Chapter 6

Nontax Costs of Tax Planning

Key Words / Outline

INFORMATION ASYMMETRY, TRANSACTION COSTS, Slide 1-2

IDENTIFICATION PROBLEM, UNCERTAINTY, HIDDEN ACTION

OR HIDDEN INFORMATION SITUATIONS
• Transaction costs (frictions) are pervasive.
• Different ways of organizing economic activity give rise to differences in
transaction costs as well as differences in tax costs.
• Hence the efficient organizational choice is not necessarily the one that
minimizes transaction costs, once taxes are considered as well.
• Causal observation suggests that the effect of taxes pervades the way that
production and exchange are organized.
• It is equally indisputable that organizational arrangements arise because
information is asymmetrically distributed among economic agents.
• Workers must often be monitored or offered incentives to induce them to
perform in the owner’s best interest.
• Customers must often be offered warranties to induce them to buy products,
and still a variety of consumer protection groups exist.
• Independent third parties are required to audit the financial statements of
publicly owned corporations.
• And even absent any regulatory requirements, many firms voluntarily pay
substantial sums to third parties to verify certain information disclosures
designed to facilitate economic exchanges among parties who are not equally
well informed.
INFORMATION ASYMMETRY, TRANSACTION COSTS, Slide 1-3

IDENTIFICATION PROBLEM, UNCERTAINTY, HIDDEN ACTION

OR HIDDEN INFORMATION SITUATIONS ..cont’d
• In many contracting problems, a desire to achieve tax minimization
encourages precisely the same organizational arrangements as do
solutions to incentive problems among differentially informed and
opportunistic agents.
• Such situations present outside observers (such as researchers,
consultants, corporate raiders, investment bankers, and regulators) with a
so-called identification problem in sorting out which economic force is
responsible for the observed contractual relations.
• Identification Problem: An identification problem arises when a
contractual relationship is consistent with more than one economic
explanation and observers cannot tell which economic force is responsible
for it.
• However, tax considerations and information-related transaction cost
considerations often have conflicting implications for efficient organizational
design. Sometimes tax considerations dominate in importance, and
sometimes information considerations dominate. Frequently, both factors
are important and trade-offs must be made.
INFORMATION ASYMMETRY, TRANSACTION COSTS, Slide 1-4

IDENTIFICATION PROBLEM, UNCERTAINTY, HIDDEN ACTION

OR HIDDEN INFORMATION SITUATIONS ..cont’d

Uncertainty: Two types of uncertainty –

Symmetric Uncertainty Strategic Uncertainty
(or Information Asymmetry)
Nature of Where all contracting parties Where the contracting parties are not
uncertainty are equally well informed, but equally well informed about what the
still uncertain, about what the future investment cash flows might be.
future cash flows from an
investment might be.
Hidden- This arises when one This arises when one contracting party
action or contracting party has control has observed a characteristics of the
Hidden- over an action choice that production function that cannot be
information affects future cash flows, where controlled but affects future cash flows,
situations the action choice is and that characteristics is only
unobservable to other imperfectly observable by the other
contracting parties, so-called contracting parties, so-called Hidden
Hidden-Action or Moral Information or Adverse Selection
Hazard situations. situations.
INFORMATION ASYMMETRY, TRANSACTION COSTS, Slide 1-5

IDENTIFICATION PROBLEM, UNCERTAINTY, HIDDEN ACTION

OR HIDDEN INFORMATION SITUATIONS ..cont’d

Effects of Uncertainty in the Context of Progressive Tax Rate Schedules

Progressive tax rate schedules (PTRS)→ Influence a firm’s risk tasking
incentives with respect to investment choices and hedging activities and can
influence organizational choice (e.g., joint venturing with more profitable entities)
Hidden-action problems →Can inhibit tax arbitrage through capital market
activities (by influencing borrowing and lending rates) and can influence
contracting in labor market.
Hidden-action problems in case of Agency relationship: Hidden-action
problems arise because (1) an agent has control over an action that affects
future cash flows, (2) the agent derives personal pleasure or displeasure
from taking this action, and (3) the action is not observable to principals. If it
were not costly for principals to monitor the actions of agents, agents could
be induced to undertake those actions that are mutually beneficial to the
principals and the agents by writing appropriate incentive contracts that
penalize agents for choosing the “wrong” actions.
INFORMATION ASYMMETRY, TRANSACTION COSTS, Slide 1-6

IDENTIFICATION PROBLEM, UNCERTAINTY, HIDDEN ACTION

OR HIDDEN INFORMATION SITUATIONS ..cont’d

Hidden-information problems →Can impede asset sales that might minimize

taxes.

Hidden-information problems arise when one contracting party observes a

characteristic of the production function she cannot control that affects future
cash flows and that characteristic is not perfectly observable by the other
contracting parties.

Income Shifting and Organizational Forms:

• Income shifting and organizational forms that minimize taxes often give rise to
costs along other dimensions, leading to a trade-off between taxes and non-
tax costs.
• For example, income shifting within an organization might require more
centralized organizational structures, but information asymmetries might
require more decentralized organizational structures.
• Shifting income across time will often result in costs arising from financial
reporting consequences of the income shifting.
 Slide 1-7
6.1 SYMMETRIC UNCERTAINTY, PROGRESSIVE
TAX RATES AND RISK TAKING

 Symmetric Uncertainty →Where all contracting parties

are equally well informed – not subject to asymmetric
information – but uncertain, about what the future cash
flows from an investment might be.
 Risky →when there is uncertainty about the future cash
flows, the investment is risky.
 Progressive income tax system: if income is positive,
t>0%, but if income is negative or zero, t = 0%
 Risky Investment →when uncertainty about future cash
flows (or profitability) is linked with a progressive income
tax system, some taxpayers may be less inclined to take
on risky investment.
 Slide 1-8
6.1 SYMMETRIC UNCERTAINTY, PROGRESSIVE
TAX RATES AND RISK TAKING
..cont’d
Example:
 Investment fund (not tax-deductible) = $100,000 for investing in 1 of 2 projects
 Return from Riskless Project: certain pretax profit of $20,000
 Return from Risky Project: Pretax profit of $150,000 half the time and a loss
of $100,000 half the time
 Progressive tax rate: If income>0, t = 40%, and if income ≤ 0, t = 0%
Solution:
Pretax Return Pretax Rate of Return
Riskless Project $20,000 $20,000/$100,000 = 20%
Risky Project .05($150,000) $25,000/$100,000 = 25%
+.5(–$100,000) =$25000 preferred

After-tax Return After-tax Rate of Return

Riskless Project $20,000(1–40%) = $12,000 $12,000/$100,000 = 12% pref.

Risky Project .05 [$150,000(1–40%) –$5,000/$100,000 = –5%

+.5(–$100,000) =–$5000
 Slide 1-9
6.1 SYMMETRIC UNCERTAINTY, PROGRESSIVE
TAX RATES AND RISK TAKING
..cont’d
Analysis:
 Absent any taxes, Risky Project is preferred (R 25% vs. 20% R)
 With taxes, Riskless Project is preferred (r 12% vs. -5%)
 Progressive tax rate: If income>0, t = 40%, and if income ≤ 0, t = 0%
Why is the Riskless Project tax-preferred with taxes?
 Because the tax rate schedule is progressive, the expected tax is higher
for the risky project than for the riskless one ($30,000 vs. $8,000).
 This example shows a general feature of a progressive (or convex) tax
system: The average tax rate (ATR) paid increases with the variability of
taxable income levels.
 So, even when taxpayers are risk-neutral and face a progressive tax-rate
schedule, they exhibit risk aversion toward assets with variable pretax
returns.
 Slide 1-10
6.1 SYMMETRIC UNCERTAINTY, PROGRESSIVE
TAX RATES AND RISK TAKING
..cont’d
Risky Investments: Start-ups vs. Existing Successful Businesses
 Corporate carry-backward or carry-forward of losses rules reduce the
progressiveness of the tax-rate schedule, if losses have to be carried forward
(such as for start-up companies), the tax-rate schedule is still progressive
(kinked) around zero taxable income. Thus start-ups face ‘progressive tax-rate
schedules’ (PTRS).
 In the extreme, if the risky investments do not prove successful (because of
technology changes, lack of customer demand, or failure of the R&D program to
generate products), then the start-up effectively faces the PTRS – tax losses
obtain no tax benefit.
 The PTRS in these situations offers advantages to existing successful business,
such as Microsoft Corporation, IBM, Intel, and Merck, to undertake risky
investments, because the losses can be immediately deducted against the
businesses’ other income, which reduces the after-tax cost of the investment.
 Start-ups with no income, however, face a nonzero probability that the tax
losses will not be used.
 Thus, a PTRS discriminates against start-ups, resulting in several implications.
 Slide 1-11
6.1 SYMMETRIC UNCERTAINTY, PROGRESSIVE
TAX RATES AND RISK TAKING
..cont’d
R&D and O&G (Oil and Gas) Activities
 R&D Activities (USA): (1) Qualifying R&D expenditures are immediately
deductible as incurred. (2) The sale of successfully developed technology
generally gives rise to capital gains. (3) An R&D tax credit of 10% of the
investment expenditure is immediately available, subject to the condition
that the deduction for R&D must be reduced by the amount of any R&D
tax credit.
 O&G Activities (USA): O&G activities receive favorable tax treatment
because (1) drilling and exploration expenditures are immediately
deductible as incurred; (2) O&G investments receive a percentage
deletion allowance in which 15% of revenue from the well is explicitly tax-
exempt; and (3) part of the income (sale of the well) may be subject to
favourable capital gains treatment.
 Slide 1-12
6.1 SYMMETRIC UNCERTAINTY, PROGRESSIVE
TAX RATES AND RISK TAKING
..cont’d
R&D and O&G (Oil and Gas) Activities
Example on R&D Activities: A corporation makes an R&D investment of $1.
The R&D expenditure is immediately deductible. An R&D tax credit of 10% of
the investment expenditure is immediately available without any condition.
Initially the corporation’s marginal tax rate (MTR) is 40%. Any income
generated from the investment will be taxed in the future, when the
corporation’s tax rate is expected to be 30%. The research is risky.
Probability Payoff Tax Rate E(Pretax Cash Return) E(After-tax Cash Return)
90% 0 0% 0.00 0.00
10% 11 30% 1.10 0.77
R = 10% r = 54% 1.10 0.77

R = (Expected pretax payoffs/Investment) – 1 = ($1.10/$1) –1 = 10%

After-tax investment = Investment – Tax savings from immediate deduction
of investment – Tax credit = $1 – 40%*$1 – 10%*$1 = $0.50
r (after-tax rate of return) = (Expected after-tax payoffs/After-tax investment) – 1
= ($0.77/$0.50) –1 = 54%
 Slide 1-13
6.1 SYMMETRIC UNCERTAINTY, PROGRESSIVE
TAX RATES AND RISK TAKING
..cont’d
R&D and O&G (Oil and Gas) Activities
Same Example on R&D Activities with negative payoff and Negative R, but Zero r

Probability Payoff Tax Rate E(Pretax Cash Return) E(After-tax Cash Return)
90% –0.3 0% –0.27 –0.27
10% 11.0 30% 1.10 0.77
R = –17% r = 0% 0.83 0.50

Same Example on R&D Activities with negative payoff and Negative R, but Positive r

Probability Payoff Tax Rate E(Pretax Cash Return) E(After-tax Cash Return)

90% –0.2 0% –0.18 –0.18

10% 11.0 30% 1.10 0.77
R = –8% r = 18% 0.92 0.59
 Slide 1-14
6.1 SYMMETRIC UNCERTAINTY, PROGRESSIVE
TAX RATES AND RISK TAKING
..cont’d
R&D and O&G (Oil and Gas) Activities
 Effect of NOL carryforwards or ‘no income’: If the research is undertaken by a
firm with accumulated tax losses–called ‘net operating loss’ (NOL) carryforwards –
or by a start-up company with no income against which to offset the R&D
deductions or the R&D tax credit, the after-tax returns decline dramatically.
 Example: When R&D investment = $1, R&D expenditure deductible at 30% and
10% R&D tax credit, the R =10% and r =54%. Suppose, due to NOL, the R&D
expenditure is effectively deductible at a rate of 20% and the present value of R&D
tax credit is only 5%. Then
R = ($1.10/$1) –1 = 10% and
r = [$0.77/($1 – $0.20 – $0.05)] –1 = ($0.77/$0.75) –1 = 2.67%
Possible responses to the above situations:
1. To undertake the investment anyway and suffer the tax cost.
2. To abandon the investment.
Either way, the tax rules discourage research expenditures by low-tax firms.
However, low-tax firms can finance the activity in a way that sells the rights to
favorable tax treatment to a party that is in a better position to take advantage of
the tax write-offs.
 Slide 1-15
6.2 TAX PLANNING IN THE PRESENCE OF RISK-
SHARING AND HIDDEN-ACTION CONSIDERATIONS

Hidden-Action Problems in case of Borrowing or Lending

[Contracting in Capital Markets]
Operating costs as Nontax Costs:
• Commission to salesforce/brokers
• Investment in information system to track assets, customers and for other purposes
• Investment in internal control systems
• Cost of creating contracts with various parties
• Investigation costs for verifying creditworthiness of borrower
• Costs to ensure the clients’ behavior as per commitment
Hidden-action problems increase the borrowing rate because the borrower can
make risky investments (the hidden actions) that increase the variability of future
cash flows, thereby increasing the likelihood of default on the loan for any given
level of expected return on investment. Borrowers do so because they do not
bear the full cost of such risks. In particular, the borrower’s liability on loans is
limited to the value of the borrower’s assets that are distributed in the event of
bankruptcy. In pricing the loan, the lender must take these hidden actions into
account as well as bankruptcy administrative costs. (This particular hidden action
is known as the asset substitution problem in finance.)
 Slide 1-16
6.2 TAX PLANNING IN THE PRESENCE OF RISK-
SHARING AND HIDDEN-ACTION CONSIDERATIONS

Hidden-Action Problems in case of Borrowing or Lending

[Contracting in Capital Markets]
Ways of Elimination of Hidden action problems
• Hidden action problems can be eliminated by securing the loans and closely
monitoring the value of the secured assets.
• Alternatively, they can be eliminated by monitoring the actions of the borrower.
In practice, however, the monitoring costs are too high to eliminate the
problem. Instead, lenders use debt covenants that curb borrowers’ investment
opportunities and lenders also keep an (imperfect) eye on the value of the
borrowers’ assets.
 Slide 1-17
6.2 TAX PLANNING IN THE PRESENCE OF RISK-
SHARING AND HIDDEN-ACTION CONSIDERATIONS
Hidden-Action Problems in case of Employer-Employee Compensation
Contracting [Contracting in Labour Markets]
In the case of employer-employee compensation contracting, an identification
problem can arise when the employee is receiving deferred bonus-type
compensation which will be high when the firm’s profits in the future are high and
zero when the firm’s profits are negative. This compensation scheme is an optimal
response to two different economic forces.
• It could indicate a hidden action problem in which the employee’s effort level is
unobservable today but will affect profits in the future (an incentive contract).
• It could also arise when there are no hidden action problems at all but the
employee is subject to a constant tax rate while the employer faces a progressive
tax schedule.
In the presence of hidden-action problems, if employees face high taxes today and
lower taxes in the future while employers face low taxes today and higher taxes in the
future, then the tax-minimizing contract will typically defer compensation. Deferred
compensation is subject to default risk. If hard work by employees decreases the
likelihood of default, then the deferred compensation arrangement can also have
desirable incentive effects. The incentives can be increased even further by tying the
interest rate on the compensation deferral to firm profitability.
 Slide 1-18
6.3 TAX PLANNING IN THE PRESENCE OF HIDDEN-
INFORMATION CONSIDERATIONS

In a corporate restructuring, the sellers of the firm or of firm assets are

typically better informed about the value of what they are selling than
are the prospective buyers. If the sellers know that the assets are worth
more than the prospective buyers’ expectation of their value, given their
limited information, then the parties may find no mutually agreeable
price for the assets, and the restructuring may not occur even in the
presence of substantial tax benefits from doing so.

Example (Tax Planning Problem # 2, page 152): An owner-manager

of a firm is contemplating selling it to any one of a number of
prospective buyers. The firm has NOL carryforwards known to be worth
$50 million more to the buyers than to the seller. While the current
owner knows the value of the firm, the prospective buyers are uncertain
whether the firm is worth $500 million (including the extra $50 million
value in NOLs) or $700 million. The poorly informed buyers consider
both possibilities to be equally likely.
 Slide 1-19
6.3 TAX PLANNING IN THE PRESENCE OF HIDDEN-
INFORMATION CONSIDERATIONS

Example (Tax Planning Problem # 2, page 152):

Buyers’ offer and Seller’s acceptance in the selling process of the firm:

The only rational price the buyers should offer is $500 million. Why not $600
million, the expected value of the company? Because the seller knows whether
the company is worth $500 or $700 million. If the company is in fact worth $700
million the seller will retain the firm even though it is worth $50 million less to it
than to a buyer. Any bid above $500 million will result in the seller not selling the
$700 million firm. Why not $450 million, the value of the lower-valued company
to the seller. By assumption, there are many prospective buyers competing to
acquire the firm. Competition will force the winning bid to $500 million.

The seller will not always accept the highest rational offer made. Because the
seller will rationally walk away from all bids if the firm is in fact known by the
seller to be a higher-valued firm. The tax benefits will rationally be left lying on
the table.
 Slide 1-20

6.4 TAX PLANNING AND ORGANIZATIONAL DESIGN

When a complex organization is composed of distinct legal entities, its left

pocket is often taxed differently from its right pocket. This consideration applies
not only to multinational enterprises but also to enterprises that operate
exclusively within a single country. Sources of differences in taxation across
legal entities include:
(1) multistate taxation,
(2) industry-specific taxation,
(3) size-specific taxation, and
(4) special rules relating to NOLs and tax credits. In the NOL and tax credit case,
tax rules often prevent these attributes (NOLs and tax credits) from offsetting
the tax liability of any other entity in the consolidated group following a
merger.
 Slide 1-21

6.4 TAX PLANNING AND ORGANIZATIONAL DESIGN

Organizational Designs for Tax Planning Considerations

Centralized Efficient tax planning might require coordination of activities

vs. across many business units, or actions at the lower levels such
Decentralized as project selection and investment decisions might need to be
management approved by top management who better know the tax situation
facing the firm, and thus this coordination or approval could
call for more centralized decision-making.
The advantages of decentralized decision-making (better
decisions) could outweigh any tax costs or tax savings arising
from more centralized decision-making. Transfer pricing for
tax planning purposes may pollute the planning and control
features of a transfer pricing system in a decentralized firm
where important information is widely dispersed.
 Slide 1-22

6.4 TAX PLANNING AND ORGANIZATIONAL DESIGN

Organizational Designs for Tax Planning Considerations

Local vs. Local supply might be more cost-effective, ignoring taxes, than is
Foreign foreign supply because of lower monitoring costs, lower
suppliers of coordination costs, and lower transportation costs.
goods used Vertical integration with a foreign supplier may enable the
in corporation to recognize profits in a low tax jurisdiction where
production the tax rate is lower, perhaps through judicious transfer pricing
(subject to the scrutiny of the taxing authority.

Foreign Foreign subsidiary is separate tax paying entity and its income is
subsidiary taxable in the country of parent company when it is remitted.
vs. Foreign Foreign branch is subject to pay tax in the foreign country of
branch business and its income is taxable in the country of parent
company whether remitted or not subject to double taxation relief.
 Slide 1-23
6.5 CONFLICTS BETWEEN FINANCIAL REPORTING AND
TAX PLANNING

Importance of Numbers in the Financial Statements

There are a number of reasons why managers might be concerned about the
numbers in their financial statements:
1. Compensation contracts for top managers are often based on accounting
earnings.
2. Bond covenants written by lenders to curb conflicts of interest between the
lender and the borrower are often based on accounting numbers such as debt
to equity ratios, restrictions on dividends as a percent of retained earnings,
current assets to current liabilities, and interest coverage (earnings before
interest/interest).
3. Analysts and investors use accounting numbers to price securities (both debt
and equity), and managers might be concerned that reporting lower income
could lead to lower stock prices and higher interest costs.
4. Regulators often use accounting numbers to monitor and regulate firms.
5. Lobbyists and other interested parties use accounting numbers to push for
increased taxes and other penalties.
6. Large differences between book income and taxable income can lead to greater
scrutiny and audit adjustments by the taxing authority.
 Slide 1-24
6.5 CONFLICTS BETWEEN FINANCIAL REPORTING AND
TAX PLANNING

Conflict of Tax Considerations with Financial Reporting Considerations

• Often in tax planning a conflict emerges between tax savings/benefits and

financial reporting costs. However, there is not always a trade-off to be
made between tax savings and negative financial reporting consequences
(e.g., use of debt for tax savings may result in higher leverage ratio and
lower reported income).
• Often times lowering taxable income to reduce taxes also results in
reporting lower book income. Reporting lower book income can give rise
to financial reporting related costs – such as the costs of violating bond
covenant agreements with lenders or the stock market implications of
reporting lower earnings.
• Managers whose compensation is tied to reported profitability might
forego tax savings due to an inherent conflict of interest.
 Slide 1-25
6.5 CONFLICTS BETWEEN FINANCIAL REPORTING AND
TAX PLANNING
Conflict of Tax Considerations with Financial Reporting Considerations
Income Shifting Across Time
• Firms have incentives to defer (accelerate) taxable income if statutory tax
rates are expected to decline (increase).
• The corporate tax-rate reductions offer firms incentives to defer income and
give researchers an opportunity to examine firms’ willingness to trade off tax
savings with financial reporting costs.
• However, in addition to financial reporting costs, it is important to note that a
variety of nontax costs are associated with shifting income. One example is
potential tax costs to the other party to whom or from whom income is shifted
(an example of multilateral tax planning).
• Also, shifting income can change the timing of underlying economic activities,
which may bring about large nontax costs such as reduced operating
efficiencies, deterioration in customer relations, and additional inventory
holding costs (arising from delaying shipping). The planning and coordination
of income-shifting activities also entails administrative and implementation
costs, and managerial compensation plans might be affected by shifting
income across periods.
 Slide 1-26
6.5 CONFLICTS BETWEEN FINANCIAL REPORTING AND
TAX PLANNING
Conflict of Tax Considerations with Financial Reporting Considerations
LIFO/FIFO Studies
Inventory Valuation Methods:

US GAAP IASB (under IAS 2 Inventories):

(1) Specific identification; and (1) Specific identification (IAS
(2) Cost flow assumptions: 2.23); and
(a) average cost method (weighted- (2) Cost flow assumptions (where
average or moving-average method); specific identification is not
(b) FIFO method; and applicable):
(c) LIFO method (a) FIFO method; or
- specific-goods LIFO (traditional (b) weighted average method
LIFO or unit LIFO) approach (IAS 2.25).
- specific-goods pooled LIFO approach
- dollar-value LIFO method]. ** IAS 2 does not permit the use
of LIFO (IAS 2.IN13).
 Slide 1-27
6.5 CONFLICTS BETWEEN FINANCIAL REPORTING AND
TAX PLANNING
Conflict of Tax Considerations with Financial Reporting Considerations
LIFO/FIFO Studies : USA
Use of Dual Inventory Valuation Methods for different purposes:
• Many companies use LIFO for tax and external reporting purposes.
• However, they maintain a FIFO/average cost/standard cost system for internal
reporting purposes.
• There are several reasons to do so:

(1) Companies often base their pricing decisions on a FIFO, average, or

standard cost assumption, rather than on a LIFO basis.
(2) Recordkeeping on some other basis is easier because the LIFO
assumption usually does not approximate the physical flow of the product.
(3) Profit-sharing and other bonus arrangements often depend on a non-LIFO
inventory assumption.
(4) Finally, the use of a pure LIFO system is troublesome for interim periods,
which require estimates of year-end quantities and prices.
 Slide 1-28
6.5 CONFLICTS BETWEEN FINANCIAL REPORTING AND
TAX PLANNING
Conflict of Tax Considerations with Financial Reporting Considerations
LIFO/FIFO Studies : USA
Choice of LIFO:
• Companies ordinarily prefer LIFO in the following circumstances:
(1) if selling prices and revenues have been increasing faster than costs and
(2) if a company has a fairly constant “base stock.”

• Conversely, LIFO would probably not be appropriate in the following

circumstances:
(1) if sale prices tend to lag behind costs,
(2) if specific identification is traditional, and
(3) when unit costs tend to decrease as production increases, thereby
nullifying the tax benefit that LIFO might provide.
 Slide 1-29
6.5 CONFLICTS BETWEEN FINANCIAL REPORTING AND
TAX PLANNING
Conflict of Tax Considerations with Financial Reporting Considerations
Political Cost Impediments to Tax Planning:
Paying little or no explicit tax in socially unacceptable ways might have political costs
through negative campaign by advocacy group. In the USA, AMTBIA (alternative
minimum tax book income adjustment) was introduced largely for the perception that
large firms were paying little in taxes while at the same time reporting high profits to
shareholders.
Other Book-Tax Conformity Costs:
When filing their tax returns, corporations must provide a reconciliation between taxable
income and book earnings [Instruction 2.c.; Corporate Return Form IT-11GHA u/r 24(1aa)].
Other Informational Cost Impediments to tax Planning:
In USA, billions of dollars are spent:
• To secure professional assistance in reducing tax obligations;
• In maintaining records to support taxpayers’ claims concerning their tax obligations;
• To write and to enforce contractual agreements that are designed, in part, to reduce the
joint tax burdens among contracting parties.
Effective tax planning must be viewed relative to the costs of implementing these strategies.
 Slide 1-30

End of the Chapter

Thank you.