TAX EVASION AND NON-COMPLIANCE ATTITUDE OF INCOME TAXPAYERS IN SRI-LANKA

TAX EVASION AND NON-COMPLIANCE ATTITUDE OF INCOME TAXPAYERS IN SRI-LANKA MBM.Amjath PhD Research Scholar, Dept of Commerce, Annamalai University/Senior Lecturer Gr-I, Dept of Accountancy & Finance, South Eastern University of Sri Lanka, Dr. K. Vijayarani Professor and Head, Commerce wing- DDE, Annamalai University, Annamalainagar-608002, Chidambaram ABSTRACT This study explores the Analysis of tax evasion and income tax noncompliance attitude of income taxpayers in Sri-Lanka. The main objective of the study is to explore and analyze the factors influencing on the tax evasion and the noncompliance attitude of taxpayers in Sri-Lanka. This area of research did not appear to have been previously studies in Sri-Lanka context and in this respect the research represent an original contribution while research have been conducted in Sri-Lanka. Tax evasion is said to occur when eligible taxpayers deliberately fail to comply with their tax obligations, which may cause serious damage to total tax revenue loss and create problems of the proper functioning of the public sector and threatening its capacity to finance the public expenses. Tax compliance means true reporting of all tax bases, correct computation of the tax liability and timely filling and paying correct amount of tax on due. Data collection tool applied in this study was a set of questionnaire used by Marti et.al cited Nugi Nkwe. The structured questionnaires were distributed directly to the individuals and collected within two weeks. This questionnaire comprised five points Likert scale to evaluate demographic profile and attitudinal factors. A sample from various categories of employments and eligible to pay income tax were taken as sample respondents for the study. The result of the study tries to generalize how the tax evasion and attitude of taxpayers influences in the tax system in Sri-Lanka. The Chi-Square test of independence was used to test hypothesis that attributes were independent of each other and mean and standard deviation were also used to draw conclusion that the job categories and income source of respondents were independents in tax evasion and noncompliance attitude income taxpayers. Keywords: tax evasion; noncompliance attitude; taxpayers attitude; tax revenue; www.apjor.com Page 84

Introduction The objective of this article is to explore the empirical evidence of tax evasion and noncompliance attitude, and how it influences in total revenue generating activities of Sri-Lanka. Tax evasion means try to escape or paying less than actual amount of tax. Tax evasion is said to occur when eligible taxpayers deliberately fail to comply with their tax obligations, which may cause serious damage to total tax revenue loss and create problems of the proper functioning of the public sector and threatening its capacity to finance the public expenses. Tax compliance means true reporting of all tax bases, correct computation of the tax liability and timely filling and paying correct amount of tax on due (Luigi Alberto Franzini 1998). When taxpayers do not comply with this principle, it becomes noncompliance of taxation. It is expected generally that all taxpayers should furnish all the required tax return and relevant document on time and returns with accurately calculated tax liability in accordance with the Inland Revenue (IR) manuals, regulation and court decision applicable (Roth.J., Scholz,J. and A Witte(Eds), 1989). In developing countries, tax noncompliance is a serious issue faced by tax authority even though various tax reforms undertaken by governments to increase tax revenue without affecting taxpayers. Previous statistical evidence has indicated that tax revenue to Gross Domestic Product (GDP) varies from developed countries to developing countries. Developed rich counties showed, tax revenue to GDP was one third while it was 17 per cent in Latin America and Caribbean countries; Lumuba Omweri Marti, Migwi S. Wanjohi, Obara Magutu (2010). The average ratio of the tax revenue to the GDP should be in the range of 20 percent to the middle income countries like Sri-Lanka. But it was 14.3 per cent revenue to GDP in recent past years in Sri-Lanka (state of the economy, 2012). There may be many reasons for such a keeps in reducing trend to the tax revenue to GDP for a long period of time in Sri-Lanka. Statement of the Problem In Sri-Lanka, the percentage of income tax to the total tax revenue shows in reducing trend for a long period of time even though, wide reforms undertaken to rectify the loopholes in the tax system and tax administration. The government of Sri-Lanka could not collect sufficient amount of tax revenue as expected, since the large numbers eligible taxpayers do not comply their correct tax dues on time and running underground economic activities. The performance report of Inland Revenue Department (IRD) showed very poor performance in income tax compliance contribution from 2000 to 2012 in Sri-Lanka. The issue of tax evasion and the attitude of noncompliance is major problem to be address in this situation. Therefore this research focused to investigate in deeply to what extent the attitude of tax evasion and the tax noncompliance influences in income taxpayer. Objective of the Study The main objective of the study is to explore and analyze the factors influencing on the tax evasion and the noncompliance attitude of taxpayers in Sri-Lanka. Hypothesis: Hypothesis for this study has been developed considering tax evasion and noncompliance attitude of working communities in public and private sectors is given as follows. H 01 : There is no relationship between Job category and the of noncompliance attitude of taxpayers. H 02 : There is no relationship between Job category and the tax evasion of taxpayers. H 03 : There is no relationship between Income source and the noncompliance attitude of taxpayers. H 04 : There is no relationship between Income source and the tax evasion of taxpayers. www.apjor.com Page 85

Methodology: Data collection tool applied in this study was a set of questionnaire used by Marti et.al cited Nugi Nkwe, 2013. The structured questionnaires were distributed directly to the individuals and collected within two weeks. This questionnaire comprised five points Likert scale to evaluate demographic profile and attitudinal factors (for noncompliance;1- Very strongly disagree and 5-strongly agree and for tax evasion 1- Very strongly agree and 5-strongly disagree ). All the questions were divided into three major categories Psychological factors, economical factors, and demographic factor. A sample from various categories of employments and eligible to pay income tax were taken as sample respondents for the study. The result of the study tries to generalize how the attitude of taxpayers influences in the compliance attitude. The Chi-Square test of independence was used to test hypothesis that attributes were independent of each other and mean and standard deviation were also used to analyze the data to achieve the objective of the study. Literature review Tax evasion Tax evasion is said to occur when eligible taxpayers deliberately fail to comply with their tax obligations, which may cause serious damage to total tax revenue loss and create problems of the proper functioning of the public sector and threatening its capacity to finance its basic expenses. In economic point of view, evasion problems originate in the fact that the variables that define the tax base (incomes, sales, revenues, wealth, and so on) are often not observable. That is, an external observer cannot usually see the actual magnitude of an individual s tax base, and hence cannot know true tax liability, when it is related to cash payments and criminal activities transaction and the tax base cannot be verified at all (Luigi Alberto Franzini 1998). Sometimes this knowledge can be obtained by means of costly audits, in which case it can be verified at a cost but principle of taxation argue that tax collection cost at minimum level. Compliance Attitude There are numbers of theoretical and empirical research have been done to date but, the modern use of economic tools for the analysis of tax compliance can be credited to Allingham and Sandmo (1972). Taxpayers compliance attitude can be explained in connection with tax compliance attitude of an individual. A study conducted in Malaysia among 1073 respondents of individual taxpayers explored that four underlying factors such as tax rate, probability of being audited, perception of government expenditure and the role of tax administrators are significantly influences on the impact of tax compliance attitude Mohd Rizal Palil, Mohamed Abdul Hamed, Mohd Hizam Hanafiah(2013). Tax compliance can be influenced by many factors such as nature of public institutions, perception of fairness of the taxes, prevailing socio economic condition and chances of noncompliance being detected and punished. In economic point of view, external observer cannot see the actual magnitude of individual tax base and evasion obviously. In a situation where the taxpayers make cash payment, transaction within home or criminal activities, it is not being easy identified. The term tax compliance has been defined many researchers in various situation from many countries. A very simple definition described that the tax compliance is the taxpayers willingness to pay their taxes Kirchler (2007). In another research, the tax compliance explained that the taxpayers willingness to obey tax laws to maintain an economic equilibrium in a country Andreoni et al. (1998). Song and Yarbrough (1978) explained about tax compliance that the taxpayers ability and willingness to comply with tax laws that are determined by ethics, legal environment and other situational factors at a particular time and place. On the basis of psychological and economic point of view as an issue of reporting an actual income and further claim that tax compliance attitude is influenced by enjoying of tax evasion; or paying a penalty tax on the undeclared amount www.apjor.com Page 86

at a rate which is higher than the taxpayer would have paid had the income been fully declared within the specified time Allingham and Sandmo (1972). As similarly, several tax authorities, including the Malaysian tax authority, define tax compliance as the ability and willingness of taxpayers to comply with tax laws; declare the correct income in each year; and pay the right amount of taxes on time (Mohd Rizal Palil, Mohamed Abdul Hamed, Mohd Hizam Hanafiah(2013), cited IRS 2009; ATO 2009; IRB 2009). Alm (1991) and Jackson and Milliron (1986) define tax compliance as the submission of report regarding all incomes and payments of all taxes by considering laws, regulations and court judgments. Taxpayers Attitudes Attitude is a Psychology-based feeling of likes and dislikes for certain people, groups, situation, object and intangible ideas rather than beliefs. It relates to one s own personal positive views or negative views about a attitude or event. Theoretically, it has indicated that attitude is a partial indication of behaviour. Individual evaluates an event or object positively or negatively and positive and negative evaluation is the main dominant characteristic of an individual s attitude. In relation to taxation, taxpayers attitudes may be positive or negative views of tax compliance attitude. The outcome of positive views is tax compliance and negative views are tax non compliance. Individual attitudes varies considerably toward compliance relates to social and Cultural norms which increases overall trust in government and desirable policy instrument to complement the usual enforcement options. Some comply with the fullest extent required, irrespective of whether the tax authority is actively auditing them or their industry. Other taxpayers essentially play the audit lottery with the hope of avoiding the imposition of penalties Nugi Nkwe (2013). Data Presentation and Analysis Income Source Total Public Sectr Private sectr Source: primary data Table -1 Income Source * Job Category Cross tabulation Job Category Medica l Enginee r Lecture r Legal Adminis trative Count 13 9 15 0 11 0 Business Total within Income Source 27.1 18.8 31.2 0.0 22.9 0.0 100.0 Count 0 3 2 11 3 36 within Income Source 0.0 5.5 3.6 20.0 5.5 65.5 100.0 Count 13 12 17 11 14 36 within Income Source 12.6 11.7 16.5 10.7 13.6 35.0 100.0 48 55 103 www.apjor.com Page 87

Negative attitude Neutral attitude Positive attitude Mean SD Asia Pacific Journal of Research Vol: I. Issue XXVI, April 2015 It is obvious from the table-1 that 103 respondents from various categories of jobs in public sectors 48 and private sectors 55 were considered for the study. There were no medical professional in private sectors and no legal professional and business respondents in public sector. Perhaps, the highest numbers of respondents from business sectors 36 (65.5) contributed for the study. Table -2 Non-compliance Attitude Item code. Questions related to income tax noncompliance attitude 1. We are paying a fair share of tax 49 14 40 2.86 1.456 2. Tax laws are easy to understand to you 47 25 31 2.82 1.135 3. You are paying tax fines and penalties 64 15 24 2.29 1.362 4. Inland Revenue Department gives rewards to 73 22 08 1.90 1.053 you 5. Tax authority makes an aggressive tax 37 26 38 2.93 1.207 enforcement 6. Non-Tax payers are detected at maximum level 45 32 26 2.70 1.219 7. There is fear of tax audit and prosecution 24 37 42 3.13 1.117 8. There are tax harassments by IRD 26 33 44 3.16 1.170 9. Business profits are not reported properly 30 33 37 3.15 1.141 10. Your peer pay tax honestly 34 40 27 2.92 1.064 Source: Primary data Table -2 explained the opinion of on non-compliance attitude of 103 respondents working public and private sector with various job categories. It was noted that there were three categories of summarized opinion on non-compliance attitude of respondents given in the table. It was indicated that 73 of respondents against the statement regarding reward given by IRD with the lowest mean of 1.90 and standard deviation of 1.053. At the same time 64 of respondents were disagreed that they were paying tax fines and penalties. According to the item code -6, it was clear that 45 of respondents disagreed detection of non-taxpayers with the mean value of 2.70 and standard deviation of 1.219. Further, 47 of respondents with mean value 2.82 and standard deviation of 1.135 and 49 of respondents with mean of 2.86 and standard deviation of 1.456 represented their negative opinion of noncompliance attitude. However, 40 of respondents were uncertain about peer pay tax honestly with mean and standard deviation of 2.92 and 1.064 respectively. Further, 38 of the respondents indicated positive opinions that tax authority makes aggressive tax enforcement while 42 of respondents with mean of 3.13 with the standard deviation of 1.117 opted that there was fear of tax audit and prosecution. At the same time they agreed with mean of 3.15 that Business profits are not reported properly. All these positive statements, the respondents confirmed with mean value of 3.16 and www.apjor.com Page 88

Positive to tax evasion Neutral Negative to tax evasion Mean SD Asia Pacific Journal of Research Vol: I. Issue XXVI, April 2015 standard deviation of 1.170 that there were tax harassments by IRD. Finally it was cleared why the noncompliance trend continue in the system of taxation in Sri-Lanka. Table -3 Items related to income tax evasion Item Code Items related to income tax evasion 1. Tax evasion is ethical if tax rates are too high 52 9 39 2.85 1.587 2. Tax evasion is ethical even if tax rates are not too high 18 27 54 3.53 1.127 3. Tax evasions is ethical if the tax system is unfair 57 3 40 2.73 1.616 4. Tax evasion is ethical if large portion of money is wasted by Government 62 4 34 2.43 1.550 5. Tax evasions is ethical if everyone is doing it 27 18 54 3.45 1.227 6. Tax evasions is ethical if significant portion of the money collected wind up in the pockets of dishonest politician or their family and/ or friends 29 32 39 3.19 1.213 7. Tax evasions is ethical if probability of getting caught is low 27 22 50 3.36 1.179 8. Tax evasions is ethical if it is supported by unjust tax law 63 2 35 2.51 1.520 9. Tax evasions is ethical if you cannot afford to pay 25 4 71 3.91 1.408 Tax evasions is ethical even if you pay less while others are 10. 3.80 1.255 about to pay more 26 6 68 Source: primary data Table -3 explained the opinion of on tax evasion of 103 respondents working public and private sector with various job categories. It was noted that there were three categories of summarized opinion on tax evasion of respondents given in the table. It was indicated that 63 of respondents agreed the statement regarding Tax evasions is ethical if it is supported by unjust tax law with the lowest mean of 2.51and standard deviation of 1.520. At the same time 62 of respondents were agreed that Tax evasion is ethical if large portion of money is wasted by Government with the mean of 2.43and standard deviation of 1.550. According to the item code -3, it was clear that 57 of respondents agreed that Tax evasion is ethical if the tax system is unfair with the mean value of 2.73 and standard deviation of 1.616. Further, 52 of respondents with mean value 2.85 and standard deviation of 1.585 represented their positive opinion of tax evasion that Tax evasion is ethical if tax rates are too high. However, 32 of respondents were uncertain and 39 negative about Tax evasions is ethical if significant portion of the money collected wind up in the pockets of dishonest politician or their family and/ or friends with mean of 3.19 and standard deviation of 1.616. Further, 50 of the respondents indicated negative opinions that Tax evasions is ethical if probability of getting caught is low with the mean of 3.36and standard deviation of 1.179. At the same time the respondents www.apjor.com Page 89

disagreed 54 with mean of 3.53and the standard deviation of 1.127regarding that Tax evasion is ethical even if tax rates are not too high while 54 of respondents with mean of 3.45 and the standard deviation of 1.277 opted that Tax evasions is ethical if everyone is doing it. Interestingly, 68 of respondents with the mean of 3.81and standard deviation of 1.255 were disagreed that Tax evasions is ethical even if you pay less while the highest of 71 of respondents, with mean of 3.91and the standard deviation of 1.408 disagreed regarding Tax evasions is ethical if you cannot afford to pay. Finally it was cleared from their opinion why the tax evasion trend continued in the system of taxation in Sri-Lanka. Table-4 Overall tax system Frequency Percent Valid Percent Cumulative Percent Justifiable 53 51.5 51.5 51.5 Valid Unjustifiable 50 48.5 48.5 100.0 Total 103 100.0 100.0 Source: calculated from primary data Table -4 explained the opinion of the 103 respondents regarding overall tax system of Sri-Lanka. It was noted that 51.5 5 of respondents agreed tax system was justifiable while 48.5 of the view that tax system was unjustifiable. Although the respondents were positive to the tax system, the tax noncompliance and tax evasion continued to exist. Therefore the further test was carried out to conclude the study. Table-5 Chi-Square tests result (Pearson Chi-Square at 0.05) Non-Compliance attitude Tax evasion Item code Job category Income source Job category Income source 1 0.375 0.329 0.028 0.162 2 0.186 0.131 0.271 0.551 3 0.745 0.497 0.478 0.154 4 0.560 0.223 0.898 0.069 5 0.343 0.237 0.313 0.458 6 0.694 0.666 0.741 0.708 7 0.580 0.683 0.771 0.442 8 0.705 0.048 0.007 0.227 9 0.053 0.041 0.185 0.349 10 0.242 0.635 0.355 0.976 Source: calculated from primary data www.apjor.com Page 90

It was observed in the table 5 that Pearson Chi-Square test results. The test result for job category and source of income for income tax noncompliance behaviour and his tax evasion was given in the table. The test of all p-values for noncompliance attitude for job category showed in the column was much higher than commonly accepted level of 0.05. Therefore the null hypothesis (H 01 ) could not be rejected. It means that the observed value is not significant differ from the expected and the two variables that the job category and the noncompliance attitude of taxpayers were in dependent of each other. So, accept null hypothesis (H 01 ) that the job category influenced significantly in income tax noncompliance attitude. Further, it was observed in the same table - 5 for the test result for income source and income tax noncompliance behaviour. The test of all p-values except item code 8, and 9, showed in the column was much higher than commonly accepted level of 0.05. Therefore the null hypothesis (H 03 ) cannot be rejected except item code 8and 9. It means that the observed value is not significant differ from the expected and the two variables that the income source and the compliance attitude of taxpayers were in dependent of each other. So, accept null hypothesis (H 03 ) that the income source influences significantly in income tax noncompliance attitude. In the case of tax evasion in the same table -5 for the test result job category, the test of all p-values for tax evasion for job category Except item code 1and 8 showed in the column was much higher than commonly accepted level of 0.05. Therefore the null hypothesis (H 02 ) could not be rejected except item code 1and 8. It means that the observed value was not significant differ from the expected and the two variables that the job category and the tax evasion of taxpayers were in dependent of each other. So, accept null hypothesis (H 02 ) that the job category influenced significantly in income tax evasion. Moreover, it was identified in the same table - 5 for the test result for income source and tax evasion. The test of all p-values showed in the column was much higher than commonly accepted level of 0.05. Therefore the null hypothesis (H 04 ) cannot be rejected. It means that the observed value was not significantly differing from the expected and the two variables that the income source and the tax evasion of taxpayers were in dependent of each other. So, accept null hypothesis (H 04 ) that the income source influences significantly in tax evasion. In conclusion, the factors influencing on the tax evasion and the noncompliance attitude of taxpayers in Sri-Lanka has been elaborated to achieve the underlying objective of the study. The respondents from various categories of employees work in public sector as well as in the private sectors were independent regarding tax evasion and noncompliance attitude in most instances. Moreover, individual respondents also substantiated the same conclusion by expressing their views to achieve objective. Therefore, the government of Sri-Lanka in discussion with tax implementation authority must take necessary steps to rectify the loopholes in the tax system and tax administration to include eligible taxpayers into tax net to increase tax revenue. References: 1. Allingham, M.G. & Sandmo, A. 1972. Income tax evasion: A theoretical analysis. Journal of Public Economics 1(3-4): 323-38. 2. Alm, J. 1991. A perspective on the experimental analysis of taxpayer reporting. The Accounting Review 66(3): 577-93. 3. Andreoni, J, Erard, B. & Feinstein, J. 1998. Tax compliance. Journal of Economic Literature 36:818-60. 4. Jackson, B.R, & Milliron, V.C. 1986. Tax compliance research: Findings, problems and prospects. Journal of Accounting Literature5:12565. 5. Kirchler, E., 2007. The Economic psychology of Tax Attitude Cambridge: Cambridge University Press. www.apjor.com Page 91

6. Luigi Alberto Franzini, 1998, Tax evasion and tax compliance. University of Bologna, Italy. 7. Lumuba Omweri Marti, Migwi S. Wanjohi, Obara Magutu (2010). Taxpayers Attitudes and Tax Compliance Behaviour in KENYA. African Journal of Business & Management (AJBUMA) 8. Mohd Rizal Palil, Mohamed Abdul Hamed, Mohd Hizam Hanafiah(2013). Taxpayers Compliance attitude : Economic factor Approach, Journal of Pengurusan 38, 75-85 9. Nugi Nkwe.(2013). Tax Payers Attitude and Compliance Attitude among Small Medium Enterprises (SME) in Botswana Business and Management Horizons. 10. Roth.J., Scholz,J. and A Witte(Eds), 1989, Taxpayer ComplianceVolume1: An Agenda for Research, University of Pennsylvania Press, Philadelhpia. 11. Sri-Lanka State of the Economy-2012: Institute of Policy Studies of Sri-Lanka 12. Song, Y. D. & Yarbrough, T.E. 1978. Tax ethics and Taxpayer attitudes: A survey. Public Administration Review 38(5): 442-452. www.apjor.com Page 92