Asymmetry in the Change of Corporate Tax Burden in Response to the Change in Book Income
Asian Tax Journal Vol. 16 No. 3 (2015), pp. 73-100
Abstract
The objective of this study is to investigate how the association between financial reporting and tax reporting are affected by the items that are treated differently by the accounting standards and tax laws. Such items are represented by allowance for uncollectable accounts and entertainment expense and are considered most significant in tax adjustments of Korean firms. Since these items are tax deductible as long as they are within the limit specified by the tax law, taxable income would not be reduced under the circumstances where book income is decreased. More specifically, when the allowance for uncollectable accounts or entertainment expense is increased over the tax limit, taxable income is not decreased because it is not affected by the amount of expense over the tax limit which is subject to the tax adjustments. Thus, we anticipate that change in corporate tax burden is asymmetric, which implies that when the book income decreases the corporate tax burden decreases at a lower rate than the rate at which it increases as book income increases. We analyze listed firms from 2001 to 2012 to investigate the asymmetry in the change in corporate tax burden by adjusting the model of cost stickiness developed by Anderson et al.(2003). We find following empirical results. First, the percentage of decrease in tax burden for an increase in book income is smaller than the percentage of increase in tax burden for an equivalent increase in book income. Second, such asymmetry of change in corporate tax burden is stronger under the circumstances where the allowance for uncollectable accounts or entertainment expense in the prior period is recognized slightly less or more than the tax limit. This study makes a contribution to the literature by theoretically and empirically analyzing the asymmetric association between financial reporting and tax reporting. We expect that our findings will cast a caveat that financial information users and stake－holders should be careful when inferring tax information from publicly announced financial data. In addition, our findings will provide tax authorities or policymakers with opportunities to re－consider the validity of tax limit rules.
Keywords
- Book Income
- Taxable Income
- Corporate Tax Burden
- Asymmetry
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