Income taxation is fundamentally territorial. Due to the existence of multiple sovereign states' interests in the tax collected over economic activities, the legal framework for taxation is also complex. The doctrine of state sovereignty provides the conceptual foundations for the legal framework within which States can exercise their taxing power over economic activity. In the terms of public international law, sovereignty demarcates the State’s tax jurisdiction. Therefore, the outer limits or borders of a sovereign State’s taxing powers are set by public international law. Within these limits, every State is free to set rules that regulate its tax jurisdiction over natural and juristic persons. It does so either unilaterally, in its domestic law, or by entering bilateral or multilateral treaties with other States.
The taxing jurisdiction of a State stands on a legally relevant connecting factor or nexus between the State and the tax subject (the taxpayer) or the taxable event (the tax object), which links the subject or object to that particular fiscal jurisdiction. These connections, which are contained in the domestic law, include factors such as the tax residence of the taxpayer and the source of income. The term ‘fiscal attachment’ is often used to describe this legal relationship between a State and a taxable subject or the tax object. According to international usage, a jurisdictional claim based on such a legally relevant connection between the State making the claim and the tax residence of the taxpayer is referred to as ‘residence taxation’.
In contradistinction to a jurisdictional claim based on ‘residence taxation’ is the concept of ‘source taxation’. Source taxation is an imposition upon the income arising within the jurisdiction of a state exercising taxation power. The business activity may be regarded as sufficiently connected with a particular ‘source State’, when the state exercises its taxing power based on the source of that income or the situs of the property, in accordance with the broad principle of territoriality.
The same holds true, before Ethiopia exercises its jurisdiction over a certain income there should be a connecting factor or tax nexus. According to article 7 of the Ethiopian Income Tax Proclamation no 979/2016 (Hereafter ITP), the two main connecting factors underlying the taxation of income are residence and source. A resident taxpayer will be taxed on income derived directly and indirectly from its worldwide source. Whereas the general rule for non-residents is that taxpayers are liable to Ethiopian tax on all items of income that have their source in Ethiopia. However, the purpose of this piece is limited to highlighting the determination of residency under the Income Tax Legislation. So, the focus is only given to the determination of residency, out leaving the principle applicable to Non-Residence (Taxation based on source). A taxpayer, whether an individual or a company, will be resident in Ethiopia for tax purposes on the basis of domicile, physical presence, citizenship, establishment or formation, and place of effective management.
Ethiopia has adopted a residence-based (or worldwide) system of taxation that can be described as a ‘residence minus’ system, which means income derived by ‘residents’ from all sources are subject to tax (unless that person is deemed to be exclusively a resident of another country for the purposes of the application of any international tax agreement). The income tax legislation defines residence separately for the tax purpose. This is done to maintain peculiarity from laws governing ‘status’ in Ethiopia. For the income tax purpose, both natural and juristic persons could be subject to residence taxation in terms of Article 7(1) jointly read with Article 5. Specifically, Article 5 sets out three circumstances that connote residency.
- A resident individual (Natural Person). A resident individual is an individual who; has a domicile in Ethiopia (Domiciliary Test); or is a citizen of Ethiopia who is a consular, diplomatic, or similar official posted abroad (Citizenship Test); or is present in Ethiopia, continuously or intermittently, for more than 183 days in a one-year period (Physical Presence Test).
- A resident body (Juristic Person). A resident body is a body that: is incorporated or formed in Ethiopia; or has its place of effective management in Ethiopia
- The Government of the Federal Democratic Republic of Ethiopia, and any Regional State or City Government in Ethiopia.
Residence Taxation-- Natural Persons
In the case of natural persons, residence taxation is an implicit concept of ‘political allegiance’, ‘nationality’ (which is usually understood as equivalent to citizenship), and ‘residence’. Thus, for natural persons, tax jurisdiction is tacitly based primarily on a pre-dominant physical presence within a certain jurisdiction. ITP ascribes three tests that are relevant in the determination of residence for income tax purposes. A natural person qualifies as a resident, if he is domiciled in Ethiopia or if he meets the requirements of the ‘physical presence test or the citizenship test. The first two tests are mutually exclusive.
In determining whether a natural person is a resident, the first test is being ‘domicile in Ethiopia’. If the answer is affirmative, that is the end of the inquiry, and the person is thereby established to be a resident. If the answer is negative, a second inquiry takes place, based on a ‘physical presence test, in which statutory criteria are applied, involving a determination of the number of days in which the person was ‘physically present in’ or ‘physically outside’ the country. The citizenship test is a standalone criterion. The tests are discussed as follows.
- Domiciliary Test
As a general rule, a person ‘is domiciled in the country where, in the settled routine of his life he regularly, normally or customarily lives. Put somewhat differently, a person’s domiciliary will, essentially, be the country that he regards as his home and to which he would naturally and as a matter of course return from his wanderings. The partially subjective nature of this criterion adds considerable uncertainty to the question as to when or whether Ethiopia tax-resident, who has lived abroad for a substantial period of time and has ceased to be physically present in Ethiopia. (Interested researchers can work on the tax fate of Expatriate employees)
Nevertheless, the Domiciliary test is the first test to determine the residence of a natural person. However, it is defined nowhere in the income tax legislation; thus, it is important to look at the definition of the Civil code (arts. 183 to 191) attached to the domicile.
Art. 183. - Definition.
The domicile of a person is the place where such person has established the principal seat of his business and of his interests, with the intention of living there permanently.
Three important cumulative elements can be drawn from this provision in determining domicile
- The place should be where he/she has established the principal seat of his business. A company's principal place of business is the primary location where its business is performed.
- The place should be a place of his interest. The location of an individual's place of his interests is determined by examining his or her family and social relations, occupation, political, cultural, and other activities, place of business, and the place from which his or her property is administered. For example, subscription to Ethiopia Bunna Football Fans Team and attending matches continuously implies a place of interest. Besides, it requires a case-by-case analysis.
- In that place, the taxpayer should have the intention of living there permanently. How we can identify this? The presumption is stetted under article 184 “Where a person has his normal residence in a place, he shall be deemed to have the intention of residing permanently in such place.
So, in order to determine the residence of a specific person, we need to establish, by certain evidentiary rules, that the person is permanently settled in a particular area with the intention to live there. A person cannot have multiple domiciles; because, normally, an individual cannot have the intention to live in multiple areas permanently in a manner prescribed by the law. The normal residence of a person is deemed to be a permanent residence of a person.
The question of whether a person is ‘domiciliary’ in a country is one of fact, one relevant fact being the subjective state of mind of that person in regard to whether he or she has an ‘intention of living there permanently. In the case of an assessment that is disputed on the issue of the taxpayer’s residence, it will be for the courts to decide on the particular facts of each case whether the person in question was or was not domiciled in Ethiopia.
- Physical Presence Test
“A resident individual is an individual who is present in Ethiopia, continuously or intermittently, for more than 183 days in a one-year period.”
Article 5 (2)(c) provides that an individual is a resident individual if the individual is present in Ethiopia for 183 days in any one-year period. This test is primarily relevant to foreign nationals working on assignments in Ethiopia or to a person not qualifying for the domiciliary test. Such persons will normally have a home outside Ethiopia but are considered to be a resident if they are present in Ethiopia for the 183-day period.
The prescribed day period may be consecutive days or the day period is tested by reference to any one-year, not necessarily one tax year. Council of Ministers Federal Income Tax Regulation No.410/2017 under article 5 provides for the circumstances to be considered while calculating the number of days an individual is present in Ethiopia for the purposes of Article 5(2)(c) of the Proclamation. These include;
- a part of a day that an individual is present in Ethiopia (including the day of arrival in, and the day of departure from, Ethiopia) shall count as a whole day of such presence;
- the following days in which an individual is wholly or partly present in Ethiopia shall count as a whole day of such presence: a public holiday; a day of leave, including sick leave; a day in which the individual’s activity in Ethiopia is interrupted because of a strike, lock-out, delay in the receipt of supplies, adverse weather conditions, or seasonal factors; days spent by the individual on holiday in Ethiopia before, during, or after any activity conducted by the individual in
- However, a day or part of a day when an individual is in Ethiopia solely by reason of being in transit between two different places outside Ethiopia shall not count as a day present in Ethiopia.
- Citizenship Test
“A resident individual is an individual who is a citizen of Ethiopia who is a consular, diplomatic, or similar official posted abroad”
Art 5 (2(b)) provides that a citizen of Ethiopia who is a consular, diplomatic, or similar official (such as a trade official) posted abroad is a resident individual for income tax purposes. The inclusion of Ethiopian Government officials working abroad as residents are necessary as often, they will be exempt from tax in the country of service, particularly under international agreements (such as the Vienna Convention on Diplomatic Relations). The exemption applies in the country of service on the assumption that the foreign government official will be taxed in their home country.
There is an Amharic proverb that says ‘’የትም ፍጪው ዱቄቱን አምጪው”. The same goes, whichsoever test is employed to determine residency it does not affect its taxability. What the reader should have to understand is that the very purpose of having a variety of tests in the determination of residency is to increase tax liability and to enlarge the tax base. Ultimately ensures the taxability of every person.