Nexus of Corporate Tax Planning In Malaysia's Trading and Services

Abstract

The tax is an essential part of the budget process, as it determines the distribution of financial resources at the federal level. This study examines the level of corporate tax planning among public listed companies in Malaysia following the 2017 Malaysian Code of Corporate Governance (MCCG) reforms. The study sample is based on 490 firm-year observations from 2012 to 2016 (pre-MCCG) and from 2017 to 2021 (post-MCCG). The panel data consists of trading and services industry data retrieved from Thomson Reuters Datastream. The objective of the study was to assess the level of corporate tax planning before and after the MCCG reforms. It also aims to provide empirical data on whether corporate governance affects corporate tax planning. The results show a significant difference in the effective tax rate pre-MCCG compared to post-MCCG. The study provides insights into the MCCG phases to identify the financial indicators that affected corporate tax planning during this period, thus providing information for upcoming research.

Keywords: Corporate tax planning, effective tax rate, Malaysian code of corporate governance, statutory tax rate

Introduction

Corporate governance has been regarded as the most significant tool in measuring and evaluating the efficiency of financial reporting. In addition, the relevant mechanisms are considered a fundamental part of monitoring the actions of managers. After the 1997 financial crisis, Malaysia introduced several corporate governance systems modelled on those employed in developed Western countries to improve the quality of financial reporting and enhance investor confidence. The Malaysian Securities Commission took a significant step to improve the governance standards of Malaysian publicly traded companies by introducing the MCCG. This was introduced in 2000 to improve financial reporting standards (Ismail et al., 2021). The introduction of the MCCG marked a new milestone in the development of effective corporate governance practices in Malaysia.

Corporate Tax Reporting in Malaysia

Taxes are one of the tools the government uses to boost the country's economy. The Income Tax Act of 1967 sets the rules that govern corporate income tax in Malaysia. Tax calculations are based on chargeable income rather than accounting income. The company's financial statements must be prepared in conformity with accepted accounting principles, to provide financial information that is reliable and valuable to users. Therefore, it is important to have high-quality financial reporting that is free from accounting manipulation to ensure the correct payment of taxes.

A company must pay taxes based on the statutory tax rate (STR) issued by the Inland Revenue Board of Malaysia (IRBM). The IRBM has reduced the tax rate from 40% in 1988 to 24% in 2021 to improve tax compliance. The declining trend of STR in Malaysia is shown in Figure 1. According to a study by Azlan Annuar et al. (2018), consistent STR reductions have had a positive impact on the expansion of the Malaysian economy. Otherwise, a high STR would have discouraged foreign investors from investing in Malaysia, which would have slowed the country's economic growth.

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For tax reporting purposes, companies adjust their pre-tax net income based on tax treatment, i.e., double deductions, allowable expenses, non-allowable expenses, taxable income, non-taxable income, and tax-exempt income. Tax incentives result in actual tax payments being much lower than the STR (Vržina et al., 2020). According to Mgammal and Ku Ismail (2015), companies use different approaches to minimise their tax liability; therefore, they use tax planning strategies to reduce their tax burden. Therefore, the level of corporate tax planning for companies will vary depending on the tax incentives provided by governments and the accounting treatment chosen by managers in preparing their financial and tax reporting.

Problem Statement

Corporate scandals are often associated with deficiencies in corporate governance that do not curb opportunistic behaviour and dishonesty. The collapse of Enron and WorldCom drew attention on corporate governance issues globally. Strengthening corporate governance by regulators would therefore reduce the incidence of financial manipulation and consequently curb aggressive tax planning. Recently, numerous studies have been conducted on the relationship between corporate governance and corporate tax planning (Kovermann & Velte, 2019). Hence, the objective of this study is to understand that corporate governance plays an important role in the preparation of financial statements, which may affect the level of corporate tax planning of Malaysian companies. In this study, it was hypothesised that there is a significant relationship between effective tax rates (ETR) before and after the implementation of the 2017 MCCG.

Research Questions

Following the MCCG reforms, a deluge of research on Malaysian corporate governance appeared in academic journals. These empirical studies have revealed a wide range of research areas. Financial reporting quality can be improved through board monitoring by preventing earning manipulation, thereby reducing the prevalence of aggressive tax planning strategies among public listed companies in Malaysia. This study, therefore, attempted to answer the following question:

To what extent did the trading and service sectors of Malaysian listed companies engage in corporate tax planning before and after the introduction of the revised MCCG in 2017?

Purpose of the Study

Despite the mixed results of previous work and the growing interest in this topic, few studies have been conducted on corporate tax planning in the context of MCCG regulations. It would be interesting to investigate whether these adjustments affect the level of corporate tax planning of Malaysian listed companies. Therefore, the objective of this study was to examine the level of corporate tax planning in the context of the 2017 MCCG reforms.

Research Methods

This study examines the impact of the MCCG on the level of corporate tax planning among trading and service companies in Malaysia. Financial data from Thomson Datastream for the period 2012 to 2021 was used to validate the research objective. The study sample includes financial information from 2012 to 2016 (pre-MCCG 2017) and from 2017 to 2021 (post-MCCG 2017). The balanced panel data analysis was based on 490 firm-year observations. The study used the effective tax rate to evaluate tax planning strategies. According to Salawu (2017), ETR is the appropriate metric to measure the efficiency of tax planning and indicates the amount of taxes paid by a company.

In line with previous research in the field of taxation, this study examines the viability of corporate tax planning using the ETR. The ETR was calculated as the ratio of a firm's tax expense to its pre-tax profit (Hanlon & Heitzman, 2010). Thus, in this study, ETR was calculated as follows:

ETR = Current Tax Expense

Profit Before Tax

The first criterion for selecting the sample for this study was that the companies had to have positive pre-tax income. Therefore, companies with negative pre-tax income were excluded. ETR was measured by calculating current tax expense divided by pre-tax income, so negative pre-tax income was meaningless. Second, the sample had to include trading and services companies listed on Bursa Malaysia during the study period. This is due to the fact that the MCCG has been a mandatory listing on Bursa Malaysia since 2001. Therefore, companies that had been delisted at any time were excluded. Finally, companies with incomplete financial information were excluded from the analysis to ensure a high balance of data and to avoid inaccurate conclusions due to missing data.

Findings

All The data stream primarily included a population of 191 companies from the trading and services industries listed on Bursa Malaysia between 2012 and 2021. After excluding companies with negative pre-tax earnings, only 77 companies remained in the sample. In addition, companies that are no longer listed on Bursa Malaysia and companies that changed their accounting year between 2016 and 2021 were excluded. Finally, the sample was reduced by an additional 26 companies due to missing data. By eliminating these outliers, the final sample resulted in 49 companies with 490 firm-year observations, as shown in Table 1.

Figure 2 shows the mean ETR values for the pre-MCCG (2012 - 2017) and post-MCCG (2017-2021) periods. A comparison of ETR from both periods shows that the post-MCCG ETR was higher than the pre-MCCG ETR. The results show an increasing ETR during the post-MCCG period. A higher ETR indicates a decrease in tax avoidance activity and vice versa, suggesting that companies were conducting less aggressive tax planning strategies.

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Table 2 presents the descriptive statistics of the final sample. The E-Views statistical tool was used to analyse data from several companies over time. A higher ETR signifies that the companies had a higher tax liability during post-MCCG compared to pre-MCCG 2017. The level of ETR for the 49 companies pre-MCCG ranged from 7% to 71%; meanwhile, for the post-MCCG, the rate ranged from 2% to 97%. The mean value for ETR post-MCCG was 26% and increased to 28% during the post-MCCG period.

A t-test was then conducted to determine the difference in corporate tax planning in the trading and service companies listed in Bursa Malaysia before and after the 2017 MCCG revision. The mean ETR values for the periods 2012 to 2016 and 2017 to 2021 were compared, as shown in Table 3. The p-value of 0.0026 shows a significant difference in the ETR of trading and service companies listed on Bursa Malaysia between the periods before and after MCCG 2017. The study shows that the amendment of MCCG 2017 had a positive impact on ETR, which is a positive sign of higher tax collection by tax authorities. This result suggests that the MCCG reforms would curb and combat aggressive tax planning by the Malaysian trading and services industry.

Conclusion

This research scrutinised the impact of the MCCG reforms on the level of corporate tax planning (proxied by ETR) in Malaysian trading and services companies listed on Bursa Malaysia. By analysing 490 firm-year observations from the ten years between 2012 and 2021, this study found a significant difference between the pre-MCCG ETR and the ETR post-MCCG 2017. Although the initiatives behind the MCCG reforms were not directly aimed at improving corporate tax reporting, this study empirically demonstrated that a corporate governance mechanism significantly affects ETR levels. The results show a substantial relationship with ETR before and after the 2017 MCCG, which adds to the literature and understanding of the impact of corporate governance on the level of corporate tax planning. Furthermore, regulators can use the information to decide on best governance practices to improve tax collection. The information collected in this study could help market participants understand the role of corporate governance in monitoring the aggressiveness of corporate tax planning activities.

However, this study has its limitations. First, the study was limited to trading and service companies listed on Bursa Malaysia; future studies could expand the sample to other sectors and compare the extent of corporate tax planning in different industries. The current results cannot be extrapolated to other sectors, as the latter may have different characteristics and more effective corporate governance. In addition, future studies could examine how the impact of financial characteristics might affect differences in ETR before and after the release of the 2017 MCCG.

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