CHAPTER ONE

1.0 INTRODUCTION

In recent time the world economy has developed tremendously and this has been linked with activities of Small and Medium Scale Enterprises (SMEs), especially in developing countries. A Study carried out by the Federal Office of Statistics shows that in Nigeria, Small and Medium Scale Enterprises make up 97% of productive units of the economy (Ariyo, 2005). Although smaller in size, they are the most important enterprises in the economy due to the fact that when all the individual effects are aggregated, they surpass that of the larger companies. The social and economic advantages of small and medium scale enterprises cannot be overstated. Panitchparkdi (2006) sees SMEs as a source of employment, competition, economic dynamism, and innovation which stimulates the entrepreneurial spirit and the diffusion of skills. Because they enjoy a wider geographical presence than big companies, SMEs also contribute to better income distribution. Over the years, small and medium scale enterprises have been an avenue for job creation and the empowerment of Nigeria’s citizens providing about 50% of all jobs in Nigeria and also for local capital formation. Being highly innovative, they lead to the utilization of our natural resources which in turn translates to increasing the country’s wealth through higher productivity. Small and medium scale enterprises have undoubtedly improved the standard of living of so many people especially those in the rural areas (Ariyo, 2005).

However, the mortality rate of these small firms is very high. According to the Small and Medium Scale Enterprises Development Agency of Nigeria (SMEDAN), 80% of SMEs die before their 5^thanniversary. Among the factors responsible for these untimely close-ups are tax related issues, ranging from multiple taxations to enormous tax burdens among other issues etc. In many government policies, small and medium scale enterprises are usually viewed and treated in the same light as large corporations. However, their size and nature make them unique. Therefore, in dealing with small and medium scale 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 SMEs and the most effective ways to administer them. The importance of SMEs 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 favorable environment is created for these SMEs to grow through proper regulation, the SMEs 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.

However, Holban (2007) posited that taxation can contribute to development and welfare through three sources; It must be able to generate sufficient funds for financing public services and social transfers at a high level of quality, it should offer incentive for more employment and for an efficient and lasting use of natural resources, finally it should be able to reallocate income. But in the case of SMEs, tax must be imposed in such a way that puts their income and need for survival into consideration. It is expedient that enough profit is allowed them for the purpose of expanding their businesses. The tax policy must be one that will not encourage SMEs to remain in the informal sector or to evade or avoid tax payments. More so, many small firms in Africa, including Nigeria, choose to remain in the informal sector because the perceived benefits outweigh the perceived costs. Firms rarely see their tax contributions at work and the compliance costs are high, thus discouraging compliance. The government is also discouraged from collecting taxes from small firms, because the cost of monitoring and collecting taxes from small businesses by revenue authorities, whose resources are usually scarce, sometimes outweighs the revenues generated by small businesses (Stem and Barbour 2005).

Taxation increases incentives for public participation in the political process and creates pressure for more accountability, better governance, and improved efficiency of government spending. Taxation also creates incentives for governments to upgrade their institutions for tax collection and administration and to provide more public services (Moore, 2007).

Taxes have existed virtually as long as there have been organized governments. The first tax law legislation was introduced in 1919 and ever since then taxes have evolved through a number of reforms. The government in an attempt to widen the tax base and collect more revenue has had to levy several taxes especially on business enterprises in Nigeria which constitute a large part of the formal sector. The taxes charged on business enterprises in Nigeria include; corporation tax, value added tax, presumption tax and exercise duty. In 1997 the Income Tax Act was made. This was to give guidance in assessment and computation of taxes (Campsy, 1997). The Nigerian government has made some recommendable efforts to promote development through taxation since the inception of the current taxation laws for purposes of promoting development. The main objective of taxation in Nigeria has always been to mobilise resources needed to meet the aspiration of government. This is because for any government to be effective, strong, competent and capable of spearheading development, resources have to be readily available in its treasury so as to be in position to provide goods and services to the people adequately. The Nigerian government has always had to ensure proper resource mobilization (Musa, 1992).

According to Manasseh (2000), a tax is generally referred to as a compulsory levy imposed by government upon assets of various categories and taxation is a compulsory and non refundable contribution imposed by government for public purposes. In Nigeria a considerable fraction of the businesses are sole traders operating small scale business, locally owned and managed by individuals or families and often with very few employees working at a single location (Nigeria development bank report, 1988). Taxation in Nigeria is based on system that existed in Britain as it was a British colony. This also applied to other colonies elsewhere and for East Africa, one tax system operated under British administration. This process began in 1900 with the hut tax regulation which imposed a standard charge for every hut/dwelling.

During that period, taxation was aimed at raising revenue for the administrative structure imposed by the colonial government but also as a means of encouraging monetary/economic activities. It was the Local Authority Ordinance of 1991 that governed the collection of taxes. In September 1991, after a period of review the URA was established. All taxes including income tax came under the umbrella of the URA. From 1992, URA has been organizing and strengthening the administrative procedures and in 1993 this process assisted by a grant from the British government of approximately US$ 10million.

Kano state is located in Nigeria. At least 50 small scale business enterprises were selected in Kano municipal, capital of Kano state and almost all of them employ 2-4 people. These small scale businesses are locally owned and managed by private individuals who sometimes employ their family members. These small scale businesses bear a wide tax burden which has led to poor performance. Therefore, it was against this background that the researcher undertook the study to investigate more about the problem using Kano state as a case study to evaluate the impact of taxes on performance of small scale business enterprises.

1.2 Statement of the Problem

Taxes are raised by the governments to generate revenue used to provide services to the public such as; Health centers, telecommunication, roads, schools and electricity and this have helped to improve on the performance of small scale business enterprises. Despite the services provided, small scale business enterprise’s performance in Rivers State is still poor. This could be due to the increasing tax burden brought about by tax rates which are revised annually. These rates seem to be taking an upward trend (Gordon and Dawson, 1987) which has led to winding up of some small scale business enterprises. This prompted the researcher to investigate more about the impact of taxes on performance of small scale business enterprises.

1.4 Objectives of the Study

The purpose of the study was to evaluate the impact of taxes on performance of small scale business enterprises in Kano State. However the following are the specific objectives of the study.

To determine the effect of the levied taxes on profitability of SMEs in Kano state
To determine the effect of taxes on annual sales growth of SMEs companies in Kano state.
To assess whether multiple taxation has significant effect on the failure of SMEs in Kano state

1.5 Research Questions

What is the effect of the levied taxes on profitability of SMEs in Kano state
What is the effect of taxes on annual sales growth of SMEs companies in Kano state.
Does multiple taxation has significant effect on the failure of SMEs in Kano state

1.6 Scope of the study

The study covers small scale businesses in Rivers State. Specifically, the study investigates the performance of small scale businesses, the awareness of the tax payers regarding their obligations, the problems faced by the tax payers and the relationship between the taxes paid and the performance of the small scale businesses. The study is carried out in Kano State, Nigeria. The area is purposely selected because the researcher schools within the vicinity and this therefore facilitates data collection.

1.7 Significance of the study

The findings of the study are significant on the following ways;

To scholars and researchers, the findings of the study are expected to contribute to the existing literature about taxation and the effect it causes to the economy as a whole.
To the tax authority and government, the study will guide them in adjusting tax policies so that they suit requirements of small scale businesses.
To future academicians especially of Nigeria University students, the study will help in gaining insight about taxes and performance of small scale business enterprises.
The accomplishment of the study will enable the researcher to acquire hands on skills about processing of research work and data analysis. This proficiency will enable the researcher to handle such related work with a lot of precision and proficiency.

CHAPTER TWO

LITERATURE REVIEW

2.1 CONCEPTUAL ISSUES

For some decades now, Nigeria has depended on oil for its major income and foreign exchange. Oil accounts for about 80 percent of federal government revenues, and 95 percent of foreign exchange earnings (Chu, 2008). The National Centre for Economic Management and Administration (NCEMA) reports that Nigeria, with a population of about 160 million, is Africa’s most populous country and the continent’s third largest economy yet it still remains one of the poorest oil producing countries. With a continuously declining per capita income, comparatively unfavorable social indicators, dynamic world economy and the fact that countries are looking into alternative sources of energy it is time to begin to look into alternative sources of income for sustenance in the long run when the demand for oil will dwindle to nothing. Therefore, it would not hurt to diversify the economy even before the demand for petroleum products finally diminishes. This means it is time to pay more attention to the other sectors of the economy.

This translates into looking at non-oil based sectors in Nigeria such as agriculture, manufacturing, commerce and tourism. These industries are primarily made up of SMEs, as such it goes without saying that SMEs are important to the Nigerian economy. The country is blessed with fertile farmlands, vast mineral deposits and a wealth of human resource, making it a very favorable place for small and medium enterprises. These resources have placed Nigeria in a prominent position in Africa. For governments; however, large companies are a more attractive, more clear-cut and less complex set than SMEs. In designing public policies, particularly tax policies, governments have usually targeted the large companies (Holban, 2007). Therefore, there is a need to devise methods to encourage the growth and development of these enterprises so as to ensure that they reach their full potential. Subsequently, a favorable business and regulatory environment needs to be created for them to thrive. Thus, for this study, the focus will be on supporting SMEs growth through tax policy. Most large companies have their roots in small and medium enterprises; they started out as SMEs before expansion. This means that the future large corporations are the SMEs of today that should be nurtured to ensure their growth and transformation to large scale enterprises. Furthermore, they are generally perceived to be the seedbed for indigenous entrepreneurship and to generate all the many small investments, which would otherwise not have taken place (Aryeetey & Ahene, 2004).Therefore, Nigeria needs to encourage the development of its private sector by creating a friendly environment for the growth of SMEs, strengthening the factors that lead to business success, and addressing the problems threatening the existence and advancement of small and medium enterprises (Chu, Kara & Benzing, 2008) With the dismantling of trade and other barriers.

Consequently, SMEs in developing countries are struggling to survive under intense competitive environments both domestic and international. In developing countries like Nigeria, there is an urgent need to provide the required enabling environment for the development of SMEs, so that they could adequately play the role expected of them in economic transformation, Such role includes mobilization of domestic savings for investment, appreciable contribution to gross domestic product, increased harnessing of local raw materials, employment generation, and significant contribution towards poverty reduction efforts through sustainable livelihoods and enhancement in personnel income, technological development and export diversification (Smatrakalev, 2006). It is for this reason that an ideal tax policy needs to be adopted in order to ensure economic growth and proper utilization of resources. However this is not the case because taxes are levied for regulating the investment behavior of the households and not for suffocating any entrepreneur initiative which seem to be a major constraint to the development of the SMEs they are out to cater for.

Olorunshola (2003), the concept of SMEs is relative and dynamic. The characteristics of SMEs are uncertainty, innovation and evolution. A firm understanding of SMEs would require a good knowledge of its features. In Nigeria, SMEs usually lack efficient organizational structure and management culture while the urban SMEs are more structured, the rural ones are less structured. This represents one of the most important characteristic of SMEs in Nigeria. SMEs are in most cases a one man business or partnerships enterprise, although they may be registered as limited liability company, (Udechukay, 2003). Olurunshola (2003) affirmed that this ownership style has led small and main enterprise to have a simple management structure and make it easier to manage than that of large firms, and few numbers of staff and in some cases low level of education of some owners of SMEs. SMEs almost share the same characteristic with a sole proprietorship in that, there is no legal personality between the SMEs and their owners, which means that the life span of SMEs depends on the life of the owners; when the owner dies, the business dies alongside. Another feature of the SMEs sector in some countries is its heterogeneous nature, ranging from retail outlets to hugely paid professionals and substantially manufactured organisation small and medium enterprise are also likely to vary in organizational form, from sole proprietorship (one man business), scale corporations (public or private), professionals and partnerships.

Furthermore, the processes of production in SMEs setting are Labour intensive and manual because of the small capital and they always serve as supplier to the large manufacturing firms since their products are mostly raw materials output to the large firm (Hanefah, Ariff and Kasipfflai, 2002). Just like a one man business SMEs also require low startup capital than large companies (Akinsulise, 2010).

In addition, the contribution of SMEs to tax revenue is usually lower than its contributions to output and employment (International Tax Dialogue, 2007), that notwithstanding SMEs have not become competitive enough to increase their share of output even though they form three fifths of the number of manufacturing industries which are solely relied upon by large manufacturing companies for their supplies (products) (Hanafah et al. 2003).

Depending on the country’s international standing at any point in time and the economic policies adopted by government, the importance of the various source of revenue varies from time to time. Nigeria has mixed economy i.e., government undertakes commercial investment alongside the private sector with social oriented economic policies, government undertakes greater commercial investment. Though taxation may not be the most important source of revenues to government in term of the magnitude of revenue derivable from taxation, however, taxation is the most important source of revenue to the government, from the point of view of certainty, and consistency of taxation. In a social oriented economy, only a small percentage of revenue may be derived from taxation while in a capitalist oriented economy, a greater percentage of government revenue, is derivable from taxation (Osita, 2004). According to Eftekhari (2009), taxation has always been an issue for the government and taxpayer alike from the early years of civilization. The issue of taxation has generated a lot of controversy and several political conflicts over time. According to its importance, several economic thrones have been proposed to run an effective system. Osita, (2004) sees taxation as a compulsory levy by government through its various agencies on the income, capital or consumption of its subjects. Tax is basically of three structures proportional, progressive and regressive. Proportional tax is define as a type of tax in which tax payer is levied an amount in proportion to his earning, progressive tax levies are higher rate on higher income earners, while the regressive tax is the one that charges higher rate to person receiving lower income. Tax is classified into two broad categories as direct and indirect tax.

2.2 Taxation

Taxation is an ancient practice which is as old as the emergence of an Organised human society known as state, various studies in the past have define tax based on the role expected to play in the economy tax is a fee charge [levied] by government on a product, income or N activity. Where tax is levied directly on personal or corporate income it is known as direct tax. While if levied on the price of a good or service then it is called an Indirect tax. It is a pecuniary burden laid upon individuals or property owns to support the government, a tax is not voluntary payment or donation but an enforced contribution, exacted pursuant to legislative authority and is any contribution imposed by government (Parkin, 2006).

The economic definition of taxes is quite different in that economics does not consider many transfers to government to be taxes. For example Some transfers’ to the public sector are comparable to prices, this include tuition at public university, colleges and fees for utilities provided by local government. (Steven, 1984). In Morden taxation system taxes are levied on money. The method of Taxation and the government expenditure has been highly debated in Politics and economics. Tax collection is preformed by a government Agency board of internal revenue based on tax act, 1993 (Johnson, 2000).

The importance of tax cannot be over emphasize and still been collected in Kano long before the coming of colonial administrators. It was collected by the then local chiefs for the purpose of administration and defence. Every person was expected to give part of his or her proceeds from cultivation of land to the state, for the benefit of the community as a whole. Tax policies represent key resource allocator between the public and private sector in a country, it is usually imposed on individuals and entity that make up a country. The funds provided by tax are used by the state to support certain obligations such as education system, health care system, pension for the elderly, unemployment benefit, and public transportation (Chinyere, 2000).

Taxes are levied in almost every country of the world, primarily to raise revenue for government expenditure although they serve other purpose as well. In modern economies, taxes are the most important sources of Government revenue. They represent a general obligation of tax payers are not levied or paid in exchange for any particular benefit. The Kano state government has for long been unable to realised its economic objectives due to low revenue generation which was as a result Of inefficiency of existing tax collection procedures, known popularly as The ortthodoxTax collection procedures [i.e. the use of the staff of board Of internal Revenue] as sole tax collectors: most problem of this Procedure is that it is characterised by in efficiency and massive Corruption There were cases of revenue collectors printing personal Receipt booklet and issuing fake receipt to tax payers. Especially the Private business Operators. Consequently, monies collected as Revenue are not being properly accounted for, hence the shortfall in tax Revenue estimated over the years. And this has a very serious economic Implication for the overall development of Kano state.

2.2.1 Tax Planning

The implementation situation of SME income tax planning is distorted tax planning, that is to say, on the one hand, more and more SMEs pay tax in accordance with the law, and on the other hand, because of the role of the interest mechanism and other various reasons, more and more SMEs tax-related cases appear (Karing and Wanjala, 2005). According to the survey, the vast majorities SME have not yet started or are considering carrying out tax planning, which can not fight for the legitimate tax interests and ruin financial interests leading to a large number of emerging additional tax burden (Fjeldstad and Rakne, 2003). In addition, SME tax planning is treated unreasonable. Due to the limitations of the concept, SME tax planning activities often encounter misunderstanding, punishment and censor from some basic taxation law enforcement agencies (Karing and Wanjala, 2005).

Tax law is said to be barely connected with universal law as we understand it. However, tax law is founded not only on principles but also on practicality. There is no element of perpetuity about tax law, only the constant clash of the immediate and semi permanent (Kibua and Nziok, 2004). A State cannot run a democracy well without taxation and a taxation system cannot be run well without democracy. Oliver Wendell Holmes has said on one occasion, “Taxes are what we pay for civilized society” (Neely et al. 1996).

2.2.2 Prospects of Tax Collection

Adam smith [1776] identified the following prospects of tax collection:

1. The administration of tax collection will be strengthened to ensure more efficient tax collection through training of staff, awareness campaigns and computerizations.

2. Government should continue to ensure that tariff policy enables our local industries to be competitive.

3. Specifically aggressive action should be taken to block revenue leakage on light duty goods and bulk items.

4. Government should ensured fair tax administration base on the principle of derivation of tax proceeds; it is recommended that the tax law should be enacted.

5. VAT has become a veritable source of revenue earning for government and therefore needs to be strengthened and expanded to broaden the tax base and to bring the VAT administration closer to the tax-payers, new local VAT offices should be established all over the state.

2.2.2 Problems of Tax Collection

Lawal, [1982] cited in chinyere [2000] posits that the following are problems of tax collection:

1. In adequate staff or manpower to carryout the assignment efficiently and thus has contributed to the low revenue generated for the state.

2. Mismanagement of tax collected: taxes collected were not been utilized for the purpose for which it was collected thus makes tax payers not give out their wealth for the state.

3. Bribery and corruption: in this day, tax collector personal interest has over ride their official interest in the performance of their duties consequently affects revenue generation for the state.

4. Lack of voluntary compliance from tax payers these attitudes of tax payer causes tax avoidance evasion an delinquency.

5. Poor accounting records, must business traders professional do not keep proper records of their income and expenditure.

6. Inadequate facilities: - the facilities like motor vehicle, motor cycle to carry out the assignment effectively is inadequate.

2.2.3 Charecteristic of Good Tax System

Jean-Jacque [1998] cited in chinyere [2000] summarised the under listed Characteristic:

1. A good tax system should try to accommodate the attitudes and Problem of tax payers.

2. It should run in harmony with importance of state objectives.

3. A good tax should be flexible enough to move the changing Requirement of the state economy.

4. Tax system should recognise the basic right of the tax of the tax Payer.

5. It should also yield adequate revenue for the treasury.

2.3 Taxation of SMEs

Atawodi and Ojeka (2012) explained that, the choice of tax policy to employ depends on the use of one or both two groups of instruments. The first being the use of special tax preferences and the other incentives to support start-up and growth of small companies (Atawodi & Ojeka, 2012). These incentives comprise of the lowering of corporate income tax rates, special tax exemptions or tax holidays and relieves for small businesses. The underlying reason for all these is to effectively raise revenue through measures that suit a country’s circumstances and administrative capacity (Atawodi & Ojeka, 2012).

Developing countries such as Ghana are usually struggling in terms of raising internal revenues for development. In order to solve this issue, scholars have discussed among others that the widening of the tax net is the way to go. This is due to the urgency to provide infrastructure, create jobs and reduce unemployment, expand the productive sectors of the economy and to significantly raise public revenues from the non-oil sectors. With this process, tax policies are to aim at bringing all taxable adults into the tax bracket with a graduated rate that should ensure that the well-off pay their own share while the low income earners are given savings incentives. An effective and efficient tax administration system should be integral to any country’s well-being (Atawodi & Ojeka, 2012). It is with this notion that Baurer (2005) argues that the tax administration must provide an even playing field for business by ensuring that all taxpayers meet their tax filing and paying requirements.

The authorities and the administrators of taxes should seek to balance their educational and assistance role with the enforcement role. According to Atawodi and Ojeka (2012), the rationale behind the whole system of tax is consistent with two of the three major theories of tax namely; the Ability-to-Pay Principle and the Equal Distribution Principle. The two principles stress equality and fairness. The Ability-to-Pay theory is of the view that individual should be taxed based on the individuals’ ability to pay while on the other breadth, the Equal distribution Principle proposes that the incomes, wealth as well as the monetary transactions of the individuals should be taxed at a fixed percentage. This implies that, the individuals who earn more and buy more should pay more taxes, but will not pay a higher rate of taxes (Atawodi & Ojeka, 2012).

2.3.1 Tax Compliance and SMEs

Tax compliance has been seen to be a complex issue to define according to (Marti, 2010). In simple terms, tax compliance can be defined as the fulfilment of all tax obligations as specified by the law freely and completely. It has been found that regulatory burdens fall excessively on small and medium enterprises (Pope & AbdulJabbar, 2008). The nature and size of small and medium enterprises makes the issue of tax compliance one of particular importance (Atawodi & Ojeka, 2012). Especially since most SMEs have access to limited resources and inadequate expertise to comply with diverse and complicated regulation. Marti (2010) also believes that high compliance costs can result in tax avoidance, tax fraud, and inhibit investment by way of diminishing competitiveness of the country in terms of taxation attractiveness.

There is also the issue of noncompliance of tax and this could come in the form of: the failure to submit a tax return within the required period or total non-submission of tax returns, understatement of income, overstatement of deductions, failure to pay assessed taxes by due date. In some cases noncompliance of tax may mean an outright failure to pay levied taxes. Further, studies have shown that the problem of tax evasion is a widespread in development worlds.

Empirical study by Fagbemi, Uadile and Noah (2010) have reported that noncompliance of tax is prevalent in developing countries and it hinders development thereby leading to economic stagnation and other social and economic problems. Chipeta (2002) has identified high tax rates as one of the reasons of tax evasion. Chipeta (2002) further pointed out that a higher tax rate increases the burden of the tax payer and reduces his disposable income hence, the probability of evading tax is higher Many scholars have addressed the questions that emerge from this literature especially the in-elasticity of tax location decision with respect to tax differences across jurisdictions. The issue of incomplete integration between personal and corporate tax has been addressed. Government need to review tax bias against entrepreneurs and design tax policies for entrepreneurship to remedy market failures, while avoiding adverse side effects. Marginal tax rates exert a statistically and quantitatively significant influence on the growth of firms. Marginal tax rate may be defined as the amount of tax paid on an additional cedi of income. This leads to the conclusion that raising income tax inhibits the growth of small firms.

2.4 Performance of Small Enterprises

Different approaches are used for performance evaluation in which goal approach, time frame approach, balanced scorecard , system approach, and ineffectiveness approach are included (Jean-Francois, 2004). In stakeholder approach, centre of attention is the ability of a business to meet the needs and expectations of its stakeholders (Daft, 1995).Competing values approach expands the range of other approaches.

By using competing values approach, four other models are developed in which rational goal; internal process, open system and human relations are included (Quinn and Rohrbaugh, 1983). Performance of an organization can be evaluated by focusing on problems and retarding factors that inhibit the performance of organizations (Camaron, 1984). Out of the above mentioned approaches, goal approach is the superlative approach to evaluate the performance due to its straightforwardness (Pfeffer and Salancik 1978). Most trendy approach of performance evaluation of SME's is balanced scorecard approach. Balanced scorecard has four dimensions in which financial growth, quality, customers and learning growth is built-in (Kaplan and Norton, 1992).Balance scorecard actually focuses on maintaining symmetry between monetary and non monetary measures (Neely et al. 1996).

Book-tax differences, on average, are systematically related to earnings growth, future stock returns, and earnings persistence (Hanlon, 2005) and among other implications, book-tax differences are useful measures in evaluating firm performance. Consistent with these studies, Shevlin (2002) and Hanlon, Laplante, and Shevlin (2005) find that while book income explains a firm‟s annual stock returns better than estimated taxable income, estimated taxable income, on average, has incremental explanatory power for book income. However , there is little evidence regarding taxable income as an alternative performance measure and, in particular, cross-sectional differences in firms that mitigates or enhances the ability of taxable income to inform investors regarding firm performance (Lev and Nissim, 2004).

2.5 Challenges of SMEs

There are a lot of problems that bedevil SMEs and stunt their growth. Although there are some problems peculiar to a particular country, the challenges faced by SMEs in different countries and geopolitical divisions are basically the same. For instance, a survey of Turkish SMEs by Organization for Economic Co-operation and Development (OECD) in 2004 showed that they were suffering the consequences of policy inconsistency, poor access to finance, insufficient know-how and low level of technology, and so many others. The same problems were also registered by other authors concerning other regions like the Philippines, Malaysia and other European states and of course in Sub-Saharan Africa-Nigeria inclusive as shown by different authors on the issue. Uzor (2004) believes that the constraints faced by SMEs in developing countries are not only accentuated with ineffective policy design, but also by market failures in the region. Their lack of information technology and knowledge of automation is gradually being reduced given that they serve as contractors and or suppliers for larger firms particularly the foreign manufacturing firms. A major difficulty faced by SMEs is that of lack of access to short and long term capital. Publication of the Weekly Trust of Saturday, January 22, 2011 recognizes the fact that collateral based financing has become increasingly difficult for SMEs, whether as existing businesses, in their expansion states or as startups hence more SMEs are resorting to viability lending in which case they obtain loans based on the viability of the business and health of cash flow, Banks are usually reluctant to lend to SMEs and this is because of problems such as the SMEs’ inability to meet the bank’s lending requirements, promoters’ low education, management and entrepreneurial skills and poor and unreliable financial records which makes financial review difficult (Aderemi, 2003). There is also the problem of unsound accounting system and lack of full financial disclosure (Jan, n.d.). Areetey& Ahene, (2004) buttressed this assertion by listing lack of access to land, utility installation and services, and import procedures as constraints to SME growth. Summarily, these problems make SMEs a “high-risk” venture. The above named reasons are in and of themselves problems that impede SME growth because not only do they become obstacles in accessing financing, they are capable of hindering growth on their own. Moreso, in Nigeria, the problems faced by SMEs as posited by Oboh (2002); Okpara (2000); Wale-Awe (2000) and Chu, Kara & Benzing, (2008) include astronomically high operating costs; lack of transparency and corruption; and the lack of interest and lasting support for the SMEs sector by government authorities, dilapidated state of Infrastructural facilities, unreliable employees and Weak economy, unsafe location, undependable electricity supply are common phenomenon.

2.6 Empirical Issues

According to Tomlin (2008), economists argue that the resources smaller companies direct towards tax compliance are resources that could otherwise be used for reinvestment, facilitating future growth. Hence, there is a belief that taxes and a complex tax system put disproportionate pressure on smaller businesses. Small taxpayers under the regular system of taxation are discriminated against, since the compliance requirements, cost of compliance and tax rate are the same for both small and large enterprises. Reducing the compliance costs and tax rate increases the small enterprises profit margin. It also increases the Government’s tax revenue, since the simplified provisions for a micro enterprise historically reduce the size of the shadow economy and the number of non complying registered taxpayers (Vasak, 2008). Furthermore, SMEs usually have to operate in an overbearing regulatory environment with the plethora of regulatory agencies, multiple taxes, cumbersome importation procedure and high port charges that constantly exert serious burden on their operations. Many SMEs have to deal with myriad of agencies at great cost as stated earlier; they are heterogeneous and these differences in size and structure may in turn carry differing obligations for record-keeping that affect the costs to the enterprises of complying with (and to the revenue authorities of administering) alternative possible tax obligations. Public corporations, for example, commonly have stronger accounting requirements than do sole proprietorships, and enterprises with employees may be subject to the full panoply of requirements associated with withholding labour income taxes and social contributions (International Tax Dialogue 2007).

An overly complex regulatory system and tax regime or one opaque in its administration and enforcement makes tax compliance unduly burdensome and often have a distortion effect on the development of SMEs as they are tempted to morph into forms that offer a lower tax burden or no tax burden at all (Masato, 2009) and this results in a tax system that imposes high expenses on the society. A poorly executed tax system also leads to low efficiency, high collection charges, waste of time for taxpayers and the staff, and the low amounts of received taxes and the deviation of optimum allocation of resources (Farzbod, 2000). Existing empirical evidence clearly indicates that small and medium sized businesses are affected disproportionately by these costs: when scaled by sales or assets, the compliance costs of SMEs are higher than for large businesses (Weichenrieder, 2007), Among the factors militating against SME tax compliance are: high tax rates, Low efficiency, high collection charges, waste of time for taxpayers and the staff, and the low amounts of received taxes and the deviation of optimum allocation of resources (Farzbod, 2000). Others according to Yaobin, (2007) are double taxation, no professional tax consultancy, weak tax planning, high taxation cost.

Although there is certain policy measures geared towards SME growth in Nigeria, the support needs to be increased, standardized and systematic. Iwuji (2003) believes that it is the role of the government to provide an enabling environment and social services that support businesses and persons. This means enhancing the investment climate in Nigeria for increased economic growth and subsequent tax contribution from all citizens which is necessary because a good number of SMEs operate in the informal economy due to the fact that they deem the tax environment within which they operate unfavorable. These SMEs constitute untapped revenue potential and an even playing field in many countries (International Tax Dialogue, 2007) as such they need to be captured by the tax net. The legislation is a necessary regulator for protection of the business environment and security of the economic agents, for establishment of the necessary social security regulations but at the same time it hampers the business with additional expenditures and administrative obstacles, which place in different positions the SME. They can either share part of the staff or hire people to deal only with studying the legal requirements and complying with the new regulations, or contract some personal service firm (like E&Y, Deloitte and Touché, Price Waterhouse etc) to deal with their tax compliance, planning etc. For SME this is a great expense out of their abilities (Smatrakalev, 2006). Shahroodi, (2010) believes that for a tax system to be efficient the tax policy needs to be designed such that the tax rates are appropriate and rational, the exemptions are lower in amount, the tax authorities are more efficient, the tax burden of the indigent people should be lighter and the fight against corruption and tax evasion should be strengthened. Tax policies can be designed in such a way that they do not only directly affect SMEs but also indirectly push for their growth for example the practice in China where tax policy has been designed to encourage SME financing by granting exemptions from business tax for financial corporations that provide guarantee for loans to SMEs and granting tax deductions to market entities and venture capitalists that invest in high- tech SMEs the tune of 70% of the investment value. Another way is by designing tax policies that encourage human capital training. (Yaobin, 2007) declared that special tax regimes for SMEs may he appropriate policy instruments for minimizing the cost of collection, It is important to note that the awareness of the dangers of inadequate attention to the taxation of SMEs has grown. It can lead, for example, to distortions of competition as a result of uneven tax enforcement, with incentives created to limit growth and to avoid tax through artificial splitting of enterprises (International Tax Dialogue, 2007). Furthermore, policy incentives such as tax rebate for SMEs with emphasis on local sourcing of raw materials, serious in adding value to commodities for exports and other business ethics, should be employed by government. Similarly, government could increase funding for the development of the sub-sector through direct budgetary allocations and enhance private sector investment opportunities that will focus on specific areas of capacity enhancement. Also, tax law should be simplified continuously, mainly for three reasons, namely to lower both compliance costs and administrative costs, to reduce uncertainty faced by taxpayers; and to improve the levels of voluntary compliance (Kasipilai, 2005). Pro-business (and Pro-SME) Tax regimes and enforcement should be simple, consistent and predictable.

2.7 Theoretical Framework

2.7.1 Theory of Business Growth

Various authors have postulated theories on business growth. The oldest and the most referred to theory, according to Elhiraika and Nkurunziza (2006) is Gibrat’s law of proportionate effect (LPE); (1931). Here, Gibrat stipulates that the rate of growth of a firm is independent of its initial size. By implication it would mean that large firms are preferable in context of private sector development given that they create more employment than small firms. Conversely, Jovanovich (1982) states in his learning model that younger firms learn over time, which helps them improve their performance as they accumulate market knowledge. According to this model, young firms grow faster than old ones. Moreover, given that younger firms business are usually smaller than older ones for the reasons discussed earlier; Jovanovich deduces that small firms grow faster than large ones. This is a convergence process where small firms will eventually become as large as any other longer firm in the same sector as time goes by.

Church and Lewis (1983) as cited in Olawale & Garire (2010) on the other hand claim that as a new small firm start and develops, it moves through some growth stages. He also identified the stages of growth as; existence, survival, success, take off and resource maturity. In each stage of development as different set of factors is critical to the firm’s survival and success the Churchill Lewis model gives an insight into the dynamics of SMEs growth including the distinguishing characteristics, problems and requirement of growing SMEs and explains business growth process amongst SMEs, The precise moment in time in which a startup venture becomes a new business has not yet been theoretically determined. However, the ideal business survival could be equated with a firm that has fully completed the transaction to stage - two organizations in the five stages of small business growth.

CHAPTER THREE

METHODOLOGY

3.0. Research Design

This research is a causal study. This is because it aims at establishing causal relationship between two variables i.e. the relationship between tax system and the performance of SMEs. Since it involved collecting the views, perspectives or opinions of respondents regarding a particular issue or research interest, the research employs the survey method that uses questionnaire, personal interviews with respondents and perusal of past records and publications. The choice of this method was made due to the fact that the survey method is effective when it comes to getting opinions, attitudes and descriptions as well as getting cause and effect relationships. The study uses both qualitative and quantitative methods. The selection of small and medium enterprises was done by judgmental sampling in order to attempt at obtaining a fair representation of the population.

3.1 Target Population

For the purposes of this study the population designated comprised of selected SME’s in the Kano Metropolis who were registered about 1794000 tax payers. The study had (30%) small enterprises as the sample populations of the accessible population. The study used quota sampling method, because of the small population and the desire to reduce the sampling error; all the categories of licensed owner managers were used. The quota sampling method was suitable as some information related to specific category in the licensing of enterprises.

3.2 Sample Size

The size of the sample and the way in which it is selected will definitely have implications on the confidence one can have in the data and the extent to which the team can generalize. The study sampled fifty (50) SMEs with up to date information with respect to their tax payment.

3.3 Sampling Technique

Sampling is the process of selecting a sufficient number of elements from a population so that by studying the sample and understanding the properties or characteristics of the sample, researchers would be able to generalize the properties of the sample to the population (Panitchparkdi, 2006).

In order to get very accurate result for this study, the purposive sampling method was used to select the sample from the population. This method is a non-random sampling technique where the researcher establishes a criterion devoid of randomness for selecting the sample. In the purposive sampling, the sample is chosen to suit the purposes of the study. These methods will be used due to the time constraints and the difficulty involved in assessing the list of all SMEs from the authorities. It will also help to target SMEs who are tax payers and willing to accept the questionnaire.

3.4 Primary Data Collection

Questionnaires served as a preliminary data collection technique for providing empirical analysis in the study. Both open- and closed- ended questionnaire were self-administered. The nature of the study was explained to the respondents, hence the respondents’ confidentiality of any information provided was assured. Respondents were provided with detailed instructions as to how the questionnaires should be completed and returned. The rationale behind providing clear instructions and assuring confidentiality of information is based on the fact that this significantly reduces the likelihood of obtaining biased responses.

3.5 Methods of Data Analysis

To analyze the effect of the tax system on SMEs performance, regression method, particularly multiple linear regressions will be the major statistical tool that will be used. The reasons for using regression method are: firstly, almost all variables in the present study are measured by interval/ratio scales; secondly, if the sample size is sufficient, regression is undoubtedly a more powerful way to test the relationship between two or more variables than other statistical methods like non-parametric tests.

CHAPTER FOUR

4.0 Result and Discussion

4.1 Data Presentation

Table 4.1 depicts the gender distribution of the respondents. It was observed that 52.9% of the respondents were males while 47.1% were females. Fig. 4.1 shows the pie chart on the age of business in which 62% responded that they had been in business between 5-10 years, while 28% responded that they had been in business between 3 to 5 years, 7% had been in business between 10-15 years, 2% in business for over 15 years while 1% of respondents had less than 3 years in business.

Table 4.1: GENDER

	Frequency	Percent	Valid Percent	Cumulative Percent
MALE	54	52.9	52.9	52.9
FEMALE	48	47.1	47.1	100.0
Total	102	100.0	100.0