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UGANDA’S TAX ADMINISTRATION SYSTEM AND TAX COMPLIANCE AMONG SMEs, A CASE STUDY OF LIRA MUNICIPALITY 

CHAPTER ONE

INTRODUCTION

• Introduction

This chapter covers background to the study, statement of the problem, objectives of the study, research hypotheses, scope of the study, justification of the study, definition of key terms and conceptual framework.

1.1       Background to the study

Taxation is perceived as a load which each citizen ought to bear to sustain his or her government because the government has certain functions to perform for the benefits of those it governs. In developing countries, tax non-compliance is a serious challenge facing income tax administration and hindering tax revenue performance. Even though various tax reforms are geared towards increasing tax revenue for several years, total revenue collections have remained consistently low and is relatively shrinking (Alabede, Zainol & Kamil, 2011).

Tax compliance can be described as the process of fulfilling the tax payer’s civil obligation for tax payment and filing of tax returns including the provision of necessary documents and explanations required by the tax authority in a timely manner (Oyedele, 2009).

Achieving high levels of voluntary tax compliance and maintaining it , remains a formidable and continuous challenge to fiscal policy makers in developed and developing countries alike. This is the case because, irrespective of the nature of the economy, the principal objective of taxation is one and the same: to raise revenue towards the financing of public goods and services, and funding of governments (Martina, Silvia, Eric & Alfred, 2008).

Small Scale Enterprises (SMEs) as profit making entities are subjected to taxation.  Since the individual SME remit smaller tax revenues, more focus is centred on the large tax payers. This presents a prime chance for non-compliance among SMES. Tax compliance is currently a topical issue, especially in developing countries as governments at various levels are seeking ways to improve efficiency in tax revenue collection to finance their budgets. Small scale enterprises are the majority business taxpayers in most developing countries and as such their compliance levels directly impact on government tax revenue collections.

The overall objective of the study was, investigating relationship between Uganda’s tax administration system measured in form of tax registration, tax education, tax assessment and tax audit  and tax compliance (returns filing, tax payment and accurate reporting) of SMEs in Lira Municipality. The significance of this study is discussed at length under section 1.7 of this book.

1.1.1 Historical background

Taxation has evolved right from the ancient empires. It was put into practice by diverse empires in different geographical locations and times; perhaps like temple and monument construction, taxation is a common phenomenon of human society. Taxes have been traced by archaeologists as far back as King Scorpion the First’s empire in southern Egypt between 3300 and 3200 BC. There is evidence through archaeology where records of taxation have  been found in clay tablets and on jars and vases discovered in King Scorpion I’s tomb. The thrilling part of the discovery is not only that taxation occurred so early, but that the tablets, jars and vases have the oldest use of writing with symbols representing constants and forming syllables-hieroglyphics (William, 2002).

In Western Europe, quasi-voluntary compliance emerged through a bargaining process. This brought rulers and potential taxpayers together to negotiate about who was to be taxed, the basis for assessing taxes, how taxes should be collected, and the purposes of revenue use.  Where this bargaining process succeeded, it enhanced the effectiveness and legitimacy of the state in three ways. Consultation promoted quasi-voluntary compliance so that taxes could be collected more effectively. Revenues were enhanced as a result. Bargaining also helped to generate consensus about and coherence of national policies and priorities for revenue use. Finally, paying tax became a valid basis for claiming political influence and where this took root the foundation for an eventual move towards electoral democracy was established (Therkildsen, 2006).

Korchmina (2018) compiles an account of the history of tax compliance basing on Russia and Britain. In 1812, the Russian government introduced the progressive income tax, with the highest tax rate of 10 per cent. After Britain, the Russian Empire became the second country to adopt this levy – under the threat of Napoleonic invasion. It is reported that by then, tax compliance was much higher in Russia compared to Britain. The example of Russian income tax in 1812 gives clear evidence of the significance of the voluntarily component in the payment of income taxes. Even in an under-governed and late-industrialized country, the collection of income tax could be organized quite efficiently, even among elites, if elites can be pressured by peer-based institutions. Despite the high level of freedom of taxpayers and the near-absence of coercion, the level of tax compliance in Russia was relatively high. Tax morale was determined by a social sanctioning mechanism among the narrow group of peers, boosted by the fear of Napoleon, which could be considered as the national pride, and tend to progressivity.  It is also likely that the Russian nobles paid the new tax because the tax burden was not very high, and the elite could consider the fiscal demands of Russian state as being fair and equal to their financial capacities. The Moscow nobles paid approximately one million rubles in income tax and, and, in the same year, they collected approximately three million rubles via donations to support the Russian troops.

Uganda’s present tax system has colonial roots. The prime objective of colonial taxation was

financial self-sufficiency of the colony.  At the same time taxation of Africans was seen as a way to push them into the monetary economy – at first by compelling them to grow cotton. Coercion and imprisonment were integral parts of taxation of Africans but not of non-Africans (Mamdani,1996; Thompson, 2003). The dual system of taxation described by Adam Smith and Lord Hailey started with the hut tax imposed on Africans in 1900 followed by the poll tax in 1905. At first revenues went to the colonial government. Native local authorities achieved their initial taxing powers in 1925, when they were allowed to commute work obligations (known as “luwalo”) into cash.  But local government taxation proper first came about when Graduated Poll Tax (GPT) was gradually introduced across all districts between 1954 and 1960 (Davey ,1974; 35-38).   Non-Africans were tax-free until 1919 when a poll tax was levied on them. A graduated personal tax for non-Africans was introduced in 1940 but substituted by income tax in 1945. For the 20th century as a whole, the most significant change in Uganda’s system of direct taxation was the abolition, at independence in 1962, of discrimination based on race. To collect taxes in a reliable and efficient manner requires quasi-voluntary compliance; taxpayers must be encouraged to ‘volunteer’ to pay, while the non-compliant must be coerced to pay if they are caught (Levi,1988, 52-70).

The lesson here is that coercison is not the answer to improve tax compliance.

1.1.2 Theoretical background

This study is informed by the Motivational Postures Theory and the Theory of planned Behavior (TBB).The motivational postures adopted by different taxpayers reflect the social distance (Ahmed & Braithwaite, 2005) cited in  Lin Mei (2017). Motivational postures are “sets of beliefs and attitudes that sum up how individuals feel about and wish to position themselves in relation to another social entity, in this case a tax authority” (Lin Mei, 2017). Motivational postures are vital in tax compliance as various studies show that the cooperative postures of commitment and capitulation are negatively associated with tax avoidance and evasion and positively associated with voluntary tax compliance (Kirchler, 2008). On the other hand, resistance, disengagement and game playing are positively associated with tax avoidance and evasion and enforced tax compliance (Ahmed, 2005; Kirchler, 2008).

The Theory of Planned Behaviour (TPB) (Ajzen, 1991) is a favored model for understanding intentions and behaviors of tax payers. This relationship is decisive to any important modifications in tax policy. Intention is a necessary component of tax compliance as it is only through the willing participation of taxpayers that revenue is collected. Thus getting an insight of the taxpayer intention to comply is as important as predicting the actual compliance behavior.

In this research, the TPB has been used to clarify the complexity of tax compliance decision making but, importantly, can also be utilised for the development of broad population compliance strategies.

1.1.3 Conceptual background

The key concepts in this study are tax compliance and tax administration system. Tax compliance is defined largely as the willingness of taxpayer to pay taxes (Walsh, 2012). Tax compliance covers filing compliance (filing returns on time), reporting compliance (reporting incomes correctly) and payment compliance (paying tax due on time). Arturo (2013) shows that tax administration comprises of taxpayer registration, taxpayer services, processing of tax declaration filings and tax payments, taxpayer audits, taxpayer objections (administrative appeals), taxpayer appeals, Collection of tax arrears (as opposed to current tax payments) and tax-fraud investigations. These measures have been adopted in the current study. The traditional role of tax administration focuses on detecting and correcting errors after they have been made.

An important part of improving taxpayers’ relationships with the tax authorities are concepts meant to clarify objectives of the state and procedures of tax authorities in the tax area, creating taxpayers’ positive attitudes towards tax collection, as well as increasing perception of fairness in tax collection and the use of collected tax receipts ( Rabatinová, 2018). Earlier studies have acknowledged that tax administration systems and tax compliance have some links. Tax revenue in many countries remains well below the levels needed to finance the achievement of the sustainable development goals, with 15 percent of GDP often cited as a rough annual estimate (Gaspar, Jaramillo & Wingender,2016). In the meantime, revenue collection is frequently characterized by significant unfairness and inequity, with particularly weak compliance and enforcement among the rich, and often significant–though overlooked– formal and informal burdens on lower income groups (Moore & Prichard, 2017). From this, it is likely that tax administration systems influence tax compliance.

1.1.4 Contextual background

Revenue collection remains a key challenge in African and Uganda in particular (Mukunda, 2017). This is mainly on account of limited tax compliance. In the last three decades, Uganda has embarked on improvements to broaden the tax base and increasing domestic revenue mobilization. Modernizing the tax administration systems is among the initiatives (World Bank, 2018b). In comparison with regional neighbours, Uganda’s tax revenue to GDP is still below the 16 per cent Sub-Saharan average and lags behind her East African Community (EAC) neighbors too (World Bank, 2018b). Tax administration in Lira has gradually improved from manual forms to electronic system where tax payers need to access tax information at their convenience and consult on tax matters 24 hours using the toll free line. There is also tax education and sensitization in different parts of the country, Lira inclusive (Uganda Revenue Authority (URA) Annual Report, 2015/2016, 2016).

Despite such efforts, tax compliance in Lira is still a challenge. Some SME entrepreneurs are illiterate and hire tax consultants to help them file returns and interpret trade laws and regulations especially for tax purposes. There are also complaints by traders about delayed administrative feedback especially in clearing imports at various customs points (Kato, 2017). Most SMEs survive at the mercy of clearing agents who sometimes may not offer satisfactory advice, hence tax disputes between URA and the tax payer (Kato, 2017).

The town Clerk of Lira on realizing poor compliance initiated sensitization of the community on its roles in promoting service delivery through voluntary tax compliance even in the absence of the law enforcement officers (Ogweng, 2018). The low tax compliance among SMEs in Lira Municipality could be a sign of general loopholes in the tax administration systems (Cong, 2018) and thus sets the basis of this study.

1.2       Statement of the problem

Uganda’s tax administration system is a key enabler of tax compliance (Godin & Hindriks, 2015; Mukunda, 2017). Enhancing the way taxes are administered is likely to result into better willingness of SMEs to pay the taxes as and when they fall due and help Uganda to generate tax revenues to ensure a stable fiscal regime. The constitution of the Republic of Uganda under Article 17 (1)(g) provides the legal basis for tax payment and tax collection (Balaba, 2020).  At the national level, URA has tried to make tax administration reforms in education, identification and registration, assessment, audits and appeals. Currently, there are a number of fora for tax education and sensitization as well as tribunals to handle tax related complaints, audits and verifications among others countrywide, including Lira Municipality (Busingye, 2017; Uganda Revenue Authority Annual Report, 2015/2016, 2016; Mukunda, 2017).

However, Lira municipality, notwithstanding the above improvements, still continues to register poor tax filing, incomplete or no tax reporting as well as untimely or even failed tax payment (Cong, 2018; Ogweng, 2018; Kato, 2017). This poor tax compliance is common among SMEs (Ministry of Trade Industry and Cooperatives, 2018; Busingye, 2017) and more so, those in Lira Municipality (Ogweng, 2018; Cong, 2018). This poor compliance normally forces Uganda Revenue Authority to impose tax penalties, forcefully collect any unpaid tax and sometime close businesses (Ogweng, 2018). If such poor tax compliance continues, Lira Municipality is likely to lose hope of self-sustenance and face very poor service delivery to the people due to limited tax collections to finance the municipality activities.

It is thus important to explore whether tax administration systems and compliance costs influence tax compliance among small and medium scale enterprises particularly in Lira municipality. This will then act as a basis to inform authorities to improve on tax administration for better tax compliance in Lira Municipality which is currently taking a negative and worrying trend.

1.3   General objective of the study

The general objective of the study is to examine the relationship between Uganda’s tax administration system and tax compliance among SMEs in Lira Municipality.

1.4   Research Objectives

This study was guided by the following research objectives;

• To determine the relationship between tax education and tax compliance among SMEs in Lira Municipality.
• To determine the relationship between tax registration and tax compliance among SMEs in Lira Municipality.
• To determine the relationship between tax assessment and tax compliance among SMEs in Lira Municipality
• To examine the effect of compliance costs on tax compliance among SMEs in Lira municipality.

1.4.1    Null rresearch hypotheses

This study aimed at answering the following research hypotheses

H1: There is no significant relationship between tax education and tax compliance among SMEs in Lira Municipality.

H2: There is no significant relationship between tax registration and tax compliance among SMEs in Lira Municipality.

H3: There is no significant relationship between tax assessment and tax compliance among SMEs in Lira Municipality.

H4: Compliance costs have no significant effect on tax compliance

1.5   Scope of the study

The scope of this study was confined to the geographical, subject and time scope.

1.5.1    Geographical Scope

The study was confined to Lira Municipality, with specific reference to SMEs in Lira. The target populations for this study was small and medium enterprises (SMEs) operating in Lira municipality, covering the divisions of Adyel, Ojwina, Central and Railways (2.2581° N, 32.8874° E).

Lira central division

Lira Central Division is located in Lira Municipal Council in Lira District. It is one of the four Divisions in the Municipality. The Division covers a land area of 203,625 hectares. The population of Lira Central Division is about 17,593, 82, males and 9295 females from 3089 households (National Population and Housing Census, 2002).

Lira Central Division was chosen since the majority of SMEs including Metal fabricators, Leisure and hospitality, timber dealers, groceries and general merchandise dealers among others are found there and are either ideal candidates for taxation or are actually paying the taxes. Lira Municipality (Central Division) was selected basing on the increasing levels of poor tax compliance amidst tax administrative reforms which creates a puzzle to the tax authorities and the Municipality administration.

 1.6.2   Subject Scope

The study was confined to establishing the relationship between tax administration systems and tax compliance of SMEs. The scope selected is small enough to be covered in depth but large enough to give a contribution to the current knowledge on tax administration and tax compliance.

1.6.3    Time Scope

This study was carried out between April 2020 and  Feb 2021. The focus was on the period 2009 to 2020 to capture recent developments in relation to the study context and perspective.

1.7 Significance of the study

The findings of the study is expected to be significant in the following ways;

This study is intended to provide policy makers, that is the Ministry of Finance Planning and Economic Development and tax law makers in parliament insights to base any possible amendments to suit the local needs. This will drive voluntary compliance among tax payers.

The Uganda Revenue Authority has so far tried several means to enforce tax compliance. This study will provide additional information to URA to understand how best to enhance tax compliance among SMEs.

Lira Municipality is mandated to collect taxes locally and also to help government bodies like URA to meet revenue targets. This study will highlight how the two bodies can cooperate for mutual benefit.

To other researchers, it is important to tell the nature of the relationship between tax administration systems and tax compliance, thus this study will provide a current reference material.

To the researcher, this study will boost the knowledge on taxation and hence be a milestone in the career growth as well as academic achievements.

Lira municipality will also benefit from the study as a basis for making reforms in administration that will appropriately address tax compliance loopholes.

1.8       Conceptual framework

                 Independent Variable                                                      Dependent   Variable

Source: Adapted from literature by (Lemgruber, Masters & Cleary, 2015; Alm, 2011; Ocheni, 2015; Maseko, 2014).

In the conceptual framework above, tax administration is thought to influence tax compliance. Tax administration is the independent variable, studied in terms of education, registration and assessment, (Lemgruber, Masters & Cleary, 2015). All these elements are thought to influence tax compliance among SMEs.

The relationship between tax administration system and tax compliance is moderated by SME operators’ perceptions and cost (Maseko, 2014). In addition, tax compliance is the dependent variable, studied in terms of tax filing, tax reporting and tax payment (Alm, 2011; Ocheni, 2015). The study assumes that tax compliance among SMEs in Lira municipality is influenced by the tax administration systems used by URA. These relationships are studied guided by Motivational Postures Theory (Braithwaite, 2003) and the Theory of Planned Behavior (Ajzen & Fishbein, 1980).

Working definitions

Tax education: Imparting knowledge and skills related to taxes among tax payers.

Tax registration: Taking note electronically of manually the details of potential tax payers for inclusion in the taxpayer database.

Tax assessment: The determination of the amount of tax due for every tax payer at a certain point in time.

Tax collection: The actually gathering or receiving of taxes by cash, cheque or electronically

Returns filling: The record and sharing of the expected tax payment to fall due in a given financial year for a tax paying entity (individual or organization).

Tax reporting: The declaration of the details pertaining to tax payments made or about to be made.

Tax payment: The actual release of the assessed tax to the tax authorities like URA or its representatives including banks, tax clearance agents or URA representatives.

Compliance costs: This relate to actual money paid and opportunity cost relating to the time and other resources expended when complying with tax laws.