Reclassifying the Rules: Category A & B Taxpayers Under Ethiopia's Revised Income Tax Proclamation

In July 2025, Ethiopia ushered in a new era of income tax legislation by amending its principal tax law. The amended Income Tax Proclamation introduces sharper definitions, updated thresholds, and more structured compliance expectations especially for Category A and B taxpayers. For practitioners, business owners, and advisors alike, understanding the shift from the previous 2016 proclamation to this revised framework is essential. This article provides a detailed comparison between the old and new proclamations, explains what the changes mean in practice, and references key legal articles that govern the current tax treatment of small and medium businesses in Ethiopia.

Redefining Category A and B: From Loose Ranges to Structured Tiers

Under the 2016 Income Tax Proclamation No. 979/2016, Category A and B taxpayers were generally defined by turnover thresholds, but the language left room for administrative discretion. Category A included incorporated businesses and any person with an annual turnover of Birr 1,000,000 or more, while Category B covered unincorporated individuals with turnover between Birr 500,000 and 1,000,000. These definitions were found in Article 39 of the 2016 law, but were not tightly integrated into a system of periodic review or economic adjustment.

In contrast, the 2025 amendment (effective July 7, 2025) restructures these classifications under Articles 74 through 76. Category A now includes all legal persons, regardless of turnover, and any individual or entity with annual turnover exceeding Birr 2,000,000. Category B applies to unincorporated individuals with turnover below the same threshold, but specifically excludes professionals such as accountants, lawyers, engineers, and others who must maintain full accounts regardless of income. These professionals are captured under Category A rules, even if their earnings fall below the stated threshold, a crucial distinction that was not explicitly outlined in the earlier proclamation.

Notably, the new law introduces a mandatory economic reassessment of thresholds every five years under Article 74(3). This is a forward-thinking clause aimed at aligning taxpayer classifications with inflation and national income trends, something entirely absent in the previous framework.

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Shifting the Tax Base: Net Income vs. Gross Sales

One of the most fundamental changes in the 2025 law is how Category B taxpayers are taxed. Under the 2016 proclamation, both Category A and B taxpayers were taxed on net business income gross revenue minus allowable expenses as outlined in Articles 40 and 41. Category A taxpayers were required to maintain full books of account. Category B taxpayers, while also taxed on net income, were often assessed using simplified records or presumptive methods, especially in cases of non-compliance or poor documentation.

This approach has changed significantly.

Under Article 79 of the 2025 amendment, Category B taxpayers are now taxed on gross annual sales, not net income. The law sets out a sliding tax rate based on revenue tiers, ranging from 2% on gross income up to Birr 100,000 to 9% for gross income just under Birr 2,000,000. The shift to gross receipts simplifies administration for tax authorities and reduces the compliance burden for small businesses, but it also removes the ability to deduct legitimate expenses, a tradeoff that can be significant depending on the nature of the business. Category A taxpayers, however, continue to be taxed on net taxable income under Article 78. This includes all business income minus allowable deductions, and the obligation to maintain full books remains unchanged. The tax rates applicable to individuals remain progressive (ranging from 0% to 35%), while corporate entities are subject to a flat 30% tax on net profit.

Quarterly Advance Payments: From Silence to Structure — But With Cashflow Costs

One of the most significant operational shifts in the 2025 Income Tax Proclamation is the formalization of quarterly advance income tax payments. This is not just a procedural adjustment — it has real financial implications for businesses, particularly those with uneven cash flow or early-stage growth trajectories.

Under the 2016 proclamation, advance payments were referenced in only the vaguest terms. Article 95 stated that taxpayers “shall make an advance payment of income tax in accordance with the relevant Directive to be issued by the Minister.” In practice, this meant that advance payment requirements were set out in sub-regulations and directives, not in the law itself. Enforcement was inconsistent, particularly for businesses outside major urban areas or those falling into Category B. The result was a system that relied more on post-year assessments than on real-time tax compliance.

The 2025 amendment corrects this by embedding a legally binding quarterly payment schedule directly into the proclamation. According to Article 81, Category A taxpayers must pay 25% of their previous year’s tax liability within five days of the end of each quarter. For Category B taxpayers, Article 82 extends the deadline to fifteen days after quarter-end, but the 25% obligation remains.

At face value, this shift brings Ethiopia’s tax system in line with international practice. But for many businesses — particularly those with seasonal revenue cycles or those in early growth phases — this structure introduces serious challenges.

For instance, consider an agribusiness that earns 80% of its revenue during two quarters of the year. Under the new rules, that business must still pay 25% of the prior year’s tax liability in quarters where no cash inflow is being realized. Similarly, a small manufacturing firm scaling its operations might have reinvested much of its working capital into equipment, wages, or expansion — leaving less liquidity for tax prepayments based on last year’s earnings.

While the law attempts to create predictability, it also assumes a linear cash flow profile that doesn’t reflect the financial realities of many Ethiopian businesses. This disconnect could lead to late payment penalties, working capital shortfalls, or even increased borrowing to meet quarterly tax deadlines — effectively turning the tax authority into a quarterly creditor. The first-year exemption outlined in Articles 81(2) and 82(2) gives new taxpayers a one-time reprieve: they pay their full tax obligation only at the end of the year. But for everyone else — especially small, growing, or seasonal businesses — the cost of compliance will no longer be measured in effort alone, but also in liquidity.

The policy goal is clear: smoother government revenue collection, reduced year-end payment volatility, and more accurate tax forecasting. But unless accompanied by administrative flexibility or support measures — such as income averaging options or sector-specific grace periods — this system may put pressure on exactly the types of businesses the broader tax reform claims to support.

What Does This Mean for Businesses and Advisors?

The revised classification and taxation system marks a clear policy shift. First, it acknowledges that turnover, not just legal form, should influence tax treatment. Second, it simplifies taxation for small, informal businesses by moving toward a gross-income basis but does so without penalizing professionals or allowing blanket treatment for all low-earning individuals. Finally, the move to quarterly payments forces all businesses, especially Category A to engage in year-round tax planning and cash flow management.

The inclusion of advance payment rules in the proclamation itself strengthens compliance and enforcement. It gives legal certainty to tax obligations and reduces reliance on ministerial interpretation.

From a policy perspective, the law also recognizes that thresholds must evolve. A 1 million Birr threshold, unchanged since 2016, does not reflect today’s inflation-adjusted business realities. The five-year reassessment clause institutionalizes a much-needed feedback loop between economic data and tax classification, a feature the previous law simply did not account for.

Final Reflection

The 2025 amendment to Ethiopia’s Income Tax Proclamation is not merely a technical rewrite; it’s a structural reset. It changes who qualifies as a small taxpayer, how they’re taxed, and how often they’re expected to settle their obligations. For Category A and B taxpayers and those advising them the implications are far-reaching.

Where the 2016 law left critical operational questions to external directives, the new proclamation brings them into the legal text. Where old definitions were ambiguous, new ones are detailed. Where tax payment cycles were unclear, the new law is exacting.

For tax professionals, this presents both a challenge and an opportunity: a challenge to adapt systems, educate clients, and stay current with administrative procedures and an opportunity to offer clarity in a system that is becoming more rules-based, predictable, and data-driven.