Financial Derivatives, Hedge Accounting and Tax Aggressiveness in Brazil

Rogiene Santos,Antonio Lopo Martinez,Rafael Moreira Antonio,José Enrique Teixeira Reinoso

doi:10.18800/contabilidad.202001.002

Abstract

This study investigated the relationship between the use of financial derivatives by non-financial corporations and tax aggressiveness in Brazil. In research on the American market, evidence was identified that non-financial entity users of financial derivatives were more tax aggressive. However, there is no reason to assume that this behavior is replicated in the Brazilian market, since tax legislation does not offer the same economic incentives, i.e., since it imposes limits on the tax deductibility of losses with these financial instruments, except in derivatives’ well-documented and proven use as a hedge tool. To verify this point, companies were classified into users and non-users of first-generation financial derivatives, and associated this classification with tax aggression metrics. The study focus was 384 non-financial companies listed on the B3 in the period from 2005 to 2015. The results of regression analysis using a probit estimate have pointed, in a distinctly different way than the American reality, that the most tax aggressive companies tend to use fewer financial derivatives. Nevertheless, when the use of derivative instruments as a hedge was controlled, it was found that when a company adopts hedge accounting, it is more likely it will be more tax aggressive. The result is presumably explained by the Brazilian tax treatment that authorizes the deductibility of losses, regardless of earnings, when using the derivative as a hedge.

Highlights

The derivative market currently stands out for reaching a total amount in the trillions of dollars, which in itself corresponds to the class of the most relevant financial products in the world nowadays
It is interesting to observe that 37% of the entities in the sample analyzed were effective users of financial derivatives, as well as while users of financial derivatives, the average of the metrics of the entities studied are very close to 34%, which corresponds to the sum IRPJ nominal rate + CSLL charged (Brazilian corporate income taxes), in general, from the non-financial companies
The values are lower than the averages, indicating that there are significant number of companies with effective tax rate (ETR) values below the 34% statutory rate, as indicated by the high standard deviations in the Total ETR, Current ETR and booktaxes differences (BTD) proxies

Summary

Introduction

The derivative market currently stands out for reaching a total amount in the trillions of dollars, which in itself corresponds to the class of the most relevant financial products in the world nowadays. The Brazilian market is, at this moment, a breeding ground for using derivative instruments because they can decrease the risk of a certain transaction, smooth corporation operating results, as well as possibly increase the entity’s own yield. Tax planning is a crucial instrument for expense reduction and decision-making of the entity managers (Hazan, 2004). Academic studies have struggled to clarify the derivative phenomenon in ligh of tax planning in the last two decades, whatever the reason why non-financial corporations use derivatives, whether due to hedge risk, to reduce non-tax costs or other agency costs, or as a sign of management quality, or, to reduce tax volatility (Zeng, 2014)

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