CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

The modern-day taxation and its use as a fiscal policy could be traced to 1926, which was a year of economic depression in Great Britain. During this period, Britain witnessed an unprecedented decline in her overall economic activities resulting to reduction in total earnings, shortage of fund in the private sector and reduced income per capital with attendant low standard of living. The effect of this depression was felt not only in Britain but almost the world over. Governments at this time were trying to revive, rehabilitate and mobilize enough capital to provide for economic and social expenses and to raise the standard of living of its populace. In doing this, various fiscal policies were formulated which include taxation (Akanbi, 2020).

The theory behind using tax incentives to promote small and medium-sized enterprises (SMEs) is at its core from the finance theory of net present value (NPV) decision rule. The rule implies that firms continue to spend on capital assets and R&D as long as the present value from an additional unit of capital or R&D is equal to or exceeds the cost of the additional unit. Consequently, it is assumed that businesses would consider tax implications in their calculation of the value of their expenditure decisions since any reduction in the cost of capital caused by tax policy leads to an equal increase in expenditure (Harger & Ross, 2016).

Tax incentives are special offerings by tax agencies granting preferential provisions to certain investments or taxpayers. Tax incentive can also be described as provisions that grant any activity or person favorable conditions that vary from the normal tax legislation provisions. Tax incentives include; tax holiday, reduced tax rates on profits, reduced tariff on imported equipment, accelerated depreciation, increased tariff to protect domestic market and loss carried forward for tax purpose. Dortet‑Bernadet and Sicsic (2017) further describes tax incentives as all the strategies and measures that provide for better tax treatment to specific activities or sectors.

Tax incentives according to Homonoff (2018) encompass all the measures adopted by government to motivate tax payers to respond favorably to their tax obligations. Tax incentives, if well managed, can lead to the springing up and gradual growth of new enterprises, which encourages production and curbs unemployment. Tax incentives should be adequately provided by the government so as to ensure an increase in employment opportunities which will eventually lead to a positive impact on the economy.

In Cameroon, tax incentives can be classified into either export promotion incentive or investment promotion incentive. Examples of investments promotion incentive are the investment deductions allowance which was implemented to accelerate investments in physical assets for instance machinery, industrial buildings, industrial building allowances that was advanced to encourage investment in buildings used for industrial purposes like allowance that was advanced to encourage investors to delve into the mining sector which was capital intensive. On the other hand, the export promotion incentives constitute three key schemes namely the EZ, the Tax Remissions and Exemption Office (TREO) and Manufacture Under Bond (MUB). The purpose of EPZ’s was to accelerate economic activity and FDI while TREO and MUB purely promoted manufacture, for export (Montmartin & Herrera, 2023).

Governments across the globe utilize tax incentive to promote economic activities and investment by enterprises, they introduce these incentives to boost some crucial sectors of the economy where they appear dormant or lacking completely. Incentives increase return on capital thus making investments more attractive and in turn increases the firm’s profitability. Despite the above benefits, tax incentives are rated poorly in investment climate and have been reported to be redundant since the investments they purport to support would still have been executed without them. Their fiscal cost could also be high which reduces the opportunities for much needed public spending on infrastructure, social support or public services requiring higher taxes on other undertakings (Onyango, 2023).

SMEs contribute a lot towards a country’s economy by inculcating entrepreneurial skills, offering employment and innovation. The promotion of SMEs in the informal sector results to development that could be sustained through the limited resources in Africa. The SME contributed to more than 50 percent of newly created jobs in 2005 Economic Survey, 2006). All firms are established on the basis of achieving different common objectives. These objectives are; profit maximization, fair dealings with suppliers and welfare of employees. In order to know whether these objectives are met, an organization has to device on means of gauging the extent of meeting these objectives or to which extent the firm is profiting the owners. Business growth is gauged using parameters such as profits, sales turnover, employees’ level of technology adoption and market share (Klemm, 2023). There is no standard measure of growth (Sidelnykova et al., 2022). He opines that neither of these options presents itself as the most appropriate measure. argues that the growth of an enterprise is reflected through increased market share, increased sales and new and improved. ‘The mind-set of an entrepreneur that guides all decision making for SMEs is a fundamental factor in the extent and rate of growth of the business’ argues McGrath (2008). This has been emphasized by Tembur (2016) who states that firms grow because they have resources which are not fully utilized within the firm and entrepreneurial motivation exists which is so profit seeking.

Small and medium sized enterprises (SMEs) play a vital role in the economic development of a country and are generally recognized and adjudged as major drivers of economic activities and national growth in most developing and developed nations (Twesige & Gasheja, 2019). SMEs account for the majority of businesses worldwide and are important and key contributors to job creation and global economic development (World Bank forum) Studies have indicated that SMEs contribute more than 50% of the gross domestic product (GDP) in many developing countries. More still, SMEs are the largest employers where by more than 90% of the working force is employed by SMEs. In a bid to stimulate growth of SMEs, a number of countries have used tax incentives, for both investors and listing firms, to promote activity on SME boards. Tax incentives for investors are the more common approach, particularly in advanced markets (Homonoff, 2018).Small and medium enterprises form the core of majority of the world’s economies. A study carried out by the federal office of statistics shows that in Nigeria, small and medium enterprises make up 97% of the economy.

According to Feyitimi et al. (2016) these enterprises are smaller in size, but their significance cannot be overemphasized in the sense that when individual effects are aggregated, they surpass that of larger companies. The benefits of SMEs cannot be overstated looking at it from the perspectives of social and economic effects which range from employment creation, economic dynamism, innovation, and competition, which instill, encourage, and induce the entrepreneurial spirit and diffusion of skills due to their wider geographical presence than big companies. Tumanyants and Gulyaeva (2018) posits that SMEs have unarguably improved the standard of living of so many people especially those in the rural areas. Establishment and sustainability of SME’s could be quite tasking and equally demanding. Thus, government charges less tax and gives tax holidays in order to encourage investments and improve economic activities of these small and medium sized enterprises towards improved production capabilities, economies of scale, as well as ensuring the allocation of resources in a manner that is socially desirable.

The three main challenges that SMEs faced by business owners are lack of financial support and business opportunities to grow, poor business practices and little business diversification. It is difficult for SMEs to realize full growth without adequate financial capital (Gumo, 2013). SMEs choose the capital structure based on the factors that prescribe the various costs and benefits linked to debt and equity financing. According to Klemm (2023) capital structure refers to a specific measure of equity and debt used by an enterprise to run its operations. According to Schuetze (2008) business growth can be described as the increase in the total number of employees over time since the owners may not be sure about the number of employees over time though they may not have maintained the written records which are reliable

According to Small and Medium Enterprises Development Agency (SMEDA) 80% of SME’s die before their 5^th year of operation. Among the identified factors responsible for winding ups are tax related issues, ranging from multiple taxations to enormous tax burdens. According to Varnalii et al. (2018) the objective of granting tax relief and incentives to small and medium sized enterprises is to enhance their growth and development, thus contributing to the overall economic development of the country. But the objective cannot be achieved in a situation where the would-be beneficiaries are not even aware of the existence of such incentives. Moreover, the few who are aware of these incentives do not even bother to apply for them due to the poor and inefficient tax administration system. Despite the numerous literatures on Tax incentives as it relates to SMEs their results are inconclusive and there is a need to capture more sub-variables.

1.2 Statement of the Problem

In a low-income country such as Cameroon, the role of SMEs is crucial in ensuring that the country’s social economic development agenda is achieved. SMEs are highly considered to be the accelerators of innovation and growth in the economy (Deyganto, 2022). However, SMEs face challenges with regard to financing, disproportionate regulatory burdens and competition failures compared to large entities. A favorable business environment is therefore important to minimize the impact of these barriers and seeks to provide a level playing ground for firms of all sizes. Reduction of the tax burden of SMEs through issuing incentives will free up funds to be used in innovation and efforts to access global markets and ultimately ensure business growth (Twesige & Gasheja, 2019). This can be achieved through alignment of tax-environment to the environmental specific growth needs for SMEs (Lévay et al., 2017).

The typology for SME tax incentives in Cameroon depends on factors including firm size, firm age, input- output and the sort of activities performed by the SME (Sidelnykova et al., 2022). Despite the significant contribution of tax incentives to SMEs’ growth, unequal treatment the taxpayer’s hampers with the efficiency of and tax system’s efficiency and thus tax incentive’s social benefits have to be weighed against related costs (Tumanyants & Gulyaeva, 2018). As part of the big four Agenda, the government has aligned policies under the agriculture sector to boost small holder production and reduce initial cost of investment. A recent tax exemption policy was witnessed in 2017 when the government exempted materials used in the construction of storage facilities from VAT. Empirical studies has shown different view on tax incentives and business growth. Based on the knowledge gap the study seek to assess the effect of tax incentives on the growth of small and medium businesses in Bamenda III.

1.3 Research Questions

1.3.1 Main Question

What is the effect of tax incentives on the growth and small and medium businesses in Bamenda III?

1.3.2 Specific Questions

• What is the effect tax holiday on the growth and small and medium businesses in Bamenda III?
• What is the effect of tax credit on the growth of small and medium businesses in Bamenda III?
• What is the effect of tax exemption on the growth of small and medium businesses in Bamenda III?

1.4 Research Objectives

1.4.1 Main Objective

To identify the effect of tax incentives on the growth and small and medium businesses in Bamenda III

1.4.2 Specific Objectives

• To assess the effect tax holiday on the growth and small and medium businesses in Bamenda III
• To identify the effect of tax credit on the growth of small and medium businesses in Bamenda III
• To examine the effect of tax exemption on the growth of small and medium businesses in Bamenda III