A Research Proposal On:

Vat Audit Practice and Its Significance: A Case Study in

Ethiopian Revenue and Customs Authority, Hawassa Branch

By:
Hiwot Demissie

ID No.: 007/08

A Research Proposal Submitted to Accounting Department for

the Requirement of Fulfillment of the Course Research

Advisor:
Mr. Sintayehu Gurmessa (MBA.)

January, 2017
Hawassa, Ethiopia
 ACKNOWLEDGMENTS
Above all, I would like to express my deepest heartfelt thanks to God whose hand support
me all in my life time, and for this research proposal he gives me the potential in all
aspects.

And also,I would like to express my heart felt gratitude to my Advisor Mr. Sintayehu G.
(MSc.) for his guidance and valuable support for the preparation of this research
proposal.

In addition, I would like to thank my classmate because of the availability from all of
them while discussing the topics, and ideas of this Research proposal session.

I
 ABSTRACT
This study will be assess the existing VAT audit practice in the case of Ethiopia Revenue
and Customs Authority, Hawassa Branch and find out the extent to which the VAT audit
contributed to enhancing government revenue in the context. This study will be
conducted based on data obtained from ERCA, Hawassa Branch, specifically focusing on
VAT audit. The unit of analysis is VAT audit and the concerned section is the audit unit
(wing) in the organization.

Additionally the study will be conducted to investigate the tax audit practice, and to
identify the main problems of the tax audit program performed that affects tax revenue
collection and taxpayers‟ voluntary compliance in the Ethiopian tax system. The study
will be adopted both quantitative and qualitative approaches. Specifically, the techniques
used in the study include survey with tax auditors and investigators, in-depth interviews
with tax officials and taxpayers, and documentary analysis.

The objective of this research is, therefore, to review and examine the tax audit practice
of Ethiopia Revenue and Customs Authority, Hawassa Branch with respect to the type of
audit performed and its aptness, case selection methods used, audit techniques applied,
the frequency of audit performed, and education level and experience of auditors.

II
 TABLE OF CONTENTS
ACKNOWLEDGMENTS ................................................................................................... I

ABSTRACT ........................................................................................................................ II

TABLE OF CONTENTS .................................................................................................. III

ABBREVIATIONS ........................................................................................................... V

CHAPTER ONE ................................................................................................................. 1

1 INTRODUCTION ........................................................................................................... 1

1.1 Background of the Study .......................................................................................... 1

1.2 Statement of the Problem .......................................................................................... 3

1.3 Research Questions ................................................................................................... 5

1.4 Objectives of the Study ............................................................................................. 6

1.4.1 General Objective of the study .......................................................................... 6

1.4.2 Specific Objective of the study .......................................................................... 6

1.5 Significance of the Study .......................................................................................... 6

1.6 Scope of the Study .................................................................................................... 6

1.7 Limitations of the Study............................................................................................ 7

1.8 Organization of the paper.......................................................................................... 7

CHAPTER TWO ................................................................................................................ 8

2 REVIEW OF RELATED LITERATURE ....................................................................... 8

2.1 Introduction ............................................................................................................... 8

2.2 The Meaning and Development of Value Added Tax .............................................. 9

2.3 Tax evasion and avoidance ....................................................................................... 9

2.3.1 Tax evasion ........................................................................................................ 9

2.3.2 Tax Avoidance ................................................................................................. 10

III
 2.4 Tax audit as a tool for VAT administration ............................................................ 11

2.4.1 VAT Administration ........................................................................................ 11

2.4.2 The Meaning and Role of Tax Audit ............................................................... 12

2.5 Audit of Government Revenues ......................................................................... 13

2.6 The roles of the taxpayer audit program ................................................................. 15

2.7 Scope and Extent of Tax Audit ............................................................................... 16

2.8 Need for tax Audit .................................................................................................. 17

2.9. Types and Location of Tax Audit .......................................................................... 18

CHAPTER THREE .......................................................................................................... 21

3 RESEARCH METHODS, MATERIALS AND PROCEDURES ................................. 21

3.1 Background of the organization .............................................................................. 21

3.2Description of the study area ................................................................................... 21

3.3Study Design ............................................................................................................ 22

3.4 Sample and Sampling Techniques .......................................................................... 22

3.5 Source of Data and materials .................................................................................. 22

3.6 Method of Data Analysis ........................................................................................ 22

TIME AND COST BUDGET PLAN ............................................................................... 23

Time Frame ................................................................................................................... 23

Cost Breakdown ............................................................................................................ 23

REFERENCES ................................................................................................................. 24

APPENDIX ....................................................................................................................... 25

APPENDIX 1: QUESTIONNAIRE ............................................................................. 25

APPENDIX 2: INTERVIEW GUIDE .......................................................................... 29

IV
 ABBREVIATIONS
AAA American Accounting Association

COBAC Committee on Basic Auditing Concepts

ERCA Ethiopian Revenues and CustomsAuthority

FGE Federal Government of Ethiopia

INTOSAI International Congress of International

Organization of Supreme Audit Institutions

SAI Supreme Audit Institutions

SPSS Statistical Package for Social Science

TIN Tax IdentificationNumber

VAT Value Added Tax

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CHAPTER ONE
1 INTRODUCTION

1.1 Background of the Study

Government has played an important role in the socio economic development of society. Social
development may be in the form of raising the level of living and social welfare in the form of
providing social amenities to the people. Social amenities are in the form of education, health
and sanitation, utilities like electric supply, water supply etc, and recreation facilities. The
process of socio-economic development requiring huge expenditure cannot be carried unless the
government has the perennial source of income. Every government has two important sources of
revenue. These are tax sources and non-tax sources (Mekelle University, Public Finance and
Taxation Module, n.d.).

Tax is one of the most important sources of revenue to every government. In the earlier days,
payment of taxes was optional (Mekelle University, Public Finance and Taxation Module, n.d.).
A choice was given to the people to pay the tax and to avail the benefit of social amenities in the
form of education, health and sanitation, utilities and recreation facilities. Naturally, everyone
interested in availing social amenities used to evaluate the benefit derived by him in exchange
for the tax to be paid by him. But the option in the payment of tax created lot of problems for the
government in fulfilling their obligations to society. Hence, in modern times, the option was
withdrawn and tax became a compulsory contribution by every citizen to the government to
enable the government to fulfill its commitments towards society (Mekelle University, Public
Finance and Taxation Module, n.d.).

Taxation forms an important part of the fiscal policy of any government. This is because it is
through taxation that the government can raise the revenue required for recurrent and
development expenditure. Citizens of any country have a civic obligation of paying taxes to the
government so as to enable it meet the cost of providing social and economic services. Setting up
an efficient and fair tax system is, therefore, essential for every nation in the globe, and
especially in developing countries like Ethiopia where there has been deep-rooted socio-
economic problems and increased demand for government services, infrastructures, and social

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welfare. The ideal tax systems in these countries should raise sufficient revenue and reduce
government borrowing, and should do so without discouraging economic activity.

In order to minimize the complexity of tax administration, enhance taxpayer compliance, and
encourage investment, the Federal Government of Ethiopia (FGE) has launched a tax reform
program. The government conducted a tax reform program to improve the tax system as a whole.
The reform program had two components, overhauling of the tax legislation and improving the
tax administration, both of which aimed at establishing a sustainable domestic revenue base
through modernizing the tax system, encouraging saving, trade and investment. The tax reform
included issues like changing policies to address the problem of insufficient revenue, correct
distortions that reduce economic welfare and growth, and take measures to reduce inequalities.
On the part of the government, establishing new tax laws and proclamations had made its
intention as to collect “new” and “additional” revenue there by widening and deepening its tax
base for which it needs to cover its fiscal and budgetary needs (Income tax
proclamation,286/2002). In doing this, a number of reform measures were taken including policy
and legal issues, institutional arrangements, as well as updating the tax system existed for years.
The enactment of the income tax proclamation No. 227/2001, which was decreed on the 4 th of
January, 2001 by the House of People’s Representatives (the parliament) was an important move
and indicator of governments’ commitment to pursue the reform program to facilitate
compliance and improve efficiency of the tax administration.

Following the income tax proclamation, the FGE continued to issue other tax laws, and two such
proclamations include Proclamation No. 285/2002, called the VAT proclamation, and
Proclamation No. 307/2002 - Excise Tax proclamation. The introduction of VAT (Value Added
Tax) system that replaced what was known as sales tax is, therefore, one of the most important
outcomes of the reform measures taken regarding taxation in Ethiopia. VAT is a transaction tax
collected on all goods and services at all stages of production and distribution. It is an indirect
tax and is collected on the value added at each stage. Value Added is the difference between the
sales and the value of purchases at that stage (Mekelle University, Public Finance and Taxation
Module, n.d.). The collection of VAT begins with importers or producers and ends with the
retailers. The amount of VAT collected from a transaction at different stages of distribution will

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be equal to the total amount of sales tax collected from one stage of the distribution on that
taxpayer against tax payable by him on sales (Mekelle University, Public Finance and Taxation
Module, n.d.).

VAT is the most prevalent form of consumption tax in the world. Globally, the advance of the
VAT is the most significant development in the field of the taxation in the past 50 years. VAT
started in the 1960’s in Europe and America; while in Ethiopia it started in the 21st century under
the above mentioned proclamation. The VAT proclamation in Ethiopia puts forth so many
requirements and procedures as to who will pay VAT and how. Implementation of the system is
one thing; and monitoring the system, continuous follow up, and ensuring compliance is another
thing. The proper administration and operation of these components in turn depend on the
accepted working norms and guidelines to frame its contribution to tax management.

Although tax revenue of the Ethiopian government seems to be increasing from time to time,
little is known as to how much the tax payers complied with the rules and the degree to which
tax evasion has been minimized and/or completely avoided. An important monitoring system to
ensure tax payers compliance with the existing VAT proclamation and in turn increase
government tax revenue is, therefore, to place an audit system, in particular VAT audit. The
purpose of this study is, therefore, to assess the existing VAT audit practice in the case of
Ethiopia Revenue and Customs Authority, Hawassa Branch and find out the extent to which the
VAT audit contributed to enhancing government revenue in the context.

1.2 Statement of the Problem

The VAT system has emerged as a consumption tax of choice. A well designed VAT does not
disrupt trade and investment and is highly successful in applying appropriate tax administration
system. These neutrality features are important for the proper functioning of common markets,
such as the Euro and free trade areas, which does not permit discriminatory tax on imports or
subsidies on exports. Beyond that the VAT is productive, stable, and flexible source of
government revenue. Since VAT is collected on current basis, say, monthly, its revenue
generating capacity is not affected by inflation and the effect of rate changes on revenue is
immediately visible. While VAT scores high on neutrality to pay basis, but this should not be

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acceptable if adjustment to income tax social benefit schemes can be made. In sum, the timing
of tax collections under the VAT is as under a retail sales tax. Under both taxes, net tax is
collected only when taxable products leave the ring of registered firms and are sold to final users
or why not impose the tax at retail only (Operational program development, ERCA 2005
manual).

Although a 15 percent VAT is charged on consumption of goods in Ethiopia, the level of

compliance among tax payers and/or organizations registered for VAT needs close monitoring. It
seems that there are a number of deficiencies in the implementation and management of the VAT
system from the perspective of the tax payers, registered businesses, as well as the tax authority
itself. Violations of VAT provisions jointly by the tax payers and businesses registered for VAT
through collaborating and not disclosing all taxable transactions seems to be a deep-rooted
challenge in the existing system, which is likely to degrade revenue generation capacity of the
government and hence impair public investment programs in the nation at large. If there is any
failure from the side of the concerned tax authority to regularly check (monitor) the system and
ensure compliance from businesses, the problem would become very much serious and the tax
collected from consumers might end up in the hands of businesses. This is both unfair and
illegal. People pay tax at least to enjoy common, public facilities equally and with better
advancement from time to time. Failure to monitor compliance through an audit process will
have negative consequences both in the short-run and in the long run. The habit of compliance
will be degraded and increased tax avoidance likely to follow by other businesses.

An audit, therefore, plays a central role in VAT administration especially considering historical
and cultural norms and practices as well as people’s attitude towards paying tax in the context.
As audit plays a central role, preparation and use to VAT audit manual is of the highest priority
in facilitating audit and assessment functions. Here, an audit is a selected verification of tax
payers declared tax liability which always involves a review of taxpayer’s book of accounts,
related records, 3rd party information, general tax payers, and etc. When analysis of the tax
payers compliance pattern justifies for audit and investigation of the tax payers files, the tax
office either applies spot or compressive audit to test the reliability of the tax affairs dealt with
the choice and preference of the one to another is dependent on the magnitude of the tax risk

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associated with the 0case and the number and qualification of the existing audit. (L. Kharkongor,
Commissioner of Taxes, Meghalaye, March 2009).

This study aims at investigating the VAT audit practice, problems/challenges frequently
encountered in the process, and the contribution of the audit to enhancing government revenue in
view of evidence from ERCA, Hawassa Branch Office. Specifically, the study seeks to provide
answers to the following question:

 Is VAT audit properly planned, executed, and monitored by the concerned employees
and officials of the tax authority?
 What are the major problems/challenges encountered during VAT audit?
 Does the existing VAT audit practice contributed to enhancing government revenue?

1.3 Research Questions

The researcher formulates the following research questions
 Does ERCA, Hawassa branch perform appropriate range of tax audit types targeting
noncompliant taxpayers?
 Does ERCA, Hawassa branch have adequate tax audit resources?
 What is the degree of the frequency and/or rate of tax audit performed?
 Does audit case selection methods and audit techniques used appropriate?
 What looks like the experience and capability of auditors participated in audit practices as
required by international standards?

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1.4 Objectives of the Study

1.4.1 General Objective of the study

The main objective of the study is to conduct detailed assessment regarding VAT audit practice,
identify the challenges, and its significance in view of evidence from the Ethiopian Revenue and
Customs Authority, Hawassa Branch Office.

1.4.2 Specific Objective of the study

 To identify whether VAT audit has been planned and executed (practiced) as per the
audit manual developed by the organization.

 To identify major VAT risks and methodologies used to audit VAT.

 To show the impact of VAT audit on government revenue; and

 To analyze the achievements and challenges regarding VAT audit in the context.

1.5 Significance of the Study

The results of this research may have different benefits to various stakeholders.

 It may draw additional attention from the government, and the tax authority in
particular, towards VAT audit and its potential benefits.
 Provides significant input for other researchers who are willing to make further
investigation regarding the issue;
 Helps readers to improve their knowledge regarding the issue; and
 It may be used as an additional source of reference.

1.6 Scope of the Study

There were different forms of audit in general and tax audit in particular. VAT is an indirect tax
and is more prone to evasion and/or embezzlement by the tax payers. So putting in place a proper
audit system and continuous follow up to ensure compliance is a critical issue, though it has also
been quite challenging to realize. The study deals with the extent to which VAT audit has been
practiced and/or implemented as a system, the contribution of the audit to government revenue,
and the challenges associated with it focusing only on the ERCA, Hawassa Branch Office.

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1.7 Limitations of the Study

The major limitation of the study will be lack of literature and empirical study regarding the
issue at hand. So much effort is needed to collect documents and necessary information
regarding VAT audit. The other limitation might be the challenges to obtain necessary data from
the concerned officers as well as lack of willingness among the respondents to fill and return the
questionnaire timely. The distribution and collection of questionnaires may take more time.
Shortage of time, finance, workload, as well as unavailability and shortage of data regarding
VAT audit practice are also the major limitations of this research.

1.8 Organization of the paper

The study will be organized into five chapters. The first chapter is an introduction and includes
background of the study, statement of the problem, objectives, significance of the study, scope,
limitations.The second chapter consists of review of related literaturestheoretical studies and
empirical studies in the area. The third chapter deals with the research design including the
methodology adopted and techniques used in data collection and analysis is offered.The fourth
chapter deals with data analysis and interpretation. Finally the fifth chapter presents conclusions
and recommendations.

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CHAPTER TWO
2 REVIEW OF RELATED LITERATURE

2.1 Introduction
It is commonly understood that every government seeks to raise revenue, mainly through
taxation, in order to pay its expenditure on infrastructure development (Wakie, 2010:
38).According to Jayakumar (n.d.), “… a government should tax its people like a shepherd
shears a flock or a bee gets nectar from a flower”. The tax is levied not only on products but
services that is the source of revenue for the government to plan for development activities in the
country (Jayakumar, n.d.). Tax is one of the most important sources of revenue to every
government. In fact, governments also generate their revenue from non-tax sources as well
(Mekelle University, Public Finance and Taxation Module, n.d.).

There are different types of taxes levied by government, and Value Added Tax (VAT) is one
type of such taxes that is specifically levied on consumption of goods and services in a given
economy. Value Added Taxmeans the tax which is payable only on value-added and it
istheprincipalmeansofindirecttaxationinmanycountries (Alemayehu, 2010).Indirect tax system
plays an important role in the economic development of a country by influencing the rate of
production and consumption (Alemayehu, 2010; Jayakumar, n.d.). VAT is multi-point tax
system but without the effect of double taxation (Jayakumar, n.d.). Value is added to the
products, which an organisation buys from other organisations such as raw materials, partly
finished goods, etc. After buying the organisation applies its own labour and machine to
manufacture the final products (Jayakumar, n.d.).

Once the VAT system is put into place, proper monitoring and follow up (i.e. implementation or
administration) of the system becomes critical. Tax administrations spend large amounts of their
resources in monitoring and controlling tax evasion (Bergman and Nevarez, 2006). “Is it worth
it”, Bergman and Nevarez (2006) ask. What is the role of institutional enforcement such as tax
audit in enhancing compliance? The issue of whether tax audits results in individual’s
compliance with taxes has been studied and contradicting findings obtained (Bergman and
Nevarez, 2006).In this chapter, therefore,the researcher reviews the literature on the concept of

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VAT and its procedures, and then discusses about the nature and role of tax audit in general and
VAT audit in particular.

2.2 The Meaning and Development of Value Added Tax

The value added tax (VAT) is simply a multistage sales tax that exempts the purchase of
intermediate goods and services from the tax base (Alemayehu, 2010; Jayakumar, n.d.). Value
added is the difference between sales proceeds and purchases of intermediate goods and
services over a certain period. For example, the value added for a supermarket is the
difference between the total sales receipts that month and the total invoice for goods and services
from its supplier. Ultimately, consumers carry the burden of the tax because everyone else in the
process deducts the VAT paid on inputs from the VAT collected on their outputs. Since,
consumers have no intermediate transactions to offset the tax liability to the extent to which they
purchase intermediate goods and services they carry the burden of the tax (Alemayehu, 2010).

2.3 Tax evasion and avoidance

Tax evasion and avoid a cearea world wide phenomenon (Alemayehu, 2010:15)

The problem is especially acutein transition and developing economies, since they do no thave
an appropriate infrastructure in place to collect taxes (McGeeandTyler, 2006 as cited in
Alemayehu, 2010: 15 -16).Tax avoidance is the legal arrangement of the tax payer’s affairs in
order to minimize the tax liability, where as tax evasion is illegal. Sometimes, however, the
border line between avoidance and evasion can become blurred, a fact that is evidenced by the
huge body of anti- avoidance legislation and the development of caselaw in this area
(Nightingale, 2003 as cited in Alemayehu, 2010: 16).

2.3.1 Tax evasion

Tax evasion involves the intentional disregard of the legislation in order to escape the liability to
tax (Alemayehu, 2010: 16).Tax evasion may be achieved by understating income, overstating
expenses, making false claims for allowances or failing to disclose a chargeability tax. Because
of its illegal nature, there is little hard evidence as to measure the true extent of tax evasion
(Alemayehu, 2010: 16).Whatever the actual level of evasion, it is likely to be more prevalent
when the tax system is perceived to be unfair or levied at confiscatory rates (Nightingale,2003

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as cited in Alemayehu, 2010: 16).Tax evasion is illegal and the off ender may be liable to
prosecution, however, the authorities will usually only resort to criminal prosecution
wherethecaseinvolvessubstantialamountoflostrevenue,manyminorcasesof tax evasion that are
discovered by the revenue are generally steeled out of court Alemayehu, 2010: 16)

Like all taxes, VAT issue object to evasion (Alemayehu, 2010: 16).It is vulnerable to
evasion and fraud. Fore example, traders may fail to register for the tax, they may under report
sale sor, where different good are subject to tax at different rates, they may reduced heir tax
payments by misclassifying sales in to the category subject to a lower rate (orzerorate) of tax
(Alemayehu, 2010: 16).In some respects, the particular structure of VAT may reduce its
exposure compared with other systems of sales taxation. In particular, the gradual accumulation
of the tax at each stage of the chain of production and distribution may reduce the amount of tax
at stake teach stage, and hence the gains to bema deform making untaxed sales (Alemayehu,
2010: 16). This does not make the VAT ‘self-enforcing’, as sometimes claimed, but it does
reduce its exposure to evasion compared withal tentative single-stage sales taxes levie data
comparable late, such as their tail sales taxes (Alemayehu, 2010:16).

2.3.2 Tax Avoidance

A tax such as VAT can be avoided simply by not buying the taxed good or services
(Alemayehu, 2010: 17). The arrangement of an individual’s affairs so astomitigate the
liability to tax is tax avoidance, and provided that the tax pays erect switch in the frame work of
the law, tax avoidance is legal. However, where the activity is within the letter of the law but
outside the sprite of the law, the distinction between avoidance and evasion may become blurred
(Nightingale2003 as cited in Alemayehu, 2010: 17-18).Many form of tax avoid an
cearemerely tax planning opportunities that existing the legislation for reducing the liability to
tax, for example, choosing the most tax efficient savings and investments ,ormaking sure that all
available relief are used to their full advantage (Alemayehu, 2010: 18).

As Alemayehu (2010: 18) further states, ‘loopholesin the legislation also create opportunities
fortaxavoidance’.However,onceloopholeshavebeenexploited,therevenuereacts by introducing
legislations to close those particular loopholes (Alemayehu, 2010: 18). The issuance of new
regulations or legislations to combat tax avoidance practices are, however, followed by some

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adverse consequences. The increasing body of anti-avoidance legislation merely makes the tax
system more complicated, detracting from the cannon of simplicity even though it has been
suggested that ‘an economy breaths through its loopholes’(Alemayehu, 2010: 18).The tax
avoidance industry grew to enormous proportions during the1970 sashighrates of tax mate the
costelaborateavoidanceschemesworthwhile,supportingtheviewthat‘theexistence of wide spread
avoidance is evidence that the system, not the tax payer ,stand inneed of radical
reform’(Alemayehu, 2010: 18).

2.4 Tax audit as a tool for VAT administration

2.4.1 VAT Administration
The major activities in VAT administration are identification and registration of tax payers,
processing returns, controlling collections, making refunds, auditing taxpayers, investigation of
tax fraud and evasion, and leaving penalties (Alemayehu, 2010). On the part of administration, it
is a prior ask to identify the tax payers. In this connection, preparation of a single master file,
based on unique Tax Identification Number (TIN) is crucial and this ensures that each taxpayer’s
account contains all there levant tax and payment data for the tax payer alone(Alemayehu, 2010).
The TIN system has the advantage of aiding to draw a comparison of tax statistics with the
national accounts, facilitating proper use of the data base of various systems, and enhancing the
financial recording system of the business communities.

In all countries that have implemented the VAT, bookkeeping requirements are almost the same
(Alemayehu, 2010). Nevertheless,there are differences in invoicing. In most industrialized
countries, invoices are required to be issued for transactions between VAT tax payers
(Alemayehu, 2010). Most developing and least developed countries that introduce the VAT, by
contrast, require some form of invoicing for all transactions on which VAT is charged, including
sales to final consumers by using a simplified form of invoice or a cash register receipt
(Alemayehu, 2010).Even though, there are complaints from the side of business persons that this
adds to VAT compliance costs, most tax authorities in developing countries believe that this is
essential for VAT enforcement. In addition, there is a conviction that when traders are required
to issue invoices to final consumers they will not under state their sales and in turn gives the man
incentive to demand invoices from their suppliers (Alemayehu, 2010).

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2.4.2 The Meaning and Role of Tax Audit
An audit is defined as an“independent examination of financial statements and related
financialinformation of an entity, whether profit oriented or not, and irrespective of its size,or
legal form, when such an examination is conducted with a view to expressing an opinion
thereon” (Gebeyehu, 2008: 11).The American Accounting Association (AAA) has provided the
following(broad0 definition of audit (as adopted from Gebeyehu, 2008: 11): a systematic process
of objectively obtaining and evaluating evidence regardingassertions about economic actions and
events to ascertain the degree of correspondence between those assertions and established criteria
and communicating the results to interested users (Gebeyehu, 2008: 11).

In a narrower sense, audit is an “attestation communication” because it presents the auditor’s

opinion or judgment concerning the degree of correspondence between accounting information
and established criteria (Gebeyehu, 2008: 11).

Historically, the audit function conducted by public accountants has been associated with this
activity of attesting to financial statements (Gebeyehu, 2008: 13).Tax audit (expected to be
performed by public accountants) can be thought of as an extension of this “attest function”. For
tax purpose, one assesse is liable to file a return to the concerned assessing officer with
supporting documents sometimes required by tax law for simultaneous submission with the
return. The assesse is sometimes called for by the assessing officer under the tax law for
producing the same. In this context, the question of tax audit may arise. And “tax audit” means to
audit an assesses accounting and other documentary evidences to prepare the correct tax return as
well as to prepare the statements showing the detailed computational working for different heads
of income or items in tax return and other required evidential statements regarding allowances
and disallowance for deductions and all these are to be followed by an audit report giving the
auditor’s opinion about the degree of correspondence between the information content in the tax
return and the regulatory provisions of the existing tax laws (Gebeyehu, 2008: 13).2

Thus, tax audit comprises the following as Gebeyehu states:

 Accounts and other evidences are required to comply with the “tax basis of accounting”,
i.e. as per requirement of tax laws;

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 Preparation of tax return, statement of computational working for items in the return and
statements containing particulars of allowances and disallowance for deduction;
 Giving audit report portraying the attest function whether the tax return and statements
have been fairly prepared as per the regulatory requirement of tax (Gebeyehu, 2008: 13-
14).

When we think about who does tax audits, we first think of a public inspector, a civil servant,
integrated in a public organization or agency of the government. Nevertheless, in the field of
private financial statements audit, the audit must comprise all the economic-financial operations,
including the taxes-originated ones, and the auditors opinion must also include whether the
taxpayer has correctly assessed tax liability (Gebeyehu, 2008: 14).

2.5 Audit of Government Revenues

In recognition of the importance of an efficient revenue collection system for mobilizing the
budgetary resources of the government, the need to establish revenue audit as a specialized and
independent domain has been engaging the attention of the Supreme Audit Institutions for quite
some time (Gebeyehu, 2008). As Gebeyehu (2008: 15) states, the International Congress of
International Organization of Supreme Audit Institutions (INTOSAI) held at Rio de Janeiro,
Brazil in May, 1959 recommended the following:

 Supreme Audit Institutions (SAI) ought to exercise the broadest possible supervision of
revenues.
 Supervision should not be limited to the checking of collection of revenues in line with
the accounts rendered by the collectors but, wherever possible, a check should be made to
see whether or not tax payments were in line with legislation.
 SAIs should ascertain whether there has been negligence in the matter of collections or
exaggeration in the estimates.
 The SAIs ought to be equipped to carry out their duties, especially as regards supervision
of revenues, with mechanized accounting and statistical services (Gebeyehu, 2008: 15).

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The concept of tax audit was a sub-theme in the Third International Seminar of ASOSAI held at
Bali, Indonesia in June 1988 (Gebeyehu, 2008: 16). The following guidelines were
recommended in the area of tax audit (as adopted from Gebeyehu, 2008: 16-17).

a. Audit mandate: SAIs should seek clear and specific legal authority for undertaking
comprehensive tax audits in conformity with the relevant provisions of the Lima
Declarations on Auditing Precepts.
b. Audit of individual tax assessments: It is important that individual tax files are examined
to evaluate the adequacy of the system and procedures of tax assessment and collection.
As the examination of all tax files is neither feasible nor necessary, best results may be
obtained while concentrating on high value and risk areas. Selective auditing of business
income cases rather than salary assessment, investigations of reported evasions and use of
suitable statistical sampling techniques in the review of files are preferred practices. Data
and information on tax payers collected by the tax authority may be verified against other
independent sources available.
c. Interpretation of tax laws: SAls(Supreme Audit Institutions) should scrutinize the rules,
regulations and notifications issued by the executive agencies under the tax statutes.
d. Scrutiny of decisions of tax authorities: Where quasi-judicial and discretionary powers
are vested in the tax officials, any decisions taken in the exercise of such powers should
be scrutinized in audit.
e. Audit methodology: Audit should be mainly system based and the objective should be to
discover loopholes, lacunae and deficiencies not only in tax administration but also in tax
laws. Adequate procedures for identifying and dealing with tax avoidance rising from
deficiencies in laws could be considered so that remedial action including amendments to
the laws could be taken promptly.
f. Socio-Economic implication of taxation. The social and economic goals proposed to be
achieved through tax concession and relief should be reviewed in audit.
g. Reporting on the results of tax audit: Having regard to personal privacy considerations, it
is imperative that confidentiality be maintained in reporting individual assessments in the
audit reports.

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h. Training of tax auditors: Tax audit is a specialization which requires thorough knowledge
of the relevant laws and regulations. SAIs should provide intensive and frequent training
for tax auditors taking advantage of the training facilities available in their local tax
department's training institutions as well as those in other SAIs(Gebeyehu, 2008: 16-17).

2.6 The roles of the taxpayer audit program

The tax audit program of a revenue body performs a number of important roles that effectively
carried out & can make a significant contribution to improved administration of the tax system
(Gebeyehu, 2008). The major benefit or role of the tax audit program seem to be the following:
promotion of voluntary compliance, detection of non-compliance at the individual taxpayer
level, gathering of information on the “health” of the tax system, gathering of
intelligence/information on evasion and avoidance, educating taxpayers, and identifying areas of
the law that require clarification (Gebeyehu, 2008). He briefly explains each of these roles as
presented below:

 Promote voluntary compliance: The primary role of the audit program is to promote
voluntary compliance by taxpayers with the tax laws. It seeks to achieve this by
reminding taxpayers of the risks of noncompliance and by engendering confidence in the
broader community that serious abuses of the tax law will be detected and appropriately
penalized (Gebeyehu, 2008: 17-18).

 Detect non-compliance at the individual taxpayer level: By concentrating on major

areas of risk (e.g. unreported cash income) and those individual taxpayers most likely to
be evading their responsibilities, audits may bring to light significant understatements of
tax liabilities, and additional tax revenue collections (Gebeyehu, 2008: 18).

 Gather information on the “health” of the tax system (including patterns of taxpayers’
compliance behavior): The results of normal audit activity may provide information on
the general well-being of the tax system. Audits conducted on a random basis can assist
overall revenue administration by gathering critical information required to form
judgments on overall levels of tax compliance, that over time can be used to identify
trends in overall organizational effectiveness and to gather more precise information that

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can be used to inform decision-making on future compliance improvement strategies, to
refine automated risk-based case selection processes, and even support changes to tax
legislation (Gebeyehu, 2008: 18).

 Gather intelligence: Audits may bring to light information on evasion and avoidance
schemes involving large numbers of taxpayers that can be used to increase major counter-
abuse projects (Gebeyehu, 2008: 18).

 Educate taxpayers: Audits can assist clarify the application of the law for individual
taxpayers and to identify improvements required to recordkeeping and thus may
contribute to improved compliance by taxpayers in the future (Gebeyehu, 2008: 18).

 Identify areas of the law that require clarification: Audits may bring to light areas of
the tax law that are causing confusion and problems to large numbers of taxpayers and
thus require further efforts by the revenue body to clarify the laws’ requirements and/or
to better educate taxpayers on what they must do to comply into the future. (Gebeyehu,
2008: 19).

2.7 Scope and Extent of Tax Audit

The scope of audit activities varies across countries, in part as a result of the system of
assessment in place. There are two generally accepted systems of tax assessment applied
worldwide (administrative assessment and self-assessment) (Gebeyehu, 2008: 20). In around half
of OECD countries, administrative assessment is employed to varying degrees in the
administration of personal income tax and corporate profits/income tax (Ibid). All countries
administer VAT under self-assessment principles. Assessment systems operate on the principle
that all tax returns should be subject to a degree of technical scrutiny before a formal assessment
is sent to the taxpayer (Gebeyehu, 2008: 20).

In practice, however, much of the scrutiny previously undertaken by technical staff has been
replaced in many countries by the use of automated screening techniques to identify returns
requiring scrutiny before a formal assessment is issued. To the extent that there is some level of
scrutiny carried out by technical officers, it ranges in practice from a very cursory examination of

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some tax returns to a more in-depth examination where further inquiries may be made with
taxpayers (sometimes by correspondence) before a formal assessment is issued. Even countries
that operate administrative assessment regimes complement these arrangements with a formal
program of post-assessment audits. However, in practice such programs tend to be conducted on
a smaller scale than is the case in countries only applying self-assessment principles (Gebeyehu,
2008: 20).

2.8 Need for tax Audit

According to Gebeyehu (2008: 23), four conditions tend to create the demand for the
independent performance of the audit or attest function. These conditions include the following:
conflict of interests between those who prepare accounting information reports and those who
use them; consequence of information to users while using them in decision-making; complexity
of subject matter and audit process; and remoteness of users from subject matter and preparer
(Gebeyehu, 2008: 23).When audit function is extended to tax, these four conditions are also
required to be satisfied (Ibid).

Firstly, the preparer of income tax return and relevant information (the assesse) has a conflicting
relationship in terms of financial interest with his counterpart user or evaluator of the return (the
assessing officer), because manipulated information in the tax return may reduce the tax
liability(Gebeyehu, 2008: 23-24). Second, use of the tax return, assumed to be correct and
complete, may have serious consequence on Government fiscal estimation and collection
thereof. As a result, all the budgetary appropriations may stand for nothing but a baseless
imagination (Gebeyehu, 2008: 24).Third, both financial accounting and tax accounting are
recognized as a much complex discipline due to technicalities and their distinct characteristics of
difficulties (Gebeyehu, 2008: 24).

Finally, between the preparer of the return and the information therein (by the assessee) and the
assessing officer, there exists a wall of remoteness though the latter can call for any additional
information from the former to be satisfied with the completeness and correctness of the
information provided(Gebeyehu, 2008: 24). But sometimes this may not be possible due to time
and cost constraints and some other reasonable causes. In this case, the tax authority can apply

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his best judgment, which may not be the expression of the reality and thus both the parties, the
Government and the assessee may be affected by under- or over-charging of tax. Therefore, all
the conditions creating the demand for audit with respect to tax can be found to be satisfied
(Gebeyehu, 2008: 24).

As Gebeyehu (2008: 25) further indicates, the Committee on Basic Auditing Concepts (COBAC)
suggested that the subject matter of any extension of the audit function must have the following
attributes:

 The subject matter has to be susceptible to the deduction of evidential assertions. Such
assertions have to be both quantifiable and verifiable;
 There has to be an information system to record the actions, event or results thereof;
preferably adequate internal controls have also to be in operation; and
 Consensus should exist on the established criteria against which the information prepared
from the subject matter can be evaluated.(Gebeyehu, 2008: 25).

Each of the attributes stated above is essential. Two additional conditions are also needed. They
are: auditor’s competence and summarization of findings in a report (Gebeyehu, 2008: 25).The
COBAC of AAA has recognized that extension of the attest function to the audit of income tax
return appears to satisfy all the attributes stated above. The subject matter allows the deduction
of evidential assertions, which are verifiable as well as quantifiable. Tax law requires the
maintenance of an “information system” adequate for recording the actions and events, and the
law also serves as a criterion for evaluating the subject matter information (Gebeyehu, 2008: 25).

2.9. Types and Location of Tax Audit

Audits can vary in their scope and the level of intensity to which they are conducted(Gebeyehu,
2008: 27). For this reason, various terminologies have evolved to describe different types of
audit activity. Gebeyehu (2008: 27-28) describes these types as follows:

Full audits – The scope of a full audit is all-encompassing. It typically entails a comprehensive
examination of all information relevant to the calculation of a taxpayer’s tax liability for a given
period. The objective is to determine the correct tax liability for a tax return as a whole. In some

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countries full audits are carried out as part of random audit programs that are used to gather data
on the extent, nature and specific features of tax compliance risks, for compliance research
purposes and/or the development of computerized audit selection formulae. Given their broad
scope, full audits are typically costly to undertake a substantial program of full audits will require
considerable resources and reduce the rate coverage of taxpayers that could otherwise be
achieved by a more varied mix of audit types (Gebeyehu, 2008: 27-28).

Limited scope audits – Limited scope audits are confined to specific issues on the tax return
and/or a particular tax scheme arrangement employed by the taxpayer. The objective is to
examine key potential risk areas of noncompliance. These audits consume relatively fewer
resources than full audits and allow for an increased coverage of the taxpayer population
(Gebeyehu, 2008: 28).

Single issue audits [spot audit] – Single issue audits are confined to one item of potential non-
compliance that may be apparent from examination of a tax payer’s return. Given their narrow
scope, single issue audits typically take less time to perform and can be used to review large
numbers of taxpayers involved in similar schemes to conceal non-compliance (Gebeyehu, 2008:
28).

According to Alemayehu (2010: 32), the ERCA at the Federal level uses Comprehensive audit,
Issue audit as well as Desk audits. It uses the comprehensive and issue audit jointly (Alemayehu,
2010). He further explains these types of audit as follows:

Comprehensive audit - Comprehensive audit execute without restriction on all the records of the
organization. It is generally a check of selected aspects of tax payers’ record. Its goal is to
minimize evasion through frequent control checks so that evasion can be quickly identified and
penalized. Therefore, during audit, the auditors either could check the whole records of the
organization(Comprehensive audit) or selected records (issue audit).Evenif,the results of a
Comprehensive audit will give better result and useful to combat compliance risk; it will
consume relatively much time (Alemayehu, 2010: 32-33).

Desk audit – Desk audit is done as checking for arithmetic accuracy, calculating ratio from the
return data and checking for completeness, and soon. It is conducted in the tax office without

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discussion with the tax payers. This activity is essentially clericalandisbest automated as far as
possible. Desk audit was introduced in ERCAsinceTer1, 2001 E.C. (January9, 2009) as a
campaign form. The aim of the desk audit is to clear the information gap and check the
consistency of the tax payers’ report. For instance, if their existing a discrepancy in the sales
amount between for the VAT purpose and income tax purpose, a desk audit will be done to
correspond the two reports. According to the tax and audit team coordinator of ERCA, it will
continue until the authority clears the existing information gaps. An advantage of desk audit over
the Comprehensive audit is that an audit or can verify many files. Nevertheless, the desk audit is
not replacing the Comprehensive audit, since their ultimate goal is quite different (Alemayehu,
2010: 33).

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CHAPTER THREE

3 RESEARCH METHODS, MATERIALS AND PROCEDURES

3.1 Background of the organization

The Ethiopian Revenues and Customs Authority (ERCA) is the body responsible for collecting
revenue from Customs duties and Domestic taxes. In addition to raising revenue, it is responsible
to protect the society from adverse effects of smuggling and contraband. It seizes and takes legal
action on the people and vehicles involved in the act of smuggling, any tax evasion and
avoidance while it facilitates the legitimate movement of goods and people across the border.

The Ethiopian Revenues and Customs Authority (ERCA) was established by the proclamation
No .587/2008 on 14 July 2008, by the merger of the Ministry of Revenue, Ethiopian Customs
Authority and the Federal Inland Revenue Authority for the purpose of enhancing the
mobilization of government revenues, while providing effective tax and Customs administration
and sustainability in revenue collection. The main objective of the establishment of ERCA was
to streamline the public revenue generation function by bringing the relevant agencies under the
umbrella of the central revenue collector body.

3.2 Description of the study area

The study will be conducted in Hawassa town, on Ethiopian Revenue and Customs Authority,
Hawassa Branch.

Hawassa is located in the Southern Nation’s Nationalities and Peoples Region on the shores of
Lake Hawassa in the Great Rift Valley. It’s located at about 273 km south of Addis Abeba. It
served as the administrative center of the Southern Nations Nationalities and Peoples Region.

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3.3 Study Design
For this study, the researcher applied descriptive analysis using the fact that a descriptive
research design is used to describe the data and characteristic about what is being studied.

3.4 Sample and Sampling Techniques

For this study the researcher used purposive sampling technique. This method is chosen because
the information can be obtained from these targeted respondents and/or the concerned unit than
all employees of the Branch. Attempt will be made to participate all of the employees and
officials who are responsible for tax audit in the organization.

3.5 Source of Data and materials

Both primary and secondary data will be used in the study, which will be gathered from
respondents and published and unpublished documents and reports. The primary data will be
obtained from respondents through structured interview and questionnaire to get the best possible
information from the employees of the Ethiopian Revenues and customs Authority, Hawassa
Branch. In addition to primary data, secondary data will be obtained from official documents and
reports of the Branch Office such as audit reports, VAT audit manual, and revenue reports. Also
the secondary data will be collected from existing published and unpublished materials and
proclamation which explain about VAT, VAT audit, etc. and regulations, books, manuals,
journals, magazines, research and working papers etc.

3.6 Method of Data Analysis

The data gathered will be analyzed both qualitatively and quantitatively and necessary inferences
will be drawn in the study. Statistical Package for Social Science (SPSS) version software 20.0
will be used to analyze the quantitative data. The quantitative analysis will be conducted using
descriptive statistical techniques such as percentages, trend figures, ratios, etc. Tables, charts,
and graphs will be used to present the data.

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TIME AND COST BUDGET PLAN

Time Frame
No Activity Nov. Dec. Jan. Feb. Mar. April May June

1 Topic Selection x
2 Preparation of proposal x
3 Collection of useful material x
4 Data Collection x
5 Data Analysis and writing of x x x
final research
6 Submission of research x
7 Presentation of final research x

Cost Breakdown
Item Quantity Per unit (Birr) Total Cost (Birr)
and

Paper 1 100.00 100.00

Pens 5 5.00 25.00
Pencil 1 2.00 2.00
Equipment
stationary

Binder 1 25.00 25.00

Total Cost - - 152.00
Transportation 10 trips 12.00 120.00
Internet 200hrs 0.30 60.00
Typist 1 200.00 200.00
Personal cost

Total cost - - 532.00

Contingency - - 300.00
Overall total cost - - 832.00

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REFERENCES
 Bhata, H.L. (1998).Public Finance, 19th ed. Vikas Publishing House Pvt. Ltd, New
Delhi.
 Federal NegaritGazeta, (2001)”Income Tax proclamation (Amendment ) No.227/2001
“7th year No.9, Addis Ababa/ Ethiopia
 Federal NegaritGazeta, (2002) Income Tax proclamation No.286/2002”; 8th year N0. 34,
Addis Ababa/ Ethiopia.
 Federal NegaritGazeta, Income Tax Proclamations No 286/2002, 4th July 2002, 8th year
No 34, Addis Abeba, Ethiopia.
 Federal NegaritGazeta, Value Added Tax Proclamations No 286/2002,4th July 2002,8th
year No 33, Addis Abeba, Ethiopia
 Federal NegaritGazeta, Excise Tax Proclamations No 307/2002, 31st Dec.2002, 9th year
No 20, Addis Abeba,Ethiopia.
 Gunther Taube and HelawuyTades, (1996) “Presumptive Taxation in sub- Saharan Africa
Experiences and prospect “IMF working paper 96/5.
 Gupta, A. (2001). Public Finance and Tax Planning, 1st ed. Anmol Publications Pvt. Ltd,
New Delhi.
 John M.Jordan, IMF Tax Advisor, (1999) “Ethiopia, presumptive Taxation”
Administrative considerations.
 Musgrave Richard (1997). Theory of Public Finance and Practice, 4th ed. McGraw-Hill
Inc. USA.
 P. Tyagi. n.d. Public Finance, 4th ed. Published by Jui Prakash Nathco.
 Victor Thuronyi; (1996) “Presumptive Taxation in thuronyied, Tax law Design and
Drafting”, Vol. 1, Chapter 12, International monetary fund.
 Wikipedia, (2008) “the free encyclopedia”.

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APPENDIX

APPENDIX 1: QUESTIONNAIRE
ZION BUSINESS AND TECHNOLOGY COLLEGE
Department of Accounting
Dear Respondents,
The purpose of this questionnaire is to collect data for the study work in requirement for partial
fulfillment of B.A degree in Accounting inZion Business and Technology College.The study aid
at the assessment of VAT Audit practice & its significance in ERCA in case of Hawassa Branch.
Here to, your response are highly values for successful completion of the study and I would like
immensely appreciate your response for all Question genuinely There, I can assure you that the
information provided by you, will be completely anonymous and will not be used for any other
purpose.

Thank you in advance for your cooperation

Position of the respondent

Qualification
Experience in Tax Related job
Age
Sex
Instruction: Please make a tick () mark you thought appropriate and your opinion for the open
ended questions.
1. Is there any tax audit manual?
Yes No
2. If you have the manual how do you evaluate it?
It is clear and workable it lacks some clarity
It is completely unclear
3. How much do you know the rule and regulation related to tax?
Yes almost all

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Partially I don't know
4. If the answer for No. 3 is I don't know, how do you carry out your audit funding?
Referring rules and regulations
Working with someone who has better knowledge
As per the knowledge gained through education and training
5. What are the types of assessment practiced in Ethiopia?
Administrative assessment Self-assessment both
6. Which type of assessment contribute (generate) higher revenue?
Administrative assessment self-assessment
7. Which type of assessment is exposed to the risk of misappropriation? Why?

8. Do the auditors and investigation staff have appropriate powers of access to information
held by the tax payers and other parties?
Yes No
9. If for the above, the answer is ‘no’, how can an auditor perform its activities?

10.Do the respective government officials give/pay close attention for the tax audit for
example by assigning appropriate & skilled persons allocating sufficient resources?
Yes No
11.What are the types of audit most usually applied?
Full audit limited scope audit single issue audit
Any of the three as appropriate depends on the risk identified
12. How do you measure the effectiveness of any audit technique?
Yield & productivity measures
Volume measures
Quality measures
A combination of two or more of the measured as appropriate

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13. Is there a mechanism to evaluate the audit activities?

Yes No
14. If the answer is "yes" who and how is it going to be evaluated?

15.How are audit cases selected?

16.Is only one individual auditor selecting the cases?

Yes No
17.Are audit selected taxpayers notified in advance?
Yes No
18.Does notification has impact?
Yes No
19.If 'yes' negative or positive or both?

20.Could you state the significance or/and disadvantage of notification?

21. Is there any legal framework to see the taxpayers' record keeping?
Yes No
22. If yes ,where can you see these record- keepings
In the business premise
Can be taken outside the business premise if needed
23. Do tax auditors have access to third party information sources?
Yes No
24.Is there any access to obtain information from other national revenue bodies?
Yes No
25.Are the tax payers cooperative to give essential information's?

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Yes No partially (not all)
26. For the above if the answer is "No" what could be the reason behind?

27.Do you think that you are performing the audit work as per GASP (Generally Auditing
Standards Procedure)?
Yes No partially (not all)
28.Could you state the possible reasons for the answer given for question No.28?

29.Which tax category of tax payers are more difficult to audit?

Category A tax payers Category B tax payers
Category C tax payers all categories
30.What would the possible measures (solutions) to solve the problem?

31.Is there anything to add in relation to tax audit practice in Ethiopia?

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APPENDIX 2: INTERVIEW GUIDE

ZION BUSINESS AND TECHNOLOGY COLLEGE

Department of Accounting

Dear Respondents,

The purpose of this interview guide is to collect data for the study work in requirement for partial
fulfillment of B.A degree in Accounting inZion Business and Technology College.The study aid
at the assessment of VAT Audit practice & its significance in ERCA in case of Hawassa Branch.
Here to, your response is highly valuable for successful completion of the study and I would like
to appreciate your willingness to participate in this interview and provide relevant responses

Thank you in advance for your cooperation

1. How do you determine the businesses to be included in the VAT Audit?

2. Do u think your VAT Audit approach is effective?
3. What amount of Tax revenue has been discovered annually through VAT audit in the last
five years?
4. What problems and challenges do your organizations face during Vat Audit?
5. What do you think should be done to make the existing VAT audit system more efficient
and enhancing government revenue?

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