bcom project[1]

7/31/2019 Bcom Project[1]

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ANALYSIS OF THE IMPACTS OF TURNOVER TAX COLLECTION

METHODS ON IMPROVED TAX COMPLIANCE

A CASE STUDY OF MSMEs IN EMBU COUNTY

MUTO VICTOR MURIITHI

(HD231-037-0012/2009)

RESEARCH PROJECT SUBMITTED IN PARTIAL FULFILLMENT OF THE

REQUIREMENTS FOR THE AWARD OF DEGREE OF BACHELOR OF

COMMERCE (ACCOUNTING OPTION), DEPARTMENT OF COMMERCE

AND ECONOMIC STUDIES, SCHOOL OF HUMAN RESOURCE AND

DEVELOPMENT, JOMO KENYATTA UNIVERSITY OF AGRICULTURE

AND TECHNOLOGY

AUGUST, 2011


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DEDICATION

This is my original and has not been presented for any of the study programs in

any other university.

Signature: ________________________ Date: ______________________

Name: Victor M. Muto

HD231-037-0012/2009

This proposal has been submitted for examination with my approval as the

university supervisor.

Sign: __________________________

Mr. G. G. Kamau


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DEDICATION

I want to dedicate this piece of work to my parents, Mr. & Mrs. Ngondi, my

siblings, Martin, Kevin and Diana for their unending support, my best friend

Yvvn for her encouragement during preparation of this document and to Mr. D.

Nyaga for the inspiration.


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ACKNOWLEDGEMENT

Foremost, I want to thank the Almighty God for the providence of strength and

good health that has enabled me to complete this proposal successfully.

I thank my university supervisor, Mr. G. G. Kamau for his unending sacrifice

and dedication of time to guide me and to ensure that I was intellectually

instinct.

Special thanks to my parents, Mr. & Mrs. Ngondi who have provided financial,

physical and moral support, and to my siblings, Martin, Kevin and Diana for

their cooperation.

I also extend my appreciation to Mr. D. Nyaga who inspired me to write this

project proposal and for his steadfast support.

I thank my best friend, Yvvn for her daily encouragement and also show my

gratitude to members of Eagles Club, Embu College Campus, Ian, Davie,

Esther, Elijah and Joy for their support.


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ABSTRACT

The main objective of this research was to analyze the impacts of turnover tax

collection methods on improved tax compliance. Turnover tax is a new tax

regime that came into effect on 1st January 2008 after introduction through the

Finance Act 2007. This study set out to verify how true that statement is.

Technology, simplicity of tax collection methods and tax penalties were the

factors that were used to carry out this research and their impact on turnover tax

collection methods thus influencing improved tax compliance.

The research study was carried out in Embu County targeting all micro, small

and medium enterprises (MSMEs). The sample population included 40

businesses in Embu County (Embu East, North and West Districts). The research

design used is descriptive design with instrumentation of questionnaires;

sampling design used is simple random sampling.

The research data collected from the enterprises of study is analyzed and

presented in tables and informational charts and discussed in details. From the

research carried out, it was observed that the turnover collection methods have

an influence on improved tax compliance.


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TABLE OF CONTENTS

Declarationi

Dedication.ii

Acknowledgment..iii

Abstract.iv

List of Tablesvii

List of figuresviii

Acronyms....ix

CHAPTER 1:

INTRODUCTION1

1.1.Background of the study.1

1.2.Statement of the problem........8

1.3.Objectives of the study........9

1.4.Research questions..9

1.5.Justification.10

1.6.Scope...11

1.7.Limitations of the study..11

CHAPTER 2: LITERATURE

REVIEW12

2.1.Introduction......12

2.2. TheoreticalReview..14

2.3. Critique of the existing literature relevant to the study34

2.4. Summary andGaps..35


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2.5. ConceptualFramework36

CHAPTER 3:

METHODOLOGY...41

3.0.Introduction..41

3.1 ResearchDesign41

3.2 TargetPopulation..41

3.3 SamplingFrame42

3.4 Sample & Sampling Technique42

3.5Instruments42

3.6 Data collectionprocedure.............................42

3.7 Data processing and analysis42

CHAPTER 4: RESEARCH FINDINGS &

DISCUSSION...43

4.1.Introduction..............................43

4.2. ResponseRate..43

4.3. Registration ofbusiness...43

4.4. Quantitative DataAnalysis..44

4.5. Qualitative Analysis55

CHAPTER 5: SUMMARY, CONCLUSIONS AND

RECOMMENDATIONS

5.1.Introduction..56


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5.2.Summary..56

5.3.Conclusions..58

5.4.Recommendations59

APPENDIX 1:

REFERENCES60

APPENDIX 2:

APPENDICES.63


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LIST OF TABLES

Table 4.1: Registration ofbusiness.44

Table 4.2: Age ofbusiness..45

Table 4.3:Ownership..46

Table 4.4: Annualsales..46

Table 4.5: TaxRegime47

Table 4.6: Identification of simplification procedures related toTOT..48

Table 4.7: Use oftechnology.48

Table 4.8: Integration of technological equipment inbusiness.49

Table 4.9: Filing of returns49

Table 4.10: KRA onlineservices..50

Table 4.11: Convenience ofETR......................................................................50

Table 4.12: Do you know when youre supposed to file your tax returns51

Table 4.13: How often do you file returns ontime...52

Table 4.14: TaxProcedures...52

Table 4.15: Which tax procedures have contributed to your timely filing ofreturns.53

Table 4.16: Simplification of taxprocedures.53

Table 4.17: Are you aware of the penalties charged under the Kenya TaxLaws..54


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Table 4.18: Have you ever been penalized for late submission ofreturns.55

Table 4.19: Stringency ofpenalties.55

Table 4.20: Influence of penalties on early submission ofreturns.55

Table 4.21: Effectiveness of taxpenalties..........................................................56


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LIST OF FIGURES

Figure 2.1: Data from investment climatesurveys.26

Figure 2.2: Conceptualframework.36

Figure 4.1: Annualsales.46

Figure 4.2: Convenience of ETR50

Figure 4.3: Simplification of taxprocedures..53


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CHAPTER ONE

1.0 INTRODUCTION

This chapter consists of the background of the study, the statement of the

problem, the objective of the study, the research questions, the significance of

the study, scope of the study, and limitations of the study.

1.1 Background of the study

Taxes are considered a problem by everyone. Not surprisingly, taxation

problems date back to earliest recorded history.

1.1.1 TAX HISTORY CHRONOLOGY

EGYPT

During the various reins of the Egyptian Pharaohs tax collectors were known as

scribes. During one period the scribes imposed a tax on cooking oil. To insure

that citizens were not avoiding the cooking oil tax scribes would audit

households to insure that appropriate amounts of cooking oil were consumed and

that citizens were not using leavings generated by other cooking processes as a

substitute for the taxed oil.

GREECE

In times of war the Athenians imposed a tax referred to as eisphora. No one

was exempt from the tax which was used to pay for special wartime

expenditures. The Greeks are one of the few societies that were able to rescind


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the tax once the emergency was over. When additional resources were gained

by the war effort the resources were used to refund the tax. Athenians imposed a

monthly poll tax on foreigners, people who did not have both an Athenian

Mother and Father, of one drachma for men and a half drachma for women. The

tax was referred to as metoikion

ROMAN EMPIRE

The earliest taxes in Rome were customs duties on imports and exports called

portoria.Caesar Augustus was considered by many to be the most brilliant tax

strategist of the Roman Empire. During his reign as "First Citizen" the publican

were virtually eliminated as tax collectors for the central government. During

this period cities were given the responsibility for collecting taxes. Caesar

Augustus instituted an inheritance tax to provide retirement funds for the

military. The tax was 5 percent on all inheritances except gifts to children and

spouses. The English and Dutch referred to the inheritance tax of Augustus in

developing their own inheritance taxes. During the time of Julius Caesar a 1%

sales tax was imposed. During the time of Caesar Augustus the sales tax was 4

percent for slaves and 1 percent for everything else.

Saint Matthew was a publican (tax collector) from Capernaum during Caesar

Augustus reign. He was not of the old publican but hired by the local

government to collect taxes. In 60 A.D. Boadicea, queen of East Anglia led a

revolt that can be attributed to corrupt tax collectors in the British Isles. Her

revolt allegedly killed all Roman soldiers within 100 miles; seized London; and

it is said that over 80,000 people were killed during the revolt. The Queen was


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able to raise an army of 230,000. The revolt was crushed by Emperor Nero and

resulted in the appointment of new administrators for the British Isles.

GREAT BRITAIN

The first tax assessed in England was during occupation by the Roman Empire.

Lady Godiva

Lady Godiva was an Anglo-Saxon woman who lived in England during the 11th

century. According to legend, Lady Godiva's husband Leofric, Earl of Mercia,

promised to reduce the high taxes he levied on the residents of Coventry when

she agreed to ride naked through the streets of the town. When Rome fell, the

Saxon kings imposed taxes, referred to asDanegeld, on land and property. The

kings also imposed substantial customs duties.

The 100 years War (the conflict between England and France) began in 1337 and

ended in 1453. One of the key factors that renewed fighting in 1369 was the

rebellion of the nobles of Aquitaine over the oppressive tax policies of Edward,

The Black Prince. Taxes during 14th century were very progressive; The 1377

Poll tax noted that the tax on the Duke of Lancaster was 520 times the tax on the

common peasant.

Under the earliest taxing schemes an income tax was imposed on the wealthy,

office holders, and the clergy. A tax on movable property was imposed on

merchants. The poor paid little or no taxes. Charles I was ultimately charged

with treason and beheaded. However, his problems with Parliament came about

because of a disagreement in 1629 about the rights of taxation afforded the King

and the rights of taxation afforded the Parliament. The King's Writ stated that


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individuals should be taxed according to status and means. Hence the idea of a

progressive tax on those with the ability to pay was developed very early.

Other prominent taxes imposed during this period were taxes on land and

various excise taxes. To pay for the army commanded by Oliver Cromwell,

Parliament, in 1643, imposed excise taxes on essential commodities (grain, meat,

etc.). The taxes imposed by Parliament extracted even more funds than taxes

imposed by Charles I, especially from the poor. The excise tax was very

regressive, increasing the tax on the poor so much that the Smithfield riots

occurred in 1647. The riots occurred because the new taxes lowered rural

laborers ability to buy wheat to the point where a family of four would starve. In

addition to the excise tax, the common lands used for hunting by the peasant

class were enclosed and peasant hunting was banned (hooray for Robin Hood).

A precursor to the modern income tax we know today was invented by the

British in 1800 to finance their engagement in the war with Napoleon. The tax

was repealed in 1816 and opponents of the tax, who thought it should only be

used to finance wars, wanted all records of the tax destroyed along with its

repeal. Records were publicly burned by the Chancellor of the Exchequer but

copies were retained in the basement of the tax court.

COLONIAL AMERICA

Colonists were paying taxes under the Molasses Act which was modified in

1764 to include import duties on foreign molasses, sugar, wine and other

commodities. The new act was known as the Sugar Act. Because the Sugar Act

did not raise substantial revenue amounts, the Stamp Act was added in 1765. The


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Stamp Act imposed a direct tax on all newspapers printed in the colonies and

most commercial and legal documents.

1.1.2 Tax in Kenya

Turnover tax (TOT) was introduced in Kenya under Finance Act 2006 and was

supposed to be effective from 1st January 2007. The law was found to be

defective and it was reintroduced through Finance Act 2007 with effect from 1st

January 2008. TOT is an indirect tax chargeable at the rate of 3% of a businesss

total sales or tax on turnover. It targets businesses with turnover between

Kshs.500, 000 and Kshs.5, 000, 000 annually. For TOT purposes business

include any trade, profession or vocation, and every manufacturer, adventure and

concern in the nature of nature, but does not include:

i. Employment income

ii. Exempt incomes under the First Schedule of the Income Tax Act cap 470

iii. Business incomes subject to final withholding tax i.e. bank interest,

dividends, income earned from government bonds and treasury bills and

payments made to non-residents

iv. Persons in receipt of business incomes but with annual turnover below

Kshs.500, 000

v. Limited companies

vi. Rental income

vii. Professional management fees


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The tax period is three (3) calendar months starting from 1st January every year,

and is payable on or before 20th of the month following the end of the tax period.

Returns are to be filled every quarter. A person may elect to be exempt from

provisions of Sec 12 C which means that the taxpayer has an option to either

register under TOT or continue to follow the current system.

TOT payers must deregister if annual turnover exceeds Kshs.5, 000, 000 or if a

companys profits run down below Kshs.500, 000, they can write to the

Commissioner General upon the scrutiny of their books of account to be

removed from remitting the TOT.

Business owners who subscribe to pay the turnover tax will qualify for

exemption from the income tax brackets and be eligible for VAT cuts. The

business owners will be required to keep proper records of their business

transactions so as to show that they fall in the tax bracket. These include

cashbooks, sales/purchases receipts and invoices, ETR receipts where available

and bank statements. According to the regulations, turnover tax returns shall be

submitted quarterly using pay-in-slip.

About 75% of the non-designated firms either file nil tax returns or do not file

tax returns at all. The large proportion of micro and small non-designated

businesses that are registered for VAT increases tax administration costs yet

their contribution to the total revenue is very low. According to the current

international practice, micro and small enterprises are accorded special tax

treatment in the bid to enhance tax compliance. This is attributed to their

inability to maintain books of accounts for their transaction and complexities that


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are inherent in the regular tax regimes. A special tax regime that is based on

turnover is usually designed for such firms.

In Kenya, most of the micro and small traders either keep incomplete business

records or do not keep any record at all. This is attributed to low levels of

education attained by majority of the traders. To enhance their tax compliance,

there is need to isolate the micro and small traders from the current tax regime in

accordance with international best practice.

In view of the prevailing scenario, it was decided that the VAT threshold be

raised from the previous threshold of Kshs.3m to Kshs.5m such that 85% of the

non-designated business whose turnover fall below Kshs.5m of the new

threshold be subjected to turnover-based tax regime at 3% of the gross sales

turnover per annum without considering any overhead expenses. The objective

of introducing turnover tax in Kenya was geared towards bringing the informal

sector into the net and to simplify processes for the small and micro-enterprises

by:

i. Simplifying tax procedures

ii. Simplifying tax computations

iii. Simplifying record keeping

The expected outcomes is to make return filing easier and reduce their cost of

compliance since record keeping will be minimized and costs of hiring tax

agents eliminated.

1.2 Statement of the problem


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The Government was finding it hard to meet its services with the revenue being

collected. Many projects could not be completed because the Treasury had no

additional funds to give. Each ministry was scrambling for the little that was

there with the Treasury. In view of the problem, the Government found it wise to

widen the tax base by introducing turnover tax (TOT) to get more revenue to run

the services. The tax system has been very effective because of high penalties,

ease of collection methods and the use of technology.

This paper therefore aims to analyze the impacts of turnover tax collection

methods on improved tax compliance.

1.3 Objectives of the Study

1.3.1 General Objective

To analyze the impacts turnover tax collection methods on improved tax

compliance.

1.3.2 Specific Objectives

1. To investigate how high penalties on tax default influences turnover tax

good performance.

2. To establish that the simplicity of the collection methods used influence

turnover tax good performance.

3. To examine how the use of information technology in tax collection

influence turnover tax good performance.


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1.4 Research Questions

1. Does high penalties imposed on tax default influence turnover tax good

performance?

2. Does the simplicity of the collection methods used influence turnover tax

good performance?

3. Does the use of information technology in tax collection influence

turnover tax good performance?

1.5 Justification

Against the background stated in the problem statement, Kenya introduced TOT

regime through the Finance Act 2007 and became effective from 1 st January,

2008. The empirical results of this study are expected to inform about the

usefulness challenges and limits of TOT in Kenya. The study will prove

important to a number of stakeholders:-

i. Tax authority-This study will identify some tax administrative factors

that need attention of the tax authorities and officers for correction as

literature on countries that have implemented simplified tax regimes for

small and medium enterprises indicate that they have experienced

problems with tax avoidance and fraud schemes used by large

businesses.

ii. Tax payers-Tax payers would wish to have a tax system that is certain,

convenient, simple, fair and economical. This study will reveal whether

this is being achieved in the administration of TOT in Kenya.


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iii. Consultants-This study will be bring out a deeper understanding of TOT

administration and highlight the key problems faced by the tax payers

and KRA. The study will therefore help tax consultants to solve tax

payers problems and come up with better tax policies.

iv. Academicians-The study will offer an extension of knowledge of the tax

system in Kenya and reach conclusions that will be valuable in

understanding the key factors considered or to be considered by policy

makers in their endeavor to achieve sustainable economic growth and

development. It will also provide a basis for further research.

1.6 Scope

The scope of this study was limited to micro, small and medium enterprises

(MSMEs) in Embu County (Embu East and Embu West Districts). The

researcher focused in all businesses that are within the Kshs.500, 000 and

Kshs.5, 000, 000 ranges (turnover tax bracket). The research was carried out

from June 2011 to October 2011.

1.7 Limitations of the Study

The study was conducted in small and medium enterprises in Embu County and

the following were the limitations:

i. Uncooperative respondents-some respondents were unwilling to fill the

questionnaires while others left some questions blank. Others failed to

hand in back the questionnaires to the researcher.

ii. Confidentiality-some respondents feared to give some confidential and

useful information of their institutions.


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CHAPTER TWO

2.0 LITERATURE REVIEW

2.1 Introduction

There are many ways to tax individuals and corporations. Taxes may be levied

on consumption (such as the VAT, sales or excise taxes), flows of income (such

as enterprise and individual income taxes), or wealth and assets (such as property

taxes, assets taxes and some income taxes). In fact, the tax systems of most

countries are a combination of these different types of taxation. Developed tax

systems tend to tax income according to relatively complex structures which

utilize sophisticated accounting, record keeping, and tax administration in order

to balance various goals of the tax system including equity and efficiency.

Consumption taxation in more developed systems consists of excise taxes, value-

added taxes and sales taxes, with varying degrees of complexity. In all countries,

some enterprises and individuals remain outside of the tax system through the

use of different types of evasion or avoidance mechanisms.

In many cases, it is easier for individual taxpayers and small enterprises (versus

large corporations) to remain outside of the tax net for the simple reason that

they can remain inconspicuous to the tax administration. For these types of

entities, complicated and administratively burdensome tax systems further

discourage compliance with the tax laws. Tax administrations are often left with

the choice of going after large firms where the potential tax revenue pay-back

is higher or going after less lucrative small taxpayers/ additionally, complicated

tax systems make it difficult and expensive for start-up firms (particularly small

enterprises) to act in good faith in terms of tax compliance due to the costs


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associated with record keeping and the need for specialized information to

comply with complex tax laws.

At the same time, large and small taxpayers find it beneficial to take advantage

of loopholes in the tax system in order to minimize their tax payments. These

factors, tax avoidance, tax evasion, and the expense and difficulty for start-up

enterprises to comply with complex tax laws, have led many countries to adopt

specific tax regimes to counter these problems. In many countries, imputed or

presumptive taxation has traditionally been used as a way to get some tax

revenue from these taxpayers who might otherwise go completely untaxed.

These systems calculate the tax base via easy-to-obtain indicators or other

methods, instead of relying on taxpayer self-assessment. This method of taxation

can accomplish tow things; it can reduce the cost of compliance by the taxpayer

as the tax base is easier to calculate than that of the income or corporate tax, and,

once the system is determined, it reduces the cost of tax administration. Once

part of the simplified system, it theoretically becomes more difficult to

disappear from the view of the tax administrators by going to the shadow or

underground economy.

Imputed/presumptive taxation is therefore often regarded as a stepping-stone to

the regular tax system, such that a taxpayer would be subject to this simplified

regime for a limited period of time and then become part of the regular tax

system. It is against this background that turnover tax which is a type of

presumptive tax was introduced in Kenya.


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2.2 Theoretical Review

2.2.1 Technology

Technology is the making, usage, and knowledge oftools, machines,

techniques, crafts, systems or methods of organization in order to solve a

problem or perform a specific function. It can also refer to the collection of such

tools and machinery. Technology has influenced the way we work, play, and

interact with others. It is not surprising that technology has also affected how tax

systems are designed and administered in developing countries. These changes

have not always been for the better. In a pioneering study of tax administration

in developing countries, Radian (1980) noted that the three decades since World

War II had seen a number of cycles of ineffective reform, including

computerization. Many countries shared the experiences of Trinidad, in which

the Commissioner of Internal Revenue said that "since 1969 we have not

produced any meaningful statistical data. In that year, we transferred our returns,

processing and accounting work onto a computer Radian (1980, 217).

Technological change continues. Most countries have now moved from rooms

full of clerks posting entries by hand in large ledger books-or, as we observed in

one country as late as the early 1990s, writing in pencil on little pieces of paper-

to widespread use of computers to administer their tax systems. The transition

from hand to mouse has been incomplete and uneven. Major differences exist

among and within developing countries, both with respect to how their tax

systems are designed and administered, and, more generally, with respect to how

technological advances have changed the manner in which their economies

operate.
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Roller and Waverman (2001) demonstrate that the introduction of mobile

telephones has enabled developing countries to bypass the heavy infrastructure

development of land-based telephone systems, and has facilitated market

integration and more rapid economic development. Does the use of technology

in the tax systems of developing countries mark a similar opportunity for

developing countries to improve tax administration and design? Ideally, to

answer this question one needs to consider the costs and benefits of different

types of technological changes for administrators, taxpayers, and third parties

involved in the taxing process in countries at different levels of development.

We cannot undertake this major task here; instead, we present an overview and

selective survey of many of the issues raised by how technology influences tax

administration and design. Technology is definitely not a "magic bullet" to solve

the manifold problems of development taxation. It may, however, provide part of

the answer for many countries.

Experience in Kenya and elsewhere demonstrates that the successful

introduction of new technologies requires consideration of the susceptibilities of

existing staff and their resistance to change Peterson (1996). Indeed all those in a

position to affect how well any new IT system can function must work together.

As a complex system is more likely to engender resistance and problems, the

design, structure, and operations of the system should be as simple as possible.

In some situations it may even be advantageous to entrust part of the

responsibility for setting up an information system to organizations outside the

tax administration, or even outside the government.
http://encyclopedia2.thefreedictionary.com/magic+bullethttp://encyclopedia2.thefreedictionary.com/magic+bullet


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The availability, cost, and accessibility of computers make them ideal for the

large--scale information-processing and coordination problems facing tax

administrations in even the poorest countries. Among the areas that may be

computerized are: (1) taxpayer records and tax collection (taxpayer compliance);

(2) internal management and control over resources; (3) legal structure and

procedures; and (4) systems to lower taxpayer compliance costs.

i. Tracking Taxpayers

Almost all tax systems use a taxpayer identification number (TIN) to track

taxpayers. In every country that has successfully adopted improved technology

for tax administration, allotting a unique identification number has been a

necessary requirement. Without such a number, information can neither be

stored properly nor used effectively. Countries may use a number unique to the

tax system or one linked to other government activities. Several countries have

begun issuing "smart" ID cards to citizens that contain TINs as well as other

information.

Improvements in technology allow governments to coordinate the numbers

assigned with respect to various government services and financial services to

TINs issued by taxing authorities. The coordination will make it more difficult

for those without TINs to access government services to obtain passports or

driver's licenses, register cars, transfer and register property, or use public

schools or hospitals. TINs could also be required to open bank accounts,

purchase airline tickets over certain dollar amount, or gain access to electrical,
http://encyclopedia.thefreedictionary.com/Financial+serviceshttp://encyclopedia.thefreedictionary.com/Financial+services


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gas or water services--thus increasing the costs of operating outside the tax

system.

ii. Information Reporting and Withholding

An important task of tax administration is to bring together information from

different sources, both within the administration and from other relevant

government and private sources, in order to verify the information supplied by

taxpayers themselves. Tax laws in most countries already require various private

and public agencies to furnish information regarding various transactions and

activities to the tax authorities. In some but not all cases, those agencies are also

supposed to withhold a part of the payment made by the agent to the potential

taxpayer. Withholding, thus, serves the two-fold purpose of helping to identify

potential taxpayers and ensuring that at least a part of the tax is realized at

source, thereby minimizing risk as well as delay in payment. Neither internal nor

external sources of information are of any use in the absence of an efficient

system of monitoring, or of adequate IT infrastructure to collateand store data

with easy access for retrieval and cross-checking. A reliable single, centrally

maintained register of taxpayers, each with a unique TIN, is, therefore, essential.

Withholding in developing countries could cover not only traditional items, such

as wages, interest, and dividends, but also professional fees, payments to

independent contractors, rents, and (in some instances) a wide range of business

transactions. Some countries have even introduced what may be called "reverse

withholding" in which purchasers (government agencies or large enterprises)
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withhold tax from sellers (small enterprises). Such widespread withholding is not

a panacea Soos (1990). It makes its own information demands as the tax

administration must be able to control withholders to make sure they hand over

to the Treasury the amounts withheld, and it must also be able to check whether

amounts that taxpayers credit against their liabilities have in fact been withheld.

But it can still be very useful, particularly with respect to imposing some taxes

on the informal activities.

From an administrative perspective, most taxes collected in developing countries

come from a relatively small number of tax collecting agents. Accurate tracking

of fiscal flows through such large entities, which probably account for 80 percent

or more of current collections in many countries, is critical to successful tax

administration. Before devoting much effort to this difficult task, however, it is

critical to ensure that tight control is maintained over the payments and liabilities

of large taxpayers. One way to do so, commonly recommended by experts, is to

set up a "large taxpayer unit" (LTU) to monitor closely the non-filing, stop-

filing, and compliance behavior of such taxpayers Baer, Benon, and Toro (2002).

In some developing countries, experience in computerizing the information

flowing through and to such LTUs has proven to be a useful testing ground for

developing systems that can be later extended to the whole taxpaying population.

iii. Processing Returns and Payments

One of the first uses of IT was to process tax returns and payments. Partly

because banks had more adequate data processing systems than tax

administrations, several Latin American countries initially outsourced the receipt
http://acronyms.thefreedictionary.com/LTUhttp://www.thefreedictionary.com/testing+groundhttp://acronyms.thefreedictionary.com/LTUhttp://www.thefreedictionary.com/testing+ground


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and processing of tax returns and payments to the banking systems. More

recently, even countries like Panama and Paraguay have adopted electronic

filing, which has facilitated return processing. Since 2001, Chile, likely the most

advanced tax administration inLatin America, has supplied most wage-earners

and pensioners with "pre-populated returns" that contain taxpayer identifying

information, details on gross income received from various sources, tax

withheld, information on certain deduction items, a calculation of the tax

assessed, any credits, and the tax payable or refundable (OECD, 2006).

iv. Auditing Tax Payers

Auditing is a necessary element of good tax administration. If information

matching or cross-checking fails to identify underpayment of tax, then auditing

is the only way to uncover intentional noncompliance. Typically, auditing means

the examination of filed returns by tax authorities to determine the correctness of

self-assessed taxes. The authorities may also use audits as the basis for statistical

studies of taxpayer characteristics to be used in developingpresumptive

indicators--a prominent feature of taxation in many developing countries Bird

and Wallace (2004). The success of auditing and the feasibility of various

auditing strategies depend on the quality of the information available to the

auditor, which in turn depends on three factors: the information gathered from

the taxpayer and third parties, the information processing

capacity of auditors, and the strategy pursued. As more advanced IT systems

improve the first two factors, the authorities have a greater range of auditing

strategies.
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Technological advances will alter the economic environment in which

governments seek to collect tax revenue. These advances will make some

persons or transactions easier to tax. Particularly in developing countries, use of

various methods of electronic payments will move more transactions from the

informal to the formal economy. As discussed earlier, technology will also

provide tax administrators with more tools to track the movements of goods and

individuals. It should also increase opportunities and reduce costs of cooperating

with tax administrators in other countries to improve tax compliance of persons

with investments and activities outside the country. But technology will also

make some persons or transactions harder to tax.

For example, it is currently much harder for tax authorities to track goods in

digitized form than those that are physically transported across or between

countries. Foreign lawyers, accountants, and management consultants can

provide services with little or no physical presence in a country. Advances in the

financial service industry allow domestic investors access to foreign banks and

securities with simple internet access. The globalization of financial markets has

made it harder for any one country to tax income from mobile capital.

Technology may also influence incentives of governmental officials in the

design and administration of tax systems. Hettich and Winer (1999) set out a

model in which changes in administrative costs may affect both the size of the

public sector and the choice of tax structure. Costs may change because of
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changes in administrative technology like those we have just discussed or they

may change because technology has changed the nature of the economy.

Electronic Tax Register

A lot of debate has been going on in the country between business owners and

the Kenya Revenue Authority (KRA) on the adoption of Electronic Tax

Registers. Electronic Tax Registers were introduced by KRA to replace the

manual paper system of remitting VAT returns that was considered inefficient

and straining. To enhance the accountability systems for Value Added Tax, the

Kenya Revenue Authority (KRA) has spearheaded the introduction of the

Electronic Tax Registers and Electronic Signature Devices. These devices offer

unique benefits to traders and the Revenue Authority alike by recording

transaction data in such a manner that it cannot be deleted. The Government of

Kenya on the other hand allowed businesses to offset the cost of the ETR

installation against the input VAT as well as training of traders on the use and

benefits of those devices, Lumumba Omweri Martin (2010).

Electronic Cash Register is a device used by traders to record sales and issue

receipts. It also stores information such as sales, stocks, and can also issue

reports e.g. daily sales. Electronic Tax Register (ETR) is a Cash Register but

with Fiscal Memory. Fiscal Memory is a special Read Only Memory built into

the cash register to store tax information at the time of sale. ETR can be used as

stand alone or configured into a network. ETR has special security features e.g.

seal, memory, serial no., special technical specifications etc.


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Taxpayers using electronic tax register or tax printer shall: [Public Notice 49

(2004)]

i. Perform the registration of each sales occurrence with the use of the

electronic tax register or tax printer and perform a printout of a fiscal

receipt from each occurrence of sales and to deliver the original of the

receipt to the purchaser.

ii. Prepare the daily report at the end of sales for a given day, not later than

before the performance of the first sales on the following day, prepare the

monthly fiscal report after finishing the sales on the last day of the

month, and prepare the annual report as indicated in Public Notice No.

48

iii. Register the sales with the use of the substitute tax register.

iv. Verify the correctness of the electronic tax register or tax printer

operations, taking particular care with reference to the correct

programming of the names of goods and services and their appropriate

allocation to tax rates and to prompt reporting of each malfunctioning in

the electronic tax register operations.

v. Upon each request of the control authorities, make the electronic tax

register available for the control with respect to its being intact and the

correctness of its operations.

vi. Perform every six month the obligatory technical inspection of the

electronic tax register by an appropriate service point.

vii. Perform the printout of all documents issued by the electronic tax register

and their copies.

viii. Store the copies of tax register reports within five years.


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ix. Use the electronic tax registers only to record their own sales, without the

right for their use by any third parties.

x. Report the cash register at the appropriate tax office within 7 days from

the date of its fiscalisation to obtain the tax register record number.

xi. Permanently affix the electronic tax register record identification

number, on its casing.

xii. Record entries in the fiscal cash register.s ledger performed by the

taxpayer.

xiii. Store the tax register ledger in the place and within the period of its use

and make it available upon the request of appropriate authorities and the

service staff.

xiv. Present the loss of cash registers for technical inspection before their

repeated usage by the taxpayer for the maintenance of the records.

2.2.2 Simplicity of collection methods

Simplicity is an important attribute for a tax system and there have been many

attempts at simplification in different countries. However these attempts have

not been very successful. The main reason is that there are, of course, important

factors that cause tax systems to be complex and not all of them are bad. Another

important matter is that it is not always clear what is meant by tax simplification.

A further difficulty has been that attempts at simplification have often been made

on an ad hoc basis and, once the enthusiasm has exhausted itself, the trend

towards greater complexity continues.

The goals of most tax reforms have been to raise more revenue for government,

achieve various economic and social goals, and improve the efficiency of the tax


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collection process. However, tax reforms in general have paid little attention to

improving the tax system to make it easy for businesses and entrepreneurs to

comply. This is especially true in developing countries. The cost of compliance

with the tax system for business is not trivial; it constitutes a significant fraction

of the actual tax owed. Some of these costs are indirect in nature and as a result

tend to be underestimated. However, investment climate assessments (ICA) and

tax cost of compliance surveys of the World Bank have revealed the magnitude

of these costs.

In the World Banks ICA surveys, tax rates were identified as a major constraint

by 37 percent of businesses overall; 27 percent specifically identified the tax

administration as a major constraint. Figure 2.1 shows that tax rates and

administration are two of the top six constraints identified by businesses in

nations outside the Organisation for Economic Co-operation and Development

(OECD). Cost-of-compliance and doing business surveys collect information on

the time that businesses spend and the costs they incur to comply with their tax

liabilities. According to the Doing Business 2010 report, businesses spend an

average of 275 hours on 30 different tax payments per year. These numbers are

corroborated by Foreign Investment Advisory Service (FIAS) cost-of-

compliance surveys, which have found that a typical medium-size business in

the Ukraine spends about 2,400 hours per year complying with tax liabilities;

essentially, this implies hiring a fulltime accountant dedicated entirely to tax

work. The time that businesses spend complying with taxes would be better

spent performing the primary task of conducting the business.


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Figure 2.1: Data from investment climate surveys

Tax simplification improves compliance and reduces the cost of tax collection.

Simplifying a tax system also involves streamlining its administration, reducing

redundancies and points of contact, and improving the efficiency of existing

procedures. Improved procedures and processes (such as the use of automation

and risk-based audits, reduced discretion, and so on) also reduce the costs of

administering the tax system. Improved compliance-resulting from an improved


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investment climate and more accessible tax system-also contributes to lowering

the cost of collection.

A strategy to simplify the tax system requires several inputs. Each tool provides

the policy maker or advisor with the necessary inputs to simplify the tax system:

i. Using tax-compliance cost surveys to understand the time and cost of

paying taxes and the instruments responsible for this burden.

ii. A tax inventory, including a sub-national tax inventory, of the several

licenses, fees, and taxes that businesses have to pay.

iii. Process maps that illustrate various administrative procedures, with

special emphasis on those that generate points of contact with taxpayers

Tax simplification is not simple. Albert Einstein said, Everything should be

made as simple as possiblebut not simpler. Everyone, everywhere, agrees

that tax systems should be simplified, yet each year tax codes grow longer and

more convoluted. The problem is far from new. In 1377, the great medieval Arab

polymath Ibn Khaldun wrote: At the beginning of the dynasty, taxation yields

large revenue from small assessments. At the end of the dynasty, taxation yields

small revenue from large assessments Muqaddimah (1958).

Simplification is not an end in itself, but a means toward greater transparency,

predictability, and fairness in the tax system. It is futile to believe that

simplifying taxes will simplify the complexities of the nation itself. Complexity

is the inevitable result of the fact that the politically optimal tax structure

requires marginal political opposition per dollar of tax revenue to be equalized


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across taxable activities for each taxpayer, as well as to be equalized across

taxpayers for each activity Hettich and Winer (1988:705).

Major reviews of the tax system have been carried out in recent years, all of

which have considered ways of tax simplification leading to a reduced tax

compliance costs therefore improved compliance. Each of these reviews has

recommended tax simplification in a number of areas, especially tax payment

methods and the imposition of penalties and interest. The objective of tax reform

should be simplifying the tax system. Reasonable simplification can more

adequately eliminate the necessity of engaging tax consultants, and other

associated costs, thereby combating tax evasion and avoidance.

2.2.3 Tax Penalty

The penalty is a sum of money determined by law (legal penalty) or under

contract (contract penalty) which the responsible party is obligated to pay if the

obligation is not carried out or is carried out improperly. A penalty is paid for

violation of contract conditions regarding time, quality, and method of

performance; it is recovered regardless of whether losses actually occur or how

large such losses are.

Depending on the combination of losses and penalties recovered, the following

types of penalties are distinguished: an offset penalty, discharged with the

recovery of losses; an exclusive penalty, the collection of which excludes

recovery of losses; a contract penalty, collected together with losses; and an

alternative penalty, by which the aggrieved party has the right to demand

recovery of either the penalty or actual losses.


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The penalty is used to strengthen plan and contract discipline. The collection of

penalties by socialist organizations is therefore viewed by the law not only as a

right but also as a duty to the state. Payment of a penalty does not release the

responsible party from performance of the obligation itself, with the exception of

cases where the plan on which an obligation between socialist organizations was

based is no longer in force.

According to the Income Tax Act, Cap 107, A person guilty of an offence

under this Act for which no other penalty is specifically provided shall be

liable to a fine not exceeding one hundred thousand shillings or to

imprisonment for a term not exceeding six months or to both. Cap 109 (1)

of the same Act, a person shall be guilty of an offence if he, without reasonable

excuse

(a) Fails to furnish a return or give a certificate as required by section

35(5); or

(b) Fails to furnish a full and true return in accordance with

the requirements of a notice served on him under this Act or fails

to give notice to the Commissioner as required by section 52(3);

or

(c) fails to furnish within the required time to the Commissioner

or to any other person any document which under this Act, or

under a notice served on him under this Act, he is

required so to furnish; or


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(d) Fails to keep records, books or accounts in accordance with the

requirements of a notice served on him under section 55(1), or

fails to keep those records, books or accounts in the

language specified in the notice; or

(e) Fails to preserve a record, document or book of account in

contravention of Section 55 (2); or

(f) Fails to produce a document for the examination of the

Commissioner in accordance with the requirements of a notice

served on him under this Act; or

(g) Destroys, damages or defaces any accounts or other documents in

contravention of a notice served on him under section 56(1); or

(h) Fails to attend at a time and place in accordance with the

requirements of a notice served on him under this Act; or

(i) Fails to answer any question lawfully put to him, or to supply any

information lawfully required from him, under this Act; or

(j) Fails to deduct and account, or fails to account for tax, as

provided by section 37, or fails to supply prescribed certificates

as is required by that section; or

(k) When requested by the Commissioner, fails to furnish the

identifying number required under section 132, or fails to

include in any return, in a statement or in other documents

the identifying number when required to do so.

Tax Evasion

Imposition of penalties usually arises out tax evasion. Tax evasion is said to

occur when individuals deliberately fail to comply with their tax obligations. The


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resulting tax revenue loss may cause serious damage to the proper functioning of

the public sector, threatening its capacity to finance its basic expenses. Although

tax compliance is a major concern for all governments and analytical

investigation of tax evasion can be traced as far back as the work, one of the

pioneers of law and economics, Cesare Beccaria (1764), the problem was long

segregated from the main body of economics and left essentially to the attention

of tax authorities and jurisprudence. The modern use of economic tools for the

analysis of tax compliance can be credited to Allingham and Sandmo ([1972]

1991), who extended the influential work of Becker (1968) on law enforcement

to taxation using modern risk theory.

By distancing effective payments from statutory taxes, tax evasion defines a

specific revenue deficiency, known as the tax gap. Let us emphasize from the

outset that the tax gap is not equal to the amount of additional revenue that

would be collected by stricter enforcement, for perfect enforcement would

significantly affect the economic scenario (some firms would go bankrupt,

taxpayers would modify their labor supply, prices and incomes would change,

and so on), so the tax base would surely be altered. As a result, at least in theory,

net revenue could even turn out to be smaller. Thus standard measures of tax

gaps must be interpreted cautiously. They are only roughly suggestive of the

likely immediate effects of marginal improvements in enforcement. Also, one

should be wary of the clich that statutory taxes represent the ideal world and tax

gaps an intrinsic evil.

In economic terms, evasion problems originate in the fact that the variables that

define the tax base (incomes, sales, revenues, wealth, and so on) are often not


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observable. That is, an external observer cannot usually see the actual

magnitude of an individuals tax base, and hence cannot know his true tax

liability. Sometimes this knowledge can be obtained by means of costly audits,

in which case we say that the tax base is verifiable (at a cost). In other cases, as

when it is related to cash payments, the tax base cannot be verified at all.

Taxpayers can take advantage of the imperfect information about their liability

and elude taxation.

A related concept is tax avoidance (or reduction), by which individuals reduce

their own tax in a way that may be unintended by tax legislators but is

permissible by law. Avoidance is typically accomplished by structuring

transactions so as to minimize tax liability. In some cases, avoidance is

encouraged by legislation granting favorable tax treatment to specific activities

in contrast to general taxation principles. From a legal standpoint, evasion differs

from avoidance in being unlawful, and hence punishable (at least in theory). As

far as economic function is concerned, however, evasion and avoidance

obviously have very strong similarities; sometimes, indeed, they can hardly be

distinguished (see for instance Feldman and Kay, 1981; Cowell, 1990;

McBarnet, 1992). This adds to the difficulty of interpreting the real implications

of the tax gap.

Theories of Taxation

The economists have put forward many theories or principles of taxation at

different times to guide the state as to how justice or equity in taxation can be

achieved. The main theories or principles in brief, are:


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i. Benefit Theory

According to this theory, the state should levy taxes on individuals according to

the benefit conferred on them. The more benefits a person derives from the

activities of the state, the more he should pay to the government.

ii. Cost of Service Theory

Some economists were of the opinion that if the state charges actual cost of the

service rendered from the people, it will satisfy the idea of equity or justice in

taxation. The cost of service principle can no doubt be applied to some extent in

those cases where the services are rendered out of prices and are a bit easy to

determine, e.g., postal, railway services, supply of electricity, etc., etc. But most

of the expenditure incurred by the state cannot be fixed for each individual

because it cannot be exactly determined. For instance, how can we measure the

cost of service of the police, armed forces, judiciary, etc., to different

individuals?

iii. Ability to Pay Theory

The most popular and commonly accepted principle of equity or justice in

taxation is that citizens of a country should pay taxes to the government in

accordance with their ability to pay. It appears very reasonable and just that taxes

should be levied on the basis of the taxable capacity of an individual. For

instance, if the taxable capacity of a person A is greater than the person B, the

former should be asked to pay more taxes than the latter.

2.3 Critique of the existing literature relevant to the study

Several theories have been advanced in this research, but are subject to criticism.

i. Benefit Theory


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This principle has been subjected to severe criticism on the following grounds:

Firstly, if the state maintains a certain connection between the benefits conferred

and the benefits derived. It will be against the basic principle of the tax. A tax, as

we know, is compulsory contribution made to the public authorities to meet the

expenses of the government and the provisions of general benefit. There is no

direct quidpro quo in the case of a tax. Secondly, most of the expenditure

incurred by the slate is for the general benefit of its citizens, It is not possible to

estimate the benefit enjoyed by a particular individual every year. Thirdly, if we

apply this principle in practice, then the poor will have to pay the heaviest taxes,

because they benefit more from the services of the state.

ii. Cost of Service Theory

Dalton has rejected this theory on the ground that theres no quid pro qua in a

tax.

Tax Reforms in Kenya

From independence in 1963 until the early 1980s, public spending in Kenya was

financed through a somewhat uncoordinated set of taxes and fees inherited from

British rule and supplemented by foreign aid inflows. The oil shock in the early

1970s led to the countrys first significant fiscal crisis, in response to which

some relatively minor tax reforms were undertaken. Sales taxes were introduced

as a means of generating extra revenue, and trade taxes were used in an attempt

to reduce the ballooning balance of payments deficit. One motivation for the

relatively heavy reliance on good-specific sales and excise taxes was the belief

that the government could get the prices right, especially through its use of

trade taxes in the pursuit of first, import-substitution policies and then export-led

growth strategies.


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The use of:

Technology

High penalities

Simplified tax

methods

Reduced costs

Filing is made

easy

Increased

compliance

The primary aim of Tax Modernization Program (TMP) was to raise the

revenue-to-GDP ratio from 22% in 1986 to 24% by the mid-1990s, although this

target was increased to 28% in 1992 (Muriithi and Moyi 2003).

2.4 Summary & Gaps

From the foregoing literature, it can be seen that turnover tax has come a long

way, especially in the ease of collection methods. From the adoption of

technology, TOT collection has been made easier as the customers are able to

file in their returns with ease with the introduction of the electronic tax registers.

With installation of high penalties on tax default, customers have been obligated

to file in their turnover returns to avoid coming into contact with the stringent

consequences of tax default.

Many researchers have documented on turnover tax. However, there is a

research gap on how to make collection of turnover tax more simple and easier,

and also to come up with ways of preventing tax evasion.

2.5 Conceptual Framework

The following is the conceptual framework for analyzing the usefulness, limits

and pitfalls of turnover tax in Kenya.


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Fig. 2.2 Conceptual Framework

Prior to the introduction of TOT, value added tax which had replaced sales tax

was operational. Sales tax was operational in Kenya since 1963 until 1990 when

Vat was introduced. Sales tax is a consumption tax charged at the point of

purchase for certain goods and services. The tax is usually set as a percentage by

government charging the tax. The tax can be included in the price (tax inclusive)

or added at the point of sale (tax exclusive). Most taxes are collected by the

seller, who pays the tax over to the government. The tax burden often falls on the

purchaser but at times falls on the seller.

Sales tax is imposed on the gross value of goods sold at one particular stage of a

business activity e.g. it may be levied either at wholesale stage or retail trade

stage. When goods are manufactured and then various processes are completed

before the goods are sold to the final consumer, sales tax is imposed only at one

particular stage of the production process. Sales tax often exclude items or

provides rebates in an effort to create progressive effects necessary items such as

non-prepared food, clothing or prescription drugs are exempt from sales tax to

alleviate the burden on the poor. Sales tax is dependent on proper record

keeping. In Kenya during tax reforms in 1990, sales tax was scrapped and

replaced with VAT.

VAT was introduced in Kenya in 1990 to replace sales tax. This shift was

motivated by the argument that Vat (relative to sales tax) had higher revenue

potential and that its collection and administration were more economic, efficient

and expedient. Since 1991, a number of steps have been taken to rationalize and

strengthen the Vat, most importantly by moving several items subject to VAT


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from specific to ad valorem rates and broadening VAT coverage in the service

sector. Generally, four measures were applied to broaden the base of VAT.

First, retail-level sales tax was changed to manufacture-level VAT. Second, the

tax point was gradually moved from the manufacturer to the retail level in a

number of sectors including jewellery, household appliances and entertainment

equipment, furniture, construction materials, vehicle parts, and pre-recorded

music. As a result, the coverage of VAT on good supplied at retail level

expanded tremendously from 1990 to 1995.

Third, goods were defined to exclude the supply of immovable tangible and all

intangible property and rental or immovable property. Fourth, the coverage of

service sector was expanded to include business services; hotel and restaurant

services, entertainment, conferences, advertising, telecommunications,

construction, transport, the rental, repair and maintenance of all equipment

(including vehicles) and a range of personal services.

Measures aimed at VAT rationalization included the reduction of the maximum

rate from over 150% to 15% (between 1990 and 1997) and the reduction bands

from 15 to 3. Additional measures including raising the minimum turnover level

for compulsory registration from Kshs.10, 000 to Kshs.40, 000 and introducing

stiff penalties for defaulters in the following areas: late VAT returns, failure to

issue VAT invoices and failure to maintain proper books of account.

Another aspect of VAT that elicited interest from the taxpayers was the tax

refund system. At the time of inception, the refund system was characterized by

weak controls and corruption that led to loss of revenue Nyamunga (2001).


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Administrative changes were undertaken thereafter (mid 1990s) to streamline the

refund system.

Since VAT relies heavily on proper recording, the willingness of traders to avail

their accounts to the scrutiny of the tax authorities is crucial. As such,

transparency in the running of the business concerns is inevitable. A limitation of

VAT relative to the sales tax is that the compliance process is longer. Such a tax

is more open to graft since each stage of verification, approval and validation,

avails an opportunity to extort bribes. Sequencing is therefore a symptomatic

problem with VAT. Similarly, corruption erodes its efficacy.

In 2004/05 the government proposed to increase the VAT threshold from

Kshs.3m to Kshs.5m. The total number of taxpayers envisaged to have been in

that bracket was approximately 66, 000. Out of this number, 52, 000 fell below

the turnover of Kshs.5m. The Government of Kenya thought otherwise, that it

was prudent to bring them into the tax bracket under the presumptive tax during

the Finance Bill 2007 and the tax was named turnover tax.

TOT is a subset of presumptive tax which is meant to target the hard to tax. It

is rooted under the practices of tax administration and has much to do with

groups of legible tax payers whose tax amount are quite low compared with

administrative cost that would have been incurred by the tax administration to

assess the proper amount of tax.

The following challenges are anticipated in its implementation:-


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i. Identifying and registering small tax payers

ii. Addressing the equity principal of taxation in the TOT regimes is an

issue. There are difficulties in ensuring that both vertical and horizontal

equity is achieved in the regime.

iii. Transition from the TOT to the regular regime. Some of micro, small and

medium enterprises (MSMEs) may tend to stagnate in the presumptive

regime instead of graduating to the regular regime, especially where tax

liability is expected to increase with graduation.

iv. Low voluntary tax compliance. There is a challenge in voluntary

compliance and filing of returns is expected to be poor. This will make it

difficult to achieve the overall objective of the regime in enhancing tax

compliance of the sector at minimal costs.

v. Risk of not keeping proper records or manipulating if the records kept.

It is upon this basis that this research is examining whether the introduction of

TOT has some impact on improved tax compliance.


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CHAPTER THREE: METHODOLOGY

3.0 Introduction

The methodology seeks to put the research question into prospective and also to

establish whether the tax simplification leads to improved tax compliance. It

presents the route map of arriving at certain generalization, justification and

recommendation. This epistemology of finding the relationship will guide the

collection of data and analysis of that data in this project.

3.1 Research Design

The searcher used descriptive research which analyzed the impacts of turnover

collection methods in improved tax compliance with a subject population and in

this case the population was MSMEs in Embu County. The research design was

chosen because it seeks to identify the components leading to the problem, future

consequences and possible solutions to the problem.

3.2 Target Population

The target population of this study will be the MSMEs in Embu County. The

population is estimated to be 200 businesses within the location of the study. The

population was chosen due to limitation of resources and its near accessibility by

the researcher.

3.3 Sampling Frame


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The researcher sampled 40 businesses and would be representative of the entire

population. The sample was appropriate because of the proximity to the

researcher.

3.4 Sample and Sampling Technique

Simple random sampling procedure will be used to identify the sample size to be

interviewed and administer questionnaire.

3.5 Instruments

The instrument to be used by the researcher is questionnaires.

3.6 Data Collection Procedure

The study will use participatory method, using the instruments mentioned above

in item 3.4. Benefits of using this method are that responses are gathered in a

standard way, so questionnaires are more objective, potential information can be

collected from a large portion of a group.

3.7 Data Processing and Analysis

The data collected will be coded, edited and presented in tables and graphs. Data

will be analysed in simple statistical methods. This will help the researcher to

analyze and compare the findings from the taxpayers (businesses).


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CHAPTER FOUR

4.0 RESEARCH FINDINGS AND DISCUSSION

4.1 Introduction

This chapter presents the results of data collected by use of questionnaires, and

analyzes and interprets the findings.

4.2 Response Rate

This study was carried out between 14th and 18th November, 2011 during which a

total of 40 questionnaires were administered to a sample of 40 MSMEs. At the

end of the study period, 32 questionnaires had been received which represented a

response rate of 80%. The response rate was sufficient for analysis and statistical

confidence for generalization of the study findings.

4.3 Registration of Business

Respondents were asked whether their businesses were registered with the

Registrar of Business and all the 32 respondents gave a Yes response, giving

100% response rate. This is represented in table 4.1 below, analyzed by

frequency and percentages of total response.

Table 4.1: Registration of Business

RESPONSE FREQUENCY PERCENTAGE

YES 32 100%

NO 0 0%

TOTAL 32 100%


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4.4 Quantitative Data Analysis

4.4.1 Age of Enterprise

Respondents were asked to indicate when they started their businesses. 50% of

the businesses were started 10 years ago, 25% was started 7-9 years ago while

businesses that started 5-7 years ago represented 25%. This is illustrated in table

4.2

Table 4.2: Age of Business

AGE OF BUSINESS FREQUENCY PERCENTAGE

BELOW 5YRS 0 0%

5-7 YRS 8 25%

7-9 YRS 8 25%

ABOVE 10YRS 16 50%

TOTAL 32 100%

4.4.2 Ownership

Respondents were asked to select the type of ownership from a list of 3 types of

business which included sole proprietor, partnership and company, as shown

below in table 4.3

Table 4.3: Ownership

TYPE OF OWNERSHIP FREQUENCY PERCENTAGE

SOLE PROPRIETOR 24 75%

PARTNERSHIP 4 12.5%

COMPANY 4 12.5%

TOTAL 32 100%


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75% of the enterprises were sole proprietorships while partnership and company

types of ownership each had 12.5% representation.

4.4.3 Annual Sales

Respondents were asked to state the annual sales of the business. 62.5% of the

MSMEs had annual turnover of Kshs.500, 000-Kshs.5, 000, 000; 18.75% of the

businesses ranged between Kshs.50, 000-Kshs.250, 000 annual sales and another

18.75% at Kshs.250, 000-Kshs.500, 000. None of the enterprises had annual

turnover of above Kshs.5, 000, 000. This is further illustrated below in Table 4.4

and Figure 4.1

Table 4.4: Annual Sales

TOTAL ANNUAL SALES FREQUENCY PERCENTAGE

Kshs.50, 000-Kshs.250, 000 6 18.75%

Kshs.250, 000-Kshs.500, 000 6 18.75%

Kshs.500, 000-5, 000, 000 20 62.50%

Above Kshs.5, 000, 000 0 0%

TOTAL 32 100%


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4.4.4 Tax Regime

Respondents were asked to select the tax regime under which they are registered

with. 20 out of the 32 respondents chose TOT (Turnover Tax) which represented

62.5% while 37.5% chose VAT. This is further demonstrated in Table 4.5

below.

Table 4.5: Tax Regime

TAX REGIME FREQUENCY PERCENTAGE

TOT 20 62.50%

VAT 12 37.50%

NONE 0 0%

TOTAL 32 100%

4.4.5 Identification of Simplification Procedures Related to TOT

Figure 4.1: Annual Sales


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To achieve this objective, respondents were asked to choose from a list the types

of records they kept. The distribution is shown below in Table 4.6.

Table 4.6: Identification of Simplification Procedures Related to TOT

Types of Records Maintained Frequency Percentage

Cashbook 10 31.25%

Sales Receipts & Invoices 6 18.75%

Purchase Invoices 10 31.25%

Bank Statements 6 18.75%

TOTAL 32 100%

31.25% of the enterprises kept a cashbook; 18.75% kept sales receipts and

invoices; 31.25% kept purchases invoices while 18.75% kept bank statements.

4.4.6 Use of Technology

The respondents were asked whether they had integrated the use of technology

in their business. 75% of the respondents said Yes while 25% said No. This is

shown below in Table 4.7.

Table 4.7: Use of Technology


Yes 24 75%

No 8 25%

TOTAL 32 100%

4.4.7 Integration of Technological Equipment in the Business

The respondents were asked whether they had integrated the following

technological equipment in to the business, i.e. computer with internet access,


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computer without internet access and electronic tax registers. 24 out of the 32

respondents had integrated ETR which was 75%. Only 6 enterprises (18.75%)

had a computer with internet access, while the rest had a computer without

internet access which represented 6.25%. This is shown below in Table 4.8.

Table 4.8: Integration of Technological Equipment in the Business

TECHNOLOGICAL EQUIPMENT FREQUENCY PERCENTAGE

Computer with internet access 6 18.75%

Computer without internet access 2 6.25%

Electronic Tax Register 24 75%

TOTAL 32 100%

4.4.8 Filing of Returns

The respondents were asked whether the use of technology has made their filing

of returns easier. 93.75% of the respondents said Yes while 6.25% said No.

Table 4.9 below illustrates further.

Table 4.9: Filing of Returns


Yes 30 93.25%

No 2 6.25%

TOTAL 32 100%

4.4.9 KRA Online Services

The respondents were asked whether they access KRA online services. 75% of

the respondents said Yes while 25% said No. This is further illustrated below in

Table 4.10.

Table 4.10: KRA Online Services


Yes 24 75%No 8 25%


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TOTAL 32 100%

4.4.10 Convenience of Electronic Tax Register

The respondents were asked to rate the convenience of the ETR to their business.

A rate scale of 1-5 was presented to the respondents, i.e.

5. Very Good 4. Good 3. Average 2. Poor 1.

Very Poor

75% of the respondents chose 4 making it a convenient machine in the business.

This is further illustrated in Table 4.11 and Figure 4.2 below.

Table 4.11: Convenience of ETR


Very Good 4 12.50%

Good 24 75%

Average 2 6.25%

Poor 2 6.25%

Very Poor 0 0%TOTAL 32 100%


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Figure 4.2: Convenience of ETR

4.4.11 Do You Know When youre Supposed To File Your Tax Returns?

The respondents were asked whether they knew the time they are supposed to

file their returns. All the respondents said yes. This is illustrated in Table 4.12

below.

Table 4.12: Do you know when you're supposed to file your tax returns?


Yes 32 100%

No 0 0%

TOTAL 32 100%

4.4.12 How Often Do You File Returns On Time?

The respondents were asked how often they filed their tax returns on time. 30 out

of the 32 respondents (93.75%) said Yes while only 2 (6.25%) said No. Table

4.13 illustrates further.

Table 4.13: How Often Do You File Returns On Time?


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Yes 30 93.75%

No 2 6.25%

TOTAL 32 100%

4.4.13 Tax Procedures

The respondents were asked whether they were aware of the tax procedures

necessary for filing returns. 50% of the respondents said Yes while 50% said No.

This can be further demonstrated by Table 4.14 below.

Table 4.14: Tax Procedures


Yes 16 50%

No 16 50%

TOTAL 32 100%

4.4.14 Which Tax Procedures Have Contributed To Your Timely Filing of

Returns

The respondents were requested to choose from a list of three tax procedures that

contributed most to their timely filing of returns. 28 of the respondents (87.5%)

chose tax computation. This is further illustrated below in Table 4.15

Table 4.15: Which Tax Procedures Have Contributed To Your Timely Filing of ReturnsRESPONSE FREQUENCY PERCENTAGE

Elimination of consultancy costs 2 6.25%

Elimination of bookkeeping costs 2 6.25%

Tax Computation 28 87.50%

TOTAL 32 100%

4.4.15 Simplification of Tax Procedures


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The respondents were requested to choose from a variety of options on how they

would rate the simplification of tax procedures. 62.5% of the respondents rated

the simplification of tax procedures as average. The analysis of this has been

shown below in Table 4.16 and Figure 4.3

Table 4.16: Simplification of Tax Procedures


Excellent 2 6.25%

Good 6 18.75%

Average 20 62.50%

Poor 4 12.50%

Very Poor 0 0.00%

TOTAL 32 100%

Figure 4.3: Simplification of Tax Procedures

4.4.16 Are You Aware of the Penalties Charged Under the Kenya Tax

Laws?

The respondents were asked whether they were aware of the penalties charged

for tax evasion or late submission of tax returns. 93.75% said Yes while 6.25%

said No. Table 4.17 illustrates further.

Table 4.17: Are You Aware of the Penalties Charged Under the Kenya Tax


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Laws?


Yes 30 93.75%

No 2 6.25%

TOTAL 32 100%

4.4.17 Have You Ever Been Penalized Due To Late Submission of Returns?

The respondents were asked whether they have ever been penalized for late

submission of returns. 6.25% of the respondents said Yes while 93.75% said No.

Table 4.18 illustrates further.

Table 4.18: Have You Ever Been Penalized For Late Submission of Returns?


Yes 2 6.25%

No 30 93.75%

TOTAL 32 100%

4.4.18 Stringency of Penalties

The respondents were requested to choose from a variety of options so as to rate

the stringency of penalties. 62.5% of the respondents rated the penalties as

average. This can further be demonstrated below by Table 4.19

Table 4.19: Stringency of Penalties


Very Strong 2 6.25%

Strong 8 25%

Average 20 62.50%

Weak 2 6.25%

Very Weak 0 0.00%

TOTAL 32 100%


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4.4.19 Influence of Penalties on Early Submission of Returns

The respondents were asked whether the imposition of penalties had influenced

their early submission of returns. 93.75% of the respondents said yes while

6.25% said No. This is further illustrated in Table 4.20 below

Table 4.20: Influence of Penalties on Early Submission of

Returns


Yes 30 93.75%

No 2 6.25%

TOTAL 32 100%

4.4.20 Effectiveness of Tax Penalties

The respondents were requested to choose from a variety of options so as to rate

the effectiveness of tax penalties. 75% of the respondents said the penalties are

effective. This is further illustrated below in Table 4.21

Table 4.21: Effectiveness of Tax Penalties


Very Effective 2 6.25%

Effective 24 75%

Average 4 12.5%

Not effective 2 6.25%

Very Weak 0 0%

TOTAL 32 100%

4.5 Qualitative Analysis

The following are the findings obtained from the study:-

The number of MSMEs in Embu County was thirty-two (32). Most of the

MSMEs have been in existence for over ten years, with over 75% over the

enterprises being solely owned (sole proprietorships). 62.5% of the MSMEs

have an annual turnover of between Kshs.500,000-Kshs.5,000,000.


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Most of the enterprises have integrated the use of technology in their business

with 75% of the MSMEs integrating the use of the ETR machine. Technology

has enabled the MSMEs to file their returns on time with over 93.75%

acknowledgement. The convenience of the ETR machine has been greatly

acknowledged by the MSMEs.


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CHAPTER FIVE

SUMMARY, CONCLUSIONS AND RECOMMENDATION

5.1 Introduction

The research was conducted with an aim of determining whether the

simplification of TOT collection methods has led to improved tax compliance in

Kenya. This chapter gives details of the summary of the data collected,

conclusion and recommendations based on the following.

5.2 Summary

5.2.1 Bio-Data

From all the enterprises interviewed, 50% have been in existence for more than

10 years, 25% between 7-9 years while 25% have been in existence between 5-7

years. All these businesses have been registered by the Registrar of Business.

75% of the enterprises were solely owned, 12.5% were partnerships whilst

12.5% were registered as private companies.

62.5% of the businesses had annual turnover between Kshs.500, 000 and Kshs.5,

000, 000; 18.75% Kshs.50, 000 and Kshs.250, 000 whereas 18.75% ranged

between Kshs.250, 000 and Kshs.500, 000. 62.5% of the MSMEs were

registered under the TOT regime while the rest under VAT regime.

31.25% of the enterprises kept purchase invoices, 31.25% kept a cashbook,

18.75% kept sales receipts & invoices whereas 18.75% kept bank statements.

This was an indication that the businesses maintained all the vital records.

5.2.2 Technology


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75% of the enterprises had integrated the use of technology with 75% integrating

the use of ETR machines into their businesses. 93.75% of the enterprises

acknowledged that with the integration of technology into their businesses, it has

made their filing of returns easier. 75% of the MSMEs access KRA online

services with 75% of the enterprises acknowledging that the ETR machine has

been of good convenience to them.

5.2.3 Simplicity of Collection Methods

All the businesses were fully aware of when they are supposed to file in their tax

returns, with 93.75% of them always filing their returns on time. 50% of the

MSMEs knew the tax procedures necessary for filing returns with 87.5% rooting

for tax computation as the tax procedure that has contributed to their timely

filing of returns. 62.5% of the businesses rated the simplification of tax

procedures as average with only 6.25% rating it as excellent.

5.2.4 Tax Penalty

93.75% of the enterprises were aware of the tax penalties with only 6.25% not

fully aware. 6.25% of the MSMEs have ever been penalized for late submission

of returns, with 62.5% saying the stringency of penalties is average. 93.75% of

the businesses acknowledged that the imposition of penalties has influenced their

early submission of returns. 75% of the enterprises said the enterprises were

effective.

5.3 Conclusions

5.3.1 Bio Data


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From the study,

it can be concluded that the businesses have been operating for some time with

most of them being within the TOT threshold. A significant number of these

enterprises are solely owned (sole proprietorships) with rest being either

partnerships or private companies. All these enterprises maintain all the vital

records, i.e. purchase invoice, sales receipts and invoice, cashbook and bank

statements.

5.3.2 Technology

From the research conducted, it can be concluded that most

bcom project[1]

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