Book-Tax Differences and Reporting Incentives


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Abstract

In Europe, a number of countries align tax accounts and single accounts, while allowing companies to characterize consolidated profits to capital markets in a different way. Using single (group) accounts as a proxy for tax (book) accounts, this paper provides a systematic analysis of factors affecting the divergence of book and tax income. Consistent with previous literature I first show that book-tax differences are positively related to reporting aggressiveness in earnings and the level of tax sheltering. Despite tax sheltering driving book-tax differences, I fail to provide any evidence consistent with book-tax gap being indicative of reduced tax collections. I further show that reporting timeliness is also associated with book-tax differences. Due to a different level of timeliness in book and tax income, the book-tax gap can increase (decrease) during economic upturns (downturns). Furthermore, I point to the role of book-tax gap in financing and show consistently that higher book-tax differences reduce underinvestments and are not associated with overinvestments. Altogether my evidence suggests that book-tax differences are not overly opportunistic but are rather related to firms’ incentives to provide timely information to stakeholders and firms’ financing activities.
 
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Paolo Perego
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