Taxes and Haven Activities: Evidence from Linguistic Cues

Abstract

Because so many multinational firms now use tax havens, researchers can move beyond using a simple dichotomous tax haven characteristic to identify tax-avoiding firms. Using recent advances in textual analysis proposed by Hoberg and Moon (2017, 2018), this paper uses the qualitative information in public filings to learn about the economic mechanisms of income shifting and refine researchers’ use of tax havens to identify tax-avoiding firms in two ways. First, we classify each tax haven country listed in Exhibit 21 into offshore input versus output activities. Second, we classify the use of input tax havens into those with and without economic substance based on firms’ mention of their physical presence in tax havens. We find that firms with offshore input activities in tax havens report lower effective tax rates, especially in tax havens where firms mention their physical presence. This translates into an estimated decrease of $1.3 million in cash taxes paid per firm-year. Overall, linguistic cues in firms’ qualitative disclosures provide robust incremental information beyond the dichotomous use of tax havens to reveal firms’ use of tax havens for tax-avoidance purposes.

Keywords: linguistics, tax haven, offshoring, economic substance, physical presence

JEL Classification: G30, H25, H26, M41