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Tax compliance - educate instead of penalising SMEs

Repost of publication on The Sun Daily on 5 April 2021.
THE owners of SMEs in many cases do not understand the difference between themselves as individual shareholders and the company as a separate entity. There is always a tendency to mix up their private and corporate proceeds and expenses thereby distorting the tax liabilities of the SMEs and the owners.

Majority of the shareholders of the SMEs do not understand the complexities and responsibilities of tax compliance. As far as they are concerned, they pass the information to the tax agents and expect them to fulfil their responsibilities. The shareholders of the SMEs pay little attention to their tax affairs other than their desire to fulfil the basic compliance requirement. Their focus is principally running the business and tax compliance is seen as another "headache" imposed by government which does not add value to their business.

There is undeniably a minority of SMEs that intentionally underpay the taxes: hiding cash sales, using fictitious invoices, manipulating year end stock values, using companies' assets for personal use, charging private expenditure to the companies etc. This is unacceptable tax evasion.

Effect of imposing penalties at the rate of 45% to 100% on any tax adjustment arising from the tax audit or investigation on SMEs will be counterproductive as it will increase the animosity towards the Inland Revenue Board (IRB). This would be seen as additional unnecessary burden imposed by bureaucrats who do not understand the "pain" businessmen have suffered to earn the income.

In many cases, the tax adjustment may arise out of the interpretation of the law or the inability to provide the documents due to the poor record keeping. In some cases, the adjustments could be due to understating sales or overstating expenses.

The penalty rates imposed are entirely based on IRB's discretion and taxpayers are never provided with an explanation on how they arrive at the penalty rates. This subjectivity does not help in building goodwill between the IRB and the taxpayers.

What should be done?
Education is the best answer. SMEs must understand that paying taxes is not an option. Taxes must be collected to fund government expenditure and therefore, they have to pay their share of taxes. They also need to understand that if they deliberately under declare their taxes, they will be penalised.

SMEs should be given a chance to correct their mistakes and they should be educated generally on how to comply with the tax laws. SMEs should also be called upon for a meeting after the audit to specifically educate them on how to avoid similar mistakes in the future.

This should be done through a programme where SMEs audited for the first time from 2021 should not face any penalties if there are any tax adjustments to encourage them to improve their compliance. Thereafter, SMEs which have been audited should be put in the program where they will be assisted and monitored over the next two years. SMEs should be told that they may face an audit in the subsequent periods. This will bring both parties into responsible relationship.

Cooperative tax compliance
Another suggestion is to introduce a voluntary cooperative compliance program where SMEs can engage the IRB throughout the year to seek their views on the tax treatment on the transactions they undertake. If the IRB is keen on improving the tax compliance, they should consider moving their resources from tax enforcement to tax compliance.

If the aim is to collect taxes, then improving tax compliance through education is the answer.