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Elimination of tax debt bias -Reduction in losses* due to lower bank leverage, under different assumptions of the effects of CIT on leverage (EUR bn)
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During the period 2008-2012, EU governments incurred substantial costs bailing out banks. As corporate income taxation (CIT) in most countries still favors debt- over equity-financing, reducing or eliminating this debt bias would complement regulatory reforms reducing costs of financial crises. To estimate this effect, we use a two-step approach. F...
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Citations
... Modigliani and Miller [26,27] were the precursors of these controversies on the corporate capital structure theory. Then, authors talked about these biases in the related literature, including among others, the authors in [1,32,13,16,20,19,18,22,23,24,37,38,39,41], to quote only those. But the list of these biases is not exhaustive in the related literature. ...
This paper analyzes the biases in CIT in some countries around the world. Most corporate tax systems are found in the Tax Codes. The sample covers the Tax Codes in force in ten countries in Africa, America, Asia and Europe. Assuming that corporate tax is the cost of using public capital, the analysis of the content of these tax codes relating to corporate income taxation, has made it possible to identify several biases or differences in taxation and/or tax treatment. The biases in CIT identified relate to financing, investment, result, rate and tax base. This paper is one of the first to expand the literature by analyzing the biases in CIT, likely to affect tax behavior and, by extension, the financial behavior of firms.
... This explains that companies that are included in large-scale companies pay lower taxes than small-scale companies, this is because largescale companies have more resources that can be used for tax planning by adopting effective accounting practices and political lobbying to reduce corporate tax. Langedijk et al. (2014) argues that small-scale companies cannot be optimal in tax planning due to a lack of experts in taxation (Schratzenstaller et al., 2017). When the company's tax planning activities are not optimal, it will cause the company to lose the opportunity to receive tax incentives which can reduce the tax imposed on the company. ...
This study aims to determine and explain the effect of company size, profitability, leverage, capital intensity, and inventory intensity on tax revenue for the tax amnesty program at energy companies listed on the Indonesia Stock Exchange. This research is a research that uses an associative approach. The sample in this study were 13 energy companies listed on the IDX in the 2013-2017 period which were determined by the Saturation Sampling method. This study uses descriptive statistics, multiple linear regression test for panel data models, hypothesis testing (t-test and F-test) and coefficient of determination as research analysis techniques. The results obtained show that partially the Capital Intensity, Leverage and Company Size affect tax revenue from the Tax Amnesty program, while Inventory Intensity and Profitability do not affect tax revenue from the Tax Amnesty program. Furthermore, Company Size, Inventory Intensity, Capital Intensity, Profitability and Leverage simultaneously affect tax revenue from the Tax Amnesty program. This means that tax revenue for the Tax Amnesty program at energy companies is influenced by company size, inventory intensity, capital intensity, profitability and leverage.
Keywords: Company Size, Inventory Intensity, Capital Intensity, Profitability, Leverage, Tax Amnesty
JEL Classifications: H23, H27
DOI: https://doi.org/10.32479/ijeep.11134
... This is neither plausible nor possible in the current legislative and tax regimes. These regimes are biased towards debt-based modes of financing as revealed by the studies of renowned international institutions like the IMF (de Mooij, 2011), the European commission (Langedijk Nicodème, Pagano, & Rossi, 2014) and the OECD (Cournède, Denk, & Hoeller, 2015;OECD, 2015). This biasness has distorted the work of the financial system and created a lot of havoc and systemic risks that tend to expose the world to financial crises in almost every decade. ...
This essay contributes to the topic of the discussion forum (DF) through the treatment of two points that were spelled out in the framework of the DF provided by the editorial board (EB) of the Journal and elaborated by the lead paper (Hassan, 2020). These are: the institutional setups of the sixties vis-à-vis that of the seventies of the development of Islamic finance (IF), and the theory of "IF intermediation". Though the essay shares the same subheadings of the specified points, the treatment and emphasis are somehow different from those dealt within the lead paper and other existing Islamic economics and finance literature. The author discovers that most of the literature does not go beyond the prevailing shallow treatment of the first point; historical records and narrations of the two experiments. For this reason, some Muslim economists consider the significance of Mit-Ghamr local savings bank as "only historical for the time being" (Ahmad, Rahman, & Valie, 1995, p. 352). In pursuing such a synthesis, the author hopes to draw some insightful lessons that can guide us in bringing an "important venue" to the existing proposals for the reform agenda of IF rather than indulging into a "vicious circle" that does not transcend a few factors that have been in circulation for some time without reaching proper resolve. It is also hoped that the explored dimensions are given due consideration in the discussions surrounding the future of IF in theory and practice.
... There is no explicit aim to target the behavior of taxed entities as concerns their capital structure. Nevertheless the empirical and theoretical literature documents that higher CIT rates set incentives for both non-financial firms and banks to increase leverage in order to lower tax expenses ( Feld et al., 2013;Gropp and Heider, 2010;De Mooij and Keen, 2016;Langedijk et al., 2015 ). This debt bias of taxation results from the fact that interest rate costs for external debt are generally tax deductible, and thereby reduce the taxable net income of a company, whereas interest on equity is not. ...
Regulatory bank levies set incentives for banks to reduce leverage. At the same time, corporate income taxation makes funding through debt more attractive. In this paper, we explore how regulatory levies affect bank capital structure, depending on corporate income taxation. Based on bank balance sheet data from 2006 to 2014 for a panel of EU-banks, our analysis yields three main results: The introduction of bank levies leads to lower leverage as liabilities become more expensive. This effect is weaker the more elevated corporate income taxes are. In countries charging very high corporate income taxes, the incentives of bank levies to reduce leverage turn ineffective. Thus, bank levies can counteract the debt bias of taxation only partially.
... His focus is indeed on how the internal capital market can be exploited to reduce the total tax burden on multinational banks, while the implications for financial stability are not considered. When it comes to the microsimulation exercise, our work follows Langedijk et al. (2015), who investigate the public finance impacts of eliminating the debt bias, and provide a rich set of sensitivity results based on different behavioral parameters for the reaction of bank capital structure to taxation. Like theirs, our contribution adds to the recent literature that emphasizes how tax policy creates distortions in terms of increased systemic risk (De Mooij, Keen, and Orihara 2014). ...
... First, starting from our econometric model, we predict the counterfactual debt ratios implied by our estimates in the different reform scenarios. Then, following Langedijk et al. (2015), we assess the financial stability implications of the tax reforms using a microsimulation bank portfolio model. The next sections describe more in detail the simulation framework and the working assumptions to build the tax reform scenarios. ...
... At any rate, accounting for adjustment to asset riskiness allows us to take a cautious stance and avoid over-estimating the reduction in systemic losses. Intuitively, the fact that lower debt ratios trigger at the same time an increase in asset portfolio risk implies a reduction in the actual gains to financial stability, as highlighted in Langedijk et al. (2015). In general, we deliberately do not over-emphasize the absolute level of the losses obtained in the different scenarios, but rather focus on the changes in the comparison across scenarios. ...
We find evidence of tax‐driven strategic allocation of debt and asset risk across group entities of European banks. We evaluate the effects that establishing tax neutrality between debt and equity finance has on systemic risk, and show that the degree of coordination in implementing the hypothetical tax reform matters. In particular, a coordinated elimination of the tax advantage of debt would significantly reduce systemic losses in the event of a severe banking crisis. By contrast, uncoordinated tax reforms are not equally beneficial precisely because national tax policies generate spillovers through cross‐border bank activities. (JEL G21, G28, H25)
... His focus is indeed on how the internal capital market can be exploited to reduce the total tax burden on multinational banks, while the implications for financial stability are not considered. When it comes to the microsimulation exercise, our work follows Langedijk et al. (2015), who investigate the public finance impacts of eliminating the debt bias, and provide a rich set of sensitivity results based on different behavioural parameters for the reaction of bank capital structure to taxation. Like theirs, our contribution adds to the recent literature that emphasizes how tax policy creates distortions in terms of increased systemic risk (de Mooij et al., 2014). ...
... First, starting from our econometric model, we predict the counterfactual debt ratios implied by our estimates in the different reform scenarios. Then, following Langedijk et al. (2015), we assess the financial stability implications of the tax reforms using a microsimulation bank portfolio model. The next sections describe more in detail the simulation framework and the working assumptions to build the tax reform scenarios. ...
... At any rate, accounting for adjustment to asset riskiness allows us to take a cautious stance and avoid over-estimating the reduction in systemic losses. Intuitively, the fact that lower debt ratios trigger at the same time an increase in asset portfolio risk implies a reduction in the actual gains to financial stability, as highlighted in Langedijk et al. (2015). In general, we deliberately do not over-emphasize the absolute level of the losses obtained in the different scenarios, but rather focus on the changes in the comparison across scenarios. ...
... Some of the reasons include the fact that equity holders do not have to dilute the corporation's ownership with the new equity holders, and debt increases the corporation's value and return on equity via tax privileges imposed by the government (Mirakhor and Iqbal, 2013). Specifically, corporate income tax creates benefits for debt, as interest payments shield earnings from taxes, while dividends and share repurchase do not (Langedijk et al., 2014). The different preference of debt over equity financing can also be found due to regulations that are imposed by the government. ...
Purpose
The purpose of this paper is to examine incentives for risk shifting in debt- and equity-based contracts based on the critiques of the similarities between sukuk and bonds.
Design/methodology/approach
This paper uses a theoretical and mathematical model to investigate whether incentives for risk taking exist in: debt contracts; and equity contracts.
Findings
Based on this theoretical model, it argues that risk shifting behaviour exists in debt contracts only because debt naturally gives rise to risk shifting behaviour when the transaction takes place. In contrast, equity contracts, by their very nature, involve sharing transactional risk and returns and are thus thought to make risk shifting behaviour undesirable. Nonetheless, previous researchers have found that equity-based financing also might carry risk shifting incentives. Even so, this paper argues that the amount of capital provided and the underlying assets must be considered, especially in the event of default. Through mathematical modelling, this element of equity financing can make risk shifting unattractive, thus making equity financing more distinct than debt financing.
Research limitations/implications
Global awareness of the dangers of debt should be increased as a means of reducing the amount of debt outstanding globally. Although some regulators suggest that sukuk replaces debt, they must also be aware that imitative sukuk poses the same threat to efforts to avoid debt. In short, efforts to ensure future financial stability cannot address only debts or bonds but must also address those types of sukuk that mirrors bonds in their operation. In the wake of the global financial crisis, amid the frantic search for ways of protecting against future financial shocks, this analysis aims to help create future stability by encouraging market players to avoid debt-based activities and promoting equity-based instruments.
Practical implications
This paper’s findings are relevant for countries that feature more than one type of financial market (e.g. Islamic and conventional) because risk shifting behaviour can degrade economic and financial stability.
Originality/value
This paper differs from the previous literature in two important ways, viewing risk shifting behaviour not only in relation to debt or bonds but also when set against debt-based sukuk, which has been subjected to similar criticism. Indeed, to the extent that debts and bonds encourage risk shifting behaviour and threaten the entire financial system, so, too, can imitation sukuk or debt-based sukuk. Second, this paper is unique in exploring the ability of equity features to curb equityholders’ incentive to engage in risk shifting behaviour. Such an examination is necessary for the wake of the global financial crisis, for researchers and economists now agree that risk shifting must be controlled.
... Some of the reasons include the fact that equity holders do not have to dilute the corporation's ownership with the new equity holders, and debt increases the corporation's value and return on equity via tax privileges imposed by the government (Mirakhor and Iqbal, 2013). Specifically, corporate income tax creates benefits for debt, as interest payments shield earnings from taxes, while dividends and share repurchase do not (Langedijk et al., 2014). The different preference of debt over equity financing can also be found due to regulations that are imposed by the government. ...
Purpose
The purpose of this paper is to examine the extent of risk shifting behavior in bonds and sukuk. The examination is significant, as economists and scholars identify risk shifting as the primary cause of the global financial crisis. Yet, the dangers of this debt-financing feature are largely ignored – one needs to only witness the record growth of global debt even after the global financial crisis.
Design/methodology/approach
To identify the signs of risk shifting existence in the corporations, this paper compares each corporation’s operating risk before and after issuing debt. Operating risk or risk of a firm’s activities is measured using the volatility of the operating earnings or coefficient variation of earning before interest, tax, depreciation and amortization (EBITDA). Using EBITDA as the variable offers one distinct advantage to using asset volatility as previous research has – EBITDA can be extracted directly from firms’ accounting data and is not model-specific.
Findings
Risk shifting can be found in not only the bond system but also the debt-based sukuk system – a noteworthy finding because sukuk, supposedly in a different class from bonds, have been criticized in some quarters for their apparent similarity to bonds. On the other hand, this study thus shows that equity feature, when it is embedded in bonds (as in convertible bonds) or when a financial instrument is based purely on equity (as in equity-based sukuk), the incentive to shift the risk can be mitigated.
Research limitations/implications
Global awareness of the dangers of debt should be increased as a means of reducing the amount of debt outstanding globally. Although some regulators suggest that sukuk replace debt, they must also be aware that imitative sukuk pose the same threat to efforts to avoid debt. In short, efforts to ensure future financial stability cannot address only debts or bonds but must also address those types of sukuk that mirror bonds in their operation. In the wake of the global financial crisis, amid the frantic search for ways of protecting against future financial shocks, this analysis aims to help create future stability by encouraging market players to avoid debt-based activities.
Originality/value
This paper differs from the previous literature in two important ways, viewing risk shifting behavior not only in relation to debt or bonds but also when set against debt-based sukuk, which has been subjected to similar criticism. Indeed, to the extent that debts and bonds encourage risk shifting behavior and threaten the entire financial system, so, too, can imitation sukuk or debt-based sukuk. Second, this paper is unique in exploring the ability of equity features to curb equity holders’ incentive to engage in risk shifting behavior. Such an examination is necessary for the wake of the global financial crisis, for researchers and economists now agree that risk shifting must be a controlled behavior – and that one way of controlling risk shifting is by implementing the risk sharing feature of equity-based financing into the financial system.
... Historical regulation of the debt-equity distinction led to the scholarly position in favor of using the interest tax shield in corporate financing policy, urging corporations to be highly indebted and unstable (De Mooij, 2012;Kashyap & Zingales, 2010;Langedijk, Nicod eme, Pagano, & Rossi, 2014). Corporate indebtedness has become a serious impediment to financial stability (Campa, 2013). ...
The debt-equity distinction is critical in modern corporate finance. We assess the compliance of the interest tax shield with the maqasid al Shariah in finance. For our analysis, we use the ends of maqasid al Shariah as proposed by Akram Laldin & Furqani, 2013. We develop a survey questionnaire to survey an international sample of well-informed individuals in the field of Islamic economics and finance. We use mean comparison, exploratory factor analysis (EFA), and structured equation modeling (SEM) to evaluate 176 responses. Our results reveal that experts consider the interest tax shield as anathema to the ends of maqasid al Shariah in Islamic finance. We find that the interest tax shield discourages equity financing and hinders the objective of overall human well-being. We recommend reframing the tax shield in favor of equity financing to promote profit and loss sharing.
... Advantages of debt include increased tax shields, while the downside may be that high debt levels increase the risk of financial distress. From a tax perspective, debt financing is normally preferred because interest payments reduce the taxable income of a company while dividends and share repurchases do not (Langedijk et al. 2014). This often encourages excessive debt financing, which results in complex financial transactions and high leveraged ownership, which would not exist under normal business circumstances (Hemmelgarn & Nicodeme 2010;Lloyd 2012;Shackleford, Shaviro & Slemrod 2010;Shaviro 2009). ...
Background: The Organisation for Economic Cooperation and Development (OECD) made a number of recommendations in relation to interest deduction limitations as part of the Base Erosion and Profit Shifting (BEPS) project. In 2016 the South African National Treasury indicated that the interest deduction limitations contained in the Income Tax Act would be reviewed in the light of these recommendations.
Aim: This paper aimed to describe funding structures of companies in South Africa liable for tax and how this relates to other characteristics, including ownership, of the companies.
Setting: The research was performed using data from tax returns submitted by companies liable for income tax in South Africa.
Methods: This paper reports on descriptive analyses of the research conducted.
Results: The results showed that the mean interest-to-earnings before interest, taxes, depreciation, and amortisation (EBITDA) ratio for certain foreign-owned entities differed significantly from that of domestically owned entities.
Conclusion: The results may present evidence of profit-shifting activities. They also highlight trends in interest-to-EBITDA ratios that may be of relevance for future legislative developments. Further related research is required if interest deduction limitations in the South African tax legislation are to be reviewed in light of the OECD proposals.
