One who intends to invest and resell a business capital asset, needs to be acquainted with the term “capital gains tax” before deciding and dealing with investment matter.

Profit that could be made from the sale of an investment, such as a stock, or sale of other business capital assets, such as buildings, and other immovables are considered as taxable income in the view of almost all tax jurisdictions.

In the business environment, there are two ways in which capital gain is manifested. The first is the condition in which companies enhance their capital by selling the share above par value resulting in the rise of premium, while the other is the creation of gain from disposal of the capital asset above the value of its acquisition cost.

Let us come to Ethiopian income tax proclamation 979/2016 art 59(1) that imposes tax on gain derived from both scenarios.

Capital gain tax is a tax that is paid on income derived from selling an asset for more than its initial acquisition cost. The amount of tax depends on how long the asset is held and the amount of income derived during disposal of the asset.

There are short-term and long-term capital gains. Short-term capital gains refer to the profits derived from selling of an asset held for one year or less. On the other hand, Long term capital gains are the profits derived from selling an asset held for more than one year.

"One who intends to invest and resell a business capital asset needs to be acquainted with the term ‘capital gains tax’ before deciding and dealing with investment matters."

1. Capital Gain Tax in the Ethiopian Tax Environment

The Ethiopian income tax proclamation 979/2016 art 59 provides that a person who derives gain from disposal of immovable asset, a share or a bond shall be liable to pay income tax.

The amount of gain on disposal of a taxable asset shall be the amount by which the consideration of the asset exceeds the cost of the asset at the time of disposal of the asset. While loss on disposal of taxable asset is the amount by which the cost of the asset at the time of disposal exceeds the consideration for disposal.

In accordance with the income tax proclamation 979/2016 Art 59(7) exceptionally, immovable asset does not include a building held and wholly used as a private residence for two years prior the disposal of the asset.

2. Categorization of Capital Assets

For determining the tax on gain from disposal of capital asset, the income tax proclamation grouped the business capital assets into “A” and “B”.

Group “A” includes assets like building, warehouse, and other immovables etc. While on the other hand, Group “B” covers shares and bonds including a mining and petroleum right in the mining industry.

3. Tax Rate of Capital Gain

a. The gain derived from the disposal of capital asset group “A” is taxed at the rate of 15%.

b. The gain derived from the disposal of asset group "B” is taxed at the rate of 30%

4. Method of Computation of Capital Gain Tax

This is a simple formula to arrive at capital gain through calculation.

Y= A-(B+C)

D=B-F

Where:

• “A” is sale’s price of the capital asset.
• “B” is the purchase’s price of the capital asset including any additional cost for the asset.
• “C “is inflated amount of the purchase price of the asset.
• “Y” is taxable income or gain derived from disposal.
• “D” is Book value of the asset.
• “F” accumulated depreciation.

Inflation is a rise in general prices of goods and services that erodes the purchasing power of a currency which is considered in the process of assessment of capital gain tax during disposal of capital asset. Therefore, in the income tax law, the amended income tax regulation no 485/2022 had provided the possibility of adjusting the time value of money at disposal only for group “A” asset whereas the lately amended income tax regulation (ITR) no 520/2022 has also enabled inflation adjustment for group “B” asset using the prevailing inflation rate in the country’s economy to ensure fairness in the tax system.

The rate for inflation adjustment is a quantitative estimate at which the decline in purchasing power occurs can be reflected in the increase of an average price level set by National Bank of Ethiopia or any appropriate body.

"The Ethiopian income tax proclamation 979/2016 categorizes business capital assets into Group ‘A’ (immovables like buildings) and Group ‘B’ (shares and bonds), each with different tax rates for capital gains."

4.1 Capital Gain Tax Assessment on Category “A”

The following hypothetical example illustrates how CGT is computed on category “A” asset. Black Star Plc. which was established at the beginning of 2020 by five shareholders decided to dispose one of its warehouses to Shooting Star Plc, by the end of 2022.

The information provided to Revenue authority is as follow:

• • Sales price of the building.…................................. ETB 3,000,000
• • Initial acquisition cost of the warehouse (2020) …....... ETB 1,500,000
• • Accumulated depreciation..…...................... ETB 217,143.75
• • Book value…….………………..………. ETB 1,282,856.25
• • To begin with the tax assessment, we must determine the inflated amount of the cost of capital asset.

a. Table of Inflation’s Computation

b. Computation of Capital Gain Tax

To arrive at the gain of the transaction, we apply the above formula.

Y= A-(B+C)

3,000,000- (1,500,000+346,338) =1,153.662 (taxable gain/income/)

• • The initial capital has been inflated with the amount ETB 346,338.00 over the service years.
• • Then, the current value or cost of the asset after inflation adjustment will be: 1,500,000+ 346,338=1,846,338
• • Then, the capital gain will be = (3,000,000-1,846,338 = 1,153,662)
• • Finally, the capital gain tax (CGT) will be: 1,153,662 X 15%=ETB 173,049.30
• • The obligation to pay the capital gain rests on Black Star Plc.
• • Due date for payment of the tax is the end of the following month after the transaction took place.

c. Taxing the Sales Amount of the Capital Asset that Exceeds the Book Value ( ITP art.21(4) after Disposal

In addition, under this transaction, the gain over the book value derived as the result of the capital asset’s disposal is registered as income and hence, this will be added to annual taxable income which eventually results in corporate income tax that will be taxed at the rate of 30%.

This seems to have been imposed double tax on a single transaction, whereas the reason is that the tax authority claims the depreciation cost of the asset that had been deducted as expense over the last periods of the service life of the asset which is now recovered through disposal of the asset.

Let us look at the gain between the sales price and the book value of the asset from which the difference is added to taxable income to get to annual corporate income tax.

The amount gained over the book value of the asset which will be added to taxable income in the year:

(A-D) = (3000000-1,282,856.25) = ETB 1,717,143.74.

4.2 Capital Gain Tax Assessment on Category “A”

(a). Inflation’s computation

During the disposal of group “B” capital assets, the method of inflation adjustment is similar with that of group “A” capital assets as illustrated above.

(b) Capital Gain Tax on premium

The income tax proclamation No.979/2016 Art.59(1) and the lately amended income tax regulation 485/2022 has been re-amended with regulation No.520/2022 in which the gain that can be derived in the form of premium from selling of shares of company over and above the par value to resident investors is provided to be taxed while gain from selling of the shares over and above to non-resident investors will be exempt from capital gain tax.

The amended income tax regulation No. 520/2022 which came into force in August 2022 describes that the purpose of amendment targets to countervail the barriers impacting the economic operation caused by some articles in the income tax regulation.

Let us see an example to illustrate how the tax on premium is computed.

A company established in June 2014 by two resident investors with paid capital ETB 1,000,000 of which 1000 shares each with per value is ETB 1000.

In June 2018, the shareholders decided to issue and transfer 400 shares to new investors. Following this fact, let us look the below transactional events that need to be furnished to Ministry of Revenue and the process of computation of capital gain tax.

• - The new transfer value of one share is ETB 2000 (par value)
• - The number of issued and transferred shares is 400.
• - Total value of transferred shares is ETB 800,000= (2000X400) as per new par value
• - Initial per value of share was ETB 1000
• - Total value of transferred shares at prior par value (400 X1000) = 400,000.
• - Hereupon, we need primely to determine the inflated amount of the initial contribution.

"The method of computation for capital gain tax involves a formula that considers factors such as the sale’s price, purchase’s price, inflated amount of the purchase price, book value of the asset, and accumulated depreciation."

Note: The inflation rate is applicable based on the inflation rate acknowledged by appropriate body.

• ▶ The initial contribution has been inflated with the amount of ETB 99,772.20 over the last four years.
• ▶ Then, the inflation adjusted value of the share will be: (400,000 + 99,722.20) =ETB 499,722.20
• ▶ The capital gain/premium/ will be: (800,000-499,722.20) =300,277.80 which will be added to annual taxable income of the company.
• ▶ The capital gain tax will be: (800,000- 499,722.20) X30%=90,083.34
• ▶ The filling period is the year-end aggregated with CIT.

5. Loss of Capital Asset During Disposal

The income tax proclamation No. 979/2016 Art.59(4) provides that, if loss on taxable asset is encountered at the time of disposal, the loss could be recognized and offset against the gain on disposal of a taxable asset of the same class during the year with the following conditions:

• • The loss may be used only to offset against gains derived from disposal of taxable assets.
• • The amount that has not been covered by the gain derived from the same class of asset in the year could be carried forward indefinitely.
• • Loss incurred during disposal of a taxable asset to a related person or company is not allowed.

6. Relevant Issues of Capital Gains (Art.71)

No gain or loss arises during the disposal of assets due to the following conditions:

• • Between spouses as part of a divorce settlement
• • Disposal of the asset to beneficiaries or executors due to death
• • Disposal caused by loss or destruction and compulsory acquisition of assets if the consideration of the asset is reinvested by the recipient.
• • If the cost of the replacement asset exceeds the consideration for the replaced asset, then the cost of the replacement asset shall be the cost of the replaced asset at the time of disposal.