1.1 Background of the Study

Nigeria as one of the developing countries in the world, the growth of Small and Medium Enterprises (SMEs) is very vital for the growth of the economy in general as SMEs account for over 70% of the total business activities in the country. SMEs in most developing countries are usually neglected by both the formal financial institutions and the government unlike the developed countries like China, USA, etc. where SMEs are not taken with levity as they believe were to be the engine room for the development of any economy. SMEs serve as a source of employment generation, innovation, competition, economic dynamism which ultimately lead to poverty alleviation and economic natural growth (Ariyo, 2005). Apart from SMEs potential for self-reliant industrialization using local raw materials, they are in a better position to boost employment, guarantee even distribution of industrial development and facilitate the growth of non-oil exports. The recent industrial development has focused on sustainable development through small business development. However, it has been observed that tax policy has a very crucial part in the determination of the growth or decline of SMEs. SMEs serve as a source of economic dynamism which ultimately leads to poverty alleviation and natural growth in which tax incentive has a very crucial part to play on the growth and achievement of SME’s long run advantage. Tax incentive is an essential constituent of the general or external business environment of SMEs as it is a tool for motivating prospective and small scale entrepreneurs.

Over the years, SMEs have served as avenue for job creation and the empowerment of Nigeria’s citizens providing about 50% of all jobs in Nigeria and also for local capital formation as cited by Ojochukwu and Stephen (2012). They also further implied in their journal that SMEs have undoubtedly improved the standard of living of so many people especially those in the rural areas. However, the morality rate of these small firms is very high. According to the Small and Medium Enterprise Development Agency of Nigeria (SMEDAN), 80% of SMEs die before their 5th anniversary (Kuewumi, 1996). Among the factors responsible for these untimely close-ups are tax related issues ranging from multiple tax burdens. Taxation system in Nigeria has experienced series of significant dynamism in modern times. The Nigerian tax system experienced this dynamism because of the objective of repelling stale or obsolete provisions and simplifying the main ones. The government tax policy view that large corporations and SMEs are the same. Due to the size and nature of SMEs, they have a unique characteristics which needs to be considered by the government in making tax policies in form of incentives as it can influence the economic growth or decline of the of SMEs. In recent times, tax incentives are given to an extent to SMEs in order to ensure their existence and development.

Unfortunately, these incentives also have an adverse effect on the budget of the government as it reduces the expected revenue by the government. Many countries have introduced investment incentives for varying reasons, in some cases, the incentives may be seen as a counter weight to the investment disincentives inherent in the general tax system. Investors often emphasize the relative importance of the tax system in investment decisions if compared with other considerations such as political and economic stability, availability of social infrastructure, security of life and property and the general cost of doing business and so on ( Sanni, 2002). Over the years, both the Federal and State Governments have adopted the use of tax incentives to stimulate economic activity in economically distressed urban and rural locations. Since their inception, social scientists have questioned their effectiveness. The conventional wisdom is that tax incentives particularly for foreign investments are bad, both in theory and in practice because they are often ineffective, inefficient and prone to abuse and corruption. Yet, almost all countries use tax incentives (Easson, 2001).

1.2 Statement of the Problem

Given the huge potential of SMEs in the economy, the need to examine tax incentives as a tool for economic growth of SMEs cannot be over-emphasized. SMEs faces a whole lot of problem after start-up as a large percentage die before they mark their 5th year. A 2001 World Bank survey on Nigeria showed that although 85% of the firms had relationship with banks and government incentives, most of them still had no access to their credit and tax benefit they stand to derive from tax incentives packages (Terungwa, 2011). Government is still battling with how to use tax incentives to enhance domestic investments in SMEs, as they encounter quite a great deal of problem in enabling them which tends to hinder the increase in the contribution of SMEs to the total economy. It is against this background that this research aims to investigate tax incentive as a tool for economic growth of small and medium scale enterprises.

1.3 Research Questions

The research questions raised for the purpose of this study are; i) What advantages do SMEs derive from tax incentives? ii) What is the effect of tax incentives on profit after tax (PAT) of SMEs in Nigeria? iii) What is the relationship between tax incentives and the performance of SMEs in Nigeria?

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