19 Taxation

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    Tax knowledge diffusion via strategic alliances
    ( 2019-09-01) Mueller, Jens ; Weinrich, Arndt
    This study examines strategic alliances as channels for tax knowledge diffusion between firms. Despite solid insights on within-firm determinants of tax planning, little is known about tax knowledge diffusion via cross-firm connections. Since theory suggests that the role of strategic alliances in tax knowledge diffusion is ambiguous, we test our notion empirically. To tease out potential tax knowledge diffusion, we analyze changes in the tax planning behavior of high-tax firms in strategic alliances with low-tax firms in comparison to high-tax firms in strategic alliances with other high-tax firms. We apply a multivariate regression model, a difference-in-differences approach and use basic textual analysis to identify the main business purpose of a strategic alliance. We find a substantial increase in the tax planning behavior of high-tax firms in strategic alliances with low-tax firms relative to high-tax firms in high-tax strategic alliances. Additionally, our results suggests that high-tax firms are able to adjust their tax planning behavior within two years of network initiation when cooperating with low-tax firms. Because we are also able to provide a series of robustness checks, we interpret the identified responses to be consistent with existing tax knowledge diffusion via strategic alliances.
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    Do Constituency Statutes Deter Tax Avoidance?
    ( 2019-08-31) Wu, Kaishu ; Ye, Jonathan
    The constituency statutes, passed mainly in the U.S. in the last century, allow firm directors to consider the interests of stakeholders other than shareholders (i.e., non-financial stakeholders) when making business decisions. One type of critical decisions managers make pertains to corporate tax planning, which creates value for the shareholders at the expense of the public interest or social welfare. In this paper, we investigate whether this law change with a permissive nature affects directors, and hence, managers' attitude towards corporate tax avoidance. Employing a staggered difference-in-difference method, we find that firms incorporated in the states that have adopted constituency statutes exhibit significantly higher ETRs based on current tax expense, but not total tax expense or cash tax paid. This causal relationship suggests that managers, with the permission to consider the social impact of tax avoidance, become less aggressive in tax planning. We further find that the effect of adoption is stronger for financially unconstrained firms and firms in retail businesses, where the demand (cost) for tax avoidance is lower (higher). Finally, we show that our main results are driven by firms located in states with a high sense of social responsibility and the firms with high levels of tax avoidance prior to the adoption. Overall, the findings in this paper suggest a positive social impact brought by the passage of constituency legislations.
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    Financial Security Issuance and Cash Savings through Tax Planning
    ( 2019-08-31) Rashid, Harun ; Anderson, Mark ; Warsame, Hussein
    In this paper, we investigate how firms’ issuance of equity and debt securities are associated with cash savings through tax planning. According to the pecking order theory of Myers and Majluf (1984), due to higher cost of capital attributed to information asymmetry, firms use the least costly financial resources, such as cash on hand followed by debt issuance and equity issuance to carry out investments. However, the literature on pecking order theory has not considered cash savings through risky tax planning. Since issuance of shares is the most costly and the last resort for raising capital, and issuance of debt is less costly and signals firms’ profitability, we predict that firms that issue shares will save more cash via aggressive tax planning than firms that issue debt, which are not expected to engage in as much aggressive tax planning. Using a sample of U.S. publicly listed firms for the period 1987-2016, we find that an increase in share issuance is associated with a decrease in cash effective tax rate (CASH-ETR), indicating that firms that issue shares save cash by tax planning. We do not find any evidence that debt issuance reduces CASH-ETR or induce tax avoidance behavior. Our findings are robust when we use first difference estimation method, propensity score matching, and gross equity and debt issuances as explanatory variables, instead of net equity and debt issuances. This study provides insights into the interplay between the taxing authority and shareholders, especially when firms raise external capital.
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    Lobbying with the Competition: Do Firm Differentiation, Law Specificity, and Firm Strategy Matter?
    ( 2019-08-31) Olson, Adam ; Tice, Frances ; Weaver, Connie
    In this paper, we examine how firms choose their lobbying participation given the competitive advantages that can be gained from: (1) firm-specific attributes in the form of differentiation, (2) specificity of tax laws under which firms operate, (3) and other tax strategy policies that firms have at their disposal to gain a competitive advantage. We use tax lobbying surrounding the 2004 American Jobs Creation Act and the 2017 Tax Cuts and Jobs Act as our empirical setting. We find that firm differentiation increases individual lobbying and decreases trade association lobbying when the laws being lobbied are narrow in scope. However, broader laws significantly reduce the relation between firm differentiation and individual lobbying. We also find that tax planning and tax lobbying is coordinated, and it is not impacted by law specificity. The findings from our study provide important insights into the circumstances under which firms will choose to lobby for laws and in what format firms will conduct their lobbying.
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    Early Evidence on the use of Foreign Cash following the Tax Cuts and Jobs Act of 2017
    ( 2019-08-31) Beyer, Brooke ; Downes, Jimmy ; Mathis, Mollie ; Rapley, Eric
    The Tax Cuts and Jobs Act of 2017 (TCJA) imposes a mandatory repatriation tax on multinational firms’ unremitted foreign earnings, reducing internal capital market frictions through a deemed repatriation of unremitted foreign earnings and eliminating future repatriation tax costs. This change to the U.S. corporate tax system gives multinational firms access to lower cost internal capital (i.e., foreign cash). This study provides evidence that multinational firms with greater levels of pre-TCJA foreign cash increased their post-TCJA repurchases but did not change their shareholder dividends or capital expenditures. We further document that the increase in repurchases is driven by those firms that had greater pre-TCJA repatriation tax costs and firms in weaker financial health. This outcome is consistent with internal capital market theory and suggests a decrease in internal capital market frictions allows companies access to trapped foreign cash. However, our results suggest firms used the repatriated foreign cash on shareholder payouts rather than capital investment. This conflicts with a stated goal of the TCJA to spur domestic economic growth directly and highlights an unintended consequence of the TCJA.
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    The Effect of Paid Preparer Competition on Individual Tax Avoidance
    ( 2019-08-30) Batta, George ; Finley, Andrew ; Rosett, Joshua
    This study considers how competition among paid preparers affects individual tax avoidance. Merging individual tax return data reported to the IRS at the county level with household income reported by the U.S Census Bureau, along with supply of paid preparer establishments from the National Employment Time Series (“NETS”) database, we observe that paid preparer competition is positively associated with underreporting of income, consistent with competition facilitating client appeasement for avoiding more taxes. Our results are robust to various proxies for paid preparer competition and tax avoidance. In additional analysis, we note that our findings are stronger in counties whose taxpayers more frequently engage a paid preparer and among establishments that do not purport to be a CPA firm. This study contributes to our understanding of how competition impacts financial intermediaries’ decision-making and the environmental factors affecting paid tax preparers’ recommendations.
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    The general anti-avoidance rule
    ( 2019-08-30) Kerr, Jon ; Cowx, Mary
    Although a general anti-avoidance rule (GAAR) being enacted within a country is becoming increasingly more common, the presence of a GAAR is generally overlooked and thus its effect left unstudied. In this paper we provide an initial investigation by studying the effect that the presence of a GAAR within a country has on corporate tax avoidance behaviors. Using an indicator for the enactment of a GAAR within a specific country, we find a statistically and economically significant increase in aggregate tax collections and a statistically and economically significant decrease in firm-level tax avoidance. Additional analyses show that the firm-level results are strongest for firms with higher levels of tax avoidance, for countries with lower levels of tax enforcement prior to the implementation of a GAAR, and for countries where the burden of proof lies, at least partially, with the taxpayer. In final analyses, we find that the GAAR is associated with a decrease in the volatility of reported ETRs.
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    Auditor-provided Tax Services and Clients’ Tax Avoidance: Do Auditors Draw a Line in the Sand for Tax Advisory Services?
    ( 2019-08-30) Nesbitt, Wayne ; Persson, Anh ; Shaw, Joanna
    In this study, we empirically examine the upper bound of the relationship between auditor-provided tax services (APTS) and clients’ level of tax avoidance. This question is of significant interests for regulators because recent incidents of audit firms’ involvement in clients’ tax aggressive activities have reignited concerns about the extent to which non-audit services could impair auditor independence and audit quality. Using quadratic and linear-log regressions, we document a negative association between tax fees paid and clients’ effective tax rates, but the association diminishes as clients become more tax aggressive. Interestingly, using quartile regressions, we find evidence that for the most tax aggressive firms (firms in the lowest quartile of ETR), the association between APTS and ETR turns positive. This positive association is consistent with audit firms reducing their level of tax service engagement when clients become more tax aggressive, possibly due to regulatory, reputational, or litigation concerns. These results are consistent with audit firms adhering to PCAOB’s Rule 3522, which prohibits the provision of tax aggressive services to public clients. In cross-sectional analyses, we find some evidence that large clients influence audit firms to be more tax aggressive, consistent with economic bonding between these parties. These results should be informative to policymakers and regulators in their review of non-audit services.
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    ( 2019-08-29) Akamah, Herita ; Song, Xiao
    The extant literature documents an insignificant association between cash tax avoidance and IRS enforcement as proxied by the frequency of the IRS’s downloads of annual reports. This result is puzzling given the IRS’s interest in curbing tax avoidance and several stakeholders’ perception of cash tax avoidance garnering undesirable IRS scrutiny. To shed light on this puzzle, we posit that the IRS focuses its enforcement efforts on only the cash tax-avoiding firms that are likely to yield favorable enforcement outcomes to the IRS such as levied interests and penalties. Consistent with this view, we provide evidence of a significant positive association between cash tax avoidance and the IRS's acquisitions of the 10-Ks hosted on EDGAR when firms are profitable both in the current year and in the past. We further document a more pronounced effect for large firms and firms with foreign operations. In addition, using IRS budgets as an instrument for IRS attention, we find that the firms that are the subject of incremental IRS attention (i.e., consistently profitable and large) have greater future cash tax payments. Overall, our findings support substantial IRS scrutiny of the financial statements of cash tax-avoiding firms when the firms will likely pay back taxes, interest, and penalties to the IRS. Our evidence speaks to the seemingly lax IRS enforcement espoused by the media and civil society organizations and suggests a rather more efficient enforcement process underlies this perceived laxity.
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    Asymmetric Information between the Taxpayer and the Tax Authority – Income Shifting via Patents
    ( 2019-08-29) Amberger, Harald ; Osswald, Benjamin
    We examine whether, when, and to what extent asymmetric information between a multinational corporation (MNC) and the local tax authority over how to value intra-firm royalty payments facilitates tax-motivated income shifting via patents. As the value of patents is often firm specific, the local tax authority lacks information on comparable transactions when assessing an MNC's transfer-pricing strategies. Using a sample of affiliates of European MNCs and employing the relative share of patents held by an MNC as a measure, we show that tax-motivated income shifting increases in the level of asymmetric information. We also find that more external comparable information available to the local tax authority and stricter tax enforcement mitigate this relation. In contrast, more extensive transfer-pricing documentation requirements are less effective in this setting. Overall, our results suggest that the level of comparable information is an economically important determinant of tax-motivated income shifting via patents. The effectiveness of tax-policy measures in curbing income shifting critically depends on their ability to increase the set of comparable information.