SEC comment letters are supposed to keep companies in line with the regulator’s disclosure rules, but they can also indirectly increase a company’s provision for income taxes, according to a new study published in The Accounting Review.
In other words, after receiving an SEC comment letter dealing with tax disclosures, companies tend to pay more in income taxes—at least in the short term.
In the study, close to 500 firms that received a comment letter regarding tax information increased their provision for income taxes 1.4 percentage points in the following year and their actual cash payments by 1.5 percentage points. The average effective tax rate for each company rose on average about 5%.
“While it is not the SEC’s mission to enforce tax laws, its charge includes overseeing the financial information that companies provide to investors, which of course includes tax data,” said coauthor Thomas Omer of the University of Nebraska-Lincoln. “In our survey of almost 3,000 comment letters over nine years (2004 to 2012), about 30% had to do specifically with taxes. And, even though their purpose was not to increase tax payments, they had that effect.”
The nearly 500 affected companies averaged about $5.6 billion in assets. Increased income taxes netted federal, state, and foreign governments an additional $3 billion in new revenue.
While comment letters seem to impact tax rates, Omer said there is no data to suggest the SEC and the IRS are working together to prop up tax revenue.
“While the agencies are not prohibited from coordinating their efforts and sharing data, in point of fact they don’t,” Omer said. “Given the results of our study, maybe they ought to consider doing so ….”
Even competing companies can be affected by SEC correspondences. Companies in industries where two or more peers received letters also increased their tax provisions for the following year.
“Peer firms respond to tax-related scrutiny by decreasing the level of their tax avoidance … after observing resolution of tax-related letters in their industry,” according to the study.
Despite the increase in company taxes in the year following a tax-related comment letter, those provisions dropped back down to normal levels two and three years out.
Of the 2,820 SEC comment letters in the study, 845 were tax-related. The plurality of the 845, about one third, had to do with taxes owed on foreign earnings. The others pertained to such issues as non-foreign taxes, company reserves for unrecognized tax benefits, deferred tax assets or liabilities, and estimates of whether deferred tax assets would be realized.