The determinants of tax evasion and tax avoidance in small and medium-sized enterprises

Abstract

This study looks at the determinants of tax evasion and tax avoidance in small and medium-sized enterprises. Tax is the income which is paid to the government to fulfil the need of the public.

Tax revenues are major and important income sources for governments in most countries. Sufficient tax revenues make many governments projects possible and help elected officials and politicians to remain in office longer if the government implements programs and projects demanded by the public.

In today’s globalizing economic environments, there is an increasing demand for a variety of public services and programs.

However, the rate of increase in the tax revenues to finance these public services and programs falls short of the necessary public spending. The potential tax revenue of a country based on its legal or tax law is much larger than the tax revenues that are actually collected.

Due to the lack of full tax compliance, government budgets are rarely balanced in most countries, and the gap between revenue and spending is increasing.

The Cameroon government imposes charges on citizens and corporate bodies called taxes in a bid to raise funds to pay for public services or facilities. It also uses taxation in the redistribution of wealth, and in encouraging or discouraging the consumption of some goods and services.

 The main question is why taxpayers evade taxes. To understand tax evasion, one can examine what factors cause taxpayers to evade taxes. If factors that affect tax evasion are identified, policies can be developed to prevent tax evasion.

However, tax evasion is the act of not paying the tax by the use of illegal ways. Allingham and Sandmo being the first researchers studying tax evasion found a relationship of tax evasion with low penalty fees and low detection. Tax evasion basically is affected by various factors but it also affects many economic factors.

The purpose of this study is to investigate factors related to tax evasion and tax avoidance behavior using survey data collected from SMEs in Buea.

Factor analysis and multiple regression techniques are employed. The results show that taxational and fiscal factors, economic factors, administrative factors, and other factors have statistically significant effects on tax evasion behavior.

 CHAPTER ONE

 INTRODUCTION

1.1 Background of the study

Tax is the amount that is imposed on an individual or corporate income or profit or on commodities that have been levied by the government to finance the government expenditure.

According to James and Nobes (1997), a tax is a compulsory levy made by public authorities for which nothing is received in return.” Taxes are normally classified as direct taxes and indirect taxes.

Direct taxes are taxes that are directly on the income of individuals or the profit of companies or capital gain or wealth. Indirect taxes are direct taxes imposed on goods and services that consumers pay. Examples of indirect taxes are value-added tax, per unit tax, sales tax, goods and service tax.

Small and Medium-size enterprises are usually small individually-owned or family managed businesses offering basic goods and services. SMEs tend to lack organizational and management structures, and are generally characterized by uncertainty, innovation, and evolution.

Udechukwu (2003) notes that SMEs are mostly sole proprietorships and partnerships, and only a few are registered as limited liability companies. SMEs generally have a simple management structure, and in many cases, the owner is the manager.

With few employees who in most cases lack the appropriate skills and competencies. Given the simple management structure and extensive dependence on the owner, the lifespan of the enterprise is often dependent on the longevity of the owner and his/her interest in continuing the business.

Tax revenue contributes to the development and welfare through three sources; financing public services and social transfer at a high level of quality, reallocating income and offering incentives for more employment and the efficient use of natural resources, (Holban 2007).

According to OECD report on promoting SMEs for sustainable development (Organization for Economic Co-operation and Development, 2000), SMEs play a key role in the transition and developing countries (Organization for Economic Co-operation and Development, 2000).

These firms, constitute a major source of employment and generate significant domestic and export earnings, thus SMEs development emerges as a key instrument in poverty reduction efforts and their advancement is key to sustained economic growth, for they are an integral part of a country’s economic fabric and their success affects the wellbeing of the society as engines of job creation, economic growth, and innovation.

An efficient tax system encourages growth; investment, innovation, and facilitates international trade and mobility. Assessing the determinants of tax evasion and tax avoidance would include economic factors such as income level, sources of income, marginal tax rate, demographics factors such as age, gender, and education, and behavior factors such as tax fairness, the complexity of the tax system, taxpayers’ understanding of the tax authorities, social customs and tax morals.

Tax non-compliance is an act of not respecting the tax law and rules of a country by not paying the tax or by not declaring the true value of the actual income. This may include tax evaded in an illegally way and legally means, that is, it involves tax avoidance and tax evasion. Tax avoidance is performing an act of minimizing the tax liabilities within the law.

Tax evasion is performing an illegal act of avoiding paying taxes. Kesselman (1997) stated that pure tax evasion   (PTE)   involves non-reporting, understatement, or misreporting of taxable income, profits, or sales.

Some PTE activity is related to extreme financial manipulation that goes beyond the bounds of legal tax avoidance. Another PTE occurs in conventional, legitimate businesses that underreport their receipts or overstate their expenses”.

Tax avoidance refers to an attempt to reduce tax payment by legal means for instance by exploiting tax loopholes, it is also the legitimate minimizing of taxes and maximizes after-tax income, using methods included in the tax code.

Businesses avoid taxes by taking all legitimate deductions and tax credits and by sheltering income from taxes by setting up employee retirement plans and other means, all legal and under the internal revenues code or state tax codes. Of course, you must be able to prove that you qualify for any deductions or credits that you take. A tax shield is a deliberate use of tax expenses to offset taxable income.

The number of tax shields has been reduced since 2018, with the tax cuts and job acts removing many schedules a deduction, like a mortgage interest and charitable deductions. Tax planning is the method through which tax avoidance is achieved.

The point to be raised in tax avoidance is whether there is any moral obligation for anyone to pay more tax than the law demands. There is no public duty to pay more tax than required and, therefore, the onus of blocking the loopholes is left to the tax legislation. Some examples of tax avoidance strategies include;

Taking legitimate tax deductions to minimize business expenses and lower your business tax bill.

Setting up a tax deferral plan such as an IRA, plan to delay taxes until a later date

Taking tax credits for spending money for legitimate purposes, like taking a tax credit for giving your employees paid family leaves.

Tax evasion, on the other hand, is using illegal means to avoid paying taxes. Usually, tax evasion involves hiding or misrepresenting income. This might be underreporting income, inflating deductions without proof, hiding or not reporting cash transactions, or hiding money in offshore accounts. The internal revenue code says that the willful attempt to evade or defeat any tax law is guilty of a felony.

If convicted, tax evasion can result in fines of up to $100000 ($500000 for a corporation) or imprisonment of up to five years or both, plus court the cost of prosecution. Tax evasion is part of an overall definition of tax fraud, which is illegal intentional non-payment of taxes. Fraud can be defined as an act of deceiving or misrepresenting and that’s what someone evading taxes does, deceiving the IRS about income or expenses. The IRS criminal investigation unit prosecutes cases under the broad designation of tax fraud.

 Tax evasion is most commonly thought of concerning income taxes, but tax evasion strategy is failing to pay turn over taxes you have collected from others to the proper federal or state agency. T

hese taxes are called trust fund taxes because they are given in trust to a business, with the expectation that they will be turned over to the appropriate state or federal agency failing to pay employment taxes to the IRS and sales taxes to a state taxing authority and other federal state and local taxes can mean high fines and penalties. Some examples of tax evasion if you knowingly fail to report income or you don’t file an income tax return. Some practices considered tax evasion/tax fraud

Underreporting income (claiming less income than you actually received from a specific source, particularly cash Income.

Not reporting an income source

Providing false information to the IRS about business income or expenses

Deliberately underpaying taxes owed

Substantially understating your taxes (by stating a tax amount on your return which is less than the amount owed on the income you reported).

Overstating the number of deductions

Keeping two sets of books

Making false entries in books and records

Claiming false deductions without having documents to support them

Hiding or transferring assets or income.

From the decided cases, the dividing line between tax evasion and tax avoidance could be very thin and is not as distinct as it sounds because at times it may involve suppression of information to hide the real meaning or the aimed achievement of certain transactions. Both end up in tax minimization.

What the courts look for is to see whether, in the process of the arrangement of the taxpayer’s affairs to gain these tax advantages, the law is breached.

It is sufficient to note that this attitude of the court appears to have influenced the increasing trend in international tax avoidance schemes. As the government is reviewing the laws to redefine what constitutes tax evasion, the tax advisers are busy designing for the taxpayers, complex and sophisticated means of beating the laws.

1.2 Statement of the problem

Taxation denotes the practice of governments imposing charges on citizens and corporate bodies in a bid to raise funds to pay for public services or facilities such as national defense and security, public health, road construction and maintenance, courts, schools, libraries, and parks.

A government may also use taxation in the redistribution of wealth. It is one of the most acclaimed discussions during top-level political debates in both developed and developing countries. Through taxation, governments could encourage or discourage the consumption of any goods or services.

Every taxpayer in Cameroon is required to fill and submit a tax return to the taxation office in the taxation area of concern. The exception to this are taxpayers who are fully taxed at source such as civil servants, employees of public corporations and public establishments, regional and local authorities.

Although there is a general perception that taxes are an important source of funds for the development of an economy and the provision of social services, people still evade and avoid tax.

One of the greatest challenges faced by the Cameroon tax system today is the problem of tax evasion, a phenomenon that occurs when efforts are made by individuals, firm’s trusts, and various other entities to avoid paying taxes by illegal and unfair means.

Usually, this takes place when SMEs deliberately hide their incomes from the tax authorities to reduce their tax liability. SMEs face problems such as low educational level of the population, lack of simplicity and accuracy of the tax legislation, inflation, deliberate policy by the tax authorities, tax pressures (high rates), a significant informal economy, anarchic distribution of powers among the different government levels especially in federal countries, the very structure of the countries’ tax system, the inefficiency of the tax administrations.

Not minding other challenges that SMEs faced in developing countries like Cameroon include; high tax rates, complex and opaque tax laws, inefficient and corrupt tax inspectors, low-income taxpayers which cause people to evade and avoid tax. These factors have led to an increased rate of tax evasion and tax avoidance.

1.3 Objectives of the study

The main objective of the study is to find out why SMEs in Buea evade and avoid taxes.

Specifically, this study seeks to;

• Look at the effect or consequences of tax evasion and tax avoidance

• To find solutions or recommendations on how to stop these causes.

1.4 Research questions

The main research question;

• Why SMEs in Buea evade and avoid tax? (The causes of tax evasion and tax avoidance).

Specific research questions;

• What are the effect or consequences of tax evasion and tax avoidance?

• Are they solutions to stop SMEs from evading and avoiding tax?

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