Wait, what? Shareholders prefer their corporations to pay taxes?

Thursday, December 13, 2018

calculator, tax bookThey do when incentives like shareholder credits for corporate taxes paid exist.

Some countries around the world, such as Australia and Canada, run an integrated tax system. What that means is that corporate tax rates and individual tax rates are set up in a way that income is taxed only once, on aggregate, as it makes its way from the corporation to the shareholder. To accomplish this objective, shareholders include their proportion of the corporation’s pre-tax income in their individual taxable income, but receive a credit to their individual tax liability for taxes that the corporation has already paid. Andrew Bauer (Assistant Professor and Canada Research Chair in Taxation, Governance and Risk; School of Accounting and Finance) and his colleagues Dan Amiram (Tel Aviv University) and Mary Margaret Frank (University of Virginia) developed a little illustration to show that this creates an incentive for shareholders to want the corporation to pay taxes and to avoid spending money on costly tax planning – all in the name of valuable shareholder credits and thus greater shareholder after-tax cash flows.

Taking this illustration into the real world, the researchers found a set of European countries that eliminated their integration (or imputation) systems, mostly in the mid-2000’s. Comparing these “eliminating” countries to other countries that did not change their tax policy, they found that getting rid of the credits got rid of the incentive to pay taxes – and corporations in those eliminating countries engaged in substantially more tax planning after the change. Why? In the new tax system without integration, the income can be taxed twice as it transfers from corporation to shareholder, so to maximize shareholder cash flows the new incentive is to minimize the amount of corporate income that is initially taxed.

So yes, shareholders can prefer their corporations to pay taxes. But don’t go overboard – no silver bullet exists to kill taxpayers’ inherent preference to minimize their taxes.

Bauer and his colleagues’ research, to be published in a forthcoming 2019 issue of The Accounting Review, shows that other factors can limit the attractiveness of the shareholder credit incentive. The more a corporation operates in foreign jurisdictions (which do not offer credits), the less dividends it pays (and thus less credits generated), the greater its growth opportunities, and the more dispersed are the shareholders, the weaker is the incentive to generate shareholder credits by paying higher corporate tax. In these cases, shareholders would rather the corporation minimize its taxes. 

Nevertheless, an integrated tax system with its shareholder credits might just change the way you, I or governments think about shareholder incentives to pay taxes.

Dan Amiram, Andrew. M. Bauer, and Mary Margaret Frank. 2018. Tax avoidance at public corporations driven by shareholder taxes: Evidence from changes in dividend tax policy. The Accounting Review, forthcoming.


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