UNIVERSITY OF PERPETUAL HELP SYSTEM DALTA

Molino Campus
COLLEGE OF ACCOUNTANCY

ASSESSMENT OF FACTORS AFFECTING TAX COMPLIANCE BY SMEs

IN MOLINO, BACOOR CITY, CAVITE

An Undergraduate Thesis
Submitted to
Mr. Francisco H. Villamin Jr.

In Partial Fulfillment
Of the Requirements for the Course
Business Research Methods with Thesis

DOMINIC JASPER AMBONA

RIA LORAINE CAPARAS
FREDGIELYN LACSON
CAMILE OMPAD
VIVIANNE REALCE

October 2016

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Molino Campus
COLLEGE OF ACCOUNTANCY
Chapter 1
THE PROBLEM AND REVIEW OF RELATED LITERATURE AND
STUDIES
Introduction
Almost all of the large companies today originated from being a small
or medium enterprise suggesting that the future large corporations are the SMEs
of today that needs nurturing to ensure their growth. SMEs are generally
perceived to be the nursing for indigenous entrepreneurship which will result
into growth of small investments, which would otherwise not have taken place.
The pervasiveness of tax noncompliance remains of serious concern to
the majority of tax administrators around the world. Tax noncompliance not
only poses a serious threat to effective tax and voluntary compliance; it also has
a negative impact on the economy. In 2008/2009, Her Majesty's Revenue and
Customs (HMRC) estimated the United Kingdom tax gap to be around 42
billion, and of this, 15 billion was due to tax fraud, evasion and some criminal
activities (HMRC, 2010). Whilst the Inland Revenue Board of Malaysia
(IRBM) reported that the additional taxes and penalties of 2010 amounted to
about RM1, 013.63 million of the finalized audited corporate tax cases Inland
Revenue Board of Malaysia, (IRBM, 2010). The rising tax noncompliance has
urged the government and tax administrators to examine the factors that cause
tax noncompliance.
In developing countries, tax noncompliance is a serious issue facing
income tax administration and hindering tax revenue performance. Despite the
various tax reforms undertaken by governments to increase tax revenue over the
years, prior statistical evidence has proven that the contribution of income taxes
to the government's total revenue remained consistently low and is relatively
shrinking (Alabede et al., 2011). Compliance costs involved in taxation are
major hindrances to draw out compliance behavior of taxpayers. Sometimes the
administration of income tax creates problems for business taxpayers when it
imposes onerous reporting and record keeping requirements resulting to
increased costs of tax for those who try to comply with the tax law. For
providing voluntary compliance with taxation, social scientists are also charged
with important roles for providing into data of revenue administration with

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COLLEGE OF ACCOUNTANCY
research activities, as much as the revenue administration that represents the
taxation facet of finance organization is charged with significant roles.
Although a lot has been done on tax compliance in relation with tax rates,
penalty, social norms, tax administration and tax fairness, it is not clear whether
tax prowess and compliance costs suffered by SMEs affect compliance levels.
Most large companies have their roots in Small and Medium Enterprises
suggesting that the future large corporations are the Small and Medium
Enterprises of today that that must be nurtured to ensure their growth. Tax
noncompliance is a substantive universal phenomenon that exceeds cultural and
political limitations and takes place in all societies and economic systems.
There many studies that explain the behavior of tax compliance in a more
realistic situation. They focus on the determinants of tax compliance,
respectively on economic and non-economic factors (Nicoleta, 2011). Tax noncompliance is an area of concern for all government and tax authorities, and it
continues to be an important issue that must be addressed. Regardless of time
and place, the main issue faced by all tax authorities is that it has never been
easy to persuade all taxpayers to comply with the regulations of a tax system. It
is a well-known fact that the revenue generated from the taxation of individuals
and businesses is an important source of income for government. In an
economy such as ours, that is struggling to remain afloat, it is even more
important. Tax revenue is the source of funds used for developmental projects
such as provision of infrastructural facilities such as good roads, stable power
supply, stable water supply etc. All of which combine to create an enabling
environment for businesses to thrive - and in turn the economy at large- to
grow. Small and Medium Enterprises being profit generating establishments are
also expected to pay their dues. The important question however is how much
tax should they pay? Small and medium scale enterprises are volatile
establishments that need special treatment. Putting their nature into
consideration, every little resource at their disposal can make a world of
difference. For this reason, a number of SMEs in Molino, Bacoor city choose to
remain in the informal sector because they feel the cost of compliance is too
high. And a considerable number of those who pay, only do so because they are
coerced by the relevant authorities.
The above brings to bear reasons why the issue of taxation of SMEs is
really important in our economy. Tax provides revenue for the government to

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create an environment that will ease the running of all businesses SMEs
inclusive. At the same time if an SME is faced with high compliance costs, it
has a very high tendency to avoid paying taxes hence; the revenue that would
have been generated and used to create this environment is lost thereby
reducing the SMEs chances of survival.
This research therefore is aimed at evaluating the factors that encourage
non-compliance with tax obligation by Small and Medium Enterprises and
consequently determine if government tax policies tops these factors. In doing
this, a study was conducted using Small and Medium Enterprises in Molino,
Bacoor City Cavite.

Review of Related Literature and Studies

Small and Medium Enterprises
According to Department of Trade and Industry, there are 941,174
establishments in the Philippines as of 2013 provided by the Philippine
Statistics Office. 99.6% (or 937,327) of these are Micro, Small, and Medium
Enterprises (MSMEs). Of the total number of MSMEs, 90.3% are Micro, 9.3%
are small, and the remaining 0.4% are medium enterprises. MSMEs produced
jobs a total of 4,770,445 compare to 2,719,166 for the large enterprises. This
shows that Micro, Small, and Medium enterprises contributed almost 63.7% of
the total jobs produced by all types of business establishment in the Philippines
According to the Magna Carta for Micro, Small and Medium
Enterprises (RA No. 6977, as amended by RA 8289, and further amended by
RA 9501) Sec.3 Small and Medium Enterprise shall be defined as any
business activity or enterprise engaged

in industry, agribusiness and/or

services, whether single proprietorship, cooperative, partnership or corporation

whose total assets, inclusive of those arising from loans but exclusive of the

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land on which the particular business entitys office, plant and equipment are
situated, must have value falling under the following categories:
Micro
Small
Medium
Small and medium

less than
P 3,000,000
P3,000,001
P15,000,000
P15,000,001
P350,000,000
enterprises (SMEs) are seen as crucial for a

countrys economic growth, employment creation and innovation. The

contributions SMEs usually make to tax revenue are lower than its
contributions to output and employment. That fact notwithstanding, SMEs have
not become competitive enough to increase their share of output even though
they form three-fifths of the number of manufacturing firms where larger
manufacturing companies rely on SMEs for their supplies.
Characteristics of Small and Medium Enterprises
SMEs are featured by uncertainty, innovation and evolution, thus
making its concept relative and dynamic (Its thought continually changes). An
adequate knowledge of SMEs characteristics is essential for its strong
understanding.
As noted by Ronald U. Mendoza and Monica Melchor (Published 10:54
AM, November 11, 2014), many Philippine SMEs remain too small, only
meagerly augment household incomes, and are not able to take advantage of
opportunities brought about by ASEAN integration.
Overall, SMEs face numerous constraints to further growth and
productivity, including credit constraints, cumbersome registration procedures
and strict regulatory environments, and other challenges related to an economic
playing field that is not level between large and small firms. SMEs, especially
start-ups, have lower probabilities of survival than larger firms, leading to high
rates of market entry and exit across nearly all economic sectors.
Small and medium-sized enterprises (SMEs) account for more than 90%
of all enterprises, employ 50-99% of the domestic workforce and contribute

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COLLEGE OF ACCOUNTANCY
around 32-77% of total domestic output in their respective countries in
ASEAN. The number of SMEs grew by 66% from 492,510 in 1995 to 816,759
in 2011 in the Philippines. Similarly, the numbers of those employed by these
firms have grown by 45.7% from 2.7 million in 1995 to 3.9 million in
2011.These growth figures mask a wide array of challenges faced by these
firms, notably with the onset of economic integration in ASEAN.
Generally, numerous inhibitions were faced by the SMEs for its further growth
and productivity, including credit constraints, burdensome registration
procedures and strict regulatory environments, and other challenges related to
an economic playing field that is not level between large and small firms.
SMEs, especially start-ups, have lower probabilities of survival than larger
firms, leading to high rates of market entry and exit across nearly all economic
sectors.
There is a need to undergo a successful business transformation in
different aspects of their operations to go beyond not just surviving but also to
actually compete such those are spanning enhanced entrepreneurial skill,
innovation in process and product development, more successful collaboration
across SMEs and with larger firms, and improved crisis resilience among other
factors.
Taxation of Small and Medium Enterprises
According to ASEAN Organizations, Policy Incentives Granted to Local
SMEs in the Philippines are:
1. Direct Tax
Tax incentive for importers and exporters
-

Tax credits are available for taxes and duties paid on purchases of raw
materials of products for export, domestic capital equipment, domestic
breeding stock, and genetic materials.

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-

A tax credit of 25% of the duties paid on raw materials and capital
equipment and/or spare parts.

Tax incentives also available to enterprises registered with the Philippine

Economic Zone Authority (PEZA). These incentives are shown below:
-

4 to 8 years income tax holiday. A 5% tax on the modified gross income

is imposed after the end of the income tax holiday.

Tax and duty exemption on imported capital equipment and raw

materials.
National and local tax exemption.
Tax rebate for the purchase of domestic capital good.

2. Indirect Tax
Under the Investment Priority Plan (IPP), SME owners shall be eligible for the
following incentives.
-

An exemption from wharfage dues and export tax, duty import and fees.
Additional deduction for labor expense (ADLE).

Additional deduction for necessary and major infrastructure works. Excise tax
on exported goods produced or manufactured locally can be credited or
refunded upon submission of the proof of actual exportation and upon receipt of
the corresponding.
Republic Act No. 10644: Go Negosyo Act
This is the full text of Republic Act No. 10644: An Act Promoting Job
Generation and Inclusive Growth through the Development of Micro, Small
and Medium Enterprises, otherwise known as the Go Negosyo Act. It was
enacted into law on 15 July 2014 by the late president Benigno Simeon Aquino
III.
The following are the salient features of the Act:

Establishment of Negosyo Centers in all provinces, cities and

municipalities nationwide

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Establishment of a Start-up Fund for MSMEs to be sourced from the

MSME Development Fund and BMBE Fund

Technology Transfer, Production and Management Training, and

Marketing Assistance for SMEs

Recomposition of the MSME Development Council and its additional

functions

The DTI Department Administrative Order No. 14-5 Series of 2014:

Implementing Rules and Regulations for Republic Act No. 10644, An Act
Promoting Job Generation and Inclusive Growth through the Development of
Micro, Small and Medium Enterprises, otherwise Known as the Go Negosyo
Act was published on 29 December 2014.
Tax Compliance of Small and Medium Enterprises
According to Marti (2010), tax compliance is a complex term to define.
In other words, tax compliance refers to fulfilling all tax obligations as
specified by the law freely and completely.
It has been found that regulatory burdens fall disproportionately on
small and medium enterprises, as noted by Pope & Abdul-Jabbar (2008). Tax
compliance is one of a particular importance to the SMEs size and nature,
especially since most of them have access to limited resources and inadequate
expertise to comply with diverse and complicated regulation. He also believes
that high compliance costs can result in tax avoidance, tax fraud, and restrain
investment by way of decreasing competitiveness of the country in terms of
taxation attractiveness.
Tax compliance is a major problem for many tax authorities and it is not
easy task to persuade taxpayers to comply with tax requirements even though
tax laws are not always precise. The definition of tax compliance in its most
simple form is usually cast in terms of the degree to which taxpayers comply
with the tax law. However, like many such concepts, the meaning of
compliance can be seen as a continuum of definitions. One suggestion is that
the degree of non-compliance may be measured in terms of the tax gap. Tax gap

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represents the difference between the actual revenue collected and the amount
that would be collected if there was a full compliance.
Tax non-compliance may be in one of many forms; it could either be
failure to submit a tax return within the stipulated period or non-submission,
understatement of income, overstatement of deductions, failure to pay assessed
taxes by due date and in some cases non-compliance may mean an outright
failure to pay levied taxes. (Kasipillai & Abdul Jabbar, 2006).
A study of Loo and Ho examined that high compliance can be realized
from small business when taxpayers liability including compliance cost are
correctly accounted for. The authors note that taxpayers must be invariably
competent to understand the income tax laws and the administrative procedures.
This said, individuals who are less inclined to tax systems may either be underpaying or over-paying taxes. As well, the revenue authority has to provide
adequate resources to meet the functional literacy elements of the taxpayers in
terms of skills and knowledge required to deal with tax issues.
The concept of tax compliance denotes how the taxpayers accommodate
rules and regulations bordering the tax system in a country. Although, the
concept of tax compliance connotes different viewpoints, Prior studies
postulates that tax compliance involves the willingness of taxable entities to act
in line with tax laws and administration without coercion (James and Alley
2004; Palil and Mustapha 2011).
The results of the survey carried out in the capital city of Kyrgyzstan
among 500 tax payers showed that the most important factors affecting the tax
culture are; trust in the government, quality of public services and availability
of informal economy (Abdieva et al. 2011).
However, Isa (2012) found that corporate taxpayers perceived tax
computation, tax ambiguity and record keeping as tax complexity. Even though,
Massarrat-Mashhadi & Sielaff (2012) stressed that taxpayers understand the
tax complexity. In another study conducted by Saad (2012) it was noted that
taxpayers are aware and compliant with their respective responsibilities. In
contrast, the argument by Loo et al (2010) argued that when the tax laws are
complex and tedious the taxpayers may find it difficult to comprehend. This is
compounded more when the taxpayers have no knowledge on tax related

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issues. In the other argument by Isa (2012) which pointed out that tax
computation, record keeping and ambiguity are complicated to the taxpayers
also seem logical. Because they have to understand the process before they
would be able to do the tax computation as well as record keeping. If both
arguments are critically analysed, it all lies on tax knowledge because both tax
law and computation of tax and others cannot be feasible without tax
knowledge.
Thus, how small business manage to avoid taxation and the deficiency
in mapping out strategies in developing countries especially Ghana. Lignier and
Evans (2012) using cross-country data through a web-based questionnaire in
2010 revealed that the average cost of compliance during the income tax year
was around $28,000, representing a significant increase in real dollar terms, and
in relative terms. However, their findings revealed that respondents seemed to
be unaware of the eligibility rules for the various concessions, which could
explain the low take-up rates. This apparent indifference was compounded by a
perception that most small business tax concessions were too complex and not
worth the effort.
Using a baseline approach through electronic survey, Smulders et al,
(2012) evaluated and compared the tax compliance costs affecting small
business sector in South Africa. Their findings revealed that tax compliance
costs as well as core accounting costs are regressive with respect to business
size, with the compliance burden being heavier for smaller businesses.
However, the study concluded that small business tax concessions were
perceived as being more complex than useful.
Simon (2012) examined the riskiness for tax non-compliance. Using
theoretical approach revealed that deviations from the standard model including
the endowment effect, framing of decisions, limited attention, loss aversion and
mental accounting have influenced the operation of tax system in most
developing economies.
In exploring the factors that influence business tax payers decision on
whether to report income and deductions, JoAnne et al, (2012) used the theory
of planned behaviour based on Ajzen and Fishbeins model of reasoned action
approach. Their findings reveal that intention to comply is not always a strong
predictor of compliance behaviour. The majority of taxpayers who wanted to

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comply failed. As complexity and difficulty in performance increases,
additional factors are required to predict compliance, such as awareness of the
rules. Complexity also reduces the predictability of behaviour. Behaviour
prediction can be enhanced by quantifying environmental complexity,
providing performance support, and eliminating potential obstacles. Intention
can only be leveraged for compliance strategies when the tax system creates the
optimal environment for taxpayers to successfully comply.
An individual psychological variables, such as moral beliefs and
attitudes are non-economic influences on tax compliance have to be focused on.
Meanwhile, some economists have tried to control the influence of social norms
in models of tax compliance behaviour (Bobek et al 2012). Randlane (2012)
indicated that one should not ignore the biologically inherited and socially
acquired norms that shape moral values, and tax morale affecting tax
compliance is a socio-psychological factor which is connected to the internal
motivation of a person to pay tax.
The tax compliance is also affected by social norms as well as public
services, confidence in public institutions, subjective & cultural characteristics
of the person, the fairness of the tax, persons own conception about moral
principles, perception of others, awareness of how tax revenues have been used,
his/her trust in the country and administrative & tax policy (Randlene 2012).
The study was conducted using SMEs in Zaria, North-Central Nigeria to
evaluate and rank the factors that encourage noncompliance with tax obligation
by SMEs (Atawodi & Ojeka 2012). The authors found that high tax rates and
complex filing procedures are the most crucial factors causing non-compliance
of SMEs. Other factors like multiple taxation and lack of proper enlightenment
affect tax compliance among the SMEs surveyed only to a lesser extent. They
recommended that SMEs should be levied lower percentage of taxes to allow
enough funds for business development and better chances of survival in a
competitive market. Moreover, they suggested that government should also
consider increasing tax incentives such as exemptions and tax holidays as these
will not only encourage voluntary compliance but also attract investors who are
potential viable tax payers in the future.
Ojochogwu & Stephen (2012) assessed factors that affect tax
compliance among small and medium enterprises (SMEs) in North West

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Nigeria. The study was conducted using SMEs in Zaria, North- West Nigeria. It
was found that high tax rates and complex filing procedures were the most
crucial factors causing non-compliance of SMEs. Other factors like multiple
taxation and lack of proper enlightenment were noted as variables affecting tax
compliance among the SMEs surveyed only to a lesser extent. Therefore, they
recommended that SMEs should be levied lower percentage of taxes to allow
enough funds for business development and better chances of survival in a
competitive market. The government should also consider increasing tax
incentives such as exemptions and tax holidays as these will not only encourage
voluntary compliance but also attract investors who are potential viable
taxpayers in the future.
Tax compliance is a persons act of filing their tax returns, declaring all
taxable income accurately, and disbursing all payable taxes within the stipulated
period without having to wait for follow-up actions from the authority. Tax
Compliance in pure administrational terms therefore includes registering or
informing tax authorities of status as a taxpayer, submitting a tax return every year
(if required) and following the required payment time frames. In contrast, the wider
perspective of tax compliance requires a degree of honesty, adequate tax
knowledge and capability to use this knowledge, timeliness, accuracy, and
adequate records in order to complete the tax returns and associated tax
documentation (Mohd et al, .2011).
The wider perspective of compliance becomes a major issue in a selfassessment system since the total amount of tax payable is highly dependent on the
levels of tax compliance this perspective reveals, although it is inevitable that tax
authorities will seek to influence the areas taxpayers have influence over
determining to reduce the risks of non-compliant behavior they face otherwise e.g.
through continuously conducting tax audits of different sorts and other means such
as various compliance influencing activities including tax education.

While tax non-compliance is defined as failure to comply with tax laws

and/or report incorrect income, the act of claiming incorrect deductions, relief and
rebates and/or paying the incorrect amount of tax beyond the stipulated time frame.
The other classification of actions is tax evasion which consists of illegal and
intentional actions taken by individuals to reduce their legally due tax obligations.
Individuals and firms can evade taxes by underreporting incomes, sales, or wealth,
by overstating deductions or by failing to file appropriate tax returns. In every

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jurisdiction, tax authorities are empowered to collect revenue from taxpayers.
Although there are a number of taxpayers who have reported their income and paid
their tax liabilities properly, there are a few taxpayers who have not done so (Peter,
2013).

Small scale enterprises being profit generating establishments are also

expected to pay their dues. Since the individual SSE pays a very small amount
of tax compared with what the larger establishment would pay, tax authorities
tend to give the larger corporations more attention. This suggests that a good
number of SSEs evade taxes that would have otherwise been invested in
development projects that would have benefitted them (SSEs). Tax compliance
is currently a topical issue, especially in developing countries as governments at
various levels are seeking ways to improve efficiency in tax revenue collection
to finance their budgets. Small scale enterprises (SSEs) are the majority
business taxpayers in most developing countries and as such their compliance
levels directly impact on government tax revenue collections (Daniel, Akowe &
Awaje, 2016). Tax compliance level which is internal factor affecting tax revenue
not only undermines tax administration infrastructure but also makes the tax base
narrow and inequitable. When the level of compliance is low, government revenue
collections always fall behind targets (Peter, 2013).

According to Nkwe (2013), small businesses are key players in the

economy of developing countries as they generate significant employment and
output. Due to the importance of this sector in the countrys economy, it is
important that the strategies of tax administration that are implemented enhance
the SME taxpayers attitude and compliance towards paying taxes. The results
of the survey carried out in the capital city of Kyrgyzstan among 500 tax payers
showed that the most important factors affecting the tax culture are; trust in the
government, quality of public services and availability of informal economy
(Abdieva et al. 2011). The perception that the government is not accountable to
taxpayer has been identified as a major challenge facing the tax authority
(Onuba 2011).
Facilitating compliance involves such elements as improving services to

taxpayers by providing clear instructions, easy to fill forms and assisting and
educating them on their duties and obligations. Monitoring compliance requires
establishing and maintaining current accounts of taxpayers and management

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information systems covering both ultimate taxpayers and third party agents
such as banks involved in the tax system as well as appropriate and prompt
procedures to detect and follow up on non-filers, nil filers and delayed
payments. Deterring noncompliance requires establishing both a reasonable risk
of detection as well as applying penalties effectively. The ideal approach is to
combine these measures so as to maximize their effect on compliance as it
were, to move a country from a low compliance to a high compliance
environment (Masinde and Makau 2010).
Taxation knowledge is necessary to increase public awareness especially
in areas concerning taxation laws, the role of tax in national development, and
especially to explain how and where the money collected is spent by the
government (Mohd, 2010). Attitude towards tax compliance can be improved
through the enhancement of taxation knowledge. When a taxpayer has a
positive attitude towards tax, this will reduce his or her inclination to evade tax
payment (Eriksen&Fallan, 1996). Taxpayers who have attended a tax course
would be expected to have better tax knowledge and tax compliance attitude in
comparison with taxpayers who have never attended a tax course (Mohd, 2010).
Tax Policy and Level of Voluntary Compliance among Small and
Medium Enterprises
Since the compliance requirements, small taxpayers under the regular
system of taxation are discriminated against cost of compliance and tax rate are
the same for both small and large enterprises, according to Vasak (2008). An
increase in the small enterprises profit margin is possible when the compliance
costs and tax rate are reduced. The simplified provisions for small and medium
enterprises reduce the size of the informal economy and the number of noncomplying registered taxpayers thus increasing the Governments tax revenue.
Additionally, SMEs usually have to operate in an overbearing regulatory
environment with the adequacy of regulatory agencies, multiple taxes,
cumbersome importation procedure and high port charges that constantly exert
serious burden on their operations. The tax compliance was unduly burdensome

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and often have a distortional effect on the development of SMEs as they are
tempted to morph into forms that offer a lower tax burden or no tax burden at
all (Masato, 2009) which are caused by an overly-complex regulatory system
and tax regime or one opaque in its administration and enforcement, and the
earlier results in a tax system that imposes high expenses on the society. A
poorly executed tax system also leads to low efficiency, high collection charges,
waste of time for taxpayers and the staff, and the low amounts of received taxes
and the deviation of optimum allocation of resources (Farzbod, 2000).
An indication from the existing empirical evidence clearly states that
small and medium sized businesses are affected disproportionately by these
costs: when scaled by sales or assets, the compliance costs of SMEs are higher
than for large businesses (Weichenrieder, 2007).
Tax Policy that will Encourage Voluntary Compliance by Small and
Medium Enterprises
SMEs set up unexploited revenue potential and an uneven playing field
in many countries (International Tax Dialogue, 2007) as such they need to be
captured by the tax net. Legislations may restrict compliance and the growth of
business through additional expenditures and administrative obstacles, though
they are essential regulator for protection of the business environment and
security of the economic agents, for establishment of the necessary social
security regulations. Thus Shahroodi (2010), stated that the tax policy needs to
be designed such that the tax rates are appropriate and rational, the exemptions
are lower in amount, the tax collection organization are more efficient, the tax
burden of the indigent people should be lighter and the fight against corruption
and tax evasion should be much more intense, for a tax system to be efficient.
The design of tax policies could be in a way that they do not only directly affect
SMEs but also indirectly push for voluntary compliance and their growth.

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Special tax regimes for SMEs may be appropriate policy instruments for
minimizing the cost of collection, a emphasized by Yaobin (2007). Government
intervention should help maintain balance while ensuring that countries exploit
the social benefits from greater competition and entrepreneurship because
awareness of the dangers of inadequate taxation of SMEs has grown because of
the potential of uneven tax enforcement to cause distortions of competition,
voluntary compliance by larger enterprises and by wage earners (International
Tax Dialogue, 2007). A simple, consistent and predictable Pro-business (and
Pro-SME) Tax regimes and enforcement should be established to lower
compliance and administrative costs, and hence reduce uncertainty faced by
taxpayers as well as improve the levels of voluntary compliance (Kasipillai,
2005).

Theoretical Framework
Economic Deterrence Models: There are no completely developed
economic theories tending to the issue of tax compliance, however there are
different models which have been produced to address the issue. These models
of tax compliance depend on deterrence theory. Deterrence theory is a theory
under criminology and was created by Becker (1968). This theory depends on
the idea that, if the consequence of carrying out a crime exceeds the benefit of
the crime itself, the individual will be deterred from committing the
wrongdoing. This is established in the idea that all people are aware about the
contrast between right and wrong and the consequences connected with wrong
or criminal practices. Advocates of deterrence theory believe that individuals
obey or disregard the law subsequent to calculating the gains and consequence
of their activities.

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Economic Deterrence model, one of the economic-based models was
developed by Allingham and Sandom (1972), who expanded the normal utility
model of criminal activity started by Becker (1968) to the tax field. This model
consolidates the idea of an economically rational taxpayer who will dodge
taxation as long as the result from evading is greater than the normal cost of
being caught. Allingham and Sandmo (1972) proposed an original economic
model based on the normal utility capacity of the taxpayer who evades. This
model includes various aspects. First, the taxpayer has some level of risk
avoidance, the more risk averse the taxpayer is, the less likely he is to evade
charges. Also, the taxpayer needs information with regards to the taxation
framework in order to assess the likelihood of being distinguished, and the
extent of penalties that might be brought about upon detection. Under A-S
model the taxpayer decides on the amount of taxes to answer to the taxing
organization. At the point when making this decision the taxpayer tries to
expand expected utility which is characterized to be the total of the utility value
of every result weighted by the likelihood that the specific result happens. The
A-S model demonstrates that the higher probabilities of audit deter under
reporting and that a higher rate for the proportional tax prompts lower levels of
reported income. The general conclusion of this theory is that compliance
depends largely on tax audit and penalty. The suggestion of the theory is that
citizens will pay taxes because of the apprehension of sanctions.
Psychology Theories
Psychology research hypothesis set that taxpayers are affected to comply to
their obligations by psychological elements. They focus on the taxpayers'
morals and ethics. The theories prescribe that a taxpayer may comply despite
when the probability of recognition is low. Instead of the economic theories that

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expanded audits and penalties as answers for compliance issues, psychology
theories lay emphasis on changing individual behaviors towards tax system.

Conceptual Framework
The research adopted a conceptual framework where factors affecting
tax compliance will be taken as an independent variable while tax compliance
was itemized as dependent variable as illustrated in the Conceptual figure.
Factors affecting tax
compliance
- Compliance cost
- Fines and penalties
- Attitude and perception
of traders
- Tax knowledge and
education
- Perceived opportunity
for tax evasion

Dependent variable

Tax Compliance by SMEs

Independent

variable
Figure 1: Conceptual Framework: Factors affecting tax compliance
The figure shows the relationship between the independent variable and
dependent variable used to study the assessment of factors affecting tax

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compliance by Small and Medium Enterprises (SMEs) in Molino, Bacoor city,
Cavite. The independent variables are fines and penalties, tax compliance cost,
taxpayers attitude, tax knowledge and perceived opportunity for tax evasion.
Fines and penalties as an independent variable influencing tax compliance is
indicated by the complex nature of the tax system and high tax rate. Tax
compliance cost is characterized by the time it takes and the cost of compliance
by SMEs. Taxpayers attitude is indicated by the attitude the taxpayers peers
have with regards to tax compliance as well as the motivation tax compliance
holds for the SMEs. Tax knowledge and education is characterized by the
taxpayers capacity to comprehend taxation laws, and their willingness to
comply. Perceived opportunity for tax evasion is indicated by the intended or
non-intended noncompliance on tax. The dependent variable for the study is tax
compliance by SMEs government policies and regulations are the peripheral
variables for this study.
Tax Compliance Cost
The costs of complying with tax obligations have generated widespread interest
among academics, government policy makers and business organizations.
Contemporary research in the area was pioneered by Sandford who examined
the cost of complying with Valued Added Tax (VAT) and other taxes for
taxpayers in the United Kingdom (UK) in the 1970s and 1980s (C Sandford, M
Godwin and P Hardwick, 1989). Sandford (1989) defined Tax compliance costs
as the costs Acknowledging the fact that high compliance costs diminish
competitiveness of the country in terms of taxation attractiveness, public
services have become increasingly interested in ways to simplify their tax
legislation systems. Slemrod and Yitzhaki (1996) identified compliance costs as
one of the three components of the social costs of taxation. These social costs
can be paraphrased as costs incurred by society in the process of transferring
purchasing power from the taxpayers to the government. Administrative costs
are the costs that exist besides the occurrence of compliance costs that are borne
by the companies. These costs are cited as costs that the government must also
take into account as a public cost to ensure that the tax legislation is obeyed.
For example, it obtains the costs to collect taxes and to maintain the system to
collect the taxes. These are to some extent substitutable, for example when a
country transfers from a system where the tax office calculates the tax owed, to

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a self- assessment system. Compliance costs can be divided into three parts:
time spent, cash expenses and psychological costs. The total time spent contains
employee costs (in-house staff) and external costs (fees paid to outside
accountants and other advisors). These compliance costs include costs that are
incurred by a company, but are beyond the control of its management
(Hijattulah and Pope, 2008).
Fines and Penalties
Fines and penalty rates may substitute each other due to their multiplicative
linkages as long as neither of them is set to zero (Kirchler et al 2007). Higher
fines simply make evading taxes more hazardous for taxpayers and should deter
them from evasion. Empirically, the deterrent effect of fines could not always
be supported. The observed effects were weaker than expected and some
studies even suggest that an increase of penalties can have undesirable effect
and result in more tax avoidance (Kirchler et al, (2007). Alm et al., (1992)
supports the evidence that fines do affect tax compliance though the impact was
virtually zero. From the tax administration viewpoint, researchers have
concluded that compliance could be influenced by educating taxpayers of their
social responsibilities to pay and thus their intention would be to comply. As a
behavior problem, tax compliance depends on the cooperation of the public.
There are greater gains in assisting compliant taxpayers meet their fiscal
obligations rather than spending more resources pursuing the minority of nocompliers. Assisting tax payers by improving the flow and quality of
information or education them (e.g., TV campaigns) in to becoming more
responsible citizens has the potential to yield greater revenue than if it were
spent on enforcement activities.

Attitude and Perception toward Tax Compliance

While taxpayers are influenced by the system of tax structure either to comply
or not, evidence suggest that attitude and perceptions of the taxpayer also play
an important role in their compliance decisions. These involve perceptions of
government spending, perceptions on the fairness of the system, poor social
influence and the ethics and attitudes towards compliance.

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Tax Knowledge and Education
The impact of information on compliance behavior has been evaluated in
various studies. Knowledge as one of the variables in compliance is identified
with the taxpayers capacity to comprehend taxation laws, and their willingness
to comply. The particular of knowledge that identifies with compliance is the
general comprehension about taxation regulations and data relating to the
opportunity to avoid tax (Kasipillai, Norhani, and Noor, 2003). Taxation
information is important to expand awareness particularly in areas concerning
tax laws, the role of tax in national development, and particularly to clarify how
and where the money gathered is spent by the administration (Mohd, 2010).
Subsequently, training programs composed by the tax authorities are needed to
enhance taxpayers' capacity to comprehend self-assessment framework and to
build their confidence in satisfying their obligations as taxpayers (Mohani,
2001). Greater education is specifically connected to a probability of
compliance.

Educated

taxpayers

might

know

about

noncompliance

opportunities, yet their potentially better comprehension of the tax system and
their higher level of moral development advocates a more favorable taxpayer
behavior and therefore greater compliance (Chan et. al. 2000). One of the
measures to expand voluntary compliance is by assuring that taxpayers have a
specific level of capabilities, capacity and confidence to practice their tax
obligation (Mohani, 2001).
Perceived Opportunity for Tax Evasion
Entrepreneurs are regularly mentioned as a high-risk group in terms of tax
compliance because their chances to avoid are high. Opportunity has regularly
been reported as a major explanatory variable in non-compliance (Webley,
2004). Specifically, if earnings are not subject to mechanized third-party
reporting, or if taxes are not withheld at source, chances to avoid charges exist
(Williams and Round, 2009). The connection between opportunity and non compliance appears to have no less than two different aspects. To begin with, in
case where individuals don't purposely capitalize on circumstances, the
particular circumstances prompting to evasion opportunities may even lead to
non - compliance. Opportunities often come about when tax filings are not
automated. Through the absence of mechanization tax filing procedures will

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probably get to be mistake even without intention to capitalize on the involved
opportunities. Thus, opportunities may prompt an increase in intended and in
unintended non compliance. For instance, Robben et al. (1990b) demonstrate
that an experimentally induced chance to cheat (more possible outcomes to
deduct non-deductible costs) increased non - compliance regardless of whether
the parties really intended to be non - compliant or not. Second, expecting that
individuals will capitalize on opportunities, they can do as such just if the
opportunities are perceived in the first place. Although, chances to evade
regularly have a tendency to remain unnoticed. While taxpayers see
opportunities for evading little amounts, just a minority sees opportunities for
avoiding bigger amounts (Antonides and Robben, 1995). Such inability to
perceive opportunities even continues in research experiments explicitly
controlling opportunities. While controlling for intended evasion obliterated the
impact of chance on avoidance, at the same time controlling for intended
avoidance and saw opportunity re-established the primary effect of chance on
non compliance (Robben et al., 1990b). In general, genuine opportunities can
increase both intentional and accidental evasion. Although such a qualification
is hypothetically and practically meaningful, it is hard to figure out if filing
mistakes were deliberate or not. Those taxpayers facing high chances for
evasion may feel less certain about how to pay their charges accurately (Ahmed
and Braithwaite, 2005), and consequently, threats may likewise obtain partly
unexpected over-reporting, just to be on the safe side. Opportunity is a key
constituent of little business tax compliance and its duty is directed by its
perceptual associates. Given the chance to evade, those unwilling to evade may
become involuntary non - compliant and those willing to avoid may neglect to
see the opportunity to do so. In order to establish the real impact of chance, it is
important to control for compliance intention as well as opportunity
recognition.

Statement of the Problem

This study aims to identify the assessment of factors affecting tax
compliance by SMEs in Molino, Bacoor city, Cavite.
Specifically, it aims to determine the following:

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1. What is the profile among selected Small and Medium Enterprises
(SMEs) in terms of:
a) Name of Business,
b) Type of Business,
c) Capital
d) Years of Operation
e) Number of Employees
2. What are the categories of cost of Tax Compliance?
3. How do the following factors affect the respondents in tax
compliance?
a) Compliance cost,
b) Fines and penalties,
c) Attitude and perception of traders,
d) Tax knowledge and education,
e) Perceived opportunity for tax evasion
Hypothesis
Null Hypothesis (Ho)
1

There is no significant difference on assessment of Tax Compliance

by Small and Medium Enterprises (SMEs) operating in Malabon

City when the profile of the respondents is considered.

There is no significant difference when the factors that affect the
respondents businesses in complying tax are considered.

Alternative Hypothesis (Ha)

1. There is a significant difference on assessment of Tax Compliance
by Small and Medium Enterprises (SMEs) operating in Malabon
City when the profile of the respondents is considered.
2. There is a significant difference when the factors that affect the
respondents businesses in complying tax are considered.

Significance of the Study

The study intends to assess the factors affecting tax compliance by
Small and Medium enterprises in Molino, Bacoor city, Cavite. In general, the
study is of importance to the public by providing knowledge about the moral
obligations behind tax payments.
Government

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This study would be able to help the government agencies, specifically
the Bureau of Internal Revenue, increase the number of voluntary
compliance of taxpayers which could result to greater tax revenue.

Business Owners
This study would be able to help the business owners to increase his/her
voluntary compliance about tax policies, declare the true profit and
avoid the unnecessary penalties and compromise.
Accountants
This study would be able to help the accountants to prepare financial
statements accurately, declare the true profit and avoid the unnecessary
penalties and compromise.
Future Researchers
Through this study they can be more inquisitive about many factors that
may serve as a basis for the improvement of the tax compliance of
SMEs. They can also evaluate the assessment of the tax compliance by
Small Medium Enterprises (SMEs) operating in Molino, Bacoor City,
Cavite. Moreover, they can use this as a basis and source for their future
studies.
Scope and Delimitation of the Study
The research study shall cover Small and Medium Enterprises operating
in Molino, Bacoor, Cavite. The target population shall comprise of small and
medium business enterprise operators because the problem of tax compliance is
rampant as evidenced by the absence of electronic tax register (ETR Machine)
among others. The study area was most suitable because it has the relevant,
adequate and diverse target population to enable the researcher pick the sample
size required, from which to obtain desired data.

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Definition of Terms
Policy it is a method and principles that guide and determine the present and
future outcomes or decisions.
Small Medium Enterprises (SMEs) is made up of enterprises which
employs fewer than 250 persons.
Compromise It is a deal between different parties that each party gives up
something what is demand.
Regulations - is a general concept and official rule of the authority that how
should be done.
Constraint it is something that controls the limits or restricts actions.
Tax A compulsory financial contribution imposed by a government to raise
revenue, levied on the income or property of persons or organizations, on the
production costs or sales prices of goods and services, etc.
Tax Compliance The Degree to which a taxpayer complies (or fails to
comply) with the tax rules of his country, for example by declaring income,
filing a return, and paying the tax due in a timely manner.
Tax Evasion It refers to the conscious or unconscious action and behavior of
a person who is liable to pay tax but who fails to fulfill this duty by either under
reporting his tax liability or failing to account for his income generating
activities altogether. Tax evasion also refers to the reduction or minimization of
tax liability by illegal methods.
Tax Avoidance Refers to the legal reduction in tax liabilities by practices that
take the full advantage of the tax code, such as income splitting and postponement
of taxes.

Tax Rate The tax rate is the tax imposed by the federal government based on
an individual's taxable income or a corporation's earnings. It can also be defined
as the percent of income paid as tax.
Tax Obligation Responsibilities pertaining to tax payment and declaring of
tax returns which a person duly registered is required to observe.

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Tax Compliance cost It refers to the expenditure of time or money in
conforming with government requirements such as legislation or regulation.
Tax Attitude The way of thinking or feeling about taxes.
Tax Administration It refers to the procedures attached to tax compliance
including registration and filling of returns.
Fines and Penalties A fine or penalty is money paid usually to a government
authority, as a punishment for a crime or other offence.

Small and Medium Enterprises Those entities with full-time employees not
exceeding 199 or asset size not exceeding Php 100 million.
Small Enterprises An enterprise with 10-99 Employees
Medium Enterprises An enterprise with 100-199 Employees