Detection of Income Shifting Strategy and Determining Factors
Sabar Warsini, Titi Suhartati, Herbirowo Nugroho
Accounting Departement, Politeknik Negeri Jakarta, Depok, Indonesia
Keywords: Income Shifting, Leverage, Audit Quality
Abstract: The Indonesian government reduces the corporate income tax rate to 22%, effective in 2020 and 2021, and
will decrease again to 20%, effective starting in 2022. This research aims to investigate the strategies
implemented by public companies in dealing with the corporate income tax rate reduction and the determining
factors. By using a sample of 343 Indonesian public companies, this study finds that the mean value of
discretionary book tax differences in 2019 is positive and is significantly different from zero. These results
prove that Indonesian public companies are implementing an income shifting strategy one year before the
lower tax rates are imposed. Furthermore, this study also investigated determinant factors that influence on
income shifting. Income shifting strategy is influenced by the company characteristic and the corporate
governance mechanism. Using the multiple regression method this research found that interest expense can
produce tax saving so the use of the higher debt in the structure of the company financing can limit income
shifting. In terms of the role of the external auditor, this study has not been able to prove the role of the
external auditor as an effective monitoring mechanism against opportunistic management to do income
shifting
1 INTRODUCTION
Income taxes is a significant expense for a company.
From 2010 to 2019 the Indonesian government
imposed a corporate income tax rate of 25%, which
means companies are required to give a quarter of
their profits to the government. Compared to other
Asian countries, the corporate income tax rate applied
by the Indonesian government is still relatively higher
than other Asian countries, such as: Singapore
imposes a corporate income tax rate of 17%, Brunei
Darussalam 18%, Thailand, Cambodia and Vietnam
at 20%, Laos 24%, and Malaysia 24%. Only the
Philippines still applies a higher tax of 30% (The
Global Competitiveness Report, 2018).
Nadine (2018) stated that the high corporate
income tax rate is one of the factors that encourage
taxpayer to do tax avoidance. High tax rates are also
an inhibiting factor for a country's economic growth.
Wasylenko (2019) state that the World Bank
periodically releases reports on the economic
performance of developing countries and finds that
countries with lower marginal tax rates have higher
economic growth rates.
The Indonesian government try to develop
economic growth and to increase investment in
various ways. One of an effective way is through the
provision of tax incentives. The economic slowdown
occurring 2019, globally and worse by the pandemic
covid-19 affect all countries in the world. As
happened in other countries, the covid-19 pandemic
has had a tremendous impact on the business sectors
in Indonesia. The Covid19 pandemic has threatened
economic stability due to the decline in productivity
of various affected sectors. Therefore, through
Government Regulation Number 30 of 2020 (PP
30/2020), the government provides incentives in the
form of lowering corporate income tax rates for
domestic corporate taxpayers in the form of public
companies.
The government provides incentives tax to
Indonesian public companies in form of the reduction
corporate income tax rates to 22 % into effect in 2020
and 2021, and will decline to 20 % in 2022. The
policy to reduce corporate income tax rates is a
positive signal for public companies as taxpayers.
How does company management respond to the
policy to reduce tax rates? Research in various
countries has found evidence that taxpayers respond
to lower tax rates by implementing income shifting
strategies in an effort to reduce the amount of tax
burden that must be paid. These studies are: Tao Zeng
(2018) in China, Won-Wook Choi and Hyun-Ah Lee
Warsini, S., Suhartati, T. and Nugroho, H.
Detection of Income Shifting Strategy and Determining Factors.
DOI: 10.5220/0010511300490053
In Proceedings of the 9th Annual Southeast Asian Inter national Seminar (ASAIS 2020), pages 49-53
ISBN: 978-989-758-518-0
Copyright
c
2021 by SCITEPRESS Science and Technology Publications, Lda. All rights reserved
49
(2013) in Korea, Grubert and Altshuler (2016) in
France, Brandstetter (2017) in Germany. The income
shifting strategy that is carried out is to adjust
commercial profit and fiscal profit. The income
shifting strategy can be done by delaying revenue
recognition and accelerating the recognition of
expenses in the fiscal year one year before lower tax
rates are imposed. Referring to the results of previous
research, this research predicts that “Indonesian
public companies are suspected of implementing an
income shifting strategy in the one year period prior
to the enactment of a lower tax rate”
If it is proven management of public companies
do income shifting strategy so the next question is
which factors influences income shifting strategy?
What factors affecting tax avoidance depends on the
underlying theory. Referring to the theory of capital
structure (Ross, Westerfield, and Jaffe, 2015) said
that companies using debt in the capital structure have
lower the tax charges than others. Previous studies
found evidence that leverage have negative effects on
tax avoidance (Lin, Tong, and Tucker, 2014).
Another previous research by Kovermann (2018) also
proved that tax evasion behaviour are lower in
company with the higher level of leverage. Referring
to the capital structure theory and the results of
previous research, then this research is suggesting
that the company with higher debt was lower income
shifting.
Tax avoidance studies have also found
widespread evidence of their underlying motives, and
the implications of tax avoidance (Hanlon and
Heitzman, 2010). The conventional view holds that
management conducts tax avoidance for efficiency
purposes. This has an impact on improving the
prosperity of the owner, but the agency theory
perspective developed by Desai and Dharmapala
(2007) states that management could avoid taxes to
make personal gain. Therefore, the development of
tax avoidance research further considers corporate
governance mechanisms, and it is evident that tax
avoidance and its implications are influenced by
corporate governance mechanisms.
Based on the perspective of agency theory, Nemis
and Cetenak (2012) state that audited financial
statements are a monitoring mechanism to provide
financial information to users. The quality of the
information contained in these statements is strongly
influenced by the quality of the audit that can be
determined by two factors namely: (1) the auditors’
capabilities in running the audit process, and (2). their
independence from their clients. Richardson, Taylor,
and Lanis (2015) state that the quality of auditors has
a crucial role in reducing agency problems that arise
due to conflicts between management and owners.
Previous research that examined the influence of
the audit quality on tax avoidance, we found it is not
conclusive. The test results by Heltzer, Mindak, and
Shelton (2012) found no significant evidence of
auditor influence on tax avoidance. But another
research has proven that tax avoidance is lower in
companies that are audited by qualified auditors
(Kanagaretnam, Höglund and Sundvik, 2019).
Referring to the corporate governance mechanism
theory and the results of previous research, then this
research is suggesting that the quality of auditing
lower income shifting.
This study aims to find empirical evidence
whether Indonesian public companies implement
income shifting strategies to respond to tax rate
reduction policies, and also find empirical evidence
whether income shifting strategies are influenced by
the level of leverage and the quality of the audit. The
results of this study are expected to contribute to the
development of tax avoidance research. Our research
should be useful to regulators attempting to reduce
corporate malfeasance, to investors in being more
careful when using earnings report information and
paying attention to corporate and institutional
characteristics when investing.
2 METHODOLOGY
From 664 Indonesian public companies listed on the
Indonesian Stock Exchange (IDX) up to 2019, we
determine the following selection criteria: 1) Non
financials industry because this industry is strictly-
regulated industry; 2) Non real estate and
constructions industry because this industry has their
own accounting rules, for example revenue
recognition; 3) Non mining industry because they
have different tax arrangements to other industries
(lex-specialist); 4) Availability of financial data and
other data required to measure all the variables used
in this research. The final sample of 343 firms
represents 51.89% of all observations.
There are two models used to answer the research
questions. The value of income shifting is calculated
using the book-tax differences approach, referring to
Tang and Firth (2012), the formula used is as follows:
BTDi = αi + α1TAXi + α2FIASi + α3SALESi
+ α4OINi + εi (1)
Operational Variables of Model (1)
ASAIS 2020 - Annual Southeast Asian International Seminar
50
BTDi = book-tax differences is the difference
between commercial profit and fiscal profit, TAX is
the tax expenses, FIAS is the fixed asset value,
SALES is the sales value, OIN is other income, The
independent variable of model (1) is the component
that causes the difference between commercial profit
and fiscal profit. Income shifting value is the value of
discretionary book-tax differences (DBTD) which is
calculated using the residual value or error of the
equation. Testing the significance of the value of
income shifting using the mean different analysis
The second model to test the effect of leverage
and audit quality on income shifting uses the
following model:
INSFi = α0 + α1LEVi + α2AUDITi + α3SIZEi
+ εi (2)
Operational variable of Model (2):
INSF is the value of income shifting, LEV is debt to
assets ratio, AUDIT is the quality of external auditors
measured using industry specialization, is a dummy
variable = 1 if the auditor controls the industrial
market share 30%, and is worth 0 if the other is.
SIZE is the size of the company as a control variable
measured by the value of the natural logarithm (Ln)
of the company's total assets. The independent
variable of model (2) is the variable that affects tax
avoidance. The analysis used a significance t-test.
The financial reports data sourced from IDX website
www.idx.co.id and annual report data sourced from
the Indonesian public company website.
3 RESULTS AND DISCUSSIONS
Table 1 presents the descriptive statistics, which
provide an overview of the sample profiles and
research variables. The mean value of the INSF
variable is 0.2725, which means that on average, the
sample companies did income shifting in 2019. In this
study, income shifting was calculated using
discretionary book-tax differences (DBTD). A
positive DBTD value indicates that the company has
reported a higher commercial profit than fiscal profit.
High commercial profits will get a good assessment
for investors, and lower fiscal profits will have an
impact on lower tax paid. The mean value of variable
LEV is 0.4635 indicates that on average the use of
debt on Indonesian publics funding structure is
significantly high at 46.35%. AUDIT is measured by
an industry specialization audit, with an average
value of 0.3835, indicating that 38.35% of the
observed firms are audited by industry-specific
auditors.
Table1. Descriptive statistics
Variable Maximum Minimum Mean Stdev
INSF 0.9346 -0.1452 0.2725 0.1995
LEV 0.8263 0.1699 0.4635 0.1919
AUDIT 1 0 0.3835 0.2472
SIZE 1.0743 18.3002 8.8123 4.1715
N 343
INSF = income shifting, LEV = leverage, AUDIT = audit
quality, SIZE = firm size
One sample compare mean t-test used to verify
whether Indonesian public companies do income
shifting before the lower corporate income tax rate is
implemented. Testing result is presented in table 2
Table 2. one sample t-test of income shifting
One-sample
t-test
variable mean Sig.(2-
tailed)
2019 INSF 0.2725 0.02446
N = 343
The result of different test shown that mean of
income shifting in 2019 is significantly different from
zero with a significance level below 5 %. This result
is consistent with the conjecture that companies
shifted taxable income in the year preceding the
corporate income tax rate decrease. The results of this
study are in line with previous research in other
countries such as: in Korea by Won-Wook Choi and
Hyun-Ah Lee (2013), in China (Tao Zeng, 2018), in
French (Grubert and Altshuler, 2016), and in
Germany by Brandstetter (2017). The income shifting
strategy can be done by setting up accounts that have
different treatment between generally accepted
accounting standards (GAAP) and tax regulations.
These accounts include: fixed asset accounts related
to depreciation expense, tax expense paid, differences
in recognition of sales or income, and recognition of
other income.
Further testing conducted to determine factors
that affect income shifting. Factors affect considered
in this study is the level of leverage and quality of the
audit. The testing used the multiple regression model
and the testing result is presented in the following
table 3.
The results show that the coefficient of LEV is -
0.1039 significant based on the p-value lower than 10
%. This is consistent with this research prediction that
the bigger the use of debts in the capital structure of
company will the lower income shifting by the
company. The results of this research are in line on
Detection of Income Shifting Strategy and Determining Factors
51
the capital structure theory presented by Ross,
Westerfield, and Jaffe (2015). The greater use of debt
in financing benefits of tax saving, because the higher
interest expense as a deduction taxable income.
Hence the use of higher debt can restrict the
management to perform the act of tax avoidance.
These results support the results of previous studies
conducted Lin, Tong, and Tucker (2014).
Table 3. Regression result
Independent
Variable
prediction INSF as dependent
variable
coefficient p-value
Constant 0.4228 0.000
LEV - -0.1039 0.062*
AUDIT - -0.0033 0.733
SIZE +
/
- -0.0148 0.068*
N = 343 Ad
j
R
2
= 0.1484
INSF = income shifting, LEV = leverage, AUDIT =
audit
q
ualit
y
, SIZE = firm size
Financial reporting is not independent from the
role of auditors. External auditor’s services not only
limited in the financial audit services but also
includes. tax services. To understand the role of
external auditors in aggressive tax behaviour, this
research examines the effect of audit quality on the
income shifting. Audit quality is difficult to assess, so
much of the previous research has used auditor size
and/or reputation as a proxy for audit quality.
However, with the emergence of financial reporting
scandals from companies audited by KAP Arthur
Anderson, such as Enron and Dynegi Corporation, the
use of auditor reputation as a measure of quality may
not reflect actual audit quality (Heltzer, Mindak, and
Shelton (2012).
By using industry-specialized auditors the results
of this study have not been able to prove the effect of
audit quality on income shifting. The p-value of
coefficient AUDIT is 0.733 is higher than level of α
= 10%. The results of this research failed to support
the agency theory which states quality audit is able to
act as an effective monitoring mechanism against
opportunist action by managers (Richardson, Taylor,
and Lanis, 2015). This finding is also not in line with
the results of previous studies which found that audit
quality reduces tax avoidance (Kanagaretnam, Lee,
and Lim, 2016; Höglund and Sundvik, 2019).
We include SIZE as a company characteristic
control variables. SIZE is measured by the natural
logarithm of the total assets of firm i. And the results
show that the size of the company significantly
negatively influence income shifting. The result of
this research supports the political hypothesis theory
states that large companies liable to be public interest
so they kept reputation.
4 CONCLUSIONS
Using sample of 343 Indonesian public companies,
this research has found evidence that the tax rate
reduction policy has been responded by public
companies as tax payers by implementing an income
shifting strategy in one year before the lower tax rate
is effectively enforced. Income shifting strategy is
influenced by the company characteristic and the
corporate governance mechanism. The results of this
research consistently find that interest expense can
produce tax saving so the use of the higher debt in the
structure of the company financing can limit income
shifting. In terms of the role of the external auditor,
this study has not been able to prove the role of the
external auditor as an effective monitoring
mechanism against opportunistic management
actions.
ACKNOWLEDGEMENTS
The researchers thank the Accounting Department
and the Jakarta State Polytechnic Research and
Community Service Unit (UP2M), which has
provided opportunities and facilitated researchers to
conduct this research. Furthermore, the researcher
also expressed his deep gratitude to the Jakarta State
Polytechnic Director, who had provided funding for
this research activity.
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