Introduction

An exit tax is levied when an individual renounces their citizenship or ends their residence in a given country. The principal threat, as perceived by the relevant tax authority, is that the tax base will be eroded or will disappear altogether once the taxpayer is no longer subject to domestic law. An exit tax is imposed to give the tax authority one last opportunity to collect tax revenue from the individual who wants to leave the jurisdiction without facing the realisation of an immediate tax gain or loss. The approach focuses on capital, including human capital, that has increased in value while subject to domestic tax. Beyond standard capital gains, smaller groups of taxpayers may be subject to final tax liabilities concerning deferred compensation plans or accumulated tax benefits, concerning a non-taxable corporation or property transfers.

Governments try to deal with problems that may arise in this context, including scenarios where people have physically moved outside the taxable reach of the granting state but continue to enjoy some of the benefits of membership in the state, including welfare benefits, such as those that are political, economic or personal security related, and consular representation and diplomacy. The notion of an exit tax in Ethiopia is approached from the point of the disposal of assets during liquidation, when the relevant entity in its entirety ceases its operations in Ethiopia, or the transfer of shares/sale of shares occurs, in the case of one party’s exit from the country, instead of an end to the whole operations. Ethiopian tax laws enforce the taxation of capital gains, which are either gains attributable to a permanent establishment in Ethiopia or assets attached thereto. If the conditions to this effect are satisfied, or in the case of a collective loss in regard to company distributions, tax treatment is governed by Ethiopia. The relevant rules govern only the tax treatment and not, in any way, the actual existence of a permanent establishment in the country.

The taxing jurisdiction

Ethiopia applies a combination of residential taxation and the source principle of taxation to create a nexus between its income tax powers and the applicable taxable persons, transactions and objects. According to the Federal Income Tax Proclamation (979/2016), the tax authority has the power to levy income tax on resident taxpayers with respect to their worldwide income and non-residents with respect to their Ethiopian-source income.^[1]

Residency is presumed if the taxpayer has a domicile in Ethiopia, is a citizen of Ethiopia or they are present in the country for 183 days within one year. On the other hand, concerning corporate bodies (artificial taxpayers), there are two alternative tests to assess their residence status, namely an assessment as to whether the company is incorporated or established in Ethiopia (incorporation test) or whether the organisation is deemed to be incorporated in Ethiopia when the company was formed according to the commercial laws in the country. For other forms of corporate bodies, incorporation is achieved as per the applicable laws, for instance, a cooperative society^[2] or instances where Ethiopia is its effective seat of management. In this regard, there is a test to identify a company’s effective seat of management, according to whether a body’s key decision-makers convene in that jurisdiction. The board of directors and shareholders, for instance, are the main decision-makers in businesses. Should such meetings take place in Ethiopia, the business will be considered an Ethiopian resident. However, the way a corporate body conducts its daily business, including decisions made by lower level management in Ethiopia, does not mean that Ethiopia is its state of residence.^[3]

A variety of alternative tests are offered by the Income Tax Proclamation (2016) to ascertain whether a non-resident taxpayer’s income originates from Ethiopia. For instance, the following circumstances render income as Ethiopian-source income, regardless of the location in which the income is paid to the non-resident:^[4]

• income-generating activities that are carried out in Ethiopia, including work, business, sports and lottery wins;
• the sale or lease of property, including buildings, situated in Ethiopia; and
• situations where a non-resident group makes money from its long-term presence in Ethiopia.

Taxable activities

In accordance with Article 6 of the Income Tax Proclamation, taxable income includes but is not limited to:^[5]

• employment income derived by an employee is considered Ethiopian-source income to the extent that it is derived from work performed in Ethiopia, regardless of the location in which it is paid, and if it is provided to an employee by the Federal Democratic Republic of Ethiopia, regardless of the location of the employment;
• business income derived by a resident of Ethiopia is Ethiopian-source income except to the extent that is attributable to a business conducted by the resident through a permanent establishment outside Ethiopia;
• business income derived by a non-resident is Ethiopian-source income to the extent that it is attributable to a business conducted by the non-resident through a permanent establishment in Ethiopia. In addition, the non-resident’s sale of goods or merchandise in Ethiopia that are the same as or comparable to that which are sold by the non-resident through a permanent establishment in Ethiopia would also be deemed Ethiopian-source income, as well as any other business operations the non-resident engages in in Ethiopia that are the same as or comparable to those carried out by the non-resident through a permanent establishment in Ethiopia;
• other types of income that are considered to be subject to tax in Ethiopia are the following:
  – a dividend paid to a person by a resident body, rental income from the lease of immovable assets located in Ethiopia and movable assets located in Ethiopia;
  – a gain arising from the disposal of immovable assets located in Ethiopia and a membership interest in a body, if more than 50 per cent of the value of the interest is derived directly or indirectly through one or more interposed bodies from immovable assets located in Ethiopia;
  – shares in or bonds issued by a resident company;
• an insurance premium relating to insurance if the relevant risk relates to Ethiopia;
• income from a performance or sporting event taking place in Ethiopia;
• winnings from a game of chance held in Ethiopia;
• interest, royalties, management fees, technical fees or other income subject to tax under the Income Tax Proclamation as follows:
  – funds paid to a person by a resident of Ethiopia, other than in the form of an expenditure of a business conducted by the resident through a permanent establishment outside Ethiopia;
  – funds paid to a person by a non-resident in the form of an expenditure of a business conducted by the non-resident through a permanent establishment in Ethiopia;
• foreign income is any income that is not Ethiopian-source income.

Exit tax overview

The introduction of exit tax provisions in various countries has sparked debates and criticisms regarding their proportionality and impact on taxpayers. When the operation of a company ceases for various reasons and that company relocates to the residential state of its parent company or another jurisdiction, the realised gain upon disposal of certain assets or tax on the relocation of the company’s unrealised gain will be applicable as such a change of residence has an effect on the tax status of the individual in the original state of residence, as well as in the new country of residence.

As a principle, Ethiopian tax law does not say much about the applicable exit taxes. Nevertheless, upon a closer look at the different provisions in the Income Tax Proclamation and its ‘taxable activities’ as detailed above, the exit of a company or an individual is a taxable event. In addition, the Ethiopian tax authority requires an entity, upon exit, to report to the authority in terms of its previous audit reports and current asset books. So, for the purpose of clarity, let’s classify such taxable events that occur during the disposal of assets of a company and the transfer of shares.

Gain on the disposal of assets  

Gains on the disposal of assets are taxed pursuant to Article 21 of the Income Tax Proclamation (979/2016) as ‘business income’ if the consideration for the disposal of the asset exceeds the net book value (cost-depreciation over time) of the asset at the time of disposal. For those assets other than trading stocks, which relate to the definition in Article 59 of the Income Tax Proclamation concerning a ‘gain on the disposal of certain investment assets’, gains occur on the disposal of the asset where the gain is higher than the cost of the asset. For the purpose of this article, we will focus on Article 59 of the Income Tax Proclamation as it covers the exit tax a company might face when leaving Ethiopia, assuming those investments are made by a foreign company that has a permanent establishment in Ethiopia, that the company made a direct investment in Ethiopia or is involved in a joint venture entity with another company in Ethiopia.^[6]

The Income Tax Proclamation states: ‘In accordance with Article 59 of the Proclamation (979/2016), a person who derives a gain on the disposal of an immovable asset, a share or bond (referred to as a “taxable asset”) shall be liable to pay income tax of 15% for a class “A”^[7] income taxpayer and 30% for a class “B”^[8] income taxpayer.’

Nevertheless, when the cost of the asset at the time of disposal exceeds the consideration for the disposal then a loss should be recognised and should be used to offset a gain on disposal of a taxable asset of the same class during the year, subject to some conditions. Under this provision class A taxable assets are referring to immovable property and class B taxable assets are referring to shares and bonds.

In accordance with Article 6(3) of the Capital Gains Tax Directive No 8/2011, the following elements should be taken into consideration during the calculation of a capital gain:

F=A-(B+D)

E=B-C

A. Asset sale price.

B. Cost of an asset (including any expenses incurred in relation to the asset).

C. The asset's net book value.

D. Inflation adjustment.

E. Overall income from the sale of an asset or a loss in business income and/or a gain in regard to rental income or a deductible loss in rental income.

F. Taxable income from the transfer of capital resources from the profit generated from the sale of the asset.

Gain on the transfer of a membership interest

Another means of ceasing an operation is by transferring the company’s shares to a third party or another shareholder. Any gain driven from the sale of shares will be taxed under Article 59 of the Income Tax Proclamation as a disposal of assets, unless those business assets are transferred in accordance with Article 35 of the Income Tax Proclamation.

Article 35 of the Income Tax Proclamation states: ‘A transfer of shares to another business organisation as part of a reorganisation procedure shall not be treated as the disposal of an asset. Instead, the transferee shall be treated as having acquired the business asset for a cost equal to the transferors cost for the asset at the time of the transfer, and if the transferee has issued shares in exchange for the transferred asset, the cost of the shares is equal to the cost of the transferred asset at the time of the transfer.’

Furthermore, Article 6 of Income Tax Regulation (410/2017) sets out the taxing right in Ethiopia on a gain arising from the disposal of an interest in a share or a bond issued by a resident company. Such types of taxable assets are classified under class B assets and a tax rate of 30 per cent is applied to the taxable amount. The taxing right of Ethiopia still exists when the shareholder is a non-resident, as long as the share that is being transferred is directly or indirectly related to an asset in Ethiopia.^[9]

Tax treaty considerations

Ethiopia has entered into various double taxation avoidance agreements (DTAAs) with other countries. These treaties typically allocate taxing rights between Ethiopia and the other treaty partner, depending on the type of income or gain. For exit tax purposes, the treaty provisions related to capital gains are the most relevant provisions. The treaty might allocate the right to tax capital gains either to the country of residence or the country where the assets are located.

As a principle, Article 48 of the Income Tax Proclamation states, in case of a conflict between the terms of a tax treaty having legal effect in Ethiopia and the Income Tax Proclamation, the tax treaty shall prevail over the provisions in the Proclamation.

However, where a tax treaty stipulates that income originating from Ethiopia is either exempt or excluded from taxation, or that the application of the tax treaty lowers the rate of Ethiopian tax, the advantages of such exemption, exclusion or reduction are not accessible to a body that, for the purposes of the tax treaty, is a resident of the other contracting state, when 50 per cent or more of the underlying ownership or control of that body is held by an individual or individuals who are not residents of the other contracting state. This applies unless the resident of the other contracting state is a company listed on a stock exchange in the other contracting state or is a company carrying on an ‘active business’^[10] in that other contracting state and the Ethiopian-source income derived by the company is attributable to that business.^[11]

Conclusion

Unlike other countries, Ethiopia does not tax an individual or company due to the mere fact that they are ceasing their residency in Ethiopia. However, taxes will arise in terms of assets that are being disposed of or transferred for a ‘valuable’ gain by the taxpayer who is ceasing their residency in Ethiopia. The tax rates applicable to those taxable assets will vary based on the class of the taxpayer and the depreciation of the asset. In addition, the Income Tax Proclamation recognises tax treaties that have been concluded by Ethiopia for the purpose of the avoidance of double taxation and, in case of conflict, the provisions in the relevant treaty will override the terms set out in the national regulations.