Transfer pricing, earnings management and tax avoidance of firms in Ghana
| Date | 07 January 2019 |
| DOI | https://doi.org/10.1108/JFC-10-2017-0091 |
| Published date | 07 January 2019 |
| Pages | 235-259 |
| Author | Mohammed Amidu,William Coffie,Philomina Acquah |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial crime |
Transfer pricing, earnings
management and tax avoidance of
firms in Ghana
Mohammed Amidu,William Coffie and Philomina Acquah
Business School, University of Ghana, Legon, Ghana
Abstract
Purpose –This paper aims to investigate howtransfer pricing (TP) and earnings management affect tax
avoidanceof firms in Ghana.
Design/methodology/approach –The authors use a panel data set from2008 to 2015 to further shed
light on transfer pricing-tax avoidance nexus by examining the complex interaction of three key variables:
transferpricing, earnings management and tax avoidance.
Findings –The results show that almost all the sample firms have engaged in some form of transfer pricing
strategies and the manipulation of earnings to avoid tax during 2008-2015. There is evidence to suggest that non-
financial multinational corporations manipulate more earnings than the financial firms while financial firms also
use more TP than non-financial firms. The overall results suggest that the sensitivity of tax avoidance to transfer
pricing decreases as firms increase their earnings management. By extension, these results have importantpolicy
implication for policymakers in assessing the effectiveness of tax laws relating to transfer pricing.
Originality/value –The authors investigate how transfer pricing and earnings management affect the
avoidanceof firms operating in Ghana.
Keywords Tax avoidance, Earnings management, Developing country, Transfer pricing
Paper type Research paper
1. Introduction
Globalization allows flow of the financial resources from developed countries into the
emergent economies (Tomedi and Schreiber, 2014). The rising pace of globalization has
driven the concept of nations and states due to flexibility of transfer pricing and its role in
avoiding taxes by redirecting public revenue to shareholders (Sikka and Willmott, 2010).
Globalization has come to eliminate thelimitations of territorial jurisdiction of corporations
and has paved an easier way of establishing subsidiaries, affiliate joint ventures, special
purpose entities and trusts in jurisdictions with favourable conditions to benefit from low
tax havens. Accordingly, Chang and Lin (2010) show that multinational corporations
(MNCs) derive various benefits from international trade, including trade expansion, job
opportunities, transfer of technology, flow of international market information, frequent
promotion of industries, technical research and development, economic growth and
increased taxes. Therefore, the MNCs attempt to embrace these benefits with the ultimate
goal of maximizing global profit and minimizing their global taxes by locating their
affiliates in countries with very low or zero tax rate. In an attempt to achieve the goal of
global profit maximization and tax minimization, the multinational firms have resorted to
several tax avoidance mechanisms which have led to revenue losses of both tax haven
countries and developingcountries attempting to operate as tax haven with low tax rate.
Research on internationaltax avoidance practices suggest that MNCs avoid international
taxes by means of transfer pricing manipulation, thin capitalization, tax haven utilization,
Transfer
pricing
235
Journalof Financial Crime
Vol.26 No. 1, 2019
pp. 235-259
© Emerald Publishing Limited
1359-0790
DOI 10.1108/JFC-10-2017-0091
The current issue and full text archive of this journal is available on Emerald Insight at:
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payment of intangibles, income shifting and financing structure of affiliate (Jacob, 1996;
Chang and Lin, 2010;Taylor and Richardson, 2012;Henn, 2013;Brock and Pogge, 2014).
More so, most of these studies reveal that transfer pricing manipulation is the main
avoidance mechanism used by these corporations in an attempt to achieve their goal of
global profit maximization and tax minimization objectives (Gravelle, 2009;Pendse, 2012;
Janský et al.,2013)[1]. The manipulation of this transfer pricing occurs when a company in
an attempt to either purchase or sell to an affiliated entity under-price or over-price the
goods or service for the reason that the two companiesare located in a variable different tax
jurisdictions (Clausing, 2003;Dyreng and Lindsey, 2009;Slemrod and Wilson, 2009;Cristea
and Nguyen, 2013;Brock and Pogge, 2014). Thismanipulation then offers an opportunity to
the MNCs to relocate profit from countries that these profits originated to countries with
lower tax rates. This effect is frequently observed in the developing economiesas a result of
their human capital inadequacies to deal with the complex nature of transactions
undertaken within affiliated entities and inadequate policies to eliminate such practices.
Also, transfer pricing has the propensity to reducethe entitlement of domestic shareholders
and employees due to theunder reporting of profit.
Strands of literature show that tax avoidance behaviour serves as motivation for
earnings management (Graham et al., 2012;Wang and Chen, 2012). Studies on earnings
management have professedthat devices such as changes in accounting procedures, taking
a bath, income maximization and income smoothing are the major instruments that
managers use in managing earnings (Healy, 1985). However, the literature on earnings
management stipulates that in an attempt to manage earnings, firms structure their
transaction in a way that create differences in the taxable profit and the accounting income
(Hanlon and Heitzman, 2010). These empiricalstudies have outlined that managers manage
earnings so as to report lower profit to pay less tax (Dhaliwal et al., 2004;Desai and
Dharmapala, 2006;Desai and Dharmapala, 2009). These avoidance mechanisms result in
loss of revenue which hinders the ability of the government to undertake its social and
economic responsibilities (Sikka and Willmott, 2010;Otusanya, 2011;Taylor and
Richardson, 2012). According to Desai and Dharmapala (2009), tax avoidance mechanisms
give room for opportunistic managers to pursue self-seeking objectives and manage
earnings in ways that provide benefits to managers and that do not benefit shareholders.
Thus, managers managing earnings are more likely to insulate themselves by avoiding
more taxes as avoidance providesthem shield from shareholder scrutiny. Again, minimized
tax payment leaves excess “after tax”cash flow that can either be distributed as extra
dividends or invested in profitable projects. Although various studies have analysed the
variables of interest and have established relationships among them, these relationships
have been examined independently in most cases. Prior studies have failed to exploit how
the relationship between transfer pricing and earnings management can jointly influence
tax avoidance behaviour of MNCs. Therefore, the study seeks to examine how transfer
pricing and earnings managementinfluence tax avoidance of MNCs operating in developing
countries. It is analysed withinthe Ghanaian context.
The contribution of this study is in two folds: first of all, it examines the prevalence of
transfer pricing and earnings management as it pertains to MNCs operatingthe developing
countries. This serves as a response to the calls by prior research for more research on
earnings manipulation and transfer pricing in different economic settings (Healy and
Wahlen, 1999). Second, the study examines the effect of the interaction of the transfer
pricing and earnings managementon tax avoidance.
The rest of the paper is organized as fellows. Section 2 reviews relevant literature on
transfer pricing, earnings management and tax avoidance. Section 3 discusses the research
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