“Last year one of the food retailers got a mismatch notice because someone declared bogus purchase from that retailer in his tax return. To justify its purchase, even bearer cheques were issued and cash withdrawn in name of food retailer. The food retailer had to physically threaten the person to rectify his error to tax office.”
This was a case discussed in a SME Tax Training two weeks back organized in DCCI, Dhulikhel in association with IRD, GIZ and ICAN. The SMEs selected for the training had turnover less than Rs. 5 million (we call them micro SME here). Mismatch is a buzzword among the tax payers these days. Businesses of all types are facing the issue, but the small tax payers are facing its ruth more than others. Any mismatch arising from attempted tax evasion by the tax payer is justified, but not all mismatches are intentional or part of tax avoidance scheme. The case above is a classic example arising from mala fide intention of an unknown party affecting the micro SME. Such cases cannot be prevented by just having fair books of accounts and transparent tax payment. Further, micro SME with few million turnover, lack technical capacity and financial resources to maintain a robust accounting system or pay for an accountant or advisor. So, how does a micro SME protect itself from mismatch issues arising out of third party’s fault?
Aggrieved tax payers have invented a custom solution, “Some of businesses chose to cover their Tax Plate with clothes. Some just do not print the last one digit in their plate.”
This may be preventive, but not a solution. The only way a micro SME can protect itself from such mismatch issues is by maintaining proper books of account to support its business transactions. But can we expect that? How practical is this?
First, micro SME do not have enough financial resources to hire a full time accountant to do their accounting. They cannot do it themselves. Further, in absence of guidelines from IRD, they do not know what documents to maintain. But maintaining proper accounts is essential not just to protect from mismatch, but also as a legal requirement.
The impractical legal requirement
The profit criteria in Sec. 4 of Income Tax Act, that says “profit not exceeding 2 lakhs per annum” means that small tax payers who pay tax on basis of their location (Max. Rs. 5,000 per annum) are expected to maintain their accounting records. What accounts to be maintained? In a country where food stalls in big cinema halls (where even the higher bureaucrats and ministers visit for movies) that do millions of sales each month do not provide invoice to customers (they give cash receipt and take it back during food delivery), should small businesses be expected to issue invoices for petty sales? Presumptive tax payers can be very small, from a hair salon and tea shop to a dairy and small food items retailer.
If IRD does not require disclosure of profit from turnover tax payers (Rs. 2m to Rs. 5m), why should they bother about profit of proprietorship firms below NPR 2m turnover?
Trouble multiplies with registration
Have you ever wondered how many of the canteens inside Singh Durbar are legally registered? It will be a futile exercise searching for their Tax Plate whenever you happen to visit there.
In our trainings organized in four districts, SMEs had a common complaint, “Trouble multiplies with registration.”
Lets take the case of one of our participants, a 68 years senior citizen operating a small hotel. He had lost his son during Maoist conflict and daughter-in-law committed suicide, leaving on him the full onus of looking after seven grand children. The hotel was legally registered as a sole proprietorship firm, and had annual turnover of less than NPR 1 million. He exhibited a keen interest in tax, but was always felt confronted with the administrative hassles of tax payment and annual renewals.
A sole proprietorship firm can normally be registered in Municipality or VDC or in the District office of Department of Cottage and Small Industry (DCSI). PAN from tax office can be obtained with registration document either from above. In addition, an excise license is required for any hotel that sells liquor. This means the sole proprietor should pay at least three to four different annual charges, visiting three offices:
- Annual presumptive income tax in Tax Office
- Excise license renewal charge in Tax Office
- Business renewal charges in Municipality and/or
- Renewal charges in District office of DCSI
Besides this, it’s almost mandatory for them to be member of DCCI and their association (For eg. The Hotel Association).
Beside annual tax payments, they are even expected to comply with TDS requirements.
The tax law imposes TDS responsibility to all registered businesses in payments subject to tax, and this includes small sole-proprietorships too. Such small businesses employee low salaried staffs, normally within the minimum exemption limit. But the law requires monthly TDS even for the 1% Social Security Tax. Similarly, office rents are subject to TDS of 10% and services are subject to 15% TDS. Small business do not understand the concept of TDS, nor are technically equipped to submit online TDS returns on monthly basis. Thus, they prefer to exclude all those expenses in their record keeping, so as to avoid TDS, and for house rent, declare a nominal rental amount.
An exemption on TDS requirement or simplified procedures (such as annual or semi-annual TDS payment) or no Social Security Tax for low salaried employees would be essential to remove the current situation of non-compliance by SMEs.
No exemptions for partnership and companies
While we have presumptive tax and turnover tax provisions for sole proprietorship firms, the partnership and small companies (say with similar turnover) are not exempted. They are required to submit full tax returns, the way a large corporate or a bank does. Thus the requirements for small partnership and companies are too tough to comply with. And even in case of sole-proprietorship firms, voluntary registration in VAT makes them ineligible for presumptive tax or turnover tax payments, and so requires full tax returns.
Flaws in Turnover Tax
Turnover tax is a new provision applicable from ongoing FY 2015/16 (FY 2072/73). It applies to natural persons with turnover exceeding Rs. 2 million upto Rs. 5 million. While it may appear that turnover tax simplifies tax calculation by having direct tax rate based on turnover, but a closer look at the provisions indicates inherent flaws that penalizes tax payer.
A small tax payer based in municipality and with turnover up to Rs. 2 million pays Rs. 2500 as annual tax. But if his turnover increases to say Rs. 2.1 million, the tax liability becomes at least Rs. 31,500, a huge marginal tax. How would someone pay it? Instead the tax payer would be motivated to either under declare his turnover or register a different firm in his family name.
It appears that it is tough being a micro SME, unless you choose to do away with tax provisions at the risk of paying penalties or falling on the trap of mismatch. In terms of number of tax payers, small businesses represent substantial portion of registered businesses in tax department. But as seen above their compliance requirement are tough or impractical for them to be fully compliant with. Instead of making them non-compliant, it would be preferable for IRD to come up with simplified administrative procedures or requirements for them.