THE EFFECTS ON TAX COMPLIANCE COSTS TOWARD SMEs
Taxation is a compulsory levy, imposed by government on ether income, expenditure or capital assets for which the taxpayer receives nothing specific in return. The main purpose why government was imposing a tax is to increase money for public purposes. In fact, the examination of tax reform undertaken by most countries revealed that the tax reform is carried out with the objectives of improving the efficiency, equity, neutrality and administrative simplicity of their tax system. According to Kasipillai (2003), taxes in Malaysia can be categorized into two namely direct taxes and indirect taxes. Direct taxes are corporate tax, individual income tax, petroleum tax, real property gains tax and stamp duty. While indirect taxes like import duty, excise duty, sales tax and others. For this project, income tax will be stressed, whereby income tax is a sum of money collected from the income of a person or company by the government for the purpose of developing a country’s economy. This paper more focuses a part of income tax namely Self Assessment System (SAS), and the purpose is to see the effects of SAS on tax compliance costs of Small and Medium Enterprises (SME), particular in Malaysia.
This paper is organized as follows. The following section will defined and briefly discussed the overview of implementation SAS in Malaysia. Section three succinctly discussed the concepts and prior studies on tax compliance cost. The next section will be discussed the concepts and the importance of SMEs in Malaysia. Section five will being discussed the issue of SAS and how it brings the impact on compliance cost to SMEs in Malaysia. This paper will end with the section that makes some brief concluding comments.
SELF ASSESSMENT SYSTEM (SAS)
SAS for tax purposes is not a new phenomenon. Canada and the United States first implemented SAS in the 1910s, followed by Japan in 1947. However, over the last two decades, there has been considerable growth in the adoption rate of SAS by tax regimes in both developed and developing countries. Example, Sri Lanka introduced SAS in 1972, Pakistan in 1979, Bangladesh and Indonesia in 1984, Australia in 1986-1987, New Zealand in 1988, Ireland in 1988, United Kingdom in 1996-1997 and Malaysia 2001-2004 (Loo, McKerchar and Hansford, 2005). In each of these countries, there have been differences in the extent of adoption SAS since some of them moving to full adoption, while others have adopted SAS only in part.
According to Palil (2005), in Malaysia, the new systems namely SAS will be implemented stage by stage and Government would be implementing SAS in stages as follows:
Year of Implementation
Business, partnerships and cooperatives
Table 1: Stage of implementation SAS in Malaysia
SAS is essentially an approach whereby taxpayers are required by law to determine their taxable income, compute their tax liability and submit their tax returns on existing tax laws and policy statements issued by the tax authorities (Palil (2005) and, Kasipillai and Hanefah (2000)). In a simple understanding, SAS is the manner in which a taxpayer works out and pays his own income tax. It is not a new tax but a system whereby the taxpayer is given the responsibility to compute his own liability. The introduction of self assessment basis of taxation would involve a substantial shift of responsibility to the taxpayers in terms of their compliance obligations. SAS relies heavily on the principle of voluntary compliance and on taxpayers having a good understanding of the tax law in order for them to meet their obligations.
Loo, McKerchar and Hansford (2005), said that the main objectives of the adoption SAS is to simplify the tax assessment system and to encourage voluntary compliance. Besides that, by adoption of SAS, it also estimated that, this system would improve the efficiency and the effectiveness of tax administration, reduce tax administration cost and tax evasion and ensure the timeliness in tax collections (Sarker, 2003). With the introducing this system, it’s mean that, the tax payers needs to carry out the greater responsibilities or need to be more aware of their own tax affairs. From the perspectives of tax authorities, SAS is more cost effective rather than traditional system and may encourage an earlier and timely collection of taxes. While, for tax payers perspectives, this system allows democratic exercise of tax payers rights and increase the involvement by the tax payers since they are computing themselves the amount of taxes. According to Sandford (1994), there are two possible issues that arise as the outcomes of the implementation of SAS. The first issue is SAS could effects the increase in the tax payer’s compliance cost and the second issue is increase in tax evasion.
TAX COMPLIANCE COSTS
According to Hijattullah and Pope (2008a), tax compliance means compliance with tax reporting requirements, which the taxpayer files all required tax returns at the proper time and that the returns accurately report tax liability in accordance with the tax laws, regulations and court decisions applicable at the time the return is filed. Since no tax is perfectly efficient, if the tax shifting were efficient, it would not result in any reduction in the overall resources available to the community as a whole. There are three cost are common in a tax system: administration costs, compliance costs and economic efficiency costs. The compliance costs of taxation are defined by Sandford, Godwin and Hardwick (1989) as the costs incurred by taxpayers or third parties, notably businesses, in meeting the requirements laid on them by a given tax structure (excluding the payment of the tax itself and any distortion costs arising from it). Compliance cost have been largely attribute to the tax complexity of the tax system and these increase the effective rate of tax, thereby reducing the efficiency and equity of tax.
As mentioned by Hijattullah and Pope (2008a), for a business, the compliance costs include the cost of collecting, remitting and accounting for tax on the products or profits of the business, and on the wages and salaries of its employees, together with the cost of acquiring the knowledge to enable this work to be done, including knowledge of their legal obligations and penalties, and the associated overhead costs, including costs of storing records as required by the tax authorities. Compliance costs can be divided to financial or non-financial, include: (a) direct financial costs (for example, the cost of obtaining professional advice from a tax agent or other tax practitioner), (b) opportunity costs (for example, the cost of spending time complying with self assessment obligations at the expense of running a business) and (c) non-financial compliance costs, such as stress from the uncertainty about whether the right amount of tax has been paid.
There are three major components of tax compliance costs, include: (a) money costs, (b) time costs and (c) psychological costs to the taxpayers. The money or financial costs refer to an amount spent on tax professionals (i.e. tax agents, accountants, investment advisers and legal practitioners) and expenses relating to taxation guides, books, communication and other incidental costs. Time costs are incurred in keeping records of tax information, completing the tax form or preparing tax details for tax professionals, as well as time spent in dealing with the tax authorities. Psychological costs refer to the effects upon a taxpayer having to deal with his/her tax affairs, such as the anxiety of handling complex tax matters.
One of the earlier studies in computing a company’s compliance costs was undertaken by Bryden in 1961. Where, that study was carried out for the Canadian Tax Foundation, to seek information from companies on two questions i.e. the cost of paying those taxes for which companies is it liable and the cost of acting as a collection agent for governments with regard to the tax liability of others. Slembrod and Blumenthal (1996) in their study found that compliance costs of companies increased by an average of 77 per cent over a ten-year period. Whilst, Evans and Walpole (1997), pointed out that the first study in the Asia Pacific region was only published in Australia in 1990, followed by a series of four compliance costs studies on major Australian taxes. Since then, a number of studies have been conducted largely in Australia, and also in other Asia Pacific countries such as New Zealand, Singapore Malaysia, Hong Kong and India. Conclusively, all previous studies have supported that the existence of a fixed costs effect on smaller firms and ensuing regressively.
SMALL AND MEDIUM ENTERPRISES (SMEs)
Small and Medium Enterprises (SMEs) in Malaysia have played significance function in the economic growth of the nation. Over the last decade, an increasing recognition of the importance of SMEs has been evident in Malaysia, particularly in 2005 through the establishment of the National SME Development Council (NSDC). In 2005, there were almost 520,000 SMEs comprised around 99 per cent of all enterprises in Malaysia, contributed almost 48 per cent of the total value-added of business establishments and around 65 per cent of total employment. SMEs contributed the large portion of corporate income tax to Malaysian income tax revenue (Hijattullah and Pope, 2008b). SMEs is being measured using various measurement including the number of full time employees, annual sales turnover, amount of assets or shareholder’s funds, paid-up capital, and combinations of these methods.
The Small and Medium Industries Development Corporation (SMIDEC), a primary government agency responsible for the development of SMEs in Malaysia, has defined SMEs as businesses with an annual sales turnover not exceeding RM25 million, and with full-time employees not exceeding 150. While, National SME Development Council (NSDC) (2005, pp3-5) defined SMEs based on two criteria, they are number of employees or annual sales turnover. The SMEs are further categorized primarily into four sectors: manufacturing, manufacturing related services, services (including information and communications technology) and primary agriculture.
ISSUE OF SAS AND THE EFFECT ON THE TAX COMPLIANCE COSTS OF SMEs
The implementation of the SAS, the regular amendment of the various tax laws and perhaps the increasing complexities of the tax system may have had an adverse impact on SMEs. According to Hanefah, Ariff and Kasipillai (2001), during the early years of SAS, the compliance burden and associated costs under the SAS regime were expected to increase extensively. Thus, to see the effects of implementation SAS towards Malaysian SMEs on compliance costs, I convey the comparison study between prior and post implementation SAS in Malaysia by looking for the elements in compliance costs whether the cost is increase or decrease after SAS is being implemented in Malaysia.
Compliance Costs Prior Adoption of SAS
According to Hijattullah and Pope (2008b), in Malaysia there have been two published compliance costs studies conducted prior to the introduction of the SAS. The first study, conducted by Loh et al. (1997) estimated the income tax compliance costs of public listed companies in Malaysia. And, the second study, conducted by Hanefah, Ariff and Kasipillai (2001), focused on SMEs, but was limited to companies in the northern peninsular of Malaysia. Where, both of the studies found that, the regressive nature of tax compliance costs among smaller companies. A summary of the results of both studies is presented in Table 3.
As shown in Table 3 below, the average compliance costs of SMEs in absolute values are almost one-third of the large companies. Hanefah, Ariff and Kasipillai (2001), emphasized that the composition of both internal and external costs, as measured by costs percentage, of SMEs were completely different from large companies.
The costs percentage is given in parenthesis.
a 1995 Loh et al. (1997) figures ; and
b 1999 Hanefah, Ariff and Kasipillai (2001) figures.
c Both studies did not report their additional or other costs separately.
d This total was not equal to overall reported mean compliance costs of RM21,964 due to differences in the response number. Refer footnote 35 of Hanefah, Ariff and Kasipillai (2001) for details.
Compliance Costs Post adoption of SAS
Hijattullah and Pope (2008b), who are done a study about the effects of the self assessments system on the tax compliance cost of small and medium enterprises in Malaysia. They found that, the average compliance costs of RM9,295 is 58 per cent lower than the average compliance cost of RM21,964 in the pre-SAS study. Surprisingly the cost is lower in the context of the SAS absolutely contrast to the presumed expectation. Table 4 below shows the comparative findings of the pre-SAS and post-SAS studies on Malaysian SMEs.
a 1999 figures from Hanefah, Ariff and Kasipillai (2001).
b 2006 data from Hijattulah and Pope, (2008).
c All values are in current year prices (The comparison was made at nominal value. If inflationary effects were to be considered, the yearly inflation rate, over the period of 1999 to 2006 was around 2 per cent, except for 3.0 and 3.6 per cent respectively in 2005 and 2006 (Economy Reports 2003-2004, 2004-2005, 2005-2006, 2006-2007 and 2007-2008 issued by the Treasury of Malaysia). The percentage is given in parentheses.
d This total was not equal to RM9,295 due to differences in the response number.
e Refer Table 3.
f Inclusive of additional costs component.
The result of the study obviously shows that, the argument stated by Sandford (1994) that the implementation of SAS will increase the compliance cost among the tax payers is not totally true. Because, after implementation SAS in Malaysia, the compliance cost incurred by Malaysian SMEs was significantly decreases. This is proved by the findings found in the study of Hijattullah and Pope (2008b). And, the authors come out with a few reasons regarding the decreasing in the compliance cost incurred by Malaysian SMEs. The main reason that lead to the decline in compliance cost is may be because SAS has been implemented more than six years in Malaysia.
Furthermore, the prior study conducted by Hanefah, Ariff and Kasipillai (2001), related to the tax year 1999 and the data was collected in 2000. It is important to highlight that there were two major tax changes announced by Ministry of Finance in 1999, namely the introduction of SAS and the application of a current year basis to replace the existing preceding year basis. The timing of the previous study itself may have stimulated the respondents to exaggerate their compliance costs. Nonetheless, the increase in the proportion of external work, from 25 per cent to almost 41 per cent in the post study conducted by Hijattullah and Pope (2008b), provides evidence that tax professionals, as expected, now play a significant role in the SAS regime and directly lead to the decreasing in compliance cost incurred by Malaysian SMEs. Additionally, the increasing nature of routine income tax work under the SAS (from 59 per cent to 74 per cent), as measured by computational percentage, adds consistency to the current estimate.
Another possible explanation may relate to the economic climate when the prior study was conducted. The major Asian financial crisis during Hanefah, Ariff and Kasipillai’s study may have encouraged SMEs to highly overstate their compliance costs. The timing of the current study is perhaps suitable given that no major income initial costs or start-up effects were removed as the SAS has been in place for more than six years. It is also possible that this significant decline is due to the success of numerous simplification measures taken by the Inland Revenue Board (IRB). The most important of these are the substantial reduction of capital expenditure categories for capital allowance purposes, the simplification of the business basis period, the introduction of dual tax rates for SMEs, and permitting 100 per cent capital allowance for small value assets during the relevant purchased year.
In article by Hijattullah and Pope (2008b), they also mentioned about the study that conducted in Singapore by Ariff, Ismail and Loh (1997). That study found a significant decrease of 30% in the tax compliance costs for just one year (1994 to 1995) after implementation SAS. Thus, the researchers strongly believed that the decrease was largely attributable to the simplification measures taken by the Inland Revenue Authority of Singapore (IRAS). Therefore, it is most likely that the numerous efforts taken by the IRB have resulted significant benefits for the business community directly will lead to the decreasing in the compliance cost incurred by the companies in each country.
Currently more attention now is given to the impact and extent of knowledge on the tax preparers’ work performance. So, another one that I think which might lead to the decreasing in compliance cost incurred by the Malaysian SMEs is due to the increasing in the tax knowledge among the tax payers. As defined by Loo, McKerchar and Hansford (2009), tax knowledge refers to a taxpayer’s ability to correctly report his or her taxable income, claim relief and rebates, and compute the tax liability. Tax knowledge is one of the most essential parts so that the tax payers will be enabled to assess their tax payable at their own. According to Palil (2005), tax knowledge is a major factor in determining the accuracy of the tax return. In particular, the study conducted by Loo, McKerchar and Hansford (2009) showed that the lack of tax knowledge did cause numerous errors in the tax returns furnished by those who prepared their own. These errors resulted in unintentional noncompliance and indirectly will lead to the increasing in compliance cost. In other words, I conclude that taxpayers who having more tax knowledge could enable them to exercise better tax planning and thus will result to decreasing in compliance cost.
CONCLUSION AND SUGGESTION
Based on the discussion above, the finding has shown that the income tax compliance cost of SMEs has decreased significantly under the SAS, probably by 50 per cent to 60 per cent. As mentioned by Hijattullah and Pope (2008b), this trend partly surprising, the decline is fairly reasonable taking into consideration the timing of the pre-SAS study.
The prior study was carried out during the period when some major income tax changes had just been initiated, and more importantly, during the period when a major financial crisis affected the Asian region. On the other hand, the post study was carried out during a period of relative stability in the tax system. This difference will lead to the difference result found from the prior and post study. In terms of cost nature, the regressive nature of compliance costs upon small businesses remains an important area in tax policy considerations. The IRB’s success in simplifying income tax law should be emphasized. It is expected that the IRB will continue its efforts in introducing further tax simplification measures.
After comparing both prior and post study, I concluded that, the arguments stated by Sandford (1994), where the implementation of SAS will increase the compliance cost among tax payers is not totally true of SMEs context in Malaysia. This is proved by the findings found in the study of Hijattullah and Pope (2008b). Thus, for SMEs context in Malaysia, the implementation of SAS does not give bad impact for Malaysian SMEs in term of giving high compliance cost. Furthermore, the success of the SAS depends heavily on voluntary compliance, and thus, it is very important that compliance costs are at a minimum in order to achieve higher compliance. Although, the SAS is new tax administrative system compared to the Official-Assessment System (OAS), this does not mean that compliance costs must be always high. In fact, tax compliance costs have some benefits to taxpayers and also to the tax authorities. Taxpayers enjoy benefits as a result of paying taxes to the government, in the form of government services which include infrastructure, schools, healthcare and others.
Hopefully, this concept paper provides some useful insights regarding the effects of SAS on compliance cost to Malaysian SMEs. However, further studies on compliance costs are possibly needed to convince the IRB in this regard. Currently, the IRB does not have a specific policy on compliance costs of SMEs. Thus, there is the bigger task of the IRB, to get the taxpayers to understand and comply with SAS voluntarily. Further research into other business taxpayers, with considerable attention towards tax compliance costs, is strongly recommended.
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