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CHAPTER ONE INTRODUCTION 1.1 Background to the Study Taxes are a fundamental revenue source for governments the world over. They represent a recognized compulsory contribution by individuals and corporate entities towards governance, development and maintenance of physical infrastructure as well as a tool of bridging income inequities. They are also a means by which the social contract between the State and the citizenry is being nourished and facilitated (Christensen & Murphy, 2004). Taxes also happen to be the most important, sustainable and predictable source of public finance for almost all countries (Action Aid, 2013). Thus properly harnessing amounts collected via taxes is a major concern for governments.
In assessing the extent to which a country has harnessed and financed its economy through taxation, an often used measure is the tax to GDP ratio. Scholars have however noted that the tax to GDP ratio for the developing world as a whole is relatively low when compared to what obtains in the developed economies. For instance, according to Fuest and Riedel (2009) the tax to GDP ratio for developing economies was on average approximately 12-15% as at 2005. Conversely, for the developed economies, the average for the same year was quoted as approximately 35%; a figure more than twice what obtained in the developing climes. More recent reports show some improvement in the ratio but given the potential the region has for increased tax revenue, the improvement has not been found to be impressive. For instance, a report by the International Tax Compact, ITC (2010), noted that while tax revenues in Organization for Economic Cooperation and Development (OECD) countries amounted to almost 36% of gross national income in 2007, the share in selected developing regions was estimated to be around 23% for Africa (in 2007) and 17.5% for Latin America (in 2004).
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Specifically focusing on Nigeria, as at January 2014, tax revenue to GDP ratio stood at 20% (Premium Times, 2014). However with the rebasing of Nigeria‟s GDP in 2014, which saw the country‟s GDP increase from N42.3 trillion to N80.3 trillion, making Nigeria Africa‟s largest economy, Nigeria‟s tax revenue to GDP ratio fell from 20 % to 12 %. Out of the said 12 %, only 4% was attributable to non-oil revenue. This led to a call by the then Minister of finance on the need for the taxing authorities to redouble their revenue generation efforts (Premium Times, 2014). This call by the minister as well as the assertion by Oxfam (2014) that widening income disparities are the second greatest worldwide risk in 2014, underscore the need to look deeper into the various sources of development finance, especially taxation. The highly volatile nature of oil revenue- which the Nigerian economy depends on to a large extent should, arguably, also serve as an added impetus towards looking for ways to better harness other revenue sources such as taxes.
In exploring how to better harness tax revenues, it has been documented world over that, two major activities; perpetrated by both individuals and corporations, have continued to represent a great threat to amounts of revenue collected through taxes. In addition, the said issues feature prominently in equity and efficiency related discourse. The duo of issues are tax evasion and tax avoidance. While both are aspects of tax non-compliance, the delineating feature between the two lies in the fact that tax evasion is deemed out rightly illegal while by definition tax avoidance is not. However notwithstanding the delineating line between the two, in advanced economies, the duo have been given serious consideration by their governments, through the relevant agencies. Furthermore, the two issues have sparked much research; ranging from investigating their determinants- both for individuals and for corporations examinations of the attendant consequences engendered by their continued flourish.
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The question of what factors explain the ability of firms and corporations to avoid taxes is of particular interest to researchers. The reason for much of the focus on tax avoidance as opposed to tax evasion is because evasion as a criminal act has to be proven by court. Thus using the term avoidance is seen as less dyslogistic. In however considering corporate tax avoidance as a research issue, researchers such as Shackelford and Shevlin (2001) have earlier questioned the applicability of models of individual tax evasion and avoidance such as the Allingham and Sandmo (1972) framework in explaining and predicting corporate tax avoidance. They argued that the separation of ownership and control, a hallmark of corporate entities, means that existing individual tax non-compliance frameworks cannot adequately explain same for corporations. In furtherance of the argument, Slemrod (2004) stated that this same separation of ownership and control means that shareholders need the corporation to engage in some level of avoidance. Thus, ininvestigatingwhat factors explain tax avoidance by firms and corporations, earlier studies on corporate tax avoidance focused primarily on examining whether firm-specific characteristics such as size, leverage, growth, profitability,amongst others could explain the tax avoidance phenomenon for business entities (e.g., Gupta & Newberry, 1997). These earlier studies however failed to consider agency issues in their analyses. Pointing out why failing to do so is an anomaly, Desai and Dharmapala (2006, 2007) argued that since decisions about corporate tax avoidance are made by firm managers, then the analysis of such decisions is thus embedded in an agency framework.
The agency framework is one that argues that managers are risk averse and self-serving in nature and that this risk averseness as well as self-serving nature means that managers will not typically act or make decisions in the best interest of owners. To ensure goal congruence between management and shareholders or owners, the framework suggests that managers should
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be both incentivized and monitored. Corporate governance mechanisms represent the means by which monitoring managers can be achieved. Corporate governance mechanisms can however be internal or external. The internal mechanisms are those that have to do with the efficacy of the board of directors in appropriately advising on and overseeing the design and implementation of business strategies that will ensure that managers maximize shareholder wealth. In addition, such internal mechanisms include the role that shareholders themselves play in ensuring goal alignment. Prescriptions that have to do in particular with size, independence, remuneration and financial expertise of the board have therefore featured prominently in the various codes of corporate governance that have been issued both nationally and internationally as guides to what constitutes “best practice” in oversight. On the other hand, external governance mechanisms include all other stakeholder monitoring. Therefore mechanisms such as government regulation, debt covenants, takeovers, financial analysts and the like are all aspects of external governance. Internal governance mechanisms have, in particular, been touted to be foremost amongst the monitoring mechanisms that can ensure goal alignment between owners and managers. This is thought to be so because the board of directors is responsible for the strategic direction of the company. Charting a course for effective tax management is one of such strategic direction. Therefore, like any other board room stratagem, managing taxes requires a laid down philosophy which is usually determined by the board; documented, communicated and implemented as overall corporate strategy (Erle, 2007). Thus, board related governance mechanism such as size, independence, and ownership, amongst others can arguably play a key role in determining a company‟s tax planning.