ISSUES IN SME DEVELOPMENT:Business Environment, Taxation Issues

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SME Management (MGT-601)

Lesson 10

This lecture deals with the policy-making issues on short and medium term basis. The importance of these

issues is self evident in this lecture

ISSUES IN SME DEVELOPMENT

Short And Medium-Term Issues

This lecture reflects issues where we feel we may achieve strong impacts in the short and medium-term, i.e. until 2011. They

should therefore become major topics of our deliberation and shape the formulation of our SME policy.

Business Environment

The large size of the SME sector limits the ability of the Government and business support institutions to

achieve competitive coverage by support programs. This is a fundamental reality in most countries of the

world and it is why policy framework and regulatory measures are of tremendous importance when SME

promotion is concerned.

It is agreed that only appropriate policy tools and regulations than with support programs can achieve much

more. Likewise, SME development is hampered more by inappropriate regulations than compensated by

means of appropriate support programs.

Most of the developed nations therefore have mechanisms in place to revert the biases against small firms.

For instance, the United Kingdom introduced the "Think Small First" initiative, which requires all

Government organizations to assess the impact of their actions on small business prior to implementation.

Furthermore, participation of small business in government procurement is being facilitated as a matter of

routine.

The result of such policies is that (unfortunate) surprises to small firms are less frequent. It is made sure that

businesses potentially affected are consulted and informed of any forthcoming policy shifts so as to avoid

negative impacts. They are also allowed an adequate grace period for the adjustment of economic activity

and there is no retroactivity of new regulations. Besides this, special attention is paid to minimizing the

room for bureaucratic discretion while developing policy rules or procedures.

All such mechanisms are missing in present policy or legal environment in Pakistan. The absence of a

specialized, uniform legal framework for the development of SME hampers SME operations1.

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.

Our compulsion of centralized control stems from the fear of the regulator to be misled by the

opportunistic profit-seeking entrepreneur. And our administration practice is characterized by rent-seeking

bureaucrats, who given the low level of their pay, take advantage of low literate entrepreneur.

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1 To this point, the Ten Year Perspective Development Plan 2001-2011 notes that there is a large range of

zoning and other regulations imposed by the federal, provincial and local governments and public sector

utilities which affect the functioning of SME hence, legislation similar to the US Small Business Regulatory

Enforcement Act of 1996, which includes Regional Small Business Ombudsmen, would be considered to

ensure fair and effective functioning of SME. Whatever the mechanism to enforce it, a "level playing field"

is one of the cardinal conditions for SME development.

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Of course, we all know there are many dedicated and honest professionals on both sides. But the fact of the

matter remains that there are severe attitude problems in the relationship between the two sides. The only

SME Management (MGT-601)

way to break this discouraging situation is to face the problem squarely and seek solutions in a positive spirit

and entertain systematic dialogue between the two sides.

The present divide is, among others, reflected in a language gap. Part of the concern for local business

people is the inadequate business facilitation process in the local language, which includes laws, regulations

and business support material available in the English language only.

As a starting point, we propose to consider the increased usage of Urdu in our written documentation, in

our official deliberations and communications.

A second point is how we may increase the share of SME participating in the provisions of goods and

services to 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%2 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 procurement for SME.

Further points may possibly emerge from the dialogue between Government, stakeholders and their SME

clients.

Taxation Issues

High tax rates are one of the major reasons for firms to drift into the informal economy. This holds for the

countries all over the world, including developed countries. These effects are compounded by high

compliance costs for small firms to deal with tax laws and other forms of government regulation. This is a

specific size-related disadvantage compared to large-scale firms, which have not only the necessary

accountants, but also frequently, also in-house tax and legal advisors. Compliance costs have monitory

implications (such as paying tax advisor fees or salary payments to personnel dealing with tax issues); time

cost implications (in the form of time spent by a taxpayer to handle tax issues), and physiological cost (in

terms of anxiety, stress and apprehensions related to possible mistake or a possible audit by the tax

authorities).

Firms in Pakistan's SME sector, encounter an increasingly complex legal, tax and administrative

environment, both in starting up and developing their business. According to research, 67% of enterprises

termed tax regulations as most problematic. 56%3 of businesses reports a crunch of taxes, while 28% of

businesses felt that the taxes in the country are too high.

World Bank SME Policy Note 2001, the results of SMEDA-World Bank Investment Climate Survey 2003

also conform to the findings.

3 The 56% figure is an addition of the three tax related responses: High Taxes 28%, High sales tax 16% and

high income Tax Rate 12%.

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From SME point of view, the present tax structure and administration generally distort incentives and

discriminate against small firms who are harassed by the tax authorities. Smaller firms found tax related

issues more restrictive than larger firms, 69% of firms, whose size of assets was less than Rs.1million faced

the greatest of tax related problems. Many small firms claim it is not possible for them to maintain books4.

As per law or hire a professional due to cost constraints.

The prevailing system is non-standardized and offers excessive discretion to the tax authorities. There is no

consolidation or rationale in current provincial or local tax structure either. Hence, there has been a

constant confrontation between tax authorities and the business communities resulting in very slow

expansion in tax base5. Two sectors; retailers and small to medium sized manufacturers have already

propounded the idea of fixed taxation as remedy to this continuous ailment.

Cognizant of the change required to cater to the SME sector in its policies, there have been reforms in the

advance stage of implementation of Pakistan's tax regime. But these reforms are focused on tax

administration and management, instead of addressing the aspects that directly affect SME. No incentives

are being offered to SME to enter the formal economy6. There has been no consideration as such reviewing

tax law form an ordinary SME or even micro enterprise perspective.

SME Management (MGT-601)

In Japan, after the war in 1949, old taxation system was replaced by new system to resolve the problem of

incomplete bookkeeping and fear of over taxation of SME. The new system allowed certain tax merits if a

tax return is made with a " certain formula of quick bookkeeping." This system resulted in not only the

improvement of financial accounting but also the strengthening of financing systems for SME.

5 There are 1.05million active tax filers in Pakistan. In 1999-2000 the number of salaried taxpayers was

440,000 and those filed under old self-assessment scheme were 275,000. Lowering tax rates may well lead to

substantial expansion of the tax base in compensation and be neutral for the government income. However,

without more profound improvements in the relationship between government and the enterprises, hopes

should not be raised high for tax rate changes to bring immediate tax base expansion.

6 A taskforce on the reform of tax administration, chaired by Mr. Shahid Hussain, was constituted by

government, which gave detailed recommendations in its report published in May 2001. Based on this

document and comments from the IMF and the World Bank a restructuring plan was drawn up by the

CBR. This restructuring plan is now being made operational with the World Bank support.

Reference:

.1 -As quoted above

2-SME sector By SMEDA

3-Developing SME policy in Pakistan By Policy planning and strategy department (SMEDA)

4-Small entrepreneurs in developing countries by Dr Asghar S. Nasir

Book Recommended

Small entrepreneurs in developing countries by Dr Asghar S. Nasir

Key terms

Arbitrary (dependent on will or pleasure)

Bilateralism (consist of both parties)

Inter alia (among other things)

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