The Financial Express

From entrepreneurs to pay workers

The legal environment and the SME sector

| Updated: November 19, 2020 16:40:25

Lankabangla and Fianancial Express Lankabangla and Fianancial Express
The legal environment and the SME sector

Educational institutions in Bangladesh give a negative impression about business and encourage students to do government jobs. The family and society also have little respect for the business profession. Despite all propaganda, a section of young people try to be entrepreneurs.

After a few attempts, most of those young people migrate as skilled workers and a few of them succeed to be entrepreneurs. Such migration of entrepreneurs and skilled workers which amounts to 'brain drain' is scant in Bangladesh. There is no study on such a subject. However, some indications about this are found in the case of Pakistan, as is seen from a report published in the national daily Dawn (October 2004). It is plausible, however, that self-employed/entrepreneurs in small and medium enterprises (SMEs) in Bangladesh are perhaps compelled to change their profession and take up other jobs (maybe, choose to become wage labourers) because of the difficulties they face including those that originate from high compliance costs in the SME sector. It is hoped that a research will be carried out as part of this study and that will throw some light on this issue.

SMEs in developing countries such as Bangladesh generally tend to do business without having formal registration, license, and taxpayer's identification number (TIN) and other formal documents. This type of informal structure in which they do business often makes it difficult for enterprises to enjoy the exemptions and incentives. In Bangladesh, income tax regulations are generally found to be unfavourable for new investments and for new entrepreneurs to launch business ventures. Given the fact that the process of registration is complicated and the costs involved in this process are high. New enterprises feel discouraged to become formal and consequently, their complex rules and regulations are one of the major constraints that discourage small businesses to become formal. A simple tax system is generally considered to be conducive for small businesses to flourish and compared to the one that has too many special provisions. A number of studies have suggested making tax-related rules and regulations simpler with a view to encouraging the entry of more small firms into formal business.

The nature of the relationship between small and undocumented enterprises/ self-employed with that of formal and registered enterprises in the market determines the nature and the extent of the impact of tax exemptions and concessions provided across various categories of enterprises. Whilst well-structured tax expenditures try to balance the growth and development of enterprises, unstructured tax expenditures may restrain the growth of small enterprises particularly by infusing bias towards particular categories of enterprises.

The new VAT law doesn't allow VAT Challan for credit of VAT for their buyers. This means those who don't register under the VAT law and also registered for the turnover tax shall remain out of the mainstream business. The business house without tax registration is not eligible to participate in the tender for government purchases. Businesses are not allowed to open bank accounts without tax registration and remain out of credit facilities from financial institutions.

Research in Indonesia has indicated that in applying for licenses and fiscal concessions and in dealings with labour or taxation offices a large cost is associated which becomes more complicated due to the prevailing political economy with existing regulations.

Furthermore, the design of financial policies for various types of industries determines the various dimensional impact on enterprises of various sizes as has happened in the case of Korea. A cross-country study involving 4,000 firms of various types from 54 countries found the disproportionate impact of the subsidy on small firms arising from lack of adequate coverage. Investment incentives provided to new firms show an unfavourable impact on small firms in the case of Thailand. The burden of tax compliance cost originating from the prevalent financial, legal, and regulatory framework was found to be higher in the case of SMEs in Malaysia. The potential financial burden for informal SMEs who do not enjoy VAT exemption appears to be higher for those SMEs who sell their products at the same price compared to firms that are compliant.

There is a tendency among the firms to operate below the threshold level in order to avoid taxes, if the firms feel that compliance will entail a higher tax burden. A study by the SME Foundation on the various types of SMEs in Bangladesh shows that the entrepreneurs consider the payment of income tax and VAT as obstacles to running their business. The study finds that 74.71 per cent and 88.23 per cent of entrepreneurs from small and medium enterprises respectively under the light engineering sector have considered the income tax payment as an impediment to their business whereas in the case of large firms it has been only 50 per cent. Given the limited scale of reliable information and lack of research on the impact of tax exemptions and incentives on productivity, efficiency, and profitability of SMEs of Bangladesh, it is rather difficult to draw any conclusion in these regards.

Bias in tax expenditures may be revealed in a number of ways. Firstly, it may occur because undocumented enterprises which do not have formal registration and other related documents are not eligible for support. Secondly, it may happen through exclusion of certain SME-oriented sectors from the preference list, and thirdly this could happen because some SMEs are excluded because these are located outside the preferential areas, etc.

SMEs may indirectly get affected due to corrupt practices in tax and expenditure-related activities. Weak monitoring and an enforcement mechanism related to tax expenditures may adversely impact enterprises which are not eligible for these benefits. Tax exemptions provided for legalizing the undocumented income through investment in certain sectors could distort the equity in the market. Similarly, misuse of the tax holiday facility may cause bias against small enterprises operating in the same sector. Fraudulent practices through the extension of tax exemptions given in case of salaries of foreign technicians working in local firms provide an undue advantage against those firms which do not employ such employees. The practice of such illegal activities on a large scale may distort the competition in the market which may disproportionately affect the small and informal enterprises.

The writer is a Legal Economist.
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