Deferred Taxation Under Default Risk

23 Pages Posted: 21 Jul 2018

See all articles by Cristian Carini

Cristian Carini

University of Brescia

Michele Moretto

University of Padua, Dep of Economics and Management

Paolo M. Panteghini

Department of Economics and Management; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Sergio Vergalli

University of Brescia - Department of Economics; Fondazione Eni Enrico Mattei (FEEM), Milan

Date Written: June 01, 2018

Abstract

In this article, we have used a continuous EBIT-based model to study deferred taxation under default risk. Quite surprisingly, default risk has been disregarded in research on deferred taxation. In order to underline its importance, we first calculated the probability of default, over a given time period, together with the contingent value of tax deferral. We then applied our theoretical model to a sample of 27,749 OECD companies. We showed that, when accounting for both firms with a negative EBIT and firms with a probability of default higher than 50% (over a 10-year period), a relevant percentage of firms were close enough to default. Hence, these taxpayers should not consider deferred taxation in their financial statements, for the sake of prudence. Moreover, under default, the expected present value of deferred taxes was much lower than that obtained in a deterministic context. Hence, if we look at deferred taxes from the Government’s point of view, we must consider them as being risk-free loans. However, only a portion are subsequently repaid, due to default. This implies that, when a Government allows accelerated tax depreciation it should be aware of future losses due to default. So far, these estimates have been missing, although techniques do exist and are quite practical.

Keywords: capital structure, contingent claims, corporate taxation and tax depreciation allowances

JEL Classification: H250, M410

Suggested Citation

Carini, Cristian and Moretto, Michele and Panteghini, Paolo M. and Vergalli, Sergio, Deferred Taxation Under Default Risk (June 01, 2018). CESifo Working Paper Series No. 7057, Available at SSRN: https://ssrn.com/abstract=3210530

Cristian Carini

University of Brescia ( email )

Piazza del Mercato, 15
25122 Brescia
Italy

Michele Moretto

University of Padua, Dep of Economics and Management ( email )

via Del Santo 33
Padova, 35123
Italy
+39 049 8274265 (Phone)
+39 049 8274211 (Fax)

Paolo M. Panteghini (Contact Author)

Department of Economics and Management ( email )

Contrada Santa Chiara 50
BRESCIA, BS 25122
Italy

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.cesifo.de

Sergio Vergalli

University of Brescia - Department of Economics ( email )

Via San Faustino 74B
Brescia, 25122
Italy

Fondazione Eni Enrico Mattei (FEEM), Milan ( email )

Corso Magenta 63
20123 Milan
Italy

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