Information Sharing between Tax and Statutory Auditors: Implications for Tax Audit Efficiency

Figures & data

Table 1. Different informational structures considered in the game

	regime 1: no information exchange	regime 2: information exchange
Taxpayer observes	• true values (b, t)
Statutory auditor observes	• $\hat{z}=(\hat{b},\hat{t})$
Tax auditor observes	• $i=(b^{\prime },\hat{t})$	• $i=(b^{\prime },\hat{t},c)$

Figure 1. Timeline of events

Table 2. Taxpayer types' payoffs. $K_1=({\omega }_T+F_T)\left[{\pi }_T\right(1,0\left)\right(1-{\pi }_S(1,0))+{\pi }_T(0,0\left){\pi }_S\right(1,0\left)\right]$ and $K_2=({\omega }_T+F_T)\left[{\pi }_T\right(1,0,N\left)\right(1-{\pi }_S(1,0))+{\pi }_T(0,0,C\left){\pi }_S\right(1,0\left)\right]$

Type	$\hat{z}$	Payoff in regime 1	Payoff in regime 2
$(1,0)$	$(1,0)$	${\omega }_B$	${\omega }_B$
$(1,1)$	$(1,0)$	${\omega }_B-{\pi }_T(1,0)({\omega }_T+F_T)$	${\omega }_B-{\pi }_T(1,0,N)({\omega }_T+F_T)$
	$(1,1)$	${\omega }_B-{\omega }_T$	${\omega }_B-{\omega }_T$
	$(0,0)$	$-{\pi }_T(0,0)({\omega }_T+F_T)$	$-{\pi }_T(0,0,N)({\omega }_T+F_T)$
$(0,1)$	$(1,0)$	${\omega }_B(1-{\pi }_S(1,0\left)\right)-{\pi }_S(1,0)F_B-K_1$	${\omega }_B(1-{\pi }_S(1,0\left)\right)-{\pi }_S(1,0)F_B-K_2$
	$(1,1)$	${\omega }_B(1-{\pi }_S(1,1\left)\right)-{\pi }_S(1,1)F_B-{\omega }_T$	${\omega }_B(1-{\pi }_S(1,1\left)\right)-{\pi }_S(1,1)F_B-{\omega }_T$
	$(0,1)$	$-{\omega }_T$	$-{\omega }_T$
	$(0,0)$	$-{\pi }_T(0,0)({\omega }_T+F_T)$	$-{\pi }_T(0,0,N)({\omega }_T+F_T)$
$(0,0)$	$(1,0)$	${\omega }_B(1-{\pi }_S(1,0\left)\right)-{\pi }_S(1,0)F_B$	${\omega }_B(1-{\pi }_S(1,0\left)\right)-{\pi }_S(1,0)F_B$
	$(1,1)$	${\omega }_B(1-{\pi }_S(1,1\left)\right)-{\pi }_S(1,1)F_B-{\omega }_T$	${\omega }_B(1-{\pi }_S(1,1\left)\right)-{\pi }_S(1,1)F_B-{\omega }_T$
	$(0,0)$	0	0

Note: The statutory (tax) auditor's auditing probabilities for the reports $\hat{z}$ (information sets i) are denoted as ${\pi }_S\left(\hat{z}\right)$ (${\pi }_T\left(i\right)$).

Table 3. Results

			Low importance of financial statements			Medium importance of financial statements			High importance of financial statements
			Information Exchange			Information Exchange			Information Exchange
			No (regime 1)	Yes (regime 2)	R1$\to$ R2	No (regime 1)	Yes (regime 2)	R1$\to$ R2	No (regime 1)	Yes (regime 2)	R1$\to$ R2
Panel A: Reporting Probabilities
${\pi }_{1,0}(1,0)$			1	1	$\to$	1	1	$\to$	1	1	$\to$
${\pi }_{1,1}(1,1)$			+	+	$\to$	+	+	$\to$	+	+	$\to$
${\pi }_{1,1}(1,0)$			+	+	↘	+	+	$\to$	+	+	$\to$
${\pi }_{1,1}(0,0)$			+	+	↗	+	+	$\to$	0	0	$\to$
${\pi }_{0,1}(0,1)$			0	0	$\to$	0	0	$\to$	0	0	$\to$
${\pi }_{0,1}(1,0)$			0	+	↗	0	0	$\to$	0	0	$\to$
${\pi }_{0,1}(1,1)$			+	+	$\to$	+	+	↗	1	1	$\to$
${\pi }_{0,1}(0,0)$			+	+	↘	+	+	↘	0	0	$\to$
${\pi }_{0,0}(0,0)$			+	+	↗	+	+	$\to$	+	+	$\to$
${\pi }_{0,0}(1,0)$			+	+	↘	+	+	$\to$	+	+	$\to$
${\pi }_{0,0}(1,1)$			0	0	$\to$	0	0	$\to$	+	+	$\to$
Panel B: Tax Auditor's Information Sets (Probability of Occurrence)
Type	iR1	iR2
$(1,0)$	$(1,0)$	$(1,0,N)$	1	1		1	1		1	1
$(1,1)$	$(1,1)$	$(1,1,N)$	${\pi }_{1,1}(1,1)$	${\pi }_{1,1}(1,1)$		${\pi }_{1,1}(1,1)$	${\pi }_{1,1}(1,1)$		${\pi }_{1,1}(1,1)$	${\pi }_{1,1}(1,1)$
	$(1,0)$	$(1,0,N)$	${\pi }_{1,1}(1,0)$	${\pi }_{1,1}(1,0)$		${\pi }_{1,1}(1,0)$	${\pi }_{1,1}(1,0)$		$1-{\pi }_{1,1}(1,1)$	$1-{\pi }_{1,1}(1,1)$
	$(0,0)$	$(0,0,N)$	$1-{\pi }_{1,1}(1,1)-{\pi }_{1,1}(1,0)$	$1-{\pi }_{1,1}(1,1)-{\pi }_{1,1}(1,0)$		$1-{\pi }_{1,1}(1,1)-{\pi }_{1,1}(1,0)$	$1-{\pi }_{1,1}(1,1)-{\pi }_{1,1}(1,0)$		0	0
$(0,1)$	$(1,1)$	$(1,1,N)$	${\pi }_{0,1}(1,1)$	${\pi }_{0,1}(1,1)$		${\pi }_{0,1}(1,1)$	${\pi }_{0,1}(1,1)$		$1-{\pi }_S(1,1)$	$1-{\pi }_S(1,1)$
	$(0,0)$	$(0,0,N)$	$1-{\pi }_{0,1}(1,1)$	$1-{\pi }_{0,1}(1,1)-{\pi }_{0,1}(1,0)$		$1-{\pi }_{0,1}(1,1)$	$1-{\pi }_{0,1}(1,1)$		${\pi }_S(1,1)$	0
		$(0,0,C)$		${\pi }_{0,1}(1,0){\pi }_S(1,0)$			0			0
		$(1,0,N)$		${\pi }_{0,1}(1,0)(1-{\pi }_S(1,0\left)\right)$			0			0
		$(0,1,C)$								${\pi }_S(1,1)$
$(0,0)$	$(0,0)$	$(0,0,N)$	${\pi }_{0,0}(0,0)+(1-{\pi }_{0,0}(0,0\left)\right){\pi }_S(1,0)$	${\pi }_{0,0}(0,0)$		${\pi }_{0,0}(0,0)+(1-{\pi }_{0,0}(0,0\left)\right){\pi }_S(1,0)$	${\pi }_{0,0}(0,0)$		${\pi }_{0,0}(0,0)+{\pi }_{0,0}(1,0){\pi }_S(1,0)$	${\pi }_{0,0}(0,0)$
	$(1,0)$	$(1,0,N)$	$(1-{\pi }_{0,0}(0,0\left)\right)(1-{\pi }_S(1,0\left)\right)$	$(1-{\pi }_{0,0}(0,0\left)\right)(1-{\pi }_S(1,0\left)\right)$		$(1-{\pi }_{0,0}(0,0\left)\right)(1-{\pi }_S(1,0\left)\right)$	$(1-{\pi }_{0,0}(0,0\left)\right)(1-{\pi }_S(1,0\left)\right)$		${\pi }_{0,0}(1,0)(1-{\pi }_S(1,0\left)\right)$	${\pi }_{0,0}(1,0)(1-{\pi }_S(1,0\left)\right)$
	$(1,1)$	$(0,0,C)$	0	$(1-{\pi }_{0,0}(0,0\left)\right){\pi }_S(1,0)$		0	$(1-{\pi }_{0,0}(0,0\left)\right){\pi }_S(1,0)$		$(1-{\pi }_{0,0}(0,0)-{\pi }_{0,0}(1,0\left)\right)(1-{\pi }_S(1,1\left)\right)$	${\pi }_{0,0}(1,0){\pi }_S(1,0)$
	$(0,1)$	$(1,1,N)$	0			0			$(1-{\pi }_{0,0}(0,0)-{\pi }_{0,0}(1,0\left)\right){\pi }_S(1,1)$	$(1-{\pi }_{0,0}(0,0)-{\pi }_{0,0}(1,0\left)\right)(1-{\pi }_S(1,1\left)\right)$
		$(0,1,C)$								$(1-{\pi }_{0,0}(0,0)-{\pi }_{0,0}(1,0\left)\right){\pi }_S(1,1)$
Panel C: Audit Probabilities
R1	R2
${\pi }_T(1,0)$	${\pi }_T(1,0,N)$		${\displaystyle \frac{{\omega }_T}{{\omega }_T+F_T}}$	${\displaystyle \frac{{\omega }_T}{{\omega }_T+F_T}}$		${\displaystyle \frac{{\omega }_T}{{\omega }_T+F_T}}$	${\displaystyle \frac{{\omega }_T}{{\omega }_T+F_T}}$		${\displaystyle \frac{{\omega }_T}{{\omega }_T+F_T}}$	${\displaystyle \frac{{\omega }_T}{{\omega }_T+F_T}}$
${\pi }_T(0,0)$	${\pi }_T(0,0,N)$		${\displaystyle \frac{{\omega }_T-{\omega }_B}{{\omega }_T+F_T}}$	${\displaystyle \frac{{\omega }_T-{\omega }_B}{{\omega }_T+F_T}}$		${\displaystyle \frac{{\omega }_T-{\omega }_B}{{\omega }_T+F_T}}$	${\displaystyle \frac{{\omega }_T-{\omega }_B}{{\omega }_T+F_T}}$		0	0
	${\pi }_T(0,0,C)$			${\displaystyle \frac{{\omega }_T-{\omega }_B-F_B}{{\omega }_T+F_T}}$			0			0
${\pi }_S(1,0)$			${\displaystyle \frac{{\omega }_B}{{\omega }_B+F_B}}$	${\displaystyle \frac{{\omega }_B}{{\omega }_B+F_B}}$		${\displaystyle \frac{{\omega }_B}{{\omega }_B+F_B}}$	${\displaystyle \frac{{\omega }_B}{{\omega }_B+F_B}}$		${\displaystyle \frac{{\omega }_B}{{\omega }_B+F_B}}$	${\displaystyle \frac{{\omega }_B}{{\omega }_B+F_B}}$
${\pi }_S(1,1)$			0	0		0	0		${\displaystyle \frac{{\omega }_B-{\omega }_T}{{\omega }_B+F_B}}$	${\displaystyle \frac{{\omega }_B-{\omega }_T}{{\omega }_B+F_B}}$
Panel D: Efficiency Measures
Lost Tax Revenue (LTR)			${\mathrm{LTR}}^1<{\mathrm{LTR}}^2$			${\mathrm{LTR}}^1>{\mathrm{LTR}}^2$			${\mathrm{LTR}}^1={\mathrm{LTR}}^2$
Tax Audit Frequency (TA)			${\mathrm{TA}}^2<{\mathrm{TA}}^1$			${\mathrm{TA}}^2<{\mathrm{TA}}^1$			${\mathrm{TA}}^2={\mathrm{TA}}^1$

Notes: This table displays the equilibrium results for low, medium, and high importance of financial statements depending on whether there is or there is not an information exchange between the statutory and the tax auditor. ${\pi }_z\left(\hat{z}\right)$ is the probability that type z submits report $\hat{z}$, + means $0<{\pi }_z\left(\hat{z}\right)<1$. The arrows show whether reporting probabilities increase (↗), decrease (↘), or remain unchanged ($\to$) as a result of the information exchange between the statutory auditor and the tax auditor. The statutory (tax) auditors' auditing probabilities for the reports $\hat{z}$ (information sets i) are denoted as ${\pi }_S\left(\hat{z}\right)$ (${\pi }_T\left(i\right)$). LTR is lost tax revenue and TA the tax audit frequency defined in section 3.2.1. All mathematical derivations are displayed in detail in the online Appendix.

Figure 2. Tax audit frequency (TA) in regime 1 (black, solid) and regime 2 (blue, dashed). High importance of financial statements for ${\omega }_T\in [0,1.5]$, medium importance for ${\omega }_T\in (1.5,2.1)$ and low importance for ${\omega }_T\ge 2.1$. Parameters: p = 0.8, ${\theta }_T=3/7$, ${\theta }_S=9/11$, ${\omega }_B=1.5$, $F_B=0.6$, $F_T=0.4$

Figure 3. Lost tax revenue (LTR) in regime 1 (black, solid) and regime 2 (blue, dashed). High importance of financial statements for ${\omega }_T\in [0,1.5]$, medium importance for ${\omega }_T\in (1.5,2.1)$ and low importance for ${\omega }_T\ge 2.1$. Parameters: p = 0.8, ${\theta }_T=3/7$, ${\theta }_S=9/11$, ${\omega }_B=1.5$, $F_B=0.6$, $F_T=0.4$

Table A1. Legal obligations to file financial accounting statements and statutory auditor reports to the tax administration

Country	Obligation to file financial accounting statements together with the tax return	Obligation to file the audit report together with the tax return
Australia	Yes	No${}^3$
Austria	Yes	No
Belarus	Yes	No
Belgium	No	Yes
Brazil	Yes	No
Canada	Yes	No
China	Yes	No${}^3$
Czech Republic	Yes	No
Denmark	Yes	No
Estonia	No	No
Finland	Yes	No
Germany	Yes	Yes
Hong Kong	Yes	Yes
Hungary	No	No
Ireland	Yes	Yes
Italy	No	No
Japan	Yes	No
Korea	No	No
Luxembourg	Yes	No
Netherlands	No	No
Panama	No	No
Poland	Yes${}^1$	Yes
Russia	Yes	No${}^3$
Slovakia	No	No
South Africa	Yes	Yes
Spain	Yes	No${}^2$
Sweden	No	No
Switzerland	Yes	No${}^3$
Ukraine	Yes	No
United Kingdom	Yes	Yes
Uruguay	No	No
USA	No	No
Vietnam	Yes	Yes

Note: Data source: Own survey conducted between March and June 2016 among tax managers, directors, and partners of PricewaterhouseCoopers.${}^1$Non-audited financial statements do not need to be filed.

${}^2$The audit report is a publicly available information.

${}^3$Survey respondents state that in practice the audit report is often enclosed along with the financial statements or that the revenue agency may request it as part of a tax audit.