Book-tax Conformity: Empirical Evidence from Germany

Book-tax conformity is an old issue in Germany. For more than one hundred years the determination of corporate taxable income has been characterized by the so-called Maßgeblichkeitsprinzip, which governs the traditionally close relationship between financial and tax accounting. While there have been calls for more book-tax conformity in the U.S., there are, however, several reasons why Germany and other European countries are moving towards a two-book approach, under which the two income measures are largely independent. Although the academic attention has – not least through the recent debate on the Accounting Law Modernization Act (BilMoG) – focused on these developments, next to nothing is known about the actual differences between book and taxable income in Germany.

To close this gap in the literature, we use a unique matched tax return - financial statement dataset to examine the magnitude and sources of book-tax differences in Germany. For the first time, the dataset enables us to evaluate the extent to which financial and tax accounting differ based on actual tax returns rather than on estimated taxable income. In doing so, we are not only able to provide explanations for the observed reporting gap, but also to investigate whether book-tax differences reflect corporate reporting behavior.

Despite the close link between financial and tax accounting, we find that corporate taxable income and income reported to shareholders diverge considerably. Overall, tests indicate that taxable income exceeds annual net income before taxes reported to shareholders, on average, by approximately 10%. Given this, we continue and examine the relation between firm specific book-tax differences and publicly available financial statement variables using a model that controls for various other tax and non-tax factors known to be associated with book-tax differences. The regression results suggest book-tax differences are largely attributable to legal differences between financial and tax accounting. In contrast to the U.S., where book-tax differences are assumed to reflect tax planning, we cannot provide evidence that earnings management or tax aggressive reporting adds to the reporting gap. Further analyses show, however, that firms actively engaged in corporate restructuring - an area where conformity between financial and tax accounting is generally not required - exhibit larger book-tax differences than other firms. We interpret this result as evidence of firms willing to give up the administrative advantages of a system of close relationship between financial and tax accounting in order to achieve desired tax or financial accounting results, if book-tax conformity is not required. Thus, the results not only provide insights into the relatively unexplored area of behavioral response to changes in the degree of book-tax conformity, but also add a new perspective to the discussion surrounding the implementation of the BilMoG-Act in 2010.

Zinn, Benedikt and Christoph Spengel (2012), Book-tax Conformity: Empirical Evidence from Germany, ZEW Discussion Paper No. 12-051, Mannheim.