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The Impact of Foreign Operations and Foreign Ownership on Corporate Tax Avoidance in the Australian Dividend Imputation System

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The Impact of Foreign Operations and Foreign Ownership on Corporate Tax Avoidance in the Australian Dividend Imputation System The Impact of Foreign Operations and Foreign Ownership on Corporate Tax Avoidance in the Australian Dividend Imputation System Xuerui Li A Thesis Submitted for the Degree of Doctor of Philosophy of The Australian National University May 2018 © Copyright by Xuerui Li 2018 All Rights Reserved Declaration of Originality This thesis is an original written work incorporating an account of research completed in the Doctor of Philosophy (Commerce) program. It has not been submitted for any other degree or purposes. To my best knowledge, the thesis contains no material previously published or written by another person except where due reference is made in the text of the thesis. ------------------------------------ Xuerui Li Research School of Accounting The Australian National University i Acknowledgements This thesis would not have materialised without the support, encouragement, and advice from several people in the preparation and completion of this thesis. I wish to thank, first and foremost, my supervisor Associate Professor Alfred Tran for his constant encouragement and invaluable guidance. He has always been my inspiration when I hurdle all the obstacles towards completion of this thesis. I owe gratitude to my advisors, Associate Professor Mark Wilson and Dr Sorin Daniliuc, for their comments and suggestions on the statistical analyses of the thesis. I would like to offer special thanks to Associate Professor Alfred Tran, Associate Professor Mark Wilson, and the Research School of Accounting in the College of Business and Economics at The Australian National University for their assistance in purchasing corporate annual reports from the Australian Securities and Investments Commission and the access to the Osiris database. I also would like to acknowledge the comments from the audience at the Australasian Tax Teachers Association Conference (January 2015), the Tax and Transfer Policy Institute Seminar (October 2015), and the Accounting & Finance Association of Australia and New Zealand Conference (July 2016). I cannot find words to express my gratitude to my family, colleagues, and friends. The support from my family made me feel understood and able to concentrate on my study without facing financial burdens. My colleagues and friends always cheered me up when I felt discouraged and lost confidence in myself. Those times we spent learning together would be one of the most pleasant memories in my lifetime. This thesis was edited by Elite Editing, and editorial intervention was restricted to Standards D and E of the Australian Standards for Editing Practice. ii Abstract This thesis investigates the impact of foreign operations and foreign ownership on corporate tax avoidance of listed Australian companies and large Australian companies owned by foreign multinational enterprises (MNEs) in the Australian dividend imputation system. With dividend imputation, listed Australian companies can ‘pass’ their corporate income tax to shareholders as a tax credit (franking credit) to offset shareholders’ personal tax liabilities. Therefore, listed Australian companies may not have strong incentives to engage in costly tax avoidance arrangements. However, only domestic income tax payments can be attached to dividends as franking credits, and only domestic shareholders can claim the franking credits received as tax offset. Thus, the corporate tax avoidance-reducing effect of dividend imputation may be undermined by foreign operations (which are subject to foreign taxes) and foreign ownership. Three empirical studies are carried out to investigate the corporate tax avoidance- reducing effect of the dividend imputation system in a comprehensive manner. The first study provides an overview of the impact of franked dividend distributions, foreign operations, and foreign ownership on corporate tax avoidance of listed Australian companies. It is found that companies distributing more franked dividends or having a lower proportion of foreign ownership engage in less corporate tax avoidance. No significant relationship between foreign operations and corporate tax avoidance is found, possibly due to listed Australian companies shifting foreign profits to Australia (inward profit shifting) in order to pay Australian income tax to frank their dividends. The second study focuses on the relationship between foreign operations and corporate tax avoidance. It examines if listed Australian companies with mainly domestic ownership but with foreign subsidiaries take advantage of the tax rate differentials across countries to reduce their worldwide tax liabilities. The results show that companies with subsidiaries in low-tax countries, or high-tax countries, or both, have similar worldwide tax liabilities compared to their counterparts without such subsidiaries. The findings provide further indirect evidence to support the ‘inward profit shifting’ conjecture. The third study focuses on the relationship between foreign ownership and corporate tax avoidance. It examines whether large foreign-owned Australian companies (FOACs) iii which are subsidiaries of foreign MNEs engage in intra-group transfer pricing and thin capitalisation to avoid Australian tax in comparison with domestic-owned listed Australian companies (DOLACs) which have little incentives to do so. The results show that FOACs use intra-group transfer pricing and pay high interest rates on intra-group debts to shift profits out of Australia to reduce their Australian tax liabilities, which are manifested in their lower gross profit margins and operating profit margins, higher interest expenses but not higher leverage ratios, as well as lower pre-tax profits and income tax expenses in comparison with DOLACs. The thesis contributes to the literature by documenting how foreign operations and foreign ownership shapes the tax avoidance behaviours of large companies in the Australian dividend imputation system. It also has significant policy implications for countries and organisations considering integrating corporate and shareholder taxes and formulating rules and regulations to tackle corporate tax avoidance. iv Table of Contents Declaration of Originality................................................................................................ i Acknowledgements .......................................................................................................... ii Abstract ........................................................................................................................... iii Table of Contents ............................................................................................................ v List of Tables ................................................................................................................ viii List of Abbreviations ..................................................................................................... ix Chapter 1: Introduction ................................................................................................. 1 1.1 Motivation of the Study .......................................................................................... 1 1.2 Research Questions ................................................................................................. 4 1.3 Research Design and Major Findings ..................................................................... 6 1.3.1 Study 1 ............................................................................................................. 6 1.3.2 Study 2 ............................................................................................................. 7 1.3.3 Study 3 ............................................................................................................. 8 1.3.4 Summary ........................................................................................................ 10 Chapter 2: Corporate Tax Avoidance ......................................................................... 11 2.1 Introduction ........................................................................................................... 11 2.2 Theories for Corporate Taxation and Integration of Corporate and Shareholder Taxes ................................................................................................. 12 2.3 Corporate Tax Avoidance Incentives .................................................................... 14 2.4 Prevailing Corporate Tax Avoidance Mechanisms............................................... 16 2.5 Corporate Tax Avoidance Measures and the Influential Factors .......................... 18 2.5.1 Corporate Tax Avoidance Measures .............................................................. 18 2.5.2 Firm-level Characteristics Associated with Tax Avoidance .......................... 20 Firm size .............................................................................................................. 20 Profitability ......................................................................................................... 21 Foreign entities and foreign operations .............................................................. 21 Leverage .............................................................................................................. 22 2.6 Summary ............................................................................................................... 23 Chapter 3: The Australian Dividend Imputation System—Mechanism and Literature Review.........................................................................................................
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