Tax Avoidance and Geographic Earnings Disclosure

This study tests the relation between corporate tax avoidance and disclosure of geographic earnings. After the adoption of Statement of Financial Accounting Standards No. 131 in 1998, firms opting to no longer disclose geographic segment earnings in their financial reports experience a decrease in their worldwide effective tax rates through reduced foreign tax rates. These results are consistent with firms shifting income to lower-tax foreign operations and attempting to mask this tax avoidance behavior by no longer disclosing geographic earnings. However, evidence of the relation between tax avoidance and non-disclosure exists only until implementation of Schedule M-3 in the annual corporate tax filing beginning in 2004. Schedule M-3 requires firms to provide detailed information, including profitability, of foreign entities that are part of the consolidated financial group but whose net income is excluded from consolidated taxable income. Thus, Schedule M-3 reduces the ability of firms to hide geographic profits in lower-tax jurisdictions, making tax avoidance behavior more apparent to the IRS. This study contributes to our understanding of the interaction between financial reporting behavior and tax