*FACTORS INFLUENCING THE LEVEL OF TAX COMPLIANCE:
A CASE STUDY OF SMALL BUSINESS ENTREPRENEURS
HENTIAN NILAI, NEGERI SEMBILAN
Noor Suhaila binti Shaharuddin
Sarifah binti Ismail
Selangor International Islamic University College
Abstract
Tax compliance is defined as reporting all incomes and paying all taxes according the laws,
regulations and decisions of the courts where applicable while non compliance of tax is the
failure of taxpayer to pay taxes within the stipulated period. Many prior studies on tax
compliance have focused on individual taxpayers in selected countries. However, little is said
about the compliance level among small business entrepreneurs. It was reported that, certain
business categories such as transportation, pharmacy and restaurants were found not to fully
comply with tax laws. Therefore, further research on the tax compliances on business
especially for small business is needed as non compliance of tax will cause losses of current
income to the government. The purpose of this study is to investigate the selected factors,
namely the amount of tax knowledge and IRB role in educating the public on tax matters
towards positive compliant attitude that may have influence the tax compliance level among
small business entrepreneurs. The present study however is not an exhaustive research for all
possible factors, but an attempt to enhance knowledge of certain influences on the noncompliance phenomenon. The findings of this study would be beneficial to tax policy makers
to focus on targeted group that require a better understanding on tax matter, which then will
increase the compliance level among the tax payers.
1
1.0
Introduction.
Taxation is a vital economic tool that the government employs to regulate the economy. In
Malaysia, the types of taxes imposed may be classified into two categories namely direct tax
and indirect tax. During the early stages of its development, Malaysia relied heavily on
indirect taxes compared to direct taxes as sources of revenue. Consequently, in 1999 the
importance of direct taxes increased from 23.3% to 60.1% of revenues. This was due mainly
to changing of economic structure in which the government emphasize the importance of
personal tax as a major part of tax revenue.
The successful implementation of tax system relies on voluntary compliance by taxpayers.
This would require them to acquire a better understanding of the tax system and possess a
higher amount of tax knowledge in order to comply with tax laws (Barr et.al,1977). In
Malaysia, under the Self Assessment System (SAS), the taxpayers are expected to determine
their own income tax payable and submit their returns to the Inland Revenue Board (IRB).
The IRB will then audit some taxpayers randomly and if they are found to give inaccurate
information which they furnish in their returns, they will subject to various penalties.
Although taxpayers are expected to compute their own tax payable and submits his or her
completed annual return within the stipulated period, the problem of non-compliance still
exists. Non-compliance of tax, as defined by Weigel et.al., (1987) ‘an indication of taxpayers’
failure to pay tax on time, whether intentional or unintentional’ is a serious threat towards
voluntary tax compliance as it can cause losses of current income to the government.
However, according to Price (1992), the level of tax compliance among the taxpayers’ can be
increased by improving their perception on the tax system and their understanding on tax
knowledge. The tax authorities therefore should develop programs that cover all aspects of
efficient tax system to promote a high level of compliance rate.
Many prior studies on tax compliance have focused on individual taxpayers in selected
countries. However, little is said about the compliance level among business entrepreneurs. It
was reported that, certain business categories such as transportation, pharmacy and restaurants
were found not to fully comply with tax laws. Therefore, this study searches for the answer of
why there are some business comply with tax laws whilst others not to. In other words, what
are the inherent factors that might influence the level of tax compliance among business
entrepreneur? This study however, focuses on small business entrepreneurs rather than for all
categories of businesses due to the limited time frame given for the researcher to complete the
research.
The above question is addressed by undertaking a review of the relevant literature on tax
compliance and incorporating two factors that may have influence the level of tax compliance
among small business entrepreneur. They are amount of tax knowledge and the role of IRB in
educating the public towards positive compliant attitude. The present study however is not an
exhaustive research for all possible factors, but an attempt to enhance knowledge of certain
influences on the non-compliance phenomenon.
This paper is organized as follows. In the next section, a review of the literature will be
presented. Section three describes the research methods employed in the study. The following
section presents the results of the study. The overall discussion and conclusion is dealt in the
final part of the study.
2
2.0
Literature review
Tax compliance as defined by Alm (1991) as ‘reporting all income and paying all taxes in
accordance with the applicable laws, regulations and court decisions’. On the other hand,
Roth (1989) defined compliance as ‘reporting all required tax returns as the proper time and
the returns accurately report tax liability in accordance with the Internal Revenue Code,
regulations and court decisions applicable at the time the return is filed’. Mottiakavandar et.al.
(2004) further added that, a taxpayer is said to have complied with tax laws if the individual
submits in his or her completed annual return within the time stipulated, report his or her true
tax liability and settles the tax liability without any enforcement.
From the above definitions, we can see that the taxpayers are forced to understand the tax
laws and are required to compute their own tax payable. They are now more concerned on the
accuracy of the tax liability as to avoid any penalty imposed by revenue authorities. However,
taxpayers can seek professional assistance to prepare their annual tax return if they do not
have the knowledge to compute their own tax payable. This, in turn will lead to extra
compliance cost borne by the taxpayers.
Compliance has been found to be influenced by many factors such as high tax rates,
complexity of the law, gender and ethnicity differences and ethical behaviors. One of the
earliest studies was a study undertaken by Sabri (1993). This study was conducted in
Malaysia that based on the sample confined to Klang Valley residents who have filed tax
returns with IRB. He studied on the demographic variables namely age, occupation, monthly
personal and household income, and educational background in relation to tax knowledge.
The survey result indicates that gender, age, employment sector and educational level are
shown to have significant relationship with tax compliance whereas race, marital status and
income level shows no significant with tax compliance. As for educational backgrounds,
Sabri (1993) found that respondents with higher education level have higher tax knowledge,
and thus would have a better attitude towards tax compliance. This would mean that, when
one gets more knowledgeable in tax matters, one tends to more compliant with tax laws.
Another study carried out by Hijattulah and Kasipillai (2004) examined the existence of
differences in tax compliance attitude and behavior among gender and ethnic groups in
Northern Malaysia. Finding of the study reveal that gender, academic qualification and the
person preparing tax return were statistically significant as determinants of non compliance
attitude. As for ethnicity factor, the result does not show significant differences among ethnic
groups on the overall non-compliance attitude. However, Chinese and Indians are found to be
more compliant as compared to Malays in respect of replacing disallowable deduction with
other deduction in which IRB would not easily trace and claming more expenses to help make
ends meet.
In a recent study by Mottiakavandar et.al. (2004) looks at the compliance level of small
business entrepreneurs (sole proprietors and partnerships) in Malaysia. The study also
attempts to determine the level of taxpayers’ knowledge on general tax laws. The sample of
this study was selected from the list of names available from the Registrar of Business as at
31 December 1999 with 312 respondents in Northern Peninsular Malaysia. The results
showed that gender, age, race, education level and income level have a significant relationship
with the amount of tax, attitude towards own compliance and intention to comply. As for
gender factor, there is a significant relationship with the amount of tax knowledge and attitude
towards own compliance. The age factor has a significant relationship with intention to
3
comply and other demographic variables such as race, education level and income level have
a significant relationship with amount of tax knowledge.
Other studies too have suggested that, the level of tax compliance can be increased by
improving the taxpayers’ understanding of the tax system (Noraza et. al, 2003). Once they
possess the necessary tax knowledge, it will increase their awareness and confidence towards
the tax system. This will eventually lead to a greater compliance level. To achieve this, the
role of tax authorities in educating the public regarding the tax system comes into existence. If
the tax payers able to understand the system better, it will reduce their reliance on the tax
agents and reduce their compliance cost. As such, a formal education program should be
developed by IRB, for instance by organizing more seminars and courses at affordable prices
to the public, to avoid any confusion and misunderstanding among the taxpayers on the tax
rules and regulations, Natrah et.al (2003).
After discussing the relevant literature with regard to tax compliance, this study will now
attempt to investigate the factors that might influence a taxpayer to comply with tax
regulations. In response to this issue, the study is performed by incorporating two common
factors which are expected to influence a taxpayer to comply with tax laws. They are amount
of tax knowledge and the role of IRB in educating the public towards positive compliant
attitude.
3.0
Research Methodology
3.1
Questionnaire Design
The data collection for the study was a questionnaire consisting of three sections namely
Section A, Section B and Section C. The questionnaire was pre-tested on staff of the Selangor
International Islamic University College which includes lecturers and administrative
personnel. This to ensure the questionnaires items are clearly sentenced and structured so that
it is easily understood by the layman. The questionnaire had a cover letter explaining the
purpose and nature of the study and all responses would be treated confidentiality.
Section A contained questions on the respondents demographic background. Respondents
were asked to select their age group range and monthly income range between one category
and the other. As for gender, education level, types of business organizations, race and marital
status, the respondents were asked to select from the respective categories.
Section B was designed to measure the amount of tax knowledge where the respondents were
tested on the income tax laws such as relief, deductible expenses and tax rates. There are only
8 simple questions judging the tax knowledge of the respondents. Some of the question
required the respondents to answer Yes, No or Do Not Know answer and some of it required
the respondents to tick for the correct answer. Marks were given for each question in which
three marks for correct answer, one mark for wrong answer and two marks for do not know
answer. These were consistent with the method adopted by prior studies (Fallen and Eriksen,
(1996); Mottikavandar et. al. (2004) where marks were allocated for each question in order to
measure the amount of tax knowledge. Based on this mark, it would mean that, the higher the
scores obtained, the higher will be the level of tax knowledge and thus the greater the
tendency for the taxpayers to comply with tax laws.
4
Finally, Section C contained questions on the IRB effort in educating the public on tax
matters which are expected to increase the compliance level of the taxpayers. IRB have to
ensure that the tax system is well accepted by the taxpayers. Only if the taxpayers perceive the
tax system is easy and simple to understand for them to compute tax payable and make
payment, it will eventually lead to greater voluntary compliance.
In this regards, the respondents were asked on how they get the information on tax, whether
from IRB or Non-IRB (example tax agents, colleagues). Some of questions required “Yes” or
“No” response for example whether they have attended any courses or seminars organized by
IRB, or whether they received any publication of rules and guidance pertaining to tax matters.
Based on this, if the respondents tend to answer more on IRB or “Yes” response it would
mean that the effort of IRB in educating public on tax matters is success.
3.2
Research sample
The sample covered in this study consisted of small business entrepreneurs that operating
their business under the controlled of PLUS Expressway Berhad. These entrepreneurs are
called as stall operator and they are bound with the rules and regulations provided by PLUS
Expressway Berhad. However, for this study, only business that operating their business in
Nilai, Negeri Sembilan were selected as the sample and it required a shorter time period of
collecting data for the researcher to complete the research. Apart from that, the aim of the
study is to provide an initial insight into tax compliance and to provide a useful basis for
future work in this area.
There were 32 stalls operating their business along side North South Highway and no
particular business activities were excluded from this study as the sample of the study is too
small. In order to ensure a higher response rate, the researcher would personally administered
the questionnaires to ensure that all questions were returned and answered. Being present on
the field, would enhance the confidence level of the respondents in giving their respond to the
questions.
3.3
Measurement of variables.
In this study, the amount of tax knowledge was categorized into two groups whether low or
high levels. This is consistent with prior research on tax compliance conducted by
Mottiakavandar et.al. (2004). As discussed earlier, the amount of tax knowledge was
measured by allocating marks for each questions. Three marks for correct answer, one mark
for wrong answer and two marks for do not know answer. Based on the marks obtained, 16
have been used as the cut-off point between these two groups. If the value is above the cut-off
point, it is assumed that the respondents had high tax knowledge and for the value below its
cut-off point the respondents had low tax knowledge.
As for the effort done by in educating the public on tax matters, it is measured categorically.
If the answer is Yes, it is denoted as “1” and for the reverse answer it is denoted as “0”.
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4.0
Results
This section will present the results of the study. The section has been structured as follows.
Section 4.1 will present general characteristics of the respondents. The next section, 4.2
discusses the analysis on the association of compliance level with the two independent
variables of the study.
4.1
Profile of Respondents
There were 30 stall operators agreed to participate in this study, thereby providing a response
rate of 93.8%. Of these 30 stalls, 14 are from the food category and 16 are from beverages
category. Table 1 reports the characteristics of respondents who agreed to answer the
questions. It was found that, 15 of the respondents were males and the remaining were
females. The majority of the respondents were Malay (73.3 per cent), 20 per cent were
Chinese and the remaining of 6.7 per cent were Indians. In terms of age, the large majority of
respondents were more than 40 years (63.3 per cent), 6.7 per cent of the respondents were less
than 30 years and the remaining of 30 per cent were from the age group 30 – 39. The majority
of the respondents were married which represent 66.7% per cent of the total respondents.
With regard to the academic education about 66.7 per cent of the respondents have completed
their secondary school. As for income level, about 73.3 per cent of the respondents were
earning a monthly income less than RM5 000 and the remaining of 26.7 per cent earned
between RM5 001 to RM7 000.
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Table 1 : Summary of Respondents Characteristics
Characteristics
Frequency
1 Gender
Percent
Male
15
50.0
Female
Total
2 Race
15
30
50.0
100.0
Malays
22
73.3
Chinese
6
20.0
Indians
Total
3 Age
2
30
6.7
100.0
below than 30 years
2
6.7
30 to 39 years
9
30.0
40 to 49 years
15
50.0
4
30
13.3
100.0
Single
6
20.0
Married
20
66.7
4
30
13.3
100.0
Up to SPM
18
60.0
STPM/Certificate
3
10.0
Diploma
3
10.0
Degree
1
3.3
Others
Total
6 Monthly income
5
30
16.7
100.0
Below RM5 000
22
73.3
RM5 001 - RM7 000
Total
8
30
26.7
100.0
50 years and above
Total
4 Marital Status
Others
Total
5 Academic education
7
4.2
Data Analysis
4.2.1 Amount of Tax Knowledge
The analysis of the amount of tax knowledge of the respondents is reported in Table 2.
The results show that, out of 30 respondents, only 14 of them (46.7 per cent) had high level of
tax knowledge and the remaining of 16 respondents (53.3 per cent) had low tax knowledge.
This would mean that, respondents with a higher level of tax knowledge would have a greater
tendency to comply with the tax laws. Apart from that, it may also be seen from the Table 3,
the mode for most of the question is 2.00 indicating that majority of the respondents would
answer “do not know” for the questions posed to them, suggesting that they are not sure with
the tax laws. One of the possible reason that the respondent could not answer the question is
mainly due to poor tax knowledge and their understanding on the importance of tax system is
still low.
The analysis was further extended to examine the detail of questions answered by respondents
in Section B of the questionnaire. The analyses are summarized in Table 3.
It can be noted that, more than half of the respondents (56.7 per cent) claimed that, they know
which tax return form should be completed and submitted to IRB and 43.3 per cent of the
respondents do not know which return should be submitted. However, only 12 (40 per cent) of
respondents know the submission date of the annual return and 16 of them (53.3 per cent) are
not sure with the date line of the tax return.
As for donation, only 8 (26.7 per cent) of respondents would give the correct answer stated
that approved donation is a deductible expenses and the rest of responses (ranging from 13 per
cent to 60 per cent) mentioned for the reverse answer. In terms of unapproved donations, there
were 6 (20 per cent) respondents said that, it is not deductible expenses in arriving at total
income. Table 3 also reveals that, about 36.7 per cent of respondents stated that a resident
individual may be entitled for a rebate of zakat or any other Islamic religious payment while
about 40 per cent of the respondents are not sure on the rebate for zakat.
It may also be seen that, the majority of the respondents (66.7%) are not sure with the amount
of relief entitled for individual, but 4 of them (13.3 per cent) would give the correct answer.
To the question of whether this relief is also meant for non-residents, only 6 respondents
(20 per cent) responded “no” indicated that this relief is only available for resident
individuals.
Respondents were also required to answer on how to compute the income tax payable for an
individual. Out of 30 respondents, 7 would answer correctly (23.3 per cent), which means
they would refer to the tax rate schedule provided by IRB, 18 do not know how to compute
the tax payable (60 per cent) and the remaining of 5 respondents (16.7 per cent) would give
the wrong answer.
The above results indicate that majority of the respondents had low tax knowledge as the
percentage of “do not know” and “wrong answer” is higher than the “correct” answer. This is
perhaps due to the fact that these particular groups of respondents have insufficient tax
knowledge and their awareness towards the tax system is still low. Therefore, some necessary
steps should be taken by the relevant authorities to ensure a better compliance rate.
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Table 2 : Scores obtained by respondents
Total marks
Frequency
Percent
14.00
3
10.0
15.00
2
6.7
16.00
9
30.0
17.00
8
26.7
18.00
5
16.7
22.00
3
10.0
Total
30
100.0
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Table 3 : Tax Knowledge
Correct
Mode
1
2
3
4
Do not know
Wrong
N
%
N
%
N
%
3.00
17
56.7
13
43.3
0
0
Submission
date
2.00
12
40.0
16
53.3
2
6.7
Approved
donation
2.00
8
26.7
18
60.0
4
13.3
Unapproved
donation
1.00
6
20.0
12
40.0
12
40.0
Tax return
form
5
Zakat
2.00
11
36.7
12
40.0
7
23.3
6
Personal
relief
2.00
4
13.3
18
60.0
8
26.7
Relief for
Nonresident
2.00
6
20.0
19
63.3
5
16.7
Individual
tax rate
2.00
7
23.3
18
60.0
5
16.7
7
8
10
4.2.2 The role of IRB in educating the public.
The analysis on the role of in educating the public on tax matters that may have influence the
respondents to comply with tax laws are presented in Table 4.
Table 4 shows that about 56.7 per cent of the respondents claimed that they would seek
assistance from professional service (for example tax agents) if they have any matters
pertaining to tax, while the remaining of 43.3 per cent would seek assistance from tax
officials.
To the questions of whether the respondents have attending any seminars or courses organized
by IRB, the majority of them (86.7 per cent) would response “no” even though the seminar
was conducted without a charge.
Apart from that, the respondents when posed the questions pertaining to the accessing through
the IRB website, only 1 person that aware with the existence of such website and made used
of it to get information on tax and the rest, they never know the existence of such website.
Respondents were also asked whether they have been visited by any tax officers from IRB to
explain on tax matters, 14 (46.6 per cent) of the respondents would response “yes” and the
rest of the respondents would give the reverse answer.
When asked whether they have received any rules or guidelines sent by IRB pertaining on tax
matters, majority of the respondents (86.7 per cent) said that they never received such
guidelines.
The above findings would suggest that, the effort done by IRB in educating the public
regarding tax matters is not yet successful. Thus, an immediate action is needed and IRB
should continuously support the public by developing an extensive programs. The programs
should be planned in such a way that it could enhance the awareness of the taxpayers on the
importance of understanding the tax system.
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Table 4 : The role of IRB
IRB
Non IRB
N
13
%
43.3
N
17
%
56.7
Attending
seminars/courses
4
13.3
26
86.7
3
Assessing IRB
website
1
3.3
29
96.7
4
Visited by tax
officers
14
46.7
16
53.3
5
Rules and
guidelines
4
13.3
26
86.7
1
Assistance/guidance
2
12
5.0
Conclusion, Limitations and Suggestions for Future Research.
The present study attempt to provide an initial insight into the factors affecting the tax
compliance among small business entrepreneurs. The results show that majority of the
respondents had low tax knowledge, thus suggesting low level of tax compliance. According
to Eriksen and Fallen (1996), it is generally perceived that taxpayers with greater tax
knowledge would be more compliant compared to those having low tax knowledge. As for the
effort done by IRB, it was found that it still not yet successful and an extensive tax education
programs should be develop to achieve a better and high compliance rate. It is vital to educate
taxpayers and give them sufficient confidence in recognizing their tax obligations. Such
education programs should include the discussion on ethical values in order to promote
voluntary compliance (Noraza, et.al.,2003).
The findings of this study are subject to several limitations. First, the sample of the study were
limited to only 30 stall operators located in Nilai, Negeri Sembilan. As such, the results of the
study may not be generalized to the whole of stall operators that operating their business
under the controlled of PLUS Expressway Berhad. It is possible that if the sample size could
be increased for future research to give a better representation of the whole population.
Second, only two variables are used to explain the compliance level among the small business
entrepreneurs. It would be very much interesting if future study can be extended by looking at
the demographic variables that may influence the compliance level.
It is hoped that, the present study would be beneficial to tax policy makers to focus on
targeted group that require a better understanding on tax matter, which then will increase the
compliance level among the tax payers.
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