Financial Derivatives in Corporate Tax Avoidance: Why, How and Who?

Abstract:     
Financial derivatives have an increasingly common, yet underexplored, role in corporate tax avoidance. This study examines why derivatives are appealing for tax avoidance, how they reduce taxes, and which firms likely use them in this manner. I find that derivatives are appealing because they enable replication of economic positions, blur economic substance, and introduce ambiguity in tax reporting. Tax shelter analyses reveal that, when combined with creative ownership structures, derivatives reduce taxes by generating noneconomic losses and offering disparate tax treatment of similar (and often identical) financial positions. Lastly, consistent with the tenets of effective tax planning, I predict and find that suspected derivatives-based tax avoiders have more temporary book-tax differences, investment sales, and material operations in tax haven countries than other firms.

Number of Pages in PDF File: 50

working papers series