The legality of Levying Income Tax on Illegal Amounts Received by a Taxpayer ---- Personal Reflection

Income tax is essentially a tax levied on a person’s income from various sources. It is a direct tax in the sense that it is demanded from the very persons who, it is intended or desired, should pay it. Hence, every person either a natural person or a corporate entity should have to pay income tax on the respective income they derived.  Nevertheless, Income-driven by a taxpayer may not always be holy. Some incomes earned illegally can be mixed with the lawfully acquired income of the taxpayer. For instance, a shop selling contraband products with lawful once, a hotel collecting payment from prostitutes… etc. At the end of the day, if not understated, such incomes will be reported to tax authorities.

There are two scenarios here, the activity, not only being illegal, can’t be reported to authorities (selling marijuana), and the activity is illegal but it can be reported (contrabanded edible oil, pasta…). However, it remains blurred whether the legality or illegality of the income is an issue to worry about during the collection of tax.  In pursuit of this, the central focus this piece wants to press on is the legality of the collection of income tax on illegally driven amounts. In doing so, the writer will try to unpack some important elements from the Income-tax proclamation No 979/2016.

As the name itself indicates, the proclamation dedicates itself to the regulation of imposition of tax on INCOME. Income can be derived by either resident or non-resident taxpayers. Art 7 of the proclamation demarcates the playground or area of applicability of this particular legislation. The proviso set outs its applicability on an income-driven by a resident (the main components of a resident are discussed under Article 5 of the proclamation) and income-driven by a non-resident from an Ethiopian source (Non-resident is defined against a Resident).

However, be it resident or non-resident the legislation is applicable to income received or accrued to a person. Whether the taxpayer received a benefit or a benefit accrued to him on a daily or monthly basis the total income will be aggregated to determine the taxable income of the taxpayer. Although different circumstances and calculations are employed depending on the taxpayer, it's common that the income tax is levied on the aggregate income received or accrued to the taxpayer, save as any deductions and exemptions. Article 2(12)

“Gross income”, in relation to a person, means the total income taxable under Schedules ‘B’ or ‘C’ derived by the person without deduction of expenditures.

Even if, the whole amount of income that constitutes gross income is not where the tax is imposed, at least the whole amount of income will form part of the gross income. This is to say, actual income tax is imposed on the “taxable income”, i.e after the removal of necessary exemptions and deductions. However, the removal will take place once the gross income is determined. Therefore, any amount derived by the taxpayer forms part of its income. Subsequently, what is income for the purpose of the income tax legislation will be the issue.

Definition of Income Under the Income Tax Proclamation

This term is central to the operation of the income tax legislation, as income tax is imposed under the Schedules is in reference to amounts of income. Thus, the definition is crucial to appreciate the umbra and penumbra of the aforementioned legislation. Colloquial, income means “money received, especially regularly, for work or through investments.” This definition is not inclusive of the whole concept of what the term stands for under the income tax legislation. For one thing, income does not only refer to cash, it also encompasses payment in kind. Further, it is not necessary for the benefit to be regular, as it includes non-recurring (not-happening frequently) benefits.

It follows, therefore, it’s of paramount importance to see the meaning attached to it under the income tax legislation. Article 2(14) sets out the definition of income for the purpose of the proclamation.

‘’Income” means every form of economic benefit, including non-recurring gains, in cash or kind from “whatever source derived” and in whatever form paid, credited, or received”

Important components of the definition:

  • Economic Benefit: An economic benefit is any benefit that we can quantify in terms of monetary value. Anything less won’t qualify as an economic benefit. Further, this economic benefit need not necessarily be on regular basis. One-time benefit can also be considered as an economic benefit.
  • Non-recurring gains, in cash or kind: the amount derived shouldn’t necessarily be frequently earned by the taxpayer. Why not its windfall earning—it will constitute income for the income tax legislation.
  • Derived for rental and business income tax it refers to the meaning provided under Article 2 (5) ---Derive” means: for the business and rental income tax: for a taxpayer accounting for tax on an accrual’s basis, when the arising of the right to receive; or for a taxpayer accounting for tax on a cash basis, when it is

An income is said to be derived when the taxpayer accounts on an accrual basis from the time the right to receive the income materializes or when the taxpayer accounts tax on a cash basis when the taxpayer receives the amount due. Different instances where an income is considered to be received are discussed under Article 2(15);

 “Received”, includes: (a) applied on behalf of the Taxpayer either at the request of the Taxpayer or under any law; (b) reinvested, accumulated, or capitalized for the benefit of the Tax Payer; (c)credited to an account or carried to a reserve for the benefit of the Taxpayer, or (d) otherwise made available to the Taxpayer;

  • In whatever form paid, credited, or received: - the amount derived is considered as an income irrespective of the mode of payment. It can be in actual payment or in the form of credit. As long as, the benefit is derived by the taxpayer the mode in which it's paid is not a concern.
  • From whatever source derived: source refers to from where a certain income is generated. Then, the question follows….

 

Does the phrase “From Whatever Source” refers to Irrespective of its Legality?

In the event that the taxpayer either mistakenly or intentionally includes an illegal amount derived in a certain year of assessment and where it subsequently transpires that the amount is illegally driven; does this amount form the gross income? As previously discussed, the definition of income is very central to the administration of income tax. Arguably, one of the elements in that definition is “from whatever source”. The element can be understood to have the meaning that any income is legible under this proclamation irrespective of the source it was derived.

For instance, assume a certain driving license institution that issues a license not following the normal procedure—informally known as license selling. At the same time, the institution renders services for formally registered trainees. At the end of each year, the institution reports to tax authorities the aggregated income, from both illegal and legal activities. The question is, is it necessary for the authority to ascertain the legality of the source?

As the law stands currently, the income tax is levied over an income irrespective of the source. This is to say, the means the income is derived is not a point of concern for taxing authority. The mere fact the accrual or receiving of a certain benefit in cash or in-kind exists, the source is not an issue to worry about. One of the defining elements for income is the phrase which reads as “from whatever source” and this, in turn, underscores the taxing authority has no onus to ascertain the legality or the illegality of the income.

Concluding Remark

Some scholars do have the belief that the benefits from illegal activities are virtually non-taxable. For this assertion, they provide two reasons; administrative limitation and legal limitation. Concurring with administrative limitations, I have a dissenting opinion on legal limitations. As long as the income appears on the taxpayer income statement, the source of income is irrelevant. Simply taxing authorities should impose the respective income tax on it. Any practice which requires an explanation of the source is against the very definition of income. I would say, at least theoretically, illegal income is taxable.

 

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Friday, 02 December 2022