Journal of Australian Taxation
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COMPLIANCE
COSTS OF SMALL AND MEDIUM ENTERPRISES[*]
By
Mustafa Hanefah,[**]
Mohamed Ariff[***]
and Jeyapalan Kasipillai[****]
Several new findings on compliance costs
of small and medium enterprises ("SMEs") are reported in this article
for the first
time from an emerging economy, Malaysia. Prior studies were done
using large exchange-listed firms. This article reports findings
from postal as
well as personally-administered survey questionnaires relating to compliance
costs for the tax year 1999 as reported
in responses collected in early 2000.
The compliance costs of SMEs are substantially higher compared with the costs
measured for
exchange-listed and, therefore, larger firms. The average tax is
merely one-eleventh of the average tax paid by a typical listed
firm, yet the
average compliance cost of a listed firm is only three times that of a typical
SME. Thus, compliance costs are four
times more burdensome for SMEs. These
findings are particularly significant for tax administration and legislators
because of the
large burden even with self-assessment planned to be implemented
in stages, commencing with self-reports by companies in 2001. Self-assessment
is likely to increase, especially at the start of self-assessment year, the
already high compliance costs of SMEs.
Tax compliance cost studies have become
popular in several developed countries, where taxpayer opposition and
opposition lobbies are
well organised against new taxes or for that matter any
form of tax increase. Not so in developing countries. The few studies, to
be
cited later, that reported on compliance costs in emerging/developing economies
did indicate that the public listed companies
surveyed had much lower
compliance costs than is the case for similar companies in matured economies
with middling economic growth
rates. The higher compliance costs in such
countries may be traced to the greater complexity of taxation as well as the
greater administrative
surveillance of taxpayers, that is, more efficient tax
collection. However, a missing link in this line of research in developing
countries is the estimate of such costs for the SMEs. Without this measure, it
is not possible to provide information for the emerging/developing
economies on
the full range of cost experiences across the full spectrum of firms, both big
and small. This study is a first modest
attempt to measure compliance costs of
SMEs in an emerging economy, Malaysia.
Widespread dissemination of compliance cost
studies done in the 1980s and in the early 1990s in matured economies has led
to governments
in such countries reporting likely compliance cost impacts
before new tax laws are considered. This is the so-called impact statement
preceding tax bills in Parliaments. Such awareness has the cumulative effect of
slowing a government's urge to impose new taxes.
Some of the significant
studies of compliance costs that have contributed to this debate were
undertaken by Slemrod and Sorum,[1] Sandford,[2] and Fayle,[3] Blumenthal and Slemrod,[4]
Ariff et al[5]
and Cheung et al.[6] Several of these studies covered small and
medium sized companies in Australia, the US and the UK while the last two
covered only
public listed companies in two Asian city states.
The only compliance cost study in Malaysia
covered the public listed companies as at 1995. The results of that study by
Loh et al[7]
suggest that average compliance costs of listed firms are high and that the
costs are regressive in the sense that costs increase
with decreasing firm
size. This study is an extension of these earlier studies but covering the
SMEs. For policy formulation purposes,
one needs to research with care both the
SMEs and the large listed firms. Studying the compliance costs of the SMEs, it
is hoped,
will provide new information on the regressive nature of tax
compliance costs. As a matter of policy, costs to SMEs should not be
permitted
to become so high as to discourage SMEs from engaging in risk-taking
entrepreneurial activities, which are essential at
the early stage of
development of an emerging economy. Thus, any findings from this study are
likely to have a major impact on policy
formulation not just in tax law changes
but also on the whole idea of how to utilise SMEs as a pro-growth economic
structure in development.
Since most firms are not listed in formal
exchanges, it is, therefore, an important step in research to obtain estimates
and confirm
the usual hypothesis about compliance costs incurred by SMEs. The
total number of firms listed in the stock market as at 1 May 1999
was merely
about 470 (Main Board) and 210 (Second Board). The official reference book for
SMEs contains 10,400 names, which make
SMEs 15 times larger in numbers.
However, the total number of listings of SMEs in the Yellow Pages of the
telephone directory and
the Ministry of Trade and Industry's ("MITI")
directory alone is many times the number listed on the exchange or in the
reference list. Hence, the experience of SMEs in this regard merits a separate
study.
The rest of the article is organised into six
sections. Part 2 provides a brief introduction to the small and medium firms in
Malaysia's
economy. Part 3 provides a description of the concepts to be applied
in this study. The methodology based on a widely used survey
procedure is
described in Part 4. Part 5 summarises the main findings. The article ends with
a short conclusion in Part 6.
SMEs form the backbone of business community
with an estimated 45,000 of these enterprises playing a significant role in
this emerging
economy, which has moved to the middle-income developing
countries category in the 1990s. Their share of revenue is very small though,
accounting for about 15 percent of the total revenue of the manufacturing
sector, for example.[8] They are regarded as the driving force of
the economy.[9]
Three-quarters of the total of 2,039 manufacturing firms are classified as
SMEs, indicating the dominance of SMEs in this sector.
Furthermore,
manufacturing SMEs contribute to around 20 percent of the total output of the
manufacturing sector, underscoring the
dominance by the larger firms of this
sector. But the larger manufacturing firms depend on the crucial services of
these SMEs as
their suppliers. The official reference list of SMEs contains a
total of 10,400 firms in 1999.
A study of SMEs can provide information to
tax planners on how compliance costs may be maintained at low levels if
compliance costs
are regularly estimated for this group of firms. The economy's
efficiency is closely tied to the continued resilience of this sector
since
manufacturing sector contributes 35 percent of Malaysia's gross domestic
product. Management of companies would like to know
their average compliance
cost and how that compares with larger enterprises to which they are suppliers.
They may even be able to
manage the controllable part of their compliance
costs, if they knew what these costs were from a careful study.
According to the MITI, small and medium
industries ("SMIs") are defined as "companies with employees not
exceeding
150 with an annual sales turnover not exceeding Malaysian Ringgit
(RM) 250 million".[10] This new and liberal
definition has been adopted by MITI since 1998. Therefore, companies satisfying
both criteria (relating to employees
and sales) would qualify to apply for the
financing facilities, a government incentive, provided to promote SMIs. In this
article,
the acronyms SMIs and SMEs are used interchangeably. The primary aim
of the new definition, it has been claimed, is to encourage
expansion of
existing industries and simultaneously create a new breed of SMEs that would
add value to the manufacturing chain. Promotion
of such companies will
encourage smaller ones to be more efficient and become resilient.
The government also targets the SMEs for
special supports. As SMEs play an important role in providing support services
to larger
industries, particularly in the manufacturing sector, the government
provides various financing facilities to encourage their active
participation
to promote economic growth. The financial facilities provided via the following
funds are:
• Industrial Technical Assistance Fund,
• Rehabilitation Fund for Small and
Medium Industries,
• Technology Acquisition Fund, and
• Commercialisation of Research and
Development Fund.
In 1998, the government allocated (Ringgit
Malaysia) RM2.5 billion equivalent to about US$660 million to the SME fund to
encourage
new investment in selected sectors, namely manufacturing,
agriculture-based and special services industries. It has been claimed,
by the
government, that this assistance will lower cost, and will directly encourage
exports, and facilitate the growth of new industries,
including start-ups in
high technology sectors.
This Part covers the concepts and definitions
relating to compliance costs of companies. Prior studies[11]
have defined compliance costs as those relating to the costs of conforming to
the mandatory requirements of a tax regime involving
the preparation and
submission of timely tax returns in accordance with the relevant tax laws in
force in a country. Compliance costs,
therefore, are costs associated with the
number of hours spent in preparing tax returns, administrative expenses, and
any money spent
on the procurement of the services of tax professionals.[12]
These costs can be categorised into internal and external costs.
Internal costs relate to the time spent by
company staff on maintaining and preparing information for professional
advisers, completing
tax forms and dealing with revenue authorities on matters
pertaining to inquiries, objections and appeals.
External costs arise from payments made to
acquire the services of lawyers, accountants and investment advisers from
outside a company.
Complying with the tax laws and regulations, including
filing annual tax returns with the Inland Revenue Board ("IRB"),
may
require these services. Compared to internal costs, external costs are more
easily recognisable and quantifiable. Internal costs
are more difficult to
quantify since it involves fairly subjective apportionment of overhead and
other costs. Time spent by the internal
staff in preparing the annual tax
returns is very subjective and therefore is difficult to quantify, yet it has
to be estimated.
Nevertheless, methods have been devised by other research
including that undertaken by Ariff et al in 1997 in this economy[13]
in computing internal costs of companies, and this study employs the same
method to compute the compliance costs of SMEs.
Sandford et al[14]
further classified compliance costs into computational and planning costs.
Computation costs arise from compiling and
maintaining relevant information on a periodic basis in advance of time to be
ready to
prepare mandatory information required by the revenue authorities at
the time of report submission. Computation costs are an unavoidable
item for
companies, and such costs are also non-discretionary in nature.
This is a discretionary item that is related
to the tax minimising efforts of a company to manage its tax-related matters.
Planning
costs are avoidable since planning involves efforts to mitigate and
legally avoid taxes. They are only covered if management in its
discretion
chooses to minimise tax.
The implementation of a self-assessment
system ("SAS") commencing in 2001 is predicated as a fair and honest
reporting of
tax liability. It requires taxpayers to maintain appropriate
records and to exercise reasonable care in the reporting and submission
of
returns affecting their tax liability. The new measures necessitate taxpayers
to incur initial costs in addition to their regular compliance costs.
Thus, compliance costs could also be subdivided into initial irregular costs
and regular costs, which have not, to the knowledge of the authors, been
identified in prior studies.
Initial costs may have two elements: costs
relating to the implementation of new tax laws and costs linked with the
learning process.
When a significant change is made to an existing assessment
system, as in this case, new compliance costs would be incurred. Not
only is
the current year basis of assessment being replaced with the preceding year as
from 1 January 2001, SAS would be implemented
in stages in ensuing years. When
major changes are made to the assessment system as in this case, it is prudent
for taxpayers to
get things right the first time, or at least be as accurate as
is humanly possible. Preparing for the new tax system may necessitate
a
sizeable amount of initial irregular costs. On the other hand, the initial
costs of complying with the tax provisions will lead
to lower costs in the future
as the taxpayer gets used to understanding the issues pertaining to the new
amendments. These are costs
associated with the learning curve.
Regular or on-going compliance costs are
costs incurred by taxpayers, who are used to the tax systems. Taxpayers who
comply with the
requirements of the law incur such costs periodically.
Most of the early studies relating to
compliance costs concentrated on individual taxpayers.[15]
Following these studies, researchers in Australia, Singapore, UK and the US
examined compliance costs of public corporations and
companies. Pope et al
investigated in 1991 the compliance costs of public companies in Australia and
estimated the overall mean compliance
costs per public company to be A$62,604
(RM143,989).[16]
Ariff et al undertook in 1995 a similar study in Singapore and their mean
compliance cost estimate was over S$78,396 (RM172,471)
for a company.[17]
A second Singapore study by Ariff, Ismail and Loh in 1997 estimated the average
compliance costs to be S$54,615 (RM120,153) following
a number of tax reporting
reforms.[18]
A study in Malaysia of public listed companies estimated the average compliance
costs per company to be RM68,836.[19]
In a comprehensive UK study by the University
of Bath on compliance costs, Sandford[20] noted that
compliance costs for small traders started to rise in the mid-1980s. This was
due mainly to heavier penalties imposed
by revenue authorities on small
businesses for not complying with tax regulations. As a result, many small
businesses were forced
to hire accountants to file their tax returns. Obtaining
professional help meant extra financial burdens for the taxpayers. This
obviously led to an increase in their compliance costs.
Similar studies had been carried out in the
US by Slemrod and Blumenthal in 1996.[21] The findings of
their survey of 1,329 large corporations revealed that corporate compliance
costs amounted to US$2 billion for 1995
(that is an average of US$1.505 million
per corporation). As a fraction of the revenue raised, corporate compliance
costs were found
to be lower than for individual income taxpayers. The findings
of this study also revealed that the cost-to-revenue ratio was higher
for state
corporate tax systems than for the federal tax system, reflecting the
non-uniformity of the state tax systems. Furthermore,
most of the respondents
were of the opinion that the Tax Reform Act 1986 made the US tax system
more complex, resulting in higher compliance costs. Likewise, for UK companies,
Sandford[22]
estimated in 1989 the average compliance costs to be £10,980 (RM69,174)
for companies with turnover of more than or equal to
£10 million (RM6.3
million). This study covered a national sample and therefore encompassed SMEs
as well. Among several studies
that investigated compliance costs in the
corporate sector, costs of complying with corporate taxation were highest for
Australian
companies.
The following section covers the data
collection and preparation of survey questionnaries.
The questionnaire was divided into four
sections. Section 1 (General Information) elicited data on the characteristics
and nature
of the business as well as the number of people employed by the
company. Section 2 (External Costs) contained questions relating
to the costs
of employing external advisers to handle taxation matters. Information about
the breakdown of the estimated fees for
tax return preparation work, advisory
and planning costs was elicited from respondents. Section 3 (Internal Costs)
provided data
on time spent on tax affairs by managers, accounting staff and
computer officials and the amount as well as proportion of wages paid
to each
group. This enabled costs attributed to different groups to be aggregated as
the appropriate unit costs. Finally, Section
4 (Other Matters) was designed to
elicit respondent's opinion on ways to improve rapport between the personnel at
the IRB and companies.
This section also sought to ascertain whether the IRB's
views had been sought on specific issues. It also examined the extent to
which
companies were prepared for the SAS and the impact of the new system on
compliance costs.[23]
The survey instrument solicited information
regarding general characteristics of the company, external and internal costs,
and aspects
of the tax system covering opinions, constraints and suggestions
for the improvement of the tax system.
The researchers conducted personal
interviews, as SMEs normally do not readily respond to mailed questionnaries.
Mailed questionnaires
were also sent to prepare the respondents for the survey,
and to establish the bona fides of the persons meeting the respondents.
The
survey population was taken from the directory of SME companies obtained from
the MITI. A total of 300 companies were randomly
drawn from a population frame.
The population frame consisted of about 10,400 firms in the reference list, but
only 300 SMEs located
in the northern region were selected for this study. In
view of the highly technical nature of the study, it was decided to use a
smaller but representative population using personal interviews that would
yield a higher response rate as well as more reliable
responses. A total of 67
SMEs responded favourably to our request to participate in this study providing
a response rate of 22.3
percent.
Reliability analysis was carried out and
various sections were found to be reliable and valid after certain questions
were eliminated.
Based on Cronbach's Alpha, the overall reliability coefficient
score obtained for the questionnaire was 0.80. Generally, the above
reliability
coefficient indicates that there is a high level of consistency in the
responses. Reliability coefficients of 0.65 and
above are considered more than
acceptable for most behavioral science applications.[24]
As for validity, the views of tax professionals were sought in designing the
questionnaires. Discussions were also held with fellow
academics pertaining to
the design of the instrument and the method adopted in this study.
A pilot study was carried out five months
earlier among 12 SMEs located in the Northern region of West Malaysia to test
the reliability
and validity of the instrument. Personal interviews were
conducted with finance managers and accountants of companies. Every step
was
taken to ensure that the final survey instrument was clearly understood by the
respondents.
A total of 73 SMEs responded to our request
to participate in this study. Six returned questionnaires could not be utilised
as the
information provided was unrealiable, leaving 67 acceptable responses
thereby providing a response rate of 22.3 percent. The response
rate was low, as
SMEs normally dislike divulging information, especially anything relating to
detailed tax matters. The returns were
classified into three groups (1, 2 and
3), based on the sales turnovers of the SMEs, to facilitate comparison of
compliance costs
across size groups. Group 1 comprised companies with turnover
of less than RM5 million. Group 2 encompassed companies whose turnover
ranged
between RM5 million and RM50 million. Group 3 comprised companies with sales
turnover exceeding RM50 million. Descriptive
statistics such as the mean values
obtained for the cost items were used to test for significant differences in
compliance costs
among various groups of companies. The procedure followed by
Ariff et al in 1995 was adopted.[25] By regressing
compliance costs on turnover values, past compliance cost studies on public
listed companies have indicated that the
absolute amount of compliance costs is
higher for larger firms[26] though compliance
costs per unit of revenue decline as firm size increases due to the economy of
scale effect.
The general characteristics of the companies
are summarised in Table 1. Turnover of the SMEs ranged from RM600,000 to RM466
million
(US$157,895 to US$70 million) with 21 companies having sales turnover
of less than RM5 million; 38 between RM5 million and RM50 million;
and the rest
having more than RM50 million.[27]
Most of the companies were from the
manufacturing sector (37) followed by commerce or trading (8) and construction
and property development
(7). The remainder of the companies were from the
financial, insurance and service sectors as well as computer firms.[28]
Table
1 - Profile of Respondents in Mail Questionnaire
Survey
in Malaysia (1998)
|
Characteristics of Companies |
Companies |
|
(a) Turnover in RM million Group 1: Less than 5 Group 2: Between 5 and 50 Group 3: More than 50 (b) Main Business Activity Construction and Property Development Commerce/Trading Computer/Software/IT Financial, Insurance, Real Estate and Business Service Manufacturing Transport, Communication and Storage Others (c) Estimated Tax Liability Less than RM100,000 RM100,000 - RM499,999 RM500,000 - RM1 million More than RM1 million |
21 38 8 7 8 1 4 37 1 9 17 15 5 9 |
The statistics on the actual taxes paid are
given under Item (c) of Table 1. The tax liability of each company varied from
less than
RM100,000 to more than RM1 million.[29] The others did not
reveal their estimated tax liability. The average tax paid by a company
included in the study is RM571,149 (US$150,300)
with a range of RM3,472 to
RM3.3 million. The average tax per company paid by each listed company
determined in an earlier study[30] that covered listed
firms was RM6.5 million (US$1.7 million) at the then average exchange rate. The
average tax of an SME in this
study is therefore one-eleventh of the average
tax paid by a listed firm. This is our estimate of the order of the SMEs tax
liability
under the current laws.
Table
2 - Dollar Compliance Costs per RM1,000
Sales
Turnover (RM)
|
Groups |
1998 Year of Assessment |
|
1 |
629,715 |
|
2 |
771,072 |
|
3 |
70,830 |
|
Average |
21,964 |
Another significant new statistic is the
estimate of compliance cost. The average compliance cost of SMEs is RM21,964
(US$5,780 using
the 1999 exchange rate) per firm. The average for the listed
firms reported in the cited study was RM68,836 (US$27,100). The relative
compliance cost of SMEs is therefore one-third of the much larger costs of an
exchange-listed company. This seems to indicate the
severe regressive nature of
compliance costs for SMEs. The internal compliance cost constitutes 75 percent
of the total cost while
the external cost stood at 25 percent. For listed
firms,[31]
the external cost was reported to be 72 percent of the total. This suggests
that the components of compliance cost (internal and
external costs) are not
similar in SMEs and listed companies. The SMEs do not spend more
on external advice as in the case of listed
companies but rather rely heavily on their own staff to comply with the tax
laws. In addition
to the above costs, ten companies stated that they had to
incur additional costs in complying with company income tax requirements
for
the 1998 financial year. These additional costs were incurred to handle back
duty inquiries, stamping of documents, appeals against
Scheduler Tax Deductions
for employees and others.
Table
3 - Regression of Compliance Costs on Sales Turnover of Companies
|
Intercepts |
Slope Coefficient |
R-Squared |
F-Ratio |
|
2.053E-04 20.422 |
6.978 -0.0032 |
.005 |
0.001 |
The slope parameter with a value of 6.978 is
not statistically significant. In this study, the respondents were all SMEs.
Since they
form a more homogenous group than the listed firms, the above
analyses of the data suggest that the compliance costs do not significantly
vary among the size groups within the SMEs, though the cost differences are
large.
Table 4 below shows the breakdown of
compliance cost into the computation and planning components.
Table
4 - Breakdown of Compliance Costs by Size (% Of Compliance Costs)
|
Size Group |
Computation Costs (RM) |
Planning Costs (RM) |
Total costs (RM) |
|
1 |
498,734 (79%) |
130,981 (21%) |
629,715 |
|
2 |
302,258 (39%) |
468,814 (61%) |
771,072 |
|
3 |
67,304 (95%) |
3,526 (5%) |
70,830 |
|
Average |
12,960 (59%) |
9,004 (41%) |
21,964 |
The average computational cost was RM12,960,
which amounted to 59 percent of the average total compliance costs. This ratio
of 59
estimated for the SMEs differs from the 50 percent incurred by
Singaporean public listed companies[32] and the 45 percent
incurred by Australian companies.[33] Malaysian listed
companies, on the other hand, incurred 61 percent computation costs.[34]
The average planning costs per company in this study were RM12,960 (US$3,410),
which represent 59 percent of the average total compliance
costs. This
proportion is not strictly comparable to the 50 percent or the 45 percent
incurred in the other two countries. The difference
could be due to the
complexity of the tax system, perhaps accounted for by the scope for tax
planning, the stage of development of
the economy and the size of the company.
Computation cost for SMEs is 1.5 times the
average planning cost reflecting the fact that a typical company used more
resources to
keep routine cost data associated with tax audits, withholding
tax, payments to staff as well as data provided to advisers to complete
returns. Costs were also incurred in relation to tax objections, inquiries and
appeals. Computation costs of Group 3 companies amounted
to 95 percent of the
average total compliance costs. This should be contrasted to the computation
costs of Group 1 companies which
amounted to 79 percent of the overall average
and 39 percent for Group 2 companies.
The differences in computation costs between
Group 1 and Group 3 companies and between Group 2 and 3 companies were not
statistically
significant, whereas the differences between Group 1 and Group 2
companies were only marginally significant (at a low acceptance
level of p =
0.08). The smaller companies, on average, spent less than one-third of their
compliance costs on tax planning activities
compared to 61 percent in the case
of Group 2 companies, and 5 percent for Group 3 companies. This probably
reflects the complex
nature of the business activities of larger companies with
more diversified investment opportunities and financing patterns, which
may
require special tax considerations, for example, development tax offsets and
capital allowances.
These results also indicate that there are no
significant differences in planning costs among the three groups of SME
companies. This
means that companies in the three categories spend almost an
equal amount on tax planning irrespective of their size.
Table
5 - Breakdown of Compliance Costs by Sources of Costs (% Of Compliance Costs)
|
Group |
Internal Costs (RM) |
External Costs (RM) |
Total Costs (RM) |
|
1 |
428,845(77.2%) |
126,570 (22.8%) |
555,415 |
|
2 |
578,013 (75.5%) |
187,837 (24.5%) |
765,850 |
|
3 |
31,200 (47.4%) |
34,650 (52.6%) |
65,850 |
|
Average |
15,493 (75%) |
5,210 (25%) |
20,703[35] |
Only 25 percent of the total compliance costs
incurred by all companies was paid to external advisors. It is useful to
compare this
result with the findings reported for listed firms, which indicate
that payments to external advisors represented about 72 percent
of the total
compliance costs incurred by listed companies. A majority of the SMEs therefore
prepared tax returns and related documentation
internally compared to listed
companies, 91 percent of which sought the assistance of external professional
advisers to handle their
tax matters. The main reason for 25 percent of the SME
respondents relying on the external advice was to handle the non-routine income
tax affairs while a small percentage of the respondents said that they
undertook tax planning, and other related tax matters. The
other reasons for
using the external adviser included the desire to undertake income tax planning
(10.4%), the need to handle routine
matters or lodge income tax returns (29.9%)
and other related matters (1.5%).
This finding suggests that smaller companies
are less likely to employ external advisers to prepare their tax returns and
that these
advisers probably handled other routine matters pertaining to corporate
tax. SMEs spent 75 percent of the expenses on internal resources
to comply with
tax laws rather than on external advisors.
The breakdown of computation costs into
internal and external components across companies in the various groups is
found in Table
6.
Table
6 - Breakdown of Computation Costs into Internal and External Costs (% Of
Computation Costs)
|
Group |
Internal Costs (RM) |
External Costs (RM) |
Total Costs (RM) |
|
1 |
409,664 (82%) |
89,070 (18%) |
498,734 |
|
2 |
168,836 (56%) |
133,422 (44%) |
302,258 |
|
3 |
28,704 (43%) |
38,600 (57%) |
67,304 |
|
Average |
9,063 (70%) |
3,897 (30%) |
12,960 |
Thirty percent of the total computation costs
of all companies pertain to payments to external agents, thus the internal
costs were
70 percent. The proportion of external costs of Group 1 companies
was 18 percent, 44 percent for Group 2 companies, and 57 percent
for Group 3
companies. This finding is consistent with the responses made by the smaller
companies in the sample.
The breakdown of costs from tax planning
activities incurred from internal and external resources by the three groups in
question
is provided in Table 7.
Table
7 - Breakdown of Planning to Internal and External Costs (% Of Planning Costs)
|
Group |
Internal Costs (RM) |
External Costs (RM) |
Total Costs (RM) |
|
1 |
125,742 (96%) |
5,239 (4%) |
130,981 |
|
2 |
422,110 (92%) |
36,704 (8%) |
458,814 |
|
3 |
3,209 (91%) |
317 (9%) |
3,526 |
|
Average |
8,464 (94%) |
540 (6%) |
9,004 |
Only 6 percent of planning expenditure was
due to fees paid to external advisers for their services in formulating tax
plans. The
external cost component for the largest companies was also only 9
percent compared to 4 percent for a smaller company.
The authors also calculated compliance costs
as percentages of tax revenues paid to the IRB as declared by the sampled
firms.
Table
8 - Percentage of Compliance Costs to Tax Revenue
|
Group |
Estimated Tax Revenue (RM) |
Compliance Costs (RM) |
Percentage Costs to Tax |
|
1 |
1,775,843 |
629,715 |
31.3 |
|
2 |
16,262,172 |
771,072 |
4.70 |
|
3 |
8,013,639 |
70,830 |
0.82 |
|
Average |
566,304 |
20,964 |
3.70 |
Sanford[36] showed that UK
companies, on average, incurred compliance costs of 2.2 percent of the total
tax revenue. Pope et al[37]
estimated the compliances costs of Australian
public companies with respect to income taxation in 1986/87 to be anywhere
between 11.4
and 23.7 percent of the tax revenue collected from public
companies. The result for Singapore was an average of 4.0 percent for all
companies for the 1995 year of assessment.[38] The numbers for the SMEs
in Malaysia are the lowest. The average of 3.70 per cent (that is, 31.3%, 4.70%
and 0.82%, respectively,
for Groups 1, 2 and 3) appear to be comparable to the
Singapore results, again with the proviso that the size differences are not
controlled. The percentage compliance burden for SMEs in Malaysia is lower than
the percentage in Australia but higher than the percentage
in the UK. The
Australian comparison highlights the complexities of the tax system in that
economy while that of the UK shows the
reforms made in the late 1990s to lessen
the compliance costs in that economy. An alternative plausible explanation is
that the companies
in the Sanford[39] and in the Pope et
al[40] samples
were smaller, and if the consistent findings that smaller firms have higher
costs (the regressive principle) holds, one might
expect higher percentage of
compliance costs to tax revenue than reported on an unadjusted basis. This
indicates that the Malaysian
SMEs have relatively low absolute compliance cost
compared to Australia and Singapore but higher compared to UK. Compared to 1.1
percent compliance costs as a percentage of taxes paid by the listed Malaysian
firms, the 3.70 percent compliance costs to the SMEs
is rather burdensome.
The findings also indicate that larger SMEs
use accounting firms and legal advisers as their main sources of external
advice. Accounting
firms were sought mainly to undertake accounting,
secretarial and tax return preparation work. The main reasons for seeking
external
advice were to handle routine income tax affairs and to undertake
income tax planning. External assistance was also sought by these
companies
because the depth of technical knowledge, particularly in specialised areas,
was not readily available within the firm
and also because it was more
cost-effective.
5.4 Qualitative Responses
The open-ended responses to qualitative
questions contained interesting comments. These comments reveal considerable
convergence of
views among respondents with respect to their impression of the
IRB and its staff. Some frequently mentioned responses were:
(i) "IRB staff are not very
helpful";
(ii) "IRB personnel maintained strict
confidentiality on taxpayers' records";
(iii) "Difficult to access IRB staff
over the telephone";
(iv) "Tax return forms are not processed
quickly".
A general concern is the absence of IRB tax
rulings on specific issues. The respondents would like to see the IRB becoming
transparent
suggesting, for instance, that tax rulings should be made readily
available when such information is sought by taxpayers. Some respondents
pointed to the inadequacy of training of IRB staff adding that their attitude
towards time management and their speed in responding
to queries by SMEs
required urgent attention.
An important area of tax research during the
last two decades has been the issue of costs to taxpayers in complying with
taxation
obligations. As for Malaysia, the issue of compliance costs is more
significant for a number of reasons. First, there is increased
consciousness of
the vital role of SMEs to the general economy. Several governments such as
those in Australia, Malaysia and Thailand
see small and medium companies as the
vehicle for greater economic growth as well as the means to create more
employment opportunities.
The US economy has found that the fast growth in
employment between 1993 to 1999 was actually generated by the SMEs applying new
technologies.
Secondly, tax systems appear to become increasingly
more complex either due to major amendments being made to existing laws or new
assessment systems being introduced as is the case in this emerging economy.
This study is particularly significant for taxpayers,
as the self-assessment
system will be implemented in 2001, commencing with companies. Compliance costs
are expected to significantly
increase because of this, particularly during the
initial stages of the new assessment era, when companies are getting things
right
the first time or as correct as humanly possible. The implementation of
SAS in Malaysia will result in transfer of costs from administration
(IRB) to
compliance (taxpayers). Thirdly, there is an increasing outcry by the public
for more tax authority accountability. Although
there will be a shift in costs
from the revenue authorities to taxpayers once SAS is introduced, government
accountability dictates
that there should be an overall reduction in economic
costs.
Interesting findings have been obtained in
this first study of small businesses. The average tax paid by the SMEs is
one-eleventh
of the taxes paid by a typical listed firm. Yet the compliance
cost of a listed firm is only three times that of the compliance costs
of a
typical SME. This suggests that the compliance cost is four times more
regressive for an average SME. Considering the average
tax paid by the SME,
compliance cost is approximately four percent of the tax liability. That is,
compliance costs amount to four
cents in a dollar of tax paid. For the
exchange-listed Malaysian firms, the compliance cost is 1.1 percent of the
taxes paid. Again
this confirms the four-fold regressiveness of tax compliance
costs of small businesses in Malaysia.
Finally, an important aim of this study was
to report relevant research data to assist in the formulation of realistic
proposals for
tax reforms that would result in an overall reduction in
compliance costs for both small and large firms. The proposals may hinge
on
measures that could be introduced by the government that will lower costs of
SMEs in adhering to the requirements of the tax provisions.
Tax simplification
should be an essential element in the tax reform
agenda. A rigorous tax education program too
must be extended to private business enterprises while the authorities need to
educate
the tax personnel on the need for better response rate and timeliness
as well as tax rulings.
[*] The authors
wish to thank the grants committee at the Universiti Utara Malaysia
("UUM") for the financial support to conduct
compliance cost studies
in Malaysia. Several research students assisted in the fieldwork and in
follow-up activities to compile the
research database at the UUM. Ariff likes
to express his thanks to the UUM for funding research visits as the Visiting
Bumi Commerce
Bank Chair. The authors are also grateful to an anonymous referee
for useful comments on an earlier version of this article. They
take full
responsibility for any errors.
[**] Associate Professor and Head of Research and Development, UUM.
[***] Professor of Finance, Department of Accounting and Finance, Monash
University.
[****] Associate Professor and Head of Taxation Research Institute, UUM.
[1] JB Slemrod and
N Sorum, "The Compliance Costs of the US Individual Income Tax
System" (1984) 37(4) National Tax Journal 461.
[2] C Sandford,
"What it Costs to Pay Tax: Policy Issues" [1989] Accountancy
113.
[3] J Pope and R
Fayle, "The Compliance Costs of Personal Income Taxation in Australia,
1986/87 - Empirical Results" (1990) 9 Australian Tax Forum 85.
[4] M Blumenthal
and J Slemrod, "The Compliance Costs of the US Individual Income Tax System:
A Second Look After Tax Reform"
(1992) 45(2) National Tax Journal
185.
[5] M Ariff, Z
Ismail and A Loh, "Compliance Costs of Corporate Income Taxation in
Singapore" (1997) 24 (9-10) Journal of Business Finance and Accounting
1253.
[6] D Cheung, S
Chan and M Ariff, "Compliance Costs of Corporate Taxation in Hong
Kong" (1999) 25(4) International Tax Journal 42.
[7] A Loh, M
Ariff, Z Ismail, M Shamser and M Ali, "Compliance Costs of Corporate
Taxation in Malaysia, 1995" (1997) 14(3)
Pacific Accounting Review 134.
[8] SMEs are
generally labour intensive and they lack information technology and knowledge
of automation. SMEs, therefore, have not become
competitive enough to increase
their share of the output even though they form three-fifths of the number of
manufacturing firms.
With larger frims, particularly foreign manufacturing
firms using them as contractors, the rate of technological knowledge is
increasing
steadily.
[9] KC Chan,
"Are SMIs Really at Risk?" The Star, Star Publications Ltd,
Kuala Lumpur, 7 February 1999 (Datuk Chan is Deputy Energy, Communications and
Multimedia Minister)
[10] Ministry of International Trade and Industry, Directory of Small
and Medium Industries (Malaysia, 1999).
[11] Slemrod and Sorum, above n 1; Sandford, above n 2; and Blumenthal and
Slemrod, above n 4.
[12] According to C Evans, K Ritche, B Tran-Nam and M Walpole, Taxation
Compliance Costs - Some Recent Empirical Work and International Comparisons,
Third International Conference on Tax Administration, 16-17 April 1998,
"pure" compliance costs are costs directly incurred
by taxpayers in
meeting the requirements of the tax law. These include taxpayers' own labour,
unpaid helper and internal staff costs,
costs of external advisers, and
incidental or overhead costs such as specific travel, stationery, postage and
computer use incurred
by taxpayers. Social welfare costs as well as
administrative costs borne by taxation authorities are, however, excluded.
[13] Ariff et al, above n 5.
[14 ]C Sandford, MR Goodwin and PJW Hardwick, Administrative and
Compliance Costs of Taxation (1989).
[15 ]See J Martin, "Costs of Tax Administration: Nature of Public
Costs" (1994) 1 Bulletin of the National Tax Association 104; J
Wicks, "Taxpayers' Compliance Costs From Personal Income Taxation"
(1966) 8 lowa Business Digest 16; and Slemrod and Sorum, above n 1.
[16] J Pope, R Fayle and DL Chen, The Compliance Costs of Public
Companies' Income Taxation in Australia 1986/87 (1991).
[17] M Ariff, A Loh and AA Talib, "Compliance Costs of Corporate
Taxation in Singapore 1994" (1995) 8(2) Accounting Research Journal
75.
[18] Ariff et al, above n 5.
[19] Loh et al, above n 7.
[20] C Sanford, "Accountant and the Cost of Compliance" [1990] Accountancy
104.
[21] JB Slemrod and M Blumenthal, "The Income Tax Compliance Costs of
Big Business" (1996) 24(4) Public Finance Quarterly 376.
[22] Sandford, above n 2.
[23] Under the Official Assessment System ("OAS"), all return
forms were checked for arithmetical accuracy, computation of tax
payable and
full disclosure of taxable income. Such a system was perceived to be an
ineffective and inefficient approach to ensure
compliance with tax law. The OAS
approach was also perceived to be inconsistent with IRB's policy of encouraging
voluntary tax compliance.
[24] JC Nunnally, Psychometric Theory (2nd ed, 1978).
[25] Ariff et al, above n 17.
[26] Pope et al, above n 16; and Ariff et al, above n 5.
[27] See Table 1, Item (a).
[28] See Table 1, Item (b).
[29] Only 46 companies out of 67 gave estimates of tax liability for year
of assessment.
[30] Loh et al, above n 7.
[31] Ibid Table 5.
[32] Ariff et al, above n 5.
[33] Pope et al, above n 16.
[34 ]Loh et al, above n 7.
[35 ]The overall average of RM20,703 in the last column is
different from the average compliance cost because of differences in the sample
size.
[36] Sandford, above n 2.
[37] Pope et al, above n 16.
[38] Ariff et al, above n 5.
[39] Sandford, above n 2.
[40] Pope et al, above n 16.
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