Empowering SMEs: Proposed alterations (Part 2)

TANZANIA: TANZANIA’S SMEs are the lifeblood of the economy, contributing over 35 per cent to the GDP and creating countless jobs.

Yet, many small businesses have been seen to struggle in attaining growth under the weight of a complex and costly tax system.

While initiatives like the Presumptive Tax System have provided some relief, significant challenges yet linger, particularly for rural and informal enterprises.

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Building on the last discussion, we intend to examine how strategic tax reforms can address these issues and unleash the full potential of Tanzania’s SMEs.

By streamlining compliance, offering targeted relief and fostering fairness, the country can create a tax environment that empowers small businesses to innovate, expand and drive sustainable growth.

For many SMEs in Tanzania, the tax system presents more hurdles than opportunities. While designed to support business growth, several aspects of the current framework inadvertently hinder the success of small enterprises.

Formalisation Psychological Barrier

Many entrepreneurs perceive Tanzania’s tax system as punitive rather than supportive, discouraging them from transitioning to formal operations.

For example, Amina’s Tailoring Shop in rural Mwanza avoids formalisation, losing access to formal credit that could have doubled her monthly revenue of 2m/-.

Tax consultant Sophia Kileo, based in Kahama District, Shinyanga Region advises, “To address this fear, the government should introduce tax holidays or reduced initial tax rates for newly formalised SMEs during their first three years. This will encourage more informal businesses to register and help bridge the gap between compliance and perceived burdens.”

This approach has seen success in Georgia, where the introduction of simplified tax regimes for small enterprises significantly increased business registrations.

Tax consultant Teimuraz Tsertsvadze, who oversaw aspects of the Georgian reform, explains in briefings that between 2004 and 2012, Georgia implemented significant tax reforms that transformed the country’s economic landscape.

These reforms doubled the GDP within four years and tripled it within eight years, despite a global economic downturn in 2009.

“Revenue mobilisation increased from 10.9 per cent of GDP in 2003 to 24.2 per cent by 2008, stabilising at 22-24 per cent in the following years. This progress underscores the vital role of streamlined tax policies in fostering economic growth and formalising businesses,” the consultant says.

Informality Outlay

Between 2010 and 2015, Tanzania took significant steps toward formalising its SME sector, which contributes over 35 per cent to the country’s GDP, according to the Economic and Social Research Foundation (ESRF).

Although specific data on registration growth during this period is unavailable, formalised businesses saw improved access to credit and government support, enabling many to expand operations and boost revenues.

Tax consultant Juma Temu from Shinyanga highlights the importance of formalisation in driving growth and enhancing the economic contributions of SMEs, particularly in rural areas.

However, he notes that for many businesses, formalising is only the first step in a complex and often costly process.

For instance, an undisclosed merchant in Shinyanga incurred 5.0m/- in penalties after incorrectly filing VAT returns due to misinformation from an unqualified consultant.

To address such challenges, Mr Temu recommends that the government invest in free, tailored tax education programmes for SMEs, both online and offline.

“Providing easy-to-understand resources and workshops will empower business owners to comply confidently and avoid costly mistakes,” he emphasises.

This recommendation aligns with the potential benefits of South Africa’s SME Connect programme. Hypothetically, if the programme had increased tax compliance among small businesses by 20 per cent over four years, it could add approximately 5.0 billion rands to national revenue.

This assumes that if SMEs currently contribute 25 billion rands annually, a 20 per cent increase in compliance would directly result in an additional 5.0 billion rands.

Further, if each SME generates 50,000 rands in tax revenue annually, bringing 100,000 more SMEs into compliance could also contribute an extra 5.0 billion rands. These projections highlight the significant impact accessible tax education can have on both compliance and economic growth.

Complexity and Digital Divide

The complexity of compliance is further compounded by the digital divide. Joshi Ujenzi, a building material retailer in Sumbawanga District, Rukwa Region, struggles with late filings due to unreliable internet, incurring 1.0m/- in annual fines.

Tax specialist Abubakar Sadiki, who is based in Rukwa suggests to bridge this gap, the government should develop offline-enabled tax filing systems and subsidise access to digital tools for rural SMEs.

“This would ensure that businesses outside urban centres can meet compliance standards without additional financial strain,” Mr Sadiki says.

The consultant says that the Bangladesh government introduced mobile-based applications and offline tax filing solutions to enhance accessibility for rural businesses.

In 2019, over 50,000 small businesses in rural areas adopted these digital tools, resulting in an 18 per cent increase in timely tax filings.

ALSO READ: Tanzania’s SMEs: Navigating tax landscape (Part 1)

This initiative not only improved compliance but also helped reduce penalties for late payments, saving businesses an estimated 2.0 billion taka (23 million US dollars) in avoided penalties.

This programme was part of a larger effort to boost tax compliance, particularly in remote regions with limited internet connectivity, ultimately fostering greater inclusion in the formal economy. Misalignment with Cash Flows Tax payment schedules frequently do not align with the seasonal cash flow cycles of industries such as agriculture.

For instance, interviews with traders in Ilala District, Dar es Salaam, highlighted that many small businesses face cash shortages during off-peak seasons, which often leads to delays in tax payments. As a result, some traders incur penalties as high as 2m/-, further straining their finances.

Tax consultant Kelvin Alphonce from Kinondoni District, Dar es Salaam suggests that introducing flexible tax payment schedules tailored to seasonal industries would ease this financial burden.

“Allowing SMEs to align their tax payments with peak revenue periods would improve both compliance and cash flow stability,” Mr Alphonce says.

He further explains that this approach has already been successfully implemented in Peru, where the government introduced flexible tax schedules for agricultural SMEs in 2019. The reform led to a 40 per cent reduction in payment delays and benefitted over 50,000 businesses, collectively saving millions in penalties.

The initiative boosted tax compliance by more than 12 per cent, demonstrating the positive impact of adapting tax systems to businesses’ operational realities.

Growth Castigation

For growing SMEs, crossing tax thresholds can often feel punitive. For example, an undisclosed handcraft business in Arusha Region experienced a 25 per cent reduction in operating cash flow after being forced into VAT registration.

Tax consultant Joyce Kachema suggests that the government should introduce intermediate tax brackets to ease the transition from the presumptive tax system to VAT.

“This approach would allow SMEs to scale gradually without the shock of sudden and significant tax obligations,” she explains.

Independent studies show that a similar reform was implemented in Kenya in 2013, where the government introduced a graduated tax scheme, taxing businesses with annual revenues between 5.0 million Kenyan shillings and 15million Kenyan shillings at a reduced 6.0 per cent VAT rate to ease the transition from presumptive tax to VAT.

Analysts deduce the reform led to a 15 per cent increase in VAT compliance and a 10 per cent rise in revenue for SMEs within two years.

Ms Kachema underscores that such gradual reforms helped SMEs formalise, gain access to government support, and contribute to the broader tax base, providing a valuable model for Tanzania.

Industry Tax Gaps

The one-size-fits-all approach to taxation stifles industries with unique dynamics. Twende Tech Solutions, a startup in Dar es Salaam, struggled to pay taxes during its first year of operations due to delayed revenues.

Tax expert Lisa Kileghe proposes, “The government should implement sector-specific incentives, such as deferred tax payments for startups or tax credits for investments in technology. These measures would support emerging industries and promote innovation.”

In Madhya Pradesh, the Startup India initiative offers a three-year tax holiday to eligible startups, enabling them to reinvest savings for growth.

While the exact number of startups benefitting from this programme in the region is not fully disclosed, the Madhya Pradesh Startup Policy, launched in 2019, has supported over 1,000 startups across sectors like agriculture, renewable energy and technology.

In 2022 alone, startups in Madhya Pradesh raised over 2.0 billion Indian rupees (27 million US dollars) in investments, with more than 5,000 jobs created statewide.

“These incentives help startups scale quickly, reducing financial burdens and promoting growth,” a local tax consultant Rajesh Yadav notes.

The government’s ongoing support is crucial for fostering a vibrant startup ecosystem, especially in rural areas, contributing to both economic growth and job creation.

SME – Taxman Disconnect

The disconnect between SMEs and tax authorities often leaves businesses feeling unheard. For instance, Tumaini Traders in Handeni District, Tanga Region raised concerns about inconsistencies in VAT filings at local tax offices.

When asked for his input, tax consultant Seleman Issa recommends, “Creating an SME advisory council that meets regularly with tax authorities would provide a structured platform for feedback.

This would ensure that policies are better aligned with the realities SMEs face in the local context, fostering greater trust and collaboration between stakeholders.”

This recommendation reflects Rwanda’s approach, where initiatives such as the Rwanda Development Board (RDB), Private Sector Federation (PSF), Rwanda Business Development Fund (BDF), SME Development Programme, Hanga Umurimo Programme and the National Employment Programme (NEP) provide vital support to SMEs through business registration, financial assistance, training and job creation.

These efforts have resulted in over 200 policy adjustments between 2015 and 2020, leading to a 35 per cent increase in compliance rates, according to an anonymous Rwandan analyst.

Penalty-Centric Enforcement

The current focus on penalising non-compliance, rather than offering support, instils fear among SMEs.

For example, an undisclosed block manufacturing unit in Morogoro Region paid millions in fines due to system glitches that delayed their filings in 2024.

Tax specialist Sophia Kileo from Kahama District, Shinyanga Region recommends that instead of imposing immediate penalties, first-time offenders should be given warnings or grace periods.

“A more supportive enforcement approach would foster better compliance and reduce the financial strain on SMEs, which is a widespread challenge, especially in my locality,” Ms Kileo says.

She says that a similar strategy was successfully implemented in Australia through the Taxpayer Assistance Programme, where the Australian Taxation Office (ATO) introduced penalty relief measures to promote voluntary compliance, particularly for first-time offenders.

Through penalty remission and Voluntary Disclosure programmes, businesses are given the opportunity to correct errors without facing immediate penalties, provided they demonstrate genuine effort to comply.

The ATO’s first-time offender relief further reduces or waives penalties for unintentional mistakes, fostering a more cooperative relationship between businesses and tax authorities and ensuring greater compliance and fairness in the process.

Cross-border Tax Collusion Cross-border SMEs often face the dual burden of formal and informal taxation. For instance, a textile import-export business in Kigoma Region reported spending an additional 15m/-nian shillings annually on bribes and unofficial fees, which significantly erodes profit margins.

The manager and co-owner emphasises, “To tackle this issue, the government must enhance oversight at border points and streamline the formal crossborder tax compliance process. This would eliminate informal taxation and foster smoother regional trade for SMEs.”

A similar approach was adopted in Uganda with the One-Stop Border Post (OSBP) initiative. Tax consultant Sarah Musoke highlights a World Bank report, which states that the project reduced border clearance times by 60 per cent, saving both time and money.

She estimates 10 billion Uganda shillings annually. This improvement effectively reduced informal taxes and bribes previously paid by businesses at the border, enhancing regional trade relations and lowering transaction costs.

As a result, Ugandan SMEs experienced a 15 per cent increase in trade volume within the first two years of the OSBP’s implementation and the initiative led to a 20 per cent reduction in overall costs for cross-border businesses.

Behavioural Incentives

Amid these challenges, SMEs often receive little incentive for maintaining consistent compliance.

A mining business in Chunya District, Mbeya Region, with over seven years of tax compliance, shares its frustration at receiving no tangible benefits.

The owner, an artisan miner, suggests, “Incentivising consistent compliance with tax rebates or reduced filing requirements would not only encourage SMEs to stay compliant but also help build trust in the system, motivating businesses to continue contributing honestly.”

A relevant case study from South Africa highlights the Tax Compliance Status (TCS) programme, introduced by SARS as part of the Small Business Tax Amnesty Scheme.

This initiative offered incentives like tax rebates and reduced filing requirements to businesses that consistently met their tax obligations. Small businesses in sectors like construction saw lowered compliance costs and streamlined paperwork, allowing more focus on growth.

SARS research showed a 15 per cent increase in compliance and that 75 per cent of SMEs reported better cash flow, while overall SME revenue grew by 10 per cent, reflecting greater confidence in the tax system.

● We want to hear from you! Share your thoughts and experiences on how Tanzania’s tax system impacts SMEs by reaching out to us at 0655963224 or emailing kelvinmsangi@ protonmail.com Your input is invaluable in shaping policies that are fair, efficient and supporting the work done by the Samia Tax Reform Commission. Let’s work together to create a tax environment that empowers small businesses and drives economic progress for all Tanzanians. Join the conversation today!