SME(NBP) | Small And Medium Sized Enterprises | Taxes

Small & Medium Enterprises

WASIM AHMAD M.Com(Pb), JAIBP, DBL(PU)

OUTLINE
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Importance of SMEs Definition of SME Problems & Issues for SMEs Govt. Initiatives for SME development SME Policy Financing To SMEs

Importance of SMEs

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There are about 3.2 Million Business Enterprises in our Country. Enterprises employing up to 99 persons constitute over 95 %. SMEs employ about 78 % of the Non-Agri labor force. SMEs contribute over 30 % to GDP. SMEs contribute around Rs. 140 B to Exports.

Importance of SMEs
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SMEs account for 25 % of the exports of manufactured goods. SMEs are sharing 35 % in manufacturing value added. According to the economic survey of 1998-99, SMEs with a mere 20 per cent investment and resource to less than 10 per cent of the total formal credit, generated 80 per cent of the country's total employment. Various types of loans available are small loans for business and industry, small loans for industrialists, lending for small and medium industries.

Importance of SME Sector
100 90 80 70 60 50 40 30 20 10 0

USA France Pakistan

# of SME as Share in Share in Share of Employment Production Total # of Enterprises

Share in Exports

Share in Investments

Share in Loans

SMEs contribute significantly to the local economies but have limited access to loan funds

Business Units by Employment Size
200 & above 100 to 199 50 to 99 10 to 49 1 to 9 0% 20% 40% 60% 80% 100% 0.09% 0.1% 0.23% 2.50% 97%

Source Census of Establishments 1988

Industrial Units by Employment Size
250 & above 1 to 250 01 50 to 1 00 1 to 49 0 1to 9
0% 20%

2% 3% 11% 57% 28%
40% 60%

Sectoral Split of Business Units
Mining & Qua rrying 0 1 .0 % Community Se rvice s 3 .0 % 3 6 truction Ma nufa cturing Cons 0 4 .0 % 1 .3 % 4 7

Ele ctricity/ Wa r te 08 .1 % Fina & Ins nce nce ura 14 .7 %

Tra nsport 0 4 .9 %

Tra , Hote de ls 4 .6 % 9 7

Credit To SMEs

57 % of New Investment and 67 % of Working Capital Comes from Internal Finance or Retained Earnings Only 7 % of New Investment and Working Capital from Banks.

Classification of SMEs

SMEs have been historically classified as:  Industry  Trade; Wholesale, Retail & Services Criteria For Definition: The criteria is based on;  Fixed Assets  Employment  Turnover/sales Fixed Assets include Land, Building, Machinery Employment: Essence of SMEs is job creation. Turnover/Sales: Sales have been researched to arrive at the Annual Turnover/Sales

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SME- Definition
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SMEDA SME BANK FBS UNDP Sindh Industries Deptt. Punjab Industries Deptt. PSIC SBP

SME as defined by SBP

Small and Medium Enterprise (SME) means an entity, ideally not a public limited company, which does not employ more than 250 persons (if it is manufacturing / service concern) and 50 persons (if it is trading concern) and also fulfills the following criteria of either ‘a’ and ‘c’ or ‘b’ and ‘c’ as relevant:

(a) A trading / service concern with total assets at cost excluding land and building upto Rs 50 million.

SME as defined by SBP

(b) A manufacturing concern with total assets at cost excluding land and building upto Rs 100 million. (c) Any concern (trading, service or manufacturing) with net sales not exceeding Rs 300 million as per latest financial statements.

An Individual, if he or she meets the above

criteria, can also be categorized as an SME.

Characteristics of SMEs
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Owner is the manager & few employees. Owned & operated independently. Relatively small investment, production, sales, dealings etc. Inadequate efficiency of business operations - no relationship with other firms or parties for
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Investment Management, finance, tax, accounting

Growth of SMEs vis-à-vis Large Scale
Large-Scale
Output Growth Rate Capital Formation Growth %

Small-Scale
Output Growth Rate Capital Formation Growth %

1970s 1980s 1990s

4.84 8.16 3.6

-2.28 8.15 -5.02

4.4 4.7 2.6

5.5 10.5 7.2

Challenges & Issues in SME Development
Business Environment  Relationship between Government and SME  Taxation issues  Labor issues  Delivery of assistance and access to resources  Finance

Challenges & Issues in SME Development
Human Resource Development  Technology Transfer and Up-gradation  Market and Industry Information  Literacy  Law and Order  Intellectual Property Rights  Infrastructure

World Bank Survey
Issues Identified
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Percentage 55% 39% 38% 21% 28% 12% 12% 10% 8% 8%

Lack of finance Shortage of skilled labour Getting business site Bribes Orders/Marketing of Product Lack of Knowledge Government interference Raw Material License for work New Technology

Business Environment
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Large size of the SME sector. Limits the ability of Government and business support institutions to achieve complete coverage by support programs. “Think Small First” initiative which requires all Government organizations to assess the impact of their actions on small business prior to implementation.

Relationships between Government and SME

The relationship between Government and SME seems to be fundamentally flawed. In many cases this extends also to other large organizations and their interaction with smaller clients as SME.

Relationships between Government and SME

A second point is how we may increase the share of SME participating in the provision of goods and services to the public sector, as it is common practice in many countries. A typical SME in Pakistan caters to the domestic private sector. It is noted that fewer than 4% are supplying to the government sector. Some of the issues are related to tough bargaining price (36%) and supplies on credit (34%) and other are related to absence of rules on how to the public sector should increase its

Taxation
Findings & Observations

 Lack of awareness about the taxation system (58%-income tax, 44%-sales tax)  Perception about tax agencies (32-36% said that fines and harassments are the major factors)  Complexity in procedures results in high cost of compliance  Tax policy is biased in favor of largescale enterprises  Timeframes for various procedures are neither followed nor implemented

Labour Issues
Findings and Observations        Lack of proper mechanism and implementation machinery Inefficient labour judicial system Lack of awareness about laws & policies amongst SMEs Predatory inspection system Large number of overlapping laws (56 Labour laws–inclusive of sector specific) Laws not run in consonance with advancement in industries Perception about Social Welfare; limited coverage and efficacy of the social safety net

Source: ILO - SMEDA report

Delivery of assistance and access to Resources

Competitive advantage is determined by the productivity with which a country, region or cluster uses its human, capital and natural resources. Pakistan’s international competitiveness markedly declined over past few years.15 Part of the blame is shared by lower productivity of the workers. The evidence reveals that median labor productivity, as measured by annual value added per worker, is 25 percent lower in Pakistan than in India and 35 percent lower than in China.

Finance

It has been observed that 57% of new investment for Small and Medium Enterprises and 67% of working capital finance come from internal finance or retained earnings; only about 7% of funds for investment or working capital come from banks or other financial institutions. Even suppliers’ credit rivals the contribution of the banks as a source of working capital (4.5%). Another survey concludes that SME are indeed being rationed out of the credit market, rather

Human Resource Development

One of the major challenges that SME have to face is the emergence of the knowledge-based economy. People must continue to innovate, change and upgrade. There is a need to nurture the entrepreneurial spirit and skill development for adopting innovative technologies.

Technology Transfer and Upgradation

In our country, growth oriented exporting firms still have problems sourcing quality inputs due to the lack of a network of reliable suppliers. This adds to their transaction costs. Likewise, the SME are not large enough to furnish sufficient demand to be an incentive for a big high quality input supplier.

Market and Industry Information

Access to market and industry information is one of the keys to develop successful business strategies. Frequently, business and trade associations are able to provide their members with such services. By associating with like institutions in foreign countries, they are also able to establish links and obtain information on foreign markets.

Literacy

The evidence reveals that SME find it extremely difficult to grow because of their inability to delegate to soundly trained staff. The day, the small businessman feels comfortable to delegate, SME start progressing.

Law and Order

Law and order situation in Pakistan has always been regarded as worrisome. One survey reports that one in five respondents report that the business was the target of at least one crime during 2002. Another assessment suggests that businesses in NWFP spend 4.5%, Sindh and Punjab 1-2% of their revenue on security. One in four SME consider law and order to be a severe problem.

Intellectual Property Rights

Intellectual Property Rights (IPR) is a vital issue that needs to be looked into. It has been observed that many developing countries, with the help of a change in their IP systems and laws, are able to attract Foreign Direct Investment (FDI) in the Research and Development (R&D) especially in the industrial and scientific field. Therefore, promotion and protection of intellectual property spurs economic growth, creates new jobs and industries, enhancing the quality and enjoyment of

Infrastructure

Basic physical infrastructure is a prerequisite to growth and development. Power outages and access to connections are considered an irritant which significantly affects the productivity of firms in Pakistan. It is estimated that a typical business in Pakistan loses 5.6% in annual sales revenue due to just this single factor.

GOVT. Initiatives for SME Development

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Small and Medium Enterprise Development Authority (SMEDA) SME Bank Small and Medium Enterprise Center (SMEC) One Village One Product (OVOP) National Technical Education and Vocational Training Authority (NTEVTA)

SME POLICY Objective

The objective of SME Policy is to provide a short and a medium to long- term policy framework with an implementation mechanism for achieving higher economic growth based on SME led private sector development.

Scope
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Business environment Access to finance Human resource development Support for technology up-gradation and marketing

Recommended Definition

Recommended Definition
(a) To be eligible, an enterprise must fall into the respective size category as measured by "Employment". (b) The number of persons employed includes the owner and his or her family members i f they are working in the enterprise e. (C) "Assets" exclude the value of land and buildings.

Cost of Doing Business

The small entrepreneurs spend on the average  over Rs. 15,000 per year  and 12% of their entrepreneurial time in coping with government regulations Respondents highlighted rising cost of business due to  government taxes (56%)  corruption (39%)  utility charges (30%)  oppressive role of local officials (26%).

Policy & Regulation A list of laws assigning levies or taxes on SMEs 
Taxation Laws
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1. 2. 3. 4. 5. 6. 7. 8. 9.

Income Tax Ordinance 2001 Sales Tax Act, 1990 Employer’s Old Age Benefit Act, 1976 (EOBI) (Provincial) Employees Social Securities Ordinance, 1965 Workers Welfare Fund Ordinance, 1971(WWF) West Pakistan’s Maternity Benefits Ordinance, 1958 Workers Children (Education) Ordinance, 1972 Companies Profit (Worker’s Participation) Act, 1968 Employees Cost of living Relief Act, 1973

Laws
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Assigning Levies

10. Worker’s Compensation Act, 1923 Assigning Standards for Wages and Workplace 11. The Payment of Wages Act, 1936 12. The Minimum Wages Ordinance, 1961 13. Pakistan Minimum Wages for Unskilled Workers Ordinance, 1969

Laws
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Policy & Regulation
Impacts of Regulations on Business Entry
80 60 40 20 0
India Thailand

77

Business Days required to receive operational legal status

India Pakistan Thailand

50 35 22 4
USA

Singapore 4 USA UK

ILO-SMEDA Study 2001

Policy & Regulation
Key Indicators of Regulatory Environment - Problems
7% 1 7% 0 6% 5 5% 6 5% 2

Sales Tax / Excise Tax

Income Tax

Government interference

Government laws Non availability of and Regulations finance

Constraints to Business Expansion Figure 1
Tax administration Tax rates Cost of financing Corruption Regulatory policy uncertainty Electricity Access to financing
2 0 3 0 4 .1 6 4 .6 5 4 .6 2 4 .4 0 4 .1 0 3 .2 9 3 .6 7 4 0 5 0

Constraints to business expansion in Pakistan

6 0

Issues in SME Financing

Sources of Working Capital for SMEs
Financial Sector Contributing 7% Working Capital
other 8% Informal 1% Equity 12% Trade Credit 4% Banks/ FIs 7%

Retained Earnings 68%

Source: Gallup Survey of 1000 Industries in 2002 covering 12 cities & 8 sectors

Sources of Investment for SMEs
other 12% Informal 2% Equity 17%

Financial Sector Contributing 8% Investment

Retained Earnings 59%

Trade C redit 2% Banks/ FIs 8%

Source: Gallup Survey of 1000 Industries in 2002 covering 12 cities & 8 sectors

Loan Disbursement Pattern
80%
%age Exposure to Each Category

60% 40% 20% 0%

69.9% 2.9% 0.5% 5.0% 3.1% 2.1% 4.3%

5.7%

6.4%

Loan Size Rs. in ‘000
Source: State Bank of Pakistan

Loan Disbursement Pattern
Size of Firm No of Employees 0-10 11-49 50-99 100 or more All Sizes
0-5 0% 0% 100% 100% 50%

Age of Firm (years)
% age of Total

6-10 0% 35% 67% 75% 67%

11-20 0% 0% 75% 75% 64%

21 and more 0% 0% 15% 83% 50%

All Firms 0% 29% 50% 80% 59%

Source: Dr. Ehsan ul Haq, Dr. Faisal Bari- LUMS; Barriers in SME Growth - 2002

Legal Structure of Business Units in Pakistan
C orporates & Others 8% Public Sector 7%

Proprietorship s& Partnership 85%

Source: ILO SMEDA Study 2001

Comparative Access to Financial Sector Comparatively low financial sector access in Pakistan
High Affordability of Loans High Affordability of Loans

Low Access to loans High Timeliness of loans High Affordability of Loans

Access to loans

Low

Timeliness of loans High

India

High

High

Bangladesh

Low Access to loans High Timeliness of loans

Pakistan

High

Source: ITC publication - SMEs and the Global Market Place

Recommendations
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SME Bill 2005 SME Definition Feedback, Evaluation & Monitoring Capacity building of SMEs Specific Support Funds for SME Development Credit Guarantee Fund Credit Insurance Fund Venture Capital SME Financing Credit Fund SME Bank Reform

Internet Resources
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www.smeda.org.pk www.smebank.org www.sbp.org.pk www.ibp.org.pk http://caribbean.smetoolkit.org www.pasme.org.pk www.unisame.org www.smepromotions.org

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