Author(s)

Dong Zhaozhi

Corresponding Author

Dong Zhaozhi

ABSTRACT

Tax avoidance has important implications when studying earnings management, especially when the tax avoidance is triggered by a tax reform. One such tax reform is the “Replacing Business Tax with VAT” policy reform. We predict that the more potential tax benefits a company obtains through the “Replacing Business Tax with VAT” policy reform, the more likely the company will delay revenue recognition and implement accrual-based earnings management before the reform. Meanwhile, companies which can reduce their VAT tax burden by increasing raw material purchases and labor outsourcing will be less likely to implement negative earnings management. Through our empirical analysis, we provide robust evidence that companies which stand to obtain tax benefits from the policy reform will delay their revenue recognition before the reform to carry out earnings management. Additionally, the companies’ negative earnings management is positively related to the potential tax benefits they gain through the tax reform. Furthermore, companies which can reduce their VAT burden after the reform by using tax avoidance behaviors have less incentive to conduct negative earnings management. By conducting subgroup analysis on stratified samples, we also find differences before and after the reform in the earnings management behaviors of different companies.

KEYWORDS

Tax reform, tax avoidance incentive, earnings management, replacing business tax with VAT