MAKERERE UNIVERSITY

COLLEGE OF BUSINESS AND MANAGEMENT SCIENCES

SCHOOL OF STATISTICS AND PLANNING

IMPACT OF TAX ON PERFORMANCE OF SMALL MEDIUM

ENTERPRISES IN UGANDA

BY

ONGURAMONG MICHELLE DESIRE

18/U/20629/PS

A RESEARCH PROPOSAL SUBMITTED TO THE COLLEGE OF BUSINESS AND

MANAGEMENT SCIENCE IN PARTIAL FULFILLMENT OF THE

REQUIREMENTS FOR THE AWARD OF A BACHELOR`S DEGREE IN

QUANTITATIVE ECONOMICS

MAKERERE UNIVERSITY

JUNE, 2021

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 Table of Contents

CHAPTER ONE: INTRODUCTION..........................................................................................2

1.1 Introduction................................................................................................................................2
1.2 Background of the study............................................................................................................2
1.2 Statement of the problem...........................................................................................................3
1.3 General objective.......................................................................................................................4
1.4 Objectives of the study...............................................................................................................4
1.5 Hypotheses.................................................................................................................................4
1.6 Significance of the study............................................................................................................5
1.7 Conceptual framework...............................................................................................................5
CHAPTER TWO: LITERATURE REVIEW.............................................................................8
2.1 Introduction................................................................................................................................8
2.2 Theoretical review.....................................................................................................................8
2.2.1 Theory of Business Growth....................................................................................................8
2.2.2 Theory of taxation...................................................................................................................9
2.3 Empirical literature....................................................................................................................9
2.3.1 Small Medium Enterprise (SMEs)..........................................................................................9
2.3.2 Taxation and business performance......................................................................................10
2.3.3 Labour productivity and SMEs performance........................................................................11
2.3.4 Capital size and SMEs performance.....................................................................................11
CHAPTER THREE: METHODOLOGY..................................................................................13
3.1Introduction...............................................................................................................................13
3.2 Research design.......................................................................................................................13
3.3 Study population......................................................................................................................13
3.4 Sampling..................................................................................................................................13
3.4.1 Sampling design....................................................................................................................13
3.4.2 Sample size...........................................................................................................................14
3.4.3 Sampling procedure..............................................................................................................14
3.5 Study variables.........................................................................................................................15
3.6 Sources of data.........................................................................................................................16
3.7 Data analysis............................................................................................................................16
3.7.1 Univariate analysis................................................................................................................16
3.7.2 Bivariate analysis..................................................................................................................17

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3.7.3 Multivariate Analysis............................................................................................................17
References......................................................................................................................................19

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 CHAPTER ONE: INTRODUCTION

1.1 Introduction

This study will establish the impact of tax on SMEs in Uganda. This chapter therefore consists of

the background to the study, problem statement, purpose of the study, objectives of the study,

hypotheses, conceptual framework and significance of the study.

1.2 Background of the study

Globally, taxes have greatly affected the way economies perform regardless of the political and

social difference among countries worldwide (Sebikari, 2014). According to OECD, “taxes are

defined as a compulsory, unrequited payments to a general government.” These taxes are

unreciprocated whereby the welfares received from the government as a result of paying taxes is

not usually commensurate to payments tax payers pay (TazegüL, 2016). Economists believe that

smaller companies usually have small resources so they usually direct these limited resources

towards tax compliance which would have been used for reinvestment and facilitating future

growth. Therefore, such a tax system puts a lot of pressure on the small tax payers (Alvi, 2010).

Taxes have existed virtually as long as there have been organized governments. The first tax law

legislation was introduced in 1919 and ever since then taxes have evolved through a number of

reforms. The government in an attempt to widen the tax base and collect more revenue has had to

levy several taxes especially on business enterprises in Uganda which constitute a large part of

the formal sector. The taxes charged on business enterprises in Uganda include; corporation tax,

value added tax, presumption tax and exercise duty (Sebikari, 2014). In 1997 the Income Tax

Act was made. This was to give guidance in assessment and computation of taxes.

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The Ugandan government has made some recommendable efforts to promote development

through taxation since the inception of the current taxation laws for purposes of promoting

development. The main possible objective of taxation in Uganda has always been to mobilize

resources needed to meet the aspiration of government. In Uganda a considerable fraction of the

businesses are sole traders operating small scale business, locally owned and managed by

individuals or families and often with very few employees working at a single location. Taxation

in Uganda is based on system that existed in Britain as it was a British colony. This also applied

to other colonies elsewhere and for East Africa, one tax system operated under British

administration. This process began in 1900 with the hut tax regulation which imposed a standard

charge for every hut/dwelling (Alvi, 2010).

UPPAP reports local taxes to have negatively affected the development of the SMEs and affect

the ability of the poor to escape poverty (Syllabus, 2016). However, there have been some

reforms in the rate schedule for graduated tax – involving shifting the rate brackets upward.

These reforms were meant to improve the overall fairness of the graduated tax and ensuring that

it does not hurt the poor. Some improvements in the progressivity of this tax are reported by

(Ssewanyana & Kasirye, 2012).Therefore this current study will aim at finding the impact of tax

on the performance of SMEs in Uganda using secondary data collected by world bank in

Uganda.

1.2 Statement of the problem

In Uganda, taxation was highlighted as a key impediment to the performance of SMEs. Income

tax rates that are charged on SMEs are not accurate. In many instances, the tax rates are

computed with lack of assessment of the actual revenue of an entity, despite these entities

making losses. In addition, business rates have been enhanced since the introduction of devolved
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government hence increasing the tax burden to most SMEs. Most SMEs in Uganda do not

survive past their fifth-year birthday after inauguration which shows poor performance in the

SME sector (Sebikari, 2014). The deficiencies in the performance of SMEs is associated with the

poor tax policies in Uganda which affect the ability of these enterprises to mobilize the required

financial and non-financial resources.

Despite the services provided, small scale business enterprise’s performance in Uganda is still

poor. This could be due to the increasing tax burden brought about by tax rates which are revised

annually in the country. These rates seem to be taking an upward trend which has led to winding

up or shut down of some small-scale business enterprises in the Country.

1.3 General objective

To assess the impact of tax on the performance of SMEs in Uganda

1.4 Objectives of the study

1. To examine the relationship between labour efficiency and the performance of SMEs in

Uganda.

2. To examine the relationship between capital size and the performance of SMEs in Uganda.

3. To examine the relationship between socio-demographic factors and the performance of

SMEs in Uganda.

Hypotheses

1. There is no relationship between labour efficiency and the performance of SMEs in Uganda.

2. There is no relationship between capital size and the performance of SMEs in Uganda.

3. There is no relationship between socio-demographic factors and the performance of SMEs in

Uganda.

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1.6 Significance of the study

To scholars and researchers, the findings of the study are expected to contribute to the existing

literature about taxation and the effect it causes to the economy as a whole. To the tax authority

and government, the study will guide them in adjusting tax policies so that they suit requirements

of small-scale businesses. To future academicians especially of Makerere University, the study

will help in gaining insight about taxes and performance of small-scale business enterprises. The

accomplishment of the study will enable the researcher to acquire hands on skills about

processing of research work and data analysis. This proficiency will enable the researcher to

handle such related work with a lot of precision and proficiency.

1.7 Conceptual framework

The conceptual framework explains the relationship between the outcome variable and the

selected independent variables. From the framework below, performance of SMEs is the

outcome variable being affected by the capital size, labour efficiency, tax system and socio-

demographic factors as the independent variables for the study.

Figure 1: Conceptual framework

Capital size

Socio-
Labour Performance
demographi
efficiency of SMEs
c factors

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 Tax system

Source: Researcher`s construct, 2021

From the above framework, labour productivity is a measure of how much each employee

contributes to a firm’s output. The higher an SME’s labour productivity, the higher its likelihood

for growth. This is because highly productive firms command higher profits, thus being able to

employ more workers through firm expansion and pay more taxes among others. Capital size

also determines the performance of SMEs for example the more inventory capital available in the

firm the higher the performance of SMEs. Tax system highly determines the performance of the

SMEs. For example, the higher the commodity tax imposed on the final output, the less profit

margins received by the firms hence reducing on their performance. Demographically, age,

gender, education, and experience of the task are being stated to have influence on business

performance. Highly literate individuals are productive, creative and innovative as they look for

bringing out new brands in human society as per fulfilment of needs or demands as well human

wants in a civil society. The learned as well seasonable female are highly inclined to becoming

entrepreneurs as compared to illiterate and inexperienced ladies of human society. However, the

individuals between the age of 25 and 44 are willing to be entangled in innovative performance

compared to other age brackets.

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 CHAPTER TWO: LITERATURE REVIEW

2.1 Introduction

This chapter looks at taxation and its impact to SMEs in Uganda. It consists of existing literature

on taxation by different scholars/research studies from magazines, text books, journals and

newspapers. This chapter covers theoretical frameworks and empirical literature which is in line

with the current study.

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2.2 Theoretical review

This section presents the theoretical argument related with SMEs performance and taxation

effect. Therefore, it includes a theory of Business Growth and a theory of Taxation.

2.2.1 Theory of Business Growth

Gibrat stipulates that the rate of growth of a firm is independent of its initial size. By implication

it would mean that large firms are preferable in context of private sector development given that

they create more employment than small firms (Lotti et al., 2007). Conversely, Krasniqi & Lajqi,

(2018) states in his learning model that younger firms learn over time, which helps them improve

their performance as they accumulate market knowledge. According to this model, young firms

grow faster than old ones. The author deduces that small firms grow faster than large ones. This

is a convergence process where small firms will eventually become as large as any other longer

firm in the same sector as time goes by. Olawale & Garwe, (2010) on the other hand claim that

as a new small firm start and develops, it moves through some growth stages. He also identified

the stages of growth of SMEs as; existence, survival, success, take off and resource maturity. In

each stage of development as different set of factors is critical to the firm’s survival and success.

The model gives an insight into the dynamics of SMEs growth including the distinguishing

characteristics, problems and requirement of growing SMEs and explains business growth

process amongst SMEs, the precise moment in time in which a startup venture becomes a new

business has not yet been theoretically determined. However, the ideal business survival could be

equated with a firm that has fully completed the transaction to stage two organizations in the five

stages of small business growth.

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2.2.2 Theory of taxation

According to the theory of taxation by Kaplow & Fleurbaey, (2014), an efficient taxation policy

should minimize costs of taxation to society, per unit of tax revenue raised. When economic

agents are more or less similar for their size, business and value of sales and it is possible to

calculate fixed sums for them to pay, lump-sum taxes should be imposed. This would be of

especial importance in transition economies when authorities do not have the capacity to

effectively impose sophisticated tax systems. Presumably, as the market economy matures, the

tax system might take on some of the elements of tax systems found elsewhere. Good taxes meet

four major criteria. They are (1) proportionate to incomes or abilities to pay (2) certain rather

than arbitrary (3) payable at times and in ways convenient to the taxpayers and (4) cheap to

administer and collect.

2.3 Empirical literature

2.3.1 Small Medium Enterprise (SMEs)

Small Medium Enterprise (SMEs) have varying definitions based on different fundamentals of

measurement. They can be defined basing on the value of assets, capital employed, sales

turnover or number of employees. In Indonesia, the grouping of micro, small and medium sized

SMEs based on the amount of gross income and the amount of labor. According to Budi business

sector, micro, small and medium enterprises play a role important in the structure of the

Indonesian economy (Okumu & Buyinza, 2018). According to the Income Tax Act (1997), small

scale businesses are those with growth turnover of less than 50 million shillings per annum. In

Uganda it’s not only income tax Act that has tried to define small scale businesses; there are also

institutions which have tried to define small scale business (SSB) such as; Ministry of Finance

Planning and Economic Development (MFPED), the Uganda Small Scale Industries Association

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(USSIA). The MFPED defines SSB as a unit with a capital investment not exceeding US$

300,000.

Chalmers, (2020) describes performance of small-scale business as the ability to attain its goals

by using resources in an efficient and effective manner, the goals of the organization include;

survival, profit making and expansion.

2.3.2 Taxation and business performance

Taxes levied on revenue are worthwhile only if it can generate meaningful revenues at acceptable

rates and procedures (Kato & Tsoka, 2020). According to Okumu & Buyinza, (2018) through

taxation, the government takes away money from people they would otherwise spend on private

sector. As a result, purchasing power reduces per unit of production in the private sector to the

public sector. They further asserted that, one of the most frequent arguments against high income

tax is that it destroys the incentive to business people and employees to work harder and more

efficiently. According to the Khalilzadeh-Shirazi & Shah, (1991) businesses carry out tax

planning so as to have a minimal tax liability and thus increasing the purchasing power. It is

through taxes that the government takes away money from people/business they would otherwise

spend on private sector. This loss of purchasing power reduces the demand for units of products

in the private sector.

2.3.3 Labour productivity and SMEs performance

Labour factor are a greater relevance in SMEs context. In developing countries, SMEs are

represented by almost 99.5% of total companies, contributed to greater employment and to

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economic growth (Nunes et al., 2013). The effects of growth on labour productivity may be

positive or negative. If growth is associated with an increased motivation of employees due to

the expectation of higher future earnings, and informal relationships between employees is not

substantially affected, then growth can contribute into increased labour productivity. If growth

contributes into a less efficient control of the action of employees by owners/managers, and also

a relevant breaking of informal labour relationships, then growth may contribute to lower labour

productivity (Bello & Sensini, 2020; Nunes et al., 2013).

2.3.4 Capital size and SMEs performance

Working capital management covers all decisions that have an impact on current assets and

liabilities and consequently on corporate liquidity (Sensini & Vazquez, 2021). Bello & Sensini,

(2020) reported that increasing investment in working capital has a positive impact on

profitability. The researcher suggested that the growth in working capital may lead to an increase

in sales, an improvement in relations with customers, a reduction in supply costs, a reduction in

information asymmetry, thus leading to an increase in profitability (Afrifa, 2015). On the other

hand, Anton & Afloarei Nucu, (2020) suggested that the increase in working capital has a

negative impact on profitability. In this perspective, the researcher highlighted that the

investment in working capital causes the need for additional financing, the increase in financial

costs, an increase in storage costs, causing a negative impact on profitability and an increase in

financial distress and the probability of bankruptcy.

Therefore, the relationship between working capital management and profitability depends on the

size of the company, its life cycle, the power relationship with the stakeholders. In particular,

larger firms have greater bargaining strength and easier access to financial resources than SMEs

(Afrifa, 2015; Anton & Afloarei Nucu, 2020). This circumstance, although not sufficient if not

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supported by proper financial management, facilitates the management of working capital in

large companies. On the other hand, the financial constraints that often characterize SMEs

influence the management of working capital and sometimes leading to decisions dictated by the

above constraints rather than correct financial management choices (Afrifa & Tingbani, 2018).

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 CHAPTER THREE: METHODOLOGY

3.1Introduction

This chapter discuss the research design, study population, study variables, sources of data, data

collection methods and instruments, data processing, analysis and presentation and limitations of

the study.

3.2 Research design

The study used secondary data which was collected using a cross section study design. The

cross-sectional design chooses a sample to represent a population and easily provide a quick

snapshot of what’s going on with the variables for the research problem. The data was collected

by World Bank in 2013 about the SMEs in Uganda. Both methods of data collection that is to say

qualitative and quantitative methods were employed during the collection of data.

3.3 Study population

Target population is an entire group of individuals, events or objects having common

characteristics. It is the sum of all that conforms to a given specification and from which a

sample is taken. The Uganda`s Enterprise Panel Survey considered both SMEs and LEs in the

different parts of the country. However, for this current study, SMEs will be selected as the study

population.

3.4 Sampling

3.4.1 Sampling design

During the survey, Simple Random Sampling (SRS) of stalls was used. This however came in

after doing a one stage stratification of elements of study depending on regions where the

enterprise was located. This ensured a fair representation of each group.

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3.4.2 Sample size

A suitable sample size is a critical matter as it influences the statistical significance and power.

According to Nick et al. (2009), choosing the correct sample is not a matter of preference, it is a

crucial element of the research process without which you may well be spending months trying

to investigate a problem with a tool which is either completely useless, or over expensive in

terms of time and other resources. The researcher selected a sample of 1000 SMEs in the

different parts of the country using purposive sampling method. This was used in order to select

only the SMEs in the country.

3.4.3 Sampling procedure

A stratified random sampling procedure was used to select the participating enterprises in the

panel survey. Stratification refers to the division of the population into none overlapping and

internally homogeneous sub populations with respect to the variable being studied. The sample

size for this current study was determined using Cochran’s formula (1963) depending on the

population size.

n=( Z2∗p∗q ) /e 2 ……………………………………….………….3.1

Where n – total sample size to be selected

Z – Standard Z-statistic of normal distribution

α – level of significance (5%)

p – Proportion of the characteristic of interest

q = 1-p…………………………………………….………………3.2

e – Maximum possible error which the researcher willing to tolerate (0.08).

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Since p is unknown, therefore the sample size to be used is;

P = 0.5 and q = 0.7

n= (1.962*0.3*0.7)/ 0.082

n=1000 enterprises.

Design effect

Deff =1+ a(1+b)………………………………………………………...3.3

Where

Intercluster correlation coefficient and range between 0 ≤ a ≤1

‘b” is the average size of the cluster

A design effect of 1 will be assumed for this study.

3.5 Study variables

The study will use secondary data which was collected by World Bank about Uganda`s

enterprise. The variables below were captured in the data set.

Table 1: Measurable variables for the study

Variable name Data type

Performance of SMEs
Annual sales Continuous
Tax system
Tax rates Categorical
Tax administration Categorical
Labour efficiency
Labour absenteeism Categorical
Hours of working Continuous

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 Capital size
Owning a standby generator Categorical
Accessibility to finance Categorical
Size of operating area Continuous
Socio-demographic factors
Population size in the area Categorical
Gender of the top manager Categorical
Education level of the top manager Categorical

3.6 Sources of data

Secondary data included policy documents and abstracts of the various scholars relating to the

topic of discussion in question. Secondary data for this study was got from sources like libraries,

archived records from the Town Council, records of selected small-scale enterprises, government

publications, online information, text books, newspapers, and unpublished research reports. This

was because it was readily available and easier to comprehend, as it comprised of extensively

researched work.

3.7 Data analysis

In this research, data analysis was done at three levels “univariate, bivariate and multivariate

analysis” using STATA 15 for analysis. Inferential and descriptive statistics will be used.

Descriptive analysis will be performed to explore data in terms of frequencies and percentages.

3.7.1 Univariate analysis

At this level of analysis, frequency tables and descriptive statistics will be analyzed and

presented. Each variable will be analyzed at a time to establish the percentage distribution of the

respondent`s background characteristics for this study and other selected variables.

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3.7.2 Bivariate analysis

The second level of analysis is bivariate analysis whereby the association between the dependent

variable and each of the independent variable will be investigated. In this analysis, the chi-square

statistic will be used to test for the significant relationship between selected independent and

dependent variable and for continuous variables were categorized. The chi square statistic takes

the form of equation.

  
2
r c O
ij  Ei j  2

i 1 j 1 Eij
…………………………………….3.5

Where i=1... r and j=1... c

ꭓ2 represents the chi square value

Oij observed frequency

Eij expected frequency assuming independence

r number of categories of the independent variables

c number of categories of dependent variables

In this study, it will be assumed that the level of significance for all chi-square test is 0.000.

3.7.3 Multivariate Analysis

The study was after used to study the relationships between the dependent variable and the

independent variables using the binary logistic model to determine the impact of tax on the

performance of SMEs. This model took the form specified below;

………………………………3.6

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Where; is the probability increased output as the measure for the performance of SMEs, is

the constant value and β is the coefficient of the explanatory variable

X is the explanatory variables (i= 1, 2, 3, 4, 5, 6, 7)

Is the error term

Under this analysis, the researcher`s interest is in finding out the relationship between the

dependent and independent variables through taking keen interest in the level of significance

(sig) and the odds ratio (Exp (B)). In cases where the significance is less than or equal to 0.05,

that will indicate a significant relationship between the independent and dependent variables. On

the other hand, where the significance is greater than 0.05, this will indicate that there is no

significant relationship between the dependent and the independent variables.

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