and price-regulated companies 2.5% of their commission. The AMT paid will be deductible from the regular business profit tax, and any excess AMT paid can be carried forward for up to 5 years. Entities undergoing liquidation or debt restructuring are exempt from AMT, and notably, the AMT will apply even to businesses that have been granted investment incentives.  

This directly addresses a major loophole for tax evasion, forcing businesses to contribute to revenue even if they report low profitability. The explanatory note highlights that over 67% of federal taxpayers declare losses or no activity, and that businesses cannot realistically operate at a loss for years. The AMT directly combats tax evasion by ensuring that businesses that artificially inflate expenses or understate income to declare minimal profits or losses will still have to pay a minimum tax. The carry-forward mechanism provides some relief for genuine losses, balancing the anti-avoidance objective with fairness for businesses facing temporary financial difficulties. Its application to incentivized businesses also ensures that even those enjoying tax holidays contribute a minimum amount, broadening the effective tax base and improving revenue predictability. This measure significantly strengthens the integrity of the tax system.  

Table 4: Alternative Minimum Tax Rates and Triggers (Draft)

Restrictions on Cash Transactions (Article 81 & 88)

The Draft Proclamation introduces strict monetary limits on cash transactions. It prohibits payments or receipts exceeding Birr 30,000 unless conducted via an account payee cheque, account payee bank draft, bank-to-bank transfer, or an electronic payment method authorized by the National Bank of Ethiopia. This limit applies to aggregate payments from a single person in a day, a single transaction, or transactions related to one event or occasion. Exemptions are provided for public bodies, public enterprises, banks, microfinance institutions, and other entities as may be specified by directive. A severe administrative penalty is stipulated for violations: receiving money in cash in excess of the specified amount will incur a penalty of twice the amount received.  

This measure is designed to promote financial formalization and combat the informal economy. The explanatory note explicitly identifies cash transactions as a major facilitator of tax evasion and references international best practices, such as those implemented in India, to address this issue. By imposing this limit, the government aims to compel businesses and individuals to utilize formal banking or electronic payment systems for larger transactions. This increases the traceability of financial flows, directly combating the informal economy and tax evasion. It enhances the tax authority’s ability to verify income and expenses, thereby broadening the tax base and improving compliance. Furthermore, it encourages the adoption of digital payment methods, contributing to the development and transparency of the financial sector.  

Table 5: Cash Transaction Limits and Penalties (Draft)

Exemptions: Public bodies, public enterprises, banks, microfinance institutions, and others specified by directive.

Taxation of Offshore Asset Transfers

The Draft Proclamation includes provisions to prevent tax avoidance schemes involving indirect transfers of Ethiopian assets through offshore entities. Specifically, it targets situations where shares in foreign companies are transferred, but over 50% of the foreign entity’s assets are located in Ethiopia, particularly in the mining and oil sectors. In such cases, these transfers will be treated as indirect transfers of shares in the underlying Ethiopian entity and will be subject to tax in Ethiopia.  

This measure is a critical step towards closing international tax loopholes and protecting the national tax base. The explanatory note underscores the issue of foreign companies avoiding capital gains tax by transferring shares of offshore parent companies that primarily own Ethiopian assets. By enacting this provision, the government ensures that capital gains arising from the transfer of underlying Ethiopian assets are taxed within Ethiopia, regardless of where the share transfer legally occurs. This aligns Ethiopia’s tax laws with international efforts to combat Base Erosion and Profit Shifting (BEPS) strategies, which are designed to prevent aggressive tax planning. It reinforces Ethiopia’s sovereign right to tax income derived from assets located within its jurisdiction, thereby enhancing revenue integrity and promoting fairness for domestic businesses that are directly subject to such taxes.  

2.4. Changes in Withholding Tax Provisions

Non-Resident Payments (Articles 52, 56, 57, 58, 65)

Under Proclamation No. 979/2016, various payments to non-residents, including general non-resident income (Article 51), technical service and royalty payments (Article 52), dividends (Article 55), and interest (Article 56), were generally subject to a 10% withholding tax on the gross amount. Repatriated profit (Article 62) was also subject to a 10% tax.  

The Draft Proclamation introduces several changes to these rates and conditions. The general withholding tax rate for non-resident payments, including insurance premiums, royalties, dividends, management fees, and technical fees, is increased to 15%. For royalties, a resident of Ethiopia will face a 15% rate generally, but a 10% rate for royalties related to art and culture, while non-resident Permanent Establishments (PEs) will be subject to 15%. Dividends to residents and non-resident PEs will also be taxed at 15%. A notable exception is introduced for inter-company dividends within a controlling group (where one company owns 50% or more of the shares), which are exempt from tax for the distributing body. Interest rates for both residents and non-resident PEs remain at 10%, with exceptions for financial institutions and credit sales, which will be taxed under Schedule C. Repatriated profit is now subject to a 15% tax, and a “deemed remittance” rule is introduced, where profit not remitted within 12 months will be assessed as if it has been remitted.  

These adjustments aim to increase revenue from cross-border transactions, aligning with the broader objective of revenue mobilization. The higher tax burden for foreign entities receiving passive income or repatriating profits from Ethiopia is a direct consequence. The exemption for inter-company dividends within a group is designed to reduce cascading taxation within corporate structures, promoting efficient capital allocation and potentially encouraging the establishment of holding companies in Ethiopia. The “deemed remittance” rule for repatriated profits addresses profit retention strategies by foreign PEs, ensuring timely tax collection. This balanced approach seeks to generate more revenue while facilitating legitimate business structures.

Games of Chance (Article 59)

Under Proclamation No. 979/2016, income derived from winning at games of chance was subject to a 15% tax on the gross winnings, with an exemption for winnings less than 1,000 Birr.  

The Draft Proclamation increases the tax rate on gross winnings from games of chance to 20%. The draft does not explicitly mention the 1,000 Birr exemption threshold.  

This is a straightforward revenue-raising measure, targeting a source of income often considered discretionary. The increase in the tax rate enhances the government’s share of winnings from lotteries and other games of chance, thereby contributing to revenue mobilization without directly impacting essential economic activities or the broader productive sectors of the economy.

Domestic Payments (Article 97)

Proclamation No. 979/2016 imposed a 2% withholding tax on domestic payments for goods exceeding 10,000 Birr and for services exceeding 3,000 Birr. A 30% rate was applied if the supplier did not provide a Taxpayer Identification Number (TIN), which was considered a final tax.  

The Draft Proclamation increases the withholding tax rate for domestic payments for goods and services from 2% to 3%. Concurrently, the thresholds for applicability are raised: for goods, the threshold increases from 10,000 Birr to 20,000 Birr, and for services, it increases from 3,000 Birr to 10,000 Birr. The 30% rate for non-TIN compliance remains in effect as a final tax. Exemptions are provided for micro-enterprises, legal entities, government agencies, and non-profit organizations, among others.  

This change aims to balance revenue collection with administrative efficiency. By increasing the withholding tax rate, the government seeks to generate more revenue from domestic transactions. However, by significantly raising the thresholds for applicability, the tax authority may be focusing its resources on larger transactions, where the revenue yield per transaction is higher, thereby improving administrative efficiency. This approach implies that a larger volume of smaller transactions will no longer be subject to withholding, which could potentially reduce traceability for some businesses if not compensated by other measures, such as the new cash transaction limits. The continued high penalty for non-TIN compliance reinforces the government’s push for formalization within the economy.

Table 6: Comparison of Withholding Tax Rates (Current vs. Draft)

2.5. Administrative and Compliance Changes

Record-Keeping Requirements (Article 86)

Proclamation No. 979/2016 outlines varying record-keeping obligations based on taxpayer categories. Category A taxpayers are required to maintain records according to financial reporting standards, including details on fixed assets, daily income/expenses, purchase/sales records, and inventory. Category B taxpayers must maintain daily income/expense, purchase/sales, and payroll records. Category C taxpayers may maintain records of gross sales or other necessary records as per regulation. A failure to provide documentary evidence could lead to the disallowance of expenses or their inclusion in asset value.  

The Draft Proclamation introduces more stringent and specific record-keeping obligations. Professionals providing technical services (as defined in Article 4(6)) are now explicitly obligated to maintain records according to Article 86, irrespective of their turnover. Category B taxpayers  

may choose to maintain records per Category A requirements, and if these records are deemed acceptable, their tax will be assessed based on their books rather than presumptive methods. A significant new provision is that failure to submit accounting records will result in tax being assessed based on an estimate, and the taxpayer will no longer be eligible for the simplified Category B method. Furthermore, Category A taxpayers with multiple business activities under Schedule C are now mandated to maintain separate books for each activity.  

These changes aim to enhance formalization and promote data-driven assessment. By explicitly requiring professionals to keep records and encouraging Category B taxpayers to adopt more rigorous record-keeping, the government is pushing a wider range of taxpayers towards formal accounting practices. The option for Category B taxpayers to be assessed on their books provides an incentive for better record-keeping, moving away from presumptive taxation which can sometimes be inaccurate. The penalty for non-submission reinforces compliance, while mandating separate books for multiple Schedule C activities improves transparency and accuracy of income attribution, preventing cross-subsidization or manipulation. This comprehensive strategy is designed to improve the quality and availability of taxpayer data, enabling more accurate tax assessments and reducing opportunities for evasion.

Tax Declaration Obligations (Article 87)

Under Proclamation No. 979/2016, an employee with a single employer and subject to withholding tax is generally not required to file a separate tax declaration. However, employees with multiple employers or those obligated to self-withhold tax must file quarterly declarations within 30 days after the quarter end. Category A taxpayers are required to declare their tax within four months of the tax year end, Category B within two months, and Schedule D income earners within two months of the transaction.  

The Draft Proclamation introduces a significant shift in tax declaration obligations. Employees with multiple employers or those subject to self-withholding will now be required to file an annual declaration, replacing the quarterly requirement, and their employment income tax paid will no longer be considered final. A major change is the mandate for the aggregation of all income sources (across schedules A, B, and C) for individuals. The federal tax authority will aggregate and tax these combined incomes as one. If tax has already been paid to another jurisdiction on a portion of this aggregated income, it will be credited against the total tax due. For federal and regional taxpayers, the aggregated income will be taxed at the federal level, with a deduction for any regional tax already paid.  

This comprehensive income assessment aims to enhance fairness in the tax system. The explanatory note highlights that individuals with multiple income sources previously benefited from multiple tax-exempt thresholds, leading to an inequitable distribution of the tax burden. By aggregating all income sources, the tax-exempt threshold will apply only once to the total income, thereby increasing the overall taxable income for individuals with diverse income streams. This directly addresses the fairness issue, ensuring that individuals with higher overall economic capacity contribute proportionally more. The provision for crediting regional taxes paid is crucial for constitutional compliance and avoiding double taxation within the federal structure, further promoting horizontal equity and a more comprehensive tax base for higher-income individuals.  

Advance Tax Payments (Article 89)

Proclamation No. 979/2016 provided an optional installment payment system for Category C business income taxpayers, allowing them to pay half of their previous year’s tax liability by the end of the sixth month of the tax year.  

The Draft Proclamation replaces this optional system with mandatory quarterly advance tax payments for both Category A and B taxpayers. Category A taxpayers will be required to pay 25% of their immediate past tax year’s liability quarterly, within 5 days of the quarter end, with the remaining balance due with their annual declaration. Category B taxpayers will also make mandatory quarterly advance payments of 25% of their immediate past tax year’s liability, due within 15 days of the quarter end (starting from Hamle 1), with the remaining balance due with their annual tax. New taxpayers will have different initial payment schedules: new Category A taxpayers will pay with their annual declaration, while new Category B taxpayers will pay between Hamle 1 and Hamle 30.  

This change is designed to improve revenue predictability and cash flow management for the government. The explanatory note indicates that businesses often face cash shortages at tax time, leading to delays in government revenue collection, which in turn impacts the timely coverage of budgeted expenditures. By introducing mandatory quarterly advance payments, the government ensures a more consistent and predictable flow of revenue throughout the fiscal year. For taxpayers, this shifts the burden from a single large annual payment to smaller, more manageable quarterly payments, which could also improve their own cash flow management. This is a significant step towards modernizing tax administration, reducing reliance on year-end collections, and enabling better fiscal planning for the government.  

Simplified Tax System for Small Businesses (Article 50)

The Draft Proclamation introduces a new, simplified gross sales-based tax regime specifically for Category B taxpayers. Under this system, Category B taxpayers will pay a “Tax on Annual Gross Sales” at progressive rates ranging from 2% for annual gross receipts between 0-100,000 Birr, up to 9% for receipts between 1,500,001-2,000,001 Birr. This new system replaces the previous complex lump-sum tax and integrates the turnover tax. However, certain activities are explicitly excluded from this simplified regime: professional services (such as accounting, legal, and engineering), VAT-registered businesses, and businesses that elect into net income taxation. Professionals specifically are required to maintain Category A-level records.  

This streamlined approach is intended to simplify compliance for small businesses while adopting a targeted approach for professionals. The explanatory note highlights that a key objective is to simplify tax payment for small businesses, stating that the previous lump-sum system was overly complex. By implementing a straightforward gross sales tax, small businesses benefit from a much simpler tax calculation directly linked to their revenue, thereby reducing compliance costs and complexity. The integration of turnover tax further streamlines their obligations. The explicit exclusion of professionals and the requirement for them to maintain detailed records reflect a policy decision to treat intellectual-capital-based businesses differently. This acknowledges their generally higher profitability margins relative to gross turnover and aims to ensure a more equitable tax contribution from them, while encouraging formalization and improving compliance among the broader small business sector.  

2.6. Investment and Capital Mobilization Related Changes

Taxation of Limited Liability Partnerships (LLPs) and Collective Investment Schemes (CIS) (Article 19(3))

The Draft Proclamation introduces a significant change in the taxation of Limited Liability Partnerships (LLPs) and legally registered Collective Investment Schemes (CIS). Regardless of their specific legal form, these entities will no longer be subject to corporate income tax at the entity level. Instead, a “pass-through” tax treatment will apply. LLPs will be required to withhold tax from income distributed to their members, based on Schedule C rates. Similarly, CIS will withhold dividend tax on profits distributed to their shareholders, as per Article 57. It is clarified that all other obligations stipulated in the proclamation will still apply to these entities.  

This change is designed to facilitate capital formation and modernize business structures. The explanatory note indicates that the previous tax system exposed LLPs to double taxation, and it emphasizes the crucial role of CIS in mobilizing capital for investment. By exempting LLPs and CIS from entity-level corporate tax, the draft eliminates double taxation for LLPs and removes a significant tax barrier for CIS, making these structures more attractive to investors and professionals. This directly supports the government’s objective of facilitating capital mobilization for investment and modernizing Ethiopia’s business landscape, potentially attracting more domestic and foreign investment into formal channels.  

Taxation of Pledged Share Dividends

The Draft Proclamation includes a provision that clarifies and expands an existing incentive related to dividend taxation. It states that shareholders who utilize their dividend income to pay for pledged shares within the company will be exempt from dividend tax.  

This amendment aims to incentivize reinvestment and foster corporate growth. The explanatory note explains that this provision clarifies an ambiguity in the old law and aligns with the original intent of encouraging shareholders to reinvest their profits within the company. By providing a clear tax exemption for dividends used to fulfill share subscription commitments, the government offers a direct incentive for shareholders to retain and reinvest their earnings within the company. This mechanism supports internal capital generation, which can fuel corporate growth and expansion without necessarily requiring external financing. The measure thus aligns with the broader objective of fostering investment and strengthening the financial health of Ethiopian companies.  

Application of Income Tax Incentives (Article 105)

The Draft Proclamation centralizes the authority for granting income tax incentives. It stipulates that income tax incentives for investors who have obtained investment permits under the Investment Proclamation will only be granted through Council of Ministers Investment Incentives Regulations. Furthermore, with the exception of specific exemptions granted to cooperatives under the Cooperatives Proclamation, all other income tax exemptions previously granted by various other proclamations, regulations, and directives are explicitly repealed.  

This measure is intended to rationalize tax incentives and prevent the erosion of the tax base. While not explicitly detailed in the provided snippet, the centralization of incentives is a common strategy to enhance the efficient administration of tax incentives and safeguard against aggressive tax avoidance and evasion, as indicated in the preamble of the draft proclamation. By establishing a single, transparent legal framework for investment incentives, the government aims to reduce fragmentation and the potential for abuse. The repeal of scattered exemptions is a deliberate move to prevent unintended tax base erosion and ensure that incentives are granted strategically and consistently. This approach is expected to improve the predictability and fairness of the tax system for investors, as all incentives will be governed by a clear and unified policy, while acknowledging the unique socio-economic role of cooperatives through their continued exemption.  

3. Synthesis of Key Changes and Their Implications

Overall Impact on Taxpayers (Individuals, Businesses, Non-residents)

Larger Businesses (Category A) will face new compliance requirements, including mandatory quarterly advance tax payments. They will also be subject to enhanced anti-avoidance measures such as the Alternative Minimum Tax (AMT), stricter cash transaction limits, and rules addressing offshore asset transfers.

Professionals engaged in technical services will encounter stricter record-keeping rules and are explicitly excluded from the simplified gross sales taxation for small businesses. This implies a higher compliance burden and potentially higher effective tax rates for this segment.

Non-residents will face increased withholding tax rates on various income streams, including insurance premiums, royalties, dividends, management/technical fees, and repatriated profits. Furthermore, the broadened definition of Permanent Establishment means that foreign entities operating in Ethiopia for shorter durations may now be subject to local taxation, leading to a higher overall tax cost of doing business or investing in the country.

Limited Liability Partnerships (LLPs) and Collective Investment Schemes (CIS) will benefit from a “pass-through” taxation treatment, eliminating double taxation at the entity level and encouraging their formation and operation.

Impact on Revenue Mobilization and Economic Development

The Draft Proclamation is strategically designed to significantly boost government revenue. This is intended to be achieved by broadening the tax base through the explicit taxation of the digital economy, the introduction of the AMT, and the expansion of the Permanent Establishment definition. Additionally, increased withholding tax rates on certain cross-border transactions and improved compliance through stricter administrative measures, such as cash transaction limits and enhanced record-keeping, are expected to contribute to revenue growth. While the direct tax relief provided to low-income earners will result in some revenue loss, the government anticipates offsetting this through the aforementioned base-broadening and compliance-enhancing measures.  

From an economic development perspective, the reforms are geared towards fostering formalization within the economy, incentivizing investment (particularly through favorable tax treatment for LLPs, CIS, and pledged dividends), and creating a more predictable and fair tax environment. The proactive focus on capturing revenue from the digital economy positions Ethiopia to benefit from emerging sectors and ensures that new forms of wealth generation contribute to national development.

Alignment with Fundamental Tax Principles (Fairness, Efficiency, Simplicity)

The proposed amendments demonstrate a concerted effort to align the Ethiopian tax system with fundamental tax principles:

• Fairness is enhanced by redistributing the tax burden, notably by reducing it for low-income earners and by ensuring that individuals with higher overall economic capacity contribute proportionally more through income aggregation. The introduction of the AMT also aims to ensure that all profitable businesses contribute their fair share, regardless of declared losses.
• Efficiency is expected to improve through simplified tax regimes for small businesses, clearer definitions (e.g., for technical services), and attempts to streamline the administration of tax incentives. However, the introduction of new compliance burdens for larger entities and professionals may pose initial efficiency challenges during the transition period as taxpayers adapt to the new requirements.
• Simplicity is achieved for small businesses through the gross sales-based tax, which replaces a more complex lump-sum system. However, the overall tax system becomes more intricate with the introduction of new taxes (digital services, AMT) and stricter anti-avoidance rules, potentially increasing complexity for larger and more sophisticated taxpayers.

Addressing Tax Avoidance and Evasion

Combating tax avoidance and evasion is a core and explicit objective of the Draft Proclamation. Measures such as the Alternative Minimum Tax (AMT), the imposition of cash transaction limits, the expanded definition of Permanent Establishment, the taxation of offshore asset transfers, and enhanced record-keeping and reporting requirements are directly targeted at common avoidance and evasion practices. This comprehensive suite of measures signals a strong commitment by the government to improve tax compliance and safeguard the integrity of the tax system.  

4. Insights and Recommendations

Strategic Implications for Businesses and Investors Operating in Ethiopia

The proposed amendments to the Federal Income Tax Proclamation carry several strategic implications for businesses and investors operating within Ethiopia:

• Increased Compliance Costs: Larger businesses and professionals should anticipate an increase in compliance costs. This is due to new record-keeping requirements, the introduction of mandatory advance tax payments, and the need to adapt to new tax calculation methodologies, such such as the Alternative Minimum Tax.
• Shift to Digital Transactions: The stringent limits on cash transactions necessitate a rapid transition towards digital payment methods and formal banking channels for larger transactions. Businesses must invest in appropriate digital payment infrastructure and provide training to their staff to avoid severe penalties.
• Digital Economy Participants: Digital content creators and digital service providers, both resident and non-resident, must formalize their operations, obtain Taxpayer Identification Numbers (TINs), and thoroughly understand their new tax obligations. Foreign digital service providers, in particular, need to re-evaluate their Permanent Establishment status and potential Digital Service Tax liability.
• Investment Structures: The favorable tax treatment extended to Limited Liability Partnerships (LLPs) and Collective Investment Schemes (CIS) makes these structures more attractive vehicles for investment and professional collaboration. Businesses considering new ventures or restructuring existing ones may find these forms more tax-efficient.
• Tax Planning: Aggressive tax planning strategies, especially those involving the declaration of artificial losses or the use of offshore transfers to avoid Ethiopian tax, will face significantly higher scrutiny and potentially severe penalties. Businesses should review their existing tax structures to ensure full compliance with the new anti-avoidance provisions.

Potential Challenges in Implementation and Enforcement of the New Provisions

While the proposed reforms are comprehensive, their successful implementation and enforcement may encounter several challenges:

• Administrative Capacity: The tax authority will require substantial capacity building. This includes training in areas such as digital forensics for auditing digital economy activities, expertise in auditing complex AMT calculations, and robust enforcement mechanisms for cash transaction limits.
• Taxpayer Awareness and Education: Effective and widespread communication campaigns are essential to educate diverse taxpayer segments, including small businesses, digital content creators, and foreign entities, about the new rules. Lack of awareness could lead to inadvertent non-compliance.
• Technological Infrastructure: The effective implementation of digital tax measures, such as mandated platform reporting for digital content creation income and the collection of Digital Service Tax, necessitates robust IT infrastructure within the tax authority. This also requires seamless integration with financial institutions to facilitate electronic payments and data exchange.
• Informal Economy Resistance: The transition away from cash transactions may face resistance from segments of the informal economy that are deeply entrenched in cash-based operations. This could lead to initial disruption and a potential increase in informal activities if not managed carefully.
• Regulatory Clarity: The Draft Proclamation frequently refers to forthcoming regulations and directives for detailed implementation, such as the specific rate for the Digital Service Tax or exemptions for cash transactions. The timely issuance of clear, comprehensive, and unambiguous subsidiary legislation is crucial to provide the necessary operational guidance for both taxpayers and administrators.

Recommendations for Policy Makers and Taxpayers

To ensure the successful implementation and maximize the benefits of these tax reforms, the following recommendations are put forth:

For Policy Makers:

• Prioritize Regulatory Issuance: Expedite the drafting and issuance of clear, comprehensive regulations and directives. These subsidiary legislations are vital for providing the necessary operational details and resolving any ambiguities in the new provisions.
• Invest in Capacity Building: Allocate significant resources for training tax administrators. This training should cover new areas such as digital taxation, advanced auditing techniques for AMT, and effective enforcement strategies for cash transaction limits.
• Launch Extensive Public Awareness Campaigns: Develop targeted educational programs tailored for different taxpayer groups, including small businesses, digital creators, and foreign entities. These campaigns should leverage multiple media channels and local languages to ensure broad reach and understanding.
• Consider Phased Implementation: For certain complex provisions, such as the Digital Service Tax or the cash transaction limits, consider a phased implementation approach. This would allow businesses and the tax administration sufficient time to adapt their systems and practices.
• Establish Impact Monitoring Mechanisms: Create robust mechanisms to continuously monitor the economic and social impact of the new provisions. This will enable timely adjustments to the legislation or its implementation if unintended consequences arise.
• Strengthen International Cooperation: Enhance cooperation with international tax bodies and other countries. This is crucial for effectively implementing cross-border digital taxation measures and combating international tax avoidance schemes.

For Taxpayers:

• Proactive Compliance Review: Conduct a thorough review of current business practices and financial systems to ensure full alignment with the new proclamation. Particular attention should be paid to record-keeping requirements, cash transaction limits, and the new income definitions related to the digital economy.
• Seek Professional Advice: Engage qualified tax professionals to gain a comprehensive understanding of the specific implications of the amendments for their operations. Professional guidance can help ensure proper compliance and identify potential tax efficiencies.
• Invest in Digitalization: Embrace and invest in digital payment methods and accounting software. This will not only facilitate compliance with cash transaction limits but also enhance the efficiency and accuracy of record-keeping, which is increasingly vital under the new regime.
• Engage in Dialogue: Actively participate in any public consultations or forums organized by the tax authority. This provides an opportunity to offer feedback, seek clarifications on implementation issues, and contribute to the refinement of the tax framework.

5. Conclusion

The proposed amendments to the Federal Income Tax Proclamation represent a significant and necessary reform effort by the Ethiopian government. This initiative aims to modernize the national tax system, broaden its revenue base, and enhance principles of fairness and compliance across the economy. By proactively addressing the evolving digital economy, implementing robust measures to combat aggressive tax avoidance, and streamlining processes for small businesses, the Draft Proclamation lays a foundational framework for a more robust and equitable fiscal landscape.

While these transformative changes promise substantial benefits in terms of increased revenue mobilization and greater economic formalization, their successful implementation will critically depend on several factors. These include the timely issuance and clarity of subsequent regulations, the continuous development of administrative capacity within the tax authorities, and the proactive engagement and education of the taxpayer community. A collaborative approach, fostering open dialogue and cooperation between the government and the private sector, will be paramount to navigate this complex transition effectively and realize the full potential of these far-reaching tax reforms.