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Exploring Tax Avoidance in the Context of Corporate Tax

2.1 Introduction

According to Annuar et al. (2014), tax avoidance is argued to be a major problem prevailing in almost all the societies and countries across the world. Moreover, the authors claimed that issue of tax avoidance is not a new phenomenon rather it has surfaced ever since the tax legislations were enforced. In addition, several studies are being conducted to explore the issue of tax avoidance and determine alternative solutions to reduce its negative impact. In the recent years, the issue of tax avoidance in the context of the UK has been subject to considerable debate in the light of growing activities of tax avoidance by some of the large companies like Starbucks and Amazon to name few.

Correspondingly, this chapter provides the review of extant literature on the tax avoidance issue with regard to corporate tax. The review of literature is conducted in line with the generally accepted guidelines. Moreover, for the review purpose, extant literatures including journals, books, articles and reliable online sources are used.

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2.2 The Meaning of Corporate Tax Avoidance

According to Hanlon & Heitzman (2010) corporate tax avoidance is like any other management terminology but is viewed differently by different people (Hanlon & Heitzman, 2010, p. 137). In fact, the authors claimed that the corporate tax avoidance lacks any universal definition. Similar idea was also postulated by Desai & Dharmapala (2009), who argued past studies on corporate tax avoidance have erroneously defined term. This is because of the fact that tax avoidance is often used interchangeably with tax evasion. In this regard, it is worth to mention that tax avoidance and tax evasion are two distinct terms although separated by thin wall. The key difference between these two terms is that tax evasion is regarded as illegal while tax avoidance is considered to be legal. Nevertheless, the legality of the tax avoidance often been subject to question and it is quite difficult to determine ((Weisbach, 2003).

Notwithstanding, owing to the controversial nature of tax avoidance different scholars have proposed different definitions of tax avoidance. In this regard, Dyreng et al. (2008) defined tax avoidance as “the ability to pay a low amount of tax per dollar of reported pre-tax financial accounting income” (Dyreng et al., 2008, p. 63). Similarly, Frank et al. (2009) interpreted tax avoidance as “downward manipulation of taxable income through tax planning that may or may not be considered fraudulent tax evasion” (Frank et al., 2009, p. 768). However, the most comprehensive definition of tax avoidance is proposed by Hanlon & Heitzman (2010), who defined tax avoidance as “a continuum of tax planning strategies where something like municipal bond investments are at one end (lower explicit tax, perfectly legal), then terms such as “noncompliance,” “evasion,” “aggressiveness,” and “sheltering” would be closer to the other end of the continuum” (Hanlon & Heitzman, 2010, p. 137).

2.3 Measures of Tax Avoidance

Varieties of measures are ascertained to be used in the previous literatures for tax avoidance. However, most of the measures of tax avoidance are claimed to be based on the e financial statements' data (Annuar et al., 2014; Salihu et al., 2013). Based on financial statement estimates, the measure of tax avoidance is classified into three primary categories. Accordingly, the first category of tax avoidance measure deals with ‘multitude of the gap between accounting income and taxable income’ (Salihu et al., 2013, p. 416). Moreover, this measure of tax avoidance is considered to encompass three major types of gaps that include residual book-tax gap (BTG), total BTG, and tax effect BTG. The second category of the tax avoidance measures relates with tax proportions amount of business income. Accordingly, this measure include ‘effective tax rate (ETR)’ such as ‘accounting ETR’, ‘current ETR’, ‘long-run cash ETR’, ‘income tax expense to operating cash flow’ and ‘cash taxes paid to operating cash flow’. The third category of tax avoidance measures includes other measures like unrecognized tax benefits (UTB), DTAX and tax shelter measures (Armstrong et al. 2012; Wilson, 2009).

2.4 Benefits and costs of tax avoidance practices

Tax avoidance is ascertained to have both benefits and cost for the corporations engaged in the tax avoidance practices. In this regard, Annuar et al. (2014) argued that the tax avoidance practices have obvious benefits in the form of saving derived from the tax avoided. Notably, the cash savings are further argued to contribute towards increased flow of cash in the company, which creates opportunities for the company to make investment and thereby increase the overall value of the company. Moreover, tax avoidance is also claimed to increase the shareholders wealth in the form of more dividends and in terms of increased share values. Several studies in the past have documented the relationship between the tax avoidance, and the management earnings and managers’ compensations. In this regard, in an empirical study conducted by Frank et al. (2009), it was found that tax avoidance and managers compensations are positively related which implies managers are often compensated for their effective tax planning. Similar findings were also demonstrated by Rego & Wilson (2010) in which positive link between the aggressive tax planning and manager’s compensations were reported.

Though several studies have reported the benefits of tax avoidance in the corporation context, but few studies have also documented the negative impact of the tax avoidance on the corporations. In this regard, Armstrong et al. (2012) argued that since the owners of the company lacks adequate knowledge and understanding about the tax planning actions of the managers, it may create space for the managers to engage in unscrupulous practices, which may adversely influence the successful survival of the company. In addition, Christensen & Murphy (2004) documented the reputation risks arising from the tax avoidance practices by the company. Correspondingly, such risks is ascertained to distort the corporate image of the company before the general public, which in turn influence the performance of the company and may also result in losing their customer and therefore competitiveness to competitors. Tax avoidance is further claimed to have adverse implication on the government revenue and is argued to result in creating inflationary pressures (Dalu et al., 2012).

2.5 UK Government Tax Anti Avoidance Initiatives and their Effectiveness

The rising instances of tax evasion and tax avoidance by the companies in the UK in the recent years have raised several questions regarding the effectiveness of the UK government tax anti avoidance initiatives. In the wake of such instances, UK government has revealed its relentless efforts to crackdown the issues of tax avoidance and tax evasion and has introduced several new measures and changes in its tax legislations. In this regard, it has been observed that the government has increased the penalties for those not paying tax as per the set guidelines (House of Commons, 2014). Besides, it has also invested a more than £1 billion in HMRC so as to strengthen their ability to reduce the tackling avoidance and promote transparency in the tax payment system. The government has also modified economics of tax avoidance by reducing incentives and by augmenting the downsides for enrolling into avoidance schemes. In addition, the government has also introduced General Anti-Abuse Rule, which is recognised as an important development in the UK’s tax legislations. Moreover, the government bodies are ascertained to planning ahead with proposing some reforms in the international tax rules as well (Crown, 2015). Although, UK Government Tax Anti Avoidance Initiatives are in early stage but it has been noted that after the implementations of these initiatives more than 3,600 potentially non-compliant UK taxpayers were identified and £135 million were recovered. However, compared to £188 million received by France and £220 million received by Spain, the amount received by the UK is quite low but it cannot be ignored that this amount received by the UK does not represents final expected yield (House of Commons, 2014). Hence, it would be unfair to make any conclusion on the effectiveness of these initiatives in curbing the issue of tax avoidance.

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2.6 Conclusion

The review of literature facilitated significant knowledge and understanding regarding the tax avoidance, it benefits and cost as well as measures of tax avoidance. Besides, the review of literature further illustrated the UK government has undertaken several measures and has introduced new initiatives to crack down the tax avoidance practices. However, these initiatives are recognised to be relatively new and are at their early phase of implementation and thus not many researches are being conducted to measure the effectiveness of UK government tax anti avoidance initiatives. Hence, this study will investigate the effectiveness of these initiatives with reference to the case of Starbucks.

References

  • Annuar, H. A. et al. (2014). Corporate Ownership, Governance and Tax Avoidance: An interactive effects. Procedia - Social and Behavioral Sciences 164, pp.150 – 160.
  • Armstrong, C. S., Blouin, J. L., & Larcker, D. F. (2012). The Incentives for Tax Planning. Journal of Accounting and Economics, 53(1-2), pp. 391-411.
  • Christensen, J. & Murphy, R. (2004). The social irresponsibility of corporate tax avoidance: taking CSR to the bottom line. Development, 47, pp.37-44
  • Crown. (2015). Tackling tax evasion and avoidance. HM Treasury. [Online] Available At: https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/413931/Tax_evasion_FINAL__with_covers_and_right_sig_.pdf [Accessed 15 March, 2017].
  • Dalu, T. et al. (2012). The Impact of Tax Evasion and Avoidance on the Economy: A Case Of Harare, Zimbabwe. African J. Economic and Sustainable Development,1(3), pp. 284-296.
  • Desai, M. A., & Dharmapala, D (2009b). Corporate Tax Avoidance and Firm Value. The Review of Economics and Statistics, 91(3), 537-546.
  • Dyreng, S. D., Hanlon, M., & Maydew, E. L. (2008). Long-Run Corporate Tax Avoidance. The Accounting Review, 83(1), 61-82.
  • Frank, M. M., Lynch, L. J., & Rego, S. O. (2009). Tax Reporting Aggressiveness and Its Relation To Aggressive Financial Reporting. The Accounting Review, 84(2), 467-496.
  • Hanlon, M., & Heitzman, S. (2010). A Review of Tax Research. Journal of Accounting and Economics, 50(2-3), 127-178.
  • House of Commons.(2014). HMRC’s Progress in Improving Tax Compliance and Preventing Tax Avoidance. Eighteenth Report of Session 2014–15.
  • Rego, S., & Wilson, R. (2012). Equity Risk Incentives and Corporate Tax Aggressiveness. Journal of Accounting Research 50, 775-810.
  • Salihu, I. A. et al. (2013). Measures of Corporate Tax Avoidance: Empirical Evidence from an Emerging Economy. International Journal of Business and Society, 14(3), 412 – 427.
  • Weisbach, A. D. (2003). Corporate tax avoidance. Proceedings from National Tax Association ninety sixth annual conference. Chicago: Illinois.
  • Wilson, R. J. (2009). An Examination of Corporate Tax Shelter Participants. The Accounting Review, 84(3), 969-999.

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