Can state-owned companies and tax planning go hand in hand?
It depends on the incentives and on who benefits from the tax payments, says Wisconsin School of Business doctoral student David Samuel (PhD ’22). The study by Samuel and coauthor Eva Eberhartinger of WU Vienna University of Economics and Business found that state-owned companies only curb tax planning activities when the state owners benefit from the companies’ tax payments. Their research was featured in the Bloomberg Tax “Daily Tax Report.”
WSB: Before we dive in, can you clarify what ‘tax planning’ is? Does that signify taking a comprehensive snapshot of one’s tax situation or is it used more in the context of figuring out how to pay the least in a tax scenario?
Samuel: Tax planning generally suggests optimization. However, there are blurry lines where you cannot always say that the result at a certain point is going to be tax avoidance using only legal means to avoid taxes.
Tax-haven countries, for example, have been talked about a lot in the media. There’s nothing illegal in founding a corporation on the Cayman Islands, if one wanted to, and that corporation will then charge its U.S. corporation management fees because the management is officially residing in the Cayman Islands. These fees are tax deductions in the U.S., while the income generated in the Cayman Islands is tax free. So that’s a form of tax planning leading to tax avoidance.
If you look in legal literature, you find the term “tax evasion,” which is basically illegal tax avoidance. There’s a famous quote attributed to Denis Healey, former U.K. Chancellor of the Exchequer, who said, ‘the difference between tax avoidance and tax evasion is the thickness of a prison wall.’ Tax evasion is illegal, right? However, going back to the Cayman Islands example, the structure itself is legal, but you could say, well, the management really should be residing in the Cayman Islands. If they are actually in the U.S., then you can make a case that it might be illegal. So, there are all these fine differences that you face when you look deeper into these issues and that’s also something that we see in our research.
We also like to examine public debates in our classes. You can take a public debate and say, ‘Oh, Apple didn’t pay any taxes,’ but then if you attack it from an accounting perspective and look into their annual reports, you might get a different picture. It may seem as if they’re not paying any taxes, but in the end, they are paying what the Internal Revenue Service quotes and what the underlying law requires.
That’s also what I personally find so interesting about this topic. Everybody knows the saying ‘nothing is certain except death and taxes,’ [Benjamin Franklin]. There are a lot of emotions around taxation that I think everyone can relate to which is why it makes such a great subject.
WSB: What got you interested in this line of research?
Samuel: Generally speaking, my overall interest is on the effect of taxes on all kinds of corporate decisions. That’s obviously kind of a broad view, but for example, I have a paper forthcoming that looks at investment outcomes. Since we as researchers say that taxes create frictions—so firms might not do what is optimal from an economics perspective—we look at investments. I have another paper where I look at the financing decisions.
I would say that this particular research about state-owned enterprises (featured by Bloomberg) also looks at a financing decision of the firm, but at the equity part of financing. The owners—basically the equity holders or the shareholders—are in the firm and that’s kind of the financing decision because they hold the firm’s equity. There’s a long strand of research that looks at the effect of having a certain owner on a firm’s tax planning activities. In this paper, we focus on firms that have a special shareholder: the government. I should also note that the government is already an ‘uninvited’ shareholder in all firms (i.e., state-owned and not state-owned) because it is entitled to X% of the annual profit—and yes, X stands for the tax rate. So, it is unclear, and thus interesting, whether a state owner prefers to receive a higher profit (shareholder) or a higher tax payment (‘uninvited’ shareholder).
There are a lot of emotions around taxation that I think everyone can relate to which is why it makes such a great subject.
—David Samuel, WSB doctoral student
Setting our study around the German tax system had certain institutional characteristics that allowed us to easily test our question: Are state-owned enterprises actually paying more taxes than their private counterparts? And are there differences based on the type of state owner? On top of that, I’m originally from Germany so I know the institutional environment in Germany quite well. Interestingly, we find that not all state-owned enterprises pay more taxes. We argue that some owners do not prefer higher tax payments because they actually do not benefit from the tax.
WSB: Can you talk about some of the policy suggestions and incentives that came out of this?
Samuel: Yes, one suggestion relates to the current debate on governmental support due to the COVID pandemic. So, countries that are injecting equity into firms could implement good tax governance agreements. When a government enters a firm, it usually has the power—especially now because firms need the support—to put certain provisions in order. And those provisions could include good tax governance agreements that encourage things like accountability and sustainability.
The goal here is not to completely get rid of tax planning, but to perhaps eliminate certain constructs, like the German airline Lufthansa having subsidiaries in the Cayman Islands. The government can do these things in the negotiating stage, making them public and making them binding. That would then also strengthen the support of the country as a whole, because in the end it’s all of our taxpayer money that goes into these firms. As private citizens, if we’re employed, most of our taxes are withheld by our employer; we don’t have that much wiggle room with our taxes.
I think it’s also really important that these big corporations, especially now with the government involved, pay their part. You’re starting to see that more and more, for example, with environmental regulations. When big private equity firms or hedge funds enter companies, they are requiring them to be “greener” so to speak, to be more sustainable. This remains to be seen in the research, but one suspicion we have is that this trend may lead to positive spillover effects. If corporations also have good tax governance mechanisms in place, which in turn also might give them reputational advantages, we could witness some positive spillover effects.
WSB: Does the study have implications for a wider audience? Why is this relevant if you are not an accountant?
Samuel: It’s important to inform policymakers and the general public on the potentially different outcomes that state ownership can have depending on the characteristics of the state owner.
On the research side, I think our study extends prior research where there was a gap. With certain owners, especially state owners, what is the outcome that we can expect? That was an area that was somewhat unclear and I think we could shed light on that because it was a unique setting where we could differentiate among state owners.
What do these findings mean for the average person? Maybe that we should be careful. We shouldn’t automatically think that just because a company is now state-owned, partly state-owned, or maybe temporarily state-owned during a crisis (which happened during the 2008 financial crisis when the government bailed out banks and General Motors) that that means that these corporations from one day to the next will suddenly be good taxpayers.
Read the article in the Bloomberg Tax “Daily Tax Report”
Read the paper: “Monitoring and Tax Planning—Evidence from State-Owned Enterprises”
David Samuel is a doctoral student in accounting and information systems at the Wisconsin School of Business.