DIRE-DAWA UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTIG AND FINANCE

PROGRAM: MSC IN ACCOUNTING AND FINANCE

TERM PAPER ON “IMPLEMENTATION of VALUE ADDED TAX AND ITS

RELATED PROBLEMS IN ETHIOPIA” (The Case of ERCA)

COURS NAME: ADVANCED TAXATION

SUMMITED BY: HUKUBA SANIYO ID NO DDU14000522

SUMMITTED TO: MEKA F. (ASS. PROF. OF ACCOUNTING AND FINANCE)

June, 2022
Chiro, Ethiopia
Table of Content

Content Page

1. Introduction…………………………………………………………………….………..1
2. Definition, Terminologies, Rate, merits, and Demerits of VAT………………………..2
3. VAT IMPLEMENTATION PROCESS IN ETHIOPIA ..............................................6
3.1. Objective of VAT in Ethiopia…………………………………………………………8
3.2.Structure of Value Added Tax in Ethiopia ....................................................................8
3.3.Effects of VAT on Consumption and Investment .........................................................9
3.4.VAT Registration ........................................................................................................... 10

3.5.Cancellation of VAT Registration ..................................................................................12

3.6.Record keeping requirement ............................................................................................12
3.7.Administrative penalties ...................................................................................................12
3.8.VAT Refund ........................................................................................................ ………..13
3.9. .Exemption or Zero-rating ..................................................................................................13
3.10. VAT
Administration ........................................................................................................15
3.11. Standard Integrated Government Tax Administration System (SIGTAS) ..................... 16
3.12. VAT Implementation Problems in
Ethiopia ......................................................................18
4. Conclusion and Recommendation……………………………………………………………19
Reference……………………………………………………………………………………………23

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1. Introduction
Value Added Tax is a tax levied on sales of goods and services rather than an income generated.
It is borne ultimately by the final consumer on its expenditure. VAT is a tax not on the total
value of goods sold or services rendered but only on the incremental value or newly created
value by the last seller. The incremental value is the difference between sales proceeds and
purchases of intermediate goods or services excluding the proceeding VAT. It is the base for
VAT computation.

The government of Ethiopia has been introduced and effectively implemented the Value Added
Tax on January 1, 2003 by replacing the sales tax. Before practicing VAT, there are a number of
issues that given prior concern, like capacity building of the tax collection system including
effective computerization and tax officials training, considering the merit and demerits of VAT
with regard to the society living standard and avoiding the business crises raised from the
unsuccessful taxation system attempted.

Six month after the VAT proclamation No. 285/2002 has been ratified by the parliament. The
council of ministers also issues VAT registration no. 79/2002 pursuant to the Value Added Tax
proclamation for the implementation. In other words, VAT implementation in Ethiopia is based
upon the proclamation which has 13 sections and 66 articles and regulation cited above.
The six months period between the issue of the VAT laws and its effective introduction was
preparation for effective implementation of VAT administration. According to separate VAT
departments, the four functional divisions has been organized and settled within Federal Inland
Revenue Authority (FIRA) currently named as Ethiopian Revenue and Customs Authority
(ERCA). Intensive taxpayer’s educational campaign, which consisted pre-implementation
seminars, information sessions, publications, media releases and taxpayers advisory services
was conducted. These taxpayers education program had a positive effect on the taxpayers
understanding about the VAT proclamation and the related obligation and entitlements.

As stated repeatedly, VAT is a tax on consumer expenditure. It is collected on business

transactions and imports. A taxable person can be an individual, firm, company, as long as such
a person is required to be registered for VAT.
The second section of this paper describes the definition of Value-Added Tax (VAT), VAT
Terminologies, VAT Rate and Merits and Demerits of VAT. The third section discusses about
1
 VAT implementation performance and it’s problems in Ethiopia. This study has tried to assess
the VAT implementation in the country specifically in Addis Ababa (ERCA) on the title “Value
Added Tax implementation and its related problems”. The objective is to assess and analyze the
implementation of VAT and problems associated with, in Ethiopia.

2. Definition, Terminologies, Rate, merits, and Demerits of VAT

2.1. Definition of Value-Added Tax (VAT)
Value Added Tax (VAT) is a general consumption tax assessed on the value added to goods and
services. It is a general tax that applies, in principle, to all commercial activities involving the
production and distribution of goods and the provision of services. It is a consumption tax
because it is borne ultimately by the final consumer. It is charged as a percentage of prices,
which means that the actual tax burden is visible at each stage in the production and distribution
chain. It is collected fractionally, via a system of deductions whereby taxable persons (i.e.,
VAT-registered businesses) can deduct from their VAT liability the amount of tax they have
paid to other taxable persons on purchases for their business activities (Herouy, 2004).

2.2. VAT Terminologies

According to Misrak (2008), some of the terms in the VAT literature are:

• Output tax:- is the VAT that a business pays over taxable supplies made and can be recovered only on
so far as your business in VAT registered and make taxable output.
• Input tax: - the VAT that a business collects over on taxable supplies (VAT paid on sales).
• VAT payable: - this is the VAT to be paid to the authority /ERCA/ by the taxable person. It is
computed as: VAT payable = Output tax – input tax
• Zero rating: - the supply is charged with VAT at 0% but credit can be taken for VAT paid on
purchase used to make supplies.
• Positive rate: - the supply is charged with a rate of 15%.
• Exemption: - the supply is exempted from VAT. No VAT is charged on the supply and no credit can
be taken on the purchase used to make supply.

2.3. VAT Rate

According to International Monetary fund (IMF) report (2004), more than 4billion, 70%, of the
world’s population now live in countries with VAT and VAT raises about $18 trillion in tax

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 revenue, roughly one-quarter of all government revenue. Nowadays, among 190 countries of the
world, over 136 (72%) of them have made VAT part of their tax system; and from 53 members
of countries of Africa Union, 33 (60%) of them have introduced VAT. Those African countries
with their rates and year of introduction are presented in table 2.1.

Table 1: African Countries with VAT

Country Date Standard RateCountry Date Standar
Introduced (%) Introduced d Rate
(%)
Algeria 1992 21 Mauritania 1995 14
Botswan 2002 15 Mauritius 1998 10
a
Burkina Faso 1963 18 Morocco 1986 20
Benin 1991 18 Mozambique 1999 17
Cameroon 1999 18 Namibia 2000 15
Chad 2000 18 Niger 1986 17
Congo Republic 1997 18 Nigeria 1994 5
Cote-Devoire 1960 20 Senegal 1980 20
Ethiopia 2003 15 Rwanda 2001 15
Egypt 1991 10 South Africa 1991 14
Gabon 1995 18 Sudan 2002 10
Ghana 1998 10 Tanzania 1998 20
Guinea 1996 18 Togo 1996 18
Kenya 1990 16 Tunisia 1998 18
Madagas 1994 20 Uganda 1996 17
car
Malawi 1989 20 Zambia 1995 17.5
Mali 1991 15
Source: (Misrak, 2008)

The standard rate for all goods and services will be fixed by law. It will be applied as a percentage of
the selling prices or import value of the item. VAT in Ethiopia has a fixed rate of 15%. For every
taxable transaction by a registered person, every import goods other than an exempt import, and an
import of services, 15% of the value shall be applied as value added Tax. However, a zero-rate is
normally applied to all goods sold outside the country. No rate is applied to goods which are exempted.

2.4. Merits and Demerits of VAT

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 A. Merits of VAT
1. The polarity of VAT with authority is mainly due to its administrative advantage. It is much easier to
assess tax liability of a firm by using credit method. There is greater scope for cross-checking of
return submitted by firm. A general VAT is supposed to be neutral to the resource allocation forms
of production and business organization, in contrast, turnover tax encourage vertical integration of
production so as to avoid the intermediary sales and taxes to acquire a competitive advantage over
other. For example, a bicycle factory which is manufacturing its own steel pipes and rims etc. would
pay smaller turnover from another which has to purchase this material from other firm. A VAT, on
the other hand, is neutral between these processes of integration and therefore helps the economy in
adopting that form of production which is economically more suitable.
2. VAT is also neutral between factors costs because it taxes all value added. As against this, the
existing corporation taxation discourage the use equity capital and punishes profit earning, VAT
does not hinder adoption of technology which may be capital intensive.
3. It is argued that VAT avoids cost-cascading effect. The conventional sales tax lead to compounding
of tax liability, while VAT does not.
4. An implied advantage of VAT is its neutrality with regard to resource allocation.
5. A very important advantage quoted in favor of VAT Is that lesser tax evasion. Firstly, this happens
because the tax is divided into part and therefore the incentive to evade tax by any one firm is
reduced. Secondly, it is in the interest of firm to the account for the tax paid by earlier firms through
which is the inputs have come otherwise this firm pays the tax itself. If any firm therefore
understands its inputs, it will be caught by the disclosure of firms buying input from it. These types
of cross-auditing enable the authority to plug the tax leakages.
6. The use of VAT helps a country in encouraging its exports. In order to get competitive edge over
others, a country may refund the taxes paid the on the exportable goods. It is easier to separate the
tax from cost of production in case of VAT, but not so in case of other taxes which get mixed up
with the cost of production (since they relived at gross value in each case). To other advantage is that
the. General agreement on trade in tariffs also recognized VAT rebate as legitimate practice of
encouraging exports.
7. It is also claimed that VAT is conductive efficiency since a firm is not exempted from its tax liability
even if it runs into loss. It pays a tax not on its profit but on the value produced. It therefore, tries to
improve its performance, and reduced the cost of production.

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8. It is argued that for various reason, some good should enjoy a tax exemption (zero tax rate) while the
remaining one s need not be subjected to a uniform tax rate. In practice, it has been possible to
incorporate these features into VAT. Multiple (including zero) rates are now commonly found in vat
systems. A multiple tax rate variety can also easily accommodate credit systems (that is, dedicate tax
liability of a firm by the amount of taxes paid by other firm on its purchases). All this imports a great
deal of administrative flexibility to VAT so that its exact content can be modified to suit different
policy objective of the authorities.
B. Demerit of VAT
VAT, however, is not just a bundle of advantages. Rather it has serious limitations especially for
underdeveloped countries because what it has not yet become popular. (Hlbhiatia, 1996)

1. VAT is a complicated system and need and honest and efficient government machinery to do the
cross checking and link up various production activities and the resulting tax liability of each firm. It
is, therefore, necessary in its financial and economic structure and the firm should be in the habit of
keeping proper accounts.
2. This system depends a lot upon cooperative the tax payer. Each firm itself calculate it tax liability to
begin with, and also find out the taxes paid by curlier firms. Once, however, the seller realize that the
administrative machinery or the government is ill-equipped to do all the necessary cross-checking,
they will resort to the creation of false purchase invoices showing taxes paid by others. To the extent
this happens becomes a major possibility and a common practice.
3. Unless the rates of VAT are extraordinary high, the state would end up with smaller tax revenue as
against the collection from sales tax.
4. Even if the tax payers are fully honest of, the system of taxation forces them to maintain elaborate
and costly account. This becomes uneconomical, especially for smaller firms.
5. The difficult of maintaining accounts, cross checking and preventing tax evasion increase if the
system contains some exceptions (such as for food item) and differential rate of taxation ( luxurious
are likely to be taxed at higher rate than necessity ). It would be naïve to assume that a modern
government would like to have a tax system which is claimed to be neutral in its own allocate and
distributive effects. The realities of non-competitive market, income and wealth inequalities, and (in
under developed countries) the need for quickening the pace of capital formation cannot be ignored
VAT has to be selective in coverage and with differential rate. And once the authority decides to

5
 adopt he selective pattern, vested interest developed and exert pressure for exemption and
concession. In such circumstances actual decision may not remain fully objective.
Critics of VAT doubt that it includes efficiency. The claim that in a shortages economy like
ours speculative hoarding, non-competitive price rise and similar practice are quite common. In
a seller market, producers and sellers have no incentive to increase their efficiency and reduce
cost since goods will sell irrespective of their in for quality and high price. All told, VAT
requires s a highly efficient administration and competitive market. An underdeveloped country
faces these limitations in greater intensity. The direct taxation inquiry committee (1976) in its
report in 1977 examined feasibility of VAT system. It comes to the conclusion that under our
administrative and other circumstances, we should be cautious in adopting this tax form. It
recommended its adoptions on an experimental basis, in a phased manner, to limited number of
manufacturing industries (Ibid).

3. VAT IMPLEMENTATION PROCESS IN ETHIOPIA

The government of Ethiopia has been introduced and effectively implemented the Value Added
Tax on January 1, 2003 by replacing the sales tax. Before practicing VAT, there are a number of
issues that given prior concern, like capacity building of the tax collection system including
effective computerization and tax officials training, considering the merit and demerits of VAT
with regard to the society living standard and avoiding the business crises raised from the
unsuccessful taxation system attempted.

The six months period between the issue of the VAT laws and its effective introduction was
preparation for effective implementation of VAT administration. According to separate VAT
departments, the four functional divisions has been organized and settled within Federal Inland
Revenue Authority (FIRA) currently named as Ethiopian Revenue and Customs Authority
(ERCA). Intensive taxpayer’s educational campaign, which consisted pre-implementation
seminars, information sessions, publications, media releases and taxpayers advisory services
was conducted. These taxpayers education program had a positive effect on the taxpayers
understanding about the VAT proclamation and the related obligation and entitlements.

As stated repeatedly, VAT is a tax on consumer expenditure. It is collected on business

transactions and imports. A taxable person can be an individual, firm, company, as long as such
a person is required to be registered for VAT.

6
 Most business transactions involve supplies of goods or services. VAT is payable if they are:
 Supplies made in Ethiopia;
 Made by a taxable person;
 Made in the course of furtherance of a business;
 Are not specifically exempted or zero-rated.
The Value Added Tax would be levied at the rate of 15% of the value of:

 Every taxable transaction by a registered person;

 Every import of goods, other than an exempt import; and
 Import of services. (Taxation in Ethiopia, 2005)

The reasons why VAT became most preferable by most developing countries like Africans are:

 To broaden the tax base to cover more taxable points and items for better yield in revenue
 To modernize the tax administration system
 VAT serves as an incentive mechanism to encourage foreign investment and export
trade
 The tax credit method avoids cascading of tax (i.e. tax on tax) on business inputs
 VAT enables to make domestically manufactured goods to be more competitive in the
international market places by removing the tax content from goods for exported
 As the VAT is less evaded, the minimizing of the tax avoidance supports the maintenance of
equity and fairness in the application of tax legislation
VAT is tax system that has replaced sales tax in our country since Jan. 1, 2003. The tax is
collected at all stages in the production and distribution process beginning with importers and
producers of raw materials and ending with the final consumer.

It can simply say, VAT is a tax on consumption collected by an agent from a third party on
behalf of the tax authority. What are consumed in VAT is numerous, and they vary even within
a class of goods or services. Value Added Taxable transactions in some are clear and straight
forward while in some, they are controversial. Furthermore, using men and materials at its
disposal, the tax authority is strictly obliged to account for its stewardship to the government in
accordance with the provision of enabling legislation. This, there for, portrays VAT as a tax
system involving a spectrum of human activities within a broad hierarchy of levels of
responsibilities right from the consumers to the registrant /VAT payers who subsequently render
returns to the tax authority which also, in turn, as a revenue agency, remits what is collected to
the coffers of government. With this analysis, it is not out of place to describe VAT as a system
of multiple agency in which effective administration is inheritable.
7
 As was mentioned repeatedly, VAT is introduced in Ethiopia by proclamation No. 285/2002,
replacing sales tax with the following objectives:
 To collect tax on the added value whenever a sales transaction is conducted since the former
sales tax system (already replaced) did not allow collection of the tax on the added value created
whenever a sales transaction is conducted;
 To minimize the damage that may be caused by attempts to avoid and evade the tax and to
ascertain the profit obtained by the taxpayers;
 To enhance saving and investment as it is a consumption tax and does not tax capital;
 To enhance economic growth and improve the ratio relationship between Gross Domestic
Product and Gross Revenue.
3.1. Objective of VAT in Ethiopia
According to Misrak (2008:320) the following are merits of direct taxes.
♦ To collect tax on the added value whenever a sales transaction is conducted
♦ To minimize the damage that may be caused by attempts to avoid and evade the tax and to
ascertain the profit obtained by the tax payer.
♦ To enhance saving and investment as it is a consumption tax and does not capital.
 To enhance economic growth and improve the ratio relationship between Growth Domestic Product
and Growth Revenue
3.2. Structure of Value Added Tax in Ethiopia
VAT is increasingly being used throughout the world, including many African countries to raise
government revenue with less administrative and economic costs. It is believed to be a good
means to raise government revenue when relatively poor administered. Ebrill and Keen (2001)
also strengthen this idea empirically. They found that in the countries that have adopted VAT,
revenue from this source accounted on average 27% of the total tax revenue or 5% of the GDP.
And about 70% of the world’s population now lived in countries with a VAT. This implies that
VAT is a key source of most government revenues in the world. As per different empirical
evidences, VAT is a major source of revenue in most of African countries. The share of VAT in
total tax revenue it ranges from 17.4% to 42.4% Ebrill and keen (2001). This share is higher in
Ethiopia compared to other African countries. This is so because, Ethiopia’s GDP is lower than
other sub Saharan African countries. The VAT to GDP ratio ranges from 2.7% in Egypt to 6.5%
in Tunisia with an average 4.6% similarly many sub Saharan African countries have also
experienced an increase in revenue from VAT. The revenue performance of VAT as measured
by the ratio of VAT to GDP in Ethiopia which is 5.7% in much higher than then the African
8
 average (4.6%) and stood the fourth among the selected African countries. This implies that
VAT in Ethiopia is showing a good revenue performance but this does not mean VAT is
collected potentially. The ratio of VAT to GNP or disposable income is still insignificant
because the ratio is only between 2 and 3.6% from 1988 to 2001 E.C.

3.3. Effects of VAT on Consumption and Investment

Whenever the VAT has been adopted controversy emanated in relation to its effect or retail
prices. In some countries the introduction of VAT would increase prices and aggravate the
existing inflation since VAT is a consumption tax which is born by the financial consumer i.e. a
tax that could shifted to a consumers, it might at times have an inflationary effect. In Ethiopia,
VAT should not be viewed as a fundamentally new concept; rather it should be seen as a logical
and progressive development of sales tax, which had 15% & 5% rate. On the other hand, except
zero rated exports and limited number of exemptions, VAT is levied a uniform rate of 15% on
all goods and services. Thus on account of this fact it could be argued that VAT may lead to
inflation.

Differently it could also be argued that VAT may lead to an increase in price on those goods but
not much since the newly taxable value is a small percentage of total taxable goods and services
(Schenk, 2002). The experience of many other countries supports this fact. Although in some
cases the introduction of VAT was associated with a rise in consumer price index, it was a once
and for all shift, there was no further and continuous price increase (Gillis 1990).

There are also other researchers who argue that it is only if other actions, such as increase on
many supplies are, taken together that a general price increase could occur. In other words it is
not VAT itself that can be inflationary but other policies makes it so (Tanzi 1992). Tanzi
suggested that care should be taken particularly at the initial stage of introducing of VAT on
curb such undesired result.

Though, it is difficult to evaluate the inflationary effect of VAT only after a year of its
implementation, taking the above argument, VAT in Ethiopia is not accompanied with inflation
problem. However a price increase is being observed in almost all goods and services which can
explained by market imperfection and devaluation of Ethiopia currency and a general price
increase of goods would wide especially the increase in price of petroleum than by the effect of
VAT only.
9
VAT Effects on Investment
VAT is assumed to promote investment and export since full credit is given for the tax paid on
the purchase of capital goods and export are zero credited. As compared to the previous sales
tax which only allows partial refund of the tax paid on purchases of goods and services, the
current VAT system, the domestic investment cost would be reduced by the amount of tax
refunded and thus provide incentive for investment. Moreover, under VAT, exports are zero
rated. As a result of which we have a refund of the VAT paid in earlier stages and thus would
help the Ethiopian business community to become competitive in international trade. This also
leads to increase in export and hence an improvement in current account balances of the
country.

3.4.VAT Registration
The initiation function of VAT administration is to identify and register those who are obliged
to collect VAT. According to ERCA the VAT registration program was commenced in august
2002 with an aggressive campaign and during the first year of VAT operation, the number of
taxpayers registered was 4,137 throughout the country. Though the currently VAT registered
taxpayers are not clearly known, because of the problem related with the system administration,
there is a strong believe that can reach more than 85,000.

3.4.1. Registration procedures

A person applying to register for VAT is required to do so in such a form as is established by
the implementation directives issued by the Ethiopian Revenue and Customs Authority;

When a person carrying out taxable transactions files an application to be registered for VAT,
the authority is required to register the person in the VAT register, and to issue a certificate of
registration within 30 days of the registration; A person registered for VAT is required to use
his taxpayer identification number on all VAT invoices, and on all tax returns and official
communications with the authority.

There is a VAT invoice prepared by the ERCA containing the following information:
 Full name of the registered person and the purchaser, and the registered;
 Person’s trade name, if different from the legal name;
 Taxpayer Identification Number (TIN) of the registered person and the purchaser;
 Number and date of the VAT registration certificate;

10
 Name of the goods shipped or services rendered
 Amount of the taxable transaction;
 Amount of the excise on excisable goods;
 Sum of the VAT due on the given taxable transaction;
 Issue date of the VAT invoice, and
 Serial number of the VAT invoice
The registered person is required to issue the VAT invoice to the purchaser of goods or services
up on the supply or rendering, but not later than 5 days after the transaction. There are two ways
of registration stated in the VAT proclamation no. 285/2002. These are obligatory and voluntary
registrations. (Taxation in Ethiopia, 2005)

3.4.1.1.Obligation Registration and Voluntary Registration

A person who carries on the taxable activities and is not registered is required to file an
application of VAT registration in the authority if at the end of any period of 12 calendar
months the person made, during that period, taxable transactions the total value which exceeded
500,000 birr; Or if at the beginning of any period of 12 calendar months there are reasonable
grounds to expect that total value of taxable transactions to be made by the person during that
period will exceed 500,000 birr. Depending on this sub-articles (sub articles 1(16) in article 16)
the nine trade activities (line) whose annual taxable income is expected to be more than 500,000
birr to be registered for VAT and registering all companies having legal entities for VAT
without any prerequisite at the current condition. There are nine trade activities
 Jewelry trade
 Flour factories
 Electronic trade (like television, refrigerator, deck trade, etc)
 Shoes producers
 Leather and leather producers
 Computer and computer accessories trade
 Contractors from grade 1-9
 Plastic and plastic product manufactures
 All permanent importers
According to countries context, taxpayers attitudes, knowhow and consensuses determines the
number of voluntary taxpayers. This kind of registration is made by a person who carried on
taxable activities and is not required to be registered for VAT, may voluntarily apply to the
authority for such registration, if he/she regularly is supplying or rendering at least 75% of his
goods and services to registered persons. In the voluntary registration input VAT can be
11
 recovered if a person is registered. It will therefore be beneficial to voluntarily register where
the person makes mainly zero-rated supplies. In such a case, input VAT will be recovered, and
no VAT will be charged on zero-rated outputs.

3.5. Cancellation of VAT Registration

A person who has registered for VAT may cancel his or her registration by arrangement with
ERCA, department of VAT. The reason for deregistration include:

 If the business closes trading permanently;

 If the business is sold;
 When the value of taxable supplies falls consistently below the VAT registration threshold;
 If he or she has been registered in error, or she has ceased to be a taxable person
When registration for VAT is cancelled, the authority is required to remove the person’s name
and all other details form the VAT register and the person is required to return back the issued
certificate of registration. VAT registered person cannot charge VAT or issue tax invoices for
any supplies made and cannot claim a refund of VAT incurred on any goods and services
purchased from the date of the registration is cancelled.

3.6. Record keeping requirement

A registered person or any other person liable for VAT under the proclamation shall maintain
for 10 years in Ethiopia:

 Original tax invoices received by the person;

 Copy of all tax invoices issued by the person;
 Customs documentation relating to imports and exports;
 Accounting records; and
 Any other records as may be prescribed by the ERCA by directives.

3.7. Administrative penalties

The following penalties are imposed for violations of the VAT proclamation:
 Where any person engages in taxable transactions without VAT registration where VAT
registration is required-100% of the amount of tax payable for the entire period of operation
without VAT registration;
 Where any person issued incorrect tax invoice resulting in a decrease in the amount of tax or
increase in accredit or in the event of the failure to issue a tax invoice-100% of the amount of
tax for the invoice or the transaction;
12
  Where a person who is not registered for VAT issues a tax invoice-a penalty of 100% of the tax
which is indicated in the tax invoice and is due for transfer to the budget but has not been
transferred; and
 Where a person fails to maintain records required-2,000 Birr for each month or portion thereof
that the failure continues.
A person who fails to file a timely return is liable for a penalty equal to 5% of the amount of tax
underpayment for each month (or portion thereof) during which the failure continues, up to 25%
of such amount. The penalty is limited to 50,000 Birr for the first month (of portion thereof) in
which no return is failed. If any amount of tax is not paid by the due date, the person liable is
obliged to pay interest on such amount for the period from the due date to the date the tax is
paid. The interest is set at 25% over and above the highest commercial lending interest rate that
prevailed during the preceding quarter. (Taxation in Ethiopia, 2005)

3.8. VAT Refund

For any VAT refund period (month) if the allowable input tax is greater than the output tax the
amount of the excess is normally repayable to the taxable person by the authority as a tax
refund. If at least 25% of the value a registered person’s taxable transactions for a month are
taxed at a zero rate, the authority will refund the excess amount of VAT within a period of two
months after the registered person files on application for refund.

In the case other registered persons, the excess amount of VAT is to be carried forward to the
next five months and credited against payments for these months, and any unused excess
remaining after the end of this five month period will be refunded by the authority within a
period of two months after the registered person filed an application for refund.

If the authority does not pay the refund by the specified date, the authority will pay interest at
25% over and above the highest commercial lending interest rate prevailed during the preceding
quarter.

3.9. Exemption or Zero-rating

As the name indicates, exemption means no VAT is charged on the supply and no credit can be
taken for VAT paid on purchases used to make the supply while zero-rating means the supply is
charged with a VAT at zero (0) percent but credit can be taken for VAT paid on purchases used
to make the supply. Exemption of an entire firm on all its sales is allowed usually because the
13
 firm is below a certain size and in order to facilitate administration or compliance. The aim of
zero-rating, on the other hand, is to lift the entire VAT, including that already collected at earlier
stages, from a particular service or good. This is accomplished by allowing full credit for the tax
shown on the invoices for purchases if the good in question or of inputs into it. It is argued that
exemption should be granted where the lawmaker would rather not free the firm, but feel
compelled to do so owing to administrative and compliance difficulties while zero-rating is to
be given when the purpose is to lift the VAT completely from a good or service, for social and
economic ends (Gills et al, 1990). Zero-rating is often said to be unsuitable for developing
countries just because it may require tax refunds. This is quite a weak argument since tax
refunds are important in establishing fairness for tax authorities in these countries. One line of
argument against exemption is that it complicates administration, erode the tax base and distort
input-choice decisions and hence they have to be kept to minimum.

According to prominent of this argument where exemptions have been almost entirely
eliminated (as in Chile), the VAT has been much easier to administer and there for quite
successful. Exemptions, according to these proponents, require additional record keeping
segregating taxable from exempt sales, and in practice the destination between what is exempt
and what is taxed is often questionable or subjective. Some items are exempted to improve the
distributional impact of the tax-a potentially reasonable tradeoff while others might be
exempted for administrative or political reasons. This is exactly why developing countries
exempt particular commodities as they are influenced more by distributional objectives than
administrative concerns.

Administrative issues are more important under zero-rating. Since zero-rating increases the
number of VAT refunds, most developing countries astutely have limited it to exports. In
addition, tax administrations in such countries are poorly equipped to handle refunds of any
kind, and adding to the number of refunds would divert administrative resources from
enforcement of the VAT. (Gills et al, 1990)

The following types of supplies as well as imports of goods (other than by way of export) or
rendering of services are exempt from payment of VAT:

 Sale, transfer or the lease of a used dwelling;

 Rendering of financial services;
 Supply/import of national/foreign currencies and of securities;
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 Import of gold to be transferred to the national bank;
 Rendering of religious organizations or church services;
 Import or supply of prescription drugs specified in directives issued by minister of health,
rendering of medical services;
 Educational services provided by educational institutions, or child care services for children at
pre-school institutions;
 Supply of goods or rendering of services in the form of humanitarian aid, as well as import of
goods transferred to state agencies of Ethiopia and public organizations for the purpose of
rehabilitation after natural disasters, industrial accidents, and catastrophes;
 Supply of electricity, kerosene, and water;
 Goods imported by the government, organizations, institutions or projects exempted from duties
and other import taxes to the extent provided by law or by agreement;
 Supplies by the post office authorized under the Ethiopian Postal Service
Proclamation, other than services rendered for a fee or commission;
 Provision of transport; permits and license fees;
 Supply of goods or services by a workshop employing disabled individuals if more than 60% of
staff are disabled;
 Import or supply of books and other printed materials. (Taxation in Ethiopia, 2005)

3.10. VAT Administration

The Ethiopian constitution provides the central and regional governments with the power of
taxation, and the bases up on which revenue is shared between the government is established by
proclamation No. 33/1992. The ERCA administers VAT nationally as per the joint decision
made by the house of representative and council of federation.

Although VAT is administered centrally by ERCA, the revenue is shared between central and
regional governments based up on the established revenue sharing.

ERCA established a separate VAT department in Addis Ababa, and organized with appropriate
material and human resources. Beside it has expanded its branch office network by opening new
office in all regional states of the country. VAT departments core personnel were trained on
VAT legislation in order to undertake the taxpayer’s education and subsequent tax
administration functions. Some of the ERCA tax administration activities are identifying and
register the taxpayers, controlling collection, processing returns, securing delinquent
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 declarations and collection of tax arrears, making refunds, auditing taxpayers account, make
different investigation to minimize and avoid tax fraud and evasion, and following up of tax
office have to be revitalization measure taken in order for VAT to live up to the expectation as
an efficient and fair source of country revenue.

The following were administration measure taken by ERCA before exercising the VAT
proclamation and regulations effectively:

 Identification of taxpayers to be registered for VAT and distribution of booklet was made and
orientations about VAT were given to taxpayers for the purpose of introduction of rules and
regulations.
 VAT department was established separately to make effective and efficient VAT administration
system. Four divisions were formed with in this new department and job descriptions
/procedures/ was prepared. However, currently it is centralized but when problems and
ambiguities are occurred, it will be administrated and solved by VAT department.
 Journey to different countries were done by some selected staff to share the idea and experience
of different countries that used and currently using VAT system. The VAT department
established within ERCA has been organized in line with core VAT administration function,
namely:
1. taxpayers registration and education division
2. revenue collection and enforcement division
3. revenue accounts and consideration division
4. assessment and audit division
3.11. Standard Integrated Government Tax Administration System (SIGTAS)

The Standard Integrated Government Tax Administration System (SIGTAS) is an integrated

information system that enables governments to automate the administration of taxes and
licenses. This software is designed to meet the needs of developing countries who wish to
increase their control over state revenue by equipping themselves with computerized systems.
Since 1996, SIGTAS has been implemented in 20 countries located in Africa, the Caribbean,
the Middle East, Eastern Europe and Asia.

SIGTAS was designed to adapt to the changes affecting the country’s tax policy. Accordingly,
declaration forms, penalty rates and interest can be modified without programming. Thanks to
its integrated nature, SIGTAS is able to manage every facet of the tax management process
including:

 Taxpayer registration;
 Handling of tax declaration forms;
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  Assessments (including payments and withholdings);
 Collections case management and objection case management;
 Cashing, penalties and calculation of interest and penalties;
 Audit (case tracking and follow-up).
The software also provides for documentation management, objections (appeals) and payment
agreements handling. In addition, SIGTAS offers the possibility of developing interfaces to
share data with external systems such as customs, government financial software or other
government divisions. SIGTAS can operate in three languages simultaneously, which makes it
possible for tax agents to perform operations in the language of their choice and facilitate
correspondence with taxpayers.

Tax Types supported by SIGTAS are: Income Tax, VAT, sales taxes and other indirect taxes,
Licenses and permits (alcohol, professional, etc.), Pay as You Earn (P.A.Y.E.), Excise Tax,
Driving Licenses and Motor Vehicle Registration, Licenses, General Income, Property Taxes,
Withholding Taxes and others.

However the Federal Inland Revenue Authority (FIRA), now existing as Ethiopian Revenue and
Customs Authority (ERCA), announces from 24 February 2004 the development of new
software enabling to carryout duty of the collection of Value Added Tax through computer
systems named, Standard Integrated Government Tax Administration System (SIGTAS).
SIGTAS is an integrated package with all modules necessary to manage all taxes and licenses.

The Benefits of SIGTAS

For governments, it improves the efficiency of the tax collection, simplifying administration of
tax law and providing better control over compliance, is fully integrated so that government can
easily compare the taxes assessed and taxes collected, provides a detailed tax roll along with
each taxpayer’s assessments and payments, provides many management and statistical reports
to keep the government fully informed on the state of tax administration. For tax authority
complete system to manage all aspects of system administration including the taking of late-
files and late-payers, exemption period automatically provides an overall view of all taxpayer
liabilities and payments, eliminates manual calculation of penalties and interest, help ensure that
data collected is valid, provides an easy to use and allows assessment calculation from previous
year as well as the current years.

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 3.12. VAT Implementation Problems in Ethiopia
After the introduction of VAT, VAT revenue collection has shown growing trends as compared
with the replaced sales tax. The impact of VAT on government tax revenue is also shown in the
structure of tax. The contribution of VAT on domestic goods and services as well as foreign
trade shows a substantial increase though the domestic source is by far lower than that of
foreign trade. This might be associated with administrative difficulty to collect the tax from the
domestic economy and the existence of illegal practices on VAT. VAT collection from
imported goods is easy since it is collected at entry point.

In principle, VAT is collected from consumption of goods and services. So, the maximum
potential that can be collected from consumption expenditure is VAT rate multiplied by
consumption expenditure of a particular year.

Problems that are observed during the implementation of VAT related with external and internal
factors. The external problem associated with the illegal practices of the taxpayers. Even though
intensive education program has been undergoing by the tax administration, the following
illegal practices are observed:

 some VAT registered business enterprises have collected the tax with illegal invoice and
retain the tax for themselves,
 some eligible business entities have not yet registered for VAT,
 some VAT registered business enterprises offers customers an opinion to pay or not to pay
VAT,
 Some did not declare the tax they collected as per the law, and etc.
The weakness of tax administration highly attributed to the above illegal practices. The tax
administration is weak in the area of auditing, follow-up and enforcement though the VAT
department of ERCA has computerized its tax system. (Demirew, Getachew, 2004)
Wondimu Sebhat Tebebu and Mulatie Chanie Yitbarek, 2020 on their study Implementation
of Value Added Tax and It’s Challenges, they showed that the revenue office had offered limited
awareness creation and educational programs about the role of VAT, unwillingness of the taxpayers
for discussion, workshops, unwillingness of the taxpayer for category transformation though their
annual turnover has shown progress (could be transformed from turnover to VAT), refusal of the
eligible taxpayer to use cash registered machine properly and the tax office is inadequately assisting

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and following the application of this machine. Poor culture of customer’s towards taking sales voucher
and receipt for the goods or service acquired.

4,. CONCLUSION AND RECOMMENDATIONS

4.1. Conclusion

These days the best instrument which government can use as a source of revenue is taxation. It
is obvious that an economic development of a country can be certain by an effective and
efficient administration and collection of taxes. A good tax system should have one or a
combination of desirable characteristics as economic efficiency, administrative simplicity,
flexibility, political accountability and fairness for the purpose of good tax system. This is so
because, when the implementation and administration of tax system is effective, the
government’s revenue that helps to fulfill the socioeconomic needs of the society will be
amplified. It is possible to say that the major function of taxation is to marshal the necessary
funds to finance the increasingly expanding level of public expenditures.

VAT is an indirect tax levied on domestic consumption of goods and services as well as on
imported goods. It can be considered as the most important tax innovation of the second half of
the twentieth century. VAT is primarily collected by business firms or individuals at all stages
of production and distribution beginning with importers and producers of raw materials and
ending with retailers. In line with this perception, VAT is implemented in many developed as
well as developing countries.

Following the an increasing number of developing countries that have converted their sales tax
to VAT, the government of Ethiopia has introduced VAT on January 1, 2003 replacing the sales
tax aiming to raise more revenue, modernize its tax administration and encourage investment
and trades. The replaced sales tax was collected only at the point of sales; as the result it is
exposed for double taxation and had severe tax evasion problem. VAT on the other hand is
applied on the value added at each stage of production and distribution. This means that the
producer will be refunded for VAT paid on all the purchase of inputs. As per the VAT
proclamation, VAT will be levied on most consumption goods and services with the exception
of exports and exempted goods and services charging a uniform rate of 15% of sales. The

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taxpayers required to be registered for VAT has both obligatory and voluntary behaviors. Under
the obligatory registration a person who carries on taxable activity and is not registered is
required to file an application for registration if his annual return exceeds or equals to the
threshold level (Birr 500,000). The voluntary VAT registered business enterprises are eligible to
claim input tax while nonregistered are not given this opportunity. For those business
enterprises whose annual turnover of taxable goods is less than the VAT registration threshold,
are required to pay a turnover tax at a rate of 2% for goods and 10% for service.

As it was discussed repeatedly, VAT is a broad tax and this nature of the tax enables to raise
more government revenue. The rate of VAT is uniform and the scope of exemption under this
tax is limited and it is applied at each stage of production and distribution i.e. whenever
additional value is added the tax is applied. After the implementation of VAT in Ethiopia VAT
collection has shown an increasing trend in the government revenue as compared to the replaced
sales tax. This is because of the fact that VAT has the advantage of reducing the cost of
production of industries through its inherent refund system and the fact that it does not burden
exports; and it offers total transparency of the incidence of tax as VAT is multistage sales tax
levied as proportion of the value added. A very important thing that quotes in need of VAT is
less tax evasion. VAT in Ethiopia could be helpful in simplifying and modernizing the tax
administration with its invoice based characteristics and its requirements for the registrants to
hold a systematic book of accounting. Economically, VAT does encourage investment by
providing a refund for a tax paid on inputs and encourage export by zero rating items exported.
With the very concept of VAT, output tax is charged at each stage of production and
distribution to ensure that only final consumption is exposed to be taxed.

In Ethiopia, the implementation of VAT which is a new and sophisticated tax that differs
significantly from the classical tax schemes with which the people were familiar with the
formerly existed taxes is not an easy task. Hence, various misconceptions regarding its impact,
its application, and its benefit to the national economy and its advantage to simplify the tax
administration system were normal in the initial phase of its application. These
misunderstandings pave the way for the researcher to think about the gap of the implementation
of Value Added Tax and the problems it is encountering.

The external problem associated with the illegal practices of the taxpayers. Even though
intensive education program has been undergoing by the tax administration, the following
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 illegal practices are observed: some VAT registered business enterprises have collected the tax
with illegal invoice, some eligible business entities have not yet registered for VAT, some VAT
registered business enterprises offers customers an opinion to pay or not to pay VAT, Some did
not declare the tax they collected as per the law, and etc.

To tackle the obstacles for the implementations of VAT in the country, the public at large and the
government have to reach an agreement to work together to increase the taxpaying habits of the
society. Since the ultimate goal of tax specifically VAT is to collect sufficient amounts of money
that significantly be able to help the government to finance social and economic development and
reduce poverty by introducing a new tax culture which actually demands an alliance with all
taxpayers and organizational strength and efficiency from the side of the tax administrations. ERCA
has also take actions to manage the adverse situations, such as education campaign, strengthen tax
administration functions, forced registration for enterprises that its annual business transaction is
over or equal to the threshold level, and increases the controlling system for those taxpayers who are
strongly violate VAT laws and regulations as well as strengthen its follow-ups and upgrading the
performance of its employees.

4.2. Recommendations
The major recommendations that come out from the survey result goes towards both the authority
and the business community. The recommendations to the authority are:

 VAT is increasingly being used throughout the world to raise government revenue with less
administrative and economic costs than other broad based taxes. Like it has been observed in
many developing countries, VAT implementation in Ethiopia has been facing different
problems at the initial stage. Since a poorly administered VAT raises less revenue that can
change the very nature of the tax resulting in unintended economic distortions, the Ethiopian
Revenue and Customs Authority (ERCA) has to build its administration capacity on both
human and material resources to carry out its duties and responsibilities effectively and
efficiently. This can be maintained through hiring of more qualified employees, provision of
consistent training and development for staffs who will join and who have joined and using
advanced information and communications technology so as to improve its administration
capacity and control those noncompliance VAT payers.

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 There is a strong believe that well-informed taxpayer society can be considered as an important
asset for the tax authority. Therefore, the authority should conduct a consistent awareness
creation programs to update the business community and the society at large about the concepts,
rules and regulations, advantages and uses of the Value Added Tax. This can be carried out by
intensively educating the public using mass-medias like television, radio, news papers, creating
accessible websites, distribution of broachers, preparations of different seminars and workshops
on a regular basis to increase awareness.

 Even though the primary objectives of VAT implementation in Ethiopia is to raise government
revenue, to encourage investment by providing a refund for a tax paid on inputs and encourage
export by zero rating export items, VAT has not been implemented effectively and meet its
objectives as desired as possible. This is because of the existence of taxpayers that are not
compliance with the current VAT laws and inefficient tax administration to control those
noncompliance taxpayers. Therefore to tackle these constraints and achieve the desired
objectives ERCA should strengthen its tax administration by delegating responsibilities to
regional/city administration revenue collection organs to administer taxpayers with their
jurisdiction and also the taxpayers should comply with current VAT rules and regulations.
 A threshold for VAT registration has been put in place for administrative purpose. The current
threshold level (500,000 birr) is high and hence allows most business communities whose return
is below the threshold but actively participating in the market competition to stay unregistered.
Therefore the current threshold level should be adjusted into more rational level by considering
the increasing number of entities engaging in different businesses and should be minimized to
incorporate at least those business enterprises that are actively participating in the market
competition and balance the revenue generated from the tax. This can be carried out by hiring
more qualified and professional employees and reducing the threshold to the lower level.
 In general the implementation of Value Added Tax in Ethiopia has faced various problems such
as tax evasion and fraud, false invoices prepared by enterprises, increased number of enterprises
that collect VAT for their selves, selling products by offering invoices of VAT inclusive and
VAT exclusive, resistance from the business community against registration for VAT,
preparations of understated financial statements and making a business transaction reports under
threshold level after it has launched. However, to sustain the VAT system as a good means to
raise government revenue, the Ethiopian Revenue and Customs Authority should take actions

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 such as: train the taxpayers about the rules and regulations of VAT continuously, recruiting new
employees and give continuous training for the existing once, delegate the tax authority to
regional and city administration and it should also increase its follow-up and investigation to
control noncompliance enterprises, as well as effectively and efficiently performing the tasks of
identification of VAT taxpayers, processing of returns, controlling collections, making refunds,
auditing taxpayers, and levying penalties to tackle the problems it has encountered.
Reference

1. Bekure Herouy, 2004, “the VAT Regime under Ethiopian Law with emphasis on tax
exemption,” the Ethiopian and international experience on tax exemption, pp. 6-9
2. Demirew Getachew, 2004, “tax reform program in Ethiopia and progress to date”
3. Gillis, “Value Added Taxation In Developing Countries”, edited by Malkolm Gillis, Carl S.
Shoup, and Gerardo P. Sicat, a World Bank Symposium, Washington, D.C.
4. Liam Ebrill, Mickael Keen, Jean-Paul Bodin and Victoria Summers, 2001, “the modern VAT,”
IMF, Washington, D.C.
5. Misrak Tesfay, 2008, “Ethiopian Tax Accounting Theory and Practice,” 1st edition
6. Schenk, Alan, and Howell H. Zee, 2001, “Treating Financial Service Under Value Added Tax:
Conceptual Issues and Country Practices,” Tax Notes International
7. Tanzi, Vito and Howell Zee, 2001, “Tax Policy for Developing Countries,” IMF, Washington,
D.C.
8. Wondimu Sebhat Tebebu and Mulatie Chanie Yitbarek, 2020 on their study Implementation of
Value Added Tax and It’s Challenges

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