Banks as Tax Planning Intermediaries

• DOI: http://doi.org/10.1111/1475-679X.12246
• Date: 01 March 2019
• Author: BRANDON GIPPER,JOHN GALLEMORE,EDWARD MAYDEW
• Published date: 01 March 2019

DOI: 10.1111/1475-679X.12246

Journal of Accounting Research

Vol. 57 No. 1 March 2019

Printed in U.S.A.

Banks as Tax Planning

Intermediaries

JOHN GALLEMORE,

∗BRANDON GIPPER,

†

AND EDWARD MAYDEW

‡

Received 14 December 2016; accepted 9 August 2018

ABSTRACT

We provide the first large-scale empirical evidence of banks functioning as

tax planning intermediaries. We posit that some banks specialize in assist-

ing corporate clients with tax planning. In this role, banks make use of their

centrality in financial relationships; access to private information; and ability

to structure, execute, and participate in tax planning transactions for clients.

We measure bank-client relationships using loan contracts and measure client

tax planning using either the cash effective tax rate or the unrecognized tax

benefit balance. Using a difference-in-differences design, we find that firms

∗University of Chicago; †Stanford University; ‡University of North Carolina at Chapel Hill.

Accepted by Stephen Ryan. We thank Brad Badertscher, Andy Bauer, Craig Chapman,

Ted Christensen, Will Ciconte, Paul Demere, Michael Donohoe, Charlene Henderson, Mar-

tin Jacob, Pete Lisowsky, Michael Maier, Michael Overesch, Bridget Stomberg, Erin Tow-

ery, Joanna Wu, two anonymous referees, and workshop participants at the University of

Amsterdam, the Berlin-Vallendar Tax Conference, City University of Hong Kong, the Uni-

versity of Georgia, the University of Illinois, the University of Iowa, the National Univer-

sity of Singapore, Northwestern University, the University of Rochester, Singapore Manage-

ment University, Vrije Universiteit Amsterdam, Washington State University, and WHU Otto

Beisheim School of Management for helpful comments. John Gallemore gratefully acknowl-

edges the support of the Harry W. Kirchheimer Faculty Research Fund and the Account-

ing Research Center at the University of Chicago Booth School of Business. Brandon Gip-

per gratefully acknowledges the support of the Stanford University Graduate School of Busi-

ness and the MBA Class of 1969 Faculty Scholarship. Ed Maydew appreciates the support

of the Smith Richardson Merrell Fund, the James C. and Ethel M. Crone Fund in Tax Ex-

cellence, and the David E. Hoffman Professorship at the Kenan-Flagler Business School at

the University of North Carolina. An online appendix to this paper can be downloaded at

http://research.chicagobooth.edu/arc/journal-of-accounting-research/online-supplements.

169

CUniversity of Chicago on behalf of the Accounting Research Center,2018

170 J.GALLEMORE,B.GIPPER,AND E.MAYDEW

experience meaningful tax reductions when they begin a relationship with a

bank whose existing clients engage in above-median tax planning. The effects

of pairing with such tax intermediary banks are concentrated in relationships

with larger or longer maturity loans, clients with foreign income or greater

credit risk, and when the bank is an industry specialist or has above-median

investment banking activities. Finally, we find that potential clients are more

likely to choose tax intermediary banks than nontax intermediary banks, sug-

gesting that tax intermediary banks benefit by attracting new business. Collec-

tively, our results suggest that some banks act as tax planning intermediaries,

a role beyond the traditional one of financial intermediary.

JEL codes: G21; H25; H26

Keywords: banks; borrowers; tax planning

1. Introduction

Banks have come under intense scrutiny from policy makers, the media,

and the public for assisting corporate clients in tax reduction activities.

For example, both the Organisation for Economic Co-operation and De-

velopment (OECD) and the U.S. Senate contend that banks are impor-

tant players in the market for corporate tax planning (United States Senate

[2005], OECD [2008, 2009]). Examples of bank involvement in corporate

tax planning periodically appear in the media. Despite this widespread in-

terest, surprisingly little empirical research investigates banks’ role in cor-

porate tax planning (Hanlon and Heitzman [2010]).1For example, it is

not known whether some banks specialize in tax planning for their cor-

porate clients or which types of firms benefit from such assistance. Fi-

nally, it is not clear how banks benefit from providing this service. Our

objective is to shed light on these fundamental questions by providing the

first large-scale empirical evidence of banks functioning as tax planning

intermediaries.

We define tax intermediation as designing, promoting, and facilitat-

ing financial arrangements that reduce client tax burdens, including ar-

rangements that governments view as aggressive tax planning (OECD

[2008]). Banks possess several attributes that make them well-suited to act

as tax intermediaries. Through lending, banks obtain private information

(including tax returns and projected financial statements) about clients

and their operations (Billett, Flannery, and Garfinkel [1995], Bushman

and Wittenberg-Moerman [2012], Carrizosa and Ryan [2017], Minnis and

Sutherland [2017]) that enable them to identify clients that do not fully

utilize available tax planning opportunities. Banks may benefit from acting

as a tax planning intermediary. For example, firms may be more likely to

1Wefollow prior tax research (e.g., Hanlon and Heitzman [2010], Rego and Wilson [2012],

Edwards, Schwab, and Shevlin [2016]) in using “tax planning” and “tax avoidance” inter-

changeably to refer to any actions that reduce firms’ taxes.

BANKS AS TAX PLANNING INTERMEDIARIES 171

borrow from a bank that is willing and able to assist them with their tax

planning.2

That said, we do not expect all banks to be tax planning intermediaries.

A bank likely incurs substantial setup (e.g., systems, training) and ongoing

costs (e.g., skilled personnel) to be able to assist client firms with tax plan-

ning. Furthermore, certain bank capabilities (such as in-depth knowledge

of the client’s industry) and operations (such as investment banking) may

be more conducive to the bank acting as a tax planning intermediary. View-

ing tax intermediation as a form of specialization is consistent with recent

research that shows that banks do not diversify across clients and services

as traditional banking theory predicts (e.g., Diamond [1984], Boyd and

Prescott [1986], Paravisini, Rappoport, and Schnabl [2017]).

We capture bank-client relationships using loan contracts (Billett, Flan-

nery, and Garfinkel [1995], Ivashina et al. [2009], Amiti and Weinstein

[2011], Bushman and Wittenberg-Moerman [2012]). We examine two dis-

tinct but overlapping aspects of client tax planning: general tax reduction

using the three-year cash effective tax rate (Cash ETR 3-year, which is in-

versely related to tax avoidance) and aggressive tax planning as reflected

in the unrecognized tax benefit (UTB) liability disclosed under FIN 48

(UTB).3Using a large sample of banks and publicly traded clients, we in-

vestigate several research questions.

We begin by documenting substantial heterogeneity across banks in their

average client tax outcomes. For the largest 25 banks in our sample, client

Cash ETR 3-year averages 28.0%, but varies from 19.5% to 31.7% across

banks. This finding suggests that some banks play an important role in

firms’ tax planning.4However, it is also consistent with alternative explana-

tions, such as the clients of a given bank sharing characteristics (such as in-

dustry membership and geography) that are associated with tax outcomes.

In multivariate tests that control for these characteristics, we continue to

find evidence consistent with banks influencing client tax planning. Specif-

ically, we find that a firm’s Cash ETR 3-year (UTB) is strongly associated with

the average Cash ETR 3-year (UTB) of the bank’s other clients. These find-

ings are robust to several alternative specifications.

We examine whether a firm’s tax planning changes when it enters into

a new relationship with a tax intermediary bank versus one that does not

2In addition, establishing a borrowing relationship with a client firm may increase the like-

lihood that the bank is able to take a financial position in tax-favored transactions (e.g., struc-

tured finance) that it helps arrange for the client (OECD [2008], Donohoe [2015a, b]).

3UTBs are essentially contingent liabilities for tax uncertainty. Under FIN 48, now part of

ASC 740, firms recognize and disclose UTB liabilities to account for positions they have taken

in their tax returns, the tax benefits of which may later be disallowed by the tax authorities

(Lisowsky, Robinson, and Schmidt [2013]). UTBs are often used in the literature as measures

of aggressive tax avoidance. We discuss our tax planning proxies in detail on pages 12–13.

4We use “client” and “firm” interchangeably to refer to the bank’sclient firms. Similarly, we

use “tax planning intermediary bank” and “tax intermediary bank” interchangeably to refer

to banks that are able and willing to assist with client tax planning.