Complexity, Compliance Costs and Non-Compliance with VAT by Small and Medium Enterprises (SMEs) in Bangladesh: Is there a Relationship? Author Faridy, Nahida Published 2016 Thesis Type Thesis (PhD Doctorate) School Griffith Business School DOI https://doi.org/10.25904/1912/1553 Copyright Statement The author owns the copyright in this thesis, unless stated otherwise. Downloaded from http://hdl.handle.net/10072/367891 Griffith Research Online https://research-repository.griffith.edu.au Complexity, Compliance Costs and Non-Compliance with VAT by Small and Medium Enterprises (SMEs) in Bangladesh: Is there a Relationship? Nahida Faridy Bachelor in Economics (Hons), Dhaka University Masters in Economics, Dhaka University Masters in Taxation Policy and Management, Keio University Department of Accounting, Finance and Economics Griffith Business School Griffith University Submitted in Fulfilment of the Requirements of the Degree of Doctor of Philosophy September 2015 Abstract The Value Added Tax (VAT), which has existed for 24 years in Bangladesh, has contributed some 37% on average to total tax revenue over the last 15 years (Saleheen, 2012; National Board of Revenue, 2014). Although, the introduction of a VAT has increased tax revenues and expanded the tax base in Bangladesh, many small and medium enterprise (SME) taxpayers do not comply with the VAT legislation, not only failing to register with the tax authorities as taxpayers but also failing to pay the VAT (Faridy et al., 2014; The Centre for Policy Dialogue, 2014). This non-compliance by SMEs could be intentional or unintentional (NBR, 2011; McKerchar, 2003). Also it may be due to excessive compliance costs (Abdul-Jabbar & Pope, 2009; Governance Institutes Network International, 2014), which could be a result of real or perceived legislative or administrative complexity (Yesegat, 2009), to inefficient VAT administration (Barbone et al., 2012), or to other factors. Alternatively, SME non- compliance could be due to ineffective or under-enforcement of the VAT legislation by the Bangladeshi tax authorities (Saleheen, 2013c). This non-compliance by SME taxpayers represents a substantial opportunity cost in terms of foregone taxation revenue for the Bangladeshi government. In Bangladesh SMEs are a key engine of economic growth in Bangladesh (Rahman, Mondal & Iqbal, 2011; Bhattachrya & Khan, 2008),helping to mobilise small and scattered private savings (GOB, 2012; Murgai & Zaidi, 2005) in order to generate large scale low-cost employment opportunities using mainly local inputs, technologies, and entrepreneurship. This thesis investigates the nature and extent of relationships between the complexity of Bangladesh’s VAT legislation, and the costs of compliance as well as the non- i compliance (either intentional or unintentional) with the VAT legislation by Bangladeshi SMEs. The research is significant on a number of fronts. First, while there is a large and growing body of research into entrepreneurship in SMEs and on SME performance, the impacts of VAT law and policy on these constructs are not clearly understood. Second, while there are considerable bodies of research on tax compliance costs and taxpayers’ non-compliance in developed countries (including in relation to broad-based consumption taxes such as VAT), there is little research about compliance costs and the extent of taxpayer non-compliance in relation to VAT in developing countries such as Bangladesh. Moreover, the measurement of compliance costs in the taxation literature, which has been influenced predominantly by thinkers from developed nations, and has largely ignored factors that may be more relevant to developing countries such as potential corruption and psychological costs. It is important to consider these tax compliance costs in developing nations such as Bangladesh. This is because the introduction of a broad-based consumption tax like a VAT is seen by supranational organisations such as the Organisation for Economic Cooperation and Development (OECD) and the World Bank in being a critical element in providing a sufficient tax revenue base for public spending by governments (Bird, 2013). Third, there has been no in-depth empirical research in developing countries such as Bangladesh about the perceptions of compliant, as distinct from non-compliant, SME taxpayers about the legislative or administrative complexity of a VAT, or about VAT compliance costs or the deterrence effects of government enforcement activities. This thesis employs a variety of research methods. First, several focus group discussions were held with VAT payers from the SME sector (identified as either compliant or non-compliant) and VAT Officials from the National Board of Revenue (NBR). Second, a survey was conducted to obtain qualitative and quantitative data from ii both compliant and non-compliant SME taxpayers. Third, in-depth semi-structured interviews were conducted with SME taxpayers and VAT officers from the NBR. The main research findings were as follows. Most compliant taxpayers reported the main drivers of VAT non-compliance by SMEs in Bangladesh to be the complexity of the VAT Law and the costs of compliance. In contrast, non-compliant taxpayers found the main driver of VAT non-compliance to be the nature of their relationship with the government’s VAT Officials, many of whom were reported to be open to bribery and corruption. For non-compliant taxpayers, complexity of the law and their cost of compliance with it were not practically relevant issues, provided the VAT Officials with whom they dealt were open to bribery or corruption. From a societal (or the government’s) perspective, however, the costs of such bribery or corruption form part of the total costs of compliance with the legislation, and must be taken into account in any assessment of the legislation’s effectiveness. Second, while compliant taxpayers reported that they would expect non-compliance by SME taxpayers to decline with the imposition of more audits, penalties and sanctions, non-compliant taxpayers reported that, for them, the imposition of audits, penalties and sanctions was unlikely to reduce their non-compliance with the VAT legislation (presumably because the cost of bribing NBR officials was less). Third, both compliant and non-compliant VAT taxpayers reported that they experienced significant psychological costs, which they estimated represent about 15% of their total VAT compliance costs (including the costs of bribing officials). All these findings have practical policy implications, as they can assist policymakers and administrators to better understand the interrelationships between legislative and regulatory complexity, and the true costs of compliance and non-compliance with VAT legislation by SMEs in Bangladesh. Since a robust and functioning VAT system is seen iii as important for a developing economy, these findings are likely to be important not only for Bangladesh, but also for similar developing economies. iv Statement of Originality This thesis contains no material that has been accepted for the award of any other degree or diploma in any university or equivalent institution, and to the best of my knowledge and belief, contains no material previously published or written by another person, except where due reference is made in the text of the thesis. (Signed)_________________________ Nahida Faridy This Dissertation is based on The VAT Law1991 and The VAT Rules1991 in Bangladesh. v Contents Abstract ........................................................................................................................................................ i Statement of Originality............................................................................................................................. v Contents ........................................................................................................................................ vi List of Tables ............................................................................................................................................... x List of Figures ............................................................................................................................................. x List of Abbreviations ................................................................................................................................. xi Glossary of Terms ...................................................................................................................................xiii List of Published Works ........................................................................................................................... xv Acknowledgments .................................................................................................................................... xvi Chapter1 ...................................................................................................................................................... 1 Introduction ................................................................................................................................................ 1 1.1 Introduction ....................................................................................................................................... 1 1.2 An Overview of the Bangladesh Tax System .................................................................................... 3 1.3 Problem Statement and Justification for the Thesis ..........................................................................