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The Book and Tax Effects of Tax-Deductible Goodwill Impairments

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Title:The Book and Tax Effects of Tax-Deductible Goodwill Impairments
Authors:Sarah Khalil
Miles Romney
Steven Utke
Keywords:Tax Planning
Goodwill Impairments
Book-Tax Conformity
Tax Havens
Tax Avoidance
Date Issued:06 Aug 2020
Abstract:Unlike most countries, Luxembourg allows tax deductions for financial statement goodwill impairments. Firms can implement a tax strategy — locating goodwill in Luxembourg — that provides the opportunity to obtain both cash and financial reporting tax benefits upon impairment due to this book-tax conformity. Despite U.S. GAAP and tax rules that may eliminate these benefits, we find that impairing firms with Luxembourg subsidiaries have lower cash and GAAP effective tax rates than other impairing firms. We propose that firms consider these benefits in their impairment decisions, with the benefits offsetting the substantial financial reporting costs of impairments enough to increase the likelihood of impairment. Consistent with expectations, firms with Luxembourg subsidiaries are more likely to impair goodwill than other firms. We carefully rule out non-tax explanations for this effect. Of course, not all firms are willing or able to use this Luxembourg tax strategy. First, we find that only more sophisticated firms use this relatively complex strategy. Second, conforming tax strategies require that firms consider book and cash tax benefits along with financial reporting costs. Consistent with tax-deductible goodwill impairments encouraging impairment by reducing financial reporting costs of impairment, use of this strategy is focused in high-financial-reporting cost firms, where tax deductibility reduces costs relative to high-cost firms without tax deductibility, rather than low-cost firms where costs are irrelevant. In sum, we identify a specific tax strategy that some firms appear to overlook, and contribute to the literatures on the effects of book-tax conformity and on managers' impairment and information withholding decisions.
Appears in Collections: 05 Taxation

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