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CHAPTER TWO: LITERATURE REVIEW

2.1 Introduction

This chapter presents what various scholars have written about the level of tax education about Income Tax conducted, the determinants of Income Tax performance and policies for improving the performance of Income Tax in Uganda.

2.2 level of tax education in Uganda

Tax compliance is the degree to which the tax paying community meets the tax obligation as set out in the appropriate legal and regulatory provisions. He adds that compliant tax payers make timely, proper and accurate declaration to the tax authority and voluntarily settle all the due tax liabilities. Taxpayer compliance depends on economic incentives embedded in the tax structure and the effectiveness in detecting and penalizing non-compliance. At the margin, people engage in tax evasion when the expected benefits (lower taxes) are equal to the expected costs (bribes, punishment), (Maxwell, (2003).

Taxation is one of the important elements in managing national income, especially in developed countries and has played an important role in civilized societies since their birth thousands years ago, (Lymer and Oats, 2009).

In every jurisdiction, tax authorities are empowered to collect revenue from taxpayers. Although taxpayers report their income and pay their tax liabilities properly, there are many taxpayers do not bring about budgetary deficit in governments, (Torgler and Schneider, 2007).

Taxpayers’ education can be described as a method of educating the people about the whole process of taxation and why they should pay tax. Taxpayer education assists taxpayers in meeting their tax obligations to the government.  The primary existence of taxpayer education is to encourage voluntary compliance amongst taxpayers. Taxpayer education is one of the strategies of improving service delivery to the tax payers. Improving service delivery is critical to enhance voluntary tax compliance. Lack of voluntary tax compliance compels revenue authorities to use costly and coercive methods for tax enforcement (Fjeldstad and Ranker, 2003).

The education component in Uganda revenue Authority dealing with non-compliance practice among the taxpayers especially in the informal sector (Kimingu and Kileva, 2007). This is based on the possibility of non-compliance being unintentional, where the taxpayer is not aware of his/her tax obligations or fails to fulfill his/her tax obligations due to ignorance of tax laws and procedures or may be intentional due to the compliance attitudes (Christina, Deboral and Gray, 2003).

Taxpayer education program serves to: create taxpayer awareness of laws and procedures, educate taxpayers on their  tax  responsibilities  and  rights,  assist  and  motivate  taxpayer  to  comply  voluntarily,  assist taxpayers on reporting the correct income and amount of tax, maintaining close relationship between the tax authority and the taxpayer continuously, and, instill public confidence in taxation system (Oyedele, 2009).

Thus URA tax education policy is enabling the taxpayer to understand tax laws and procedures as well as creating positive tax compliance attitude (Normala, 2007).

The tax authorities have given special attention on the business, by simplification of the tax laws procedures, associations, annuals taxpayers’ appreciation day, and integrity enhancement as among the strategies (Kianuka, Kimungu and Kileva, 2007).

Tax Education to the business owners becomes necessary when the objective of raising tax revenue, at the changing environment; particularly from the official tax assessment is considered (Normala, 2007).

2. 3 The annual income revenue collected in Uganda

Different sources of income for Uganda

Source: URA 2016

Bar graph representing key Uganda’s sources of revenue

Source: URA , 2016

From the above graph, it was noted that out of total due taxes of UGX.1,489,690,880, the taxpayer had only paid UGX.666,366,724 on importation. As a result, taxes worth UGX.823,324,156 had been under declared and not paid. Evidence that these outstanding taxes had been collected by the yearend was not provided for review.

There is a risk that the URA staff that handled the customs entries for this importer did not do due diligence to ensure proper declaration or colluded with the tax payer to dodge taxes. There is also a risk of similar undetected under declarations leading to revenue losses.

In Uganda, income tax applies generally to all types of persons who derive income, whether an individual, bodies of individuals, or corporate entities. Resident persons are taxed on worldwide income, while non-resident persons are taxed only on income derived from sources in Uganda.

Income tax is imposed on three broad categories of income; Business income, Employment income and Property income.

Most of the taxes imposed are self-assessed. The self-assessment system imposes on the taxpayer, in the first instance, responsibility for calculating taxable income and the tax due on that income. The taxpayer’s calculations may however be reviewed by revenue officials when returns are filed and may be subject to further audit.

Tax revenue is generated from taxes on income, profits and capital gains, taxes on goods and services which include value added tax (VAT) and excise duty and taxes on permission to use goods or to perform certain activities for example operating a casino or lottery organizations.
Tax rates for Individuals in Business

The income tax rate for individuals depends on the income bracket in which the individual falls. Resident individuals enjoy a tax free annual income threshold of UGX. 2,820,000 per annum. The balance is taxed at 10%, 20% or 30% depending on the income bracket. Individuals who earn above UGX 120,000,000 pa pay an additional 10% on the income above 120m. It should be noted that in April 2016, while releasing URA’s 9 months revenue performance report for the financial year 2015/16, whereas URA registered a shortfall they were confident the shortfall would be recovered in the last quarter of the financial year 2015/16. The total net revenue collections were Shs U 8.1trillion, which was Shs194.6billion below target, (URA, 2015).

URA at the time highlighted that January to March 2016 was the hardest period where the agency registered a deficit of Shs 242.6bn, whereas the total net revenue performance was at 102 per cent within the first six months of the financial year 2015/16.

The report by URA on 2015/16, it registered a 16% increment in tax collections, the FY 2015/16 tax collections fell short of the annual target of Shs 11.598bn for the same financial year. This leaves us with reservation as to whether Uganda Revenue Authority (URA) will meet the set target for the Financial Year 2016/17 of Shs12.9 trillion.

Compared to Kenya, Tanzania and Rwanda, Uganda’s tax contribution to GDP also known as the gross domestic product, is the lowest. The country’s tax contribution to the GDP which is the value of goods and services produced in a country over a period of time, which could be either quarterly or annually, is hovering at between 12.5 to 12.9 per cent.

Uganda’s revenues collected grew by 18 per cent compared to Kenya’s 10.7, Tanzania’s 14.6 and Rwanda’s seven per cent, URA collected Shs 2.5 trillion in the three months to September compared to 2.1 trillion, a 17.98 per cent increase compared to the same period last year. Both domestic and customs taxes grew, Uganda Revenue Authority, (2016).

But the tax body did not meet its Shs 2.5tn target over the same period – posting a Shs 36bn deficit. Doris Akol, URA boss, said the body was focusing on trade facilitation especially at border points to expand revenue generation.

According to the performance report, the growth in withholding tax on dividends from corporate firms and bank profits posted a surplus of Shs 46.88bn. Akol said there was general improvement across sectors, adding that the tax body had embarked on a deliberate campaign to expand the taxpayer register through tax clinics, education drives and reaching out to them at their premises.

Meanwhile, the report notes that domestic taxes were largely affected by the increased offset and inputs claim in oil and gas sector, electricity, soft drinks, telecom and beer, leading to less value added tax payable.

The tax agency attributed this to the increased capital investments in the sectors. There was decrease in sales for the locally-manufactured beer brands, which affected domestic revenues. This financial year, URA is expected to collect Shs 13.1 trillion – compared to last year’s Shs 11.3 trillion – and Akol is optimistic they will beat the target.

“URA is on the right track and confident that it will surpass the annual target through the implementation of the various policy and administrative measures,” she said.

Asked how the depreciating shilling is likely to impact on tax collection, Akol said:  “The depreciating exchange rate has been felt in dampening earnings as firms are squeezed by rising input costs and a higher cost of capital.”

“This has and is expected to largely affect corporate income tax payments due to reduced profitability of firms especially in the financial and manufacturing sectors.”

Some analysts say the exit of some firms, including Uchumi and British Airways, out of Uganda, will have a dent on Uganda’s revenues. These firms had been paying income tax and PAYE to URA.

2.3 The determinants of income tax performance in Uganda

2.3.1 Tax Knowledge and Education

The influence of knowledge on compliance behaviors has been assessed in various researches. Knowledge as one of the factors in compliance is related to the taxpayers’ ability to understand taxation laws, and their willingness to comply.  The aspect of knowledge that relates to compliance is the general understanding about taxation regulations and information pertaining to the opportunity to evade tax (Kasipillai, Norhani, and Noor, 2003).

Taxation knowledge is necessary to increase public awareness especially in areas concerning taxation laws, the role of tax in national development, and especially to explain how and where the money collected is spent by the government (Mohd, 2010).

Attitude towards tax compliance can be improved through the enhancement of taxation knowledge.  When a taxpayer has a positive attitude towards tax, this will reduce his or her inclination to evade tax payment.

2.3.2 Fines and Penalties

Fines and penalty rates may substitute each other due to their multiplicative linkages as long as neither of them is set to zero (Kirchler, 2007).

Higher fines simply make evading taxes more hazardous for taxpayers and should deter them from evasion. Empirically, the deterrent effect of fines could not always be supported. The observed effects were weaker than expected and some studies even suggest that an increase of penalties can have undesirable effect and result in more tax avoidance (Kirchler, 2007).

Compliance has been strongly affected by the amount of fines than by audit probabilities. Several studies however found no support for the deterring effects of fines since it was weak (Andreoni, 1998).

Some of the findings suggest that a policy based on deterrence is effective only in combination with frequent Audits (Kirchler, 2007).

2.3.3 Perceived Opportunity for Tax Evasion

Individuals are often mentioned as a high-risk group in terms of tax compliance because their opportunities to evade are high. Opportunity has often been documented as a major explanatory factor in non-compliance (Webley, 2004).

Incomes are not subject to automated third-party reporting, or if taxes are not withheld at source (e.g. in cases of receiving gross incomes or cash payments), opportunities to evade taxes exist (Williams and Round, 2009).

The link between opportunity and non-compliance seems to have at least two different facets. First,  in  cases  where  people  do  not  deliberately  capitalize  on  opportunities,  the  specific circumstances leading to evasion opportunities might still lead to non-compliance. Opportunities usually come about when tax filings are not entirely automated. Through the lack of automation tax filing procedures are more likely to become error prone even without intent to capitalize on the entailed opportunities.

Consequently, opportunities may lead to an increase in intended as well as unintended non- compliance by deferent individuals to evade or avoid paying income tax. show that an experimentally induced opportunity to cheat (more possibilities to deduct non-deductible expenses) increased non-compliance regardless of whether the participants actually intended to be non-compliant or not, (Robben, 1990).

2.3.4 Tax Environment Policy

Compliance costs tend to increase with the number of taxes that an individual is subject to, the complexity of the tax rules, the frequency of submitting tax returns, and the number of levels of government involved in levying and collecting tax (Tanzi and Zee, 2000).

Most countries, individuals must contend with the income tax system (unless the individual falls under income tax exemption threshold). Business income tax also introduces complexities not relevant to an employee that pays tax only on labor income and non-business investment income. Complexities may multiply where more than one level of government is involved in levying and/or administering a tax and rules and procedures are not well co-ordinate (Thisen, 2003).

Thus, reduced compliance costs can bring improved efficiency resulting from more uniform tax treatment of individuals businesses.  A second efficiency consideration is that increased compliance, when resulting in increased tax revenues, may enable reduced effective tax rates on one or more possibly more elastic tax bases, with possible efficiency gains (Adams, 1993).

Policies for improving the performance of income tax in Uganda

2.3.5 Tax policy reforms and tax administration reforms

Commenting on the ability of local authorities to levy and collect tax revenues from peasant farmers, it is crucial for the local authority to have knowledge in identifying individual members of predominantly rural and self-employed population, assessing their means and extracting money from them, (Davey, 1974). He emphasized that taxing farmers so as to release additional output without curbing their enterprise was eminently one for local efforts, since it is only in the locality that their taxable capacity can be discovered adequately. This can be easily achieved if it is apparent to the tax payer that a substantial part of the revenue is spent on providing goods and services that benefit the rural community.

Literature Overview

The above literature has clearly established tax compliancy has direct effect on the domestic revenue collection of a country, implying that an increase in the number of tax compliant persons in a country leads to increased revenue collection. This can help the country to realize its goals and objectives as set out in the budget and that’s why the growing concern of tax administrations throughout the world is on how to simplify and encourage voluntary tax compliance. However, the literature fails to establish the effect of taxpayers’ education on income tax compliance. This creates  the  need  for  the  tax  agents  to  improve  their  image  by  building  trust  and  public confidence. The research was carried out using descriptive design in soliciting for information. From all the studies reviewed above, it’s clear that past research has tried to study the area but from a shallow perspective and no one has actually done the research in Uganda hence, the research tried to seek solutions to the problem statement which are mentioned later in chapter four and five.