Capital gains refer to the profits earned from the sale of business assets such as stocks, bonds, or immovable properties. Capital gains taxation is the process of taxing these gains at different rates depending on the type of asset. “Business asset” is defined to mean any asset held or used in the conduct of a business to derive business income. An asset is a business asset, regardless of whether it is revenue or capital in nature.
Consequently, for example, the structural assets of a business (such as commercial premises, plant, and equipment) are business assets. This form of taxation has a significant impact on both individuals and investors, as it affects their financial decisions, incentives for investment, and overall economic growth. Understanding the basics of capital gains taxation is crucial for individuals and investors to make informed decisions and optimize their tax strategies.
Who Pays Capital Gains Tax?
Article 59 sub-article (1) of the Federal Income Tax Proclamation No. 979/2016 (hereinafter referred to as “the Proclamation”) provides that a person who derives a gain on the disposal of immovable property, shares, or bonds is liable to pay income tax on the amount of the gain at a rate specified in the proclamation. This Clause applies to both residents of Ethiopia and nonresidents. In the case of a non-resident, a gain is taxable only if the gain is Ethiopian source income as provided under Article 7(2).
Gains considered as Ethiopian source income are:
- A gain on disposal of immovable property located in Ethiopia;
- A gain on disposal of a membership interest in a body, if more than 50% of the value of the interest is derived, directly or indirectly through one or more interposed bodies, from immovable property located in Ethiopia;
- A gain on disposal of shares in, or bonds issued by, a resident company. [A resident company is a company that: (i) is incorporated in Ethiopia; or (ii) has its place of effective management in Ethiopia as per Articles 5(5) and 6 of the Proclamation.]
Taxable assets are divided into two classes. Class ‘A’ taxable assets comprise immovable property and Class ‘B’ taxable assets comprise shares and bonds. “Immovable property” does not include a building that has been held and wholly used as a private residence for at least two years prior to its disposal. Thus, if the 2-year holding period is met, a person is not subject to tax on the disposal of their private residence.
The rate of income tax applicable to a gain on disposal of a Class ‘A’ taxable asset (immovable property) is 15%, and the rate of income tax applicable to a gain on disposal of a Class ‘B’ taxable asset (shares and bonds) is 30%, as per Article 59(2) of the Proclamation.
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