Book‐Tax Difference and Value Relevance of Taxable Income: Malaysian Evidence

Abstract

This study investigates the gap between financial accounting income and taxable income (i.e. book‐tax difference) and the value relevance of corporate taxable income in providing information on the quality of reported earnings for Malaysian listed firms during the tax years 2000 to 2004. The large gap between the financial accounting income and taxable income resulting from tax planning activities is reflected in firms’ effective tax rates (ETRs), a proxy for firms’ actual tax burdens. Thus, lower ETRs indicate high tax planning activities undertaken by the sample firms, and vice‐versa for firms with higher ETRs. This study uses a tax‐based earnings quality indicator, that is, the ratio of after‐tax taxable income to reported income (ATTI) to investigate the quality of corporate earnings. The study provides empirical evidence that firms report higher financial accounting income to shareholders and lower taxable income to tax authorities during the years 2000 to 2004. The significant and positive relation statistical results between firms’ after‐tax taxable income (ATTI) and market value of equity provided indicate the value relevance of taxable income as both an earnings quality indicator and a performance measure. Thus, the empirical results suggest investors appear to fully comprehend the quality‐related information in taxable income. This study concludes that first, tax planning activities contribute to a large gap between financial accounting income and taxable income; and second, taxable income contains useful information on the quality of reported earnings.