1.

Problem Statement

2. Study rationale

3. Reason to include developed and developing countries

Total government revenues of developing countries amounted in 2012 to about 6,9 trillion USD
(UNCTAD 2015, 185). About half of that stems from corporate contributions. The other half
comes from personal income taxes, indirect taxation and other revenue sources, such as
concessions, grants and also development aid. The latter category is often overlooked in tax
studies but is very relevant for developing countries: also, in terms of missed revenue.
Advanced economies miss own ODA target by 191 billion USD
The best-known target for international aid is that donor countries offer 0.7% of their Gross National
Income (GNI) in Official Development Assistance (ODA) (OECD no date a). In the UN Resolution of 24
October of 1970, the following commitment was assumed:

“Each economically advanced country will progressively increase its official development
assistance to the developing countries and will exert its best efforts to reach a minimum net
amount of 0.7% of its gross national product at market prices.” (UN no date a)
At subsequent UN conferences and other international summits many developed countries
reaffirmed they would hit the target by 2015. For instance, in 2005 the EU Member States pledged
to increase ODA to 0.7% of GNI by 2015 and included an interim target of 0.56% by 2010. The EU
Heads of State and Government reaffirmed their commitment to reach the 0.7% target by 2015 at
the European Council on 7/8 February 2013 (European Commission 2013).

It is common knowledge that the target has not been hit yet. The margin by which countries have
missed the mark is however quite astonishing. The gap is now a whopping 191 billion USD (UN no
date b). In fact, figure 1 shows that on average the ODA contributions have fallen since 1960. Not
only did economically advanced economies not live up to their repeatedly given commitments,
collectively they are falling short further and further. There are only 6 countries (out of 45) that
contribute more than 0.7% of their GNI 10

On the other hand, on a global policy level the outbreak of the Covid-19 virus has given rise to
support for designing a global ‘Marshall Plan’ (OECD 2020c, slide 24). This could lead to a
(temporary) larger contribution to developing countries, for instance through the forgiveness of
government debts. This could significantly bolster developing countries’ financial positions and help
them weather the Covid-19 storm.

The UN estimates that developing countries lose about 100 billion USD in tax revenue 11 due to tax
avoidance (UNCTAD 2015, 200)12. This amount is directly related to inward investment stocks linked
to offshore investment hubs. This estimate therefore only regards tax avoidance and does not
include other causes of revenue loss, such as corruption or tax evasion.

This paper focuses on developing countries, because the corporate tax receipt is especially important to
them and they have arguably been affected most by corporate tax avoidance practices (UNCTAD 2015,
200). Besides, for the international tax system to function, also developing countries have to be able to
apply the (new) rules to determine where corporate profits should be taxed. And they already have
enough problems with the system as it is now and certainly do not need or have the capacity to deal
with additional complexities (Cooper et al 2017, 9).
The objective should be to raise the total revenue developing countries collect, not to gain a
pyrrhic victory in the tax avoidance battle. UNCTAD points out that developing countries need
inbound investments (UNCTAD 2015, 210). Even though tax avoidance reduces their tax revenue
with 100 billion USD, developing countries are able to collect 725 billion USD in revenues from
their foreign investors. Economies are not zero-sum games 13. Too stringent measures to battle
tax avoidance could have as an unintended effect that investments will not take place at all or
will take place elsewhere. This would effectively reduce the tax revenue, rather than raise it.
Therefore, there has to be a balance between those measures to prevent tax avoidance and
those to stimulate investment (UNCTAD 2015, 207).

There is fierce competition amongst developing countries for foreign investment. UNCTAD
shows that tax is a very important determinant for where investments take place, more so than
is commonly believed (UNCTAD 2015, 177). Besides, it is not only the level of taxation, but also
the corresponding administrative burden and the long-term (political) stability and predictability
that are important drivers. This (also) has caused developing countries to compete between
each other to attract the foreign investments. Often by offering substantial tax advantages to
foreign investors that are not available to local competitors (Rosenzweig 2010, 995). These types
of beggar-thy-neighbour policies structurally drive down tax revenues across developing
countries (Keen and Brumby 2017). Therefore, there is a need for more intelligent (collective)
measures to stimulate investments across developing countries. A minimum tax rate as
suggested in Pillar Two (OECD 2019d, 2020a, 27-8) could be beneficial in protecting developing
countries from the sort of harmful tax competition in the corporate income tax area that is
currently very much too common. Similarly, the third option described in paragraph 6. of this
paper could be advantageous in this regard.

The UN data predates the entire OECD Base Erosion and Profit Shifting (BEPS) project 14. So,
there is a measure of uncertainty what the estimate would be today. For instance, the
divergence of formal tax rates was a key driver in the 2015 OECD estimates on tax avoidance
(Næss-Schmidt forthcoming, 2). Over the last few years, however, CIT rates the world over have
been converging strongly towards the 20-25% range. Moreover, BEPS measures that have since
been implemented (OECD 2019e) should have taken away at least some the incentives to route
investments through investment hubs. Additional BEPS measures, such as a minimum tax rate
(Pillar Two) (OECD 2019d, 2020a, 27-8), should act further to break the relationship between
investment hubs and the taxable return on these foreign investments. More quantitative
research is therefore needed to determine the effects of measures already in place or planned
and thus to more accurately quantify the level of tax avoidance the developing countries still
face today.

(i) A logical approach by looking at the coherence of the rules

of the Unified Approach from both an advanced economy and developing country perspective.
In any event, developing countries could push for wide support for a global Marshall Plan to help
countries fight and recover from the Covid-19 pandemic. This could, at least, ensure that the current
shortfall will not grow even larger as also many advanced economies face growing deficits as a result
 of emergency measures to combat Covid-19. And it could conceivably (temporarily) increase the
contributions that advanced economies provide in ODA, for instance through the forgiveness of
government debts. Such a measure would, in fact, not actually increase government expenditure
levels for donor countries but would help developing countries greatly in bolstering their financial
position and, thus, increase their ability to combat the pandemic and the fall-out afterwards.

4. Definition of developed and developing countries

 Developing countries

That has not achieved a significant degree of industrialization relative to their populations, and have, in
most cases, a medium to low standard of living.

 Developed countries

That has achieved a significant degree of industrialization relative to their populations, and have, in
most cases, a high standard of living.

The World Bank assigns the world’s economies to four income groups-low, lower-middle, upper-middle,
and high-income countries. This classification is updated each year on 1 st July based on GNI per capita in
current USD (using the Atlas method exchange rates) of the previous year. The classification change for
two reasons:

a. In each country, factors such as economic growth, inflation, exchange rates, and population
growth influence GNI per capita.

b. To keep the income classification threshold fixed in real terms, they are adjusted annually for
inflation. The Special Drawing Rights (SDR) deflator is used which is a weighted average of the
GDP deflators of China, Japan, the United Kingdom, the United States, and the Euro Area. This
year, the thresholds have moved up in line with this inflation measure.

5. Variables used in the study along with definition, data collection and measurement
I. Tax avoidance
Definition: Activity/activities taken up to postpone/defer, reduce and pass the tax obligation.
This has been defined by Hanlon and Heitzman (2010) as: Tax avoidance shows the series of
strategic planning to avoid tax such as the investment in local government bond’s in order to
save explicit taxes. They also deliberated that the other terms used to avoid the tax include “tax
evasion,” “tax aggressiveness,” “tax sheltering,” and “noncompliance”. Furthermore, they
concluded that any tax planning or strategy adopted anywhere with or without a series of action
in order reduce the taxes is categorize as “tax avoidance”. (pp. 137)

Measurement

Three different ways to measure the tax avoidance (Hanlon and Heitzman, 2010):

a) Effective annual tax rate

 Definition Robinson et al. (2010) and McGuire et al. (2014) defined that effective annual
tax rate as total tax expense reported in income statement upon earnings before
taxes.

They also argued that the effective annual tax rate shows the activities which measure
the tax avoidance and affect the firms net income. They supplemented their view that the
effective annual tax rates are also used by investors and managers to gauge the tax
burden and tax avoidance stage.

Difference between the statutory tax rate and the effective annual tax rate, where keeping the
statutory tax rate as benchmark.

The deviation between STR (Statutory Tax Rate) and EATR (Effective Annual Tax Rate) shows
a direct or positive relation with tax avoidance. So, larger the difference the greater level of tax
avoidance will be recorded.

Data of statutory tax rates

A data source named as “KPMG Global Tax Rates” will be used.

b) Longer period effective annual tax rate

Measurement: An average of five years effective annual effective tax rate will be used to
measure the firms overall tax liability.

The average effective annual tax rate can be measured by taking the sum of tax expenses
of five years and dividing it by the sum of earnings before taxes of those five years
(Dryeng et al., 2008).

c) Book-tax difference

It can be calculated as the earnings before taxes reported in income statement less taxable
income and divided by total assets, where taxable income is calculated as the total tax
expense divided by statutory tax rate (Graham et al., 2014; Kerr, 2018).

II. State level governance

 World Governance Indicators (WGI) issued and published by the World Bank can be
used to measure the State level governance.
  State level governance shows a country’s legal, political and institutional environment.
 WGI uses the six indicators to measure the state level governance such as; control of
corruption, rule of law, voice and accountability, regulatory quality, political stability and
absence of violence and government effectiveness.
 WGI shows a weakest governance level at an estimated point of -2.5 and a strongest
governance level at an estimated point of 2.5.
 Gonzalez and Garcia-Meca, 2014; declared four of these six factors as very important for
any state’s governance. These factors are; the effectiveness of a government, regulatory
quality of a government, persistence of rule law and control of corruption.
III. Accounting standards

If a country is maintaining its financial statements under IFRS then a value of “1” will be
assigned whereas for GAAP it’s assigned as “0”.

The data related to IFRS adoption countries is available at the official website of IFRS.
ifrsapplication@[Link]

IV. Tax disclosure

(SFAS) 109 In the U.S. the Statement of Financial Accounting Standards (SFAS)
109 discussed that the following disclosure items must appear in a company’s yearly
financial reports: (i) the returns tax synopsis, which details the important components
of returns tax expenditure, (ii) the rate reconciliation, reconciling presented returns
tax cost with the amount that would come from applying the local federal statutory
rate to pre-tax returns, and (iii) the schedule of deferred tax status, which supplies
information regarding DTLs and DTAs (FASB, 1992).

FIN 48: FIN 48 is an official interpretation of United States accounting rules that
requires businesses to analyze and disclose income tax risks. It was effective in 2007
for publicly traded entities, and is now effective for all entities adhering to US GAAP.
A business may recognize an Income tax benefit only if it is more likely than not that
the benefit will be sustained. The amount of benefit recognized is based on relative
probable outcomes.

V. Audit tenure
The data related to audit tenure is available in published and reported financial
statements. In previous researches a value of 1 is inserted if audit-client relationship
exceed 2 years period while 0 for less than 3 years (Augustine O. Okolie, 2014).

6. Control Variables
At State Level

Worldwide tax system (WW)

Kanagaratnam et al., 2016; assigned a value equal to one if a country’s tax system based
on a worldwide approach as compared to a territorial approach.

Common-law country (COM)

Kanagaratnam et al., 2016; used common law practice as compared to civil law practice.
Whereas, the aforementioned researcher assigned zero if a country is following the civil
law practice whereas common-law practice was assigned a value equal to one.

Economic development (GDP)

Kanagaratnam et al., 2016; economic development (GDP) is controlled by taking the log
of GDP per capita.

Statutory tax rate (STR).

The statutory tax rate can be controlled by KPMG Global Tax Rate (Atwood et al., 2012).

At Firm level

Firm size

As witnessed from the previous researches firm size can be controlled by taking the log
of the total assets (Zimmerman, 1983; Ronen and Aharoni, 1989; Omer et al., 1993; Zeng, 2010).

Profitability

Zhang (2016) took return on assets as a proxy to measure the control variable of
profitability and measured it as earnings before extraordinary items and preferred dividend to
total assets.
Leverage

Dyreng et al., (2018) measured total liabilities to the sum of assets to control the effect of
leverage.
Capital intensity

The capital intensity is measured as the sum of property, plant and equipment divided by
sum of assets (Lennox et al., 2013).
 Intangible asset intensity

Chen et al. (2010) argued that the treatment of tax and accounting on intangible assets are
different. He measured intangible assets intensity by taking the total intangible assets as
numerator and total assets as denominator.
Inventory intensity.

Inventory intensity is the ratio of total merchandise inventory divided by total assets and
it is supported by Gupta and Newberry (1997) and Adhikari et al. (2006).
7. Sample and Data

The sample data of 50 firms from each of the 40 countries, constituting as 20 developing and 20
developed countries, will be used.
The countries will be chosen on the basis of GDP for a period of ten years starting from 2011 to
2020.
 Thomson Reuters DataStream will supplement the financial information on tax
avoidance.
 The data related to non financial firms is available on “DataStream Global Equity
Indices” which include the stocks on the basis of the market capitalization.
 Moreover, the respective stock exchanges of the countries under studied will also be
undertaken to collect data; like Japan’s NIKKEI 225 stock exchange, UK’s FTSE350 and
US’ S&P 500 composite.