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International Tax and Public Finance

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01.06.2013

Investment impact of tax loss treatment—empirical insights from a panel of multinationals

verfasst von: Daniel Dreßler, Michael Overesch

Erschienen in: International Tax and Public Finance | Ausgabe 3/2013

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Abstract

We analyze the impact of tax loss treatment on multinational investment. Basically, two effects of tax loss treatment can be expected. First, firms make their investment decisions considering potential future losses. Then, the various types of conceivable loss offset provisions affect investment decisions. Secondly, existing loss carryforwards resulting from losses in the past affect the tax rate elasticity of current investment decisions. Our empirical analysis is based on data of German multinationals. We pay particular attention to industries having a high probability to make losses. Our regression results suggest that a short carryforward time limit lowers investment in particular for firms with a high loss probability. We only find mixed evidence that group loss offsetting provisions foster investment. Concerning the effects of existing losses carried forward, we find a reduced tax rate elasticity of investment for companies shielded by loss carryforwards.

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In a consolidation system, the financial statements of companies belonging to the same group are either made up together or merged at the end of the fiscal year. When there is a system of group contribution, the profitable subsidiary is allowed to contribute a part or all of its profits to the subsidiary which suffered a loss. Correspondingly, losses are transferred among subsidiaries in a group relief system. In effect, all of these three systems enable the netting of profits and losses of different tax subjects.

We can also suppose very specific cases where a loss carryforward is associated with less investment. If, for example, the accelerated depreciation is offset by a loss carryforward and losses or depreciation cannot be carried forward to subsequent periods, the attractiveness of investment in fixed assets might be lost.

We exclude observations from mining, agriculture, non-profit and membership organizations because special tax regimes may be available. Furthermore, we exclude observations of companies whose German parent is not an incorporated and legally independent entity as well as subsidiaries which are not legally independent.

The BRIC countries are Brazil, Russia, India and China. The covered OECD countries in 2007 are Australia, Austria, Belgium, Canada, the Czech Republic, Denmark, Finland, France, Greece, Hungary, Iceland, Ireland, Italy, Japan, Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, the Slovak Republic, South Korea, Spain, Sweden, Switzerland, Turkey, United Kingdom and the United States. The additional EU countries are Bulgaria, Cyprus, Estonia, Latvia, Lithuania, Malta, Slovenia and Romania.

Section 26 of Foreign Trade and Payments Act (Aussenwirtschaftsgesetz) in connection with Foreign Trade and Payments Regulation (Aussenwirtschaftsverordnung). Since 2002, FDI has to be reported if the participation is 10 % or more and the balance-sheet total of the respective foreign investment in Germany exceeds 3 million Euros. For details, see Lipponer (2008). Although previous years showed lower threshold levels, we apply this one uniformly for all years in the panel. For general interpretations of the dataset from a tax and finance perspective, see Mintz and Weichenrieder (2010).

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The subsidiaries showing the highest values of LRI in particular years operate in the tourism industry (0.412), the housing industry (0.385) and the restaurant industry (0.396). Low values can be observed in the industries of advertising (0.148), market and opinion research (0.140) and the pharmaceutical industry (0.207).

In unreported regressions we also cluster standard errors at the country level. Then standard errors are slightly higher but our general propositions remain qualitatively unchanged.

By assuming that \(\ln(\mathrm{Fixed\ Assets}_{i,t}) = \ln(\mathrm{Fixed\ Assets}_{i,t-1})\) in the long-run equilibrium, the long-run effect can be calculated as β ₂/(1−β ₁). Using the point estimators of column (1) in Table 3, the long-run effect is −0.425/(1−0.692)=−1.380.

In unreported additional regressions we also refer to a binary variable indicating if affiliated companies report actual profits. The results are however very similar to those reported in column (7) of Table 4.

The counterintuitive positive effect of LCFlimited≥5 in column (11) only measures a hypothetical fraction of the overall effect. This can be seen by calculating the overall effect. The 1 %-percentile of LRI shows a value of 0.167. Therefore, the overall effect is small for this lower boundary of LRI (0.167×(−0.459)+1×0.136=0.06) and negative for industries with a higher probability to suffer losses. The same applies to column (3).

Considering estimates of column (3) in Table 5, a loss carryforward exerts a negative effect of about −0.117 but also an offsetting effect of about 0.0915 if we suppose a tax rate of about 30 %.

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Titel: Investment impact of tax loss treatment—empirical insights from a panel of multinationals
verfasst von: Daniel Dreßler
Michael Overesch
Publikationsdatum: 01.06.2013
Verlag: Springer US
Erschienen in: International Tax and Public Finance / Ausgabe 3/2013
Print ISSN: 0927-5940
Elektronische ISSN: 1573-6970
DOI: https://doi.org/10.1007/s10797-012-9240-1

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