COST, PENALTY AND RISK AVOIDANCE IN SELF-ASSESSMENT SYSTEM: SOME SUGGESTIONS FOR SELF-EMPLOYED TAXPAYERS

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SOME SUGGESTIONS FOR SELF-EMPLOYED TAXPAYERS Abdulsalam

1 From the SelectedWorks of Abdulsalam Mas'ud Mr April 19, 2013 COST, PENALTY AND RISK AVOIDANCE IN SELF-ASSESSMENT SYSTEM: SOME SUGGESTIONS FOR SELF-EMPLOYED TAXPAYERS Abdulsalam Mas'ud, Mr Available at:

INTERNATIONAL JOURNAL OF MANAGEMENT RESEARCH AND REVIEW COST, PENALTY AND RISK AVOIDANCE IN SELF-ASSESSMENT SYSTEM: SOME SUGGESTIONS FOR SELF-EMPLOYED TAXPAYERS ABSTRACT Abdulsalam Mas ud* 1 1 PhD

2 INTERNATIONAL JOURNAL OF MANAGEMENT RESEARCH AND REVIEW COST, PENALTY AND RISK AVOIDANCE IN SELF-ASSESSMENT SYSTEM: SOME SUGGESTIONS FOR SELF-EMPLOYED TAXPAYERS ABSTRACT Abdulsalam Mas ud* 1 1 PhD Student, University Utara Malaysia. The paper reviews relevant available literature on the concept of Self Assessment System (SAS) and its compliance cost, penalty imposition and audit risks as relates to self-employed individuals. It is understood that SAS posed challenges to self-employed individuals relating to cost, penalty and risks. Based on this, it is suggested that self-employed taxpayers should acquire appropriate level of tax knowledge, ensure adequate recordkeeping of business transactions, conduct preliminary internal tax audit prior to submission of tax returns and ensure timely filling of tax returns. In so doing, they can manage such challenges posed by the introduction and implementation of Self Assessment System. Keywords: Self Assessment System, Self-employed, Cost, Penalty and Risks. INTRODUCTION Global derive towards implementation of Self Assessment System (SAS) of tax administration has result to lot of research in tax compliance behavior under the new system (Fatt, Ling, Khin, & Ahmad, 2012; James & Alley, 2002; Lai, Zalilawati, Amran, & Choong, 2013; Loo, 2011; Loo & Ho, 2005; LOO, MCKERCHAR, & HANSFORD, 2009; Madi et al., 2010; Palil, 2010; Palil & Mustapha, 2011; Sapiei & Kasipillai, 2013; Sarker, 2003). Majority of these researches were aligned to individual taxpayers. This happened for the fact that tax evasion is more evident among individuals rather than corporations even in the old system. The main problem is that SAS implementation posed many challenges to taxpayers especially in relation to tax knowledge, which is impliedly mandatory for taxpayers if they accept the onus of tax assessment and computation by themselves that hitherto is the responsibility of tax authority not taxpayers. Lack of tax knowledge has also posed taxpayers many challenges such as increase in compliance cost as they must seek the service of tax consultants to compute and assess tax for them. It also posed taxpayers to penalties and risks that can take place if the ensuing poor tax knowledge results in underreporting of tax payable. Therefore, the objective of this paper is to discuss such challenges as they relate to selfemployed taxpayers and suggests some strategies that can be adopted to avoid them. The remaining part of the paper is organized as follows; the next part is review of relevant literature based on the highlighted challenges. The third part is some suggestions offered to self-employed taxpayers for managing the challenges and the last part is conclusion derived for the discussions. *Corresponding Author

3 SELF ASSESSMENT SYSTEM Self assessment is a system of tax administration first introduced in 1913 by United States (Loo, 2006). Afterward, many countries embraced the system with Ghana in the recent time (Cudjoy, 2012). The notion behind the system is to shift tax computations responsibility from the tax authority to taxpayers (Natrah et al 2003; Barr, James & Prest, 1977). It is required under SAS that taxpayer compute his tax liability and paid into designated bank (Onyegbule, 2012). By implication, tax authorities compliance cost will go minimal, since taxpayers would voluntarily comply (Loo & Ho, 2005). SAS has already been taking shape in developed countries like New Zealand, UK and Australia (James & Alley, 2002) and in developing nations such as Malaysia, Bangladesh, Indonesia and Pakistan (Sapiei & Kasipillai, 2013). SAS exposed taxpayers to many challenges such as increase in compliance cost, record keeping, seeking tax knowledge, engaging services of external tax consultants and preliminary auditing and investigation of tax returns prior to filling (Sapiei & Kasipillai, 2013). Some of these challenges are discussed below so as understand the extent to which they affect self-employed taxpayers and whether certain suggestions are possible to assist taxpayers in managing the challenges posed by SAS. Compliance Cost Prior studies (Sandford, 1973; Slemrod and Sorum 1985, Vaillancourt, 1986; Sandford et. al., 1989) showed that self-employed taxpayers have higher compliance cost. Study by (Blumenthal & Slemrod, 1992) in US reveals that compliance cost increase with qualification; those with high education are found to have high compliance cost. But it is lower for women who compute their tax return, and it increases with age of the taxpayers. Since educational level is not determinant of tax knowledge (Devos, 2008) and tax knowledge is found to be determinant of tax compliance in SAS (LOO, et al., 2009; Palil & Mustapha, 2011), for taxpayer to accurately compute his tax liability reasonable tax knowledge is required (Lai, et al., 2013). Hence, those taxpayers without tax knowledge are compelled to solicit the service of tax professional (Chattopadhyay & Das-Gupta, 2002; Loo & Ho, 2005). Compliance cost of individual taxpayers is normally computed in terms of time spent by the taxpayers or professional tax agent. In 1982 for instance, the compliance cost of individual taxpayers in US was between $17 and $21 billion, equivalent to about two billion hours of time spent by taxpayers on filing tax returns, and about $3 billion was spent on professional tax assistance (Slemrod & Sorum, 1985). Study by (Mansor, Saad and Ibrahim, 2004) on compliance cost of SMEs in Malaysia reveals that the prominent variable in computing SMEs tax compliance cost is the times spent by owners on discussion with tax agent, learning the tax laws, paying taxes, record keeping and answering revenue authorities queries. Similarly, (Sapiei & Abdullah, 2008) found that the high time spend on compliance is for recordkeeping and the high cost spend by individuals taxpayers in on hiring the tax advisors in Malaysia, though the overall cost is found to be low in monetary value. In estimating compliance cost in US (Guyton, O Hare, Stavrianos, & Toder, 2003) reveals that on average the compliance cost is high among the taxpayers with complex tax returns compared to those with simplified tax returns; the situation is applied to both salaried and Copyright 2012 Published by IJMRR. All rights reserved 2708

4 wages workers and self-employed individuals. For instance, salaried taxpayers who enumerate their returns spend 21.3 hours on average and $114 as tax compliance cost, against 11.4 hours and $63 for salaried taxpayers who do not enumerate. Likewise, self-employed taxpayers who file tax Form 6251 (Alternative Minimum Tax) expend an average of 97.3 computation hours and $752 as tax compliance cost, as against 56.6 computation hours and $334 for self-employed taxpayers who do not file tax Form Penalty for noncompliance To enhance tax compliance deterrence measures such as penalty, audit and detection are used by tax authorities. Deterrence factors such as probability of being audited and being detected by tax authorities are found to reduce noncompliance among taxpayers (Allingham & Sandmo, 1972; Doran, 2009). For instance, in Nigeria Personal Income Tax Act (PITA) 2011 as amended strengthen such issues as recordkeeping, self-assessment and provide penalty of N50,000 and N500,000 for individuals and companies respectively for contravening the provisions of the Act (Oluchi, 2012). Furthermore, under self-assessment the failure of taxpayer to file returns will make him liable for conviction to pay N200 and further N40 for everyday during which the failure continues (FIRS, 2013). In Malaysia, if it is discovered during the audit processes that there is underreporting or misstatement, a penalty will be imposed under subsection 113(2) of the ITA Revenue authorities in Malaysia encourage taxpayers who underreport their income to voluntary make disclosure of such underreporting if later they understand that they made underreporting of their income. Failure to do so is subject to penalty depending on the time that has lapsed between omission and voluntary disclosure as shown below (IRB, 2000): Source: Malaysia IRB, (2000). * Repeated offences, the rate of penalty is 60% of tax chargeable plus additional 10% if offence repeated but not exceeding 100% of tax charged. Fig 1: Penalty for Underreporting in Malaysia The issue for penalty for noncompliance or underreporting is an international phenomena applied to various revenue authorities around the world. Copyright 2012 Published by IJMRR. All rights reserved 2709

5 Audit and Based on Judgment (BOJ) Assessment risk for underreporting Under the SAS in Nigeria taxpayers returns are subjected to audit in two ways; spot audit and risk assessment audit. Spot audit is carried-out instantly as the taxpayer submits tax returns but risk based assessment audit is a details of examination carried-out on taxpayers returns in such area where the perceived level of noncompliance or underreporting is likely to be high. The fact is that under the old assessment method there is 100% audit of all the taxpayers returns but in SAS only the areas of high risks are being audited (Onyegbule, 2011). Similarly, in Malaysia there are two types of audits; desk audit and field audit (IRB, 2000). Desk audit is held at IRB office and it dealt with straightforward issues or adjustments that can be handle via correspondence but not amounted to underreporting. Whereas, field audit normally takes place at taxpayers premises and it involves checking business and nonbusiness record of taxpayers to ascertain the correctness of the income disclosed. Normally, prior notice is given to taxpayer before field audit. Lack of tax knowledge can lead to underreporting by less-knowledgeable taxpayer, hence unintentional noncompliance (Mohani, 2001; Palil, 2010; Riahi-Belkaoui, 2004). Level of tax knowledge will not be an excuse to taxpayer, hence he/she will be held responsible for underreporting if his/her tax returns have probably been audited. Hence, the need for taxpayers to be awaked for challenge of tax knowledge so as to reduce the risk of underreporting resulting from poor of tax literacy. The main issue is that the taxpayer should be penalized for noncompliance resulting from underreporting; many tax payers try to ensure accurate compliance due to fear of being audited and penalized (Loo, 2011). Therefore, tax knowledge is important issue for selfemployed taxpayers in avoiding audit risk. Best-of-Judgment assessment on taxpayers are cited under sections 65 (2)(b) and 65 (3) Of Companies Income Tax Act (CITA) for Companies and sections 54 (2) (b) and 54 (3) of Personal Income Tax (PITA) for individuals. (Federal Inland Revenue Service, 2006). For individuals its usually applied where no record has been kept for the business hence appropriate measure are taken to estimates the tax payable by the taxpayer taking into consideration some peculiarities and ability to pay. The risk here is that, the tax charge by tax authority using Based-of-Judgment assessment may not be exactly the actual tax payable if adequate record were kept; hence, the possibility of over charge can occur. SUGGESTIONS FOR COST, PENALTY AND RISK AVOIDANCE Tax Knowledge Self-employed individuals should try as much to acquire reasonable level of tax knowledge as it applied to their businesses. Acquiring the tax knowledge has many advantages. It will save the taxpayers from hiring tax consultants to compute tax for their business, thereby saving hug tax consultancy cost. It also assists them to accurately compute their tax payable which can assist them to avoid unintentional noncompliance resulting from low level of tax knowledge (Mohani, 2001; Palil & Mustapha, 2011; Riahi-Belkaoui, 2004). Acquiring tax knowledge also has the effect of changing their perception regarding the tax fairness(mukasa, 2011). Taxpayers is good knowledge of tax laws are found to have good perception on the fairness of tax system (Mukasa, 2011). Hence, acquiring tax knowledge is of utmost important to taxpayers under SAS. Copyright 2012 Published by IJMRR. All rights reserved 2710

6 Recordkeeping Keeping adequate records of business transaction by self-employed individuals taxpayers is of paramount importance; it enable the taxpayer to know exactly what the business profit is, hence tax liability can easily be calculated from it. Lack of adequate recordkeeping can adversely affect the self-employed individuals in two ways. First, without adequate record tax payable cannot be determine, thus, the possibility of Based-of-Judgment assessment; which cannot give exact tax payable that can be obtained if adequate record were kept. Second, if the taxpayer attempted to make false declaration by forgery records, there is possibility of penalty to exist if the tax authority confirmed that the tax paid by the taxpayer is not derived from genuine business records. Therefore, keeping record by self-employed taxpayers is very significant under SAS. Preliminary Internal Audit For the fact that self-employed individuals can be subjected to two types of audit under SAS; spot and risk based audit, it is important to carefully verify their tax returns before making payment and submission of returns to tax authorities. This has the effect of enabling them to confirm the accuracy of their computation and to confirm non-existence of underreporting of profit which can result to under payment of tax payable. With appropriate level of tax knowledge, this exercise requires no service of tax consultant; self-employed individuals can perform it themselves. Thus preliminary audit on returns is highly recommended for selfemployed taxpayers before being subject to spot and risk based assessment. Timely Filling of Tax Returns In many regimes where SAS remains their tax system late filling of tax returns attract penalty. Thus, it is important for self-employed taxpayers to prepare and present tax returns as it become due. For instance in Nigeria, filling returns under SAS become due on or before 31 st Day of March every year(federal Inland Revenue Service, 2011). Failure to file the tax returns on due date attract penalty to taxpayers (FIRS, 2013). Therefore, to avoid such penalties and fines, self-employed taxpayers have to ensure timely filling of their tax returns to relevant tax authorities. CONCLUSION The paper discussed the concept of Self Assessment System and compliance cost, penalty and risks associated to its and how such relate to self-employed taxpayers. It is evident from the review of literature that self-employed taxpayers are subjected to certain cost, penalty and risks under SAS. We digest such issues and made some suggestions such as acquisition of appropriate level of tax knowledge, ensuring adequate record keeping, conducting preliminary internal tax audit and ensure timely filling of tax returns. These suggestions can assist the self-employed individuals to avoid some compliance cost relating to tax consultancy and computation, the penalty of unintentional noncompliance and the risk of audit and Based-of-Judgment Assessments. Copyright 2012 Published by IJMRR. All rights reserved 2711

7 REFERENCES Allingham MG, Sandmo A. Income Tax Evasion:A Theoretical Analysis. Journal of Public Economics 1972; 1: Barr NA, James SR, Prest AR. Self-Assessment for Income Tax. London, Heinemann, Blumenthal M, Slemrod J. The compliance cost of the US individual income tax system: A second look after tax reform. National Tax Journal 1992; 45(2): Chattopadhyay S, Das-Gupta A. The compliance cost of the personal income tax and its determinants. National Institute of Public Finance and Policy, New Delhi, Cudjoy L.GRA launches Self Assessment Policy Document to guide tax payers. Modern Ghana, Devos K. Tax evasion behaviour and demographic factors: An exploratory study in Australia. Revenue Law Journal 2008; 18(1): 1. Doran M. Tax Penalties and Tax Compliance. Harvard Journal on Legislation 2009; 46. Fatt CK, Ling LM, Khin EWS, Ahmad Z. Disclosure of self-assessment tax systems on Malaysian agriculture based industries. Journal of Development and Agricultural Economics 2012; 4(13): Federal Inland Revenue Service. Preparation And Processing Of Best-Of-Judgement (BOJ) Assessments, 2006, (No. 2005/03). Federal Inland Revenue Service. Self Assessment System, FIRS. Self Assessment Firs Guide, Guyton JL, O Hare JF, Stavrianos MP, Toder EJ. Estimating the compliance cost of the US individual income tax. National Tax Journal 2003; 56(3): IRB. Self Assessment System: IRB Guide on Tax Audit, James S, Alley C. Tax compliance, self-assessment and tax administration, Lai ML, Zalilawati Y, Amran MM, Choong KF. Quest for Tax Education in Non-Accounting Curriculum: A Malaysian Study. Asian Social Science 2013; 9(2): 154. Loo EC. The influence of the introduction of self assessment on compliance behaviour of individual taxpayers in Malaysia, Loo EC, Ho JK. Competency of Malaysian Salaried Individuals in Relation to Tax Compliance under Self Assessment. Journal of Tax Research 2005; 3(1): Loo EC, Mckerchar M, Hansford A. Understanding the compliance behaviour of Malaysian individual taxpayers using a mixed method approach. Journal of the Australasian Tax Teachers Association 2009; 4(1): Madi N, Kamaluddin A, Janggu T, Ibrahim MBA, Samah ABA, Jusoff K. Tax Literacy among Employees: Sabah and Sarawak s Perspective. International Journal of Economics and Finance 2010; 2(1): 218. Copyright 2012 Published by IJMRR. All rights reserved 2712

8 Mohani A. Personal income tax non-compliance in Malaysia. PhD thesis., Victoria University, Melbourne, Australia, Mukasa J. Tax Knowledge, Perceived Tax Fairness And Tax Compliance In Uganda, Master of Science, Makerere University Uganda, Natrah S, Muzainah M, Idawati I. The Self-Assessment and Its Compliance Cost. Paper presented at the SEMACC 2003-Research Preceedings: Issues and Challenges Confronting the Accounting Profession Today, Kangar, Malaysi. Oluchi M. PITA 2011 key benefits to taxpayers and the economy. Guage, Palil MR. Tax knowledge and tax compliance determinants in self assessment system in Malaysia. University of Birmingham, Palil MR, Mustapha AF. Factors affecting tax compliance behaviour in self assessment system. African Journal of Business Management 2011; 5(33): Riahi-Belkaoui A. Relationship between tax compliance internationally and selected determinants of tax morale. Journal of International Accounting, Auditing and Taxation 2004; 13(2): Sandford CT, Michael G, Peter H. Administrative and Compliance Costs of Taxation, Fiscal Publications, Bath, Sandford CT. Hidden Costs of Taxation, Institute for Fiscal Studies, London, Sapiei NS, Abdullah M. The compliance costs of the personal income taxation in Malaysia. International Review of Business Research Papers 2008; 4(5): Sapiei NS, Kasipillai J. Impacts of the Self-Assessment System for Corporate Taxpayers. American Journal of Economics 2013; 3(2): Sarker TK. Improving Tax Compliance in Developing Countries via Self-assessment Systems What could Bangladesh Learn from Japan. Asia-Pacific Tax Bulletin 2003; 9(6): Slemrod J, Sorum N. The compliance cost of the US individual income tax system: National Bureau of Economic Research Cambridge, Mass., USA, Vaillancourt F. The Administrative and Compliance Costs of the Personal Income Tax and Pay roll Tax System in Canada, Canadian Tax Foundation: Toronto, Copyright 2012 Published by IJMRR. All rights reserved 2713

Determining Tax Literacy of Salaried Individuals - An Empirical Analysis

IOSR Journal of Business and Management (IOSR-JBM) e-issn: 2278-487X, p-issn: 2319-7668. Volume 10, Issue 6 (May. - Jun. 2013), PP 76-80 Determining Tax Literacy of Salaried Individuals - An Empirical