Journal of Financial Crime

Cash economy: tax evasion amongst SMEs in Malaysia

Azhar Mohamad, Mohd Hasrol Zakaria, Zarinah Hamid,
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Azhar Mohamad, Mohd Hasrol Zakaria, Zarinah Hamid, (2016) "Cash economy: tax evasion amongst
SMEs in Malaysia", Journal of Financial Crime, Vol. 23 Issue: 4, pp.974-986, https://doi.org/10.1108/
JFC-05-2015-0025
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JFC
23,4
Cash economy: tax evasion
amongst SMEs in Malaysia
Azhar Mohamad
Kulliyyah of Economics and Management Sciences,
974 International Islamic University Malaysia, Kuala Lumpur, Malaysia
Mohd Hasrol Zakaria
Inland Revenue Board Malaysia, Kuala Lumpur, Malaysia, and
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Zarinah Hamid
Kulliyyah of Economics and Management Sciences,
International Islamic University Malaysia, Kuala Lumpur, Malaysia

Abstract
Purpose – The purpose of this study is to investigate the relationship between tax evasion and certain
demographic factors such as location, engagement of tax agent, size and type of small- and
medium-sized enterprises (SMEs) industry in Malaysia.
Design/methodology/approach – In this study, using proprietary tax audit data from the Inland
Revenue Board of Malaysia (IRBM) on the 2011 tax returns of SMEs, the authors run a multiple
regression analysis to examine the impact of location, agent, type of industry, size of enterprise and type
of tax evasion on SMEs’ tax evasion in Malaysia.
Findings – The authors find that tax evasion among SMEs in Malaysia is the highest when the
business is located in a suburban environment and has no tax agent. Tax evasion is also influenced by
the size of the SME (micro or medium).
Originality/value – This study gives insight that the IRBM can use to aid its collection department in
profiling SMEs that have a higher tendency to evade paying tax.
Keywords Malaysia, SMEs, Tax evasion, Cash economy, Corporate income tax
Paper type Research paper

Journal of Financial Crime
Vol. 23 No. 4, 2016
pp. 974-986
© Emerald Group Publishing Limited
1359-0790
DOI 10.1108/JFC-05-2015-0025
1. Introduction
Avoiding taxes and evading taxes may sound like similar actions, but the two terms
have very different meanings. Avoiding taxes can be accomplished through various
legal means, whereas evading taxes is a financial crime and can result in severe
penalties. This is the most important difference between the two activities. Many
methods can be used to legally avoid paying taxes, the most commonly used being
income deferral and income tax deduction. Income deferral involves postponing the
receipt of income until the succeeding tax year and frequently involves businesses that
use the accrual basis of accounting. Meanwhile, the use of tax deduction affects the total
income by reducing it, which decreases the amount of taxes that are due. Tax deductions
are granted to taxpayers and businesses to encourage certain behaviour (e.g. to attract
foreign investors, encourage R&D, etc.), spending patterns, lifestyles and so forth. Any
The authors thank the Operational and Compliance Department of the Inland Revenue Board of
Malaysia for providing the data.
 methods used to avoid taxes that fall outside of the legal boundaries are classed as tax Cash economy
evasion. Tax evasion occurs in the informal economy, where the whole activity takes
place in an informal manner – this means that the business is not only evading taxes but
also not even registered as a formal enterprise.
The fact that direct taxes collected by the Inland Revenue Board of Malaysia (IRBM)
contribute more than half of the Federal Government’s revenue means that tax evasion
activities, especially those carried out by small- and medium-sized enterprises (SMEs) 975
intending to reduce their tax liability, will lead to huge losses for the government. When
the taxation system is ineffective, many people use the opportunity to avoid paying tax,
and tax evasion becomes common. The IRBM reported that in 2010, additional taxes and
penalties amounted to about RM 1,013.63m of the finalised audited corporate tax cases
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(IRBM, 2010). This amount did not include SMEs, which are the focus of this research.
This study focuses on SMEs for several reasons. Most research on tax evasion is
focused on individual and corporate taxpayers. As reported by the Statistical
Department of Malaysia, based on the census of SMEs in Malaysia, the total number of
such firms in 2010 was 645,136. Their gross output in that year was RM 507m. These
huge figures show the potential income source for the Malaysian government if such
firms are compliant with the tax laws. However, because of their characteristics and the
nature of their business, these groups of taxpayers tend to evade tax, intentionally or
unintentionally. In addition, empirical research has established that the burden of tax
compliance is felt more acutely by SMEs than larger businesses (Abdul Jabbar and
Pope, 2008).
The main objective of this study is to determine the factors that cause tax evasion
among SMEs in Malaysia, specifically focusing on type of industry, location and size of
enterprise, based on actual tax audit data obtained from the IRBM. We contribute to the
growing literature on tax evasion by filling the gap in the work of previous scholars who
have only looked at determinants of tax evasion based on questionnaires and (limited)
secondary data. To our knowledge, this study is the first to use data-audited cases taken
from the IRBM. There is also a scarcity of empirical research on tax evasion by SMEs,
especially studies that utilise actual tax evasion/non-compliance data. The data
acquired also represents the reality of all non-compliant taxpayers throughout Malaysia
that have been audited and have not been made publicly available.
The remainder of this paper is organised as follows. In the next section, we provide a
brief description of corporate income tax, the cash economy and SMEs in Malaysia. We
review the related literature on tax evasion in Section 3. In Section 4, we describe our
research design and explain our findings. We offer some concluding remarks in
Section 5.

2. Corporate income tax, the cash economy and small- and medium-sized
enterprises in Malaysia
Income tax is one of the major sources of revenue of the Malaysian government. It has
become an essential tool helping the government to implement various policies aimed at
improving the welfare of the citizens and the development of the country. It is important
because it used to finance several types of government expenditure and, especially, to
regulate economic activity, thus ensuring the social well-being of Malaysian citizens.
The revenue is used to provide better facilities, such as infrastructure, education,
defence, health support, housing and others.
 JFC 2.1 The cash economy
23,4 There is no commonly agreed or used definition of the underground, or cash, economy.
While terms such as “underground”, “grey”, “hidden”, “shadow” and “cash” economy
are often considered to represent the same thing, their definitions generally include or
exclude different activities. Schneider and Enste (2000) provide a commonly used
definition: “all economic activities that contribute to the officially calculated (or
976 observed) gross national product but are currently unregistered”. According to
Braithwaite and Reinhart (2001), the cash economy refers to economic activity that is not
brought to account through normal channels as required by the taxation and other
regulatory systems.
The amount of tax collected depends on the structure of the economy. Before 1980,
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until it began to change into an industrial economy, Malaysia depended on its

agricultural economy. The change can be seen from the increase in the total income of
the government. In 1980, the total government revenue collected from income tax was
just RM 5.48bn, but this number has increased over time. In 1990, it was RM 10.4bn, in
2000 – RM 29.17bn – and, in 2010, almost three times the 2000 figure at RM 86.5bn. In
2011, the IRBM achieved the highest collected amount in its history because the income
tax revenue increased to over 100 billion for the first time (RM 109.61bn; IRBM internal
information – Revenue Department). The main contribution to the income tax came from
corporate tax, which included SMEs. In 2011, the latter contributed RM 55bn, more than
40 per cent of the total income tax collected. This implies that the government should
place a higher priority on corporates and enterprises to avoid a loss of tax income. The
following table summarises the total income tax collected from 1980 to 2011 (Table I).

2.2 Small- and medium-sized enterprises

SMEs are playing a significant role in the development of the Malaysian economy. The
Malaysian Statistical Department census in 2011 showed that the total number of SMEs
in Malaysia was 645,136. Of these, micro-sized enterprises were in the majority,
comprising 77 per cent, followed by small enterprises, making up 20 per cent. Only 3 per
cent were medium-sized enterprises. It was also found that 90 per cent involved business
activities in the services sector, 5.9 per cent in manufacturing and 3 per cent in the
construction sector. The remaining businesses were involved in agricultural, mining
and quarrying business activities. The census results also showed that more than 50 per
cent SMEs in Malaysia were concentrated in Selangor, Kuala Lumpur, Johor and Perak.
The above information shows that micro-sized businesses, which are mostly located in
big cities, should be focused on by the IRBM.
A large number of SMEs are producers of finished goods and services. Collectively,
these SMEs contribute to the growth of the manufacturing, service and agriculture
sectors, as well as to information communication technology (ICT) services, in terms of
output, value-added, employment and exports (SME Annual Report, 2006). Their
contributions have a big impact on the economy as a whole. In 2005, SMEs contributed
32 per cent of the gross domestic product, 56.4 per cent of employment opportunities and
19 per cent of exports. Various definitions of SMEs can be found in the literature, but this
study will use the definition proposed by the National Small and Medium Enterprises
Development Council (SMIDEC) because it is the most comprehensive. SMEs can be
divided into three categories, namely, micro enterprises, small enterprises and medium
enterprises. The definition of SMEs will be based on two criteria, namely, the number of
 Total tax collection Total corporate Contribution of
Cash economy
Year (in billion RM) tax (in billion RM) corporate tax (in %)

1980 5.48 2.54 46.40

1981 6.11 2.77 45.30
1982 6.40 2.63 41.14
1983 7.70 3.41 44.24
1984 8.45 3.44 40.67
977
1985 9.26 3.99 43.07
1986 8.67 3.46 39.96
1987 6.45 2.80 43.37
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1988 7.51 3.17 42.18

1989 7.78 3.41 43.82
1990 10.40 4.15 39.87
1991 13.20 5.35 40.52
1992 15.41 7.50 48.69
1993 17.20 8.75 50.85
1994 20.12 10.56 52.49
1995 22.67 11.71 51.63
1996 25.81 14.17 54.89
1997 30.48 16.68 54.75
1998 29.98 17.33 57.81
1999 27.05 15.29 56.52
2000 29.17 13.98 47.93
2001 41.79 21.58 51.64
2002 44.32 27.38 61.78
2003 42.82 23.16 54.09
2004 48.63 24.56 50.50
2005 56.85 28.06 49.35
2006 65.74 30.42 46.27
2007 74.70 37.57 50.30
2008 90.65 46.90 51.74 Table I.
2009 88.40 40.27 45.55 Total income tax
2010 86.50 43.80 50.63 collection from 1980
2011 109.61 55.08 50.25 to 2011

employees and the annual sales turnover. The following table describes different
definition of SMEs in Malaysia (Table II).
SMEs, however, have their own characteristics. It is dynamic in nature (Olorunshola,
2003). As noted by Ayanda and Laraba (2011), SMEs in Nigeria are usually small,
owner- or family-managed businesses offering basic goods and services, which tend to
lack organisational and management structures, although the urban ones tend to be
more structural than their rural counterparts. This is one of the most generic features of
SMEs in Nigeria. Olorunshola (2003) explained that SMEs usually have simple
management structures because of the small number of employees and the owners’ low
level of education.
Ali and Nelson (2006) identified competitiveness issues for SMEs such as high labour
costs, a lack of innovation and low access to funding and working capital. Hanefah et al.
(2002) found that the production processes of SMEs are usually labour intensive and
 JFC Group Micro-enterprise Small enterprise Medium-sized enterprise
23,4
Primary Less than five full-time Between 5 and 19 full-time Between 20 and 50 full-time
agriculture employees with annual employees with annual employees with annual
turnover less than RM turnover of between RM turnover between RM 1 and
200,000 200,000 and 1m 5m
978 Manufacturing Less than five full-time Between 5 and 20 full-time Between 51 and 150 full-
(including employees with annual employees with annual time employees with
agro-based) turnover less than RM turnover between RM annual turnover between
250,000 250,000 and 10m RM 10 and 25m
Services Less than five full-time Between 5 and 19 full-time Between 20 and 50 full-time
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Table II. (including ICT) employees with annual employees with annual employees with annual
Definition of SMEs in turnover less than RM turnover between RM turnover between RM 1 and
Malaysia 200,000 200,000 and 1m 5m

that such firms usually serve as suppliers for the larger manufacturing firms, with
operations that are highly dependent on raw, locally sourced materials. SMEs typically
require less start-up capital than larger companies (Akinsulire, 2010), and they are
usually managed and controlled by the same individual, who is both owner and
employee. SMEs are also likely to vary in organisational form, from sole proprietorships
to partnerships and to limited companies.

3. Related literature
Many scholars have studied tax compliance and evasion with a focus on individuals and
organisations. However, very few studies have been conducted on tax evasion by SMEs
in Malaysia. All the factors mentioned in the literature as influencing the attitudes and
behaviour of taxpayers are similarly likely to affect the compliance level of SMEs.
Research carried out by Mohd Yusof et al. (2014) identified several factors that could
influence tax evasion, namely, the penalty rate, the marginal tax rate, financial liquidity,
foreign ownership, company size and type of industry. They found only the marginal
tax rate and company size to be significant determinants of corporate tax
non-compliance. Their results also showed the construction industry to be the industry
that engaged in tax non-compliance to the greatest extent. Mohd Nor et al. (2010), who
also identified audit quality as a potential factor, found a negative and significant
relationship between tax evasion and a firm’s characteristics, i.e. firm size, ownership
structure, audit quality and type of industry.
In their study on factors affecting tax evasion in Malaysia, Tabandeh et al. (2012)
identified a few potential factors, such as the tax burden, income, the size of the
government, the inflation rate and trade openness. Using the multilayer perceptron
artificial neural network method and time-series data (1963-2010), they estimated the
importance of factors that affect tax evasion and found the income of the taxpayer to be
the most important, with a negative relationship. Trade openness also had a highly
important negative effect on tax evasion. The positive relationship between the inflation
rate and tax evasion showed that an increase in inflation meant taxpayers preferred to
save their money, so as to hold on to their purchasing power rather than paying tax.
When the government increases in size, its control of each sector of the economy
 becomes more difficult and tax evasion becomes more popular. The tax burden was Cash economy
found to have the lowest importance because the fact that tax is not high in Malaysia.
Mohamad et al. (2012), based on a descriptive statistical analysis, deduced that the
level of behaviour, beliefs and perceptions of fairness towards tax compliance in
Kuantan, Pahang, was at an average level. Using survey method and distributing 200
questionnaires to tax practitioners in Kuantan, the result from their correlation analysis
also indicated there was a relationship between SME taxpayers’ behaviour, beliefs and 979
fairness and their tax compliance.
Tax evasion is related to fraudulent financial reporting because the latter affects the
total tax revenues by reducing sales or increasing claimed expenses. Using an empirical
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analysis of data from the IRBM on 73 private limited companies that had been
investigated and shown to be evading their taxes. Mohd Noor et al. (2009) identified six
factors that indicated tax evasion: revenue, liquidity, leverage, the tax rate, inventories
and account receivables. However, only three were found to have a significant
relationship with tax evasion, namely, revenue, liquidity and leverage.
Kasipillai and Abdul-Jabbar (2006) looked at whether gender and ethnicity influence
tax-compliance attitudes and behaviour. They used interviews to obtain responses to a
structured questionnaire from individuals from a major urban town, chosen randomly.
In terms of gender, females were found to be more tax-compliant than males. In term of
ethnicity, a simple mean comparison revealed that Chinese and Indian respondents were
more prone to comply with tax laws than Malays. However, an ANOVA did not indicate
significant differences between the ethnic groups. Academic qualifications and the
preparation of tax returns were statistically significant determinants of a non-compliant
attitude.
Choong and Lai (2009) studied tax practitioners’ perceptions of tax audits and tax
evasion in Malaysia using a survey method in which they distributed questionnaires
to public tax seminar participants. They found that the respondents were not aware
that the IRBM had issued public rulings to guide and assist them with tax
compliance. The respondents also demonstrated a misunderstanding regarding the
tax audits’ objectives of detecting tax evasion and penalising non-compliance. They
also had difficulties in differentiating between legitimate tax planning and tax
evasion, which was thought to be because of a lack of formal tax education at
primary, secondary and tertiary levels.
Compliance cost is another important determinant of tax evasion or
non-compliance among SME taxpayers. However, this depends on the size and
ownership of the SME, and a few other factors that have been studied by a few
researchers in the Malaysian context. One such study was conducted by Mansor and
Hanefah (2008) regarding the tax compliance costs of Bumiputera[1] SMEs in
Northern Malaysia. The authors used the survey method (questionnaires) to explore
and measure the cost of tax compliance among these SMEs because their business
and tax knowledge and awareness were still relatively low. The findings showed
that the average cost of tax compliance for Bumiputera SMEs was RM 22,003 for the
year 2003. Most of the large Bumiputera enterprises relied more on external sources,
whereas small enterprises relied more on internal staff to manage tax matters. The
managers of the small Bumiputera enterprises handled tax matters as well as the
company’s affairs. The time spent by the manager was found to shrink as the size of
the enterprise increased because accountants and other accounting staff would be
 JFC hired to handle the tax work. A total of 45 per cent of the respondents agreed that the
23,4 cost of compliance was a burden for them. Thus, tax compliance costs have a
significant relationship with the size of the enterprise, followed by the type of
business, the type of external advisors and the location. The findings also indicated
that Bumiputera entrepreneurs lacked tax knowledge.
However, research carried out by Pope and Abdul-Jabbar (2008) regarding tax
980 compliance costs for SMEs in Malaysia showed different results. Using empirical
analysis of data on the total number of SMEs in Malaysia (518,996), obtained from
SMIDEC, they studied and discussed the issues, estimates and challenges of the tax
compliance and administrative burden in the context of tax policy considerations in
Malaysia. The findings showed that the major tax compliance issues in Malaysia are
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record keeping and documentation, tax complexity and tax compliance costs. The costs
comprise 59 per cent computational costs and 41 per cent planning costs. The tax
challenges for Malaysian SMEs are administration arrangements, the need for a
simplification of policies, the need for income tax simplification and the need for
compliance cost minimisation.
In another study that explored the relationship between tax compliance costs and
compliance issues in Malaysia, Abdul Jabbar and Pope (2008) tried to estimate the tax
compliance cost and measure possible non-compliant behaviour from a business
managerial perspective. They used a survey method, distributing questionnaires via
mail. Their findings showed that the average compliance cost per SME was RM 9,295.
The two types of non-compliance behaviour were the under-reporting of income and the
overstating of deductions. The findings showed that a relatively greater number of
SMEs were being compliant in terms of income reporting and accuracy of deductions.
However, the results did not indicate a statistically significant relationship between the
size of tax compliance costs and likelihood of compliance.
In their research, Sharoja and Kasipillai (2010) produced a model of tax compliance
costs and tax-attitudinal aspects. They investigated the compliance costs and behaviour
of corporate taxpayers from the perspective of external tax professionals. The findings
showed that the tax compliance cost burden was not a significant predictor of the
under-reporting of income or the over-claiming of expenses. The findings also indicated
that tax complexity, tax law fairness and tax psychological costs had significant
relationships with the likelihood of tax non-compliance of at least one type.
In Malaysia, almost 90 per cent of business is carried out by SMEs. For this reason,
the Malaysian government has put SMEs under SMIDEC’s jurisdiction. SMIDEC is an
agency of the Ministry of International Trade and Industry. Their functions are to
coordinate policies and programmes, provide advice and information and manage data
for business support purposes (smecorp.gov.my). Because the characteristics and
weaknesses of SMEs are different than those of large-scale enterprises, SMEs have
internal and external problems that can lead to tax evasion. Empirical research has also
established that the burden of tax compliance is felt more acutely by small than large
businesses (Abdul Jabbar and Pope, 2008).

4. Research design and empirical findings

4.1 Data sample
This research uses secondary data from 51 branches of the IRBM (Table III below
for the branch classification). The data were obtained from two departments (the
 Operational Department and the Compliance Department) of the IRBM involved in Cash economy
collecting tax from SME taxpayers. The data set comprises enterprises that have
been audited. The audit cases for SME tax evasion cover both field audits and desk
audits. A field audit is when the auditor examines the tax return, financial
statements and business records directly, whereas a desk audit merely involves
checking the tax return.
This study examines factors that influence tax evasion in SMEs. The dependent 981
variable is the total amount of SME tax evasion, whereas the independent variables
are location, tax agent, type of industry, size of industry and type of tax evasion. To
analyse these factors, a cross-sectional study is performed using data on SME
taxpayers that were audited in the year 2011. Table IV depicts the variables used in
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this research and their sources.

The total number of audit cases that led to the imposition of additional tax was 9,815
observations. However, cases with additional tax equal to or less than 0 were removed
from the sample, leaving 2,849 observations for the analysis. Here, we use additional tax
imposed more than 0 as a measure to determine whether a particular SME is involved in
tax evasion. Additional tax is imposed on the SMES when they are under-reporting
sales, over claiming purchases and others (such as over-claiming expenses, withholding
tax, capital allowance, stock exemptions and transfer pricing). Table V below
summarises the additional tax imposed.

4.2 Descriptive statistics

Descriptive statistics for the sample are reported in Table VI below.

Classification Branch

Urban Johor Bahru, Melaka, Seremban, Ipoh, Kota Bharu, Alor Setar, Pulau
Pinang, Kuantan, Jalan Duta, Cukai Korporat, Kuala Terengganu, Shah
Alam, Kangar, Kuala Lumpur, Bukit Mertajam, Klang, Cheras, Wangsa
Maju, Petaling Jaya, Kota Kinabalu and Kuching
Suburban Taiping, Teluk Intan, Kluang, Raub, Muar, Sg.Petani, Temerloh, Sandakan, Table III.
Tawau, Keningau, Sibu, Miri and Bintulu Branch classification

No. Variables Symbol Source

1 Tax evasion by SME TE Inland Revenue Board Malaysia

2 Location LOC Inland Revenue Board Malaysia
3 Tax agent AGENT Inland Revenue Board Malaysia
4 Type of industry TI Inland Revenue Board Malaysia Table IV.
5 Size of enterprise SIZE Inland Revenue Board Malaysia Variables and
6 Type of tax evasion TTE Inland Revenue Board Malaysia sources of data

Table V.
Total number of SME audited cases 9,815 Summary of
Total number of SMEs with additional tax equal to or less than 0 (6,966) additional tax
Total sample 2,849 imposed
 JFC No. Variables Frequency (n ⫽ 2,849) (%)
23,4
1 Location
Urban 2,138 75.04
Suburban 711 24.96
2 Tax agent
982 No tax agent 2,718 95.40
Tax agent 131 4.60
3 Type of industry
Agriculture 141 4.95
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Manufacturing 176 6.18

Services 2,532 88.87
4 Size of enterprise
Micro 1,510 53.00
Small 1,276 44.79
Medium 63 2.21
5 Type of tax evasion
Table VI. Sales 138 4.84
Descriptive statistics Purchases 3 0.11
of sample Others 2,708 95.05

From the table, we can see that most SME owners (75 per cent) are located in urban
areas, with 25 per cent in suburban areas, across all 51 IRBM branches. We can also
see that most of the SMEs (95 per cent of the 2,849 observations) do not appoint tax
agents. The SMEs that do not appoint tax agents have a greater tendency to evade
tax than the SMEs that appoint tax agents who have a greater knowledge of the tax
regulations.
In our data sample, for tax evasion cases, it appears that the service sector has the
greatest tendency to evade tax. Tax evasion cases involve more than 88 per cent of
service sector SMEs, followed by the manufacturing and agriculture sectors with 6
per cent and 5 per cent shares, respectively. Regarding size of industry, 53 per cent
of the SMEs that have been investigated for tax evasion are micro-sized businesses
(with sales ⬍ RM 250,000), 45 per cent are small (with sales of RM 250,000-1,000,000)
and 2 per cent are medium-sized (with sales ⬎ RM 1,000,000). To determine the type
of tax evasion, we refer to the part of the financial statement that the SME
manipulates to evade paying tax. As mentioned earlier, the types of evasion include
under-reported sales, over-claiming purchases, and others (such as over-claiming
expenses, withholding tax, capital allowance, stock exemptions and transfer
pricing); 95 per cent of the SMEs fall under the “others” type, whereas 4.8 per cent
manipulated sales figures and 0.11 per cent purchases.

4.3 Model specification

We examine the impact of location, agent, type of industry, size of enterprise and
type of tax evasion on SMEs’ tax evasion in Malaysia. The model can be described
as below:
 TEi ⫽ ␤0 ⫹ ␤1LOCi ⫹ ␤2AGENTi ⫹ ␤3TIi ⫹ ␤4SIZEi ⫹ ␤5TTEit ⫹ ␧i (1) Cash economy
where,
TEi ⫽ SMEs’ tax evasion (in RM)
LOCi ⫽ Location (1 ⫽ Urban, 0 ⫽ Sub-urban)
AGENTi ⫽ Tax Agent (1 ⫽ Engage tax agent, 0 ⫽ No tax agent)
TIi ⫽ Type of Industry (1 ⫽ Agriculture, 2 ⫽ Manufacturing, 3 ⫽ Services) 983
SIZE,i ⫽ Size of Enterprise (1 ⫽ Micro, 2 ⫽ Small, 3 ⫽ Medium)
TTEi ⫽ Type of Tax Evasion (1 ⫽ Sales, 2 ⫽ Purchases, 3 ⫽ Others)
εi ⫽ error term or disturbances term
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4.4 Regression results

Table VII reports the multiple regression results for this study. The model,
altogether, is highly significant (p ⬍ 0.01) with an adjusted R2 of 7.39 per cent. The
results in Table VII show that three independent variables are significant, namely,
location, the use of a tax agent and size of enterprise. The type of industry and type
of tax evasion do not significantly affect the tax evasion among SMEs in Malaysia
in the year 2011.
The negative coefficients for location and the use of a tax agent indicate that SME
taxpayers in suburban locations and those without tax agents are more likely to evade
tax and significantly so. SMEs located in suburban areas and those that do not appoint

No. Variables Ordinary least square (OLS)

C 38,980.16
1 Location ⫺20,374.23***
2 Tax agent ⫺6,912.43*
3 Type of industry
Agriculture 620.44
Manufacturing ⫺700.17
Services 0
4 Size of enterprise
Micro ⫺4,094.91**
Small 0
Medium 41,480.66***
5 Type of tax evasion
Sales 4,404.64
Purchases 0
Others 6,703.59
R2 0.0765
Adjusted R2 0.0739
Probability ⬎ F 0.0000 Table VII.
Multiple regression
Note: *** , ** , and * denote significance at 1, 5 and 10%, respectively results
 JFC tax agents are less knowledgeable about accounting and tax systems. As such, there is
23,4 a tendency for them to be less compliant and evade the taxes. The size of the enterprise
is also significant. The negative sign for micro-sized businesses indicates that these
SMEs are less likely to evade taxes, whereas the positive sign for medium-sized
businesses (sales ⬎ RM 1,000,000) shows them to be more likely to evade tax. Thus,
SME taxpayers are likely to become less compliant with their tax obligations as their
984 business expands.
It also appears that the relationships between tax evasion and this set of variables
(location, use of a tax agent and size of enterprise) found in our model provide some
support for prior studies. Jackson and Milliron (1986) stated that individuals were less
likely to evade taxes regardless of the tax situation and that they showed a greater
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tendency to evade taxes as their business grew. Milliron (1985) also stated that there is
a positive relationship between taxpayers’ understanding of tax laws and
tax-compliance attitudes. Having a tax agent will, to a certain extent, provide a taxpayer
with insight into the tax system. Thus, the IRBM needs to provide SME taxpayers with
a better understanding of the tax laws and tax systems.

5. Conclusion
Income tax is one of the Malaysian government’s major sources of revenue. It has
become an essential tool for the implementation of various government policies aimed at
improving the welfare of the citizens and the development of the country. Tax evasion
has led to a shortfall in tax revenue, which is affecting the development of the country
and the welfare of the people.
In this study, using the IRBM’s proprietary tax audit data for the year that ended in
2011 (2,849 observations), we examine the relationship between SMEs’ tax evasion and
certain demographic variables, using ordinary least squares regression. The variables
under study are location, use of a tax agent, type of industry, size of enterprise and type
of tax evasion. We find tax evasion to be greatest among SMEs located in suburban
areas, with sales less than RM 250,000 (micro-sized) or bigger than RM 1,000,000
(medium-sized) and that do not appoint a tax agent.
This study provides the IRBM with insights that it can use to improve its collection
department, by profiling SMEs that have a higher tendency to evade paying tax. By
planning better tax audits among SMEs and tightening its SME tax system, it is hoped that
the IRBM can reduce the incidence of this form of financial crime so that the nation can
prosper.

Note
1. Bumiputera is a term to describe native Malay and indigenous people of Malaysia.

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Corresponding author
Azhar Mohamad can be contacted at: m.azhar@iium.edu.my; dr@azharmohamad.asia
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