Article: Friday, 4 June 2021

Taxation influences many of the decisions made by companies and requires increasing documentation efforts to comply with the law. While taxation affects profit- and loss-making businesses, research into taxation often excludes loss-making firms. New research by Dr Saskia Kohlhase from Rotterdam School of Management, Erasmus University (RSM) and Dr Jochen Pierk from the Erasmus School of Economics looked specifically at loss-making firms to determine the impact of changes in tax rules on financial reporting.

Loss-making firms omitted from research

Tax reporting and consolidated financial reporting serve different purposes. While financial reporting informs firms’ stakeholders about the underlying economics of the firm, the purpose of tax reporting is to determine how much tax should be paid. The two systems are, however, often indirectly connected and it is important to understand whether or not firms’ financial reporting is biased due to tax incentives. These incentives are not well understood, especially for loss-making firms. In a normal year, around 30 per cent of publicly listed firms incur a loss. This number increases even further in a crisis such as the 2008-2009 financial crisis or the 2020-2021 Covid-19 crisis. With so many loss-making firms, it’s notable that they are often excluded from research into tax and financial accounting.


Opposite changes in Germany and France

The authors compared the change in financial reporting write-offs in response to changes in the rules for tax-loss offsetting in Germany and France. Dr Kohlhase and Dr Pierk determined this was an ideal setting for their study because these two countries changed their tax loss offsetting rules in 2004 in opposite directions. In Germany, where the 2004 reform restricted tax-loss carryforward offsetting to 60 per cent of taxable income, tax losses have become costlier and firms have a stronger incentive to postpone write-offs to profitable years. In contrast, in France, where the 2004 reform extended tax-loss offsetting from five years to infinity, tax losses have become less costly and firms have a lower incentive to postpone write-offs to profitable years. In a nutshell, tax losses became costlier for German firms and less costly for French firms.

Policymakers should be aware that tax-loss offsetting rules not only affect the tax payments of firms, but also firms’ financial reporting

If firms change the timing of the write-offs in their tax accounts accordingly, but leave their (consolidated) financial reporting unchanged, the gap between book income and taxable income will change (book-tax difference). Firms, however, have incentives to not report high book-tax differences as these are considered a ‘red flag’ by investors, i.e. earnings numbers seem to be inflated.


When is a loss less costly?

The researchers found that firms will adjust their financial reporting numbers in response to the tax rule changes to avoid differences between tax accounting and financial reporting.


In particular, German loss-making firms reduced their financial reporting write-offs by 0.61 per cent of total assets after the regulation change.


Whereas French loss firms increased their write-offs by 0.15 percent of total assets. 

This is in line with the researchers’ expectation, because tax losses become costlier for German firms, and less costly for French firms.


Investors evaluate the signals

This research informs policymakers and users of financial statements about the financial reporting consequences of changes in tax rules. Knowing the interdependencies between tax accounting and financial reporting is important for investors in evaluating the signals coming from financial reporting that give information about the firm’s underlying economics.

Tax losses become costlier for German firms, and less costly for French firms.

Policymakers beware

Policymakers, tax legislators, and standard setters should be aware that rules for tax-loss offsetting not only affect firms’ tax payments, but also firms’ financial reporting. Thus, the researchers’ findings are of particular interest to governments that plan to change – or have already changed – rules for tax-loss offsetting. For example, the United States Tax Cuts and Jobs Act of 2017 (TCJA) disallowed loss carrybacks, reduced loss carryforwards offsetting to 80 per cent of the taxable income, and extended the carryforward period from 20 years to infinity. Similarly, the Dutch government reduced the period to offset losses from nine to six years for fiscal years 2020 and 2021 and plans to implement loss offsetting rules comparable to the German rules as from 2022 (i.e., extend tax loss offsetting until infinity but limit it to 50% of positive taxable income).

dr. S. (Saskia) Kohlhase
Associate Professor
Rotterdam School of Management (RSM)
Erasmus University Rotterdam
Saskia Kohlhase
Pile of books with vibrant bookmarks protruding from various pages, symbolizing in-depth research.

Related articles

RSM Discovery

Want to elevate your business to the next level using the latest research? RSM Discovery is your online research platform. Read the latest insights from the best researchers in the field of business. You can also subscribe to the newsletter to receive a bimonthly highlight with the most popular articles.

Do you want to learn more about this subject?

Check out these RSM education programmes

Your contact for more information:

Danielle Baan

Science Communication and Media Officer

Portrait of Erika Harriford-McLaren

Erika Harriford-McLaren

Corporate Communications & PR Manager

Erasmus University campus in autumn, showcasing its iconic red trees, viewed from across the campus pool.