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

Abstract

The paper evaluates the financial performance of Czech entities under control of companies listed in the EU and its relation to effective tax rates. Using individual corporate data, empirical evidence of 4,917 year-firm observations indicates a wide dispersion both in performance and taxation. The domicile of the parent has an impact on the subsidiary’s effective tax rate and the effective taxation of Czech subsidiaries under control of foreign listed parents is significantly lower than for other Czech companies. Despite exhibiting tax avoidance to some extent, the data reveal 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 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.