Lisa De Simone

Internal Control Quality: The Role of Auditor-Provided Tax Services

We propose that auditor-provided tax services (tax NAS) improve internal control quality by accelerating audit firm awareness of transactions material to the financial statements. Using data from 2004 to 2012, we find robust evidence that companies purchasing tax NAS are significantly less likely to disclose a material weakness and that this result is not due to auditor independence impairment. A onestandard-deviation increase in tax NAS is associated with approximately a 13 percent decrease in the rate of material weaknesses relative to the base rate. These results are robust to tests addressing endogeneity concerns. Additional cross-sectional analyses reveal expected increased effects of tax NAS on internal control quality (1) after significant operational changes that require changes to the internal control structure, and (2) earlier in the relationship with the financial statement audit firm, when there are fewer established lines of communication between the audit team and client. This paper contributes to the knowledge spillover literature by identifying a mechanism through which tax NAS improve overall financial reporting quality.

Income Shifting Using a Cost Sharing Arrangement

This study investigates the use of a cost sharing arrangement (CSA) by a multinational corporation (MNC) with domestically developed intangible property (IP) to shift the income attributable to the IP to low-tax foreign jurisdictions. Using a strategic tax compliance model, we identify three major effects that determine whether an MNC will use a CSA to develop the IP rather than develop the IP domestically: an operating intangible effect, an undervaluation effect, and an enforcement effect. First, we find that the MNC is more likely to use a CSA to develop the IP when the MNC has valuable domestic operating intangibles, such as a global brand. Second, the MNC is more likely to use a CSA if the nature of the IP development project allows the MNC to understate the fair market value of the IP. Third, the MNC is less likely to use a CSA if the tax authority can cost-effectively challenge the position and impose retroactive revaluations of the IP. We also compare the effects of the rules in the U.S. to the OECD transfer pricing guidelines used in most other countries.

R&D and the Rising Foreign Profitability of U.S. Multinational Corporations

We investigate how R&D contributes to rising foreign profitability in U.S. multinational corporations (MNCs) through wage savings and tax incentives. Our results suggest that wage savings increase foreign profit margins attributable to foreign R&D, while tax incentives increase foreign profit margins attributable to domestic R&D. By exploring their relative importance, we find that wage savings are more important than tax incentives in explaining foreign profit margins when the wage discount substantially exceeds the tax differential, and vice versa. Cross-sectional tests show that the effect of foreign R&D wage savings increases with access to local human talent and decreases with the cost of moving R&D abroad, and the effect of tax-motivated income shifting related to domestic R&D decreases with transfer pricing risk. Our evidence sheds light on the importance of R&D in corporate income shifting that separates the location of economic activity from the location of reported taxable income.

Transparency and Tax Evasion: Evidence from the Foreign Account Tax Compliance Act (FATCA)

We examine how U.S. individuals respond to regulation intended to reduce offshore tax evasion. Specifically, we study investment responses to the Foreign Account Tax Compliance Act (FATCA), which requires foreign financial institutions to report information to the U.S. government regarding U.S. account holders. We document a

Does a common set of accounting standards affect tax-motivated income shifting for multinational firms?

15.3 billion decrease in equity foreign portfolio investment to the U.S. from tax haven countries after FATCA implementation, consistent with a decrease in “round-tripping†investment activity attributable to U.S. investors’ offshore tax evasion activities. When testing total worldwide investment out of financial accounts in havens post-FATCA, we find a decline of

Unprofitable Affiliates and Income Shifting Behavior

56.6-

When are Enhanced Relationship Tax Compliance Programs Mutually Beneficial

78.0 billion. We also provide evidence of other important consequences of this regulation, including increased expatriations of U.S. citizens and greater investment in alternative assets not subject to FATCA reporting, such as residential real estate and artwork. Our study contributes to both the academic literature on regulation and crime and to the policy analysis of regulation to reduce tax evasion.