A recent study indicates that enhanced financial auditing reports are significantly influencing the actions of multinational corporations, particularly in terms of international tax strategies. The research shows that the requirement for more comprehensive analysis in financial audits is helping to reduce the practice of shifting funds across borders to minimize tax liabilities.
Over the past two decades, audit authorities globally have implemented new standards mandating that financial auditors provide expanded audit reports that include “key audit matters” (KAMs). These KAMs identify critical, complex, or challenging issues within a company’s operations that auditors encountered while reviewing financial statements during a specified period.
According to Nathan Goldman, a co-author of the study and a professor at North Carolina State University’s Poole College of Management, initial research suggested that KAMs had minimal effect on auditing practices and little value for investors. However, this study took a different approach by examining a specific KAM related to uncertain tax positions (UTPs).
UTPs refer to the necessity for companies to maintain a tax reserve for a certain duration in case they face an audit and may owe more taxes than they initially estimated. Goldman noted that the research targeted KAMs regarding UTPs that involve multinational entities moving money among various holdings to attain favorable tax positions. The primary goal was to determine if enhanced audit reports could influence corporate behavior, specifically regarding the movement of funds internationally to lower tax obligations.
The researchers gathered financial, economic, and tax data from sources such as Amadeus, the International Monetary Fund’s World Economic Outlook Database, and The Tax Foundation. Their analysis concentrated on multinational firms based in Europe that operated across multiple countries, reported positive pre-tax income, and disclosed financial statements publicly. The study ultimately included data from 207,792 affiliate-year observations of 8,389 distinct companies and 45,909 unique affiliates across 25 European countries from 2012 to 2021.
Impact of KAMs on Corporate Behavior
By utilizing statistical methods, the researchers evaluated the influence of UTP KAMs on corporate conduct. Goldman explained that the staggered adoption of expanded audit reports by various European nations created a natural experiment that allowed them to observe any behavioral changes following the introduction of UTP KAMs.
The findings revealed a notable effect. “When a multinational corporation’s audit incorporated a UTP KAM, that corporation was significantly less likely to engage in international income shifting,” Goldman stated. This suggests that companies recognize that such practices introduce uncertainty for investors regarding their tax positions, and the presence of a KAM related to UTPs makes income shifting less appealing.
Goldman noted the intriguing aspect of this study, particularly regarding the unintended consequences of expanded audits related to UTP KAMs. He emphasized that a focus on the specific areas associated with each KAM—such as revenue or research and development—may provide a clearer understanding of their impact, rather than considering KAMs collectively.
Publication Details
The research paper titled “Tax-related Key Audit Matters and Changes in Multinational Income Shifting” was published in The Accounting Review. It was co-authored by Christof Beuselinck from the IESEG School of Management in France, Jochen Pierk from Erasmus University Rotterdam, and Cinthia Valle Ruiz from IE Business School in Madrid, Spain. The study highlights the potential broader implications of regulatory changes in auditing practices, particularly concerning multinational tax planning.
Source: NC State University. Photo: NC State University.
