Newswise – A recent study of more than 2,000 companies found that companies facing financial constraints can benefit significantly from being more aggressive in their tax planning strategies. One lesson from the result is that tax authorities should scrutinize the activities of companies facing financial difficulties to ensure that their tax activities are not becoming too aggressive.
Financial constraints are not uncommon and arise when a company cannot afford to fund a project that would add value. Sometimes the restrictions are caused by an external event – like a pandemic – that leaves companies with less revenue than they expected. Sometimes the factors that cause a limitation are specific to an individual company, such as: B. Mismanagement in the company.
“Economists are interested in how companies respond to sudden changes in their financial constraints,” said Nathan Goldman, co-author and assistant professor of accounting at North Carolina State University’s Poole College of Management. “But it’s difficult to separate various confounders from the financial pressures companies face. However, my co-authors and I recognize that the Pension Protection Act 2006 (PPA) is a great opportunity for us to examine financial constraints. “
The PPA increased retirement funding needs for all companies with defined benefit plans by nearly 500%. For example, if a company had $ 400 million in pension obligations and $ 100 million in pension assets prior to the PPA, it would have 30 years to fund 90% of its obligations. In other words, it could set aside another $ 9 million a year for 30 years. But the PPA changed that, and the same company would have paid 100% of its obligations within seven years – or an additional $ 43 million a year.
“The PPA placed new demands on the financial resources of these ‘pension companies’ – and that meant that many were suddenly faced with financial constraints,” says Goldman.
To gauge the impact of these financial constraints, the researchers looked at data from 2,647 publicly traded companies: 730 pension funds and 1,907 companies that did not provide their employees with defined benefit pension plans.
“We found that pension funds were able to make up 19% of their investment deficit by changing their tax strategies,” says Goldman. “That is a considerable sum.”
The benefits of tax strategies can vary, whether they are one-off benefits – such as R&D expenses – or recurring savings – such as relocating operations to more tax-efficient locations.
Ultimately, the researchers found that there were three key messages for the business world.
First, companies facing funding shortages should consider turning to tax planning to generate capital without increasing their debt or equity, “Goldman said. “Second, tax planning alone cannot solve liquidity needs. However, the average business generated a significant amount of cash to make up for investments that would otherwise be lost. Finally, the tax authorities should be more careful about the tax positions of companies with financial restraint – as these companies are more likely to increase the aggressiveness of their deductions and thus be more likely to be overturned.
The paper “Do Funding Restrictions Lead to Incremental Tax Planning? Evidence from the Pension Protection Act of 2006, ”appears in Contemporary Accounting Research. The paper was co-authored by John Campbell of the University of Georgia and Bin Li of the University of Houston.