Impact Of Taxation On Small Scale Business In A Developing Economy

Project and Seminar Material for Accountancy / Accounting

Abstract

Small and Medium Enterprises play a very important role in development of the Nigerian Economy. Making up about 97% of the entire economy, they serve as a source of employment generation, innovation, competition, economic dynamism which ultimately lead to poverty alleviation and national growth. Tax policy is one of the factors that constitute the Small businesses’ economic environment. This research work tries to establish if any relationship exists between the growth of Small businesses and the tax policy environment in which they operate in Nigeria. Questionnaires were distributed to Small businesses in Calabar, Nigeria and non probability judgmental sampling method was employed. It was found out that from most Small businesses surveyed; they were faced with the problem of high tax rates, multiple taxation, complex tax regulations and lack of proper enlightenment or education about tax related issues. Although there was a general perception that tax is an important source of fund for development of the economy and provision of social services, the study revealed a significant negative relationship between taxes and the business’ ability to sustain itself and to expand. In order to obtain a vibrant and flourishing SME sector, the tax policy needs to be appropriate such that it will neither be an encumbrance to the Small businesses nor discourage voluntary compliance. A suggested solution is by increasing tax incentives through reducing tax rates and increasing tax authorities’ support services towards small and medium enterprises.

Chapter One

Introduction

The desire to build a civilized country with a strong and sound economy is the desire of every Country, including Nigeria. Tax payment is the demonstration of such a desire, although some income earners see it as a means of exploitation by the government. Tax payment is a voluntarily contribution imposed by the Government on personal income earners, companies, investors, exporters, importers etc. revenue realized from taxation is a major source of revenue to the Government of Nigeria, and as such is an important tool used in the development of Nigeria and her economy. A country’s tax policies and systems are greatly related with business ventures in that country. An economy that enacts favorable and progressive tax laws and policies will definitely breed successful and finance-healthy business organizations. Once businesses flourish, the economy flourishes as well, as there is no quicker way of stirring the affairs of an economy without the help of organizations that move services, goods, money and investments from those with surplus to those with deficit; those with marketable ideas/output to those who need these ideas and products. In essence, businesses and tax policies greatly depend on one another for survival. If one is greatly affected, the other follows suite.

1.1 Background of the Study

The Nigerian Tax System has undergone significant changes in recent times. With the help of various studies and research done by tax experts, tax laws are being reviewed with the aim of repelling obsolete provisions and simplifying the main ones. Under current Nigerian law, taxation is enforced by the 3 tiers of Government, i.e. Federal, State, and Local Government with each having its sphere clearly spelt out in the Taxes and Levies (approved list for Collection)

Small businesses are generally recognized as important drivers of economic success. They are a key ingredient in the “ecology of firms” in a healthy economy, as job creators, sales generators and a source of tax/fiscal revenue. In Nigeria the importance of small business as a creator of jobs, particularly for those with a low skills level, is widely recognized. Small, medium and micro-enterprises (“SMMEs”) contribute 36.1% of the country’s gross domestic product (“GDP”) and employ 68.2% of the workforce in the private sector. In the agriculture, construction and retail sectors, SMMEs employ more than 80% of the total workforce. Over the last few years, the growth in employment by SMMEs has exceeded the growth in their contribution to GDP, highlighting the job creation potential of this sector of the economy.

Regulations and red tape are reported as one of the constraints to the expansion of businesses both in Nigeria and internationally. International research in this field shows that tax regulatory compliance costs are a significant portion of the total regulatory cost. Several other patterns emerged from the various local and international studies performed, among the most important being that tax compliance costs comprise a much larger proportion of total compliance costs for smaller firms.

Furthermore, various research has suggested that any effective approach to assist small business requires both policy and administration model adjustments in order to be effective. The 2005 year, therefore, saw the beginning of a process of structural change that was intended to build a positive tax compliance climate in Nigeria.

This report is focused on the survey of the compliance experience of professional accountants and bookkeepers (referred to as “tax practitioners” for the purposes of this document) in respect of their small business clients in Nigeria. It will be complemented by two related surveys, one of small businesses that are registered with the Federal Inland Revenue Service (FIRS), regarding their time and cost requirements for tax compliance, and one of informal businesses, regarding their perceptions about tax compliance.

1.2 Statement of the Problem

Small and medium enterprises (Small businesses) form the core of majority of the world’s economies. A study carried out by the Federal Office of Statistics shows that in Nigeria, small and medium enterprises make up 97% of the economy (Ariyo, 2005). However, the mortality rate of these small firms is very high. According to the Small and Medium Enterprises Development Agency of Nigeria (SMEDAN) Nigeria, 80% of SMALL BUSINESSES die before their 5th anniversary. Among the factors responsible for these untimely close-ups are tax related issues, ranging from multiple taxations to enormous tax burdens etc. In many government policies, small and medium enterprises are usually viewed and treated in the same light as large corporations. However, their size and nature makes them unique. Therefore, in dealing with small and medium enterprises, these unique qualities need to be considered. In levying of taxes for these enterprises in particular, issues that need to be considered are how these tax policies can be designed to bolster the growth of Small businesses and the most effective ways to administer them. The importance of Small businesses as a mechanism of economic growth and development is often ignored. They are perceived as minute establishments that have minimal effect on the state of the economy. However, if conducive environment is created for these Small businesses to grow through proper regulation, the SME sector has the highest propensity to transform our economy. In the same light, taxes are important for the government as they are the major source of funds for government expenditure. Income obtained from taxation of individuals and businesses are used to run governments as well as provide infrastructure such as good roads, water supply, and electricity which are essential for the smooth running of these businesses that are mainly manufacturing companies and as such rely on these commodities to survive.

Tax burden is a major problem in Nigeria as many business organizations are not favored by the tax systems and policies in place. Some businesses are already collapsing; while majority are still struggling to meet up with high tax rates to ensure their businesses still exist. According to a study conducted by Bateman (2007), it was reported in a survey that 90% of business owners admitted that taxes were a huge constraints to their businesses, as they claim taxes are high and do not allow new businesses to cover up initial cost.

1.3 Objectives of the Research

In-order to achieve the purpose of this research, the following are the objectives of the research:

To identify the challenges of Nigerian tax policies.
To examine the influence of multiple taxation on small businesses and the economy as a whole.
To identify ways of properly addressing the challenges of Nigerian tax policies in order to favour small businesses as well as encourage tax compliance.

1.4 Research Questions

In order to achieve the objectives stated above, the following research questions were used as a guide in achieving the objectives of this research:

What are the various challenges facing tax policies in Nigeria?
What are the influences of the challenges of tax policies in Nigeria on small businesses and the economy?
What must be done to address the challenges of tax policies in Nigeria to suite small businesses?

1.5 Significance of the Study

This study gives a clear insight into the various ways in which tax policies in Nigeria can be executed efficiently to still favor small businesses and how some taxation policies in Nigeria can be properly tackled. The study also gives a clear insight into the various causes of why small businesses fail in Nigeria as well as the challenges of the tax policies in Nigeria. The findings and recommendations of the researcher will help in building a strong and better tax policy system in Nigeria, if taken seriously by government and the general public. The challenges of taxation in Nigeria are outlined in-order for drastic measures to be taken to tackle these challenges and meet the prospects of the general public so that revenue from tax policy to the government can be increased.

1.6 Scope of the Study

This research focuses mainly on the impact of Nigerian tax policies on the economy and small businesses in developing economy. The study only torches on the challenges tax policies in Nigeria and how it can affect self employed business men and women, traders, and other forms of sole proprietorship businesses.

Based on the findings of this study other possible researchable areas may include studies on the various challenges of other forms of tax such as the Value Added Tax (VAT), Capital gains tax, Import and Export duties tax. Etc. Further research can also be done on curbing tax evasion in Nigeria.

1.7 Time Frame

This study lasted for four months before it was complete. The study lasted from January 2011 to April 2011.

1.8 Limitation

The only limitation faced by the researcher in the course of carrying out this study was the delay in getting data from the various respondents. Most respondents were reluctant in filling questionnaires administered to them due to their busy schedules and nature of their work. The researcher found it difficult to collect responses from the various respondents, and this almost hampered the success of this study.

1.9 Chapter Scheme

Chapter one of this study includes the general introduction, background information about the study, statement of the problem, objectives of the study, research questions, scope of the study, significance of the study, and the limitation of the study.
Chapter two reviews all relevant literatures relating to the study as well as the researcher’s views concerning previous studies on the challenges of tax policies.
Chapter three includes the methodology applied in collecting and analyzing data, population definition, study site, and limitations.
Chapter four presents the results of the study as well as data analyzed, and the interpretation of the analyzed data.
Chapter five includes a summary of the study, conclusion and recommendations based on the findings from the study.

Chapter Five

Findings, Conclusion and Recommendations

5.0 Introduction

This chapter includes the findings, conclusion and recommendations of this study. All findings by the researcher on the Impact of Nigeria tax policy on small businesses are stated clearly in this chapter as well as conclusion and recommendations on the study. All findings, conclusion, and recommendations for this study are based on all data analysed from questionnaires filled by respondents for this study.

5.1 Summary of Findings

The first objective of the study was to identify the challenges of tax policies and administration in Nigeria.
According to the study, the researcher succeeded in achieving this objective by developing both closed and opened ended questionnaires to business men and women who pay their taxes and fully understand how tax is administered in Nigeria. The study revealed that tax policies in Nigeria are faced with numerous challenges, as it was rated between poor to average by the respondents when asked to rate the policies used in administering taxes in Nigeria (see table 11). The study went ahead to reveal that high tax rates, numerous taxes, multiple taxation by the government, influx of fake tax officials, complex tax systems and bribery/corruption are the main challenges facing tax systems and administration in Nigeria (see table 12). In view of all these challenges identified in the course of carrying out this study, it also came to light that a bigger challenge the government might start facing in the future is massive tax evasion, as most respondents indicated that since they are not comfortable with tax administration in Nigeria, they try every opportunity they get to evade tax (see table 8). According to the study, majority of the respondents do not pay their taxes regularly, because they are not comfortable with tax administration in Nigeria, hence they see taxation as a big burden and constraint to their businesses (see table 7).

The second objective of the study was to identify the impact of these challenges on small businesses in Nigeria.
The researcher however, succeeded in achieving this objective in the study by asking the right questions to the people who actually feel the impact directly (small businesses), since most of the tax laws and policies are relevant to small business owners. According to the study, it was revealed that the current tax policy in Nigeria actually have great impact on small businesses as it has its negative and positive impacts. One major impact of Nigeria’s tax policy is multiple taxation (see table 15). Multiple taxation which is a feature in the Nigeria tax policy is indicated to be a burden to small businesses as organizations are taxed as well as employees in the organization.

The Nigeria tax policy has opened a lot of ways for fake tax officials who exploit small businesses for their selfish reasons to operate comfortably, due to the inability of the government to develop a tighter control measures in administering taxes. This has created a loophole where revenue meant for the development of the economy now go to the pockets of crooks who pose as tax officials (see table 15). Another big impact revealed by the study is stunted growth to small businesses brought about by the new policy (see table 15). Due o the state in which Nigeria’s economy is now, some of the tax laws like education tax, industrial training tax etc do not encourage small businesses to grow. Some small businesses are small in nature-both financially and operationally, hence they need a lot of time to cover initial costs they incur, and these tax policies do not allow for them to recover fully. However, if businesses fail, then the economy is in trouble. As the government try to increase its revenue it might destroy the main engine that runs the economy.

The third objective of the study was to identify ways of addressing the challenges tax policies and administration in Nigeria face.

The study revealed that in order to tackle these challenges properly and squarely, the government must create a committee to draft new tax policies that favor small businesses in Nigeria, simplify the existing tax system and policies in Nigeria, give free or cheap tax consultancy to small business owners, draft tax policies that will encourage human capital, reduce tax rates for small businesses in particular as well as exempt small businesses from paying numerous kinds of taxes in the system (see table 19). It also went ahead to reveal that another way of addressing the challenges of tax policies and administration in Nigeria is to educate small business owners on the need to pay their taxes as this will go a long way in changing the perspective of those who intentionally evade taxes (see table 19). Establishment of tighter control measures will also go a long way in eliminating fake tax officials as well as reduce bribery and corruption. Other ways of tackling the problem is to use tax proceeds from small businesses to develop development programs for small businesses.

5.2 Conclusion

Evidence from this study and other from economic research indicates that tax policies—and, in particular, regressive tax policies—do indeed influence small and medium scale businesses when it comes to working, investing, saving, and entrepreneurship. Perhaps most importantly, high and increasing marginal taxes contribute to lower rates of economic growth, reduced rates of personal income growth, lower rates of capital formation, lower than expected aggregate labor supply, and reduced entrepreneurship.

In short, high and increasing marginal tax rates reduce economic growth by creating strong disincentives to hard work, savings, investment, and entrepreneurship.

5.3 Recommendations

Tighter control measures should be put in place to eliminate the activities of fake tax officials who exploit small business owners and steal from the government. Tax policies in Nigeria cannot succeed fully in improving the economy and developing small businesses if fake tax officials keep hampering the activities of tax administrators and making tax payers to lose faith/trust in the government of Nigeria and choosing tax evasion.
A committee should be set up to look into how best they can incorporate a more friendly tax policy for small business owners, since the current policy is not favorable to them. Tax practitioners, small business experts and economist should come together and draft a better tax policy that does not only favor small businesses, but also brings constant revenue to the government for economic development.
The government of Nigeria, federal, state and local governments should develop a more simple tax system that eliminates red tape, delay and complications. More tax officials should also be employed to educate small business owners on the need to pay their taxes, as well as all the procedures necessary for filling a tax return in order to eliminate complications when administering taxes in Nigeria.
Tax rates should be restructured to fit small businesses as well as encourage new businesses. The current tax rate charged to small businesses is not favorable as most businesses still struggle to survive due to increased tax rates, small businesses do not have much retained earnings to develop new products, be innovative and creative and employ more Nigerian youths.
A special trust fund should be set up for small businesses in Nigeria. Tax proceeds from small businesses should be used exclusively for small business development as this will go a long way in economic growth and small business development.

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