Taxcompliance refers to fulfilling all tax obligations as required by the tax laws,including but not limited to declaring income, filing a return, and paying thetax due in a timely manner. High compliance costs, inadequate understanding,high tax rates and tax penalties are some of the variables that can lead to taxevasion and tax fraud.
Their size, nature and operation make the issue of taxcompliance critical among the SMEs. They are not well established in terms ofresources and expertise. (Williams and Round, 2009). Indeveloping countries, taxation in an important element in the management of thenational economy (Lyme and Oats, 2009).
The purpose of taxation in Kenya is tofinance government planned activities. Article 209 of the constitution of Kenya2010 grants powers to impose taxes as revenue source by both the national andthe county governments. However mobilizing sufficient tax revenue is a majorchallenge due to narrow tax base and cases of non-compliance among taxpayers.Tax noncompliance is a major challenge confronting tax administrations (Chau& Leung, 2009; Terkper, 2003). In 2011, it cost governments worldwide about5.1 % of their Gross domestic Product (GDP). Even in the most advancedeconomies in the world, tax evasion undermines revenue collection substantially(Rile, 2011). Ofthe three East African countries of Kenya, Uganda, and Tanzania, tax evasion asa function of GDP is high.
Uganda loses the least amount in tax evasion: In2011, it lost 856 million USD, followed by Tanzania at 1.9 billion USD, andKenya loses slightly over 2 billion USD. In 2011, the informal economyconstituted 33% of the GDP in Kenya and represented 7% of total governmentexpenditure. The tax burden in Kenya would thus be high, standing at about20.9%.
If the Kenya government is to increase its social expenditure, then itneeds to reduce tax evasion in the informal economy (Griffiths, 2005). Value Added Taxis a tax on the value added to the supply by the last seller, (Radhakrishanan,2008). VAT was introduced in Kenya in 1990 as a means of increasing thegovernment tax collections by widening the tax base. VAT is imposed by Kenyarevenue Authority (KRA) as per the laws of the Value Added Tax Act 2013. TheValue Added Tax is an indirect tax on consumption applicable on the sale ofsupplies at all levels of production and distribution. VAT registered taxpayersacts as agents in collecting and remitting collected VAT to the government. TheVAT paid on inputs in turn is claimed as credit when registered taxpayersdeclare output VAT on their sales (VAT Act 2013 Sec 17). Suppliers of exemptgoods & services (VAT Act 2013, first schedule) do not charge VAT on theirsupplies and cannot claim credit for VAT paid on their purchases.
The VATsystem also contains zero rated goods and services (VAT Act 2013, 2ndschedule). Businesses charge VAT at a rate of 0% on their supplies and areallowed to deduct the input tax paid on the purchase of those zero rated goodsand services (VAT Act 2013 Sec 17). The government formulates policy and VATlaws, KRA oversees implementation of the laws, professionals offer services toensure tax compliance, businesses act as agents in collecting VAT &remitting it to the government and the general public is concerned about theVAT rate which influences their spending and how the government is utilizingthe VAT revenue collected. VAT contributes about 23% of the total tax revenuecollection by the government (KNBS 2014).
There are a number of tax compliance theoriesthat have been developed by various scholars. The economic deterrence theory isa theory under criminology that views a taxpayer as a perfectly moral,risk-neutral or risk-averse individual who seek to derive maximum satisfaction wheneverthe expected gain exceed the cost (Becker, 1968). The fiscal and socialpsychology theory proposes that taxpayers are more willing to pay taxes if theyhave a positive attitude towards the payment of taxes (Schmolders, 1960).
Thetheory has been built on by various scholars overtime. The taxpayers’willingness to comply with tax authorities relates to the individuals’attitudes and perception of the tax system (Strumpel, 1966).Psychology theoriesexamines taxpayers’ attitudes and beliefs so as to understand and predict theirbehavior and factors affecting their tax compliance. Social psychology theoriesinductively examine the attitudes and beliefs of taxpayers in order tounderstand & predict human behavior and factors that affect taxpayers’compliance attitudes. The ability to pay theory proposes that citizens to contributeto the support of the government as nearly as possible, in proportion to theirrespective abilities in terms of revenue (Mill, 1848).