THE COMPLIANCE WORLD OF SMES

Authors: Martyn Knottenbelt, Senior Researcher, National Research and Evaluation Unit Inland Revenue, NZ : [email protected] Ph: 64 04 8901781 Elisabeth Poppelwell, National Advisor, National Research and Evaluation Unit, Inland Revenue NZ [email protected] Ph 64 4 8901841 Dr Xin Wang, National Advisor, National Research and Evaluation Unit, Inland Revenue NZ. [email protected] Rico Namay Senior Evaluator, National Research and Evaluation Unit, Inland Revenue NZ. [email protected] Acknowledgments: We would like to acknowledge the significant contribution made by Martina Battisti, David Deakins and Martin Perry in the SME Capability Project.

SUMMARY Tax is a core issue for all businesses. Small businesses (SMEs) especially are challenged with allocating limited resources to meet their compliance obligations, while still running a successful operation. Younger businesses and those with few or no employees are more likely to be at risk, with systems to maintain and new obligations to meet. Tax return data confirms they are less likely to meet their compliance obligations on time. Issues arise with all SMEs when they are unable to meet their obligations, and are faced with allocating limited financial resources across their operations and tax payment obligations. This paper looks at how SMEs deal with regulation, especially tax, the cost and the associated stress created as part of the process. It identifies those SMEs more likely to be challenged, the issues they face and what can be done to help them. It adds to current thinking by bringing together the knowledge gained from four major pieces of SME research undertaken between 2009 and 2011. It aims to create an improved understanding of the issues SMEs face, and suggests solutions to help SMEs meet their compliance obligations.

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INTRODUCTION New Zealand is one of the easiest nations in the world to start a new business (World Bank, 2010), but small business owners must still manage a range of regulations affecting their business; the most important being tax, employment and work and safety regulations (Battisti, Deakin and Perry, 2011). The contribution of SMEs to New Zealand’s economy is significant, with 40% of the total business output in 2009 coming from businesses with 19 or less employees (MED, 2011). SMEs are also significant employers, employing 580,680 (31%) of New Zealand’s employees in 2009 (MED, 2011). Despite their contribution to the economy, SMEs also have their challenges. A large proportion of the total tax debt is owed by SMEs, with the sector making up about a third of tax debtors within New Zealand (Poppelwell, Kelly and Wang, 2012).

Changes in the economy can affect SME business practices and their ability to comply with tax regulation. New Zealand has experienced challenging times, with the real GDP growth rate declining from 3% in 2007 to -1.7% in 2009, and then recovering somewhat to 1.5% in 2010. (Index Mundi, 2012). This resulted in fewer New Zealanders setting up their own businesses in 2009/2010 compared to previous years.

More SMEs ceased than were

established in the year ending February 2010 (MED, 2011), with the overall number of SMEs dropping by 1.7%. The decline in the overall number of SMEs was across almost all sectors, confirming the difficult times experienced by business recently in the New Zealand economy. Tax law and tax administrative process changes can also impact on SMEs ability to comply. Tax policy and administration in New Zealand has been aimed at reducing and limiting the cost of complying for taxpayers. However, tax changes can impact in the opposite direction, and add costs. Tax areas undergoing simplification in recent years include Goods and Services Tax (GST), income tax and pay as you earn (PAYE), fringe benefit tax (FBT) and KiwiSaver. A selection of the important changes between 2006 and April 2010 are presented in a timeline in Appendix 2.

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Significant changes affecting SMEs occurred in October 2010, with GST increasing from 12.5% to 15% and with changes to PAYE, ACC, and FBT rates. Further changes in April 2011 included the removal of depreciation on buildings, changes to depreciation on newly acquired assets, and the reduction in the company tax rate from 30% to 28%. In order to better understand this important taxpayer group, Inland Revenue New Zealand commissioned and collaborated on a range of SME research projects between 2009 and 2011. This paper focuses on four of them. The projects were undertaken independently of each other, and each focused on a different area of the SME regulation compliance environment. They include an in-depth assessment of SMEs’ attitudes and behaviours relating to tax debt; SMEs’ ability to deal with government regulation; an assessment of SME tax compliance costs (including superannuation); and a profile of SMEs that are routinely late at meeting their tax obligations. The objective of this paper is to bring together the key findings from the four research projects to gain a better understanding of the challenges small businesses face in regard to dealing with tax regulation. In addition, the paper aims to identify the implications of these challenges for SMEs arising out of the research findings, and discuss ways the tax administration can assist.

METHODOLOGY This paper draws together the findings of four projects which used a variety of methods including both quantitative and qualitative research. Some findings in the analysis are highly significant, especially those emerging from the analysis of Inland Revenue administrative data, where sample sizes are large and include most small businesses in New Zealand. Other findings in the analyses may be less significant, for example, differences between group comparisons based on the results of small surveys. As previously stated, some findings are based on qualitative methods, of which the results are not driven by statistical significance, but instead on the strength of themes emerging from in-depth interviews and focus groups.

Quantitative results are used to support themes or conclusions emerging from the qualitative research. Likewise qualitative research has been used to give some understanding to patterns which have emerged in the survey or administrative data. 3

In analysing the findings from the research projects, we searched for consistent trends and patterns in results occurring within the research pieces. In addition, references are also made to other relevant research, which are congruent with findings of the four projects. At the time of the writing of this paper, the analysis of the findings from the four projects is still on going and uses the following approach: Collating a summary of findings from the four different projects, and identifying and documenting where the findings from the projects support each other. The process involves integrating the results gained through analyses of administrative data, telephone and mail surveys, in-depth interviews, and an online tax experiment. Highlighting areas of disagreement/contradiction from the projects findings, and identifying gaps in knowledge.

Conducting interviews with the researchers and staff who conducted the four research projects, to discuss links between the project findings, identify and discuss the implications arising for SMES, discuss greatest challenges SMEs face and possible solutions/assistance the tax administration and other government agencies can provide.

Research methods used by the four projects A range of research methods were used by the four projects. These included in-depth interviews, a quantitative telephone survey, quantitative mail surveys, assessments of tax administrative data including trend analysis over an extended time period, and an assessment of factors affecting SME bill payment behaviour using an online tax experiment. A brief summary of methods used in the four projects is given below.

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SME tax debt research project Sixty in-depth interviews with SMEs were conducted by an independent research company. Findings were supported by results from a quantitative phone survey of 450 SMEs and 50 tax agents. An analysis of small business debt was also undertaken using tax administration data. In addition, 527 SME’s participated in an online tax experiment, investigating how business owners/financial decision makers prioritise bill and tax payments in times of cash-flow stress. The online tax experiment was a collaboration between Victoria University and Inland Revenue. SME compliance cost research Two quantitative mail surveys were undertaken in 2004 and 2009, with over 1,700 SME responses in each year. The survey established SME tax compliance costs and stress levels in the base year (2004), and then assessed whether SME costs and stress levels had changed (a repeat survey was undertaken in 2009). The 2004 survey was undertaken by an independent research company, and the 2009 survey was undertaken by Inland Revenue’s Research and Evaluation Unit. Profile of SMEs habitually late at meeting their compliance obligations An assessment of late filing and payment patterns among businesses was undertaken by the National Research & Evaluation Unit, using Inland Revenue data spanning up to seven tax years (from 2003 to 2009). Customers were classified as habitually late if they were late 75% or more of the time. This piece of work focused on Income tax, GST and PAYE. Additional qualitative information regarding at risk SMEs and their ability to deal with compliance obligations was obtained indirectly through a small number of in-depth interviews facilitated by an independent research provider.

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SME capability to manage regulation project In-depth interviews were undertaken with 111 SMEs employing less than 100 staff, exploring how owner-managers manage regulation. The research was augmented by a further 12 faceto- face interviews with key industry informants. Qualitative research was considered the best approach given the limited understanding of small business owners’ capability to manage regulation. A qualitative approach allowed exploration of the business context and the dynamic nature of the business owners’ responses to regulation. This project was a collaboration between the Ministry of Economic Development, Inland Revenue and Massey University. KEY FINDINGS This section synthesises the findings from the four different projects and discusses the challenges SMEs face with tax regulation and meeting their tax obligations. The findings are examined around three main themes; the size of the business, the effect economic conditions have on SME’s ability to meet tax obligations, and SME knowledge of the tax system and ability to deal with tax obligations. Theme 1: The size of the business Over 90% of New Zealand firms employ five or less employees (MED, 2011) and these small firms in particular have limited resources. Consequently understanding the ability of these small businesses to deal with the demands of tax regulation is important. Findings from the research projects suggest a number of challenges that relate to the size of the business. These are discussed below. Firm size and resource capacity The SME capability research concluded that a critical firm size of approximately six to ten staff exists, above which the firm’s resource capacity allows the owner-manager to employ expertise to manage the administrative, regulatory and/or financial side of the business.

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The researchers noted that employee numbers below this threshold, often result in ‘silent’ personnel, such as a wife or family members helping with those tasks, but they were often not suitably qualified (Battisti et al, 2011). However, findings from the SME compliance cost survey suggest the extent of family and friends involvement in assisting the business may be less. Approximately only five percent of the time required to meet tax obligations in 2009 was undertaken by family and friends (among businesses with no employees), compared with 95% by the business owner. Family and friend involvement figures appear to be similar among businesses with one to five employees (Evaluation Services, 2009). While the findings on the extent of family involvement differ between studies, it is important to note there is clear agreement that a large amount of the regulation responsibility in businesses with five or fewer employees lies with the business owner. This creates a challenge for small business owners in terms of his/her capacity and capability to deal with a variety of regulation obligations, while simultaneously providing the product or service that is core to the business. Firm size and ability to meet tax obligations Inland Revenue’s tax administration data confirms small businesses are more likely to have issues meeting their tax obligations. An analysis of SMEs who were habitually late1 (NaRU, 2011) confirmed self employed business people with no employees and no formal business structure were more likely to be habitually late compared to those employing staff. The situation was similar among SMEs with some business structure, but with no employees (i.e. a company). While, the administrative data does not explain why smaller businesses are more likely to be habitually late, the SME capability findings suggest it may be related to a combination of resource availability and lack of effective systems and processes. Small businesses that have set up a company or partnership structure performed better on GST and PAYE compliance compared to the self employed group. This suggests that having a formal business structure, even for the smallest businesses, indicates a planned approach to business management.

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Habitually late customers were IR customers who were late at filing and paying their tax returns 75% or more of the time 7

Small businesses that employ on an occasional basis were also more likely to be habitually late with PAYE returns. One possible explanation for this is that these businesses do not have the systems and processes or resources to deal with periodic additional regulatory requirements. While the number of businesses in New Zealand employing staff is reasonably constant2, there is considerable churn in terms of businesses employing occasionally over time. When analysing trends over a three year time period, only 66%3 of the businesses in 2006 were still employing three years later in 2009.

Research findings from the KPMG and Business NZ Compliance Cost survey (KPMG, Bus NZ, 2007) confirm that tax is the biggest compliance cost priority for businesses with five or less employees. Tax is a much higher priority for this group, when compared with larger SMEs. Yet results suggest SMEs within this group (especially those with no employees) are the ones who find it most challenging dealing with tax obligations. Firm size and stress associated with tax regulation. Findings from the SME capability work suggest the smaller the firm, the more likely the owner-manager is responsible for dealing with all aspects of the business (including regulation) which was often described as “debilitating” and “tiring”. The SME compliance cost research concluded that all businesses have some degree of stress dealing with their tax obligations, but findings did not confirm that smaller firms found it much more stressful dealing with tax requirements than firms with more employees. Stress levels among firms employing five or less employees were only marginally higher than firms with more than five staff, and stress levels among all SME sizes were only moderate. Tax stress levels were also marginally lower among SMEs with no employees, which could suggest PAYE adds to the total compliance stress.

The SME compliance cost findings suggest that stress may not be a key issue in regard to SME’s ability to deal with, and manage tax regulation.

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IR Business Trends, http://www.ird.govt.nz/aboutir/external-stats/tax-returns/customers-by-returns/tax-returns-customersby-returns.html 3

This calculation is based on whether businesses had submitted PAYE returns to Inland Revenue in both the 2006 and 2009 tax years 8

Firm size and external support Findings from an analysis of Inland Revenue tax administrative data indicate tax agent support improves a business’s ability to meet their tax obligations, with SMEs being less likely to file late (NaRU, 2009) and much less likely to be habitually late when filing tax returns (NaRU, 2011). An analysis of SMEs with tax debt also confirmed SMEs with an agent are less likely to have tax debt compared to those businesses without an agent (NaRU, 2011a). The findings suggest tax agent support can provide SMEs with both administrative benefits (filing on time) and financial benefits (less debt). Cost savings are considered to be a motivator for businesses to complete tax returns without tax agent support. A problem of self-completion is that SME owners may not always have the capability to deal with their tax regulation themselves, especially if their tax affairs are complex. Tax agent usage is lowest among businesses with no employees, whether self employed with no business structure, or registered as a company or partnership (NaRU, 2011). This group in particular is likely to be the most resource constrained, given that no additional support is available within the business to deal with tax regulation requirements. They are also the group most likely to find it challenging to fulfil their obligations. Firm size and sources of information and advice With few exceptions, the SME capability research found that SMEs do not have a problem accessing information and advice in relation to regulation and changes of regulation. The majority of business owners felt that there was enough information available, and believed they were able to access information and advice using a variety of channels – at least in regard to general business regulation (Battisti et al, 2011). Main sources of information and advice for SMEs were trade associations, industry bodies, chambers of commerce, accountants, lawyers, banks, government departments, and fellow business people. Most trade associations provided seminars to deal with one-off issues and concerns with regulation changes and new regulations. However, business capability issues remain, and the findings suggest SMEs have issues implementing changes and setting up processes rather than being aware of changes and requirements, and sourcing the relevant information. 9

Firm size, systems and processes A key factor determining SMEs ability to deal successfully with regulation is the extent to which owner-managers can implement management systems and processes in the business (Battisti et all, 2011). In general this work found that a good business manager put in place appropriate systems leading to better overall ability to meet their regulation obligations Findings from the SME debt research confirm that systems and process failures are directly linked to lateness and tax debt. For example, almost half (46%) of those SMEs who had no tax debt but had been late, said they had forgotten or were not aware of the due date, and a further 30% cited administration error. This suggests the majority of errors in this group were attributable to systems and process issues. A third of SMEs (35%) with some tax debt history had also forgotten the due date, again pointing to issues with systems and processes. Theme 2: The effect economic conditions have on SME’s ability to meet tax obligations Exploratory work undertaken by Inland Revenue suggests tough economic times may influence tax compliance rates. GST filing compliance rates4 tend to be higher when New Zealand’s average economic growth rate is higher, and filing compliance rates tend to be lower as the average economic growth rate5 declines. Similarly, GST filing and payment compliance rates tend to be higher with decreases in the Consumer Price Index (CPI) tradable, non tradable, and all group indexes (NaRU, 2010). These indexes are a measure of inflationary pressure, so declines in index ratings mean less inflation in New Zealand’s economy. The findings suggest decreases in inflation are associated with higher compliance rates.

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Submitting returns within 1 week of the required date. Average economic growth figures are calculated from Gross Domestic Product (GDP) and Gross National Product (GNP). Consequently, GDP and GNP have a similar relationship with SME compliance rates as the average economic growth rate. 5

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In the broader context in which SMEs operate, adjusting to economic trends (like the recent recession) can have a more significant impact on businesses than individual regulations (Battisti et al, 2011). Findings from the SME capability research concluded that the most important incident affecting businesses has been the recent recession. The recession impacted on businesses through reduced customer demand, fluctuating workload, increased competition, and as a result, constrained cash flow. Constrained cash flow as the result of the recession also significantly impacts on SMEs ability to comply with regulation, especially tax obligations. Consequently, while SME owners might have a high level of capability to manage regulation, change in the economy means they might become non-compliant due to temporary changes in business circumstances. Effect of the economy on business cash flow Findings from qualitative work undertaken with SMEs in debt adds further insight into the effect of economic downturn on cash flow and their ability to meet their tax obligations. SMEs with significant or long-term tax debt attributed their debt to the downturn in the economy, reduced income and debtors being slow to pay (or defaulting), all culminating in poor business cash flow (Colmar Brunton, 2011a). Generally, SMEs with tax debt were ‘hanging on’ or getting deeper into debt while they wait for the economy to improve. They felt that repayment of debt was out of their control, but most wanted to avoid bankruptcy due to embarrassment and/or inability to find other employment and income for themselves and staff. SMEs with tax debt caused by cash flow difficulties are likely to be more restricted in the changes they can make to avoid tax debt in the future. Options for them include setting aside funds to ensure payments can be made, generating more revenue, and improving debtor management. The potential for some of these changes depends on the economy, overall debt level of the business, and whether they can realistically trade out of difficulties. The economic downturn may also have some impact on SME’s decisions to invest in systems and processes, like accounting packages which can positively affect business capability. Likewise cash flow constraints may influence the level of investment in external advice and tax agent support.

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Debt prioritisation in times of cash flow difficulty The online tax experiment, which was a component of the SME debt project, assessed how SME owners and financial decision makers prioritised bill and tax payments in times of cash flow shortage. Arguably, the experiment is also simulating the possible negative effect of an economic recession on SMEs ability to meet tax obligations. Results from the tax experiment study concluded that when faced with a cash flow shortage and resource allocation decisions, businesses were most likely to put salary and wage payments ahead of tax, supplier and interest payments. Payments for tax rated second overall, ahead of supplier and interest payments. When businesses were made aware they would need to pay penalties and interest on unpaid tax debt in the experiment, they tended to allocate more funds to tax payments. However salaries and wages remained the key priority. Smaller businesses were more likely to reallocate supplier payments, and channel these towards their tax obligations. The experiment results highlight how cash flow shortages and an economic downturn can impact on tax obligation payments, as businesses struggle to balance payment priorities. However the existence of financial and non financial sanctions will encourage them to make tax repayment one of their key priorities. That said, it is unlikely tax obligations will become the top payment priority for all cash flow stretched small enterprises. A more likely scenario is ensuring a commitment from SMEs to address unpaid tax debt through instalment arrangements with the tax administration. Theme 3: SME knowledge of the tax system and ability to deal with tax obligations. Research results suggest SMEs knowledge of the tax system is less than ideal, and this could be compromising their ability to survive in difficult circumstances. The purpose of tax system sanctions is to encourage taxpayers to comply voluntarily with their tax obligations, and ensure breaches of tax obligations are imposed fairly and consistently. Inland Revenue’s financial sanctions are applied when a business has not met their obligation on time, after allowing for a seven day grace period. An additional factor to consider in having a well-designed penalty system is the need to ensure that sanctions are within reach of those who the system is intended for. Systems need to be well-informed and designed to encourage, and not deter SMEs from meeting their obligations (Colmar Brunton, 2011).

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This section provides insights into SMEs awareness of the sanction system (i.e. penalties and interest), and their experiences with the sanctions when they have been unsuccessful at meeting their obligations. It provides insights into how SMEs can be helped to meet their obligations through support and early intervention. The section also looks at how business owner aptitude affects their ability to deal with regulation and issue arising in the start up phase. SME awareness of penalties and interest for late payment of tax obligations An objective of the SME debt research was establishing their level of awareness of the tax penalty system, and the ramifications for not meeting tax obligations. Almost all participants (99%) in the telephone survey of 450 SMEs6 were aware financial penalties are incurred for the late payment of business tax. However, most lacked a good understanding of the late penalty process, and the rates at which late penalties and interest are applied. Consequently, most SMEs were also unaware at how quickly unpaid taxes, penalties and interest could accumulate, and the potential negative effect it could have on their business. For the vast majority, penalties and interest were an effective encouragement to pay on time, with 90% of SMEs surveyed saying penalties were very/quite influential in making sure they pay by the due dates. The fact that penalties existed appeared to be the key motivation for most SMEs paying tax on time, rather than the structure, penalty size, or the interest charges. Most wanted to avoid any unnecessary cost to their business (Colmar Brunton, 2011). Penalties, while not improving SME ability to deal with tax regulation, are a key motivator for dealing with tax regulation in a timely manner. Another key finding from the research has been that increased knowledge of the penalty system can increase compliance for SMEs in the early stages of the tax debt. For those who were late or who had been in tax debt before, increasing their knowledge of the penalties and their effect was likely to have a positive impact on their repayment behaviour.

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The research sampled three customer groups; those who had never had tax debt, customers with past tax debt, and customers who were currently in tax debt.

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For SMEs in debt for some time, receiving additional information from Inland Revenue about the sanctions is unlikely to make a difference to repayment behaviour. At this later debt stage, SMEs thought there was little they could do, and further information could be detrimental to repayment behaviour (Poppelwell et al, 2012). Lack of awareness of debt payment instalment options SMEs with overdue tax debt were not always aware they could contact Inland Revenue to discuss payment options. More than two thirds of SMEs who had been late with a tax payment, and who weren’t aware they could have contacted Inland Revenue before the due date, said they would have contacted Inland Revenue if they had known they could avoid some penalties. These results suggest that providing SMEs with information in the early stages of debt, discussing with them payment options, and the possibility of avoiding penalties is likely to encourage them to contact Inland Revenue. This could prevent some SMEs from incurring debt (Poppelwell et al 2012). The result would be a better outcome for the tax administration in terms of improved revenue collection. The benefit for businesses is that by adopting a planned approach to managing their debt, less of their income will be wasted on non productive penalties and interest. This should enable them to focus instead on business recovery. Changes in behaviour as the result of making a late payment The majority of SMEs stated they had made changes to practices and processes as a result of interacting with Inland Revenue’s late payment process. The research also found that the simpler the cause of the debt, the more likely SMEs were able to change their behaviour, thus improving their regulation capability. SMEs with tax debt caused by administrative errors said they made straightforward changes to business practices and processes to ensure it doesn’t happen again, for example, reminders of due dates and improved administrative practices (Poppelwell et al, 2012). SMEs currently in debt (for whom short-term cash flow was the main reason for late payment) are most likely to say they now set funds aside to make payments, or they keep a closer eye on their obligations and finances.

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The findings indicate SMEs with tax debt caused by long-term cash flow difficulties are more restricted in the immediate, straightforward changes they can make. They need to make more substantial changes to avoid this situation in the future, (e.g., generating more revenue, improving debtors’ management and better management of finances).

Using non-monetary sanctions to improve business capability A key objective of the debt and penalty research was to assess the impact non-financial sanctions and incentives have on improving payment of tax debt. Research participants were asked their views on five proposed non-monetary sanctions and incentives and whether they thought they would be effective in encouraging SMEs to pay their outstanding tax. The non monetary sanctions tested were; “Improved notification” from Inland Revenue, “Credit reporting” for non payers, An “annual practising certificate” from Inland Revenue for SMEs with no tax debt, “Travel restrictions” on the SME owners with tax debt, And “information on statements to show how penalties and interest build up”.

SMEs in debt or with a history of debt considered the most effective non-monetary initiatives to be improved notification and information on statements to show how penalties and interest accumulate. It is worth noting that SMEs chose non-monetary initiatives which provided support to their businesses, as opposed to sanctions. These non monetary initiatives effectively reinforce the large negative impact of cumulative penalties and interest on their business, and remind them to deal with the issue before the debt become unmanageable. When these sanctions were explored in-depth, interviewees thought that notification in itself would only be partly effective. The findings indicate that full leverage comes from the dialogue and Inland Revenue’s ability to waive penalties in return for a payment arrangement.

The optimal compliance system may need to strike a balance between

corrective elements (penalties and interest charges for late payment) and assistance from Inland Revenue to help ensure payments are made by the due dates.

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The link between aptitude and ability to deal with tax obligations Findings from the SME qualitative debt research concluded that financial and business aptitude makes the difference between SMEs who have never been in tax debt and SMEs with an experience of tax debt. Other Inland Revenue research by both Research New Zealand (2011) and Colmar Brunton (2004) with customers at the top of the compliance pyramid (i.e. often not meeting their obligations) identified that business owners do not always have the business skills to meet their tax obligations. On a similar theme, the SME capability work concluded an important aspect of SME’s ability to deal with regulation effectively, was the manager/owner(s) capability and longer-term approach to business planning (i.e. business aptitude). Challenges in the business start up phase A theme emerging from interviews with SMEs starting up businesses was the feeling of uncertainty, and owners not knowing whether they were complying or not. This suggests a lack of clarity among SMEs in regard to their obligations in the early phases of business development (Battisti et al, 2011). While based on a small number of interviews, SME capability findings suggest that some owners operating a business for less than 12 months do not recognise the full impact of tax regulation on their business. This may be due to the income tax deferral system in the first year of business, with the impact of provisional tax on the business, yet to be felt (Battisti et all, 2011). Some SMEs interviewed in the debt research (Colmar Brunton, 2011a) emphasised the need for information and education in the business set up phase. They suggested preventative education for new businesses could be effective, ensuring new owners understand tax requirements and have the appropriate systems and processes in place. They also recognised the benefits tax agents could provide, in terms of support and managing the business accounts. No supporting analysis of administrative tax data was undertaken in these projects, looking at the effect of tax agent support on SMEs ability to deal with regulation during the businesses in the start up phase, or the effect of tax agent support on business survivability.

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Work by the UK tax office (House of Commons, 2007) indicates proactive support by the tax administration (in terms of phone contact or workshop attendance) does result in an increase in tax compliance rates for newly registered businesses. Inland Revenue currently offers newly registered businesses the opportunity to attend free workshops or seminars (please refer to the letter invite example in appendix 1), but measures of their impact on management capability and compliance are not currently available. DISCUSSION New Zealand is one of the easiest nations to start a new business. However, small business resource capacity, effective business systems, and the effects of the economy remain issues irrespective of the regulatory environment in which New Zealand’s smallest businesses operate. Whether or not family, friends or employees help, most of the regulation responsibility lies with the small business owner. Administrative data supports observations that smaller businesses (with few or no employees) are more challenged meeting their tax obligations. This group is more likely to be at risk, even though tax is a higher compliance priority for them compared to larger businesses (Business NZ & KPMG, 2007).

Findings suggest the

stress associated with meeting tax obligations is not a key issue affecting SME’s ability to deal with tax regulation. Rather, issues remain with systems and processes, economic conditions, and resource capacity. Awareness and access to regulation information and advice Firms in general think there is enough general regulation information available and they are able to access information and advice from a wide variety of sources. Government is also considering expanding its support to small businesses through the development of a one stop shop for businesses. However the SME debt research exposes gaps in detailed knowledge in regard to the late payment system. The effects of these sanctions impact on all SMEs who are unable to meet their tax regulatory requirements within the required timeframes. The potential impact of penalties and interest on business resources is significant.

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Opportunities exist for “at-risk” SMEs to benefit from an improved understanding of tax debt repayment options, through early dialogue with the tax administration. Potential outcomes are a more planned approach to managing their tax debt, providing SMEs with more certainty, and minimising the exposure of their business to unproductive penalties and interest. This should enable SMEs to focus instead on improving business systems and where possible, improvement of the businesses cash flow position. Findings also suggest that an improved understanding of the cumulative impact of penalties and interest early in the debt cycle is important, and will motivate businesses to address their tax debt sooner. Translating information and advice into improved business capability The SME capability research suggests SMEs have issues translating information and advice into improving business systems, processes and capability. Characteristics of some SMEs who struggled to implement changes in practice were those who relied on few external sources and had limited access to professional advice (Battisti et al, 2011). The SME debt research shows businesses do make simple changes to their systems and processes as the result of interaction with the late payment system (e.g. when forgetting or missing the due date). However, these systems and process improvements are not made as the result of using available information and advice on tax regulation to improve business systems and capability. A range of organisations provide information and advice to small businesses (e.g. Trade associations, government business.govt.nz, Chambers of Commerce).

It is difficult to

establish how much of this information and advice available to businesses is translated into improved systems and processes, as a proportion of businesses continue to have challenges meeting their tax obligations. Benefits of external support Inland Revenue’s administrative data shows tax agent usage improves small business ability to deal with regulation. Benefits can be both administrative and financial (i.e. more likely to be on time and less likely to have tax debt). The benefits of support by other providers (i.e. business coaches, industry associations, government agencies) has not been measured directly in these four pieces of work.

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Tax agent support is lowest among businesses with no employees. This group in particular is the most resource constrained and challenged, given that no additional support is available within the business to deal with tax regulation requirements. With lower levels of external support, it is likely systems and process issues and capacity are a significant challenge among this large customer group. The effect of the economy on business capability The research indicates that recession affects SME ability to meet tax obligations. Slow debtor repayments, reduced customer demand, fluctuating workload and lower income impact on business’s cash flow, and consequently their ability to meet tax payments. While SME owners might have a high level of capability to manage regulation, a significant change in the economy means some become non-compliant due to temporary changes in business circumstances. Recession effects are also likely to have a follow-on impact on ability to invest in systems (like accounting and tax software) and professional advice. The positive effect of sanctions on tax regulation While penalties and interest do not improve SMEs ability to deal with tax regulation, they do motivate small businesses to meet their obligations in a timely manner. For the vast majority, penalties and interest are an effective encouragement to pay on time. Penalties and interest also bring about behaviour change for those with simple non-compliance reasons (e.g. forgetting or missing the due date), with SMEs reporting changes to business practice as a result. In regard to non financial sanctions tested in the research, SMEs in debt chose non-monetary initiatives which provided support to their businesses, as opposed to further corrective action. These non monetary initiatives effectively reinforce the large cumulative impact of penalties and interest on their business, and remind SMEs to deal with the issue before the debt situation becomes unmanageable.

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Financial ability to meet regulatory requirements Both the SME debt, SME capability and the wider Habitual non-complier qualitative work identified the effect that cash flow problems have on SMEs meeting their tax obligations. Some issues can be resolved through better business planning, by putting aside funds to meet obligations. However, business cash flow is likely to remain an on-going issue with changes in economic climate, and with the fact that new business take time to establish themselves and improve profitability. It is also likely that a proportion of businesses will experience cash flow difficulties at any one time. An achievable and likely overall business capability goal would be reducing the proportion of SMEs who have cash flow issues dealing with tax regulation and compliance, through improving business planning. CONCLUSIONS The combined findings of the four pieces of research have highlighted the resource, and systems and process issues some SMEs face in regard to dealing with tax regulation. The smallest businesses (i.e. no employees) in particular are most likely to be challenged, with no additional internal support and being less likely to use external resources, like tax agents. At-risk SMEs are likely to benefit from improved systems and processes, but initial observations suggest SMEs who struggle to implement system and process changes in practice are those who relied on few external sources and had limited access to professional advice. Providing businesses with practical support to implement systems in the business may be one key to improving capability, as well as educating small businesses on the cost benefits of adoption of electronic systems (e.g. established system, less late tax payments, support from provider, and an established system). The research has confirmed that tax administration interventions can play an important role in improving outcomes for businesses who have difficulties meeting tax requirements. Proactive reminders and contact at the early stages of tax debt are likely to prompt businesses to deal with their debt before it becomes unmanageable. The outcome should be positive for both SMEs and Inland Revenue. SMEs in tax debt should be able to adopt a more manageable approach to tax debt by minimising their exposure to penalties and interest via installment arrangements, or through paying off debt earlier.

The positive outcome for the tax

administration should be an improvement in revenue collection.

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While tax administration support can help improve compliance capability through proactive intervention and early education, it is important to note much of the onus to improve systems and processes still lies with the small business operators themselves. References: Battisti., M, Deakin., D and Perry M (2011). SME Capability to Manage Regulation New Zealand Centre for Small & Medium Enterprise Research, Massey University. Business NZ, KPMG (2007): Summary report of the Business New Zealand – KPMG Compliance Cost Survey. Colmar Brunton (2004). Understanding taxpayers’ compliance decisions. Research to inform the On-Time Compliance Strategy. Colmar Brunton, Social Research Agency. Colmar Brunton (2011). Business tax late payment penalties and interest charges: Report on a survey of SMEs and tax agents. Colmar Brunton, Social Research Agency. Colmar Brunton (2011a). Prevention and management of SME tax debt Final report of qualitative research findings. Colmar Brunton, Social Research Agency. Evaluation Services (2009). Changes in SME tax compliance costs 2004 to 2009 Evaluation report 2, Evaluation Services, Inland Revenue New Zealand. House of Commons (2007). Committee of Public Accounts. Helping newly registered businesses meet their tax obligations. Index Mundi, 2012 http://www.indexmundi.com/g/g.aspx?v=66&c=nz&l=en data source: Central Intelligence Agency-World Fact Book. MED, (2011) SMEs in New Zealand: Structure and Dynamics 2011, Ministry of Economic Development, September 2011. NaRU (2009). Differences in Customer Compliance Caused by Location. What lies behind the

geographical differences in customer compliance and behaviour? National Research Unit, Inland Revenue New Zealand. NaRU (2010). Meta analysis. A synthesis of findings from the External Factors, Demographics, and Compliance by Locations project. National Research Unit, Inland Revenue New Zealand.

NaRU (2011). Compliance Focus Habitual Non-Complier Project Tier 2 Analysis National Research Unit, Inland Revenue New Zealand. NaRU (2011a) Understanding the debt owed by SME customers: An analysis of Inland Revenue’s administrative data. Final report. Poppelwell., E, Kelly, G, Wang., X (2012) Intervening to reduce risk: Identifying sanction thresholds among SME tax debtors. National Research and Evaluation Unit, Inland Revenue. Research New Zealand (2011). The voice of Habitual Non-Compliers A Qualitative Research Report.

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World Bank Report (2010.) Doing business: Measuring business regulations, retrieved from http://www.doingbusiness.org. Appendix 1: Inland Revenue invite to new GST registrants to attend a free workshop/seminar Date…………

Inland Revenue P O Box…. Office Postcode

Mr/Mrs……… Address…… Post code Dear…………. FREE Business Tax Seminars and Workshops - Get it right from the start Now that you are registered for GST we would like to invite you to attend one of our free seminars or workshops in [insert location from contact table]. This will help you understand: What records you need to keep When/what expenses are deductible What free online tools are available on our website When and how to file returns To find dates and more details about the various seminars and workshops near you, please visit www.ird.govt.nz and enter the keyword “workshops” into the search box. Booking is essential due to room capacity. To register your interest in a particular session please provide your name, business IRD number, contact details and preferred dates by: Email: [insert from contact table] Or Telephone: [insert from contact table]

We hope you are able to take advantage of this opportunity to have a better understanding of business taxes. Yours sincerely James Smith Manager Customer Services 22

Appendix 2:

Figure 1: Selection of key tax changes relating to SME compliance costs

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