Objective- This study examined the governance of accounting rules and tax rules on the level of tax burdens paid by SMEs in Malaysia. According to the tax gap theory, taxpayers utilize the different rules between accounting and tax which is known as the dual reporting system in their tax avoidance strategies in order to pay lower taxes. The tax gap is the difference between the statutory tax rate (STR) and effective tax rates (ETRs).

Methodology/Technique - This study analysed financial statements of 148 SMEs (740 firm-years) prepared for the years 2008 to 2012.

Findings The statistical results revealed that the dual reporting system had caused a significant gap between the STR (the tax rate that SMEs supposed to pay) and ETRs (the actual tax rates paid by SMEs) in the Malaysia tax system. In addition, the findings provided evidence of the tax avoidance strategies utilised by SMEs which cause lower ETRs as follows: exempt income and tax incentives, disallowable expenses, absorbed losses and capital allowances, deferred tax expenses, size and leverage. Thus, the findings confirmed the tax gap theory in the SMEs tax system which implied a loss of tax revenue to the government due to tax avoidance activities.

Findings The findings had provided useful feedbacks to the policymakers such as accounting bodies and the relevant tax authorities to address the issue and realign the two systems which are accounting standards and tax system to minimize the gap.

Type of Paper Empirical paper

Keywords: , Dual Reporting System; ETRs; SMEs; STR; Tax Gap