Amsterdam Business School
Value relevance of deferred tax accounting under IAS 12
Name: Bart van Son Student number: 6182127 Date: 04-01-2016
Words: 14,013
First supervisor: Prof. Dr. L.R.T. van der Goot Second supervisor: Dr. W. Janssen
MSc Accountancy & Control, specialization Accountancy Faculty of Economics and Business, University of Amsterdam
2 Abstract
For a sample of IFRS firms in Europe this thesis examines the value relevance of deferred tax assets (liabilities). While much research has focused on the Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, (SFAS No. 109) (FASB 1992)1, this thesis will focus on International Accounting Standard No. 12, Income Taxes, (IAS No. 12). It is assumed that deferred taxes provide no incremental information about future tax payments. Specifically, this thesis examines whether deferred taxes are value relevant by measuring the extent to which deferred taxes lead into future tax payments. The research method is a cross-sectional regression test of future tax payments of IFRS companies in Europe. Deferred taxes are divided into deferred taxes associated with expenses (revenues) included in IFRS GAAP income prior and after taxable income. The results suggest that there is no asymmetrical association between deferred tax assets and liabilities and future tax payments, since I did not find evidence that deferred tax assets and liabilities lead into future tax payments. The discussion section of this thesis provides suggestions for future research.
1 Statement of Financial Accounting Standards No. 109 (SFAS No. 109) is now part of Accounting Standards Codification section 740 (ASC 740)
Table of contents 1 Introduction ... 5 1.1 Background ... 5 1.2 Research question ... 6 1.3 Contributions ... 7 2 Theory ... 8
2.1 IFRS Definitions and materiality guidance ... 8
2.1.1 Definitions of income taxes by IAS 12 ... 8
2.1.2 Materiality guidance in IAS 1 ... 9
2.2 Accounting for income taxes under IFRS and US GAAP ... 9
2.2.1 Accounting for income taxes under IFRS ... 10
2.2.2 Accounting for income taxes under US GAAP ... 10
2.2.3 Differences between IFRS and US GAAP ... 10
2.3 Literature review ... 11
2.3.1 Liability and equity view ... 11
2.3.2 Value relevance ... 11
2.3.3 Value relevance of deferred tax – effects on security prices ... 12
2.3.4 Value relevance of deferred tax – future tax payments ... 13
2.3.5 Value relevance of deferred tax – usefulness of different deferred tax categories . 14 2.4 Hypotheses ... 20
3 Method ... 21
3.1 Data and sample selection ... 21
3.2 OLS Regression model ... 27
4 Results... 29
4.1 Value of deferred taxes on the total balance sheet. ... 29
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4.3 The empirical results and the hypotheses ... 32
4.4 Additional regressions ... 33
5 Conclusion ... 38
5.1 Conclusion... 38
5.2 Limitations... 39
5.3 Suggestions for future research ... 39
5.4 Discussion ... 40
Literature ... 41
1 Introduction
1.1 Background
Even though IAS 12 Accounting for Taxes on Income is issued in 1979, it is still a little researched subject this is pointed out by Graham et al (2012) as: “accounting for income taxes and its implications for financial reporting and effective tax planning attracted limited attention in scholarly circles. The introduction of SFAS No. 1092 in 1992 generated more research in the late 90’s and early 00’s. Research has focused on earnings management regarding the valuation allowance in deferred tax (Bauman 2001, and Philips 2003). Research has also focused on the value relevance of deferred taxes in relation to the effects on security prices, and the relation to future tax payments. IAS 12 follows the so-called ‘comprehensive balance sheet method’ of accounting for income which recognizes both the current tax consequences of transactions and events and the future tax consequences of the future recovery or settlement of the carrying amount of an entity’s assets and liabilities. Due to the fair value approach of recognizing assets (liabilities) in the balance sheet, there is no real debate if temporary differences should be recognized in the balance sheet or not. In general, this is consistent with Hail (2013) who finds that the value relevance of the balance sheet appears to have increased recently, while the value relevance of the income statement has decreased over time. While there is no real debate about recognizing assets in the balance sheet, the question remains if deferred tax liabilities are value relevant or not. Different studies of White et al. (1994), Amir et al. (1997, 2001) and Chludek (2011) show that deferred tax liabilities have no value because they never reverse; the lack of reversal is due to the fact that deferred tax liabilities have little cash flow consequences when an entity keeps investing in new (depreciation related) assets. In the last few years the IASB provided an exposure draft raising questions regarding the value relevance of assets (liabilities). While IAS 12.53 states that deferred tax assets and liabilities cannot be discounted. IFRIC Update, June 2004 states that, the general view of the IFRIC was that current taxes payable should be discounted when the effects are material. Exposure Draft ED/2009/2 of March 2009 solicits that IAS 12 should use the two-step approach of deferred tax asset recognition instead of the current single step approach. The analytical research of Guenther and Sansing (2000, 2004) and Dotan (2003) suggests that different components of deferred taxes can be separated in two categories, depending on whether the revenue or expense that created the deferred taxes are
2 SFAS No.109 is the standard from the United States for “accounting for income taxes”. This standard has been replaced by ASC 740. A comparison with the IFRS standard IAS 12 is included in section 2.2.
6 included in GAAP income prior to or after taxable income. Laux (2013) suggested based on empirical evidence that “deferred taxes associated with temporary differences that are included in GAAP income prior to taxable income are associated with future tax payments. In contrast, deferred taxes associated with temporary differences that are included in GAAP income after taxable income are not associated with future tax payments”.
1.2 Research question
The empirical evidence from Laux (2013) shows that there is an association between deferred taxes and future tax payments. However, Laux (2013) states that the magnitude of the effect on future cash flows is small, especially since the model already include current taxes payable. Also in his research Laux (2013) segregates deferred tax in to those adjustments that are included in GAAP prior to taxable income such as warranty expense, restructuring charges and items that are included in GAAP after taxable income such as depreciation. The results indicate that deferred tax assets associated with expenses (revenues) included in GAAP income prior to taxable income increases future tax payment when they reverse. The results do not indicate that deferred tax assets associated with expenses (revenues) included in GAAP income after taxable income increases future tax payment when they reverse. These results can also be interpreted that adjustments included in GAAP prior to taxable income mainly have a short term character and adjustments included in GAAP after taxable income mainly have a long term character. To measure the value relevance of deferred taxes, this thesis first measures how substantial deferred taxes and liabilities are for the sample firms by measuring the percentage of deferred tax assets and liabilities in relation to the total assets of the sample firms. Since there is no uniform threshold for materiality described in IFRS the determination of what is material can be subjective. The threshold used in this thesis is therefore similar to the threshold used in the article of Poterba et al. (2011). The deferred tax assets (liabilities) in relation to total assets are categorized in the ranges (-) zero percent to (-) three percent, (-) three percent to (-) five percent, and larger (smaller) than (-) 5 percent. Secondly this thesis pursues on the research of Laux (2013) by measuring value relevance about whether deferred taxes provide incremental information about future tax payments. The question is whether results similar to Laux (2013) are found when data is used from companies in Europe who report under IFRS in the timeframe 2008-2012.
1.3 Contributions
Laux (2013) describes three reasons why the relation between deferred tax assets (liabilities) and future tax payments are interesting for research: First, the objective of financial reporting is to provide information that is relevant or capable of making a difference in the decisions made by users. Further, the FASB is obligated to consider whether the benefits of reporting particular information are likely to justify the costs incurred to provide and use that information (FASB 2010, SFAC 8). Thus, given the complexity of the accounting for deferred taxes and the perceived costs in supplying and using the information, it is important to examine whether deferred tax assets and liabilities actually provide incremental information about future tax payments. Second, it is important to examine whether deferred tax assets and liabilities are a substantial part of the balance sheet. The research of Poterba et al. (2011), which used a sample of 96 firms in the US in the period 1993-2004, demonstrated that 35 percent of their sample firms report a net deferred tax position in excess of 5 percent of total assets and almost 10 percent report a net deferred tax position exceeding 10 percent of total assets. In this thesis it is determined whether the results of Poterba et al (2011) are also applicable on IFRS companies in Europe. Third, recent theoretical research challenges conventional wisdom which suggests that the association between deferred taxes and future tax payments depends on whether and when the deferred tax assets and liabilities reverse.
This thesis contributes to accounting research in two ways: first, while most research has focused on SFAS No. 109 this thesis is focused on IAS No. 12. The results of this thesis are applicable on IFRS companies in Europe. To the best of my knowledge only one paper from Chudlek (2011) has used a dataset of companies in Germany under IFRS. Second, previous research has focused on the relation between earnings management and deferred tax assets while this thesis will focus on the relation between value relevance and deferred tax assets.
The remainder of this thesis is as follows: Section 2 of this thesis discusses the main findings of prior literature and describes the hypotheses. In section 3 describes the data and firm selection method and also gives the OLS regression model. Section 4 provides the results. In section 5 the conclusion of this thesis is given.
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2 Theory
The theory section of this thesis first describes the main definitions in section 2.1.1 regarding income taxes and then describes the definition of value relevance. The materiality guidance which is included in IAS 1 is described in section 2.1.2. After describing definitions and materiality guidance the differences of accounting for income taxes under IFRS and US GAAP are described in paragraph 2.2. The main findings of previous literature are described in section 2.3. Section 2.3 is divided into different subsections. In section 2.3.1 the different views on how to record deferred taxes are explained. In section 2.3.2 it is explained whether investors consider deferred taxes to be relevant. Section 2.3.3 explains the effect of deferred taxes on security prices. In Section 2.3.4 it is explained whether deferred taxes lead to future taxes paid. In Section 2.3.5 is it explained which categories of deferred taxes are considered to be value relevant based on whether they lead to reversal and future taxes paid. The hypotheses of this paper are described in section 2.4.
2.1 IFRS Definitions and materiality guidance
2.1.1 Definitions of income taxes by IAS 12
The following definitions of income taxes are described in IAS 12.5
Deferred tax assets: The amounts of income taxes recoverable in future periods in respect of:
1. deductible temporary differences
2. the carryforward of unused tax losses, and 3. the carryforward of unused tax credits
Deferred tax liabilities: The amounts of income taxes payable in future periods in respect of taxable temporary differences.
Tax base: The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes
Temporary differences: Differences between the carrying amount of an asset or liability in the statement of financial position and its tax bases
Taxable temporary differences: Temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled
Deductible temporary differences: Temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled
2.1.2 Materiality guidance in IAS 1
The definition of materiality is described in IAS 1.7: “Material Omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions that users make on the basis of the financial statements. Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factor. Assessing whether an omission or misstatement could influence economic decisions of users, and so be material, requires consideration of the characteristics of those users. The Framework for the Preparation and Presentation of Financial Statements states in paragraph 25 that ‘users are assumed to have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence.’ Therefore, the assessment needs to take into account how users with such attributes could reasonably be expected to be influenced in making economic decisions.” IFRS also describes how the concept of materiality should be used with respect of presentation and disclosure requirements. IAS 1.29 describes that: “An entity shall present separately each material class of similar items. An entity shall present separately items of a dissimilar nature or function unless they are immaterial.” In IAS 1.30 it states that: “Financial statements result from processing large numbers of transactions or other events that are aggregated into classes according to their nature or function. The final stage in the process of aggregation and classification is the presentation of condensed and classified data, which form line items in the financial statements. If a line item is not individually material, it is aggregated with other items either in those statements or in the notes. An item that is not sufficiently material to warrant separate presentation in those statements may warrant separate presentation in the notes.” In IAS 1.31 it is stated that: “An entity need not provide a specific disclosure required by an IFRS if the information is not material.”
2.2 Accounting for income taxes under IFRS and US GAAP
While most research focused on US GAAP, this thesis focuses on IFRS. A summary of the accounting principles for IFRS and US GAAP are described in paragraph 2.2.1 and 2.2.2. The differences between the standards are summarized in section 2.2.3. A full example how to account for deferred taxes is included in appendix 1.
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2.2.1 Accounting for income taxes under IFRS
Chludek (2011) describes the purpose of deferred tax accounting as ‘The purpose of deferred tax accounting is to account for future tax effects that will arise due to different recognition and measurement principles of accounting standards versus tax law’. IAS 12.5 distinguishes taxable temporary differences from deductible temporary differences. Taxable temporary differences relate to deferred tax liabilities and should all be recognized3 (IAS 12.15). Deductible temporary differences relate to deferred tax assets and are only recognized to the extent that it is probable that taxable profit will be available against (IAS 12.24) Besides taxable (deductible) temporary differences IAS 12.34 describes the measurement criteria for the carryforward of unused tax losses and unused tax credits: “A deferred tax asset shall be recognized for the carryforward of unused tax losses and unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilized.” In IFRS this tax asset is recognized based on the “single-step approach” which means that only deferred tax assets which are probable to recover are recognized in the balance sheet.
2.2.2 Accounting for income taxes under US GAAP
Accounting for income taxes under US GAAP is according to ASC 740-10-30-5 based on the “two-step approach” whereas in the first step all deductible temporary differences are recognized in the balance sheet. In the second step a valuation allowance is recognized for the portion which is probable not to be realized.
2.2.3 Differences between IFRS and US GAAP
While under US GAAP4 deferred taxes are classified into current and non-current components, under IFRS all deferred taxes are classified as non-current.
The tax basis in US GAAP is a question of fact under the tax law. In IFRS the tax basis is determined with the help of the amount deductible for tax purposes. The tax basis is influenced by the way in which the entity intends to settle of recover the carrying amount (by sale or through use).
Under US GAAP an entity records a full deferred tax asset and then reduces that recorded asset by a valuation allowance if realization of the asset is not “more likely than not.” The
3 Only for initial recognition of goodwill and for transaction in business combination there is specific guidance which amount should be recognized.
4 FASB Update “2015-17—Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes” will be effective as of 15 December 2016 which requires entities to present deferred taxes as non-current.
amount of benefit to be recognized is based on the largest amount of tax benefit that is greater than 50% likely to being realized upon ultimate settlement. Under IFRS an entity records a deferred tax asset if it is probable (i.e. greater than 50 percent likely) that the asset will be realized.
2.3 Literature review
2.3.1 Liability and equity view
There are two theories with respect of value relevance of deferred taxes: the liability view and the equity view. In the view of the proponents of the liability approach, deferred taxes account for future tax benefits (costs) and should therefore contribute to firm value (liabilities). Proponents of the equity view find the associated cash flows relating to deferred taxes highly uncertain and therefore argue that the present value of deferred taxes are close to zero and should be of no value relevance. Particularly, if large parts of temporary differences reverse due to ceasing recurring operating activities, the firm will most likely be in severe financial difficulties, with the consequence that accruing tax benefits (tax liabilities) cannot be used (paid) because of lacking taxable income (cash inflow), such that deferred tax cash flow will not be realized even in case of reversing temporary differences. For the reasons, proponents of the equity view argue that deferred taxes account principally for distant and, in several dimensions, uncertain cash flows, being of no or only little relevance for the amount of tax payments in the next years, the associated cash flows having a present value that is close to zero. Therefore, deferral taxes are effectively part of equity according to this view. Both IFRS and US GAAP follow the liability view of recognizing deferred tax assets (liabilities).
The majority of these studies, while concluding that deferred tax is incrementally useful, do not resolve the issue of the cost of calculating deferred tax under either the balance sheet approach or income statement approach in comparison to the additional information deferred tax provides.
2.3.2 Value relevance
The discussion about the value relevance of accounting started with the academic paper of Ball & Brown (1968). The income number of financial statements should provide useful information for investors’ decision making process. In their research, Ball & Brown (1968) examined whether the accounting outcome is used by investors and so reflected in the stock prices of securities.
12 This empirical research shows that accounting information is value relevant to investors in terms of that they use this unexpected firm specific information in adjusting their valuation of the stock prices. In IFRS investors are determined to be one of the main financial statements users. The main objective of IFRS is to increase accounting quality so examining whether financial statements are value relevant is one of the key objectives. The definition of value relevance in an accounting setting is closely related to the valuation of equity (liability) in relation with the firm value of equity (liability). Barth et al (2001) describe value relevance as “an accounting amount is defined as value relevant if it has a predicted association with equity market values”. Hung (2000) describes value relevance as “value relevance is the ability of an accounting measure to capture or summarize information that affects firm value”.
2.3.3 Value relevance of deferred tax – effects on security prices
There has been much empirical research on the effect of deferred tax on security prices. If deferred tax does have an effect on future cash flows as suggested in previous research then the discounted value of that effect should be reflected in the share price.
For a sample from 1969 to 1985, where APB Opinion No 11 is applied, Chaney and Jeter (1994) investigate whether there is an association between security returns and the deferred tax component of earnings. A number of theories are developed and the results show there is a negative association between deferred tax and security returns.
Lev and Nissam (2004) develop a tax fundamental formula which includes temporary differences, permanent differences and tax accruals to explain an extended earnings/price ratio of a firm. The new earnings/price ratio includes tax and deferred tax. The findings indicate that pre-SFAS No 109 the tax fundamental including deferred tax is negatively related to earnings/price ratio. This suggests that the tax fundamental is not reflected in the stock prices. However post-SFAS No 109 there is a weak relationship to stock returns. The explanation for this is that investors had learnt how to include tax information into pricing of stock returns. However this type of analysis is based on the assumption that the market is efficient in adjusting stock prices for information.
Diehl (2010) took this research one step further and investigated which components of deferred tax are associated to security prices. The components of deferred tax assets include depreciation (where more depreciation is claimed for accounting purposes than tax purposes), employee benefits, unearned income, and losses. The components of deferred tax liabilities
include depreciation, prepaid expenses and deferred revenues. It suggests that financial statements users often view deferred tax assets as beneficial to future earnings (as they reduce the future tax payments) and deferred tax liabilities as detrimental. However this is not always the case as deferred tax liabilities are important to the market as they indicate the extent to which each entity is minimizing income taxes. Diehl (2010) also suggests that deferred tax liabilities in aggregate tend to be larger for successful companies than deferred tax assets. A sample is taken from the end of 2008 to the end of 2009 from the Fortune 500 and the disaggregated deferred tax components are correlated with the share prices. The results indicate that increases in unearned revenue reduce stock process and increases in deferred revenue increase stock prices.
2.3.4 Value relevance of deferred tax – future tax payments
Cheung et al. (1997) investigates the link between deferred tax and future tax payments. Future tax payments can of course be converted to future taxable earnings using the average effective tax rate. This research uses a pooled time series cross sectional regression to predict one step ahead tax payments for 1979 to 1994 which covered three different accounting standards. There are three scenarios (1) tax paid in the current year regressed against tax paid in the previous year, (2) tax paid in the current year regressed against tax paid and deferred tax in the previous year and (3) tax paid in the current year regressed against tax paid in the previous year and deferred tax two years prior. The conclusion is that deferred tax aids in predicting future tax payments. However, the limitations to this study include the deferred tax variable two years prior excluded current changes in deferred tax liabilities and deferred tax assets (as they were not identifiable on Compustat) and it spanned three accounting standard time periods.
Legoria and Sellers (2005) test whether SFAS 109 provides an incremental ability to predict future cash flows over APB No 11(“income statement approach”). A sample is taken from 1994 to 1998 and a cross sectional regression model used to estimate future operating cash flows. The results indicate that SFAS 109 is incrementally better at predicting cash flows, and where deferred tax assets, liabilities and valuation allowance are disaggregated it is even more useful.
Chludek (2011) investigates the significance of deferred tax in a regression model used to predict taxes paid. The sample period is 1975 to 1994, covering three different accounting standards affecting deferred tax. The research establishes that while deferred tax information is relevant for explaining two years ahead tax paid, its contribution to the prediction model is insignificant. It also establishes that in certain industries deferred tax is more useful. While the
14 study of Chludek (2011) shows that a large part of deferred taxes tend to reverse, there was no evidence found that deferred taxes have some information content for stock prices
2.3.5 Value relevance of deferred tax – usefulness of different deferred tax categories
Prior research and financial statement analysis texts suggest the association between deferred taxes and future tax payments depends on whether and when the deferred tax assets and liabilities reverse. The next paragraph summarizes findings from prior literature whether there is a distinction between different categories of deferred taxes.
The research of White et al. (1994) indicates that ‘‘the components of the deferred tax liability should be analyzed to evaluate the likelihood of reversal or continued growth. Only those components that are likely to reverse should be considered a liability.’’
Amir et al. (1997, 2001) examine both empirically and analytically whether investors value deferred taxes based on the expected time until reversal. Amir et al. (1997) hand-collect deferred tax asset and liability data from the tax footnote included in the 10 K5 filings for a sample of Fortune 500 firms for the years 1992–1994. They separate the deferred tax components based on their assessment of the timing and likelihood of reversal. Amir et al. (1997) find that the valuation coefficient on the deferred tax liability associated with depreciation is close to zero. They interpret the finding as providing evidence that investors discount the deferred tax liability based on the expected growth rate in fixed assets. In addition, Amir et al. (1997) find that that the valuation coefficient on the deferred tax asset associated with restructuring charges is greater than that of environmental liabilities and employee benefits because investors expect that it will reverse sooner.
Amir et al. (2001) use an analytical model of firm valuation based on Feltham & Ohlson (1996) to examine the value relevance of the deferred tax liability associated with depreciation. They interpret their findings as providing evidence that the deferred tax liability adds value because it represents the deferral of tax payments. Thus, they contend that the deferred tax liability should be discounted based on the time until it reverses. However, in contrast with prior empirical research, they demonstrate that new originating temporary differences do not offset the tax related cash flows of reversing temporary differences.
5 Pre-described format of the annual report for public companies in the U.S. required from the U.S. Securities and Exchange Commission.
Guenther and Sansing (2000, 2004) and Dotan (2003) split deferred taxes into two categories. The first category includes deferred tax assets and liabilities associated with revenues or expenses that are included in GAAP income prior to taxable income. For this category, the authors predict that the timing of the reversal affects the timing of future tax payments. For instance, Guenther and Sansing (2004, 442) state, ‘‘Deferred tax assets associated with restructuring charges or employee post-retirement benefits will reverse in the year the firm makes cash payments, and the cash payments will result in income tax deductions. For these types of deferred tax assets the timing of the reversal does change the timing of when taxes are paid.’’ The second category includes deferred tax assets and liabilities associated with revenues or expenses that are included in GAAP income after taxable income. For this group, the authors predict that the timing of the reversal does not affect the timing of future tax payments. For instance, Guenther and Sansing (2000, 2004) and Dotan (2003) provide evidence that the deferred tax liability related to depreciation is not associated with future tax payments.
Guenther and Sansing (2000) reports two new results that have important implications for how deferred taxes and their reversals affect firm value. First, they found that although the market value of a deferred tax liability relating to depreciation is less than its book value, the same is not true of deferred tax assets associated with expenses that are accrued for book purposes but not for tax purposes. The book and market values of deferred tax assets are equal in as long as the book value of the related liability is equal to the present value of the future cash flows needed to pay that liability. Therefore, deferred tax assets associated with liabilities that are recorded at their present value of the associated future cash flows (e.g., post-retirement health care benefits) have a market value equal to their book value. In contrast, deferred tax assets associated with liabilities that exceed the present value of future cash flows required to pay them (e.g., warranty liabilities) are worth less than their book value, because the related liability itself is also worth less than its book value. Second, Guenther and Sansing (2000) demonstrate that the timing of the expected reversal of deferred tax assets and liabilities should have no effect on firm value. Deferred tax liabilities that are expected to reverse later are not worth less than deferred tax liabilities that are expected to reverse sooner; deferred tax assets that are expected to be realized quickly are not worth more than deferred tax assets that are expected to be realized slowly; and firms that avoid a reversal of deferred tax liabilities arising from differences between book and tax depreciation by reinvesting in new assets do not increase the value of the firm. The reason for this is that in order to delay the reversal of the deferred tax liability arising from depreciation differences, a firm must purchase new assets, which generates new accelerated tax depreciation.
16 Guenther (2004) finds that the deferred tax liability reverses more quickly when either the tax depreciation rate or the book depreciation rate increases. However, while increasing the tax depreciation rate increases the value of the deferred tax liability itself, increasing the book depreciation rate has the opposite effect. In addition, an increase in the discount rate decreases the value of the deferred tax liability, but has no effect on the reversal rate. Guenther (2004) concludes that an increase in the rate of reversal is neither necessary nor sufficient for the value of the deferred tax liability to increase. He also finds that the value of the deferred tax liability is not equal to the present value of future changes in the deferred tax liability because the value of the deferred tax liability only depends on cash flows associated with tax depreciation, whereas the changes in the deferred tax liability depend on both tax and book depreciation.
In Dotan (2003) a distinction is made between different temporary tax liabilities. Temporary differences that lead to the recognition of deferred tax liabilities can be classified into two categories, which are labelled by Dotan (2003) in type-I and type-II. Type-I items arise from transactions in which the tax payment or deduction follow their recognition for financial reporting. An example is instalment sales, where sales revenues are recognized at the time of sale and taxed only when collected. The type-II category consists of cases in which the tax payment or deduction precede their recognition for financial reporting. The most notable example of the type-II category is accelerated depreciation, where an asset is depreciated for tax purposes (tax depreciation) at a higher rate than for financial reporting purposes (book depreciation). An alternative characterization of type-I and type-II items is as follows. In type-I items, reversal of the deferred tax liability is triggered by the tax event (i.e. tax cash flows) while in type-II items, it is the accounting recognition of the tax expense or benefit that triggers reversal.
Dotan (2003) found that while type-I deferred taxes have value, type-II do not. He demonstrates that the depreciation-related deferred tax liability, normally the largest contributor to the balance of the deferred tax liability, has no value whatsoever. While conventional wisdom agrees with this result, it is based on the argument that the depreciation-related deferred tax liability has no value because it never reverses; he shows that its lack of value is due to the fact that it has no cash flow consequences. Dotan (2013) finally argues that for both types of deferred taxes, reversals are never value relevant. For type-I deferred taxes, it is the timing of tax cash flows (which always coincide with the timing of reversals) that is relevant, while for type-II deferred taxes, they have no value regardless of their reversals. The results, that depreciation-related deferred tax liability and similar items have no value, does not necessarily imply that the accounting practice of matching taxes to earnings has no value. By matching taxes to earnings, the financial statements communicate to users the effective tax rate of the firm. The deferred tax
liability, which is the balance sheet manifestation of such a matching process, is not a real liability because it does not reflect any future tax payments. It would be more accurate to label the depreciation-related deferred tax liability "unearned tax benefits". The result, however, may cast doubt on the economic reason for the FASB and the IASB adopting the "Liability Approach" rather than the "Deferral Approach"6 in regard to items such as depreciation-related deferred tax liability. The justification for recognition of the “Liability Approach” is, however, that it is the matching of income and (tax) expenses. Type I categories are classified by Laux (2013) as
GAAP_FIRST. Type II categories are classified by Laux (2013) as TAX_FIRST. The findings
from Laux (2013) are described in the next paragraph.
In order to assess the theoretical predictions by Guenther and Sansing (2000, 2004) and Dotan (2003), Laux (2013) performed an empirical assessment by examining whether deferred tax assets and liabilities provide incremental information about future tax payments. The first empirical analysis examines whether deferred tax assets and liabilities provide information about future tax payments that is incremental to the information provided by current taxes payable (i.e., the information about the tax status of the firm that would be available in the financial statements if the accrual for deferred taxes was not provided). Furthermore, it is examined whether investors understand this association. Using an empirical variation of the Feltham and Ohlson (1995) valuation model, Laux estimated cross-sectional regressions of the market value of equity on the deferred tax components controlling for abnormal operating earnings, net operating assets, and net financial assets. A summary table of the articles included in the literature review is stated in table 1.
6 Similar to the “Equity Approach”
Table 1. Summary table of articles included in the literature review*
Author (s) Year Value relevance research type Major findings
Ball, R., & Brown, P. 1968 Value relevance - general - Accounting information is value relevant to investors in terms of that they use this unexpected firm specific information in adjusting their valuation of the stock prices. Chaney, P. K., &
Jeter, D. C. 1994 Effects of deferred taxes on effects on security prices - There is a negative association between deferred tax and security returns Lev, B., & Nissim, D. 2004 Effects of deferred taxes on
effects on security prices - Under SFAS No 109 there is a weak relationship between deferred taxes and stock returns. Diehl, K. A. 2010 Effects of deferred taxes on
effects on security prices - Financial statements users often view deferred tax assets as beneficial to future earnings (as they reduce the future tax payments) and deferred tax liabilities as detrimental.
- Deferred tax liabilities in aggregate tend to be larger for successful companies than deferred tax assets.
Cheung, J. K., Krishnan, G. V., & Chung-Ki, M.
1997 Effects of deferred taxes on
future tax payments - Deferred tax information aids in predicting future tax payments Legoria, J., & Sellers,
K. F. 2005 Effects of deferred taxes on future tax payments - SFAS 109 is incrementally better compared to ABP No 11 ("income statement approach") at predicting cash flows, and where deferred tax assets, liabilities and valuation allowance are disaggregated it is even more useful.
Chludek, A. K. 2011 Effects of deferred taxes on
future tax payments - A large part of Deferred taxes tend to reverse while there was no evidence found that Deferred taxes have some information content for stock prices White, G. I., Sondhi,
A. C., & Fried, D. 1994 Usefulness of different deferred tax categories - The components of the deferred tax liability should be analyzed to evaluate the likelihood of reversal or continued growth. Only those components that are likely to reverse should be considered a liability.
Amir, E.,
Kirschenheiter, M., & Willard, K.
1997 Usefullness of different deferred
tax categories - The valuation coefficient on the deferred tax liability associated with depreciation is close to zero- The valuation coefficient on the deferred tax asset associated with restructuring charges is greater than that of environmental liabilities and employee benefits because investors expect that it will reverse sooner
Table 1. Summary table of articles included in the literature review* (continued) Author (s) Year Value relevance research type Major findings
Amir, E.,
Kirschenheiter, M., & Willard, K.
2001 Usefulness of different deferred
tax categories - The deferred tax liability adds value because it represents the deferral of tax payments Guenther, D. A., &
Sansing, R. C. 2000 Usefulness of different deferred tax categories - Deferred tax assets associated with liabilities that are recorded at their present value of the associated future cash flows have a market value equal to their book value. In contrast, deferred tax assets associated with liabilities that exceed the present value of future cash flows required to pay them are worth less than their book value, because the related liability itself is also worth less than its book value.
- The timing of the expected reversal of deferred tax assets and liabilities should have no effect on firm value.
Guenther, D. A., &
Sansing, R. C. 2004 Usefulness of different deferred tax categories - The deferred tax liability reverses more quickly when either the tax depreciation rate or the book depreciation rate increases. However, while increasing the tax depreciation rate increases the value of the Deferred tax liability itself, increasing the book
depreciation rate has the opposite effect.
- The value of the deferred tax liability is not equal to the present value of future changes in the deferred tax liability because the value of the deferred tax liability only depends on cash flows associated with tax depreciation, whereas the changes in the deferred tax liability depend on both tax and book depreciation.
Dotan, A. 2003 Usefulness of different deferred
tax categories The depreciation-related deferred tax liability has no value relevance because it never reverses. The lack of value is due to the fact that it has nog cash flow consequences. Laux, R. C. 2013 Usefulness of different deferred
tax categories - Deferred taxes associated with temporary differences that are included in GAAP income prior to taxable income are associated with future tax payments- Deferred taxes associated with temporary differences that are included in GAAP income after taxable income are not associated with future tax payments
2.4 Hypotheses
In order to test the results of Laux I use data from European countries instead of countries from the United States which report under IFRS instead of US GAAP. Also, I use a different time period, namely 2008-2012 instead of 1994-2007. The two basic assumptions are similar to the article of Laux (2013): “To measure the degree in which deferred taxes map into future cash flows there are two basic assumptions. “Deferred tax associated with expenses included in GAAP income prior to taxable income is usually recognized to the period in which they relate to, while deferred tax liabilities (assets) associated with expenses (revenues) included in GAAP income after taxable income are usually recognized on a cash basis and therefore will be recognized when the expense is actually settled.” This difference in the two assumptions leads to two different hypotheses:
H1: Deferred tax assets (liabilities) are a substantial part of the balance sheet of companies in the European Union who report under IFRS in the timeframe 2008-2012.
H2a: Deferred tax assets (liabilities) associated with expenses (revenues) included in IFRS GAAP income prior to taxable income provide incremental information about future tax payments.
H2b: Deferred tax liabilities (assets) associated with expenses (revenues) included in IFRS GAAP income after taxable income do not provide incremental information about future tax payments.
3 Method
The methodology section first describes the data and sample (firm) selection in section 3.1. The OLS regression model is presented in section 3.2.
3.1 Data and sample selection
Data is obtained from Compustat Fundamentals Annual, while deferred tax data, which are not available in the databases, are hand-collected from the notes to consolidated financial statements. Hand collected data are matched with the Compustat data by using firm name and year. The match is validated by total deferred tax assets (Compustat item: TXDB). The observation period covers fiscal years 2008 to 2012. Firms with a balance sheet date up to 31 March are included in the previous year (e.g. a firm with a balance sheet date if 31 March 2011 is included in reporting (fiscal) year 2010). Given that deferred tax data have to be hand-collected, the sample has to be restricted to a manageable size. Therefore, the sample consists of the largest 187 firms that compose the EuroSTOXX 600. The list which I copied comprised the EuroSTOXX 600 index as of 28 February 2014, from the total list of 603 firms; I first excluded firms from specific industries such as banks, financial services, real estate and insurance firms. In the research of Laux (2013), these industries are excluded in order to make the research comparable to other articles in which these industries are excluded as well. Poterba (2011) investigated how financial firms differ from other firms in regard to deferred tax positions he stated: “Financial firms have relatively smaller deferred tax positions than non-financial firms, largely because their base of financial assets is so large. In every sample year, more than three-quarters of the financial firms in our sample have a net deferred tax position, either positive or negative, that represents less than 3 percent of total assets. About half of non-financial firms, in contrast, have deferred tax positions in this range. The extreme values of the ratio of deferred tax positions to firm assets are also smaller for financial than for non-financial firms”. From the remaining population of 462 firms I selected the 200 largest firms based on total assets. During the collection of data I also excluded firms who report in USGAAP (Compustat item: US), all firms which are included in the sample are “Domestic standards generally in accordance with or fully compliant with International Financial Reporting Standards (IFRS).” (Compustat item: DI). And I eliminated firms which did not provide deferred tax disclosures. I also eliminated 2 firms which were included in the index twice because they have two different countries of incorporation. After the eliminations I had a sample size of 187 firms. An overview of the firm selection is included in panel A of table 2. A full overview of the selected firms is included in appendix 3. Panel B of table 2 describes the countries of incorporation of the sample. The most significant countries of
22 incorporation are the United Kingdom with 50 firms, France with 30 firms, Germany with 24 firms, Switzerland with 16 firms, and Sweden with 13 firms. The total amount of countries included in the sample is 16. Even though all the firms used domestic accounting standards generally in accordance with or fully compliant with International Financial Reporting Standards (IFRS), the tax regimes of the selected countries differ from each other. The EuroSTOXX 600 index comprises different industries.
Table 2: Firm selection
Panel A: Firm selection Number of firms
Firms in EuroSTOXX 600 index 603
Industry: Banks -47
Industry: Financial services -32
Industry: Real estate -25
Industry: Insurance -37
Firms excluded from initial selection -262
Firms with US GAAP -7
Firms with insufficient data -4
Firms double counted in index -2 *
Total firms: 187
Panel B: Firms by country of incorporation Number of firms %
United Kingdom 50 26.8% France 30 16.0% Germany 24 12.8% Switzerland 16 8.6% Sweden 13 7.0% The Netherlands 11 5.9% Spain 10 5.3% Italy 7 3.7% Denmark 6 3.2% Finland 5 2.7% Luxembourg 3 1.6% Jersey 3 1.6% Belgium 3 1.6% Ireland 3 1.6% Norway 2 1.1% Portugal 1 0.5% Total firms: 187 100.0%
* Relates to two firms which were included in the sample twice because they had two countries of incorporation. The firms excluded were Unilever Plc and Reed Elsevier N.V. The firms which remain are Unilever DRC N.V. and Reed Elsevier Plc.
Number Total
Panel C: Firms by industry of firms % index %
Automotives 10 5.35% 14 2.32%
Banks 0 0.00% 47 7.79%
Basic Resources (energy) 8 4.28% 22 3.65%
Chemicals 10 5.35% 24 3.98%
Construction & Materials 11 5.88% 20 3.32%
Retail 11 5.88% 29 4.81%
Financial services 0 0.00% 32 5.31%
Healthcare 14 7.49% 33 5.47%
Industrial Goods & Services 31 16.57% 102 16.90%
Food & Drinks 11 5.88% 27 4.48%
Media 10 5.35% 28 4.64%
Utilities 16 8.56% 26 4.31%
Oil & Gas 9 4.81% 32 5.31%
Personal & Household Goods 14 7.49% 30 4.98%
Travel & Recreation 6 3.21% 20 3.32%
Technology 10 5.35% 21 3.48% Telecommunications 11 5.88% 25 4.15% Unknown 5 2.67% 9 1.49% Real estate 0 0.00% 25 4.15% Insurance 0 0.00% 37 6.14% Total firms: 187 100% 603 100%
Panel D: Sample by Firm-years Observations
2008 firm-years 183
2009 firm-years 186
2010 firm-years 186
2011 firm-years 187
2012 firm-years 187
Total firm years 929
An overview of industry composition of the sample and of the total index is included in panel C of table 2. Four industries are not included in the sample because they have been eliminated as stated in panel C of table 2. Therefore the remaining industries have a higher composition in relation to the total index. The largest industries in the sample are industrial goods & services with 31 firms, utilities with 16 firms, healthcare with 14 firms, and personal & household goods with 14 firms. The observation period for this sample is 2008 – 2012. The total amount of observations is stated in panel D of table 2. For four firms there was insufficient data in the year 2008, for one firm there was insufficient data in the year 2009 and 2010. These firm years have been excluded from this sample which brings the amount of firm-years down to 929.
24 For the 929 firms I collected imported the ISIN codes into the Compustat Global - Fundamentals Annual database. I selected the identifying information Company Name, the International Security ID, and the Data Year – Fiscal (Compustat item: FYEAR). I also selected the data items Income Taxes Paid (Compustat item: TXPD), Deferred Taxes Balance Sheet (Compustat item: TXDB), and Assets – Total (Compustat item: AT). From the deferred tax disclosure note in the consolidated financial statements of the selected firms I hand collected the deferred tax categories, if there was a valuation allowance presented, I netted this amount with the corresponding tax credit. I also collected the total amount of deferred tax assets and the total amount of deferred tax liabilities. IAS 12.74 allows offsetting of deferred tax amounts if the entity has the right to settle current tax amounts on a net basis by the same taxing authority. If a firm chose to present on a net basis, I included the gross basis from the deferred tax disclosure note. To determine the net deferred tax asset (liability) I netted the total amount of deferred tax asset with the deferred tax liability. After collecting the data I categorized the deferred tax categories into three main categories: GAAP_FIRST, TAX_FIRST, and OTHER. The main components of GAAP_FIRST deferred tax assets (liabilities) consist of employee benefits and accrued expenses. The main components of TAX FIRST deferred tax assets consist of property, plant and equipment and goodwill and intangible assets. All other components of deferred tax assets (liabilities) are classified into OTHER. Refer to appendix 2 for a comprehensive list of all identified deferred tax assets (liabilities) and their categorization to GAAP_FIRST, TAX_FIRST, and OTHER. I scaled the deferred taxes by dividing them with total assets (Compustat item: AT). The main components of GAAP_FIRST and TAX FIRST deferred tax can be summarized as follows:
Table 3: Mean deferred tax balances scaled by total assets*
TAX_FIRST GAAP_FIRST Year Obs. Income Taxes Paid Property, plant and equipment Goodwill and intangible assets Pensions, Employee
benefits Accrued expenses
2008 183 0.022 -0.010 -0.012 0.005 0.002
2009 186 0.018 -0.009 -0.011 0.006 0.002
2010 186 0.022 -0.010 -0.013 0.006 0.002
2011 187 0.025 -0.010 -0.014 0.007 0.002
2012 187 0.027 -0.010 -0.014 0.008 0.002
After categorizing and scaling the regression variables, the distribution of the regression variables is stated in table 4. The average (median) GAAP_FIRST deferred tax asset scaled by TOTAL
ASSETS is 0.8 percent (median 0.5 percent). The average (median) TAX FIRST deferred tax
liability scaled by TOTAL ASSETS is 2.4 percent (median 1.3 percent). The remaining regression variables are classified into OTHER the average (median) deferred tax asset (liability) scaled by TOTAL ASSETS is -0.4 percent (median 0.4 percent). The distribution of the regression variables can be summarized as follows:
Table 4: Descriptive statistics of 929 firm-year observations from 187 listed firms from the EuroSTOXX 600 index (all scaled by total assets except for item: TOTAL ASSETS)*
Variable Obs. Mean Std. Dev. 25% Median 75% TAXPD 929 0.023 0.022 0.010 0.017 0.029 GAAP_FIRST 929 0.008 0.012 - 0.005 0.012 TAX_FIRST 929 -0.024 0.031 -0.038 -0.013 - OTHER 929 -0.004 0.033 -0.013 0.004 0.014 TAXCF 929 0.006 0.013 - 0.003 0.009 DTA 929 0.023 0.019 0.008 0.019 0.033 DTL 929 -0.037 0.031 -0.050 -0.028 -0.014 NET DTA (DTL) 929 -0.013 0.038 -0.033 -0.008 0.009 TOTAL ASSETS 929 52,384 81,197 7,674 22,957 61,392
* The negative sign indicates a deferred tax liability, a positive amount indicates a deferred tax asset. * The variables can be described as follows:
TAXPD: Cash taxes paid / Total assets
GAAP_FIRST: Deferred tax assets (liabilities) related to expenses (revenues) recognized in GAAP income prior to taxable income / Total assets.
TAX_FIRST: Deferred tax liabilities (assets) related to expenses (revenues) recognized in GAAP income after taxable income / Total assets.
OTHER: Other deferred tax assets and liabilities / Total assets. TAXCF: Tax carryforwards / Total assets
DTA: Deferred tax assets / Total assets DTL: Deferred tax liabilities / Total assets
NET DTA (DTL): Net deferred assets (liabilities) / Total assets TOTAL ASSETS: Total assets
25% First quartile 75% Fourth quartile
26 For the GAAP_FIRST deferred taxes the mean is larger than the median, this suggests that the distribution has a positive skew. For the TAX_FIRST deferred taxes the mean is smaller than the median, this suggests that the distribution has a negative skew. For the OTHER deferred taxes the mean is smaller than the median, this suggests that the distribution has a negative skew.
Table 5: Pearson variables’ correlation matrix:
Variable TXPD GAAP_ FIRST FIRST OTHER TAXCF TAX_
TXPD Correlation* 1 GAAP_FIRST Correlation* .011 1 TAX_FIRST Correlation* -.166** -.012 1 OTHER Correlation* .108** .010 -.343** 1 TAXCF Correlation* -.084* -.138** -.072* -.113** 1
*, ** Indicates significance at the 5% and 1% level, respectively, for a two-tailed test.
Pairwise correlation coefficients of the main regression variables are presented in table 5. The Pearson correlations which are accurate in measuring the linear relationship of two normally distributed data sets are presented in table 5. The Spearman correlations which is better for a data set which is not normally distributed is presented in appendix 4. The relatively high negative correlation between TAX_FIRST and OTHER (Pearson = -.343; Spearman = -.465) indicates that TAX_FIRST and OTHER deferred taxes are negatively associated. The relative high negative correlations can cause multicollinearity problem in the estimation procedures, the relative high negative correlation can suggest that TAX_FIRST mainly relates to long-term deferred taxes and OTHER to short-term deferred taxes, this assumption is tested in the additional regression in section 4.4, I therefore did not exclude any of the variables from the model. TAX_FIRST is also negatively associated with TAXPD and TAXCF. GAAP_FIRST deferred taxes are only associated at a 5% significance level with TAX_FIRST deferred taxes in the Spearman correlation (Pearson = -.012; Spearman = -.074). The OLS regression model is explained in the next paragraph (3.2).
3.2 OLS Regression model
The empirical analysis examines whether deferred tax assets and liabilities provide information about future tax payments that is incremental to the information provided by current taxes payable (i.e., the information about the tax status of the firm that would be available in the financial statements if the accrual for deferred taxes was not provided). Cross-sectional regressions of future tax payments (ranging from one to five fiscal years ahead) on proxies for current taxes payable and the deferred tax variables are performed to examine whether deferred tax assets and liabilities provide incremental information about future tax payments. I use the following equation which is used by Laux (2013):
𝑇𝐴𝑋𝑃𝐷𝑡+𝑛= 𝛽0+ 𝛽1𝑇𝐴𝑋𝑃𝐷𝑡+ 𝛽2𝐺𝐴𝐴𝑃_𝐹𝐼𝑅𝑆𝑇𝑡+ 𝛽3𝑇𝐴𝑋_𝐹𝐼𝑅𝑆𝑇𝑡+ 𝛽4𝑂𝑇𝐻𝐸𝑅𝑡 + 𝛽5𝑇𝐴𝑋𝐶𝐹𝑡+ 𝜇𝑡+𝑛
where t denotes fiscal year and n ranges from 1 to 5. The empirical analysis covers a five-year period because the expectation is that deferred tax components are long-term in nature (IAS 1.56 requires to classify deferred taxes as non-current) and likely take several years before their tax effect is realized. The following table is a summary of the firm-years which relate to the TAX
PD:
Table 6: Summary of relation between firm-years and TAX PD
The dependent variable 𝑇𝐴𝑋𝑃𝐷𝑡+𝑛 equals cash taxes paid (Compustat item: TXPD) scaled by total assets. t+1 t+2 t+3 t+4 t+5 TAXPD t+n 2009 2008 2010 2009 2008 2011 2010 2009 2008 2012 2011 2010 2009 2008 2013 2012 2011 2010 2009 2008
28 As can be seen in the model aforementioned, the explanatory variables include TAXPD,
GAAP_FIRST, TAX FIRST, OTHER, and TAXCF. The explanatory variables GAAP_FIRST
and TAX FIRST are explained in table 2. The explanatory variable OTHER contains all balance sheet items which fit not into the explanatory variables GAAP_FIRST and TAX FIRST. The explanatory item TAXCF represents tax carryforwards and tax credits. Since it is not mandatory to disclose the valuation allowance in the financial statements this item is netted with TAXCF to maintain comparability with financial statements which do not disclose this item. A more detailed explanation about the explanatory variables is included in section 3.1. To examine whether the explanatory variables are reversing the explanatory variables are included in the columns t (t = 2008, 2009 … 2012) of table 6. The dependent variable is included in the first column (t = 2009, 2010… 2013). I expect that an increase (decrease) in the explanatory variable will lead to a decrease (increase) in the subsequent 5 years of TAXPD t+n. Deferred tax assets are included as positive numbers, deferred tax liabilities are included as negative numbers, taxes paid are included as a negative number. The error term is µ.
4 Results
The results section first reports in section 4.1 the magnitude of the deferred tax assets and liabilities in relation to the total assets in the balance sheet as stated in hypothesis one. In section 4.2 the OLS regression table is presented to indicate the results of hypotheses two and three. Furthermore, in section 4.3 two additional OLS regression tables are presented in order to further investigate the results of the OLS regression table in section 4.2.
4.1 Value of deferred taxes on the total balance sheet. Table 7a and 7b are presented below:
Table 7a: Distribution of net deferred tax position as percentage of firm assets, 2008-2012
Firms with Firms with
Sample Net DTL/Assets in range (%) Net DTA/Assets in range (%) Year Size ≤ -5% -5 to -3% -3 to -0% 0 to 3% 3 to 5% ≥ 5% 2008 183 14.2% 13.1% 39.9% 26.2% 5.5% 1.1% 2009 186 16.7% 8.6% 37.5% 29.6% 5.4% 2.2% 2010 186 17.7% 10.2% 35.5% 25.3% 9.1% 2.2% 2011 187 17.6% 9.1% 33.2% 30.5% 5.9% 3.7% 2012 187 18.7% 9.1% 27.2% 30.5% 8.6% 5.9% Average 17.0% 10.0% 34.6% 28.5% 6.9% 3.0%
Table 7b: Distribution of gross deferred tax position as percentage of firm assets, 2008-2012
Firms with Firms with
Sample Gross DTL/Assets in range (%) Gross DTA/Assets in range (%) Year Size ≤ -5% -5 to -3% -3 to -0% 0 to 3% 3 to 5% ≥ 5% 2008 183 20.2% 25.1% 54.7% 76.5% 17.5% 6.0% 2009 186 25.3% 22.6% 52.1% 69.9% 24.7% 5.4% 2010 186 24.7% 24.2% 51.1% 69.3% 23.7% 7.0% 2011 187 27.3% 18.7% 54.0% 67.9% 21.4% 10.7% 2012 187 26.7% 22.5% 50.8% 63.1% 20.9% 16.0% Average 24.8% 22.6% 52.5% 69.3% 21.6% 9.0%
Net DTL/Assets = Net deferred tax liabilities/Total assets Net DTA/Assets = Net deferred tax assets / Total assets Gross DTL/Assets = Gross deferred tax liabilities / Total assets Gross DTA/Assets = Gross deferred tax assets / Total assets
30 To measure the deferred tax assets and liabilities as percentage of the total assets in the balance sheet, I categorized the sampled firms in the ranges (-) zero percent to (-) three percent, (-) three percent to (-) five percent, and larger (smaller) than (-) 5 percent. Table 7a presents the distribution of the net deferred tax position as a percentage of firm assets over the period 2008-2012. An average amount of 61.6% of the sampled firms over the period 2008-2012 have a net deferred tax liability. An average amount of 38.4% of the sampled firms over the period 2008-2012 have a net deferred tax asset. An average amount of 63.1% of the sampled firms over the period 2008-2012 have a net deferred tax position between (-) zero percent to (-) three percent though IFRS does not give a specific threshold when a balance sheet item is material, the added value for the financial statement user can be determined as insignificant. An average amount of 16.9% of the sampled firms over the period 2008-2012 have a net deferred tax position between (-) three percent to (-) five percent, the added value for the financial statement user can be determined as insignificant. An average amount of 20.0% of the sampled firms over the period 2008-2012 have a net deferred tax position larger (smaller) than (-) 5 percent, the added value for the financial statement user can be determined as significant. However since IAS 12.74 only allows offsetting of deferred tax amounts if the entity has the right to settle current tax amounts on a net basis by the same taxing authority, it’s also worth investigating what the magnitude of the gross deferred tax position is as a share of firm assets over the period 2008-2012, this is presented in table 7b. An average amount of 24.8% of the sampled firms over the period 2008-2012 have a gross deferred tax liability, and 9.0% have a gross deferred tax asset, the added value for the financial statements user can be determined as significant.
4.2 OLS regression table
Table 8 reports the results of cross sectional OLS regressions of the equation which is stated in section 3.2. The F-statistic is significant in all regressions which suggest that H0 can be rejected since at least one of the explanatory variables is significantly associated with the dependent variable. The results indicate that there is no significant association between deferred taxes and future tax payments that is incremental to the information provided by current taxes payable. Also, the value of the incremental information is small, in particular since the model already includes TAXPD. The coefficients of GAAP_FIRST are positive and insignificant in all regressions. Except for t+4 and t+5, the coefficients of TAX_FIRST are negative and also insignificant in all regressions. The results presented in table 8 are not consistent with the results as found by Laux (2013). Whereas Laux found that a reversal in deferred tax in the
The findings in the other categories are consistent with the findings of Laux (2013). The difference can be caused by different reasons. The first reason can be that the time period of the research is different than in the research used by Laux (2013). The time period in this research is just after the financial crisis while the research of Laux (2013) is before the financial crisis. It might be that due to the financials crisis, countries made changes in tax laws to decrease the amount of taxes which had to be paid in order to stimulate the growth of the economy.
Table 8: OLS Regressions of future tax payments on current tax payments and deferred tax components of 187 publicly listed EU firms for the years 2008 – 2012.
Variable Sign t+1 t+2 t+3 t+4 t+5 INTERCEPT ? 0.00 0.00 0.01 0.01 0.01 4.85*** 5.26*** 5.00*** 5.70*** 4.95*** TAXPDt + 0.90 0.89 0.91 0.86 0.70 57.35*** 37.70*** 28.06*** 20.18*** 11.78*** GAAP_FIRSTt - 0.04 0.12 0.16 0.14 0.07 1.38 2.89 2.70 1.76 0.50 TAX_FIRSTt - -0.01 -0.01 -0.03 0.00 0.01 -0.55 -0.82 -1.13 -0.08 0.17 OTHERt - 0.00 -0.01 -0.01 0.01 0.00 -0.43 -0.77 -0.33 0.25 -0.03 TAXCFt - -0.02 -0.02 -0.03 -0.07 -0.08 -0.66 -0.50 -0.54 -0.83 -0.68 Adjusted R² 78.84% 66.93% 60.21% 54.07% 44.99% F-statistic 687.68*** 297.97*** 166.16*** 85.46*** 28.95*** Number of Observations 929 742 555 369 183
*, **, *** Indicate significance at the 10%, 5% and 1% level, respectively. In one tailed tests where an expectation is provided, and two-tailed otherwise.
A second reason can be that while all entities in this research use IFRS as adopted by the EU, the tax regimes can differ because the firms which are being researched are located in different jurisdictions. A third reason is that there can be differences in IFRS and US GAAP between the recognition and measurement of deferred tax assets (liabilities). The fourth reason can be that I selected my sample based on firms with the highest total assets, while Laux (2013) selected the sample randomly.
