Internal Digitalization and Tax-efficient Decision Making

Abstract

Our study investigates firms' internal digitalization as a crucial foundation for timely, datadriven decision making. We evaluate the association between digital infrastructure and improved decision making in tax planning decisions to analyze if the benefits of digitalization expand beyond firms' core business functions. The novel use of a survey that identifies European firms' digital infrastructure over the period from 2005 to 2016 allows us to create an index of IT sophistication. Using this index, we extend prior approaches and observe the effectiveness of tax planning decisions in terms of a firm's ability to exploit income shifting incentives. Our empirical analysis confirms the prediction that digitalized firms respond more efficiently to income shifting incentives. Further, we provide evidence that firms with sophisticated IT are more reactive to shocks in the income shifting incentive than non-digital firms. Our results suggest that internal digitalization allows firms to efficiently monitor and manage internal processes and to strategically price internal transactions. With this work, we are the first to document the association of digitalization and the performance of firms' support functions.

Business model digitalization, competition, and tax savings

“…Existing studies on the effect of digitalization on tax savings focus on the digitalization of individual processes internal to the firm. They show that firms' decision-making capabilities with respect to internal tax functions improve as a result of increased investments in software or IT (Hamilton and Stekelberg, 2016;Klein et al, 2020), allowing firms to avoid more taxes without incurring greater risk from potentially aggressive tax planning behavior (Hamilton and Stekelberg, 2016). We complement this literature by using a measure that more broadly captures digitalized business models-that is, the adoption of a variety of digital technologies in a firm's core products or services, which requires not only investments in software or IT, but also human resource development, R&D, or M&A.…”