Companies that ‘decline to state’ often dodge

Policy makers, lobby groups and citizens should take note—those who understand corporate tax avoidance behavior will be in a better position to deter it.

A recent study indicates that non-disclosure of geographic earnings can be a marker of tax avoidance.

The research was conducted by Prof. Ole-Kristian Hope, who holds the Deloitte Professorship of Accounting at the Rotman School of Management at the University of Toronto, along with Mark (Shuai) Ma and Wayne B. Thomas from the Michael F. Price College of Business at the University of Oklahoma,

Starting in 1998 it was no longer mandatory for U.S. multinational companies to disclose geographic earnings in their financial reports—disclosure was optional under the Statement of Financial Accounting Standards No. 131 (SFAS 131). The study shows that between 1998 and 2004, firms that chose not to disclose geographic earnings had worldwide effective tax rates that were 4.1 (5.2) percentage points lower than firms that continued to disclose geographic earnings (controlling for numerous other factors that are known to affect tax avoidance).

Coincidence? The study proves not. Before implementation of SFAS 131—when all firms were required to disclose geographic earnings in their financial reports—eventual non-disclosers’ effective tax rates were on par with those that continued to disclose these numbers voluntarily.

It appears that under SFAS 131 managers were able to (legally or illegally) shift profits from high- to low-tax foreign jurisdictions without much risk of exposure (a practice that ultimately diminished the tax revenues of governments in high-tax jurisdictions). To conceal their behavior, they avoided voluntarily disclosing any information related to these activities. “If you care about tax avoidance then you want as much transparency about these activities as possible,” says Hope.

In 2004, the implementation of new tax-reporting regulations (Schedule M-3), which required businesses to disclose significantly more detailed information regarding foreign profits to the Internal Revenue Service, shone a light on the problem. With the introduction of this new regulation, geographic segment disclosures are less important in terms of masking tax avoidance behavior (at least to the IRS). Specifically, controlling for other factors, after Schedule M-3 came into effect the role of non-disclosure of geographic earnings in explaining tax avoidance is diminished.

“The key takeaway is that there is clear value to greater transparency regarding firm’s foreign activities,” explains Hope. “As an outsider, this is the only way that we can learn about how [businesses] are conducting themselves, including monitoring the extent to which firms avoid taxes.”

The paper is online at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2021157.

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The Rotman School of Management at the University of Toronto is redesigning business education for the 21st century with a curriculum based on Integrative Thinking. Located in the world’s most diverse city, the Rotman School fosters a new way to think that enables the design of creative business solutions. The School is currently raising $200 million to ensure that Canada has the world-class business school it deserves. For more information, visit www.rotman.utoronto.ca.

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3 thoughts on “Companies that ‘decline to state’ often dodge”

  1. The aim is a min / max problem.

    Minimise taxation, maximise return.

    Always ways, always will be. Unless you want state ownership of everything like East Germany, Communist Russia, and we all know where that gets you.

    The game has changed. Where for example is Google based? Where the servers are? Where the user is? If its the latter, is the US going to pay taxes to overseas governments because Google’s servers are in the US? Submit to foreign taxation? I doubt it. Other countries think the same.

    However, its an irrelevance to the true issue. Governments across the world are bankrupt and they can’t tax enough to pay their debts.

    • Interesting. For the last 30+ years the overall trend has been minimising taxation. So far we have no had maximised returns. When are these returns supposed to happen?

      • Compared to what?

        Have we had taxes minimised? From the UK perspective, its just one way, up.

        More and more money is being paid in tax each year.

        If you increase taxes, that decreases returns does it not?

        Eventually, companies go bust or move.

        What you are seeing is companies move, and companies set up where its more business friendly. ie. Tax competition at work.

        In Europe, as it is in the US, its illegal to stop companies moving country (or state). So they will move or set up in different places.

        You also know have companies that aren’t dependent on location at all. Eg. Google. It’s servers can be anywhere.

        Where’s the tax? Location of the server. Location of the company. Location of the end user.

        I suspect governments think its the latter, unless the company is in their jurisdiction, when its all there.

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