Determinants of Tax Compliance in Small and Medium Enterprises in ...

JOURNAL OF ECONOMICS AND INTERNATIONAL BUSINESS RESEARCH (JEIBR) ISSN: 2328-4617 VOL. 2(3), pp. 48-57, FEBRUARY 2014 REF NUMBER: 0520140701 ONLINE: http://www.projournals.org/JEIBR

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Full Length Research Paper

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DETERMINANTS OF TAX COMPLIANCE BY SMALL AND MEDIUM ENTERPRISES IN ZIMBABWE. NELSON MASEKO Technical Manager, Institute of Chartered Secretaries and Administrators in Zimbabwe. Accepted: 26 JULY, 2014.

------------------------------------------------------------------------------------------------------------------------------ABSTRACT

T

his research investigated the determinants of tax compliance in small and medium enterprises (SMEs), focusing on how tax knowledge and compliance costs affected tax compliance behaviour of SMEs in Zimbabwe for the tax period 2009 to 2011. The main objectives of the study were to investigate how the unique business conditions of SMEs, the perceptions of SME operators towards taxation, levels of tax knowledge and compliance costs affect tax compliance of SME taxpayers. To achieve these objectives, research propositions were stated which mainly stipulated that the current tax system in Zimbabwe does not cater for the special business needs of SMEs and that strong correlations do exist among tax knowledge, compliance costs and tax compliance. The study adopted a chiefly qualitative research design. Methodological triangulation was employed, utilizing the interview method and a questionnaire survey to collect primary data from SMEs in Harare, Chitungwiza and Bindura. Interview responses were analyzed through summative content analysis and questionnaire responses were analyzed using SPSS software (V. 16.0). The results indicated that SMEs face different business conditions from large companies which cause them to bear high tax compliance burdens. The results also indicated that the perceptions of SME operators about tax fairness, tax service quality and government spending priorities greatly affect their tax compliance decisions. Tax knowledge was discovered to have no correlation with tax registration compliance but weak negative correlations with filing compliance. Compliance costs were discovered to have negative correlations with tax compliance. The study then recommended that the current tax law should be amended to incorporate provisions that grant special tax incentives to SMEs in order to improve voluntary tax compliance by SME taxpayers. The study also recommended that the Zimbabwe Revenue Authority (ZIMRA) should disseminate information on tax updates more frequently in order to improve the levels of tax knowledge for voluntary tax compliance.

KEYWORDS:

Small and medium enterprise, compliance costs, tax compliance, tax education, tax knowledge.

-------------------------------------------------------------------------------------------------------------------------------------------*Corresponding Author. Email: [email protected] Phone: +263 (0) 773 193 787

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DETERMINANTS OF TAX COMPLIANCE BY SMALL AND MEDIUM ENTERPRISES IN ZIMBABWE.

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INTRODUCTION Tax compliance is currently a topical policy issue, especially in developing countries, as governments are seeking ways to improve efficiency in tax revenue collection to finance their budgets. SMEs are the majority business taxpayers in most developing countries and as such their compliance levels directly impact on government tax revenue collections. In Zimbabwe, SMEs represent over 95% of enterprises that generate over 50% of private sector employment. Alink [1] observed that tax non-compliance behaviour in SMEs include non-registration for tax, non-filing of returns, none or poor payment record, underreporting of turnover and profit, and none or poor bookkeeping. Previous studies on tax compliance issues ([2];[13;[23]]) have identified the following as determinants of tax compliance:  tax rates;  tax audits;  perception on government spending;  role of tax authority and tax administration;  simplicity of tax returns;  probability of detection;  awareness on offenses and penalty; and  personal financial constraint.  According to Stern and Barbour [21], most entrepreneurs in Africa remain outside the tax-net because the perceived costs of compliance outweigh the perceived benefits. However, Eichfelder and Schorn [8] observed that small businesses bear a higher compliance burden due to the reason that they face ‘inverse economies of scale’ caused by tedious compliance procedures required by tax authorities. For most SMEs, because of the various limitations they face, tax compliance is sometimes associated with heavy costs that burden their operations and this is a public policy issue in most countries, [17]. An earlier study by Eichfelder and Schorn [8] and Evans [11] also indicated that tax compliance costs incurred by SMEs add to the total bureaucratic burden facing small firms, particularly in maintaining proper and sufficient records for management and taxation purposes and this is a worldwide phenomenon not peculiar to Zimbabwe. SMEs in Zimbabwe are subject to income and other direct taxes, either as individuals receiving profits from unincorporated businesses, or as corporate taxpayers. The taxation of both individuals and corporations is mainly governed by the Income Tax Act (Chapter 23:06) as read with the Finance Act (Chapter 23:04). Taxpayers who receive income from trade, regardless of their size or legal form and status, are required by law to:      

register for tax, keep and maintain sufficient records for tax purposes, carry out tax assessments, pay taxes (as due), file all tax returns in time, and carry out other tax-related duties like accounting for withholding taxes and paying employment tax on behalf of their employees.

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Journal of Economics and International Business Research (JEIBR)


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Some business operations of SMEs are subject to indirect taxes, like VAT, and the SMEs are also required to comply with all applicable provisions under the respective tax statute. The objectives of this study were as follows: i. ii. iii. iv. v. vi. vii.

To investigate how the current tax system in Zimbabwe impacts on the business operations of SME taxpayers. To investigate how the perceptions of SME operators towards taxation affect their tax compliance decisions. To identify the chief motivator for tax compliance in Zimbabwean SMEs. To assess the impact of ZIMRA penalties on SMEs’ filing compliance. To analyze the relationship between the level of tax knowledge and tax compliance decisions of SMEs. To analyze how compliance costs correlate with tax compliance behaviour of SMEs. To propose tax procedures for Zimbabwean small businesses which encourage voluntary compliance.

MATERIALS AND METHODS This study followed a chiefly qualitative research design, employing in-depth face-to-face interviews. The respondents were also asked to complete a questionnaire. The questionnaire was used in order to collect quantitative data forming entity tax profiles. Data was collected from SMEs and tax consultants between September 2011 and April 2012. An interview guide was used to collect data from SME operators and tax consultants and the researcher and his assistants captured the interview responses on numbered manuscripts. After piloting the questionnaire on a group of 10 SMEs in Bindura town, a total of 150 questionnaires were distributed to SMEs in Bindura, Harare and Chitungwiza. In the form of follow-ups on the questionnaires, the researcher and his research assistant managed to interview 13 SME operators and five tax consultants. Interview manuscripts were analysed by summative content analysis. Employing this method, the analysis of the manuscripts from the interviews followed a three stage process involving data reduction and coding, data interpretation and conclusion drawing. The responses from the questionnaires were analyzed by first coding them into variables for inputting into SPSS software e.g. penUnderR , IncTAXreg Data was then analysed predominantly by descriptive statistics and correlation analysis using Pearson correlation coefficient (r). The coded data was processed using SPSS software (version 16) and Excel spreadsheets.

RESULTS The majority (53.1%) of the SMEs that participated in the study were private limited companies, followed by those that indicated ‘other’ form of legal status with 18,8%, followed by sole traders with 15.6% and partnerships with 9.4%. Only 3.1% of the SMEs that took part in the study were public limited companies. Those that indicated ‘other’ were identified as SMEs that operated as unregistered family businesses. The majority (37.5%) of SMEs that took part in the study were from the services sector. Most of these firms operated businesses like pre-schools, public transport, business consultancy, including secretarial service providers. The second category of SMEs operated retail or wholesale businesses with about 31.3%. SMEs in the manufacturing or processing industry comprised about 12.5%, with those operating in the mining, agriculture and engineering industries forming 6.3% each.




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The majority (56.25%) of the SMEs indicated that they generated less than US$500 000 per annum, followed by those that generated between US$500 000 and US$800 000 (31.25%). Those that generated between US$800 000 and US$ 1 million and above US$1 million both accounted for 6.25%. The majority (34.38%) of SMEs had between 10 to 20 full-time employees, including the owner/s, 31.25% of the respondents employed less than five full-time people including the owner/s, 25% of the respondents employed between 5 and 10 people including the owner/s, with 6.25% of the respondents employing between 20 and 50 people including the owner/s and only 3.12% of the SMEs employed between 50 and 100 full-time people including the owner/s. There was no respondent who selected the ‘more than 100’ option in the questionnaire responses. The study also found out that:    

About 75% of SMEs were registered for PAYE. About 47% were registered for VAT. About 56% were registered for income tax, and Only 16% were paying presumptive tax.

In private limited companies, tax consultants were the majority preparers with 43.8%, with 37.5% employing accountants and in about 18.8% owners prepared their own tax returns. For partnerships, 50% of their tax returns were prepared by owners with the other half indicating that they did not prepare tax returns. For sole traders, owner preparers and hired accountants were equally distributed at 33.3% each and the other 33.3% indicated they did not prepare tax returns.

Figure 1 shows that about 78% of the respondents rated tax clearance certification as the most important reason why they want their businesses to be tax compliant while another 22% considered tax clearance certification for their businesses as important. There was no respondent who rated tax clearance certification as either less important or least important. Avoidance of tax penalties was rated second with two scores of about 69% (most important) and 31% (important). On the third place was tax compliance for business formalization which scored about 28% (most important), 22% (important), 31% (less important) and 19% (least important). Tax compliance for social acceptance was rated last with about 6% considering it to be




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most important, 9% considering it to be important, 38% considering it to be less important and about 49% considering it to be least important. A further analysis, in Table 1, of the responses revealed significant correlations between ‘filing compliance’ and ‘avoid tax penalties’ (r = 0.401) tested at 5% level of significance. Table 1: Correlations (‘filing compliance’ versus ‘avoiding penalties’)

Filing compliance Filing compliance

Pearson Correlation

Avoid penalties 1

.401*

Sig. (2-tailed)

.025

N Avoid penalties

31

31

Pearson Correlation

.401*

1

Sig. (2-tailed)

.025

N

31

32

*. Correlation is significant at the 0.05 level (2-tailed).

The results of the Bivariate Correlation Analysis in Table 2 show that there were some strong relationships between PAYE registration compliance and income tax registration and filing of returns(r=0.655 and 0.667) both tested at 1% level of significance. There was also a strong relationship between registration for income tax and filing returns (r=0.364) tested at 5% level of significance. The results also reveal that there was a very weak negative relationship between tax knowledge and registration compliance. This negative relationship has been tested to be ‘not significant’ at both 5% and 1% levels of significance. There has been found no correlation to exist between registration for PAYE and level of tax knowledge (respondent-rated) (r = 0). Table 2: Pearson correlation (r) matrix for tax knowledge and tax compliance decisions

1

2

3

1

Registered for PAYE

2

Registered for income tax

0.655**

1

3

Filing returns

0.667**

0.364*

1

4

Formal tax education Tax knowledge (respondentrated)

-0.178

-0.116

0.000

-0.017

-0.333

-0.073

7

Lacking tax knowledge Tax knowledge affects payment

-0.218

-0.143

0.296 0.234 0.333 0.218

8

Tax procedures are complex

-0.033

-0.007

0.033

5 6

4

5

0.152 0.059 0.116 0.147

1 0.078

6

7

8

0.218

1 0.123

1

1

1

0.051 0.101

1

-0.1

Dependent variables: Registered for PAYE Registered for income tax Filing returns ** Correlation is significant at the 0.01 level (2-tailed) * Correlation is significant at the 0.05 level (2-tailed)




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The positive relationships imply that taxpayers who register for taxes file tax returns with ZIMRA. The negative relationships suggest that tax knowledge does not correlate with tax registration compliance, implying that the level of tax knowledge in SMEs has no influence on their decision to either register or not to register for tax. Registration for PAYE has been found not to depend on any level of tax knowledge in SMEs. Table 3: Pearson correlation (r) matrix for compliance costs and tax noncompliance behavior

1 1 2

Registered for PAYE Registered for income tax

2

3

4

5

6

1 0.655**

1

0,727**

0.526**

1

4

Filing compliance Costs influence on noncompliance

-0.364*

-0.27

-0.419*

1

5

Costs affect payment

-0.026

-0.142

-0.187

0.13

1

6

Main costs incurred Preparer (tax agent) services costs

-0.045

-0.251

-0.163

0.364

0.014

1

0.576**

0.406*

0.725**

-0.628**

0.001

-0.128

3

7

7

1

Dependent variables: Registered for PAYE Registered for income tax Filing compliance ** Correlation is significant at the 0.01 level (2-tailed) * Correlation is significant at the 0.05 level (2-tailed)

Table 3 shows that there were a number of significant correlations between compliance costs and tax noncompliance behaviour. There were significant correlations between filing compliance and registration for PAYE (r=0.727) and between filing compliance and registration for income tax (r=0.526) tested at 1% significance level. There were significant correlations also between preparer (tax agent) and registration for PAYE (r = 0.576), filing compliance (r = 0.725) and compliance costs influence on noncompliance (r = -0.628) all tested at 1% level of significance. At 5% level of significance there were significant correlations between compliance costs influence on noncompliance and registration for PAYE (r = -0.364) and preparer (tax agent) (r= -0.419). Also at 5% level of significance there was significant correlation between filing compliance and preparer (tax agent) (r = 0.406). These findings suggest that the use of tax agents by SMEs improves both PAYE and income tax registration and filing compliance (strong positive correlations). However, the use of tax agents has been confirmed to increase compliance costs to SMEs and thus negatively influence their compliance behaviour (strong negative correlation). Compliance costs have also been confirmed to negatively influence filing compliance and registration for PAYE by SMEs (strong negative correlations). The findings also suggest that compliance costs have little negative influence on tax payment decisions (weak positive and negative correlations).

DISCUSSION For family businesses (other), 14.3% employed accountants to prepare tax returns, with 42.9% of their returns prepared by owners. SME operators indicated lack of tax knowledge about levels of taxable income, types of taxes their businesses are supposed to pay and payment dates, confirming the findings of Palil [18]. SME operators considered compliance costs to be relatively too high for their businesses as indicated in the German small business study by Eichfelder and Schorn [8]. SME operators preferred indirect to contact, Page 6 PRO JOURNALS [JEIBR] - DETERMINANTS OF TAX COMPLIANCE BY SMALL AND MEDIUM ENTERPRISES IN ZIMBABWE. By NELSON MASEKO



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through their tax consultants, to direct contact with ZIMRA. This results in tax compliance costs to the SMEs. SME tax was reported to be comparatively too high and this is causing some firms to evade tax and, when they get away with impunity, compliant peers feel disadvantaged. This finding is agreeing with the findings of Lumumba [15] about the perception of tax fairness in the absence of equity.

CONCLUSIONS The absence of a small business tax regime in Zimbabwe causes SME taxpayers to bear disproportionate tax compliance burdens. SME operators’ perceptions on tax fairness and tax service quality have the power to influence their tax compliance decisions. The level of education received by taxpayers is an important factor that contributes to their understanding of tax responsibilities, especially regarding registration and filing requirements. Compliance costs, in form of fees charged by tax consultants, are positively correlated with noncompliance behaviour and thus negatively correlated with tax compliance behaviour. Obtaining a tax clearance certificate is the highest motivation to comply with tax laws and regulations for most SME operators in Zimbabwe. Tax penalties can positively influence timely filing of tax returns by SME taxpayers. This study therefore makes the following recommendations:  

ZIMRA should use different forms of communication to timely disseminate tax education information. Tax law should be amended to give tax incentives like lower tax rates and less stringent filing requirements for small business taxpayers.

ACKNOWLEDGEMENTS ….

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[7] Cooper, D.R. and Schindler, P.S., (2003). Business Research, 8th Ed, McGraw-Hill, New York [8] Eichfelder, S. and Schorn, M., 2008, Tax compliance costs and its determinants: Evidence from German businesses, Institute of Accounting and Tax Management. [9] Engelschalk, M., (2007). Designing a tax system for micro and small businesses: A guide for practitioners. International Finance Corporation. [10] European Commission (EC) – Enterprise and Industry Directorate General, 2007, Simplified tax compliance procedures for SMEs: Final Report of the Expert Group, June 2007. [11] Evans, C. Carlon, S. and Darren, M., (2005). Record-keeping: Its effect on tax compliance, A Small Business survey programme. Report by CPA Australia, May 2005. [12] Hsieh, H and Shannon, S.E, (2005). Three Approaches to Qualitative Content Analysis, Sage Publishing. Available online at: http://qhr.sagepub.com/content/15/9/1277 . [13] Hyun, J.K., Park, C.G. and Ya, I., (2002). The determinants of tax compliance by experimental data: A case of Korea, Korean Development Institute. Available online at http://G:\225\hyun\iipf2002-full.doc. Accessed 02/02/12. [14] Income Tax Act (Chapter 23:06), Government Printers. [15] Lumumba, O.M., Wanjoli, M.S., Maguta, P.O. and Mokoro, J.M., (2010). Taxpayers’ attitudes and tax compliance behaviour in Kenya: How the taxpayers’ attitudes influence compliance behaviour among SMEs Business income earners in Kerugoya Town, Kirinyaga District. African Journal of Business and Management, vol. 1(2010). [16] Ngorima, M., 2009, ‘Expert Calls for redrafting of Tax Law’ in The Chartered Secretary, 1/2010 p7-8. [17] Organization for Economic Co-operation and Development (OECD) (2008). SME tax compliance and simplification: Background note’, prepared for ‘Roundtable Discussion at the 1st Meeting of the Working Group on taxation of SEE Investment Committee. [18] Palil, M.N. and Mustapha, A.F., (2011). The evolution and concept of tax compliance in Asia and Europe, Australian Journal of Basic and Applied Sciences, vol. 5(11), pp557-563. [19] Plumley, A.H., (1996). The determinants of individual income tax compliance: Estimating the impacts of tax policy, enforcement and IRS responsiveness, Department of the Treasury, Internal Revenue Services, Publication 1916 (Rev. 11-96) Catalogue No. 22555A, Nov. [20] Reserve Bank of Zimbabwe (2009). Surviving the new economic environment: Practical advice and policy initiatives to support the Youth, Women Groups and other vulnerable members of the society supplement to the January 2009 Monetary Policy Statement. [21] Stern, R. E. and Barbour, P. A., (2005). Designing a small business tax system that enhances growth: Lessons from Africa, Discussion paper, World Bank, Dec.




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[22] Value added tax Act (Chapter 23:12), Government Printers. [23] Yong, S. and Hooper, K., (2011). Tax compliance and SME operators: An intra-cultural study in New Zealand, PhD Thesis, Aukland Univ. of Technology, School of Business. [24] Zimbabwe Revenue Authority (ZIMRA) (2011). Revenue collections against targets 2001-2011. Available online at http://www.zimra.co.zw, accessed 27/01/12

