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Part One: Introduction to Taxation

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Part One: Introduction to Taxation Chapter One: Introduction to Taxation and Tax Accounting Chapter One Introduction to Taxation and Tax Accounting Chapter Outline: 1. What is taxation? 2. Definition of tax and duty 3. Tax accounting 4. Interdisciplinary Nature of Taxation 5. Objectives of taxation 6. History of taxation 7. Basic Elements of Tax Systems 8. Tax Related Terms 9. Basic characteristics of tax 10. Types of Tax Rates 11. Taxation Systems (Tax Rate Structures) 12. Principles of taxation 13. Canons of taxation 14. Effects of Taxation 15. Classification of taxes Chapter Objectives: After completing this chapter, you would be able to: Define taxation, tax, duty, and tax accounting Understand why government levies taxes on citizens Discuss the evolution and history of taxation in the world and in Ethiopia Define different tax related terms Comprehend basic characteristics of taxes Identify and Calculate Different Types of Tax Rates Grasp the basic principles and canons of taxation See the effect of taxation on Economy Classify taxes on the basis of different dimensions Time Required: 4 Hours 1.1) Taxation Taxation is one of the systems that government uses to collect public revenues from various sources. However, taxation is the most important system of collecting public revenue in modern economic system. Taxation is the most powerful instrument in the hands of the government for transferring purchasing power from individuals to government. The money collected through taxation – tax revenue – is used to finance government operations. That is, the money required by the government to undertake different functions –taxes– is collected from the citizens. Without taxes to fund its activities, government could not exist. Thus, a government uses taxation as a system of raising the lion share of its revenue. Government uses the money collected through taxation: To pay soldiers and police; To build dams and roads; To operate schools and hospitals; To provide food to the poor and needy; To provide medical care to the elderly people; and To finance other hundreds of operations Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011 1 Tax Accounting (ACCT-332) Taxation is used as a system of raising the lion share of public revenue in modern economic system to fulfill the requirement of the goods and services. Taxation depends on concepts from law, accounting, economics, public financial management, politics, behavioral sciences, etc. Thus, taxation can be considered as a part of special fields of study such as law (specifically tax law), accounting (specifically tax accounting), public financial management, economics, politics, etc. The scope of taxation includes tax policies, tax theories, tax decisions, and tax administration 1.2) Tax and Duty Tax is defined as an amount of money levied by a government on its citizens and used to run the country. A tax is an involuntary fee or more precisely "unrequited payment" made by individuals or businesses to a government without quid pro quo. Human beings need four types of goods and services: Private goods – consumed individually, for payment Toll goods – consumed jointly, for payment Common pull goods – consumed individually, for free Collective goods – consumed jointly, for “free” Tax is an indirect payment for collective goods and services Duties are also taxes. Duties are distinguished from taxes by their strictly economic characteristic. For example, any government imposes a compulsory levy on the goods imported from a foreign country. This compulsory levy is called Custom Duty. Custom duty is compulsory a levy on individuals and companies importing goods to the country and its purpose is to protect the domestic market and economy. When goods are imported from abroad while the same goods can be produced within the country, it affects the domestic market and economy in number of ways as follows: It reduces demand for domestic products It discourage production within the county It discourages Foreign Direct Investment in the country It results in negative balance of payment (BOP) It increases the unemployment rate 1.3) Tax Accounting Tax accounting is one of the specialized fields of accounting that encompasses activities such as: recording of tax related transactions; continuous follow-up of tax laws affecting a taxpayer i.e. individual or organizations; analyzing the consequences of tax on alternative business transactions/courses of actions determination of taxes and tax liabilities; preparation of tax returns or tax reports; and providing tax related information to assist decision makers Tax returns are government declaration forms filled and then filed with the Federal, State, or Local tax authorities. Tax returns are forms filed with the tax authority containing information used to calculate tax base and taxes (e.g. taxable income and the related income tax). Examples of tax returns (tax declarations), in Ethiopia, are: Business Income Tax Declarations VAT Declaration Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011 2 Chapter One: Introduction to Taxation and Tax Accounting Employment Income Tax Declarations Turnover Tax Declaration Excise Tax Declaration Withholding Tax Declaration Other Income Tax Declarations Tax accountant is an individual who assists a taxpayer in preparation of tax returns and who undertakes tax planning and other related activities. 1.4) Interdisciplinary Nature Taxation A. Taxation and Economics Economics used taxation as one of the tools of fiscal policy and other economic measures B. Taxation and Public Financial Management Taxation is used as one of the systems of raising public revenue and it is one of the items that public financial management is concerned with. C. Taxation and Law Law provides rules and regulations that are used to guide taxation system so that the taxation system can be streamlined. D. Taxation and Politics Political decisions on tax related issues directly or indirectly affect the environment of taxation. E. Taxation and Accounting Accounting is concerned with regulation, control, and reporting of taxes from both sides: taxpayers and tax office F. Taxation and Behavioral Sciences Taxation is one of the things that highly affect human behavior. When a government increases or decreases taxes, taxpayers may react negatively or positively which could be subject of discussion in sociology and psychology 1.5) Objectives of Taxation The objectives of taxation are: 1. To Raise public revenue 2. To Remove inequalities income and wealth 3. To Ensure economic stability 4. To Reduce regional imbalances 5. To Create employment opportunities 6. To Prevent harmful consumption 7. To Divert resources beneficially 8. To Encourage exports 9. To Enhance standard of Living 1.6) History of Taxation History of taxation is concerned with these four questions: Who paid tax? What was taxed? Who collected taxes? In what form taxes were paid? Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011 3 Tax Accounting (ACCT-332) 1) History of Taxation in the World A. Ancient Period (up to 5th Century AD) Palestine, Egypt, Assyria, and Babylonia Individual property rights did not exist The king was sole owner of everything in his domain Confiscated property and tribute payment from conquered peoples (additional source of finance) Ancient Athens (Greece) Relied on publicly owned silver mines Tribute from conquered countries Few custom duties, and Voluntary contributions from citizens. Poll tax - on slaves and aliens Eisphora - a tax imposed during war times Metoikion – a poll tax on foreigners (people who did not have both an Athenian Mother and Father) Ancient Roman Republic Poll Tax – on all roman citizens Roman military victories brought large amount of Foreign Tribute 5% Inheritance Taxes – by Emperor (Caesar) Augustus Wheat and Salt tax 1 % sales tax for most goods and 4% sales tax for slaves – by Emperor Julius and the sales tax on slaves was increased to 5% by Emperor Augustus Portoria – The earliest custom duty in Rome on imports and exports B. Medieval Period (5th to 15th Century AD) Europeans were subject to many forms of taxation: Land taxes Poll taxes Inheritance taxes, Tolls (payments for the use of bridges, roads, or seaports), and Miscellaneous fees and fines. Many people paid taxes in the form of money or crops. Taxes were paid directly to the local lords. An important development toward the end of the feudalism was taxes on Property Under the system of feudalism in Western Europe (11th Century): Kings, nobles, and church rulers all collected taxes. Kings derived income from their lands, from import and export duties, and from the various feudal dues and services owed by their vassals. Scutages - payments made in lieu of military service under King Edward of England Feudal nobility refused to pay scutages In 1215, Feudal nobility forced the king to sign the Magna Carta -the king agreed to collect scutages only with the “common consent” The Roman Catholic Church was a major tax collector during the middle ages – Tithe. The church also collected various fees, fines, and tolls. Compiled By: Kassahun Boressa, AAU, School of Commerce, Revised in 2011 4 Chapter One: Introduction to Taxation and Tax Accounting C. Modern Period (16th Century AD to Date) Strong centralized states emerged in Europe During the 16th and 17th centuries, these states relied heavily on revenues generated by the king’s own estates and by taxes on land. In England, the power of Parliament grew steadily - in 1689 the English Bill of Rights guaranteed that the king could not tax without Parliament’s consent. In 18th century, England started imposing various taxes on transactions. Taxes on imported goods (tariffs) assumed great importance. It also stated imposing income taxes. In 1799 Britain enacted the first national income tax - to finance the Napoleonic Wars. The war was ended up in 1815. The tax was discontinued after the war and revived in 1842. In the late 19th Century AD and early 20th Century AD, concerns about both fairness and the ability of tax systems to generate sufficient revenue led governments to enact income taxes.
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