Taxation of SMEs to Support Economic Recovery Post-COVID-19

Context

Whilst the impact of COVID-19 lockdowns has differed in each country, businesses large and small have suffered as a result. Many businesses have had to close and have had virtually no business income while having continuing and unavoidable expenses; e.g., property rents and maintenance costs. Others have been able to continue operations but with lower levels of income.

The key to the recovery of small and medium-size enterprises must be cash flow. Governments are doing many things to assist in their liquidity and preserve employment. These range from direct support (paying wages, facilitating loans, and providing cash injections to the self-employed) to indirect support (such as delaying tax payments).¹ However, less affluent governments that are struggling to fund essential (particularly health) services, are unlikely to be able to offer businesses direct support.

Fiscal policy must now complement any direct government support and reflect the changed world we find ourselves in. Governments also need revenue inflows to maintain public services, especially as the cost of some public services such as healthcare will have increased. So, there will be a delicate balance to be struck between the two conflicting aims.

Objectives

As a result of the global COVID-19 pandemic, lockdowns across the world have resulted in severe cash-flow difficulties for many SMEs and huge increases in unemployment. SMEs, while directly paying often less than 20 percent of the direct and indirect tax revenues, support larger businesses as both customers and suppliers. Small business start-ups fuel economic growth, as they can become the successful large businesses of the future. Hence, SMEs are a vital cog in business in all countries and provide employment for millions of employees and business owners. One of the goals of tax policy for economic recovery must be to enable this sector to recover from the financial impact of the business interruption caused by the COVID-19 lockdowns.

To help SMEs maintain cash-flow is the core goal of this fiscal policy and administration guidance. Even more fundamentally, this guidance aims to cover the immediate help that SMEs will need from tax systems to stay in business. It also looks beyond the immediate period toward how tax policies and tax administration can be re-geared so as to help the SME sector grow in the future (and, thereby, provide governments with increased revenue inflows).

Scope

This paper looks at the impact of COVID-19 on both SMEs and tax revenues. Although there is a general understanding of the businesses that constitute SMEs, there is no standard global definition of these, as the economic situation differs in each country. However, most tax administrations segregate large businesses — hence SMEs, de facto, constitute all the other businesses that are required to register for tax.

The revenue from all taxes will have suffered as a result of the COVID-19 lockdowns and the subsequent reductions of economic activity — the affected taxes — are likely to include:

• income tax on profits: company, partnership, and self-employment;

• payroll taxes (including employee social security contributions);

• VAT/sales tax;

• excise taxes;

• environmental taxes;

• withholding taxes;

• capital gains tax;

• taxes on wealth, inheritance, and estates;

• property taxes (including local business taxes and rates);

• customs duties (and other import charges);

• taxes on insurance premiums, property, financial transactions, etc.;

• business trading licenses and occupational taxes;

• license and annual fee charges (e.g., on motor vehicles); and

• user fees imposed by national or local governments (including road tolls, etc.)

The impact of COVID-19 on SMEs goes wider than taxation, as those businesses have to contend with both regulations from other public sector bodies including local and regional authorities and other constraints that contribute to the costs of doing business, including:

In most markets: Restrictions on opening hours and other licensing rules Regulations covering product approvals, content, and labelling Hygiene and other health and safety requirements Environmental restrictions Product labelling and display restrictions.

In some markets: Unreliable electricity supplies Lack of safe drinking water Inadequate sanitation Inadequate social and medical benefits Corruption of public sector officials at all levels and across all parts of the public sector Flourishing illicit markets Lack of security and ineffective crime prevention.

Tax Policy and Administration to Support Taxpayers

With many SMEs either being unable to trade or trading at greatly reduced levels of turnover, and in order to facilitate their survival, the sector is seeking ways of deferring or reducing their tax liabilities so they can preserve their struggling cash flows.

The following categories highlight possibilities that tax policymakers and administrations might consider either for all SMEs or for the hardest hit sectors.

For All Taxes Due from SMEs

• Payment grace periods for all or for the hardest hit trade sectors;

• waive penalties and interest and suspend the “harsher” debt collection activities — e.g., distraint, third party liens, court recovery, bankruptcy, or insolvency action;

• allow time to pay agreements for tax owing over a realistic and long period (but conditional on all future returns being made and all taxes being paid in full and on time);

• introduce flexible payment plans so that tax is paid over a long period (at least a year) as and when possible, provided that the quarterly or annual totals are met;

• defer payment dates for a period — so if, e.g., VAT is due 21 days after the tax period ends, that could be extended to, e.g., 51 days;

• make automatic or rapid payments of tax refunds or rebates to SMEs within set credibility parameters;

• give a discount for timely payments made in full;

• provide a tax subsidy or credit for the hardest hit trade sectors which would then have a flat amount that they can deduct from any tax due;

• allow for credit card payments of tax;

• make temporary changes in audit policy and ways to assure tax certainty;

• enhance taxpayer services to provide full information on websites and through electronic communications and call centers; and

• develop communication initiatives to advise all taxpayers of the COVID-19 tax relief available to them and how to claim if a claim is required.

Customs Duties

• Reductions or duty suspensions for some sectors (where possible under regional external tariffs); and

• deferment periods extended for payment of import duty on goods for resale.

Excise and Environmental Taxes and Duties

• Rate reductions if specific duty rates apply, but bear in mind the potential health and environmental impact. (Ad valorem duties will automatically reduce proportionately as the commodity price reduces — e.g., on road fuel.)

VAT

• Align import VAT payment date to the VAT payment date for the tax period;

• set a lower VAT rate for the sectors hardest hit;

• set or increase a higher tax rate on nonessential and luxury goods — e.g., jewellery, perfume, high-end electrical equipment, luxury cars;

• raise the VAT registration threshold to allow smaller firms to de-register;

• make automated and expedited VAT refunds within set parameters instead of any credits carried over;

• extend the VAT tax accounting periods for SMEs — e.g., instead of monthly tax periods extend to 2 or 3 months);

• introduce (or extend the availability of) annual accounting with phased payments for the smaller businesses; and

• allow cash accounting for all SMEs up to a set (or higher) threshold turnover.

Income Tax on Business Profits

• Tax rate reductions and rate band and threshold increases, including seeking to remove many small businesses from the tax net.

• Where losses are made, no income tax liability accrues and, in order to keep a small business afloat, losses should be allowed to be carried over to the following year and credited against that year’s profits. Alternatively, SMEs might be allowed to render tax returns to cover a two-year period (2020 and 2021; or 2020-2021 and 2021-2022).

• Where the 2019-2020 tax year spans the COVID-19 lockdown period, the lack of income over the period may result in no tax due and any stage payments made may have been too high. In this case, a refund should be expedited, and any remaining stage payments canceled.

• For the current tax year, in the most hard-hit sectors (travel, hotels, restaurants, gyms, sports and entertainment businesses etc.), a nil overall profit could be assumed and any advance payments abandoned, deferring all liability to the next tax year.

• Allow 100 percent depreciation for capital goods allowances for businesses in the hardest hit sectors. This would advance the depreciation allowances that otherwise would have affected over a number of years and thus assist cash flow for businesses.

• Where there is a tax regime with a minimum threshold or a presumptive tax regime based on turnover or trade sector, the rates will need to be revised for the current tax year (to ensure that loss making businesses do not end up having to pay any income tax).

• Introduce a new higher rate of income tax for businesses that have made significant profits through the crisis (with this extra tax being available to help businesses who have suffered the most).

Withholding Tax on Wages of Employees of SMEs

• Increase personal allowances, thresholds, and/or broaden the rate bands;

• reduce the tax rates;

• provide tax credits; and

• allow employers to delay paying the tax deducted for a longer period than is usually permitted.

Other Withholding Taxes Affecting SMEs

• Withholding tax on professional fees and when charged on imports could also be reduced or suspended; and

• withholding tax on property rents could be reduced or suspended.

Encouraging Economic Growth to Aid Recovery

Looking beyond the survival of businesses affected by the COVID-19 crisis, all countries will need to encourage economic growth in future years. This will be to encourage new businesses to be established and to enable existing, perhaps very small businesses, to grow. To create the investment climate that will achieve this will require countries to consider many actions that will assist this development. The following categories provide options.

Simplifying or Reducing Compliance Costs

• Simplify tax registration requirements for businesses and self-employed;

• develop presumptive taxes for the smaller SMEs (see Annex 1 for more detail);

• simplify forms and documents required — e.g., for import and export or temporary customs relief;

• develop single window and other electronic customs schemes sanctioned by the World Customs Organization that reduce form filling and simplify access so importers and exporters can make their own declarations;

• extend the availability of bonded warehouses so businesses can defer the payment of customs duties until the goods are needed for manufacturing or resale;

• work with other countries in regional customs unions or with countries having unilateral or multilateral trade agreements to simplify documentation required across international trade;

• introduce or extend simplified import procedures for low-value goods;

• through consultation, seek to reduce costs on imports and exports — e.g., port and airport fees — and thus stimulate international trade;

• develop simple payment schemes that do not require a visit in person to a tax office — e.g., mobile phone “Pay As You Go” tax payments;

• revise penalties so as to support voluntary compliance — e.g., written warning for first penalty and suspended penalty for second penalty, with third penalty triggering double penalty;

• develop user-friendly electronic facilities for all tax processes;

• exempt all investors from all fees related to companies’ registration until the end of 2021; and

• identify regulations from other public sector bodies that contribute to compliance costs for businesses — e.g., licensing, restrictions on trading hours, restrictions on lorry driver hours — and seek to quantify compliance costs — e.g., through an annual survey, focus groups, trade associations — then deregulate as far as possible.

Options for Tackling the Informal Economy

• Develop presumptive taxation schemes where none exist (see Annex 1 for more details).

• Amnesty for back tax and failure to register penalties for previous failures to register or charge and remit the correct amount of tax together with stiffer penalties for those who fail to register during the amnesty.

• Task force to develop mechanisms to improve tax declarations and payments by professionals.²

• Provide taxpayer education programs in conjunction with advisers from other public sector organizations who provide business education to those without bookkeeping knowledge or experience and knowledge of other legislation appertaining to the type of business — e.g., consumer protection, health and safety, environmental.

• Develop compliance records for all taxpayers if none exist.

• Develop a risk-based audit program if none exists.

• Put in place an anti-corruption strategy, commitment, and actions to make as much as possible of the revenue processes corruption proof. Examples are:

  • separating decisions on which businesses to audit from the local officials who have to carry out the audit;

  • encouraging electronic declarations and payments as far as possible and developing easy payment processes for those without bank accounts — e.g., “Pay As You Go” tax cards for use with mobile phones;

  • auditing all processes to identify which processes are at the highest risk of facilitating corruption; and

  • requiring staff to declare relationships with any business taxpayers and ensuring that such staff never audit those taxpayers.

Tax Regimes That Might Be Introduced

• Because all countries will have revenue shortfalls and will need funds to enable them to support recovery, consideration might be given to new taxes, such as:

  • luxury tax on designer clothing, accessories, jewellery, precious metals, as well as the use of robots, and luxury cars, yachts, planes, whether or not used for business purposes;

  • additional taxes on telecommunications and e-commerce; and

  • environmental taxes to encourage behavioral change as well as to raise revenue — e.g., plastic bags tax, pesticides tax, single use plastics tax, litter tax (on all fast food take away or drive-through businesses).

Additionally, there are suggestions for longer-term revenue enhancement particularly geared toward developing countries.³

Constraints on Tax Policy and Administration

There will be many challenges to be overcome to make both tax policy and tax administration changes, including:

• Funding for changes.

• Legislation may need to be amended after consultation with trade associations, chambers of commerce, etc. This may take time and require top level political commitment.

• IT systems may take some time to amend and will entail significant costs.

• More resources (and staff training) may be needed in the short term to develop special schemes, identify compliance costs that can be reduced through deregulation, administer and assure COVID-19 relief, communications, etc.

• Mobilizing donor assistance can be time-consuming.

Recommendations

• Time is of the essence. What governments do to help SME cash flows needs to be done quickly. Actions need to be simple and clear so that taxpayers know what applies to them and what they need to do to benefit from tax or other regulatory change.

• A first step should be to consult with trade associations and taxpayer representatives to identify their priorities for relief and relaxation of tax and other regulatory requirements affecting SMEs and then draw up a prioritized list for immediate action.

• The constraints on public sector authorities are real, and in an ideal world, it would be good to have plenty of time to develop proposals, consult, and design changes both in legislation and IT. SME cash flow cannot wait for the ideal timescale for implementing tax or other regulatory changes, so simple one-off developments may have to be deployed.

• Each country has a different mix of businesses and a different set of tax and regulatory requirements, so there is no “one size fits all.” Governments will need to choose the options that best fit their mix of businesses, priorities, and funding capacity.

Conclusion

This paper has aimed to set out a wide range of options both for relief and simplification of taxes and for reducing and simplifying other regulatory requirements. It should always be borne in mind that supporting businesses in their hour of need should result in an early economic recovery that, in turn, will result in future revenues. Where governments are seen to be assisting SMEs with their cash flow difficulties, they are also building trust and goodwill that should lead to improved tax compliance in the future.

Annex 1: Presumptive Taxes

1. What Are Presumptive Taxes?

Presumptive taxes are ways of assessing tax liability using indirect methods such as income reconstruction or by applying baseline taxation across the entire tax base. They are alternatives to formal tax regimes designed to capture the “hard to tax” who fail to register voluntarily, keep records of business costs and earnings, and render tax returns or payments, and are usually small operators with modest incomes derived from cash or barter transactions.

2. Why Use Presumptive Taxation?

In developing countries, presumptive taxation may be the most appropriate method of tax administration for specific groups of taxpayers. Most tax laws are designed by policymakers and drafted by lawyers who assume tax is assessed on well-defined measures of income and well documented in transparent accounting records. The reality is that most taxpayers do not possess the administrative resources to maintain accurate books or navigate complex tax codes. A highly informal economy impedes growth because of inefficiencies of operation. Tackling the issue needs political will to introduce stricter enforcement and better information both for officials and for taxpayers.

3. Advantages and Disadvantages of Presumptive Taxation

In order to achieve a satisfactory take-up of presumptive tax regimes, there needs to be both an enticing reward and an off-putting penalty. They may need to be offered an enticement that is of value to them — e.g., free healthcare for children and the elderly, installation of safe water and sanitation, reliable electricity supplies, etc. Pitfalls are:

• a lack of communication with representatives of the informal sector and a high risk of misunderstanding and distrust;

• surveys used to develop indicators have not been updated regularly, so assessments tend to be arbitrarily applied to vulnerable small entities;

• most presumptive schemes provide little or no analytical data to enable risk assessed audits and enforcement to take place; and

• audit and assurance procedures have tended to be office-based because of the link to “tax clearance” schemes that require taxpayers to physically visit local tax offices, taking them away from their businesses.

Many presumptive regimes are seen as corrupt, unfair, and inefficient with processes that offer little or no incentive for businesses and individuals to graduate to the formal tax regime.

4. The Main Types of Presumptive Taxation

The table below shows the most common types of presumptive regimes.

Common Types of Presumptive Tax Regimes

Regime	Advantages and Disadvantages
Simple lump-sum payments — a license regime: Licenses are easy for taxpayers to understand and comply with. Annual payments can be unaffordable, and more frequent license periods may be required (but at an increased administrative cost).	The main advantages are that licenses: are relatively easy to administer and reduce the opportunities for corruption; help authorities know who and where the small businesses are (for guidance, administration of public health, consumer protection laws, etc.); and provide an incentive to small businesses to stay on the right side of the law. However, revenue inflows can be poor, not reflecting individual situations, and licenses can be regressive.
Tax indicator regime: This involves segmenting the small taxpayers according to trade sector, size and region. This usually requires an average tax payment to be calculated using groups of indicators as proxies for business income.	The reduction in compliance burden can be attractive to small businesses. This regime can: distort investment; and present difficulties in obtaining accurate data and selecting appropriate and simple indicators. For taxpayers, there are winners and losers; the scheme does not provide for a tax reduction in respect of losses.
Turnover regime: A regime based on turnover provides more equity to the taxpayer and an easier transition to the formal tax regimes. They can be designed to give an average proxy for tax on profit; or with variable rates — e.g., for different sectors.	A turnover-based regime: has the potential for higher revenue; has a high risk of under declaration; can favor businesses with a high profit margin; and does not accommodate situations where a loss is made (and hence runs counter to the principle of income tax being charged on business profits).
Agreed regime: This regime involves using indicators to obtain an estimate of tax due which is then subject to agreement between the taxpayer and the tax administration.	The regime: is equitable; carries a very high risk of corruption; and requires extensive and regularly updated research, data collection, and analysis.