Income tax non-compliance of small and medium enterprises in Malaysia: determinants and tax compliance costs

Abstract

This study examines the influence of tax compliance costs on non-compliance behaviour, taken together with the business characteristics and managerial perceptions of corporate taxation. The study focuses on corporate Small and Medium Enterprises (SMEs) in Malaysia under the Income Tax Self-Assessment System (SAS). This is the first study on corporate income tax compliance in the Malaysian context and among the first to integrate tax compliance costs, tax attitudes and the likely compliance behaviour of corporations, both in Malaysia and internationally. Thus it makes a significant contribution given this dearth of international literature on corporate tax compliance.The study adopts a traditional large-scale postal survey questionnaire technique that has been employed extensively by studies of both tax compliance and compliance costs studies internationally. Specifically, estimation of tax compliance costs largely follows the usual technique used by Pope, the ‘father’ of tax compliance costs studies in Australia and Asia. This estimation method was first established by Sandford, the ‘grandfather’ of modern tax compliance costs studies, and has been globally employed with some modification to the local context. On the other hand, tax attitudes and the likely compliance/non-compliance behaviour of SMEs are measured from a business managerial or respondent perspective. The above primary postal survey, as well as two additional surveys—a web survey of SMEs and a postal survey of tax professionals— have been undertaken as a measure of consistency of the primary postal survey.The income tax compliance costs for Malaysian SMEs are estimated at RM9,295 per company, amounting to RM1,084 million in aggregate for the 2006 tax year. The findings of this study demonstrate that the average income tax compliance costs of SMEs under the SAS have decreased significantly by 58 percent in absolute terms. Despite this, the increasing composition of both external costs and computational costs, by 16 and 15 percent respectively, reveals that the role of tax professionals and routine tax works have become substantially greater under the SAS regime. The figure for compliance costs relative to tax revenue of eight percent is found to be similar to a pre-SAS Malaysian study, and is also within the international range overall. As for the offsetting benefits, the value of tax deductibility is estimated to be almost RM1,700 per SME company, RM196 million in aggregate, or around 18 percent of the compliance costs, thus giving average net compliance costs of RM7,595 or RM888 million in total.The current study provides evidence of the influence of tax complexity and probability of tax audit on corporate SME tax non-compliance in Malaysia. Compliance costs, in particular, together with two business characteristics, i.e. business size and tax level, and the managerial perceptions about tax fairness and the Inland Revenue Board (IRB) relationship, are found not to influence corporate tax non-compliance. On the other hand, the effect of the remaining four variables, i.e. business length, sector, tax rate and tax incentives, is inconclusive. In terms of international comparisons, the effects of business size on previous corporate tax compliance are mixed, but the business sector was found to influence corporate tax compliance.Regarding tax compliance costs, the need to recognise the presence and regressivity of tax compliance costs upon SMEs should be, at this stage, recognised at the national level. Further, at a later stage, such issues should be systematically considered and assessed for any major change in tax policy. Findings regarding tax complexity suggest that the IRB should continue their tax simplification measures in a more comprehensive manner to significantly minimise the compliance burden for all business taxpayers, of any size. In terms of tax auditing, the IRB may want to increase substantially the magnitude of such activity, and should utilise such information effectively to lift taxpayers’ levels of awareness about the likelihood of their businesses being selected for a tax audit.Finally, it is acknowledged that there are several limitations of the current study, including those usually associated with self-reporting mail surveys, which may limit the interpretation of the current findings. Despite this, the study makes a significant contribution given the limited number of studies in the field of corporate tax compliance and tax compliance costs studies, particularly for Malaysian SMEs. Future research into this area, including several extensions of this study, could make further valuable contributions in this area.