Sunday, June 06, 2010

Does it make business sense to pay taxes?

We see most businessmen do everything they can to avoid paying taxes (I don't mean tax planning as per rules). They common reasons they cite for this are
  • Our field is very competitive, other's don't pay, then how can we pay?
  • We already have very low margins, if we pay taxes we will make losses
  • Anyway the money we pay in taxes are wasted, then why pay?
They are right. There are also other real challenges in properly paying taxes.
  • Need to maintain full accounting system - requires knowledge of accounting & tax laws, paying the chartered accountant for his services, dedicate a staff for book keeping.
  • Tax officials still claim bribe even when you maintain 100% accounts. Problem is that the bribe amounts are higher than when you don't maintain 100% accounts.
  • Many customers are not willing to pay the tax.
Despite all these challenges, I contend that it makes perfect business sense to pay taxes. I will stay away from moral or ethical issues here. I won't say that we need to give back to the society/government etc. My main point is that not paying taxes gets the business into a vicious cycle and severely hampers its growth prospects.

1. Consistency and Simplicity
Maintaining full accounts gives you consistency of Data. You can show the same figures to anybody be it the bank, VAT, Sales Tax, Income Tax, Investors and Management. If somebody asks for your Sales data, you don't have to worry as to who is asking it. With this consistency comes simplcity that allows you to focus on important business issues (how to increase customer value?, how to reduce operating costs? how to get the best out of employees? etc). Instead of worrying about how to escape that government official, how to manipulate data, how do we explain this inconsistency to them etc.

2. Fund Raising and Valuation
Valuation of the business is directly proportional to the sales, profits and assets. Declaring less of them to avoid taxes undervalues your company significantly when you look to raise funds. E.g, if you profits are 1 crore and tax rate is 30%, valuation is taken as 10 x profits. When you declare 1 crore profit, you pay 30 lakhs in taxes and business is valued at 10 crores. But if you instead declare only 10 lakhs as profits, you pay only 3 lakhs in taxes (saving 27 lakhs in taxes) but getting only 1 crore in valuation. In a bid to save 27 lakhs in taxes you lost 9 crore in value.

3. Doing business boldly
When you don't pay taxes, you need to hide your assets, hide information, do only cash transactions. In a bid to hide from tax officials you importantly hide yourselves from customers/prospects. You can't advertise, you can't transport your goods, you fear government officials.

4. Use Government Incentives
Karnataka Industrial policy this time gives Subsidy on Capital Investment & Interest payments, has no tax on electricity and no APMC cess for a few years, no stamp duty, no conversion fine and so on. All these incentives can be claimed only when the records are proper and necessary licenses are obtained. The value of these incentives are much more than the money paid in taxes.

5. Paying Tax doesnot make a Profit making business into a loss making one, it only reduces the extent of profits slightly. VAT introduced in 2003 is such that you only pay tax on the 'value added' than on the 'value sold'. So the tax paid in inputs can be offset from the tax to be paid for outputs which significantly reduces your tax burden.

6. Gives you a correct picture of your business
"You can only manage what you can measure". Accounting gives you that measurement and hence a clear picture about the health of the business. Getting into the details will let you know what went wrong and how it can be corrected. Pilferage & thefts are common problems businesses have to face, inconsistency in stock date will give necessary signals. If proper
records are maintained, the owner/manager need not be physically monitoring the activity, he can delegate the responsibility and just check for accounts at the end of the day. This frees the management from day to day operational issues, allowing him to focus on strategy and growth.

I heard Bharath Goenka of Tally in a talk saying
The life of the business reduces significantly with every mal-practice it does.
You don't be ethical because it is good to be but because you are selfish