05 Taxation

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    Institutional Blockholder Political Orientation and Tax Avoidance
    ( 2020-08-17) Li, Zining ; Plecnik, James ; Ryou, Ji Woo
    Prior literature shows that institutional investors influence the tax policies of investee firms. Our study examines the effect of Republican-oriented institutional blockholders on tax avoidance, and finds that investee-firm tax avoidance increases as the ownership by Republican-oriented institutional blockholders increases. Next, we find that Republican-oriented institutional investors are most effective in influencing investee tax avoidance when (1) investee firms' CEOs have compatible political orientations, and (2) investee firms are located in compatible political climates. Our findings add to the literature on the active role of institutional investors in firm policies and provide evidence that institutional investors' political orientation can influence investee firms' tax avoidance.
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    ( 2020-08-16) Persson, Anh ; Huang, Jing ; Jiang, John
    To better align rights to tax with underlying economic activities, many countries require multinational enterprises (MNEs) to disclose their income and economic activities to tax authorities on a country-by-country reporting (CbCR) basis. We examine whether this significant international tax transparency policy shock generates positive information externalities for the capital markets. We develop a novel approach to capture the misalignment between MNE's tax and economic activities, as perceived by the capital market, using the unexplained portion of analysts' tax forecasts error. We find that this misalignment declines after the adoptions of CbCR, supporting the effectiveness of its policy objective. We then examine the tax and earnings information environment using analysts' forecast accuracy and the information content of tax and earnings to investors. We find that CbCR helps improve both tax and earnings information environment, especially when firms have more misalignment prior to the policy change. Our findings have important policy implications for governments worldwide that are trying to assess the economic consequences of CbCR.
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    Does the Diversification of Tax Strategies Affect Tax Risk?
    ( 2020-08-15) Krieg, Kimberly
    I investigate the effect that the number of different tax strategies employed by a public company has on the relation between measures of corporate tax avoidance and measures of risk. Prior studies have generally failed to find a relation between measures of overall firm risk (such as stock return volatility) and measures of corporate tax avoidance (such as low effective tax rates). One possible reason for this empirical result is the failure to consider the role that the diversification of tax risk, through utilization of a portfolio of different tax avoidance strategies, might have on reducing tax risk and, as a result, on reducing overall firm risk. I create a broad measure of diversification based on five sources of tax benefits. Controlling for the level of tax avoidance, I regress measures of risk on diversification and an interaction term and find weak support that diversification reduces tax risk, as measured by the volatility of future cash ETRs, and mixed evidence on the effect of diversification on overall firm risk, as measured by the volatility of future monthly stock returns.
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    FASB Interpretation Number 48 (FIN 48) and Corporate Innovation
    ( 2020-08-15) Goldman, Nathan ; Lampenius, Niklas ; Radhakrishnan, Suresh ; Stenzel, Arthur ; de Almeida, Jose Elias Feres
    In this paper, we analyze the real effect of financial statement tax disclosures on corporate innovation activities. In 2007, the FASB issued FIN 48, which mandates the separate disclosure of reserves for unrecognized tax benefits (UTBs). Using patent applications as a measure of corporate innovation, we employ a difference-in-difference research design with publicly listed U.S. firms as the treatment group and privately held U.S. firms not subject to the disclosure requirements as the control group. We hypothesize and find robust evidence that following the onset of FIN 48, the number of patent applications by publicly listed firms decreased. We also provide evidence that the decrease is attributable to incremental innovation, which is more subject to the UTB disclosure requirements. Overall, our evidence provides support for the real effects of disclosures on innovation activities.
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    Income Shifting and Management Incentives
    ( 2020-08-15) Ortmann, Regina ; Schindler, Dirk
    The tax literature shows that income shifting within multinational enterprises collides with optimal incentivization of managers in subsidiaries. The different modes of income shifting have received different attention, however, and the incentive implications of internal debt shifting have not yet been investigated. We analyze the different impacts of tax—efficiently setting intercompany prices for the use of intangibles (royalties) and debt shifting on incentivization of affiliate managers. Different from most other studies, we focus on endogenous, unobservable managerial effort and the firm's optimal design of the (linear) compensation contract. For EBIT(DA) as performance measure, we find that internal debt shifting does not have a direct effect on management incentives, but has an ambiguous indirect effect via its positive effect on investment. In contrast, tax—motivated royalty payments have a clearly negative incentive effect that is fully offset, however, by an higher compensation rate. Hence, the adjustment of the compensation payment reveals the firm's aggressiveness in income shifting via intangibles. There is no confounding indirect effect from tax—motivated royalty payments because these royalty payments do not affect investment.
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    Do U.S. Multinationals Use Income Shifting to Launder Corrupt Activity?
    ( 2020-08-14) Demere, Paul ; Gramlich, Jeffrey ; Nam, Yoonsoo
    We investigate a) whether U.S. multinational companies use income shifting to engage in corruption and b) the effects of this income shifting on the welfare of non-U.S. countries' citizens. We use enforcement actions under the Foreign Corrupt Practices Act (FCPA) as shocks to the costs of corruption to establish initial minimum estimates of the effects of corruption on governmental efficacy and quality of life in affected countries. Consistent with theory, developed countries benefit from FCPA actions while developing countries are harmed. After examining the main effects of FCPA actions, we consider whether income shifting serves as a replacement indirect avenue when more direct corruption means are stifled by FCPA enforcement. We find that U.S. outbound income shifting increases following anti-corruption enforcement, and that this increased outbound income shifting mitigates the positive, and magnifies the negative, effects of anti-corruption enforcement actions. Overall, the results are consistent with income shifting acting as an alternate corruption vehicle.
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    Do the Bad Guys Report? Examining whether CSR Performance Influences the Use of Socially Responsible Tax Disclosures
    ( 2020-08-14) Hardeck, Inga ; Inger, Kerry ; Moore, Rebekah ; Schneider, Johannes
    This study explores two possible influences on the decision to voluntarily include socially responsible tax disclosures in corporate social responsibility (CSR) reports: Firms' level of tax avoidance and their performance in another important area of CSR, environmental performance. Using textual analysis and keywords developed for the tax setting, we analyze 2,981 CSR reports from 22 countries, which is the largest sample that has been analyzed in a tax context. We argue that firms use socially responsible tax disclosures to build or repair reputational capital. In line with this assumption, our results suggest that firms employ socially responsible tax disclosures to deflect from poor environmental performance. In this regard, they tend to provide symbolic disclosures, that is, they portray their tax payments as contributions to society. We also find that U.S. firms use these disclosures to window dress their tax avoidance activities, though we do not find evidence of this behavior for the non-US firms.
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    The Impact of the Tax Cuts and Jobs Act on the US Defined Benefit Pension Landscape: A Comprehensive Examination
    ( 2020-08-14) Anantharaman, Divya ; Kamath, Saipriya ; Li, Shengnan
    We examine the impact of the Tax Cuts and Jobs Act of 2017 ("TCJA") on corporate defined-benefit (DB) pension policy. The TCJA's reduction of the corporate tax rate from 35% to 21% reduces the tax benefits to pension contributions. For a large sample of US firms sponsoring DB pensions, we document a surge in taxpaying sponsors' voluntary contributions to DB plans, in the window between the TCJA's passage and its lower tax rate going into effect. We estimate total TCJA-triggered contributions at $13.7-$37.9 billion. Sponsors with relatively poorly-funded plans, with actively growing obligations, with higher free cash flows and greater future investment opportunities are more likely to step up voluntary contributions in this window. The more responsive firms also engage in more "de-risking" of their plans subsequently, by shifting plan asset portfolios away from equities towards fixed-income securities, or by settling obligations. In sum, our findings point to the TCJA having acted as a trigger for what could be a fundamental reorganization of the DB pension landscape in the US.
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    Private Equity and Taxes
    ( 2020-08-13) Olbert, Marcel ; Severin, Peter
    We study corporate tax avoidance as a new dark side of private equity buyouts for domestic governments. Exploiting over 10,000 deals and private firm data in Europe, we document that target firms' effective tax rates decrease by 13% after the transaction. Those targets engaging in significant post-deal tax avoidance exhibit lower asset, employment, and productivity growth, but have higher payout ratios. Further tests show that buyouts induce more profit shifting and higher leverage, which erodes tax bases in high-tax countries. Collectively, our findings suggest that private equity can have negative externalities for governments as tax savings accrue to global shareholders.
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    How do Net Operating Loss Carryforwards Affect Firm Investment Decisions?
    ( 2020-08-11) Krieg, Kimberly ; Krull, Linda ; Li, John
    We investigate whether the existence of net operating loss (NOL) carryforwards affects firm investment decisions. When a firm has a large NOL carryforward sufficient to reduce taxable income to zero, any tax benefit from new investments is not received immediately, but rather adds to the NOL carryforward and is deferred until a future year. Thus, these investments may have a lower net present value, as compared to firms without NOL carryforwards. We examine the relation between NOL carryforwards and four types of investment — capital expenditures, R&D, foreign subsidiary investment, and intangibles — and find a significantly negative relation. We create a new measure of NOL carryforwards focusing on useable NOLs created during overall loss years. Our results are robust to using four different measures of NOL carryforwards as well as two measures of the marginal tax rate. In sum, when firms become non-taxable, as evidenced by the existence of NOL carryforwards and a decline in the marginal tax rate, managers reduce tax-favored investments as the expected tax benefits from these investments decline.