Financial Transparency to the Rescue: Effects of Public Country‐by‐Country Reporting in the European Union Banking Sector on Tax Avoidance*

Abstract

We analyze the effect of mandatory financial transparency on corporate tax avoidance. The effectiveness of comprehensive tax transparency, in the form of a public country‐by‐country reporting, to mitigate corporate tax planning is largely unknown. Capital Requirements Directive IV by the European Commission required multinational banks to publish key financial and tax data in the form of public country‐by‐country reporting. We examine tax avoidance of banks around the reform. Our focus is on multinational banks newly required to report activities in tax havens that had not been publicly disclosed before the country‐by‐country reporting mandate. We predict and find that these exposed banks increased their tax expense relative to multinational banks with no activities in tax havens to disclose, as well as relative to domestic banks unaffected by the new mandate. In additional tests, we compare our sample of exposed multinational banks to several control groups from the financial sector and other industries. Our results suggest that country‐by‐country reporting can serve as an additional policy instrument to curb corporate tax avoidance, but only when the reporting exposes the firms' tax sheltering activities to public scrutiny.

Corporate tax risk: a literature review and future research directions

“…Joshi et al (2020) reveal no effect of the implementation of Country-by-Country Reporting (CbCR) on the practice of tax avoidance by banks, especially in the European Banking Industry. However, Overesch and Wolff (2021) found that CbCR can be considered as a policy instrument which can suppress corporate tax avoidance under certain conditions. Based on that result, further research is needed to investigate the effect of CbCR on the tax risk?…”

Real Effects of Private Country-by-Country Disclosure

“…A separate literature examines the reporting effects of public tax disclosures, generally finding limited compliance with required tax disclosures (e.g.,Belnap, 2019) and a positive association between tax avoidance and the aggregation of financial reporting by segment(Brown et al, 2019) or geography(Hope et al, 2013;Akamah et al, 2018) Overesch and Wolff (2021). andJoshi et al (2020) study multinational banks' responses to public CbCR and document mixed results, overall suggesting a modest mitigating effect of public CbCR on banks' international corporate tax avoidance.Electronic copy available at: https://ssrn.com/abstract=3398116…”

How Do Investors Value the Publication of Tax Information? Evidence From the European Public Country-By-Country Reporting

“…10 Both studies conclude that increased tax transparency led to a reduction in tax avoidance opportunities as it facilitates the detection of aggressive tax planning schemes for tax authorities. This interpretation is supported by several studies that find evidence consistent with banks reducing profit shifting activities among affiliates and tax havens following the disclosure requirement (Eberhartinger et al 2020;Joshi et al 2020;Overesch and Wolff 2021).…”