Firm Level Characteristics And Effective Tax Rate

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Firm Level Characteristics And Effective Tax Rate


Abstract


The broad objective of this contribution is to investigate which firm-specific characteristics impact on effective tax rates. In addition, the study provides an insight into how corporate governance helps to moderate the conflict of interest between resource owners and management in the area of effective tax planning Leaning on the positivist theory and the. To achieve the above objectives, we select a sample of 87 companies quoted on the Nigerian Stock Exchange between 2008 and 2014. The econometric model specified for the study was estimated using panel data regression approach with a preference for the fixed effect model based on the result of the Hausman test. The result of the study shows that a negative relationship exists between the explanatory variables of leverage, capital intensity, and effective tax rate. Implying that preponderance of debt over equity financing and huge investment on non-current assets tends to minimise corporate tax liabilities. The result reports a positive relationship between profitability, firm size, the moderating variable of ownership concentration and effective tax rate. We recommend debt financing, more investment in non-current assets so that companies can take advantage of the incentives, allowances to cut down on their tax liabilities. Tax planning; Effective tax rate; Managerial opportunism; leverage; Corporate governance.


Chapter One


Introduction

1.1 Background of the Study

Planning at the level of the national economy is essential or the effective allocation of scarce resources to improve societal welfare. To achieve this objective, a solid based public finance rooted on efficient tax policy is a prerequisite. Taxation as a fiscal policy tool is required to raise revenue to fund government expenditure. Tax is a compulsory levy without a quid pro quo effect and cast a burden by eroding the disposable income of the taxpayer. To reconcile these complexities, the taxpayer is faced with the dilemma of either contending with the eroded disposable income or making a concerted effort within the confines of the tax laws to reduce his tax liability. Modern corporate taxpayers have opted for the latter.

Tax planning is neither tax avoidance nor tax evasion, but the systematic application of professional expertise in ordering the activities of the taxpayer within the approved legal or regulatory frameworks to minimize the tax liabilities of the taxpayers. Issues of tax planning drew inspiration from the celebrated case of the Commissioner of Inland Revenue v Duke ofWestminster (1938) when Tomlin opined that:

Every man is entitled, if he can, to order his affairs so that the tax under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however, inappropriate the Commissioner of Inland Revenue or his fellow taxpayers may be, of his ingenuity, he cannot be compelled to pay an increased tax.

Tax incentives, exemptions or deductions offered by the tax authority to the taxpayer, has helped to encourage tax planning activities. Tax incentives are provided by the government to promote voluntary tax compliance, promote export activities, and encourage investment in some specific sectors. Companies leverage on these incentives to minimize their tax liabilities. While these incentives are not targeted at reducing government revenue, they are meant to attract more investment and improve the sophistication of the stock exchange market. However, the extent to which firms take advantage of these strategies varies from one company to another. Not all companies have equal tax planning capabilities. Hence, the question of which firm-specific characteristics predispose firms to tax planning?

The corporate tax planning literature is relatively young but very active (Hanlon & Heitzman, 2010). Advancement in this area of research has been achieved through developments in the principal – agent- government framework which is an extension of the agency theory propounded by Jensen and Meckling (1976). The recent inclusion of the corporate governance variable in the dynamics of tax planning has broadened the vista of tax planning research.

Extant literature in the developed countries of Europe and America are replete with studies on the variation of the tax burden in relation to firm-specific characteristics (Desai & Dharmapala, 2006; Gupta & Newbery, 1997; Holland, 1998 Minick & Noga, 2010). Conversely, to the best of our knowledge, there exist sparse empirical evidence on the determinants of tax planning in developing the economy with Nigeria as a reference point (Kiabel & Akenbor, 2014).

In summary, we find evidence of a negative relationship between leverage and capital intensity which means the tax shield in interest payment, capital and investment allowances helps to reduce effective tax rate for the selected companies. The explanatory variables of profitability, firm size and the interaction between effective tax rate and ownership concentration were positive.

Following the introduction, the next session focuses on literature review and development of hypotheses. Section three explicates the methodology with emphasis on the theoretical framework and model specification. Section four presents the estimation results and discussion of findings. Section five concludes the study.


1.2 Problems of the Research

Nigerian tax rate is set periodically by the Central Bank of Nigeria, to suit the state of the economy. However the Act is plagued by several problems that impact on business firms in country. For instance, the Act also provides that there shall be levied and paid for each year of assessment in respect of the profit of every company, tax at the rate of thirty Kobo for every Naira. This rate is among the highest in the world. It may negatively affect the status of investment in Nigeria. More so, the Act provides-

Where in any year of assessment, the ascertainment of total assessable profits from all sources of a company result in a loss, or where a company‘s ascertained total profits results in no tax payable, or to payable which is less than the minimum tax, there shall be levied and paid by the company the minimum tax prescribed.

It is clear from the above that the CITA provides for the payment of corporate tax even if the company fails to secure any gain or profit. In other words, companies are obliged to pay tax even in the event of incurring loss in their business. This is a serious problem that may negatively impact on companies in general and their investment in particular. Furthermore, corporate multiple taxation is another problem that can also leave an unpleasant impact on business firms in Nigeria. For example, Section 62(1) of the CITAA provides that the company paying dividend or making distribution shall deduct there from tax at the rate prescribed under subsection (2) of this section. Thus, the Act further provides thatthe rate at which tax is to be deducted under this section shall be 10 per cent. However, section 15 of the Act imposes the payment of tax at the rate of 30 % prescribed in section 29 (1) on a dividend received and distributed by a company. The effect of this is that the company is paying tax at this instance at the rate of 40%. This is a double taxation which also impacts on business firms which is also connected with the impact of interest rates on business firms in Nigeria is the complexity of the

Nigerian tax system. Before an incentive is granted a company has to pass through various agencies for screening and scrutiny. Lack of proper co-ordination between the various government agencies responsible for administering, approving and granting of various incentives constitutes a great problem and impediment to the investment in Nigeria. This is because the problem makes the incentives very difficult and too expensive to be obtained. This is a problem that can serve as a hindrance for the promotion of investment in Nigeria. It is these problems that this dissertation addresses.


1.3 Research Questions

Looking at the above problems, the following questions may serve as a guide in the course of this research.

  1. What impact-if any- does Interest rate have on business firms?
  2. Is Interest rate effective in promoting investment in Nigeria?
  3. Is there any loophole in the present interest rate that discourages investment in Nigeria?
  4. Is Nigerian corporate incentive tax regime adequate in curtailing anti investment in Nigeria?
  5. Is there any measure to be taken which is capable of curbing dis-investment firms in Nigeria?

1.4 Aim and Objectives

The main aim of this work is therefore to ascertain the impact of the Interest rate on business firms. It equally aims at realising the following objectives-

  1. To ascertain the efficacy of the Interest rate in the promotion of investment in Nigeria;
  2. To ascertain the imperfections in the existing interest rate militating against the promotion of investment in Nigeria;
  3. To examine the adequacy of the extant corporate tax penal regime in curbing the anti-business firms in Nigeria; ;
  4. To update the knowledge contained in the written literatures existing in the field of this research; and
  5. To make recommendations capable of addressing the challenges revealed in the study.

1.5 Statement of hypothesis

  • H1: There is no significant relationship between leverage and tax planning.
  • H2: There is a significant relationship between capital intensity and effective tax rate.
  • H3: Firm size influences the firm’s effective tax rate.
  • H4: There is a significant relationship between profitability and effective tax rate.
  • H5: There is a significant relationship between ownership concentration and effective tax rate.

1.6 Significance of the Research

It must be observed that revenue generated from taxation in general and corporate taxation in particular, sustains the economic and social needs of the nation. In fact, revenue serves multifarious ends, some of which have political, economic or social bearings. In a nutshell, the essence of taxation is to raise revenue for government expenditure or finance government projects, control consumer demand, encourage investment and savings, fight economic depression, inflation and deflation, guarantee equitable distribution of income and wealth, control the general trend of the national economy, and ensure a proper allocation of national resources.

Like any other type of taxation, corporate taxation essentially aims at raising sufficient revenue for the Government. This is to enable the government to make the provision of services like defense and security of the nation; maintaining law and order; and providing health services and education to the people of the nation. Revenue from this tax could also be used on capital projects, creating social and economic infrastructures, which improves the life of people and enable the economy of the country to grow. In other words, corporate tax can also be used in shaping the economic growth and development of the nation. In addition, corporate tax has become an instrument for wealth re- distribution between the wealthy and industrialized economies represented by the Multi- National Companies (MNCs), and the poor and emerging economies from where the resources are extracted. The MNCs own the technology, expertise and capital needed to develop the industries. They repatriate their earnings and often very huge profit to their wealthy countries. To tax the companies is a way of achieving the objective of wealth re- distribution, among these nations. Corporate tax can also be utilized to guide the behaviours of economic agents. The significance of this research lies in improving the regime of corporate tax system in Nigeria.


1.7 Scope and Limitations of the Research

Geographically, the research covers only Nigeria. However, references are made to other countries where it becomes necessary in order to buttress some certain points in this research. Unlike some countries that advocate consumption as the basis of taxation, Nigeria based its tax on income. Consequently, this contains the historical background of income tax in the country. Evolution and development of the law governing the corporate taxation is also incorporated into this work.

Despite the fact that corporate tax may cover all registered and incorporated companies including the oil producing companies, nevertheless in Nigeria the taxation of any company engaged in petroleum operation is governed by a legislation different from the one governing the taxation of other companies. All registered and incorporated companies are presently taxed under the Companies Income Tax (Amendment) Act of 2007, while the companies operating in the oil downstream sub sector are taxed under the Petroleum Profit Tax Act (PPTA), This is because of the peculiarities of the companies engaged in petroleum operations. The focus of this work is on the former.

It is important to note that one of the limitations in this work is the inability to cover all companies that are liable to tax in Nigeria for the purpose of obtaining information particularly empirical data. This is because of the financial constraint that does not allow to travel and investigate the reports of all companies in Nigeria or to interview any resource person that can make a relevant contribution to the work. Further the work has also hampered by serious lack of readily available statistical data on companies and different aspect of their activities connected to the taxation and investment in Nigeria. Another limitation is the skeptical attitude of some individuals assumed to be in possession of certain facts relevant to the research. They withhold or distort the particulars on the ground that spread of such information can serve as a threat to their trade or business and office or their personality.


1.8 Organizational Layout

Chapter one of this works begins with general introduction to the research work. It begins by a brief introduction of the laws governing the corporate tax in Nigeria. Importance of taxation in general and corporate taxation in particular is succinctly highlighted. It equally scans some problems connected to the impacts of Interest rates on business firms. In addition, aims and objectives of the research as well as doctrinal or priori research method employed in the work are clearly spelled out. Moreover, geographical, historical and legal scopes of the research are all enclosed in the chapter. In order to justify the cause for this undertaking, significance of the research and those whom the research is going to benefit are also included. Besides, the chapter also states the significance of the research specifically the interest rates and its impacts on business firms in Nigeria. The chapter ends with the organizational layout that briefly states the content of the work in general.

The second chapter is on conceptual clarification and background context for interest rate on business firms. It is tagged as ―Analysis of the Concept, Development and Legal Foundation for Corporate Taxation in Nigeria. It therefore analyses some basic concept, legal foundation and development for corporate taxation in Nigeria. It also discusses the issue of corporate bodies liable to pay the tax. These include the Nigerian and foreign companies, special companies and representatives of the companies liable to pay the tax. Furthermore, corporate income chargeable to tax is also explored. Subsequently trading profits and investment receipt are thoroughly discussed. Other issues treated under the chapter include the rate of corporate tax and corporate multiple taxation.

Chapter three introduces the research methodology, from the research design, study area to the population of study and specification.

Chapter four generally analyses the research data, test the objectives and present the results and answers to the research questions.

Finally, chapter five concludes the research work. It therefore recapitulates the findings of the work and proposes some workable solutions to the problems discovered in the course of the research.


Chapter Five


Summary, Conclusion and Recommendation

5.1 Summary of Findings

Corporate tax is a tax statutorily imposed upon the profits of companies and corporate bodies. It is mainly exacted for revenue generation to enable government to properly perform its duties. In Nigeria, corporate tax revenue occupies a significant position in the economy of the country. About one trillion Naira was collected by the Federal government as corporate tax in 2013. This was equivalent to one fifth of Nigerian Federal Government budget for that year.

In the same vein, investment is very vital for it creates jobs, alleviates poverty, reduces unemployment and brings foreign capitals to the country. Thus, promotion of investment has become imperative for economic development of a nation. Government has to prepare a set of activities to attract investors. Such activities are referred to as business firms. Part of it is to provide investment climate and advertise for it in order to convince investors to invest or reinvest in the country.

However, before investing in a particular area, companies normally make a feasibility study of the investment project and determine on how, when, where and how much capital will be spent on the available opportunities for the investment. This is what is called investment decision. In making it, there are various factors that are taken into consideration and eventually impact on it. The question is whether corporate tax is part of them and whether the legislation governing it has impact on business firms. Accordingly, the research has arrived at the following findings-

5.1.1 High Rate of Corporate Tax

The present corporate tax rate which is statutorily imposed on the profits of companies in Nigeria is 30%. However, the rates of corporate tax at international level vary from one country to another. Nigerian corporate tax is among the highest in the world. It occupies the second position after the USA that has the corporate tax rate of 35%. As a result of this rate, many investors may prefer to inject their resources in a country that is tax haven favourable to their business. For instance, as at 1996 when the Nigerian corporate tax rate was reduced to 30% the rate in Ghana was 8%. This is one of reasons that make Ghana a preferred location among investors willing to invest in West Africa.

5.1.2 Imposition of Tax on Company‘s Capital

Normally, corporate tax is imposed upon the profits of any company accrued in derived from, brought into or received in Nigeria. Company‘s profit is therefore the income chargeable to tax. However, the CITAA prescribed the payment of minimum tax on companies where their total profits result in a loss, or no tax payable, or the payable tax is less than the minimum tax Furthermore, a pre operational levy of N20,000 for the first year and N25,000 for every subsequent year is also imposed on companies after 6 months of incorporation prior to the commence of business.

Corporate tax is generally payable on profits not on capital. The company‘s profits are therefore the ground on which the tax is imposed. To oblige companies to pay corporate tax in the event of incurring loss or to be paying certain amount of money ahead of the commencement of business is to tax their capital. To tax companies before the commencement of business or companies that operated at loss has negative impact on business firms. To tax them is to discourage them from investment.


5.2 Conclusion and Policy Implications

The fundamental objective of this study is to investigate the impact of firm-specific characteristics on effective tax rate with corporate governance as a moderating variable. To achieve this objective, we use 609 firm-year observations in a panel data form for 87 companies listed on the Nigerian Stock Exchange market between 2008 t 2014. We proxy the dependent variable (ETR) using the ratio of income tax expense to profit before tax.

To address the issue of managerial opportunism as propounded by Desai and Dharmapala (2008), we introduced a corporate governance variable (ownership concentration), to moderate the likely problem of agency conflict resulting from the divergent interest of resource owners and managers of the businesses. It was discovered that more independent firms without controlling shareholders reported higher effective tax rate due to the positive and significant relationship between ownership concentration and effective tax rate. The relationship between firm size and effective tax rate is positive and in line with the Zimmerman political cost theory. The variables of capital intensity and leverage are negative, signifying that they both lead to tax minimization even though the extent of minimization are not statistically significant. Our result shows that more profitable firms lack the incentive to reduce their income tax liability. By intuition, the higher the assessable profit, the higher the effective tax rate.

Our study contributes significantly to the small but growing body of knowledge on the dynamics of tax planning from a developing country perspective with Nigeria as a reference point. The coverage of 87 firms with 609 observations is considered extensive enough and forms one of the major strength of the study. The introduction of corporate governance variable to moderate the possible conflict of interest between resource owners and managers is novel to this line of research. To corporate stakeholders in Nigeria, the research will serve as a useful reference point for tax and tax-related policies and strategy towards diversifying the economy of Nigeria from its mono-product status.


5.3 Recommendations

To this extent, the work has been summarised. The major findings have been identified. Recommendations have therefore been made as follows

5.3.1 Corporate Tax Rate Reduction

The rate of tax statutorily imposed upon the profit of any company in Nigeria is thirty percent (30%). This rate is among the highest in the world. To avoid negative impact on the flow of foreign investment to the country, the amount should be reduced to 20%. This is to harmonise with some African countries such as Libya, Egypt, Mauritania and Madagascar and other Asian and European countries such as Turkey, Thailand, United
Kingdom and Russia. The reduction will definitely attract more investors and retain the existing ones.

5.3.2 Repeal of Minimum Tax Provision

Section 22A(1) of the CITAA provides for the payment of corporate tax if the company fails to secure any profit. This is a serious problem that has a negative impact on companies in general and their investment in particular. Consequently, the provision should be amended.

5.3.3 Elimination of Corporate Multiple Taxation

To encourage more investors, corporate multiple taxation must be eliminated. Companies‘ income tax alone is enough. Generating revenue to enable government to provide public services and infrastructures like education and development of information technology is part of the objectives of taxation in general and the corporate tax in particular. Consequently, companies income tax alone is enough on companies assessable profits.

5.3.4 Amendment of CITAA Provision for Non-Compliance

N600, N1,000, N20,000 and N25,000 provided under sections 74, 73(1), 71(1) and 41 (3)of the CITAA respectively as fine for corporate tax avoidance or evasion are not adequate. To ensure compliance and generate more revenue that can be used for business firms, the amount must be increased to reflect current realities. The amounts should be raised to N60,000, N10,000,N200,000,and N250,000 respectively. This is in consideration of the huge amount of profits earned by companies nowadays particularly transnational corporations. Consequently, provisions of the said sections of the Act should be amended.

5.3.5 Good Governance and Judicious Management of Revenue Collected

Good governance and judicious management of tax revenue is one of the most effective ways for business firms. Once the revenue collected is properly utilised on actual projects that have a direct impact on the taxpayers it will automatically encourage companies to invest more and positively impact on business firms. Once the revenue is not looted or squandered it will positively impact on business firms. This is because government will have more money for public services and security of life and properties. This will definitely encourage companies to expand their investments and attract new investors and increase the flow of FDIs to the country.


5.4 Contribution to Knowledge

Generally the work has mainly as certained the impact of Interest rate on business firms. In the field of knowledge, the works has specifically made the following contributions-

5.4.1 Satisfaction of the Current Need

The first contribution of this work to knowledge is that it satisfied the current need for a tax literature that provides an alternative solution to over dependence of government on oil revenue. Presently, Nigeria is in a serious economic recession. Inadequate revenue to cater for government need for the execution of its projects and other functions is one of the major problems. Upstream oil and gas sector has become the dominant driver of Nigeria economy which has become over-dependent on the sector. It provides the bulk of funding for the three tiers of government and over 95% of the foreign exchange earning in country. About 70% of the government revenue comes from the sector.

The collapse of the oil price in the international market has contributed in reducing the revenue earned by government from oil sector. Consequently alternative to this must be sought to recover from the recession. If the government budget in 2013 was about five trillion Naira and the Federal Government tax collection was about the same amount of which one fifth of it is from corporate taxation, then this should be part of the alternative sources to be emphasized on by the government. Therefore any work on it is very much needed. This is part of the literary contribution to knowledge of this research. This is because it provides reference for various institutions, non-governmental organisations and government agencies. The work is useful to academic staff, students of law and taxation, legal practitioners and other stakeholders in the field of taxation.


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