INCOME TAX ADMINISTRATION AND PROFITABILITY OF SMALL SCALE

MEDIUM ENTERPRISES A CASE STUDY OF SELECTED SMES IN IBANDA TOWN

COUNCIL

NAIGA APOPHIA

11/BSU/BBA/198

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 CHAPTER ONE

1.0 Introduction
This chapter included the following; back ground to the study, statement of the problem, purpose
of the study, objective of the study, research questions, scope of the study which includes the
conceptual scope, geographical scope and time scope and finally the significance of the study.

1.1 Background of the Study

In Uganda Small and Medium enterprises (SMEs) are increasingly seen as engines of economic
growth of the country, contributing 75% of GDP and constituting 90% of the private sector. This
is because they contribute to sustained creation of employment approximated to be 2.5 million,
improve living standards and ensure social and political stability (Hatega, 2007). On the other
hand, it has been observed from previous taxation studies that several SMEs in developing
economies are generally not compliant to tax despite the significant number of reforms intended
to enhance compliance (Terkper, 2003; James, Barbour & Stern, 2007; Ayoki, 2007). Such
enterprises cannot easily be located by tax administration (Teera, 2005), and those who can be
traced pay less than their fair share of tax (Ahmed& Braithwaite, 2005).

Income tax is therefore defined as; a tax imposed on a person's taxable income at specific rates.
A person includes an individual, company, partnership, trustee, government and sub divisions of
government. Income tax is charged on every person who has chargeable income for every year of
income. Chargeable income is derived from three main types of income, namely; business,
employment and property. In addition, a tax is referred to as a non-quid pro quo, implying that a
tax is paid by assesses without corresponding returns in form of social goods and services from
the government. Justice Holmes described tax as the price for civilization. Ismail Kintu (2011).

1.2 Statement of the Problem

Income tax administration plays a pertinent role regarding revenue collection as well as
profitability of any business entity. In an effort for the government to increase its tax base, the
tax burden for many firms increases. However, the tax administration system is poor as at times,
the tax liability computation is based on estimates, records of many small business firms are
incomplete, and some miss out completely leading to tax over charge. In return, this directly

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affects the profitability of the enterprise and may threaten its survival because taxes are paid out
of profits. Income tax administration rate system was enacted by government as per second
schedule of section 5 of the income tax act (1997) to promote SBES. However, it has affected
their profitability as measured by the return on capital employed. The Income tax administration
operates in such a way that those business whose annual turnover is less than five million are
exempt from tax. Those whose gross turnover is more than five million but less than twenty
million pay 100,000,those whose annual turnover is more than twenty million but less than fifty
million pay 250,000 or 1% of gross turnover.lastly,those whose gross turnover is more than fifty
million pay 450,000 or 1% of gross turnover which is ever lower(Pius K Bahemuka). Despite the
fact that Income tax administration was enacted to promote Small Business Enterprises, they
have continued to perform poorly (Kiiza, 2005), 35% of Small Business Enterprises do not
survive for more than one year after commencement Ismail Kintu (2011). Therefore, failure to
have an effective tax administration system adversely affects the profitability of small-scale
businesses.

1.3 Purpose of the study

The purpose of the study was to establish the effect of income tax administration on the
profitability of small-scale business enterprises.

1.4 objectives of the study

The study was guided by the following research objectives;
a. To evaluate the effectiveness of the income tax administration of the selected Small Scale
Business in Ibanda Town Council
b. To examine the profitability of the selected Small -Scale Business Enterprises in Ibanda
Town Council.
c. To establish the relationship between income tax administration and profitability of small-
scale business enterprises in Uganda.

1.5 Research Questions

The study was guided by the following research questions;
i. What is the effectiveness of the income tax administration of the selected Small Scale Business
in Ibanda Town Council?
ii. What are the profitability levels of small-scale business enterprises in Ibanda Town Council?

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iii. What is the relationship between income tax administration and profitability of small-scale
business enterprises in Uganda?

1.6 Scope of the study

1.6.1 Content scope

The study covered Selected small-scale businesses in Ibanda Town Council; specifically the
study found out the effectiveness of the income tax administration of the selected Small Scale
Business in Ibanda Town Council, examine the profitability level of selected Small -Scale
Business Enterprises in Ibanda Town Council and to establish the relationship between income
tax administration and profitability levels of selected small-scale business enterprises in Uganda

1.6.2 Geographical scope

The study was carried out among Selected Small Scale - Business Enterprises in Ibanda Town
Council- Ibanda district. Ibanda District is bordered by Kamwenge to the northwest and north,
Kiruhura district to the east, Mbarara district to the south and Bushenyi district to the southwest.
The district headquarters at Ibanda are located approximately 71 kilometers (44 mi), by road,
northwest of Mbarara, the largest city in the sub-region. The coordinates of the district are: 00
07S, 30 30E, is connected to the National Electricity Grid with a sub-station 4 miles (6.4 km)
outside Mbarara town.

1.6.3 Time scope

The study considered a period of three years, 2011-2014. This period was selected to enable the
researcher come up with coherent information from the respondents as it would enable the
respondents to give responses that are typical of their opinion from the observations made over
this period.

1.7 Significance Of The Study

The findings enrich the available literature on the study of income tax administration and
profitability of small-scale businesses.

The study assisted the tax administrators in Uganda to design and formulate tax policies that
improved on the profitability of small-scale business enterprises.

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The accomplishment of the study enabled the researcher to acquire hands on the skills about
processing of research work and data analysis. This proficiency enabled the researcher to handle
such related with a lot of precision and proficiency.

The study is vital for the public as it brings out the effect of taxes on investment, which served as
a basis for future.

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 CHAPTER TWO

LITERATURE REVIEW

2.1 INTRODUCTION
This chapter looks at income tax administration and its impact on the profitability of small scale
business enterprises in Uganda particularly in Ibanda Town Council. It consists of existing
literature on income tax administration and profitability by different schollars/research studies
from magazines, textbooks, journals, and news papers and internet.

2.1.0 DEFINITION OF TERMS

2.1.1 The concept of taxation

This refers to assessment, collection, administration and management of taxes in Uganda. It deals
with raising public revenue, managing public expenditure and public debt. It is the responsibility
of URA (Manasseh, 2009). The general idea behind taxation is the provision of public goods and
services. However, the benefits received by taxpayers from the government are not related to or
proportionate to the tax paid. (Bhatia, 2002). Taxation is a payment, which cannot be avoided
without attracting a punishment, and in return, of which the government promises no gain/quid
pro-quo to the taxpayer (Balunywa, 1988). The government is responsible for providing to its
citizens certain public facilities and services like roads, hospitals, schools, and market securities.
There are two main tax authorities; the local government authority and the central government
authority through Uganda revenue authority (URA).

2.1.2 Tax
It is defined as a compulsory and non-refundable contribution executed by government for public
purposes. Payment is not followed by concurrent benefit in return. A tax is generally referred to
as a compulsory levy imposed by the government upon the assesses of various categories. A tax
is paid without a corresponding return in terms of goods or services from the government and
hence it is referred to as a non-quid proquo payment (Income Tax Act, 1997). A tax is also
defined as a contribution levied on any person, property or business for supporting local or
national government. Muwanga J, (2004).

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2.2.0 The effectiveness of the income tax administration

2.2.1 Approaches to tax administration

According to Bird (1974), tax administration refers to the identification of the taxpayer,
assessment of tax payable, collection of taxes and enforcement of tax liability. According to
Olman (1967), tax administration refers to a structure/procedure of identification of potential
taxpayer, collection and laws governing taxation. The goal of tax administration is to foster
voluntary tax compliance (Silvani, 1992) and hence Reduce tax gap (difference between taxes
paid and owed for all taxes by all taxpayers) and compliance gap. This can be done through
assessment of potential tax payers, identifying and registering the tax payers and provision of tax
payer services among others.

The URA frequently assesses tax returns submitted by tax payers. These assessments are
typically desk reviews of self declarations and supporting documents. The tax officer may accept
the tax payers’ declaration as it is or assesses an additional tax to be paid. The government of
Uganda through Uganda Revenue Authority established in 1991 has been able to further
strengthen tax administration through a series of institutional reforms (Mutebile, 2001). URA
administers different types of taxes under different Laws (Acts) such as Income Tax, Value
added tax, Customs duties and Excise tax among many others, Hence URA is supposed to ensure
taxpayers comply with the respective tax law.

2.2.3 Problems encountered by small-scale businesses in trying to comply with tax policies
Most businesses in Uganda are owned and managed by persons who are unskilled in the
profession of accounting and thus do not keep proper books of accounts. These are especially
sole proprietors and family businesses or partnerships. These generally do not keep books of
accounts; have low sales turn over and change hands and business very often (Ravenous, 2005).
Mugulusi (2001) found out that a large proportion of business community is ignorant about taxes
they pay, how these taxes are computed, lack of knowledge is attributed to the poor methods of
sensitization used by URA. According to Ravenous (2005), the following are some of the
problems faced by taxpayers;
i. There is unfair treatment of taxpayers, some of which are not necessary tax obligations and
thus not met because of this process.

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ii. Taxpayers have little understanding of the obligation because of lack of tax education. It is
said that URA would get fewer problems with taxpayers if they were able to understand how
their liabilities come about.

2.3.0 PROFITABILITY OF SMALL SCALE BUSINESSES

The assessment of financial performance of profit entities has a well established methodology
that includes the computation and interpretation or univariate and multi-variate modes.
University predictors of performance of periods and there ratios assess liquidity position,
profitability levels and efficiency, (Makerere Business Journal, 1996). A study carried out by
USAID 1995) revealed that the small business enterprises sector employ about 20% or the
population of working age and 60% of entrepreneurs in Uganda depend on their business for at
least half of their business income. Profitability of Small Business Enterprises is therefore vital
to the economy because a large percentage of the population depend on them for their livelihood,
there is thus need to support these Small Business Enterprises (Kiiza, 2005).

2.3.1 The concept of Profitability

Boggers (1967) described profitability as the organization’s desired state where turnover is the
greater than input costs. This was corroborated by Herman son et al (1987) who said profitability
is the organizations ability to generate income. Therefore, profitability must reflect only in the
income statement of the organization to certify that the income generated is greater than the input
costs. The growth of Small Business Enterprises has retarded due to lack of knowledge on taxes.
Mitra (1997) found out that most enterprises in Uganda are struggling with no profit and hence
no taxable income yet they would not have paid it they were to use the corporate rate. This is due
to the fact that most Small Business Enterprises do not keep proper books of accounts. Taxation
has thus greatly reduced their profits thereby undermining their struggle to expand.

Taxes directly affect the profitability of business resources (Mutebi 2004). income taxation on
small business enterprises greatly reduces their profitability, limits their leverage of growth and
creates poor revenue performance, (Asio, 2004). Also, Mitra (1997) asserts that income tax
mismanagement is one of the principal causes of persistent budget deficits, he said that
mismanagement of taxes forces business to close down most of the time, making them earn less
than expected revenue since then usually loose customers on closing, Small Business Enterprises
have little capital investments such that if this capital is taxed, as it usually is, the business are

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left with no means of survival. Generally speaking the principal motive of most small business
enterprises is profitability. Maximization of profits is not the only motivation of small business
enterprises but typically the most important therefore the success of any business depends on the
profits it enjoys, (Batty 1978). The greater the percentage returns, the more successful the
business is regarded Birabwa (1996) says profits of Small Business Enterprises are maximized
through cost reduction, good management skills and good budgetary control.

2.4 Relationship between income tax administration and profitability of small scale
business
In our definition of tax, it is clearly illustrated that a tax is not a price paid by the tax payer for
any definite service or benefit from government, and tax payers have no right to any benefit from
public expenditure on the ground that they are paying taxes. However to distinguish a tax from
government receipts that may contain an external of compulsion the concept of guide pro-quo is
used is used as an illustration .the absence of a quid pro quo is necessary for a payment to qualify
as a tax, Balunwya, (1996). The regime and authorities make management of micro and small
enterprises very difficulty whereby for example lump sum pre payment and estimated
assessments are imposed on the entrepreneurs. The existence of multiple taxes of operational
businesses in general and to small business sector in particular has been ranked as second barrier
after capital to entry into small business sector, Kibwika P, (2004).

Taxes tend to stifle the growth of small private sector and especially hinder the graduation of the
informal sector firms to visible small and medium scale firms Siminyu Nicholas, (1992). The
multiplicity of taxes whose burden also fall on the micro and small scale enterprises has a
negative effect on their performance by reducing the firm's profits and its savings and investment
potential, Desoto (1989).

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 CHAPTER THREE

METHODOLOGY

3.1 Introduction
This chapter highlights the procedures that were followed in the whole research process. It
discuses the research design, the study population, sample size, data collection methods and
instruments, data processing, analysis and presentation and finally the limitations of the study.

3.2 Research Design

The researcher used a cross sectional survey design basing on the use of descriptive and
quantitative designs that was used to establish the relationship between income tax
administration and the profitability of small-scale business enterprises. This design was used for
estimating, predicting and examining associative relationships. Cross sectional studies easily
provide a quick snapshot of what is going on with the variables for the research problem.

3.3 Survey Population

The study comprised of a population of over 3000 small-scale enterprises, which included retail
shops, hard ware shops, groceries, and dealers in general merchandise and URA tax
administrators.

3.4 Sample Size

The major participants in the informal sector that is to say the small-scale business was too wide
so there is a need to choose a few manageable respondents to participate in the study. The
researcher obtained data from the 50 (fifty) respondents and these included the small-scale
businesses in Ibanda Town Council and the tax administrators.
Table 1: showing Sample distribution
stratum Size of the population
Tax administrators=a 15
Small scale business=b 35
Total=c 50
a + b= c that is 15+35 = 50

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3.5 Sampling Design and Procedure
The researcher used simple random sampling and purposive sampling techniques. Simple
random sampling approach was used during the study because of its advantages like
minimization of bias results. This implies that all participants in the study population had equal
chance of being selected. Purposive sampling was also used to select only those respondents with
importance attached to their office. This means that data was obtained from the key informants
about the subject matter. A combination of these two techniques given a wide range of response.

3.6 Data Sources

Data was obtained from both secondary and primary data sources.

3.6.1 Primary Data

Primary data was collected by use of questionnaires and interview guides in the field who were
assumed to give first hand information on the subject under study.

3.6.2 Secondary Source

Secondary data was got from sources like; Annual reports, Journal articles, internet, magazines,
newspapers and books related to the subject of the study and these were consulted at length to
extract the information required to support the findings from the study respondents. The
researcher visited such places and got information that was related to the study variables as
presented in literatures review.

3.7. Data Collection Instruments and Methods

3.7.1 Self administered questionnaire; an open and close ended questionnaire were constructed
and this was self administered where the researcher was allowed the study respondents to fill the
questionnaire in the study field. The questionnaire tools were used collect information from tax
payer of the Selected Small Scale Business other than the head of departments.

3.7.2 Interview method

An interview guide was drafted with a set of questions that the researcher asked respondents
during an interview and this was open ended in nature. The researcher personally recorded the
provided responses as per study respondents during the process of carrying out an interview.
This tool was used to collect information from respondent’s selected Small Scale Business

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enterprises. In this case, the interviews during this research were structured and were specifically
administer to staff of Selected Scale Business.

3.7.3 Observation method

The researcher observed the tickets from the tax council that the business operators had pinned in
the shelves of the businesses as well as counter books that was used to record the customers who
would take goods on credit. However, the observation method was revealed that the respondents
were never used the counter books to record all the transactions made implying that they have
poor records keeping system.

3.8.0 Data Processing and Analysis

3.8.1 Data processing

The data collected from the field was subject to processing for easy interpretation and
understanding. Data collected were checked for completeness, categorized, coded, and entered
into a computer where it was summarized into frequency tables edited and tabulation by use of
percentages.

3.8.2 Data presentation, analysis and interpretation

The data got were analyzed using micro soft word and micro soft excel. Spearman‟s correlation
coefficient was used in order to correlate income tax administration and profitability of small-
scale businesses. Ranks were selected in order to measure the degree and direction of
relationship between the variables. Quantitative data were presented in form of descriptive
statistics using frequency tables. Qualitative data was sorted and grouped into themes. The
researcher was thereafter evaluate and analyzed the adequacy of information in answering the
research questions through coding of data, identifying categories and parameters that emerge in
the responses to the variables of the study. Qualitative data were presented using narrative text.

3.9.0 Limitations of the Study

Financial constraints: Financing the research study was too costly in terms of transport costs,
feeding and processing of the proposal and research report.

Limited time: Inadequate period required for a detailed research study. Comprehensive research
study involves a great deal of collecting, analyzing and processing that requires a lot of time.

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Non-response: Owners of businesses was busy attending to their customers and rarely spared
time for the researcher.

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REFERENCES
Kintu Ismail (2011) understanding Uganda‟s tax system

Balunywa W. (1988) income tax administration in Uganda (Makerere University, Uganda)

Bhatia H. L. (2000) public Finance 23rd Edition

Bird R. (1989) Tax administration on Tax reform in developing countries (London- UK)

Drucker peter (1999) the practice of management professional publishing ltd.

Government of Uganda (1997) income tax act (Uganda)

Handerson Venon. J. and Poole William (1991) principles of economics (1st edition)

Kibwika P. (2004) challenges in the growth of small enterprises (Kampala Uganda)

Musgrave R. (1980) public finance and policy

Muwanga J. (2004) Tax reform in Uganda

Okello Karlist (2006) principles of taxation 1st edition (Uganda)

Pandey M (1995) financial management 7th edition

Tumuhibise Manasseh (2000) introduction to taxation in Uganda (Makerere University, Uganda)

Zake (2001) Journal of income tax and its administration in Uganda

Engelschalk, Michael (2007) designing a tax system for micro and small businesses

Gordon and Dawson (1987) Taxation and Small Scale Businesses in Kampala

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