BLOOMINGTON, Ind. – Low effective corporate tax rates have aroused the ire of politicians, policymakers, the media and the public. As Congress begins to debate corporate tax changes to partially fund a $ 3.5 trillion budget plan, the Biden administration is raising questions about the amount of taxes paid by corporations. But new research from Indiana University’s Kelley School of Business and fellow researchers elsewhere suggests that very low effective tax rates often do not reflect high levels of tax evasion.
Effective tax rates, or ETRs, are a measure of the tax burden calculated under US generally accepted accounting principles as a percentage of pre-tax profit. To better understand the extent of the potential limitations of ETRs, the researchers created an “adjusted ETR” for nearly 15,800 observations per business year from 3,375 companies between 2008 and 2016 to remove largely unrelated items. tax evasion.
Researchers have defined tax avoidance as the tax planning strategies used by managers to reduce their company’s explicit tax burdens, such as claiming tax credits and shifting income to low-tax jurisdictions.
The study found that companies often report low ETRs not because of aggressive tax avoidance in the current year, but rather because of changes in performance or favorable tax settlements with the IRS.
âUsers of financial statements often compare tax charges as a percentage of income to the statutory tax rate. When the ratio is lower, some may think the company is engaging in tax shenanigans, but our research shows that this is often not the case, âsaid Bridget Stomberg, associate professor of accounting and Weimer faculty member. at the Kelley School of Business. âWe find that many times very low ETRs – those below 5% – can be attributed to changes in performance that affect the ETR due to US GAAP rules. “
For example, Stomberg said that American Airlines reported an ETR of only 10% in 2014 and a negative ETR in 2015. People could compare these rates to the federal statutory tax rate – which was 35% during those days. years – and conclude that the company was doing it. something aggressive to reduce his tax liability.
âHowever, in these cases, these low ETRs reflect a turnaround in American operating performance that allows the company to deduct losses generated in previous periods – a perfectly legal and sound tax policy,â Stomberg said. . Other airlines such as Delta and United have reported similar trends in the wake of the financial crisis, which hit the airline industry particularly hard.
Companies in other industries may also have their ETRs affected in this way. Goodyear Tire & Rubber Co. reported a negative ETR in 2016, which would have been nearly 20% without taking into account the accounting effects of the losses of the previous year and its subsequent recovery.
“Even weak ETRs for reasons related to the company’s tax behavior don’t always signal aggressive tax avoidance that tax authorities are used to reversing,” said Casey Schwab, one of the co-authors of study and Professor and Ryan Endowed Chair in Accounting. at the University of North Texas G. Brint Ryan College of Business. âUS GAAP rules limit the ability of businesses to recognize any tax benefits from an uncertain or aggressive tax position in the year the position is initially reported to the IRS. If a business subsequently resolves the position favorably with the IRS – or if the IRS does not audit the position before the statute of limitations expires – it recognizes these previously unrecognized tax benefits, which reduces the ETR. .
For example, AT&T favorably concluded an IRS audit of its restructuring in 2010. As a result, the company declared a negative ETR for the year. “Given that the IRS did indeed agree with the tax positions underlying the settlement, it is difficult to say that AT & T’s low ETR indicates aggressive tax avoidance,” Schwab added. “In addition, AT & T’s decision not to recognize the tax advantages of this position when its outcome was uncertain may benefit shareholders.”
The researchers aggregated the items that lower a company’s REE in a specific year (excluding state taxes) and compared the relative magnitude of the aggregated items. This analysis indicates that the impact of claiming tax credits or shifting income to low-tax jurisdictions – what people generally think of as business tax planning strategies – is relatively lower for businesses reporting low TIEs.
Instead, non-tax items such as reversals of valuation allowances and the recognition of uncertain tax positions are the main drivers of these low EIRs.
âThis finding is surprising and changed my way of interpreting very low ETRs,â said Junwei Xia, assistant professor of accounting at Texas A&M University Mays Business School and another of the study’s co-authors. âUsers should exercise caution before concluding that very low ETRs signal aggressive corporate tax behavior. “
Although the study data ended in 2016, discrepancies between GAAP and adjusted EIRs persist. For example, salesforce.com reported an ETR of -12.9% in fiscal 2019. However, after adjusting for non-tax items, including a valuation allowance that reduced the ETR of the company of about 62.3%, salesforce.com had an adjusted ETR of 60.5%.
Researchers have also identified issues with high ETRs, which companies sometimes highlight to distract from their tax planning. However, items such as provisions for impairment, goodwill impairments, and unfavorable tax settlements with the IRS can increase GAAP ETRs, making companies appear less aggressive than they are. For example, Moody’s dealt with tax issues unfavorably with the IRS in 2016, forcing the company to accumulate additional amounts of unexpected taxes. To an unsuspecting reader, Moody’s 50.6% GAAP RTE might seem benign when it reflected an unfavorable result with the IRS. Without the impact of the regulation, Moody’s GAAP ETR would have been 23.2%.
The researchers also aggregated items that increase a company’s REE in a specific year (excluding state taxes) and compared the relative magnitude of the aggregated items. This analysis indicates that non-tax items such as provisions for impairment and the tax effects of goodwill impairments are relatively more important for companies reporting GAAP APCs above 40%. In contrast, the tax items are relatively constant for all values ââof GAAP ETRs.
“The researchers recognized the limitations of GAAP ETRs as a measure of tax evasion and proposed alternatives such as averaging amounts over multiple years, adjusting industry averages, or reviewing tax payments. instead of accrued liabilities, âStomberg said. âHowever, we find that similar issues affect these measures to varying degrees. Apart from using adjusted ETRs, measures of single-year tax payments as a percentage of pre-tax income offer the best alternative. “
The document, “What Determines ETRs?” The Relative Influence of Tax and Other Factors â, has been accepted by the journal Contemporary Accounting Research. The co-authors are two academics formerly of Kelley – Casey Schwab and Junwei Xia.
Researchers make all their data publicly available