Uncertain tax benefits, international tax risk, and audit specialization: Evidence from US multinational firms

Abstract

The purpose of this study is twofold. First, it examines the association between income‐shifting arrangements consisting of transfer pricing aggressiveness, tax haven use and foreign tax rate differentials, and Financial Interpretation No. 48 (FIN48, now ASC740–10‐25) unrecognized tax benefits (UTBs). Second, it analyzes the impact of audit specialization on the association between income‐shifting arrangements and UTBs. Using a dataset of 286 US multinational firms over the 2007–2016 period (2,097 firm‐years), our regression results show that income‐shifting arrangements represented by transfer pricing aggressiveness, tax haven use and foreign tax rate differentials are significantly positively associated with UTBs. We also observe that audit specialization magnifies the positive association between transfer pricing aggressiveness and UTBs, and foreign tax rate differentials and UTBs. Finally, in additional analysis we provide some evidence that the positive association between income‐shifting arrangements and UTBs is magnified in the post‐2010 uncertain tax position reporting requirement period. Overall, our study extends prior research on the topic of audit characteristics (i.e., audit specialization) and tax aggressiveness.

Corporate tax risk: a literature review and future research directions

“…Their study highlights the importance of human capital tax investment for corporate tax outcomes. Besides, other tax strategies such as income-shifting arrangements (the use of tax havens, the aggressiveness of transfer pricing, and the differentials of foreign tax rates) have a positive impact on tax uncertainty (as measured by unrecognized tax benefits) (Taylor et al 2018). Furthermore, acquisitions, mergers, and transfer pricing are also significant contributors to increased firm tax risk (Wunder 2009).…”

“…Specifically, it allows firms to have higher tax avoidance without increasing the tax risk (Gallemore and Labro 2015) Internal control quality Internal control in tax avoidance has a moderating role in alleviating tax volatility (Chen et al 2020) Information technology Firms with a high quality of information technology would enjoy lower tax payments (the higher tax avoidance) and lower tax risks (Hamilton and Stekelberg 2017) Corporate tax strategies and outcomes In-house tax department Bigger tax departments are related to lower tax risk and higher tax avoidance (Chen et al 2021c) Income-shifting arrangements Transfer pricing is the most impactful source of tax risk (Wunder 2009). Income-shifting arrangements are positively associated with unrecognized tax benefits (Taylor et al 2018) Tax avoidance (effective tax rates) Companies with relatively high tax avoidance (low cash effective tax rates) face higher tax uncertainty (Dyreng et al 2019). Tax avoidance results in additions to the unrecognized tax benefits reserve as uncertain tax avoidance (Guenther et al 2019) External governance…”

Transfer Pricing Aggressiveness in Indonesia: Multinationality, Tax Haven, and Intangible Assets

“…Transfer pricing is a significant form of tax avoidance that is carried out by diverting profits from countries with higher tax rates to countries with lower tax rates (Richardson et al, 2013;Sari, 2020;Muhammadi et al, 2016;Makni et al, 2020;Amidu et al, 2019;Arham et al, 2020;Wahyudi et al, 2021;Falbo & Firmansyah, 2018;Irawan et al, 2021). Supported by OECD country-by-country reporting statistics in Baerentzen (2020), one of the main findings of the report is the discrepancy between the jurisdiction of profit reporting and the jurisdiction of economic activities, such as employment, assets, and sales (Rahman & Utami, 2021;Devi & Suryarini, 2020;Taylor et al, 2018;Sari & Irawan, 2021;Utami & Irawan, 2022). In other words, the profit is not reported where the value is made, which means it is also not where the tax is paid.…”

Ownership Structure, Tax Risk, and Tax Avoidance in Indonesia Manufacturing Companies 2016-2020

“…The complexity of taxation regulation, as well as insufficient law enforcement and inconsistencies in the implementation of tax regulations, can cause disputes between taxpayers and tax authorities (W. Chen, 2021). Transfer pricing aggressiveness, investment in tax havens, and differences in foreign tax rates are highly correlated with tax benefit uncertainty and technological change (Huang et al, 2017;Sari et al, 2020;Taylor et al, 2018). Furthermore, multinational companies choose tax haven countries as a place to invest and get tax protection (Jalan & Vaidyanathan, 2017).…”