AUDITOR PROVIDED TAX SERVICES, INCOME SHIFTING, AND DEFAULT RISK

<p>This study investigates two capital markets effects of auditor provided tax services (APTS), a particular form of auditor provided non-audit services (APNAS). Firstly, this study examines the influence of APTS on income shifting by United States of America (U.S.) multinational companies and, secondly, this study examines the impact of APTS on default risk of all U.S. companies. There are two competing hypotheses on the impact of APNAS on the quality of the work of auditors and the empirical evidence is mixed. One strand of literature suggests that APNAS provide knowledge spillover effects and thus improve the quality of the work of the auditor. The other strand of literature suggests that APNAS impair the independence of the auditor and therefore lead to a decrease in the quality of the audit. APNAS may thus increase or decrease the value of audit as a governance mechanism. The U.S. Securities Exchange Commission (SEC) has banned several previously allowed APNAS such as bookkeeping, financial information systems design and implementation, appraisal and valuation, and internal audit. However, the SEC continues to permit auditors to provide tax services. This study extends the literature on APNAS by examining the effect of APTS on income shifting by multinational companies and on default risk. Using a sample of 10,248 firm-year observations on U.S. multinationals over the period 2002 – 2015 and the income shifting measurement model developed by Dyreng and Markle (2016), this study finds that APTS reduce outbound income shifting, which is consistent with knowledge spillover rather than impairment of independence. The result holds after addressing potential endogeneity concern and is robust to excluding observations from the financial crisis periods. Furthermore, the result holds after including firm-specific characteristics as influences on the income shifting parameters. Using a sample of 21,364 firm-year observations on U.S. firms over the period 2003 – 2016, this study finds that APTS have a positive relationship with default risk, consistent with impaired independence of the auditor. The result holds after addressing potential endogeneity concern and is robust to excluding the global financial crisis period. The effects of APTS on income shifting and default risk are therefore opposite in direction. However, the positive relationship between APTS and default risk is weaker for firms with high institutional holdings and a strong information environment, indicating that stronger corporate governance mitigates the impact of APTS on default risk. Furthermore, this study finds that the channel for the effect of APTS on default risk appears to be earnings quality. That is, APTS lower audit quality, thereby lowering earnings quality and increasing default risk. Given the cost of default, this is an important finding. Thus, taking the results on income shifting and default risk in combination, the question of the SEC continuing to permit auditors to provide tax services is left open to question.</p>

AUDITOR PROVIDED TAX SERVICES, INCOME SHIFTING, AND DEFAULT RISK

<p>This study investigates two capital markets effects of auditor provided tax services (APTS), a particular form of auditor provided non-audit services (APNAS). Firstly, this study examines the influence of APTS on income shifting by United States of America (U.S.) multinational companies and, secondly, this study examines the impact of APTS on default risk of all U.S. companies. There are two competing hypotheses on the impact of APNAS on the quality of the work of auditors and the empirical evidence is mixed. One strand of literature suggests that APNAS provide knowledge spillover effects and thus improve the quality of the work of the auditor. The other strand of literature suggests that APNAS impair the independence of the auditor and therefore lead to a decrease in the quality of the audit. APNAS may thus increase or decrease the value of audit as a governance mechanism. The U.S. Securities Exchange Commission (SEC) has banned several previously allowed APNAS such as bookkeeping, financial information systems design and implementation, appraisal and valuation, and internal audit. However, the SEC continues to permit auditors to provide tax services. This study extends the literature on APNAS by examining the effect of APTS on income shifting by multinational companies and on default risk. Using a sample of 10,248 firm-year observations on U.S. multinationals over the period 2002 – 2015 and the income shifting measurement model developed by Dyreng and Markle (2016), this study finds that APTS reduce outbound income shifting, which is consistent with knowledge spillover rather than impairment of independence. The result holds after addressing potential endogeneity concern and is robust to excluding observations from the financial crisis periods. Furthermore, the result holds after including firm-specific characteristics as influences on the income shifting parameters. Using a sample of 21,364 firm-year observations on U.S. firms over the period 2003 – 2016, this study finds that APTS have a positive relationship with default risk, consistent with impaired independence of the auditor. The result holds after addressing potential endogeneity concern and is robust to excluding the global financial crisis period. The effects of APTS on income shifting and default risk are therefore opposite in direction. However, the positive relationship between APTS and default risk is weaker for firms with high institutional holdings and a strong information environment, indicating that stronger corporate governance mitigates the impact of APTS on default risk. Furthermore, this study finds that the channel for the effect of APTS on default risk appears to be earnings quality. That is, APTS lower audit quality, thereby lowering earnings quality and increasing default risk. Given the cost of default, this is an important finding. Thus, taking the results on income shifting and default risk in combination, the question of the SEC continuing to permit auditors to provide tax services is left open to question.</p>

Corporate Income Shifting in an Era of Tax Multilateralism: The Impact of Exchange-of-Information Agreements

Using data from the annual reports of over 100,000 subsidiaries of multinational enterprises (MNEs) from 55 countries between 2003 and 2012, the authors of this article investigate the impact of exchange-of-information agreements ("EOI agreements") on tax-motivated income shifting. Transparency created by the signing of EOI agreements is expected to reduce the tax-motivated shifting of income by multinational corporations. Whether such agreements affect the income-shifting behaviour of multinational corporations is an unanswered question. The authors find evidence that, on average, EOI agreements do have an impact on tax-motivated income shifting. Additionally, they find that more advanced, modern EOI agreements are associated with a larger decrease in tax-motivated income shifting compared to the impact of early EOI agreements. This evidence challenges the prevalent assumption in empirical studies that EOI agreements are homogeneous. Supplemental analyses suggest that factors that affect the information asymmetry between MNEs and tax authorities, such as corporations with high levels of intangibles and tax authorities with strong transfer-pricing rules and enforcement, can diminish or enhance the effectiveness of EOI agreements in moderating tax-motivated income shifting. The evidence provided by this study shows that consideration of the tax authorities' information environment and the substance of an EOI agreement is essential when assessing the impact of such an agreement on the tax behaviour of sophisticated taxpayers such as multinational corporations.

Foreign Employment, Income Shifting, and Tax Uncertainty

We examine the effect of foreign employment on two outcomes-income shifting and the tax uncertainty of foreign transactions. Using a hand-collected sample of employment disclosures, we partition our sample into firm-years with a higher or lower degree of foreign employment. Using two distinct income shifting models, we document that, on average, a high degree of foreign employment is associated with greater tax-motivated income shifting out of the U.S. We also posit and find that a high degree of foreign employment enhances the economic substance of foreign transactions, reducing the tax uncertainty associated with foreign income. We conduct additional analyses to mitigate selection bias concerns, and we use exogenous changes to the costs and benefits of income shifting using foreign employment to strengthen identification. Our results highlight firms' use of employees as part of a tax-efficient supply chain and how foreign employment enhances income shifting opportunities between jurisdictions.