Net Operating Loss Research Articles

Neobanks in emerging markets: a risk assessment

Neobanks have risen as popular digital challengers to incumbent banks, especially in emerging markets (EMs) where the banking sector is often characterized by oligopolies. This article first estimates the value of Nubank and StoneCo in Brazil, two of the fastest-growing neobanks in Brazil. Normalizing revenue growth assumptions from their financial data, valuation models uncover that Nubank could be overvalued by about two times, whereas StoneCo could be undervalued by 80% of its fair value, as of March 19, 2024. This article then discusses firm-specific (high cumulative net operating losses, low long-term operating margins, high borrowing costs) and adherent macroeconomic (political uncertainty, foreign exchange risks, high equity risk premia) risks in EMs that explain the volatility in Nubank’s and StoneCo’s stock prices. These risks are instructive for understanding the challenges facing the business model of neobanks in EMs.

Net operating losses and Chapter 11

In this paper, we investigate the association between net operating losses (NOLs) and Chapter 11 filings by firms that decided to restructure their business (“restructuring firms”). Studying a sample of public firms in the US over a 30-year period, we show that after controlling for the expected industry post-reorganization tax rates, higher NOLs are associated with the decision to file under Chapter 11. Further investigation shows that fresh-start firms benefit from lower tax rates after emerging from the Chapter 11 procedure. We contribute to the tax literature on NOLs and important firm decisions and on taxation in fresh-start firms, as well as to the literature on Chapter 11. We inform policymakers and practitioners regarding the use of tax benefits in restructuring frameworks.

The TCJA and Domestic Corporate Tax Rates

We study changes in tax positions for U.S. C corporations following passage of the 2017 tax legislation commonly known as the Tax Cuts and Jobs Act (TCJA). While existing research has focused primarily on publicly traded companies, data limitations have prevented more holistic analyses of the corporate sector. Using a representative sample of U.S. corporate tax returns, we highlight how trends in effective tax rates (ETRs) and exposure to the legislation’s main provisions varied for public, private, multinational, domestic, and large versus small firms. We document several novel facts, including that ETRs increased on average for privately held, domestic firms and for firms in the bottom 90% of the firm sales distribution after TCJA. In contrast, public, multinational, and large firms saw substantial ETR cuts on average. We find that firms' pre-TCJA exposure to changes in the corporate tax rate and treatment of net operating losses have the strongest correlation with post-TCJA ETR changes. Overall, the analysis underscores the divergent impacts of TCJA on different firm types and illuminates the economic scope and relative significance of TCJA’s myriad provisions.

The impact of TCJA on CEO compensation

The 2017 Tax Cuts and Jobs Act (TCJA) expanded the impact of IRC Section 162(m) by disallowing a tax deduction for any compensation over $1 million paid to top executives. Under prior law, qualified performance-based compensation was exempt from the $1 million limit. Using OLS regressions, we examine whether TCJA affected CEO compensation immediately after enactment. We find evidence that CEO salaries, non-equity incentive pay, stock awards and total compensation are all higher after TCJA. While the law change increases the after-tax cost of compensation for the average firm, our results show that TCJA did not constrain CEO compensation. However, relative to the average effect, in cross-sectional analyses, we find some evidence that compensation was lower for strong CEOs post TCJA. We also find some evidence that CEOs at firms with high leverage and net deferred tax assets, including tax net operating losses, saw a decrease in various types of incentive compensation post TCJA.

Toward a better expert system for auditor going concern opinions using Bayesian network inflation factors

We develop an analytical model intended as the first stage in the development of expert systems to improve auditor knowledge in, and assist in the decision process of, Going Concern Opinions (“GCOs”). Our approach is consistent with a design science approach to developing information systems, resulting in an initial artifact, the mathematical model, which can, through iterative design science and behavioral research, inform a technology-based expert system. Based on Bayesian networks, our model provides insights about auditors’ revision, or inflation, of the probability to issue a GCO based on the interrelationship that forms with the incremental existence of one, two, or three publicly observable financial statement risk factors – net operating loss, negative cash flows from operations, and negative working capital. We calculate the revised probabilities using empirical data of GCOs from 2004 to 2015. Results reveal that the incremental relationship (one, two, or three factors present) effectively models expert auditors’ decisions to issue a GCO, and suggests the existence of these measurable inflation factors that represent situational and auditor-specific factors. We also find that Non-Big Four auditors inflate these factors differently than Big Four auditors to arrive at a decision to issue a GCO.

The economics of prepackaged bankruptcy

The economics of prepackaged bankruptcy

Net operating loss policies in Poland – a tool for tax neutrality and a firm’s antifragility

Abstract The purpose of the article is to check the impact of Net Operating Loss Policies (NOL) for firms. Net Operating Loss Policies (NOL) are a central fiscal tool because they enable firms to be taxed on their average profitability over time. A complete NOL policy has 4 dimensions: a NOL carry-forward (1), carry-back (2), unlimited in time (3) and with the time value of money (4) taken into account. No country applies a complete NOL policy. To evaluate the impact of all dimensions of NOL policies, Polish firm data from 41 sectors from the BACH database over ten years, from 2011 to 2020, are analysed. The results show that the change observed in the effective tax rate is positive with a complete NOL policy. In such case, firms pay less CIT in total, showing that the state will earn less, but should get more stability from firms which will hoard more cash. More investments or firms with more equity could be reached, strengthening the state’s stability. The variance confirms such intuition, an earlier use of a full or almost full fiscal deficit logically means a higher effective tax rate in years to come (but less in gross terms).

Understanding Consolidated Returns

Section 1501 allows all of the members of an affiliated group of corporations to elect to file a consolidated return. A consolidated return permits the includible members of an affiliated group of corporations to combine their incomes into a single return. The detailed rules for filing consolidated returns are found in regulations promulgated pursuant to a broad delegation of authority in section 1502 of the Internal Revenue Code. In general, the regulations reflect a “single entity” approach that attempts to treat the several members of a consolidated group in the same manner as divisions of a single corporation. This article explains the most important general principles governing consolidated returns and is intended to provide an overview of the consolidated return regulations for lawyers who are generally unfamiliar with the detailed rules. Among other topics, the article explains (1) the rules governing eligibility to file a consolidated return, (2) the computation of consolidated taxable income, including relevant limitations on the use of net operating losses, (3) intercompany transactions and distributions, (4) stock basis adjustments, and (5) earnings and profits calculations. It explains both the rules in the consolidated return regulations and the differences from the rules that otherwise would govern had the corporations not elected to file a consolidated return.

Tax Loss Measurement

We use financial disclosures to develop a novel proxy for net operating loss carryforward (NOL) tax benefits. This approach more accurately identifies firms with tax losses, more precisely measures...

How do most low ETR firms avoid paying taxes?

Evidence suggests a large proportion of profitable U.S. firms have low effective tax rates (i.e., an ETR between 0 and 10%). Despite widespread interest in how firms avoid paying taxes, we do not know how most firms attain low ETRs and whether they are primarily benefiting from benign or aggressive tax positions. Using a research design that explicitly examines low ETR firms, we predict and find that the majority are primarily benefiting from a benign tax position: large net operating loss carryforwards (NOLs). We also find that large NOLs allow firms to persistently retain low ETRs year after year. In contrast, we find that multinationals and tax haven firms, which should have more opportunities for aggressive tax planning, have a lower probability of attaining a low ETR (relative to domestic and non-tax haven firms). Collectively, these findings suggest that the typical low ETR firm does not incur significant tax risk. Consistent with this, we find that low ETR firms accrue unrecognized tax benefits at a similar rate as firms that pay the statutory tax rate and do not experience higher future tax rate volatility. Overall, the results shed light on the profile of the average low ETR firm and provide evidence that the majority are utilizing large NOLs rather than aggressive tax planning.Supplementary InformationThe online version contains supplementary material available at 10.1007/s11142-021-09614-8.

Net Operating Loss Carryforwards and Corporate Savings Policies

ABSTRACTWe examine the relation between corporate cash holdings and tax net operating loss carryforwards (NOLs). The literature demonstrates that firms should distribute cash to shareholders rather than retain it and generate passive investment income taxed at both corporate and investor levels. However, if the firm's tax rate on passive income is lower than shareholders'—as when the firm has NOLs—theory also shows that the firm should retain cash and invest on the shareholders' behalf. Consistent with this, we find that NOLs are associated with higher levels of savings; firms save an additional $0.12 to $0.17 per dollar of tax-effected NOL benefit. Furthermore, investors place a higher value on corporate cash in tax loss firms, consistent with NOLs increasing the after-tax returns on passive investments. The paper adds to the literature studying corporate financial policy responses to taxation and quantifies the role of NOLs in corporate savings decisions.

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.

A Re-examination of Firm Size and Taxes

We document that larger firms pay substantially lower cash effective tax rates (cash ETRs) in the long-term than do smaller firms. This pattern in long-term cash ETRs is robust to various specifications, but vanishes when cash ETRs are measured over a single year. Over a ten-year period, firms in the largest decile pay 10.8 p.p. (26 percent) lower taxes than those in the smallest decile, while this gap balloons to 14.4 p.p. (35 percent) for the largest 1 percent of firms. The relation between firm size and taxes over the long run cannot be explained by foreign operations, asset tangibility, R&D spending, capital structure, net operating loss carryforwards, or releases in the valuation allowance. While profitability explains near a quarter of this effect, about 80 percent of the association between size and taxes can be explained by the magnitude of losses within the horizon period. Overall, our results suggest large firms pay fewer taxes over the long run primarily by avoiding losses, potentially mitigating the negative consequences of tax convexity.

The Tax Effects on C Corporations of Coronavirus-Related Stimulus Acts

This paper discusses the tax effects, with a numerical case example, of the three new refundable payroll credits and the forgiven Small Business Interruption Loans created by the Families First Coronavirus Response Act (FFCRA) (2020) and the Coronavirus Aid, Relief and Economic Security (CARES) Act (2020) respectively. The CARES Act (2020) changed business tax provisions in three main areas: net operating losses, business interest expense deduction, and qualified improvement property. Through three case examples, this paper illustrates numerically how taxpayers can reduce their Federal corporation income tax liabilities by either filing amended returns for past tax years and/or strategically planning to take advantage of the changes in tax rules created by the CARES Act (2020).

Tax Loss Carryovers in a Competitive Environment*

ABSTRACTThe fact that incumbent firms can immediately deduct research and development (R&D) investments from taxable income is generally believed to give them a strategic advantage over new firms that cannot deduct the investment cost, but instead generate a net operating tax loss carryover. Using an analytical model, we show that this conventional wisdom need not hold in a competitive environment. We examine operating and investment decisions in a duopolistic industry in which an initial investment in R&D yields an immediate tax benefit for one firm, but creates a net operating loss carryover for the other firm. If both firms invest in R&D, the firm with the net operating loss carryover makes more aggressive capital investment decisions following successful R&D. This may deter the incumbent firm from investing in R&D despite the lower aftertax costs of this investment. Changing the tax loss carryover rules would thus not only affects start‐up or loss firms, but would also affect the investment decisions of profitable firms in the same industry.

How Do Most Low ETR Firms Avoid Paying Taxes?

Evidence suggests a large proportion of profitable U.S. firms have low effective tax rates (i.e., an ETR between 0 and 10 percent). Despite widespread interest in how firms avoid paying taxes, we do not know how most firms attain low ETRs and whether they are primarily benefiting from benign or aggressive tax positions. Using a research design that explicitly examines low ETR firms, we predict and find that the majority are primarily benefiting from a benign tax position: large net operating loss carryforwards (NOLs). We also find that large NOLs allow firms to persistently retain low ETRs year after year. In contrast, we find that multinationals and tax haven firms, which should have more opportunities for aggressive tax planning, have a lower probability of attaining a low ETR (relative to domestic and non-tax haven firms). Collectively, these findings suggest that the typical low ETR firm does not incur significant tax risk. Consistent with this, we find that low ETR firms accrue unrecognized tax benefits at a similar rate as firms that pay the statutory tax rate and do not experience higher future tax rate volatility. Overall, the results shed light on the profile of the average low ETR firm and provide evidence that the majority are utilizing large NOLs rather than aggressive tax planning.

Foreign banks management in the context of a pandemic: problems and solutions

The article discusses the problems encountered by enterprises in the financial sector in the context of the COVID-19 pandemic. The paper gives examples of management actions of the largest banks in Italy, Brazil, South Korea, China, Portugal, Singapore, the USA, the Philippines and Russia. World Health Organization has advised the population to use contactless payments and reduce the turnover of banknotes to a minimum. The coronavirus has increased the desire of customers to use digital services, making it an urgent need. In fact, the pandemic has led to the fact that Bank customers, who are increasingly afraid to spend time in public places, should be able to conduct banking operations without physical interaction with Bank offices. By implementing fully digital remote customer service, banks must ensure that both routine and unique (one-time, specific) banking processes will be performed without loss or disruption. Under these circumstances, financial institutions will be required to disclose information about the impact of the coronavirus pandemic on their operations in financial statements based on the relevant disclosure standards (Generally Accepted Accounting Principles, GAAP and United States Securities and Exchange Commission, SEC). Disclosure of financial statements may include risk factors such as Fund depreciation, reduced liquidity, and other aspects.The downward trend in interest rates as required by governments and national banking regulators may affect the profitability of banks. Along with a General decline in business activity, this will lead to a decrease in Bank profits. Analysts’ concerns have already resulted in a sharp drop in the share prices of many firms, which creates another problem because some deferred tax assets, such as net operating losses (NOL), are not fully accounted for in the Bank’s regulatory capital requirements. National governments impose industry-specific tax requirements on capital market enterprises, but the challenges they will face when filing and paying direct and indirect taxes are likely to be similar to those faced by other industries.

The Economic Effects of Special Purpose Entities on Corporate Tax Avoidance

ABSTRACTThis study provides the first large‐sample evidence on the economic tax effects of special purpose entities (SPEs). These increasingly common organizational structures facilitate corporate tax savings by enabling sponsor firms to increase tax‐advantaged activities and/or enhance their tax efficiency (i.e., relative tax savings of a given activity). Using path analysis, we find that SPEs facilitate greater tax avoidance such that an economically large amount of cash tax savings from research and development (R&D), depreciable assets, net operating loss carryforwards, intangible assets, foreign operations, and tax havens occur in conjunction with SPE use. We estimate that SPEs help generate over $330 billion of incremental cash tax savings, or roughly 6 percent of total U.S. federal corporate income tax collections during the sample period. Interaction analyses reveal that SPEs enhance the tax efficiency of intangibles and R&D by 61.5 percent to 87.5 percent. Overall, these findings provide economic insight into complex organizational structures supporting corporate tax avoidance.

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 Loss Measurement

We use financial disclosures to develop a novel proxy for net operating loss carryforward (NOL) tax benefits. This approach more accurately identifies firms with tax losses, more precisely measures the tax loss, and better predicts reductions in future taxes than existing proxies. We derive a prediction model, which future researchers can employ to better approximate the NOL tax benefits based on readily available financial data. We also demonstrate how NOL nonlinearity affects measurement of corporate tax status. By proposing a new measure and demonstrating trade-offs across competing proxies, we contribute to the work in public economics, corporate finance, and tax accounting that examines the responsiveness of the business sector to corporate tax incentives.