IT Environment Quality and Effectiveness of Controls Over the Tax Function and Income Tax Avoidance

Abstract

The complexity and frequent changes of multi-jurisdictional tax requirements generate a demand for a robust supporting information environment. If a firm’s information technology (IT) environment is not able to handle these tax complexities, that inability increases the risk of errors in the firm’s financial accounting for income taxes and the risk of ineffective tax avoidance strategies. We initially investigate the relation between IT-related material weaknesses (MWs) and tax-related MWs and find that having an IT-related MW is associated with a higher probability of having a tax-related MW. We then examine whether the quality of a firm’s IT environment influences its tax avoidance effectiveness. In addition, we find firms that restate their financial statements are more likely to disclose IT-related and tax-related MWs in advance of the year they announce that they must restate. We also show that having an IT-related MW hinders tax avoidance and that firms having a CFO with IT expertise or receiving the Most Admired Knowledge Enterprise award are also positively associated with tax avoidance. Our results are consistent with the idea that when firms have higher quality IT environments, they are more likely to have more effective controls over the tax function and similarly their tax avoidance efforts are more effective.

Keywords: Information technology, material weaknesses, accounting for income taxes, tax avoidance