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

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

Signature: ________________________ Name: Victor M. Muto HD231-037-0012/2009

Date: ______________________

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

Sign: __________________________ Mr. G. G. Kamau

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.

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.

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.

TABLE OF CONTENTS Declarationi Dedication.i i Acknowledgment..i ii Abstract.i v List of Tables vii List of figures viii 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. Theoretical Review..14 2.3. Critique of the existing literature relevant to the study 34 2.4. Summary and Gaps..35

2.5. Conceptual Framework36 CHAPTER 3: METHODOLOGY...41 3.0. Introduction..41 3.1 Research Design41 3.2 Target Population..41 3.3 Sampling Frame42 3.4 Sample & Sampling Technique 42 3.5 Instruments42 3.6 Data collection procedure.............................42 3.7 Data processing and analysis 42 CHAPTER 4: RESEARCH FINDINGS & DISCUSSION...43 4.1. Introduction..............................43 4.2. Response Rate..43 4.3. Registration of business...43 4.4. Quantitative Data Analysis..44 4.5. Qualitative Analysis 55 CHAPTER 5: SUMMARY, CONCLUSIONS AND RECOMMENDATIONS 5.1. Introduction..56

5.2. Summary..56 5.3. Conclusions..58 5.4. Recommendations59 APPENDIX 1: REFERENCES60 APPENDIX 2: APPENDICES.63

LIST OF TABLES Table 4.1: Registration of business.44 Table 4.2: Age of business..45 Table 4.3: Ownership..46 Table 4.4: Annual sales..46 Table 4.5: Tax Regime47 Table 4.6: Identification of simplification procedures related to TOT..48 Table 4.7: Use of technology.48 Table 4.8: Integration of technological equipment in business.49 Table 4.9: Filing of returns 49 Table 4.10: KRA online services..50 Table 4.11: Convenience of ETR......................................................................50 Table 4.12: Do you know when youre supposed to file your tax returns 51 Table 4.13: How often do you file returns on time...52 Table 4.14: Tax Procedures...52 Table 4.15: Which tax procedures have contributed to your timely filing of returns .53 Table 4.16: Simplification of tax procedures.53 Table 4.17: Are you aware of the penalties charged under the Kenya Tax Laws..54

Table 4.18: Have you ever been penalized for late submission of returns.55 Table 4.19: Stringency of penalties.55 Table 4.20: Influence of penalties on early submission of returns.55 Table 4.21: Effectiveness of tax penalties..........................................................56

LIST OF FIGURES Figure 2.1: Data from investment climate surveys.26 Figure 2.2: Conceptual framework.36 Figure 4.1: Annual sales.46 Figure 4.2: Convenience of ETR 50 Figure 4.3: Simplification of tax procedures..53

ACRONYMS TOT ETR VAT KRA MSMEs IT TIN LTU OECD ICA TMP GDP Turnover Tax Electronic Tax Register Value Added Tax Kenya Revenue Authority Micro, Small and Medium Enterprises Information Technology Taxpayer Identification Number Large Taxpayer Unit Organization for Economic Cooperation & Development Investment Climate Assessment Tax Modernization Program Gross Domestic Product

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

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

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 as Danegeld, 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

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

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. ii. iii. Employment income Exempt incomes under the First Schedule of the Income Tax Act cap 470 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. vi. vii. Limited companies Rental income Professional management fees

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

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. ii. iii. Simplifying tax procedures Simplifying tax computations 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

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.

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 1st 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.

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.

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, valueadded 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

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.

2.2 Theoretical Review 2.2.1 Technology Technology is the making, usage, and knowledge of tools, 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 paperto 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.

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.

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,

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 collate and 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)

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, stopfiling, 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

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 in Latin 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 developing presumptive 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.

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

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.

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

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

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-ofcompliance 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.

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

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

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.

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

(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

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

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:

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

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 quid pro 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.

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.

The use of: Technology High penalities Simplified tax methods Reduced costs Filing is made easy

Increased compliance

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

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).

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:-

i. ii.

Identifying and registering small tax payers 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.

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

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).

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 YES NO TOTAL

FREQUENCY 32 0 32

PERCENTAGE 100% 0% 100%

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 BELOW 5YRS 5-7 YRS 7-9 YRS ABOVE 10YRS TOTAL FREQUENCY 0 8 8 16 32 PERCENTAGE 0% 25% 25% 50% 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 SOLE PROPRIETOR PARTNERSHIP COMPANY TOTAL FREQUENCY 24 4 4 32 PERCENTAGE 75% 12.5% 12.5% 100%

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 Kshs.50, 000-Kshs.250, 000 Kshs.250, 000-Kshs.500, 000 Kshs.500, 000-5, 000, 000 Above Kshs.5, 000, 000 TOTAL FREQUENCY 6 6 20 0 32 PERCENTAGE 18.75% 18.75% 62.50% 0% 100%

Figure 4.1: Annual Sales

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 TOT VAT NONE TOTAL FREQUENCY 20 12 0 32 PERCENTAGE 62.50% 37.50% 0% 100%

4.4.5 Identification of Simplification Procedures Related to TOT

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 RESPONSE Yes No TOTAL FREQUENCY 24 8 32 PERCENTAGE 75% 25% 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,

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 RESPONSE Yes No TOTAL 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 FREQUENCY PERCENTAGE 24 75% 8 25% FREQUENCY 30 2 32 PERCENTAGE 93.25% 6.25% 100%

RESPONSE Yes No

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 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 FREQUENCY PERCENTAGE 4 12.50% 24 75% 2 6.25% 2 6.25% 0 0% 32 100% 4. Good 3. Average 2. Poor 1.

RESPONSE Very Good Good Average Poor Very Poor TOTAL

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? RESPONSE FREQUENCY PERCENTAGE 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?

RESPONSE Yes No TOTAL

FREQUENCY 30 2 32

PERCENTAGE 93.75% 6.25% 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 RESPONSE Yes No TOTAL FREQUENCY 16 16 32 PERCENTAGE 50% 50% 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 Returns RESPONSE 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

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 RESPONSE FREQUENCY PERCENTAGE 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

RESPONSE Yes No TOTAL

Laws? FREQUENCY 30 2 32

PERCENTAGE 93.75% 6.25% 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? RESPONSE FREQUENCY PERCENTAGE 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 RESPONSE FREQUENCY PERCENTAGE Very Strong 2 6.25% Strong 8 25% Average 20 62.50% Weak 2 6.25% Very Weak 0 0.00% TOTAL 32 100%

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 RESPONSE FREQUENCY PERCENTAGE 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 RESPONSE FREQUENCY PERCENTAGE 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.

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.

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

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

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 of the business have integrated the use of technology with a significant number of the enterprises integrating the use of the electronic tax register (ETR). With the integration of technology into the business, it can be seen that technology has helped most of the MSMEs by making it easier for them to file returns. It can also be concluded that the ETR machines have been of great convenience to the businesses.

5.3.3 Simplicity of Collection Methods From the study, it can be concluded that all the businesses under study were fully aware of when they are supposed to file returns with most of the businesses always filing their returns on time. Half of the MSMEs seemed to know the procedures necessary for filing returns with majority of them rooting for tax computation as the tax procedure that has contributed most to their timely filing of returns. 5.3.4 Tax Penalty

It can be concluded from the study that majority of the businesses were aware of the tax penalties with only a few of the MSMEs ever penalized for late submission of returns. It can also be concluded that the penalties charged for late submission of returns has an influence on the early submission of returns.

5.4 Recommendations From the conclusions above, the researcher recommends the following: i. The MSMEs that is within the TOT bracket (Kshs.500, 000-Kshs.5, 000,000) but registered under VAT regime should be registered under TOT regime. ii. The enterprises should incorporate the use of technology into their businesses by fully introducing the electronic tax register. The businesses should also access more the KRA online services such as filing of returns online, which is faster than manual filing of returns. iii. KRA should conduct tax returns filing procedure programs so as to enable the businesses fully aware of the procedures necessary for filing returns. The businesses should also make haste while computing their tax so as to enable them file their returns on time. iv. The stringency of the tax penalties should be maintained so as to influence the businesses to file their returns on time.

APPENDIX 1 REFERENCE

Adams, Charles 1998 Those Dirty Rotten TAXES, The Free Press, New York NY

Adams, Charles, 1993, For Good and Evil: The Impact of Taxes on the Course of Civilization, Madison Books.

Bird, Richard M. "Taxing Electronic Commerce: The End of the Beginning?" Bulletin for International Fiscal Documentation 59 No. 4 (2005): 130-40.

Bird, Richard M., and Milka Casanegra de Jantscher, eds.

Bird, Richard M., and Pierre-Pascal Gendron. The VAT in Developing and Transitional Countries. New York: Cambridge University Press, 2007.

Bird, Richard M., and Oliver Oldman. Improving Taxpayer Service and Facilitating Compliance in Singapore. PREM Note No. 48. Washington, D.C.: The World Bank, 2000.

Bird, Richard M, and Sally Wallace. "Is It Really so Hard to tax the Hard-toTax? The Context and Role of Presumptive Taxes. In Taxing the Hard-to-Tax: Lessons from Theory and Practice, edited by James Alm, Jorge MartinezVazquez, and Sally Wallace, 121-58. Amsterdam: Elsevier, 2004.

Bird, Richard M., and Eric M. Zolt. "Redistribution via Taxation: The Limited

Role of the Personal Income Tax in Developing Countries." UCLALaw Review 52 No. 6 (August, 2005): 1627-95.

Business Daily Newspaper, 16th January 2008, KRA Now Issues Rules For Turnover Tax

Ehtisham Ahmad & Nicholas Stern, The Theory and Practice of Tax Reform in Developing Countries 276 (1991).

http://www.ifc.org/ifcext/fias.nsf/AttachmentsByTitle/PublicationMTTaxSimplif ication/$FILE/FIAS-HTSfinal

http://www.taxworld.org/History/TaxHistory.htm

Improving Tax Administration in Developing Countries. Washington, D.C.: International Monetary Fund, 1992.

Internal Revenue Service, Federal Tax Compliance Research. Individual Income Gap Estimates for 1985, 1988 and 2002, Publication 1415 (Rev 4-96), 1996.

KRA: Public Notice 49 (2004)

KRA Publication on Turnover Tax.

Lumumba Omweri Martin. African Journal of Business & Management (AJBUMA): The Effectiveness of Electronic Tax Registers In Processing of Value Added Tax Returns (2010).

Mayshar, Joram, Taxation with Costly Administration, Scandinavian Journal Economics, 1991, 93(1), 75-88. Rehnquist, William H. 1992 Grand Inquests: The Historic Impeachments of Justice Samuel Chase and President Andrew Johnson.William Morrow & Company, Inc. New York, NY.

Steuerle, C. Eugene The Tax Decade

Taxpayer Seminar at KICC: Introduction of Electronic Tax Register in Kenya (January, 2005).

APPENDIX 2 QUESTIONNAIRE This questionnaire is designed to find out the impact of turnover tax collection methods has led to improved tax compliance. All the information is for academic purpose and will be treated as confidential.

A. BIO-DATA 1. Are you registered with the Registrar of Business? Yes ( ) No ( )

2. When did you start your business? a. Below 5 years ago b. 5-7 years ago c. 7-9 years ago d. Above 10 years ago 3. What is the type of your business? a. Sole proprietor( ) b. Partnership c. Company 4. What are your annual sales? a. Kshs.50,000-250,000 b. Kshs.250,000-500,000 ( ) c. Kshs.500,000-5,000,000 d. Over Kshs.5,000,000 ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( )

5. Which tax regime are you registered with?

a. TOT

( )

b. VAT ( ) c. None ( ) 6. Do you maintain the following records? Yes a. Cash book ( ) b. Sales receipts and invoices ( ) ( ) ( ) No

c. Purchases invoices ( ) d. Bank statements ( ) ( ) ( )

B. TECHNOLOGY 7. Have you integrated the use of technology in your business? ( ) No ( ) Yes

8. Do you have the following in your business?

Yes a. Computer with internet access ( ) b. Computer without internet access ( ) c. Electronic tax register ( )

No

( )

( )

( ) No (

9. Has technology made filing for your returns easier? Yes ( ) ) 10. Do you access KRA online services? Yes ( ) No ( )

11. How convenient is the Electronic Tax Register to your business? Yes ( ) No ( )

C. SIMPLICITY OF COLLECTION METHODS 12. Do you know when you are supposed to file your tax returns? Yes ( ) No ( )

13. If yes, how often do you file returns on time? a. Always( ) b. Not always ( )

14. Are you aware of the tax procedures necessary for filing returns? Yes ( ) No ( )

15. If yes, which of the following has contributed most to your timely filling of returns? a. Elimination of consultancy costs b. Elimination of bookkeeping costs c. Tax computation ( ) ( ) ( )

16. How would you rate the simplification of tax procedures? 5-Excellent 4-Good 3-Average 2-Poor 1. Very Poor ( ) ( ) ( ) ( ) ( )

D. PENALTIES 17. Are you aware of the penalties charged for tax evasion or late submission of returns? Yes ( ) No ( )

18. Have you ever been penalized due to late submission of returns? Yes ( ) No ( )

19. How stringent are the tax penalties imposed by the Kenyan law? 5. Very Strong 4. Strong 3. Average 2. Weak 1. Very Weak ( ) ( ) ( ) ( ) ( )

20. Has the imposition of tax penalties influenced your early submission of tax returns? Yes ( ) No ( )

21. How effective are the tax penalties on tax compliance? 5. Very Effective 4. Effective 3. Average 2. Not effective ( ) ( ) ( ) ( )

1. Not Very Effective ( )