Contributed By Kumlachew Dagne and Associates Law Office
The main corporate forms adopted by businesses in Ethiopia are the private limited company/PLC (largely akin to limited liability companies/LLCs in some jurisdictions) and the share company/SC (similar to joint stock companies in Western jurisdictions). The key differences between PLCs and SC relate to the minimum capital and membership requirements, the governance structure, the grounds for dissolution, and the restrictions on share transfers and business engagements. Accordingly, a PLC is required to have between two and 50 members and a minimum capital of ETB15,000 (about USD500), while an SC shall have a minimum of five members (with no maximum set in the law) and a minimum capital of ETB50,000 (about USD1,600). The structure of a PLC consists of the shareholders' meeting and a management headed by the General Manager, while an SC also needs to have a board of directors (which would be responsible for managing the company). The Commercial Code provides detailed rules regarding the governance of a share company, the valuation of in-kind contributions and the liabilities of directors. A PLC, on the other hand, has a simpler and more flexible structure of governance, which makes it a preferable choice for many investors. Nonetheless, there are restrictive provisions regarding PLCs that are of concern to investors, including the requirement for a 75% majority to approve transfers of shares to third parties or to amend the memorandum and articles of association of the company, including changes of objectives, the admission of new shareholders or capital increases. PLCs are not allowed to engage in banking and insurance businesses.
Both PLCs and SCs are taxed as separate entities.
There are no fiscally transparent entities in Ethiopia. A joint venture might be treated as fiscally transparent but, under the Commercial Code, a joint venture does not have an independent legal personality, and the business is in fact carried on in the name of one of the partners of the joint venture.
A body is resident in Ethiopia if it is incorporated or formed in Ethiopia, or has its place of effective management in Ethiopia.
The tax rate applicable to incorporated businesses is 30%.
Progressive tax rates apply to sole proprietorships based on annual income. The floor for taxable income is ETB7,200 (about USD250). The rate is 10% for those with annual income from ETB7,201 to ETB19,800; 15% for those earning ETB19,801 to ETB38,400; 20% for those whose annual income is between ETB38,401 and ETB63,000; 25% for taxable income from ETB63,001 to ETB93,600; 30% for taxable income from ETB93,601 to ETB130,800; and 35% for taxable business income over ETB130,800 (ie, above USD4,650).
In cases where individuals hold interest in other entities, the individuals will pay 10% tax on dividends obtained from these entities. Apart from this, there are no separate taxes on individuals owning an interest in transparent entities.
Taxable profits are calculated on the basis of the profit and loss statement of an incorporated entity, certified by external auditors. For tax purposes, gross income includes gross amounts derived from the conduct of business and the provision of services, gains on the disposal of business assets (ie, the difference between the cost of the asset and its net book value) and any other amount included in the business income tax. Profits are taxed on a receipt basis, although reporting profit on an accrual basis is also allowed in certain cases, especially those related to income from long-term transactions such as construction or consultancy.
Substantial adjustments are made for tax purposes on account of depreciation (on business intangibles and depreciable assets); interest expenditures, provided that the proceeds or benefit of the debt were used to derive business income and the interest rate does not exceed the rate used by the National Bank of Ethiopia and commercial banks by more than 2%); charitable donations, provided that the amount does not exceed 10% of the taxable income of the tax payer for the year; and loss carried forward from the previous tax years, with a maximum of two years.
Investments related to information and communication development are tax exempted for four years if they take place in Addis Ababa and the special zone of Oromia surrounding Addis Ababa, and for five years if they are made in other parts of the country. To the extent that research and development expenses are incurred to derive, secure or maintain amounts included in the business income, they will be treated as deductible expense.
The Investment Regulation outlines the tax incentives applicable to investments in different sectors. Manufacturing and agriculture businesses enjoy more tax holidays than other businesses, and investments outside Addis Ababa and its environs also get more tax holidays. Accordingly, the following tax holidays are granted in the following sectors:
In addition, an investor investing in emerging regions and remote areas is entitled to a 30% tax exemption for three consecutive years following the expiry of the abovementioned period. If the investor exports 60 or more of its products or services, it will be entitled to tax exemption for an additional two years.
A taxpayer is allowed to carry its loss forward (as a deduction on its taxable income) for a maximum of five years after the end of year in which the loss was incurred. However, if there have been two tax years in which a taxpayer has incurred a loss and each of those losses has been carried forward, the taxpayer shall not be permitted to carry forward any further losses – see Art. 26 of Proclamation No. 979/2016 (the Income Tax Proclamation). If a taxpayer has a loss carried forward for more than one tax year, the loss of the earliest year shall be deducted first. A loss may be carried forward only if the taxpayer’s books of account showing the loss are audited and acceptable to the authority. In addition, loss sustained in the performance of a long-term contract may be carried backward until the loss is fully deducted – see Arts. 42 and 43 of Regulation No. 410/2017 (the Income Tax Regulation).
An investor who has incurred loss during a tax exemption period (see 2.3 Other Special Incentives) can carry forward such loss for half of the exemption period after the expiry of such period. For the purpose of calculating the period of loss carry-forward, a half-year period shall be considered as a full income tax period. An investor who has incurred loss during the income tax exemption period may not be allowed to carry forward such loss for more than five years. A corporate entity shall carry a loss for a tax year forward to a subsequent tax year only when the same person holds more than 50% of the underlying ownership of the body in the loss year, the carry-forward year, and all intervening tax years.
Interest is deductible only to the extent that the taxpayer has used the proceeds or benefits of the debt or other instrument that gives rise to the interest to derive business income. No deduction is allowed for interest in excess of 2% above the rate used by the National Bank of Ethiopia (NBE) and commercial banks, unless the interest is paid to an NBE-recognised financial institution or a foreign bank permitted to lend to persons in Ethiopia. Interest to a related resident is not a deductible expense unless it is part of the taxable income for the resident.
Foreign loans require prior approval of the NBE, and interest on such loans is only deductible if the borrower produces a copy of the NBE approval letter (Art. 28 of the Income Tax Regulation).
There are no rules on consolidated tax grouping. Each company is supposed to utilise losses as stated above, and is treated as a separate entity for tax purposes.
The capital gains tax on the disposal of shares and bonds (whether by corporations or natural persons) is 30%. Gains on the disposal of immovables are taxed at the rate of 15%.
Losses on the disposal of taxable assets are recognised, and offset gains on the disposal of taxable assets of the same class during the year. Any such extra loss can be carried forward indefinitely for offset against gains on the disposal of taxable assets of the same class until fully offset. However, the loss incurred on the disposal of a taxable asset to a related person shall not be carried forward.
If a gain on a disposal of taxable assets derived by a resident of Ethiopia is a foreign income, the resident is allowed to reduce the capital gains tax payable in respect of the income by the amount of any foreign tax paid in respect of the income, but not to zero (Arts. 59 and 64(3) of the Income Tax Proclamation).
An incorporated business engaged in the rental of buildings should pay rental income tax, at the rate of 30%.
A company is required to pay 10% tax on its net undistributed profit in a tax year to the extent that it is not reinvested. There is a 10% tax on profits transferred by branches of foreign companies to their head offices.
Most closely held local businesses operate in corporate form (ie, as private limited companies) in Ethiopia.
The taxable income of individual businesses is progressively taxed, and income above ETB130,800 (about USD4,500) is taxed at the rate of 35%, while corporate entities are taxed at 30%. Individual professionals who want to be taxed at corporate rates will therefore incorporate companies (usually private limited companies, although share companies are also possible) and get dividends instead of direct business incomes. However, there will be an additional 10% dividend tax on their share in the net profit, on top of the 30% corporate income tax the company pays.
Whether closely held or not, corporations are encouraged to reinvest their earnings during the next tax year, in which case they will be exempted from dividend tax. However, if they accumulate their net earnings beyond the next tax year, they will be required to pay 10% tax on retained earnings, regardless of whether or not they re-invest them afterwards. The 10% tax on retained earnings therefore discourages the accumulation of earnings for more than one year.
Apart from the 30% capital gains on the transfer of shares and the 10% tax on dividends from the annual net profit of a company, there are no separate "dividend" taxes on the sale of shares in closely held corporations.
To date, Ethiopia does not have stock markets, and there are no publicly listed or traded corporations. Accordingly, there are no separate taxes on dividends from or on the gain on sale of shares in publicly traded corporations (apart from the capital gains and dividend tax rates discussed above).
A resident company or a permanent establishment of a non-resident in Ethiopia making a payment of a dividend, interest or royalty that is subject to tax is required to withhold 10% tax on dividends and interests, and 5% on royalty (Arts. 89, 54 and 51/2/a/ of the Income Tax Proclamation).
No reliefs are available for withholding taxes on interest, dividends and royalties.
Ethiopia has concluded double taxation avoidance agreements (DTAs) with Israel, Italy, Kuwait, Romania, Russia, South Africa, Sudan, Tunisia, Yemen, France, India, Egypt, China, the Netherlands, Saudi Arabia, Qatar, Portugal, Algeria, the Czech Republic, Iran, Turkey, the UK, the Seychelles, Korea, Poland, the UAE, Mozambique, Morocco, Singapore, Cyprus, Slovakia and Ireland. Foreign investors from these tax treaty countries are beneficiaries of the respective DTAs.
Local tax authorities do not challenge the use of treaty country entities by non-treaty country residents.
The biggest transfer pricing issues concern technical services provided by the inbound investor to its local corporation, including management support, marketing and branding, as well as research and development fees. In general, expenses incurred at the head office level for the provision of services through a local entity, whether that entity is a project office, a branch of the inbound investor or a subsidiary, including in cases of international bids/contracts, are often treated as major transfer pricing issues.
Likewise, the provision of goods to the subsidiary at a price higher than that set at the global market will also arise as a transfer pricing issue from time to time.
There are no such issues, as far as is known.
Aspects of local transfer pricing rules and/or enforcement vary from OECD standards, especially on prices for global services by the parent company on a cost sharing/allocation basis, including burden costs arrangements. Burden cost arrangements are often rejected by the tax authority on the grounds that sufficient evidence of the expenses incurred at the head office level is not presented, which would not be feasible in large multinationals that have millions of expense entries. This happens even in cases where the parent or related company does not charge any overhead or profit markup, or charges a very minimal one below that allowed by OECD rules. In cases of technical services provided by parent or related companies to the local subsidiary, there are more stringent requirements than the OECD rules. The new Income Tax Proclamation of 2016 authorises the Ministry of Finance to issue directives on such matters, but no clear directives have been issued so far.
There are no clear rules on compensating adjustments in cases where transfer pricing claim is settled.
Local branches of non-local corporations are not taxed differently to local subsidiaries of non-local corporations in Ethiopia.
Capital gains of non-residents on the sale of stock in local corporations are taxed at a rate of 30%. The tax also applies where the gain is on the shares of a non-local holding company that owns the stock of a local corporation directly.
As stated above, indirect share transfers are subject to capital gains tax, and to this extent change in control of the holding company will trigger capital gains taxes.
Change in control provisions governing the loss carry-forward and tax liabilities of a licensee or contractor in the mining or petroleum business is provided under Articles 34 and 44 of the Income Tax Proclamation. As per the Income Tax Proclamation, a person can carry a loss forward to a subsequent tax year only when said person holds more than 50% of the underlying ownership of the body in the loss year, the carry-forward year, and all intervening tax years. If a non-resident directly or indirectly disposes of a 10% or more membership interest in a body, the licensee or contractor shall be liable, as agent for the non-resident, for any tax payable under the income tax law by the non-resident person in respect of the disposal. Any tax paid by a licensee or contractor on behalf of a non-resident shall be credited against the tax liability of the non-resident.
No separate/special formulas are used to determine the income of foreign-owned local affiliates, which are taxed on the basis of their gross profits as presented in their audit reports plus additional withholding taxes on dividends or capital gains, as stated above. Foreign-owned and local companies are essentially subject to the same tax regime, except as regards transfer pricing and related issues discussed above regarding the deductibility of expenses.
Payment made by a permanent establishment doing business in Ethiopia to its parent non-resident body in reimbursement of actual expenses incurred by the parent non-resident body for the benefit of the permanent establishment shall be deducted to the extent that such expense was incurred in deriving, securing or maintaining business income. It must be ascertained that the expense was incurred for the purpose of deriving, securing or maintaining business income in order to allow a deduction for payments by local affiliates for management and administrative expenses incurred by non-local affiliates (Article 35 of the Income Tax Regulation).
Apart from this, there are no clear applicable standards to allow for the deduction of payment for management and administrative expenses incurred by non-local affiliates as stated above, whether relating to cost sharing or to burden allocation. Auditors often ask to see a direct nexus between such expenses and the actual service provided to the local affiliate on a piecemeal basis, and are not willing to allow expenses incurred by the non-local affiliate for management support, marketing and research and development unless they translate to identifiable and specific piecemeal services for which specific invoices are issued.
There are no special constraints imposed on related party borrowing. However, all foreign loans (whether or not from a related party) require prior approval of the NBE. Such approval is given if the following conditions are met:
As stated above, no interest on foreign loans is allowed unless evidence of prior approval by the NBE is presented.
Ethiopian income tax law provides that business income derived by a resident of Ethiopia, whether it is local or foreign, shall be treated as Ethiopian source income and taxable in Ethiopia, except to the extent that it is attributable to a business conducted by the resident through a permanent establishment outside of Ethiopia. If a resident taxpayer has foreign income subject to corporate tax in Ethiopia in respect of which the resident has paid foreign income tax, the taxpayer shall be allowed a tax credit of an amount equal to the lesser of the foreign income tax paid or the corporate income tax (30%) payable in respect of the foreign income. A foreign tax credit shall be allowed only if the resident taxpayer has paid the foreign income tax within two years after the end of the tax year in which the foreign income was derived by the taxpayer or within such further time as the authority allows, and if the resident taxpayer has a receipt for the tax from the foreign tax authority. In computing the business income tax payable by a resident taxpayer for a tax year, the taxpayer shall apply the foreign tax credit under this Article before applying any other tax credits of the taxpayer for the tax year. If a foreign tax credit of a resident taxpayer for a tax year is not fully credited for the year, the excess credit shall not be refunded, carried back to the preceding tax year, or carried forward to the following tax year (Article 45 of the Income Tax Proclamation).
Foreign income is not exempted from corporate income tax in Ethiopia.
Local corporations that derive dividends from foreign subsidiaries shall be liable for income tax at the rate of 10% (of the gross amount of the dividend). A resident of Ethiopia who has derived dividends (foreign income) from foreign subsidiaries is allowed to reduce the tax payable in respect of the income by the amount of any foreign tax paid in respect of the income, but not to zero. Therefore, as per the Income Tax Proclamation, the local corporation should declare this income as dividend and pay 10% dividend tax.
Intangibles developed by local corporations cannot be used by non-local subsidiaries in their business without incurring local corporate tax. As per the income tax law of Ethiopia (Art. 66), a person acquires an asset when legal title to the asset passes to the person, including, in the case of an asset that is a right or option (like intangibles), the granting of the right or option to the person. If the non-local subsidiaries allowed the use of it for free, it is treated as disposal by way of gift, and the consideration for the disposal shall be the fair market value of the asset at the time of the disposal. On the other hand, local corporations are duty bound to include details of transactions with related persons during a tax year with the taxpayer’s tax declaration for the year. Therefore, it is plausible to argue that local corporations are duty bound to declare the income as part of the business income of the company, and to pay the appropriate tax accordingly (Article 79(5) of the Income Tax Proclamation).
Local corporations are taxed on the income of their non-local subsidiaries, as stated under 6.1 Foreign Income of Local Corporations and 6.3 Taxation on Dividends from Foreign Subsidiaries. There are no separate CFC-type rules.
There are no separate rules or doctrines relating to the substance of non-local affiliates.
In principle, local corporations are not allowed to hold shares or stocks in non-local affiliates without the special approval of the National Bank of Ethiopia. Holding shares without NBE approval could potentially be treated as an illegal transaction in foreign exchange and entail grave penalties (up to 15 years of imprisonment for the corporate officers). NBE rarely gives such approvals. However, once such an approval is given, local corporations that derive gains on the disposal of shares in non-local affiliates will be liable to pay income tax at a rate of 30%. The amount of a gain on disposal of a taxable asset by a person shall be the amount by which the consideration for the disposal of the asset exceeds the cost of the asset at the time of disposal. The local corporation shall file a tax declaration within two months of the date of the transaction giving rise to the income.
Anti-avoidance provisions are included in the Income Tax Proclamation. Income splitting, transfer pricing and tax avoidance schemes are regulated by the anti-tax avoidance provisions of the income tax law. If a taxpayer attempts to split income with a related person, the Authority shall adjust the income and tax credits of both persons to prevent any reduction in tax payable as a result of the splitting of income. In respect of any transaction that is not an arm’s length transaction, the tax authority may distribute, apportion or allocate income, gains, deductions, losses or tax credits between the parties to the transaction as is necessary to reflect the income, gains, deductions, losses or credits that would have been realised in an arm’s length transaction. If the authority is satisfied that a tax avoidance scheme has been entered into or carried out and a person has obtained a tax benefit in connection with the scheme, the authority may determine the tax liability of the person who obtained the tax benefit and of any other person related to the scheme as if the scheme had not been entered into or carried out or in such manner as the authority considers appropriate in the circumstances for the prevention or reduction of the tax benefit.
There is no regular routine audit cycle in Ethiopia; there are only investigative audits. However, corporations are expected to be annually audited by external auditors, and will present their audit reports for the purposes of declaring taxable business income.
As far as is known, there are no BEPS recommended changes that have actually been implemented.
As far as is known, the Ethiopian Government has not taken an official stand on BEPs. Ethiopia is not yet a member of the OECD BEPS Inclusive Framework. Technical know-how and capacity constraints have hindered accession to the BEPS inclusive framework and the application of its standards in Ethiopia.
International tax does not yet have a high public profile, despite a few tax issues with global companies, especially on technical services tax, capital gains on indirect transfers and profit transfer tax issues. Some of the disputes in this regard emanated from a lack of clarity regarding the applicable rules, or from a lack of such applicable rules. The Income Tax Proclamation has tried to address the gaps, especially on profit transfer and capital gains tax issues.
As Ethiopia is not a member of the BEPS Inclusive Framework, it is too early to discuss the implementation of the BEPS recommendations.
Ethiopia does not yet have a clearly articulated competitive tax policy objective, despite provisions in the investment law on tax holidays. Ethiopian authorities strictly apply the law, and tax incentives are often interpreted narrowly. If Ethiopia accedes to the BEPS Framework, the tax authorities are not likely to have any difficulty in applying it strictly, and will proceed with the narrow and restrictive interpretation of tax incentives as is done now.
See 9.4 Competitive Tax Policy Objective.
See 9.3 Profile of International Tax and 9.4 Competitive Tax Policy Objective.
The Ethiopian system is both territorial and worldwide, with the latter applying to the income of Ethiopian entities from branches or taxable activities worldwide. See discussions elsewhere regarding the deductibility of interest.
As the system is a hybrid of the territorial and worldwide systems, and given the restrictions on local companies holding stock in foreign entities, the CFC proposals are not of major significance to Ethiopia. The issue might be of importance in the long run, although that will take time, given the low level of local private sector development in the country.
The proposed DTC limitation of benefit or anti-avoidance rules are not likely to have a significant effect, for reasons mentioned under 9.8 CFC Proposals.
Taxation on profits on intellectual property is a difficult issue in Ethiopia because of a lack of standards by which to determine actual gains from such profits and capacity constraints. Nonetheless, no radical changes are expected due to the proposal.
Ethiopia is in favour of transparency and country-by-country reporting.
Due to limited internet penetration, an underdeveloped private sector, the traditional ways of doing business and abject poverty, digital economy businesses are yet to grow in Ethiopia.
Ethiopia has not yet taken a clear position on this issue.
The law does not provide specific provisions on the taxation of offshore intellectual property.
There are no additional comments on the BEPS process.