BY DR JEYAPALAN KASIPILLLAI COMPLIANCE costs are expenses incurred by taxpayers in meeting the requirements laid on them by law. These are costs over and above the actual payment of tax.

Compliance costs are incurred not only by taxpayers but also by those who are required to collect the tax from them on behalf of the Inland Revenue Board (IRB).

For example, in Malaysia, employers are required under the Scheduler Tax Deduction (STD) scheme to deduct tax from their employees’ salaries on behalf of the IRB.

Broadly speaking, compliance costs include those associated with tax planning (making decisions to get the best deal, for example deciding where to build a factory); compliance (record-keeping, training, form preparation and filing); and litigation (resolving disputes with the IRB in court).

Compliance costs in Malaysia should be viewed in the context of the Self-Assessment System (SAS), which was introduced to corporations in 2001. It was extended to other taxpayers, including individuals, partnerships and trust bodies in 2004.

The SAS requires taxpayers to compute and settle their own income tax. It is a new system whereby taxpayers are given the responsibility to compute their own tax liability.

Based on their own computation, taxpayers are expected to forward their tax payments to the IRB. An advantage of the SAS is that by allowing the taxpayers to ascertain their tax liability, they will be encouraged to manage their tax affairs better.

Under SAS, the brunt of compliance costs falls on individual taxpayers and small businesses. The average compliance costs of lower income taxpayers, as a percentage of income, takes a larger toll than on higher income taxpayers.

A survey jointly undertaken by the author and other researchers in 2001 found that small and medium enterprises (SMEs) shoulder four times proportionally more compliance costs compared with larger companies that are listed on Bursa Malaysia.

In the US, small corporations (those with less than US$1mil in assets) spent at least 27 times more on compliance as a percentage of assets than the larger corporations (those with US$10bil or more assets).

The importance of SMEs to Malaysia’s economic development should not be underestimated. Available data indicate SMEs accounted for 94% of companies in the manufacturing sector. They contribute 27% of total manufacturing output, own 28% of fixed assets and employ 39% of the country’s workforce.

In addition, the value-added products from SMEs are expected to be worth RM120bil, or 50%, of total production in the manufacturing sector by 2020.

From a financial viewpoint, compliance costs affect the economy negatively. This is because compliance costs increase overheads and the cost of doing business.

There are also opportunity costs that are more difficult to quantify. For example, an hour spent complying with tax laws could have been spent tending to the business, thus adding value to the economy.

There is a direct relationship between complexity of the tax system and the amount of compliance costs incurred by taxpayers. Any increase in the complexity of the tax system will escalate the compliance costs for taxpayers. A related problem is that a complex tax system is fertile ground for tax evasion.

Rising complexity in the tax system also leads to burdensome administrative costs. The benefits of lowering the tax complexity burden would dramatically benefit small businesses since they currently bear a disproportionate amount of the burden.

Researchers have generally identified three different aspects of tax simplification: compliance simplicity, transactional simplicity and simplicity of rules.

Compliance simplicity relates to activities such as record keeping and filling tax forms while transactional simplicity means that financial transactions need not be structured to minimise taxes. Simplicity of rules reflects the ease with which tax laws can be understood.

Compliance costs fall heavily on SMEs, which comprise more than 20,000 establishments in the manufacturing sector and 192,000 in services. Since they are considered the driving force of the economy, it is timely for the Government to formulate policies that seek to simplify the tax systems.

Presently, SMEs with a paid-up capital of RM2.5mil or less enjoy a preferential corporate tax rate of 20% for the first RM500,000 of their taxable profits.

The Government should expand this incentive by subjecting the total taxable profits of SMEs to the preferential rate. In fact, it would be encouraging if the preferential rate were lowered further to 18% as it is in Singapore.

These initiatives will not only boost the economy but also allow SMEs to mitigate their compliance costs and further spur the growth and dynamism of small businesses in Malaysia.