Tax Savings Promote Productivity and Innovation
Research
08.11.2023
ZEW Study Shows: Tighter Anti-Tax Loss Trafficking Regulations Impact M&A Activity and the Overall Economy
Tax considerations play a central role in M&A decisions. If the government restricts the buyer’s ability to continue utilising the tax losses of the acquired company, the number of mergers and acquisitions with companies likely to have accumulated tax loss carryforwards decreases by 22 per cent. These are the results of a recent study from ZEW Mannheim.
The study examines the effects of restrictions on the offset of tax loss carryforwards after substantial changes in ownership, known as anti-tax loss acquisition rules, in the EU Member States and Norway from 1998 to 2019. It is based, among other things, on data from the Zephyr and Orbis databases, Eurostat, and the European Patent Office.
Corporate profits are treated asymmetrically
For tax purposes, countries often treat corporate profits asymmetrically: they tax profits but do not grant tax refunds for losses. Instead, companies must carry losses forward or backward in time (loss carryback or carryforward). In the context of mergers and acquisitions, regulations against tax loss carryforward transfers govern whether and how the buyer can use the losses of the acquired company after the takeover to reduce its taxable income. Unlimited transferability of losses may lead buyers to acquire loss-making companies solely for tax reasons. Government restrictions on this practice aim to prevent tax-motivated transactions, safeguarding tax revenue as a source of government income.
Do restrictions affect Europe’s innovative capacity?
However, by affecting incentives, these restrictions can also negatively impact economically desirable transactions. Tightening regulations on tax loss carryforward transfers appears to particularly affect young companies. “We also observe effects on market entries and exits of companies,” says study author Professor Johannes Voget, a professor at the University of Mannheim and Research Associate in ZEW’s “Corporate Taxation and Public Finance” Unit. Approximately ten per cent fewer companies enter the market. The survival rate of young companies also decreases by four per cent. “This could alter the market composition and potentially discourage entrepreneurs,” adds Voget.
Overall, macroeconomic productivity suffers under stringent regulations. “This negative effect is much more pronounced in research-intensive industries than in those with little R&D activity,” says co-author Barbara Stage, assistant professor at the WHU – Otto Beisheim School of Management and ZEW Junior Research Associate. In this context, it makes sense that the number of registered patents decreases with tighter regulations, as the ZEW study suggests. With very restrictive anti-abuse regulations against loss carryforward transfers, there is a risk of significant economic consequences, as described, which can weaken the innovative capacity of a region.
