More examples of ETRs that are artificially low for non-tax reasons. Photo credit: Casey M. Schwab, Bridget Stomberg, Junwei Xia
The low effective corporate tax rates have drawn the ire of politicians, decision-makers, the media and the general public. As Congress begins debating corporate tax changes to partially fund a $ 3.5 trillion budget, the Biden administration raises questions about how much corporate taxes pay. However, new research from Indiana University’s Kelley School of Business and other research colleagues suggests that very low effective tax rates often do not reflect high levels of tax avoidance.
Effective tax rates, or ETRs, are a measure of tax expense that is calculated under US accounting standards as a percentage of pre-tax profit. To better understand the scope of potential restrictions on ETRs, the researchers created an “adjusted ETR” for nearly 15,800 annual company observations of 3,375 companies between 2008 and 2016 to remove elements that were largely unrelated to tax avoidance.
The researchers defined tax avoidance as tax planning strategies that managers use to reduce their company’s explicit tax burdens, such as drawing on tax credits and shifting income to low-tax countries.
The study found that companies often report low ETRs not because of aggressive tax avoidance in the current year, but because of changes in services or cheaper tax returns with the IRS.
“Users of annual financial statements often compare the tax expense as a percentage of income with the statutory tax rate. If the rate is lower, some may think the company is joking about taxes, but our research has found that often they are not, ”said Bridget Stomberg, Associate Professor of Accountancy and Weimer Faculty Fellow at the Kelley School of Business. “We find that very low ETRs – those below 5% – are often due to changes in performance that affect the ETR due to US GAAP rules.”
For example, Stomberg said American Airlines reported an ETR of only 10% in 2014 and a negative ETR in 2015. People could compare these rates to the statutory federal tax rate – which was 35% in those years – and conclude that the company was doing something aggressive to reduce its tax liability.
“In these cases, however, these low ETRs reflect a turnaround in American operating performance that allows the company to deduct losses made in previous periods – a perfectly legal and solid tax policy,” said Stomberg. Other airlines such as Delta and United reported similar patterns in the wake of the financial crisis that hit the aviation industry particularly hard.
Companies in other industries can also have their ETRs influenced in this way. Goodyear Tire & Rubber Co. reported a negative ETR in 2016 which, without considering the accounting impact of the previous year’s losses and the subsequent turnaround, would have been close to 20%.
“Even ETRs that are low for reasons related to corporate tax behavior don’t always signal aggressive tax avoidance that tax authorities are happy to overturn,” said Casey Schwab, a co-author and professor and Ryan Endowed Chair of Accounting at the university of North Texas G. Brint Ryan College of Business. “US GAAP limits the ability of companies to recognize any tax benefit from an uncertain or aggressive tax position in the year the position is first reported to the IRS. It does not review the position before the statute of limitations expires – it does not recognize it beforehand recognized tax advantages, which lowers the ETR. “
For example, AT&T passed an IRS review of its restructuring in 2010. As a result, the company reported a negative ETR for the year. “Given the effective agreement of the IRS with the underlying tax positions, it is difficult to argue that AT & T’s low ETR suggests aggressive tax avoidance,” added Schwab. “Additionally, AT & T’s decision not to recognize the tax benefits of this position while its outcome was uncertain may benefit shareholders.”
More examples of ETRs that are high for non-tax reasons. Photo credit: Casey M. Schwab, Bridget Stomberg, Junwei Xia,
The researchers aggregated items that lower a company’s ETR in a given year (excluding state taxes) and compared the relative sizes of the aggregated items. This analysis shows that the effects of taking tax credits or moving income to low-tax countries – what people usually consider corporate tax planning strategies – are relatively less for companies with low ETRs.
Instead, non-tax items such as write-backs and accounting for uncertain tax positions are the main drivers of these low ETRs.
“This result is surprising and changed my interpretation of very low ETRs,” said Junwei Xia, assistant professor of accounting at Texas A&M University Mays Business School and another co-author of the study. “Users need to exercise caution before closing in on very low ETRs that indicate aggressive corporate tax behavior.”
Although the study’s data ended in 2016, there are still discrepancies between GAAP and adjusted ETRs. For example, Salesforce.com reported an ETR of -12.9% in fiscal 2019. However, after adjusting for non-tax items, including a release of allowances that reduced the company’s ETR by approximately 62.3%, salesforce.com had an adjusted ETR of 60.5%.
The researchers also identified issues with high ETRs that companies sometimes highlight to distract the scrutiny of their tax planning. However, items such as provisions for allowances, goodwill impairment, and adverse tax returns with the IRS can increase GAAP ETRs, making companies appear less aggressive than they are. For example, Moody’s unfavorably settled tax issues with the IRS in 2016, forcing the company to levy additional unexpected tax amounts. To an unsuspecting reader, Moody’s 50.6% GAAP ETR might seem benign if it reflects an adverse outcome with the IRS. Without the effects of the comparison, Moody’s GAAP ETR would have been 23.2%.
The researchers also aggregated items that increase a company’s ETR in a given year (excluding state taxes) and compared the relative sizes of the aggregated items. This analysis shows that non-tax items such as bad debt provisions and the tax impact of goodwill impairment are relatively greater for companies with GAAP ETRs greater than 40%. In contrast, the tax positions are relatively constant across all values of GAAP ETRs.
“Researchers recognized the limitations of GAAP ETRs as a measure of tax avoidance and suggested alternatives such as: “However, we find that these measures are plagued by similar problems to varying degrees. Outside of the use of customized ETRs, annual measurements of tax payments as a percentage of pre-tax income are the best alternative.”
The article “What Determins ETRs? The Relative Influence of Taxes and Other Factors” was accepted by Contemporary Accounting Research. Co-authors are two former scientists at Kelley – Casey Schwab and Junwei Xia.
The researchers make all of their data publicly available.
“Street” ERTS are more useful for predicting future corporate tax outcomes, a study shows
Casey M. Schwab et al., What Determines ETRs? The Relative Influence of Taxes and Other Factors †, Contemporary Accounting Research (2021). DOI: 10.1111 / 1911-3846.12720 Provided by Indiana University
Quote: Study: Very low effective tax rates often do not reflect high levels of corporate tax avoidance (2021, September 22), accessed on September 23, 2021 from https://phys.org/news/2021-09-effective-tax-high -corporate .html
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