Loss Carryback Research Articles

Leverage and firm value

AbstractThree highly cited studies with over 6000 citations collectively report a negative relationship between the market value of the firm and leverage. Such empirical findings clearly contradict the hypothesis of leverage adding value to the firm and an optimal capital structure that maximizes firm value—these findings have yet to be resolved. Employing a sample of 3,768 firms consisting of 39,015 observations, a stochastic frontier analysis was used to assess the relationship of leverage among other capital structure factors with firm value. It was found that in general the use of leverage promotes firm value, consistent with the trade‐off theory and that the inverse relationship between leverage and firm value was a temporary occurrence and is likely attributable to firms employing tax loss carrybacks in response to the 1986 Tax Reform Act. The estimates of technical efficiency indicate that many firms can do more to increase their value, the sample as a whole improves efficiency (value) over the sample period. The findings reconcile the reports of leverage decreasing firm value as reported in Baker and Wurgler, Fama and French, and Habib and Ljungqvist. The empirical findings suggest prior observation was a due to a decline in the value of the tax shield generated by leverage after the Tax Reform Act of 1986. Specifically, tax carrybacks extended the pre‐Tax Reform Act of 1986 tax shield value to 1991 and after 1991 the tax shield value declined.

The Effect of Industrial Diversification on Firm Taxes

ABSTRACTThis study investigates whether industrial diversification generally provides a tax advantage and how the convexity of the tax system contributes to this benefit. The main findings show that multi-industry operations lower a firm’s taxes and income volatility relative to single industry operations on average, but the benefit is not universal. Namely, there is no significant tax advantage when multi-industry firms have high crossindustry cash flow correlations or when limitations are placed on the convexity mechanism, such as when firms have recent diversifying acquisitions or a high degree of crossjurisdiction activity. To shed new light on the mechanism through which U.S. firms realize this benefit, I exploit two temporary policies expected to reduce tax convexity via extensions of loss carryback periods. I find these policies also mitigate the tax advantage. Taken together, the results underscore how context matters in determining whether a firm will realize a tax advantage from multi-industry operations.JEL Classifications: D23; G11; H25; M41.

Losses never sleep – The effect of tax loss offset on stock market returns during economic crises

We analyze to what extent more generous tax loss offset regulations are associated with a weaker decline and stronger recovery of firm stock prices during economic crises. We argue that an unrestricted loss carryforward and, particularly, an unrestricted loss carryback provides firms with additional liquidity, which should lower the risk of bankruptcy and can be used for investment purposes. Our empirical findings document that (1) an unrestricted loss carryforward and an unrestricted loss carryback result in a weaker decline and more timely recovery of stock prices during the considered crises, (2) this effect is stronger in high-tax countries, and (3) this effect is also dependent upon pre-crisis profitability.

경제위기와 결손금 공제제도의 개편방안

As a response policy to COVID-19, the Korean government has extended the loss carryforward period and the loss carryback period. This study explores a desirable reform plan for the loss offset provisions in an economic crisis, and to estimate the effect of this tax reform. In most OECD countries, loss carryback is normally allowed very limitedly, but during economic downturns, it is actively used to solve the problem of liquidity shortages of companies. Although it is not necessary to permanently extend the loss carryback period of SMEs, the expansion of loss carryback period should be given priority over that of loss carryforward period during economic downturn. In addition, SMEs that would have been subject to loss carryback are smaller and have a higher debt ratio than SMEs that did not. It suggests that the extension of the loss carryback period for SMEs can significantly help in resolving the liquidity problem of small businesses, which are having difficulty in raising funds due to the sluggish economy. Finally, we estimate the financial effect of extending the loss carryback period from one year to three years. It is expected that corporate tax will be reduced by KRW 114.1 billion and income tax by KRW 4.1 billion in 2022. However, since the loss carryforward will be reduced by the same amount as the loss carryback, from a long-term perspective, the effect of the extension of the loss carryback period on the net finance is expected to be much smaller than this.

Assessment of the international competitiveness of the corporate profit tax in Ukraine

The article is devoted to assessing the international competitiveness of the corporate profit tax system based on the approach of the US Tax Foundation, which develops International Tax Competitiveness Index of the corporate profit tax (ICI) and takes into account the level of profit tax rates, cost recovery, tax incentives and complexity of tax law. According to the analysis of the international ranking of OECD countries, Estonia, Latvia, Lithuania, and Hungary had the highest ICIs in 2019-2020. The main factors that have had a positive effect on their competitiveness are the low top marginal income tax rate, unlimited loss carryback and carryforward, no restrictions on the list of assets subject to depreciation, as well as the use of accelerated depreciation, which allows companies to compensate for a larger share of the initial value of assets, LIFO inventory or at least inventory by the weighted average cost method, no Patent Box; no tax credit for R&D, and low corporate profit tax complexity. The calculation of the ICI for Ukraine, based on the approbation of the methodological approach of the Tax Foundation, found that in 2019-2020 Ukraine with a total score of 55.07 took 24th place out of 35 OECD countries. The author characterizes the main components of Ukrainian corporate profit taxation in terms of their impact on international competitiveness; in addition, ways to increase ICI are substantiated.

Оцінка міжнародної конкурентоспроможності системи оподаткування прибутку підприємств України

The article is devoted to assessing the international competitiveness of the corporate income tax system based on the approach of the US Tax Foundation, which develops International Tax Competitiveness Index of the corporate income tax (ICI) and takes into account the level of income tax rates, cost recovery, tax incentives and complexity of tax law. According to the analysis of the international ranking of OECD countries, Estonia, Latvia, Lithuania, and Hungary had the highest ICIs in 2019-2020. The main factors that have had a positive effect on their competitiveness are the low top marginal income tax rate, unlimited loss carryback and carryforward, no restrictions on the list of assets subject to depreciation, as well as the use of accelerated depreciation, which allows companies to compensate for a larger share of the initial value of assets, LIFO inventory or at least inventory by the weighted average cost method, no Patent Box; no tax credit for R&D, and low corporate income tax complexity. The calculation of the ICI for Ukraine, based on the approbation of the methodological approach of the Tax Foundation, found that in 2019-2020 Ukraine with a total score of 55.07 took 24th place out of 35 OECD countries. The author characterizes the main components of Ukrainian corporate income taxation in terms of their impact on international competitiveness; in addition, ways to increase ICI are substantiated.

Accelerated Depreciation and Loss Carry-Back: Income Tax Measures to Strengthen the Austrian Economy in the Face of COVID-19

As part of a broad toolkit of grants and relief measures to help Austrian businesses recover from the economic consequences of COVID-19, two types of accelerated depreciation and the possibility of carrying back losses from 2020 were introduced. These amendments are outlined and commented on in the following note.

Tax Loss Carrybacks as Firm Fiscal Stimulus: A Tale of Two Recessions

ABSTRACT This paper studies effects of the five-year net operating loss carryback enacted near the ends of the 2001 and 2007–2009 U.S. recessions—a policy that gave firms larger U.S. federal tax refunds as a fiscal stimulus measure. Following the end of the 2001 recession, I find that the policy had little effect on firm financial conditions, and I find that firms allocated $0.40 of every refund dollar to investment in that period. In contrast, the policy improved firm financial conditions following the 2007–2009 recession, reducing bankruptcy risk and the probability of future credit-rating downgrades. In this period, I find that firms initially used the refunds to increase cash holdings before paying down debt in the following year. These results highlight the importance of considering macroeconomic conditions when studying firm uses of tax-related cash flow and the related effects on firm financial health. JEL Classifications: G31; H25; H32.

Who CARES? Evidence on the Corporate Tax Provisions of the Coronavirus Aid, Relief, and Economic Security Act from SEC Filings

We use U.S. Securities and Exchange Commission (SEC) filings to provide initial large-sample evidence regarding utilization of corporate tax provisions by U.S. firms under the Coronavirus Aid, Relief, and Economic Security Act (CARES). These tax provisions were intended to provide firms immediate liquidity to prevent widespread bankruptcies and layoffs in response to the COVID-19 pandemic. However, critics have argued that the provisions were poorly targeted and amounted to “giveaways” for shareholders of large corporations. We find that 38 percent of firms discuss at least one of the CARES tax provisions in their SEC filings, a result primarily attributable to the net operating loss (NOL) carryback provision. Firms experiencing lower stock returns during the COVID-19 outbreak are more likely to discuss CARES tax provisions, but not firms in states or industry sectors exhibiting large increases in unemployment. Further, we find a higher likelihood of tax provision discussions for firms with pre-pandemic losses and higher financial leverage. Finally, we document some evidence that firms facing potential reputational or political costs from discussing these tax provisions may have avoided doing so. Our analyses suggest that tax provisions under CARES were not material for most publicly-traded U.S. firms, were not likelier to benefit firms in greater need of liquidity during the pandemic, and that some firms perceived that disclosing benefits would be costly. These findings are important for policymakers as they consider additional economic relief for U.S. corporations while the coronavirus pandemic lingers.

Tax Planning Gone Awry: Do Tax-Motivated Firms Experience Worse Tax Outcomes from Losses Compared to Other Firms?

We study the tax outcomes associated with losses in publicly traded U.S. multinational firms. We find that tax planning using tax haven operations, which is commonly associated with relatively favorable tax outcomes for profitable firms, is associated with poor tax outcomes from losses compared to multinational firms that do not tax plan with tax haven operations. Specifically, we find that firms with tax haven operations receive significantly lower tax loss benefits in terms of both tax loss carrybacks and tax loss carryforwards. We demonstrate the striking asymmetry of the tax U.S. system, in which U.S. multinational firms are often unable to fully realize tax benefits for their losses despite provisions for tax loss carrybacks and carryforwards, and show that tax planning exacerbates this asymmetry. In addition, we note that our findings highlight a potential cost of tax avoidance: lower tax benefits from losses. We also contribute to the tax avoidance literature by providing a research design framework for studying tax outcomes during loss years.

Asymmetric Treatment of Tax Losses and Corporate Investment

In a sample of European private firms, we find that a less restrictive allocation of tax refunds to loss firms arising from loss carrybacks vis-a-vis carryforwards increases loss firms’ investment. However, only a third of the tax refund from loss carryback is invested. The other two-thirds are set aside as cash or returned to shareholders. We also find a delayed exit of loss firms with low productivity indicating that a less restrictive allocation of tax benefits to loss firms increases misallocation risk. While loss firms generate higher output under carryback regimes, the output gains from their investment are substantially smaller than for profitable firms. Taken together, these results suggest that a less asymmetric treatment of tax losses relative to profits increases investment and output at the cost of distorting the competitive selection of firms.

Tax Loss Carrybacks: Investment Stimulus versus Misallocation

ABSTRACT Tax regimes treat losses and profits asymmetrically when profits are immediately taxed, but losses are not immediately refunded. We find that treating losses less asymmetrically by granting refunds less restrictively increases loss firms' investment: A third of the refund is invested and the rest is held as cash or returned to shareholders. However, the investment response is driven primarily by firms prone to engage in risky overinvestment. Consistent with the risk of misallocation, we find a delayed exit of low-productivity loss firms receiving less restrictive refunds, indicating potential distortion of the competitive selection of firms. This distortion also negatively affects aggregate output and productivity. Our results suggest that stimulating loss firms' investment with refunds unconditional on their future prospects comes at the risk of misallocation. JEL Classifications: G31; H21; H25.

The Tax Attractiveness Index: Methodology

With increasing globalization, countries are competing for companies and investment. Because income tax law has not been globally harmonized so far, international companies view a country’s tax conditions as an important location factor. Corporate location decisions and, therefore, a country’s tax attractiveness depend on a variety of tax factors. In this document, we present our tax measurement tool — the Tax Attractiveness Index — which includes 20 different equally weighted tax components and provides a comprehensive picture of a country’s tax environment. Specifically, the Tax Attractiveness Index covers 20 components, which include Anti-Avoidance Rules, CFC Rules, Corporate Income Tax Rate, Depreciations, EU Member State, Group Taxation Regime, Holding Tax Climate, Loss Carryback, Loss Carryforward, Patent Box Regime, Personal Income Tax Rate, R&D Tax Incentives, Taxation of Capital Gains, Taxation of Dividends Received, Thin Capitalization Rules, Transfer Pricing Rules, Treaty Network, Withholding Tax Rate Dividends, Withholding Tax Rate Interest, and Withholding Tax Rate Royalties.

Taxation and Corporate Risk-Taking

In the recent period of low growth, many governments look for ways to encourage economic activity. Risky investment by firms is an important source of macroeconomic growth. This paper contributes to recent literature on firm risk-taking by exploring if the corporate tax system can provide incentives for firms to undertake risky investment. To do so, we first model that the effect of taxes on firm risk-taking depends on loss offset possibilities. We then confirm our predictions empirically using a large international firm-level dataset. We find that firm risk-taking is positively and significantly related to the length of the tax loss carryback and carryforward periods and that this relation increases with the level of the tax rate. For firms that cannot expect to offset losses, higher tax rates reduce risk-taking. If loss offset is probable, however, corporate tax rates have a significant and positive effect on risk-taking.

Valuation of Tax Loss Carryforwards and Carrybacks, and Its Implications for Dynamic Portfolio Selection

The R & P seminar held at Wing 11 IIM Ahmedabad on June 25, 2015 by Prof. Suresh Govindaraj, The state University of New Jersey, USA on Valuation of Tax Loss Carryforwards and Carrybacks and its Implication for Dynamic Portfolio Selection

Reform of the use of corporate tax losses: An appraisal of the options and a consideration of the next steps

The asymmetric treatment of corporate losses arguably creates impediments to risk taking, investment and innovation, which ultimately detracts from productivity growth. To deal with this situation, the Tax and Superannuation Laws Amendment (2013 Measures No. 1) Bill 2013 received royal assent on 28 June 2013 and implemented a loss carry-back system based on prior recommendations of the Business Tax Working Group however this system has since been repealed. The Business Tax Working Group originally proposed four reform options by. With the loss carry-back now implemented and subsequently repealed, it is an appropriate time to cast an eye over these other options, whilst also considering the positives and negatives of the loss carry-back option. Such option was not intended to be the end of the matter but the first step to a reform of the use of corporate tax losses.

Tax-Motivated Loss Shifting

ABSTRACT:This paper examines the implications of tax loss carryback incentives for corporate reporting decisions and capital market behavior. During the 1981 through 2010 sample period, we find that firms increase losses in order to claim a cash refund of recent tax payments before the option to do so expires, and we estimate that firms with tax refund-based incentives accelerate about $64.7 billion in losses. Tax-motivated loss shifting is reflected in both recurring and nonrecurring items and is more evident for financially constrained firms. Analysts do not generally incorporate tax-motivated loss shifting into their earnings forecasts, resulting in more negative analyst forecast errors for firms with tax-based incentives than for firms without. Holding earnings surprises constant, however, investors react less negatively to losses reported by firms with tax loss carryback incentives.Data Availability: Data are available from sources identified in the paper.

Book Reviews

Book Reviews

Short-Term Incentive Effects of a Reduction in the NOL Carryback Period

ABSTRACT We examine whether the Taxpayer Relief Act of 1997 (TRA 1997), which reduced the net operating loss (NOL) carryback period from three to two years, created a short-term incentive effect to shift income to accelerate loss recognition in the tax year 1997. We find that our sample of NOL firms in the treatment year of 1997 display higher (lower) levels of income-decreasing (-increasing) earnings management, compared to a control sample of loss firms. When we focus strictly on the NOL firms in the transition year, we find that firms with higher reported income tax expense in fiscal year 1995 display greater income shifting to accelerate loss recognition. We also find that income shifting is greater for treatment NOL firms that expect to report losses in the post-TRA 1997 regime. Overall, our study highlights how changes in tax law provisions (as opposed to tax rate changes) affect firms' reporting behavior.

Werden niedrige Steuersätze in Osteuropa durch Verzicht auf Verlustverrechnung erkauft?

AbstractThis paper investigates whether countries in the EU finance low tax rates by restrictive loss offset rules. As effects from intertemporal loss offset rules are difficult to anticipate, restrictions only marginally affect overall investments. In contrast, tax rates have a significant bearing on investment decisions. Therefore, the combination of low tax rates with restrictive loss offset rules can increase investments without affecting the tax revenue. Our analysis for the EU reveals that countries with low tax rates restrict loss offset possibilities while “high tax” countries allow an unlimited loss carryforward or even a loss carryback.