Tax waiver year effect on earnings management practices in Malaysia

Abstract

PurposeThe purpose of this paper is to address the question of whether Malaysian public listed companies manage their earnings in response to changes in tax polices. The context of this study is the tax waiver year of 1999 which came about from the introduction of the Self Assessment System (SAS) by the Inland Revenue Board of Malaysia (IRBM) in the year 2000. If companies are to minimize tax liabilities, then the tax waiver year of 1999 may provide a substantial incentive for these companies to manage earnings in 1999.Design/methodology/approachThe modified Jones Model (adjusted) is used to obtain the discretionary current accruals which represent earnings management. It is hypothesized that there is a significant positive discretionary current accrual (income increasing earnings management) in the tax waiver year of 1999.FindingsThe results indicate that that there is a negative relationship between earnings management and the effect of the tax waiver year of 1999. These results suggest that the magnitude of discretionary current accrual is not related to the tax waiver year in a way that is consistent with tax‐motivated income shifting behavior. Instead companies tend to manipulate earnings downwards during severe economic downturn. This is in line with Healy's bonus maximization hypothesis.Research limitations/implicationsThe test sample is limited to public listed companies only and some companies are excluded due to insufficient data. Therefore, the results cannot be a representation of Malaysian companies' practices.Originality/valueThe findings of this paper contribute to the sparse literature on tax‐induced earnings management practices in Malaysia. The findings could be of value to the IRBM in designing and improving on the plans for future tax‐based incentive schemes.