Ethiopia’s Income Tax Overhaul: Key Changes under Proclamation No. 1395/2025

Ethiopia’s Income Tax Overhaul: Key Changes under Proclamation No. 1395/2025

Ethiopia’s tax landscape is set for a significant transformation with the amendments to the Federal Income Tax Proclamation No. 979/2016, the amendment is numbered Proclamation 1395/2025. The Amendment outlines sweeping changes, introducing new tax regimes for the digital economy, redefining taxpayer classifications, adjusting tax rates, and bolstering anti-avoidance and compliance measures. This piece overview delves into the key updates.

Key Strategic Shifts and New Tax Regimes

The draft amendment introduces several fundamental changes to the Ethiopian tax system, targeting areas previously not explicitly covered or seeking to modernize existing structures:

1. Redefined Taxpayer Categories and Professional Classification

The classification of taxpayers undergoes a significant overhaul. The original Proclamation 979/2016 categorized taxpayers into ‘A’, ‘B’, and ‘C’ based on annual gross income, with ‘C’ being for those earning less than Birr 500,000. The amendment removes Category ‘C’ from the primary taxpayer classification.

Category ‘A’ Taxpayers: Now include any body, or any other person with an annual gross income of Birr 2,000,000 or more (increased from Birr 1,000,000).

Category ‘B’ Taxpayers: Now encompass persons, other than bodies, whose annual turnover is less than Birr 2,000,000.

Automatic Category ‘A’ for Professionals: Taxpayers engaged in specific professional services, such as accounting, auditing, economic, financial, legal, engineering, architectural, surveying, information technology, and social affairs, will now be classified as Category ‘A’ taxpayers irrespective of their annual turnover. This aims to bring these professions under stricter tax compliance and reporting standards. The Minister also retains the power to change these income thresholds within five years based on economic analysis.

2. The Rise of Digital Service and Content Creation Taxation

A major focus of the amendment is the introduction of specific provisions for the growing digital economy.

Taxation of Income from Digital Services: A new Article 53 explicitly introduces taxation for income from digital services. These services include, but are not limited to, the distribution or selling of digital media, platforms, voice services, marketing and advertising, and sales of digital or physical goods. Income from digital services derived by non-residents through entities in tax havens or if the underlying ownership of a tax haven resident is by an Ethiopian resident, will not be exempt from Ethiopian tax. This targets tax avoidance through offshore structures.

Income from Digital Content Creation: A completely new Article 22 is introduced dedicated to “Income from Digital Content Creation”. This income is classified as a business activity if it is carried out regularly for profit, if the creator operates professionally, and if records are maintained. If these conditions are not met, it will be classified as “other income”. Online platforms facilitating payments for residents in Ethiopia, especially those with annual gross income exceeding a determined amount, will be required to report this income to the Tax Authority. Digital content creators are also required to file annual tax declarations and obtain a Taxpayer Identification Number (TIN).

3. Introduction of Minimum Alternative Tax (MAT)

A significant new concept, the Minimum Alternative Tax (MAT), is introduced as a new Article 23. This ensures a baseline tax contribution from businesses regardless of reported profitability.

Applicability: The MAT applies to any body or person when their total business income for a tax year results in a loss or when their calculated tax liability is less than the MAT amount.

Rates: The MAT is set at 2.5% of the annual turnover of a body or person. Specific rates also apply to certain financial institutions: 2.5% of net banking income, 2.5% of gross premium income of insurance companies, and 2.5% of commission income.

Exemptions and Credits: Entities undergoing liquidation, bodies under debt restructuring, and taxpayers benefiting from tax incentives are exempted from MAT. Any MAT paid can be utilized as a tax credit against future tax liabilities for up to five years. The MAT specifically does not apply to Category ‘C’ taxpayers (as per the original proclamation’s Article 49), indicating its focus on larger entities. The effective date for MAT is July 1, 2025.

4. Abolition of Turnover Tax

A major policy shift is the explicit repeal of the Turnover Tax Proclamation No. 308/2002. This signifies a move away from a separate turnover tax regime, likely integrating its concepts into the redefined Category ‘B’ taxation based on gross sales.

Updated Rates and Burdens

The amendments introduce revisions to various income tax rates, impacting different income streams and taxpayer segments:

1. Adjustments to Employment Income Tax Rates: the tax brackets for employment income have been adjusted, generally reducing the tax burden for lower and middle-income earners by increasing the thresholds for each tax bracket. While the top rate remains at 35%, it now applies to monthly incomes over Birr 14,000 (previously over Birr 10,900). For example, the 0% tax bracket now extends to Birr 2,000 (previously Birr 600).

2. Changes in Rental Income Tax Rates: for individuals, the rental income tax rates have been revised. The new structure features broader income bands and a reduction in the highest tax rate from 35% to 30% for annual taxable rental income over Birr 168,000. The lower brackets have also been shifted upwards, providing tax relief for various rental income levels.
3. Revisions to Individual Business Income Tax Rates: similar to rental income, the business income tax rates for individuals have also been adjusted with higher thresholds for each bracket and a reduction in the top rate from 35% to 30% for annual taxable business income over Birr 168,000.

4. Increased Dividend and Repatriated Profit Taxes: Dividends: the tax rate on dividends derived by residents and non-residents (attributable to a permanent establishment in Ethiopia) has been increased from 10% to 15%. Repatriated Profit: The tax rate on repatriated profit for non-resident bodies operating through a permanent establishment in Ethiopia has also been increased from 10% to 15%.
5. Streamlined Interest Income Taxation The interest income tax rates for both residents and non-residents (attributable to a permanent establishment) have been streamlined. The previous distinction of a 5% rate for savings deposits with financial institutions and 10% for other interest is removed. Now, a single 10% rate applies to all interest income. This effectively increases the tax on savings deposits from 5% to 10%.

Enhanced Compliance and Anti-Avoidance Measures

The amendment introduces several measures aimed at improving tax compliance, enhancing transparency, and combating tax avoidance:

1. Mandatory Non-Cash Transactions (Lowered Threshold): to promote cashless transactions and improve traceability, a new Article 81 mandates that taxpayers cannot receive cash payments exceeding Birr 50,000 for any single transaction, or in aggregate from a single person, or for transactions carried out by a single person in a day. Such payments must now be made via bank draft, bank-to-bank transfer, or other electronic payment methods authorized by the National Bank of Ethiopia. The original proclamation did not have such specific provisions. Exceptions apply to public bodies, public enterprises, and microfinance institutions.

2. Refined Withholding Tax on Domestic Payments: the general withholding tax rate for domestic payments (for the supply of goods exceeding Birr 10,000 or services exceeding Birr 3,000) has been increased from 2% to 3%. The penalty for suppliers who fail to provide their TIN to the withholding agent remains a 30% withholding rate on the gross amount of the payment, which is considered a final tax.
3. New Administrative Penalties: a new Article 88 (renumbered from its original content) introduces specific administrative penalties for non-compliance. Category ‘A’ taxpayers are required to pay the remaining balance of their tax liability quarterly based on their declaration. Category ‘B’ taxpayers are mandated to pay 25% of their annual income tax, less any quarterly payments. Specific payment schedules are also outlined for new Category ‘A’ and ‘B’ taxpayers.

Refined Exemptions and Incentives

The amendment also adjusts existing exemptions and clarifies the framework for tax incentives:

1. New Exemptions for Insurance Premiums and Intra-Group Dividends New categories have been added to exempt income under Article 65(1). Premiums collected by the “Ethiopian Reinsurance Company” and existing insurance companies are now explicitly exempt. Dividends paid by any company in Ethiopia that directly or indirectly holds at least 12.5% of the controlling share in the first-mentioned company, are also exempt. This introduces a new intra-group dividend exemption to prevent cascading taxation within corporate structures.
2. Consolidation of Tax Incentive Framework: a new Article 105 is introduced to clarify the application of income tax incentives. It states that incentives are primarily granted under the “Investment Proclamation” and “Council of Ministers Investment Incentives Regulations”. Furthermore, a cooperative registered under the Cooperatives Proclamation is explicitly exempt from income tax.

Structural and Procedural Overhauls

The draft amendment also includes significant structural and procedural changes within the proclamation itself:

1. Replaced and Renumbered Articles: Several existing articles in the original proclamation have been completely replaced with new content or renumbered, leading to a significant reorganization of the law.
2. Revised Record-Keeping for Category ‘B’ With the redefinition of Category ‘B’ taxpayers and their taxation based on gross sales, the record-keeping requirements for them have been updated. Article 82(3) now specifies that Category ‘B’ taxpayers shall be assessed based on annual gross sales.
3. Updated Tax Declaration Requirements for Employees: employees with more than one source of employment income (generalizing from “multiple employers for a calendar month”) are now required to file a tax declaration.

Conclusion

These proposed amendments represent a comprehensive effort to modernize Ethiopia’s income tax system. By redefining taxpayer categories, particularly for professionals, introducing new frameworks for digital services and content creation, implementing a Minimum Alternative Tax, and abolishing the Turnover Tax, the government appears to be broadening the tax base, enhancing compliance, and adapting to the evolving economic landscape. The adjustments to tax rates, both increases (dividends, repatriated profit, interest) and decreases (employment income, individual rental/business income, non-resident entertainers), indicate a strategic reallocation of tax burdens. Furthermore, stringent anti-avoidance measures, such as the lower cash transaction limit and rules for tax havens, underscore a commitment to improving tax transparency and enforcement.

Yared Siyum