Worldwide and in Malaysia, small to medium sized enterprises (SMEs) play a pivotal role in a country's economic development. Besides creating job opportunity, SMEs contribute substantially to the growth and development of a nation. In SME Annual Report 2006, it was reported that Malaysian SMEs generated 32% of the country's Gross Domestic Product and 19% of exports (Central Bank of Malaysia, 2007). However, to be viable in business, SMEs face huge challenges. SMEs need to meet a host of regulatory obligations, such as licensing requirements, employment regulations, workers' compensation and tax compliance obligations among others.
Past literature generally confirms the disproportional effect of tax compliance cost on SMEs and most SMEs have poor record keeping system, thus, lead to higher tax compliance costs, as they need to seek tax agents' assistance for tax compliance (Abrie & Doussy, 2006; Arachi & Santoro, 2007; Evans, Carlon, & Massey, 2005; Hanefah, Ariff, & Kasipillai, 2001). In Malaysian setting, the introduction of self-assessment system (SAS) on companies with effect from year of assessment 2001 has also increased the tax compliance burden of SMEs. In SAS, all companies (which include SMEs) are required to determine their taxable income and tax liabilities accurately. In addition, the onus is now placed on taxpayer to understand, interpret and apply the tax laws and regulations accurately. Failure to do so will render the taxpayer liable to penalty for understatement of income or under payment of taxes. What make it worst is the Inland Revenue Board of Malaysia (the IRBM) is also aggressively intensifying tax audit and investigation, civil actions and prosecutions to combat inaccurate reporting and tax evasion.
A survey conducted by Ernst and Young (2006) found more than 80% of Chief Executive Officers (CEOs) in Malaysian public listed companies ranked tax as crucial and important factor in investment and financing decision, as tax costs are now viewed as one of the major aspects in investment evaluation and decision. Ernst and Young (2006) found that Malaysian CEOs viewed tax "not just a matter requiring regulatory compliance, but are increasingly aware of its potential in improving bottom line and creating value through strategic planning and management" (p. 3). Ernst and Young (2006) highlighted that timeliness and accuracy in tax compliance matters remains the core of tax functions in every organization, regardless of size. However, facing the global economic slowdown, most SMEs are concerned with business viability; thus, compliance with tax law is usually the last thing on the minds of SMEs.
DEFINITION OF SMES FROM TAX PERSPECTIVE
There is no one universally accepted definition of SMEs. In Malaysia, the National SME Development Council (NSDC) approved the common definition of SMEs on 9 June 2005. SMEs are defined based on number of employees or annual sales turnover (Central Bank of Malaysia, 2005). The NSDC further categorized SMEs into three sectors, namely, manufacturing, services and agricultural sectors. By definition, for the manufacturing sector, SMEs must have a full-time employees not exceeding 150 or with annual sales turnover not exceeding RM25 million. On the other hand, SMEs of services sectors must employ a number of full-time not exceeding 50 or with annual turnover not exceeding RM5 million. Similar to the services sector, an agricultural sector also needs to employ a full-time not exceeding 50 or with annual sales turnover not exceeding RM5 million to be categorised as SMEs (Central Bank of Malaysia, 2005). The common definitions of SMEs across all economic sectors are approved for adoption by all Malaysian Government Ministries and Agencies involving in SME development, as well as financial institutions. However, for taxation purpose, in the Budget 2003, the Ministry of Finance defined SMEs as companies with paid-up capital of not exceeding RM2. …