When A New Accounting Standard Invites Firms To Save Taxes
Lay summary by Lukas J. Helikum
A new study, accepted for publication at the Journal of Accounting and Economics, suggests that a new accounting standard unifying financial reporting across jurisdictions enables multinational companies to reduce their tax burden. De Simone documents that tax-motivated income shifting from high- to lower-tax countries increased by more than 10% after the implementation of a common set of accounting rules in the European Union. This finding is likely an unintended consequence and a potential drawback of accounting standard harmonization around the world and, thus, may have important policy implications.
Firms often shift taxable income in response to tax incentives, among others, via the strategic pricing of intercompany sales of goods and services. In response, many countries adopt formal rules to regulate intercompany pricing for multinational firms to minimize the adverse impact on their tax revenues. In principle, intercompany prices should be comparable to prices charged by unrelated firms for substantially similar transactions. However, as comparable prices are not always readily available, tax authorities often use benchmark firms to estimate an acceptable range. To be comparable and qualify as a benchmark, firms are typically expected to apply the same accounting standards.
The objective of the current study is to examine whether the adoption of a common accounting standard increases tax-motivated income shifting across jurisdictions by multinational companies. In a nutshell, a unified standard enables firms to choose from a larger pool of comparable companies which offers more flexibility for a firm’s intercompany pricing. This flexibility can be exploited to achieve more favorable tax outcomes.
The author analyzes a sample of 2,159 European-multinational companies, including 11,891 unique affiliates, over the period 2003 to 2012. At different points in time during the sample period, a number of European countries moved from their own national rules to a unified accounting standard (IFRS) for unconsolidated financial statements. Exploiting these events and analyzing the firms’ responses, the results suggest that firms engaged in more tax-motivated income shifting following the adoption of IFRS. The increase of about 11.5% for the average mandatory IFRS adopter affiliate is economically significant.
This study likely demonstrates an unintended consequence and highlights the potential risks of tax and financial accounting policy makers ignoring the interplay between financial accounting and tax. As such, the findings are of interest to policy makers, politicians and investors alike.
For further information
Read the Journal of Accounting and Economics original research article which this summary is based on Does a common set of accounting Standards affect tax-motivated income shifting for multinational firms? (June 2015).
Visit the profile of the research ambassador, Lukas J. Helikum, who wrote this summary.
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