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HAWASSA UNIVERSITY

M.SC., ACCOUNING & FINANCE


REGULAR PROGRAM-2014
ADVANCED TAX ACCOUNTING-CODE: ACFN- 526
UNIT- I. TAXATION – AN INTRODUCTION
PROF. ANBALAGAN CHINNIAH
PROFESSOR OF M.SC., ACCOUNTING & FINANCE
SCHOOL OF MANAGEMENT & ACCOUNTING
HAWASSA UNIVERSITY, HAWASSA, ETHIOPIA,
EAST AFRICA, MOBILE NO: 0932319331
EMAIL ID: dr.chinlakshanbu@gmail.com
Websites: www.thavan.org.in, www.ifsmrc.org
www.spcera.org, www.iracst.org
Definition of Tax
• There is no a standardized definition of tax.
Different individuals have defined tax is different
ways. Some of the definitions include:
• Tax is that part of the revenues of a state which is
obtained by compulsory dues and charges upon its
subjects.
• Tax is part of the property of each citizen which he
surrenders in order to insure the remainder.
• Tax is a compulsory contribution of the wealth of a
person or body of persons for the service of the
public power.
Conti…
• Generally, it can be said that tax is a compulsory
levy and those who are taxed have to pay these
sums irrespective of any proportionate return of
services or goods by the state, representing
absence of quid pro quo (quid-pro quo means
exchange of things of equivalent value).
• In other words, a tax is a compulsory payment or
contribution by the people to the Government for
which there is no direct return to the taxpayers.
Tax imposes a personal obligation on the people to
pay the tax if they are liable to pay it.
General Characteristics of Tax
A tax has the following characteristics:
• Tax is a Compulsory Contribution
• Benefit is not the Basic Condition
• Personal Obligation
• Common Interest
• Legal Collection
• Element of Sacrifice
• No Discrimination
• Wide Scope
Structure of Taxation
• Generally speaking, the structure of taxation may be
centralized or decentralized.
• In centralized tax structure the tax system is uniform
through out the country whereas in a decentralized
tax structure tax is not uniform throughout the
country.
• In Ethiopia regional governments and the federal
government have to harmonize their tax system so as
to avoid tax competition among regions which is not
for the nation as a whole.
• Regional states and city administration tax authorities
are permitted to set their own rate for the rural land
use fee and agricultural income tax.
Objectives of Taxation
The following are generally considered to be
objective of taxations.
• To finance government activities
• To stabilize the economy
• To provide social justice through redistribution of
income and wealth
• To discourage the consumption of selected goods
and services
• To encourage investment
• To preserve the competitive position of local small
firms
Three Terms in Relationship to Tax Enforcement
 Tax evasion
 Tax evasion involves a fraudulent or deceitful effort by a taxpayer
to escape a legal tax obligation.
 This is a direct violation of tax low.
 In simple terms it is illegal manipulations to reduce tax.
Accountants sometimes refer to avoidance as ‘tax planning’ or ‘tax
mitigation’ which emphasizes its legality.
 Tax avoidance
 Tax avoidance, in contrast, does not violate the letter of law.
 Tax avoidance is lawful, while tax evasion is not.
 Tax delinquency
 Tax delinquency refers to failure to pay a tax obligation on the date it
is due.
 Tax delinquency is associated with inability to pay a tax because of
inadequate funds, but it does cover the possibility of nonpayment of
Principles of Taxations
• It is difficult to design a good tax system as Jean
Baptists declared “the art of taxations is the art of
plucking the goose so as to get the largest possible
amount of feathers with the least possible squealing.”
• Principles of taxations are the appropriate criteria to
be employed in the development and evaluation (to
say good or bad) of the tax structure.
• The following tax principles or desirable characteristics
of the tax system have come to be generally accepted.
• The first four principles listed below are identified by
Adam Smith. In his book the Wealth of Nations
published in 1779 he termed them the “four canons of
taxation”.
• The remaining principles are identified by other
scholars.
Conti….
1. Equity Principle
• There must be a just and fair distribution of tax burden.
• There are two concepts of fairness that determine weather the tax
burden of tax is distributed fairly or no: benefit concept and ability-
to-pay concept.
2. The benefit concept
It states that only the beneficiaries of a particular government
spending program should have to pay for it.
• The benefit concept can be applied when the benefit received by
individuals can be measured and when the resulting pattern of
burden of distribution is regarded by society as equitable. It can not
be applied in most cases because:
• Much of government activities are non-excludable
• Some government activities have positive externalities like education
• Some government activities are directed explicitly at redistribution of income or
benefit from one group to the other
• Benefit can not be measured; it is subjective
Cont…
3. Ability-to-Pay Concept
It holds that people should pay taxes in proportion to their ability
to pay. There are two challenges in applying the ability to pay
concept. There are identifying the best measure of ability to pay
(income, consumption, or wealth?) and determining how the tax
burden should vary with the ability to pay.
• Horizontal equity is about equal treatment of persons in the like
circumstances. That is persons in the same circumstances should
be taxed to the same extent.
• Vertical equity is a relative treatment of persons in unlike
circumstances. An individual with a different economic ability is
assigned different tax burden. This implies that the person with
higher income should pay more in tax than one with less income.
4. Principle of Certainty
 The tax which each individual is bound to pay should be certain,
and not arbitrary.
 The time of payment, the manner of payment, the quantity to be
paid, should all to be clear and plain to the taxpayer, and to
every other person.
5. Principle of Convenience Conti…
• The mode and timing of tax payment should be, so as
possible, convenient to be taxpayer.
• This principle recommends that unnecessary trouble to the
taxpayer should be avoided; otherwise, various ill-effects
may result.
6. Principle of Economy
• Cost of collection of taxes (administrative cost) should be
the minimum possible.
• Administrative costs include employees’ salary and
benefits, cost of accommodation and materials, cost of
auditors, and other costs incurred by tax authorities.
• This cost is affected by number of taxes, number of tax
rates and brackets, tax thresholds, maximum tax rate,
Conti…
7. Principle of Productivity (fiscal adequacy)
 The tax system should be able to yield enough
revenue for the government and the
government should have no need to resort to
deficit financing.
 The tax system should produce revenue in a
reliable manner. Reliability involves stability,
certainty and sufficiency.
Cont…
8. Principle of Buoyancy
• The tax revenue should have an inherent tendency
to increase along with an increase in the tax base,
even if the rates and coverage of taxes are not
revised.
• An increase in tax revenue because of a growth of
its base is termed its buoyancy.
• A buoyant tax has an inherent tendency to yield
more tax revenue with the growth of its base.
• Thus, for example, with given rates of income tax
and the definition of taxable income, if yield from
income tax increases as national income increases,
it would be termed a buoyant tax.
Conti…
9. Principle of Flexibility
• It should be possible for the authorities, with out
undue delay, to revise the tax structure, both with
respect to its coverage and rates, to suit the
changing requirement of the economy and of the
treasury.
• It must be responsive to interstate and
international economic competition.
10. Principle of Simplicity Conti…
• The tax system should not be too complicated.
• That makes it difficult to understand and administer
and breeds problems of interpretation and legal
disputes.
• A simple tax system is essentially one which is easily
understood by all taxpayers and where all taxpayers
can easily and inexpensively comply with the system.
• Complex tax systems impose high compliance costs
upon taxpayers and high administrative costs upon
revenue authorities.
• A tax system may become complex because of
frequent addition and deletion of tax concepts, lack of
consistent concept, effects of measures that target
sophisticated taxpayers on less sophisticated
taxpayers, complex tax return forms, etc
Conti …
11. Principle of Diversity
• It is risky for the state to depend upon too few a
source of public revenue.
• Such a system is bound to breed a lot of
uncertainty for the treasury.
• It is also likely to be inequitable as between
different section of the society.
• If the tax revenue comes from diversified source,
then any reduction in tax revenue on account of
any one cause is bound to be very small.
• However, too much multiplicity of taxes is also to
be avoided. That leads to unnecessary cost of
Conti…
12. Principle of Neutrality
• The tax policy should not introduce undesirable distortion
into the normal working of the economy.
• It should be neutral. Interference with economic choice
resulting from taxation is a burden on the taxpayers in
addition to the actual money handed over in payment of
a tax.
• It is called excess burden of taxation, deadweight loss of
taxation, or welfare cost of taxation.
• Because excess burdens are a form of waste, or lost value,
the tax system should minimize them.
• Currently almost all taxes are not neutral:
– Excise tax results in substituting goods
– Personal income tax affects work-leisure decision, saving-
consumption decision
– Business tax affects investment and production method decision
(capital vs. labor intensive method)
Conti…
13. The Possible Conflict of Equity and Neutrality
Consideration
• It has been widely argued that there exist some
conflict between equity considerations and those
of avoidance of adverse effect on the economy.
• If tax is completely independent of the economic
activities which a person undertakes it is said to be
neutral, in the sense a poll tax is the ideal of all
levies.
• But such taxes are obviously inequitable under
usually accepted standards.