Tax-in or Tax-out? Evidence from the relation of financial performance and effective taxation of Czech subsidiaries under foreign control

Abstract

The paper’s aim is to investigate whether foreign direct investors (namely companies listed in the EU) tax their group profits in the Czech Republic through the local subsidiaries or whether profits of Czech subsidiaries are taxed outside the country. The analysis of tax behaviour is based on the assessment of the relation between financial performance and effective tax rates reported in the financial statements of Czech subsidiaries. Descriptive statistics shows that the effective taxation of Czech subsidiaries under control of foreign listed parents is significantly lower than for other Czech companies. Furthermore, the method of Conditional Inference Trees reveals significant variability in relative tax rates suggesting that the majority of foreign parents from western and northern EU countries prefer to tax profits in the Czech Republic rather than elsewhere. Shifting profits to the Czech Republic results in superior reporting performance of the affected subsidiaries. In contrast, empirical evidence also shows that parent companies from southern EU countries seek ways to avoid taxation. The unclear tax motives of both parent company groups hinder an appropriate assessment of the financial performance of subsidiaries from being conducted by external users.