Tempted by Informality: Taxes Rattle Small Businesses in Ethiopia

As the winter hailstorm showers over Adama City in Oromia Regional State, Yididya Ketetema found her small handbag business battered by more than the weather. A 68,000 Birr tax bill has stunned the twenty-something small business owner 

“I nearly fainted when they told me the amount,” she told Shega.

Yididya, an architect by training, stepped into the world of handmade bags after rediscovering an old sewing machine that her mother had long abandoned. A few sales a week, usually enough to cover rent and running costs, gave her hope of scaling up. Online traffic fueled bigger ambitions despite finance issues stalling the growth of Jadah Designs.

 “This year has been too tough,” she said in a defeated tone.” I am going to return my business license.”

Yididya is not alone. Other small business owners in Adama told Shega they are being pressed by local officials for payments they can scarcely afford. One was asked to contribute 15,000 birr to a Corridor Development project, and 3,000 Birr for the mayor’s office renovation, while having to pay threefold the combined amount in taxes. Neither demand came with a receipt, nor would it be deducted from taxable income. Confronted by unprecedented tax hikes, many small business owners are being enticed by the unregulated luxuries of the grey economy. 

One business owner who uses epoxy to make artistic homeware has decided to fully transition to an online format after hearing her tax burden for the year. She has cancelled plans to travel around the country and give training to prospective epoxy enthusiasts. 

“Even I am returning by business permit,” the small business owner said.

She initially thought that a business license and physical office would help scale her online business into something sustainable. Now, she feels the best way to keep earning money is through social media, unencumbered by ‘prickly’ tax officials.

“How can I pay taxes on money I have not made? “ she enquired.

While the tax season often entails anxiety and stress, small business owners across the board are reporting much more than insomnia this year. Officials are discarding more expense claims and raising assessments more aggressively than in the past. Akalu Petros, Communication Director at the Ministry of Revenues, said that everyday issues faced by small taxpayers are handled regional and city levels rather than at the federal level.

Part of the tension lies in how micro, small, and medium enterprises (MSMEs) are categorized. Micro firms are defined as having less than 50,000 Birr in capital and up to five employees. Small firms, under a different regulation, can have as much as half a million birr in capital and up to 30 workers, including the owner’s family.

Without updates, these groupings could risk fueling further discontent, dispute, and increased outflow into more informality.   

Ethiopia has been implementing a series of tax reforms to boost domestic revenue targets laid out in the National Medium-Term Revenue Strategy (NMTRS) covering three years. Consequently, the nine-year-old income tax law has been revised, while a slew of new levies have also been rolled out. But perhaps most consequential to small business owners (with less than two million Birr annual revenues) has been the adjustment to annual Turnover Taxes. They are now subject to presumptive levies of 2% to 9%, with a minimum alternative tax of 2.5 percent even in the absence of profits.

While the authorities' effort to increase the tax-to-GDP ratio by seven percentage points under the NMTRS aligns with Sub-Saharan averages in double digits, the crackdown and hasty implementation appear to be brewing discontent. Several small taxpayers, now categorized as B-class taxpayers under the amended income tax law, in the capital lamented to Shega anonymously about unprecedented hikes in their tax obligations. 

One business owner said she was spared from 20,000 Birr payments after meeting a fellow member from her local church working at the tax office. “A holy bribe of sorts,” was how she described it.

In South Africa (SA), a country that collects the largest tax volume on the continent and the second largest in terms of its proportion to GDP, small businesses are offered various incentives. Micro businesses with less than 335,000 ZAR, or around 2.7 million Birr, annual turnover are subject to zero rates. Furthermore, businesses that qualify as small are allowed deductible expenses ranging from education to entertainment. 

South Africa’s system is also highly digitized, with e-filing, streamlined audits, and compliance rewards. Ethiopia’s tax administration, meanwhile, continues to struggle. A policy brief published by the European Chamber in Ethiopia, a lobby group that has some of the biggest taxpayers in the country as members, pointed to major challenges. It cited inconsistency in tax laws, unrestricted authority of auditors, and conditions to pay half of the principal amount during tax appeals proceedings among the hurdles in tax administration. For MSMEs in Ethiopia that often rely on basic bookkeeping practices to manage their business, unforeseen increments in tax obligations too often end up being too burdensome to handle or navigate.

The Ethiopian Enterprise Development (EED) office, which supported more than 2,700 MSMEs in the first nine months of this year and facilitated nearly six billion birr in loans, offers no direct tax support.

 We have not received any formal complaint around taxation,” Robel Ahmed, the agency’s communications director, told Shega. “We have not had to reach out to tax authorities.”

One experienced finance officer and accountant pointed to the mixed impact of the recent tax reforms on MSMEs. She says the removal of the category-C tax group and the implementation of rates based on annual sales might decrease incidences of underreported profits while allowing another form of malpractice to emerge.

“I fear businesses might increasingly hide their sales,” the accountant told Shega. “The incentives to formalize their business could take a hit.”

She added that more business owners may begin trading directly with one another, bypassing banks and other formal institutions to escape heavy tax obligations. Some, particularly the tech-savvy, could even turn to cryptocurrency as an alternative.

As Ethiopia pushes to double tax revenues and tighten compliance, entrepreneurs face mounting pressure to adapt. For Ethiopia’s more than 2 million MSMEs, the balancing act is delicate: between formality and informality, ambition and survival, growth and retreat.