Deferred Tax Research Articles

Assessing the Financial Reporting Consequences of Conversion to IFRS: The Case of Equity-Based Compensation

SYNOPSIS: The potential conversion of accounting standards from U.S. GAAP to International Financial Reporting Standards (IFRS) raises the issue of unknown financial reporting consequences. We consider one important accounting issue, namely equity-based compensation, and study how IFRS conversion will affect financial statements and the quality of reported numbers. The difference between the two standards is that IFRS reports tax benefits from equity-based compensation at their intrinsic value each period. This amounts to quasi fair-value accounting under IFRS compared to historic-cost accounting under GAAP. We develop and compare pro forma GAAP and IFRS accounting reports for a broad cross section of U.S. firms. We find that IFRS yields lower deferred tax assets and recognized tax benefits for approximately two-thirds of the option grants in our sample. Moreover, reported tax items will be more volatile under IFRS and these effects will be more pronounced for firms with greater option use and stock price volatility. Importantly, we find that IFRS tax items are better able to predict future cash flows. One conclusion is that IFRS improves the relevance, and thereby, the quality, of at least some reported numbers.

The fleeting nature of permanent reinvestment: Accounting for the undistributed earnings of foreign subsidiaries

Abstract Over the last decade, an increasing percentage of the profits reported by U.S. corporations were earned by their foreign subsidiaries and retained outside the United States resulting in the deferral of income taxes. The American Jobs Creation Act of 2004 provided a temporary federal tax incentive to remit such earnings, which resulted in the repatriation of $140 billion by the 30 firms comprising the Dow Jones Industrial Average. An analysis of the financial reporting disclosures made by these firms reveals that a tax expense was not fully recognized on a substantial portion of the earnings until repatriation because of an exception for foreign reinvestments deemed to be essentially permanent in duration. The implications of the currently acceptable accounting for undistributed foreign earnings are discussed as well as recommendations to improve the relevancy and reliability of the disclosures required for this exception to comprehensive recognition of deferred taxes.

Incremental Value Relevance of Unrecognized Deferred Taxes: Evidence from the United Kingdom

ABSTRACT: We examine empirically whether the use of the partial method for deferred taxes provides incremental information of use to investors. Specifically, we test whether U.K. capital markets valued unrecognized deferred tax amounts reported in the footnotes to U.K. annual reports, pursuant to U.K. Statement of Standard Accounting Practice (SSAP) No. 15 (ASB 1985). Our empirical model is based on Feltham and Ohlson (1995). We run iterative weighted least-squares (IWLS) regression of year-end share prices on a decomposition of book value per share for a pooled sample of U.K. firm-years drawn from the years 1993 through 1998, and find positive associations with price for net deferred tax assets—both recognized and unrecognized. Moreover, we are unable to reject the null hypothesis that both parts of deferred taxes have similar multiples in our price regressions. These findings support some theoretical predictions in Sansing (1998), Guenther and Sansing (2000, 2004), and Amir et al. (2001).

Investment Implications of the Estate Tax

Although the estate tax is mostly ignored in the finance literature, it is a critical factor affecting investment returns for taxable investors. The frequent legislative changes associated with the estate tax introduce undiversifiable risk without increasing expected return. The value of tax deferral is more meaningful when viewed in an estate tax context. Alternative investments may benefit from lower estate tax valuations depending on how they are structured. <b>TOPICS:</b>Wealth management, real assets/alternative investments/private equity, legal/regulatory/public policy

Taxable and Tax-Deferred Investing: A Tax-Arbitrage Approach

We analyze an intertemporal portfolio problem with both taxable and tax-deferred retirement accounts. Using a tax-arbitrage argument, we identify conditions under which the optimal location decision (where to place an asset) is separable from the allocation decision (how much to allocate to each asset). Investors place highly taxed assets in the tax-deferred account to maximize the tax benefit and adjust their taxable portfolios to achieve the optimal risk exposure. We show that the two-account problem can be reduced to a taxable-account-only problem. The results are robust to capital gains tax deferrals, consumption and contribution decisions, and stochastic tax rates.

Tax-Deductible Pre-Event Catastrophe Loss Reserves: The Case of Florida

After Hurricane Andrew the U.S. Congress entertained proposals to allow insurers to employ tax-deferred loss reserves. Interest was strong at first, but as the events receded interest waned. However, after the most recent severe hurricane seasons the proposals are again being discussed. In this paper we examine the institution of catastrophe loss reserves in a stylized model of insurance provisions. First, we find that the benefits of the tax-deferred loss reserves depend on the actuarial assumptions regarding the expected loss distribution. Second, we make the first attempt at estimating the change in consumer behavior and the social welfare implications for permitting tax deferred loss reserves. In sum, we find under specific circumstances there are large welfare gains for allowing the tax deferral of reserves.

Tax-Deductible Pre-Event Catastrophe Loss Reserves: The Case of Florida

After Hurricane Andrew the U.S. Congress entertained proposals to allow insurers to employ tax-deferred loss reserves. Interest was strong at first, but as the events receded interest waned. However, after the most recent severe hurricane seasons the proposals are again being discussed. In this paper we examine the institution of catastrophe loss reserves in a stylized model of insurance provisions. First, we find that the benefits of the tax-deferred loss reserves depend on the actuarial assumptions regarding the expected loss distribution. Second, we make the first attempt at estimating the change in consumer behavior and the social welfare implications for permitting tax deferred loss reserves. In sum, we find under specific circumstances there are large welfare gains for allowing the tax deferral of reserves.

Information Content and Earnings Management Implication of Changes in the Valuation Allowance for Deferred Tax Assets

The valuation allowance for deferred tax assets is an estimate of the portion of deferred tax assets that is not realizable because of insufficient future taxable income. A change in the valuation allowance might contain the manager's private forward-looking information that helps users of financial statements assess the firm's future income. The inclusion of changes in the valuation allowance in income from continuing operations, however, creates opportunities for earnings management because the valuation allowance amount is based primarily on the manager's unverifiable judgment. This study provides evidence of both benefits (incremental information content) and costs (earnings management implication) of disclosing the valuation allowance for deferred tax assets. Changes in the valuation allowance contain incremental information content, in addition to publicly available information, in predicting one- and two-year-ahead income. However, changes in the valuation allowance for firms that likely manage earnings through their valuation allowance accounts are less associated with future income than for non-earnings management firms, implying that managers manipulate the valuation allowance to manage earnings.

Incremental Value Relevance of Unrecognized Deferred Taxes: Evidence from the United Kingdom

We examine empirically whether the use of the partial method for deferred taxes provides incremental information of use to investors. Specifically, we test whether U.K. capital markets valued unrecognized deferred tax amounts reported in the footnotes to U.K. annual reports, pursuant to U.K. Statement of Standard Accounting Practice (SSAP) 15. Our empirical model is based on Feltham and Ohlson (1995). We run iterative weighted least squares (IWLS) regression of year-end share prices on a decomposition of book value per share for a pooled sample of U.K. firm-years drawn from the years 1993 through 1998, and find positive associations with price for net deferred tax assets - both recognized and unrecognized. Moreover, we are unable to reject the null hypothesis that both parts of deferred taxes have similar multiples in our price regressions. These findings support some theoretical predictions in Sansing (1998), Guenther and Sansing (2000, 2004), and Amir et al. (2001).

Tax Deferral and Tax-Loss Harvesting

By not realizing capital gains, equity investors can postpone or even fully avoid future tax payments to the government. The value of the tax deferral increases at an increasing rate as the holding period lengthens. For investors who actively trade, however, tax-loss harvesting can be used. Investors then maximize losses that can offset gains in other securities. For tax-loss harvesting to work, however, the present value of uncertain tax savings must more than offset higher transaction costs.

Tax Deferral and Tax-Loss Harvesting

Tax Deferral and Tax-Loss Harvesting

Extending the Budget Enforcement Act: Revision of PAYGO Rules Necessary for Better Tax Policy

In the Federal budget process, the pay-as-you-go (PAYGO) principle as set forth in the Budget Enforcement Act (BEA) requires that all enacted direct spending and tax legislation for a fiscal year must be deficit-neutral in the aggregate. PAYGO rules have been generally praised by proponents for restraining new spending and for encouraging legislators to provide reasons for their budget decisions. Opponents have pointed to unconstrained federal spending, and frequent budget artifices as examples of the failure of PAYGO. In addition, the PAYGO rules raise excessive procedural hurdles for tax relief legislation. Numerous scholars and practitioners in the field have addressed the pros and cons of PAYGO, including the need for changing PAYGO rules or eliminating them altogether. The current PAYGO provisions are set to expire with the BEA after fiscal year 2002. This paper concludes that if the PAYGO requirements as set forth in the Budget Enforcement Act are to be extended, then at a minimum a compromise approach be adopted to reform PAYGO: to permit dynamic revenue analysis of tax legislation, or at the very least allow legislation providing appropriate tax deferrals (such as contributions to IRAs) to be exempt from PAYGO requirements. This paper discusses budget enforcement and the PAYGO concept, then identifies the problems associated with PAYGO and how PAYGO often leads to counterproductive tax policy decisions. The paper also reviews the mixed success of PAYGO in controlling federal spending. The paper then demonstrates how a reform that would allow legislation providing appropriate tax deferral to be exempt from PAYGO rules would allow both fiscal responsibility and good tax policy by promoting incentives for taxpayers to save and invest, and potentially increasing revenue to the government.

KEMAMPUAN BEBAN PAJAK TANGGUHAN DALAM MENDETEKSI MANAJEMEN LABA

The purpose of this study is to investigate whether the Deferred Tax Expenses analysis can be employed to detect earnings management in Indonesian Capital Market. This study also compares the deferred tax expenses method and the accrual method as the proxy of Earnings Management. This study finds that deferred tax expenses and the accrual measures (using Total Accruals model, Modified Jones Model and Forward Looking Model) have positive and significant impacts on the probability of earnings management to avoid losses. It means that the bigger the value of Accrual and Deferred Tax Expenses the bigger the probability of earnings management practices. Of the three models used, the deferred Jax expenses variable has similar significances compared to total accrual model and higher significances compared to the discretionary accrual models. This shown that deferred tax expenses can be used as an alternative to Accrual Models in explaining the earnings management phenomena around the earnings threshold. In the additional study, we find that factors affected earnings management can't explain the variation of Deferred Tax Expenses. Meanwhile it can be used to explain the three-accrual models significantly. This finding suggests that the use of deferred tax expenses as a proxy in earnings management is still in doubt.

Federal tax arrears in Russia Liquidity problems, federal redistribution or regional resistance?*

AbstractThree hypotheses about the nature of federal tax arrears in Russia in the second half of the 1990s are tested empirically. Tax arrears can be a result of: 1) liquidity problems in firms, 2) redistributive subsidies of the federal government, or 3) regional political resistance to federal tax collectors. Liquidity problems in firms explain a large part of the variation in tax arrears. Regional political resistance to federal tax collectors was also an important factor: For a given level of liquidity, federal arrears accumulated faster in regions where governors had a larger popular base, in regions with a better bargaining position vis‐à‐vis the centre, and in regions with governors in political opposition to the centre. We find that patterns of federal arrears are inconsistent with the redistributive politics premise that redistribution favours jurisdictions with ‘closer races’ for the incumbent in the national elections. Variation in authorized tax deferrals can be explained in part by federal redistributive politics.

Earnings management and deferred tax

This study analyses the deferred tax provisions of firms during a period in which the firms' incentive to manage earnings may have been be particularly strong and in which firms made disclosures in relation to partial deferred tax provisions which revealed readily their under- or over-provision of deferred tax. Using a sample of 58 firms for the two years 1991 and 1992, the magnitude of the under- or over-provisions found is economically significant, amounting, on average, to around 20% of the maximum potential deferred tax liability and, more important, 9% of profit or loss before tax. This paper takes such under- and over-provision of deferred tax and investigates its relationship with a number of posited explanatory variables - as derived and developed from the earnings management literature. In a multivariate setting it is found that the level of under-/over-provision is related to the following characteristics: whether the firm is reporting a pre-tax loss or a pre-tax profit; the extent of adjustment to prior year tax; and the level of surplus advance corporation tax (ACT). These findings support a general profit- smoothing hypothesis, and the finding in relation to ACT suggests that firms take an overall view in determining the required level of provision in order to manage earnings, rather than concentrating upon particular line items. There is also weaker evidence of a relationship between the level of under-/over-provision and firms' levels of gearing and effective tax rates.

The Valuation Relevance of Reversing Deferred Tax Liabilities

This paper compares two attributes of a deferred tax liability (DTL) that arise from differences in book and tax depreciation methods. The first attribute is the effect of the DTL on the market value of the firm. The second is the length of time between when the asset is placed into service and when the DTL associated with that asset begins to reverse. The paper shows that a decrease in the time it takes for the DTL to begin to reverse is neither necessary nor sufficient for the value of the DTL to increase. It also shows that the value of the DTL is not equal to the present value of the future deferred tax expense. The effect of one dollar of DTL on firm value depends only on the tax depreciation rate and the discount rate.

Unrecognized Deferred Taxes: Evidence from the U.K.

We examine whether U.K. managers use the flexibility provided under the partial method for deferred taxes to measure unrecognized deferred taxes opportunistically. We first test whether firm-specific operational and opportunistic factors are associated with the level of unrecognized deferred taxes. The tests provide evidence certain U.K. managers opportunistically measure deferred taxes to manage leverage, consistent with arguments by commentators that deferred taxes heavily influence leverage indicators that play a prominent role in the U.K. contracting framework. Because the proper identification and measurement of both operational and opportunistic determinants of unrecognized deferred taxes influence our tests, we additionally investigate whether unrecognized taxes relate to future deferred tax reversals and future operating profitability of the firm. These tests show the components of deferred taxes predict both future deferred tax reversals and indicators of future profitability of the firm as predicted. Taken together, our results indicate that, on average, the existence of balance sheet management does not nullify the predictive power of (unrecognized) deferred taxes for future deferred tax reversals and for profitability measures. One implication of the results is that the recent U.K. standard change eliminating the partial provision method for deferred taxes potentially has reduced the usefulness of deferred tax disclosures.

Earnings Management Using the Valuation Allowance for Deferred Tax Assets under SFAS No. 109*

AbstractStatement of Financial Accounting Standards No. 109 (SFAS No. 109) allows firms to use their discretion to set arbitrarily high valuation allowances against deferred tax assets. Firms can then later use these "hidden reserves" to manage earnings. Our evidence indicates that most banks do not record a valuation allowance to manage earnings, but rather to follow the guidelines of SFAS No. 109. However, if the bank is sufficiently well capitalized to absorb the current‐period impact on capital, then the amount of the valuation allowance increases with a bank's capital. In later years, bank managers adjust the valuation allowance to smooth earnings. The magnitude of the discretionary adjustment increases with the deviation of unadjusted earnings from the forecast or historical earnings.

The Valuation Relevance of Reversing Deferred Tax Liabilities

This paper compares two attributes of a deferred tax liability (DTL) that arise from differences in book and tax depreciation methods. The first attribute is the effect of the DTL on the market value of the firm. The second is the length of time between when the asset is placed into service and when the DTL associated with that asset begins to reverse. The paper shows that a decrease in the time it takes for the DTL to begin to reverse is neither necessary nor sufficient for the value of the DTL to increase. It also shows that the value of the DTL is not equal to the present value of the future deferred tax expense. The effect of one dollar of DTL on firm value depends only on the tax depreciation rate and the discount rate.

Know When oo Hold 'Em and When to Fold 'Em

Using historical returns of the S&amp;P 500, the authors simulate the after-tax return enhancement from minimizing short-term capital gains, tax deferral of long-term gains, high cost-basis tax lot sales, and tax-loss harvesting. They also demonstrate the relationship of the estate tax to these investment strategies. They show that tax deferral is not an interest-free loan from the government, but rather that the tax code operates more like a partnership carried interest and that the mechanism of tax deferral is a non-linear function of different compounding rates. They extend prior research showing that tax-sensitive investors can reap significant after-tax return advantages that are hard to match with conventional active management. In an addendum, they analyze the effect of the newly enacted tax rates under the Jobs and Growth Tax Relief Reconciliation Act of 2003, and find that the benefits of tax deferral are less, but remain significant.