Simplified Tax Accounting and the Choice of Legal Form

Abstract

This study investigates whether the ability to choose simplified methods of tax accounting is an important consideration in legal form decisions. Most European countries provide simplified, cash-based rules of tax accounting for small firms that considerably deviate from their general accrual tax accounting rules. The small business sector is thereby sought to be protected from disproportionally high compliance burdens. Simplified tax accounting, however, is only available for non-corporate businesses. If simplified tax accounting is indeed associated with a net benefit, its (un-)availability can change the relative gain to incorporation. We test this conjecture using data on corporate shares of business in 27 European countries over the period 2004–2010. Exploiting variation in eligibility thresholds for simplified tax accounting over time, the results suggest that small businesses indeed consider the option to choose simplified tax accounting in their choice of legal form.

Acknowledgements

The authors thank the reviewer, Martin Jacob (the editor), Kathleen Andries, Martine Cools, Holger Daske, Dhammika Dharmapala, Christina Elschner, Anna Feller, Maximilian Müller, Ulrich Schreiber, Christoph Spengel, Johannes Voget and conference participants at Freie Universität Berlin, the University of Mannheim, the University of Münster, WHU Vallendar and WU Vienna for valuable comments and suggestions.

Supplemental Data and Research Materials

Supplemental data for this article can be accessed on the Taylor & Francis website, doi: 10.1080/09638180.2016.1264881.

Notes

1 Even if simplifications comparable to those for small unincorporated businesses were available to small corporations, these would not offer real benefits since they are already obliged to draft commercial accounts on the basis of double-entry bookkeeping (Eichfelder & Schorn, 2012; European Commission, 2007).

2 The partitioning of taxpayers most likely causes further distortions apart from legal form choice. When eligibility criteria are defined according to firm size, enterprises may be inclined to remain small in order to ensure beneficial tax treatment (Slemrod & Gillitzer, 2014). Lately, numerous studies have confirmed bunching behavior around kinks and notches in tax legislation (Almunia & Lopez-Rodriguez, 2014; Kleven & Waseem, 2013; Saez, 2010).

3 An early study by Wolfson (1985) analyzes special tax regimes for oil and gas firms. Elschner (2013), in contrast, analyzes the impact of tonnage taxes on the choice of legal form in the shipping industry while Edmark and Gordon (2013) investigate the choice of legal form by closely held firms in Sweden under the specific incentives generated by the dual income tax. Goolsbee and Maydew (2002) consider the case of REIT spin-offs in the US.

4 Further studies analyze legal form decisions of large publicly traded business organizations and find that taxes matter in the choice between publicly traded partnerships and corporations (Gentry, 1994; Guenther, 1992; Shaw & Wier, 1993; Terando & Omer, 1993). The tax factors driving corporate conversions from C-corporations to S-corporations have also been addressed (e.g. Omer, Plesko, & Shelley, 2000). Hodder, McAnally, and Weaver (2003), for example, deal with the case of banks while Bank and Cheffins (2008) examine legal form decisions of private equity firms.

5 See Eichfelder (2009) for a comprehensive overview on international studies measuring the compliance cost burdens of both businesses and individuals. The subject of measuring compliance costs is further discussed in Slemrod (1996) and Tran-Nam et al. (2000).

6 We acknowledge that benefits and costs of choosing simplified tax accounting will probably be negligible if commercial law requires drafting financial accounts on the basis of double-entry bookkeeping anyway. The liberal professions and many small non-corporate firms, however, are not subject to the commercial code in most countries. Even if the commercial code applies, requirements to draft commercial accounts are generally harmonized with the tax provisions on simplified accounting.

7 We refer to turnover thresholds in the comparison of size restrictions for simplified accounting across countries and use it for identification in the empirical analysis because turnover is the central eligibility criterion all simplified accounting regimes have in common. Some countries, however, employ complementary criteria, for example, the number of employees or taxable income. We expect potential error from neglecting complementary country-specific criteria to be small and non-systematic.

8 In 2008, the industry classification was redefined from NACE 1.1 to NACE 2.0. We apply the conversion scheme described in Table A4 in the online appendix to arrive at consistent industry groupings for all years.

9 We exclude the financial sector and the mining industry from our data sample. Moreover, Romania and Lithuania are excluded from the sample as sole proprietorships are not adequately covered in these countries (Eurostat Business Demography, Country-specific notes, http://epp.eurostat.ec.europa.eu/cache/ITY_SDDS/Annexes/bd_esms_an1.pdf). Turkey is dropped due to missing information on simplified accounting.

10 The Czech Republic increased eligibility twice (in 2007 and 2009). Following Valta (2012, p. 671), we assign the treatment to 2007, which is the first as well as the larger increase of the threshold.

11 A description and further details on the indicator are available online at http://data.worldbank.org/indicator.

12 The response is calculated as follows: 0.0045 = 0.047 * €96,500/€1,000,000. The THRESHOLD coefficient of 0.047 is taken from Table 5, column 1 (THRESHOLD is scaled in million euro). The data on size intervals of the business population in the UK are available online from the Office for National Statistics at http://www.ons.gov.uk/businessindustryandtrade/business/activitysizeandlocation/datasets/ukbusinessactivitysizeandlocation.

13 Again, taken at face value, column (1) of Table 7 suggests that the corporate firm share in the UK decreases by 0.45 percentage points or 0.6% (= 0.45/(1 − 0.30)) in response to simplified tax accounting available up to the threshold of £77,000. Taking the consensus tax semi-elasticity of 0.7 reported in de Mooij and Ederveen (2008), a decrease of the corporate share by 0.6% could also be induced by a decrease of the tax rate differential between profits from non-corporate and corporate business by 0.9 percentage points (–0.9 = –0.6/0.7), which can be achieved by a corresponding cut in the top personal income tax rate.

14 Table A3 in the online appendix presents the marginal effects for the generalized linear model.