Cooperative Compliance or Compliant Cooperation? How cooperative approaches to tax auditing are related to firms’ tax risk management, tax risk, and compliance costs

Cooperative compliance (CC) programs are tax audit regimes that replace conventional, ex-post tax audits, with real-time cooperation between firms and tax authorities. According to the OECD, CC is based on mutual trust, transparency, and cooperation and should provide benefits for both sides. First, tax authorities benefit from increased compliance. Because CC-firms are at low risk to avoid or evade taxes, tax auditors can focus on high-risk taxpayers. At the same time, firms benefit from early feedback by the tax authorities and from the absence of later tax audits, i.e., greater certainty with regard to their tax matters. CC projects require firms to be completely transparent about their transactions and tax strategy. The OECD therefore summarizes CC as “transparency in exchange for certainty”.

In order to participate in CC, firms must use advanced tax risk management. In our working paper, we report results from a survey with firms participating in the Austrian CC pilot program Horizontal Monitoring and a control group to test associations of CC with firms’ tax risk management and their perceptions of tax risk, tax certainty, and compliance cost. We find that firms who participate in CC report better tax risk management. They also report increased tax certainty, reduced tax risk, and reduced compliance costs. Our results thus support the ideas behind CC and are important for policy makers and firms alike.

Austria’s CC pilot program

The Austrian CC pilot program, introduced in 2011, had goals and prerequisites in line with the OECD’s CC framework, as described in the evaluation report (in German). It was aimed at fostering tax compliance and at ensuring timely and correct tax collection. For firms, it sought to provide the benefits of reducing compliance costs and promoting legal certainty and planning security. Participation in the project was voluntary and only possible for large businesses, but required firms to possess (or develop) a tax control framework as part of their tax risk management.

During the course of the pilot, 13 Austrian firms (or groups of firms, respectively) from various industries participated in the project, including energy providers, retailers, and manufacturers. After being accepted into the pilot, firms underwent a last conventional tax audit. Subsequently, representatives and businesses met regularly (e.g., twice a year) to discuss tax-related transactions and questions. While the Austrian pilot did not have a specific legal basis for tax certainty – as opposed to, for example, advance rulings – the evaluation report suggests that tax authorities were nevertheless committed to honor all agreements. The pilot status of the Austrian CC project ended in 2019, when CC became incorporated into Austrian tax law and is now well established.

Although the Austrian CC pilot was deemed successful, it was still unclear how participation in the pilot related to firms’ tax risk management. While analyses of the Austrian evaluation survey suggests that firms highly valued increased certainty through CC, little was known about the quality of tax risk management, tax certainty, tax risk, and compliance costs compared to firms not participating in CC. Our working paper sheds light on these questions.

Research design and findings

In our study, we assume that CC is used as a tool by tax authorities to minimize information asymmetries and “agency costs” between themselves and taxpayers. In other words, by requiring firms to be transparent and to use advanced tax risk management, authorities put themselves in a more favorable position to ensure correct and timely tax payments. CC should thus attract firms that exhibit low tax risk and have already invested (or plan to invest) in advanced tax risk management. The offer of legal certainty through CC may consequently enable firms to reduce compliance costs associated with tax audits and with tax risk due to uncertain tax positions.

Based on these assumptions, we first hypothesize that there are significant differences between CC firms and non-CC firms in how they perceive their tax risk management and tax risk. These differences may be due to either ex-ante differences between the two groups, changes through CC participation, or a combination of both. We also hypothesize that a significant proportion of these differences can be explained by the latter: the perceived changes in these variables since entering the CC project (or a comparable amount of time for the control group). We thus explicitly attempt to disentangle the reasons for entering CC from the potential consequences of CC participation. Furthermore, we hypothesize that CC firms experienced a significant reduction in compliance costs due to the increase in certainty and the reduction in tax risk.

To measure these variables and test the hypothesized associations, we conducted a survey from October 2017 to March 2018 with Austrian CC firms and a suitable control group, in which firm representatives (mostly senior tax experts) could indicate their perceptions. For the control group, we collected data from 31 firms (out of 92 invited) who actively engaged in tax policy within the Austrian Federation of Industries. Out of the 13 CC firms, we were able to collect data from 9 firms. Despite the small number of participants, these 9 responses represent 69% of the population of Austrian CC firms at the time of the survey.

Using mediation analyses, we indeed find that CC firms perceived a significant and strong increase in tax certainty and a significant decrease in tax risk, while the control group experienced no change in tax certainty and an increase in tax risk. Results suggest that the improvement of tax certainty led to a subsequent decrease in tax risk and compliance costs for CC firms. We also find that CC firms currently report lower tax risk. In addition, we find that CC firms report significantly better tax risk management than the control group. However, we did not find a difference in the perceived change in tax risk management, which suggests that CC firms already had better developed tax risk management before entering CC.

Our study contributes to the literature in two ways. First, we provide important evidence on the effectiveness of CC on the side of firms. We show that firms perceive CC to be highly beneficial in terms of tax certainty, an advantage that appears to also positively affect tax risk and compliance costs. Second, we examine how tax risk and tax risk management are related to CC not only as a consequence of CC participation, but also as reasons to participate in CC. While we cannot provide direct evidence for causal relationships, our results suggest that CC participation does indeed attract firms with low tax risk and advanced tax risk management. Our results should therefore be of help for both firms in their decision to participate in, and for tax authorities in implementing and refining, CC programs.

 

Eva Eberhartinger is full professor and holds a chair in Business Taxation (Betriebswirtschaftliche Steuerlehre) at the Institute for Accounting and Auditing at WU, Vienna University of Economics and Business.

Maximilian Zieser has a background in economic psychology and is currently research associate and PhD candidate in the Doctoral Program in International Business Taxation (DIBT) at WU, Vienna University of Economics and Business.

This post is adapted from their working paper “The Effects of Cooperative Compliance on Firms’ Tax Risk, Tax Risk Management and Compliance Costs” which is available at SSRN.

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