European companies will be obliged to disclose their country-related profits and income taxes in the form of so-called country-by-country reporting in the future. A corresponding draft directive was approved today by the Parliament of the European Union. The aim of the directive is to detect and curb tax avoidance practices. The announcement of a preliminary political agreement on 1 June 2021 to introduce such a directive had already led to noticeable reactions on the capital market: A current study by ZEW Mannheim, in cooperation with the University of Mannheim, identified cumulative average abnormal returns between ‑0.499 and ‑0.699 per cent for up to two days after the announcement. This corresponds to a cumulative loss in firm value of 48 to 65 billion euros.

Coins standing in a glass on a wooden shelf.
The announcement of a preliminary political agreement on 1 June 2021 to introduce such a directive had already led to noticeable reactions on the capital market.

“Investors are very critical of public country-by-country reporting. The associated risks, such as reputational damage or potential competitive disadvantages, are evident. Legislators should, therefore, be aware that mandatory public tax transparency will lead to considerable non-tax costs,” says Professor Christoph Spengel, Research Associate at ZEW Mannheim.

As the study suggests, investors expect that the risks associated with the comprehensive disclosure requirements outweigh potential benefits. “We observe significantly stronger negative investor reactions for companies with lower effective tax rates, i.e. companies that might – possibly unjustifiably – be suspected of avoiding tax payments,” says Stefan Weck, researcher at ZEW Mannheim and co-author of the study. Furthermore, the results of the study indicate that investors are factoring in potential competitive distortions that could result from public country-by-country reporting. “Investor reactions are significantly stronger for companies conducting business in sectors where the number of operating companies has sharply increased in recent years,” says Raphael Müller, researcher at the University of Mannheim and co-author of the study.

The idea of obliging large multinational companies in the EU to disclose on a per-country basis how much profit they generate and how much tax they pay was first discussed in 2016. Country-by-country reporting is intended to prevent companies from shifting corporate profits to countries with low tax rates, such as Ireland or Luxembourg. Until now, disclosure of these country-specific figures was only obligatory vis-à-vis the tax authorities. In January 2021, the Portuguese Presidency of the Council of the EU published a draft for a public country-by-country reporting that requires companies with an annual global turnover of at least 750 million euros to disclose their profits or losses and income taxes aggregated on a country-level. EU Member States are now obliged to transpose the directive into national law within 18 months.

Date

11.11.2021

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