Abstract
Loss firms are an economically significant and growing segment of the population of publicly traded corporations. Relatively little is known about the tax positions of loss firms because the firms are typically dropped from tax avoidance studies. We develop a new measure of corporate cash tax avoidance that is meaningful for all observations and reflects the extent to which a firm is tax-favored. We examine the extent to which inferences about corporate tax avoidance over the past twenty-seven years change when we examine the full population of firms, as opposed to a profitable and/or taxable subsample. In contrast to prior research findings, our results suggest that on average firms are tax-disfavored, by which we mean cash taxes paid exceed the product of the firm’s pre-tax book income and the statutory tax rate. In addition, many industries that appear to be tax-favored in profitable subsamples are tax-disfavored when the entire population is examined. We also find that the extent to which firms are tax-disfavored is increasing over time, and that domestic firms are more tax-disfavored than multinationals.
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Notes
Erickson et al. (2013) examine tax-motivated loss shifting and find that firms increase losses in order to generate cash refunds arising from carryback of those losses.
See, for example, the Huffington Post story titled “This Study Shows How Low Corporate America’s Taxes Really Are” (http://www.huffingtonpost.com/entry/gao-study-profitable-corporations-no-federal-taxes_us_570e6c62e4b0ffa5937dbadb), the US News article titled “GAO: Many Companies Paid No Federal Income Tax” (http://www.usnews.com/news/articles/2016-04-14/bernie-sanders-outraged-by-gao-study-that-finds-many-companies-paid-no-income-tax), or the Yahoo article titled “Many U.S. corporations pay little in federal income taxes: report”(https://www.yahoo.com/news/many-u-corporations-pay-little-federal-income-taxes-130429817--business.html).
Callihan (1994) provides a comprehensive review of this branch of the ETR literature.
Our review of studies that use an ETR or book-tax difference measure and that were published in The Accounting Review, Journal of Accounting Research, Journal of Accounting and Economics, Contemporary Accounting Research, and Review of Accounting Studies between 2013 and 2016 revealed that 20 of 23 studies dropped firms with negative PTI or CTE, and 14 of 23 studies reset ETRs to fall between [0,1].
According to the instructions to Form 1120X, the processing time for carryback claims is typically 3–4 months. A firm that extends its corporate income tax return will ultimately file it on September 15 of a given year. A four-month processing time yields a refund receipt in January of the following year.
The use of a 34%/35% benchmark is based on the top U.S. statutory income tax rate and does not include an expected tax burden for state taxes or implicit taxes. Given a specific research need, it would be perfectly reasonable to set a benchmark that incorporates such factors (e.g., 35% plus a blended state income tax rate of X% for domestic firms).
Some of the largest IRS settlements in history have involved intercompany transactions related to internally developed intangibles and trademarks. For example, Glaxo Smith Kline Holdings Inc. agreed to pay the IRS $3.4 billion in 2006, AstraZeneca settled with the IRS for $1.1 billion in 2011, and Western Union settled for $2 billion in 2011.
We prefer to scale by firm size instead of sales because we do not consider a low margin/high sales volume firm to be larger than a high margin/low sales volume firm and because sales are undefined for financial institutions. Operating cash flow (OCF) is a potential alternative scalar but, like PTI, it is negative in a significant proportion (26%) of firm-year observations within our sample. Further, MVA is a less volatile measure of economic magnitude than are sales, operating cash flow, and even BVA. In untabulated analyses we find that the standard deviation of Δ/BVA (Δ/OCF) is approximately 4 (25) times that of Δ/MVA.
Further, our comparison of ∆/MVA and CETR within the profitable subsample in all of our analyses yields similar results, suggesting that MVA does not induce bias in the measurement of tax avoidance. We also performed our analyses scaling by sales and found that, because sales can exhibit very small values, its use in the denominator results in a significant number of extreme observations.
There are also several other measures of tax avoidance, including uncertain tax balances, discretionary permanent book-tax differences, and tax shelter participation. Like ETRs and BTDs, our measure captures the whole of the tax avoidance spectrum, whereas these other measures capture the more aggressive end.
Within our sample of one-year tax avoidance measures, approximately 13% of observations have negative values of current tax expense.
We measure current tax expense as the sum of current federal tax expense (TXFED) and current foreign tax expense (TXFO). When current federal or foreign tax expense is missing, we set current tax expense equal to total tax expense (TXT) less deferred tax expense (TXDI), state tax expense (TXS) and other tax expense (TXO). TXDI, TXS, and TXO are all set to zero when missing.
Following Dyreng et al. (2008), we consider firms to be U.S. corporations if Compustat data item FINC is equal to zero. We eliminated non-corporate firms by deleting firms with a SIC code of 6798 (REITs), firms with names ending in “-LP” containing “TRUST,” and firms with six-digit CUSIPs ending in “Y” or “Z.” In addition, we delete observations where Compustat data item STKO is equal to 1 (subsidiary of a publicly traded company) or 2 (subsidiary of a non-publicly traded company), and when STKO is equal to zero (publicly traded company) but share price is missing.
As in Lisowsky (2010) and McGuire et al. (2012), we define total current tax expense as current federal tax expense plus current foreign tax expense (Compustat TXFED + TXFO). Where either of those values are missing, current tax expense is equal to total tax expense less the sum of deferred tax expense, state tax expense, and other tax expense (Compustat TXT – [TXDI + TXS + TXO]).
Results remain unchanged when BVA is set equal to beginning total assets.
Even after winsorizing Δ/BVA1 at 1 and 99%, there are still 1761 instances where Δ is greater than 100% of a firm’s total assets. Visual inspection of the data revealed that the majority of these observations were due to total assets being less than 1. We also considered the use of total sales as a scalar for Δ, but found that its use generated a significant fraction of extreme observations due to a small denominator issue.
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Acknowledgements
We thank Paul Fischer (editor), Kathleen Andries, T. J. Atwood, Michael Donohoe, Scott Dyreng, Jonathan Lewellen, Tom Omer, George Plesko, Leslie Robinson, Steve Utke, University of Texas Tax Readings Group, our anonymous reviewers, and participants at the University of Illinois, University of Illinois at Chicago, Tilburg University, University of Memphis, and Virginia Tech accounting workshops, the American Accounting Association Annual Meeting, and the American Taxation Association Midyear Meeting for helpful comments.
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Henry, E., Sansing, R. Corporate tax avoidance: data truncation and loss firms. Rev Account Stud 23, 1042–1070 (2018). https://doi.org/10.1007/s11142-018-9448-0
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DOI: https://doi.org/10.1007/s11142-018-9448-0