Taxes and Haven Activities: Evidence from Linguistic Cues

Abstract

Using recent advances in textual analysis proposed by Hoberg and Moon [2017, 2018], this paper refines the use of tax havens to identify tax-avoiding firms in two ways. First, we classify the use of tax havens into outbound payments and inbound receipts based on firms’ activities in tax havens. Second, within outbound payments to tax havens, we further classify the use of 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 outbound payments to tax havens without physical presence report lower effective tax rates and higher unrecognized tax benefits than firms without such payments. This translates into an estimated decrease of $1 million dollars in cash taxes paid per firm-year. Overall, linguistic cues in firms’ qualitative disclosures provide incremental information beyond the simple 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