Use of Assets in Large and Mid-Size Corporations:
An Econometric Analysis of the Manufacturing
Sector using Schedule M-3 Data
George Contos, John Guyton
Office of Research
Jean LaVelle, Deborah Myers
Large Business and International
NOTE: The views expressed are those of the authors and not the official
positions of the Internal Revenue Service.
1
Objectives
• Better understand corporate taxpayer reporting
behavior
• Further research on differences in the rates of
return on assets in terms of book vs tax
• Discuss benefits of using the newly available
Schedule M-3 data to update and extend asset
structure literature
2
Asset Structure Literature
• Hypothesized that the nature and location of
assets may lead to book-tax differences in
revenues, rates of return on assets, and tax
liability
• Found evidence of increasing divergence
between what public corporations report for
book vs tax purposes
3
Book and Tax Income
• Financial (book) income:
– Calculated under the U.S. Generally Accepted
Accounting Principles (GAAP)
– Reported to shareholders and often to the public
• Tax income:
– Calculated following the Internal Revenue Code
(IRC)
– Reported to the Internal Revenue Service (IRS)
4
Book Tax Differences (BTD)
• Primary reasons:
– Temporary differences
– Permanent differences
– Consolidation differences
• Domestic Subsidiaries
• Foreign Subsidiaries
– Intercompany transfers of tangible and intangible
assets
5
Issues with Prior Literature
• Data Limitations
– Temporary vs Permanent
– Consolidation differences
• Econometric issues
– Ordinary Least Square assumption of identically
and independently distributed errors, violated
when residuals are correlated through time or
across firms (Graham et al., 2010)
6
Use of Schedule M-3 Data
• Reconciles information on financial statements
and tax returns
– For entities with assets greater than $10 million
– Introduced in Tax Year 2004
– Reports both worldwide consolidated net income and tax consolidation
net income
– Discloses which income and deduction items are temporary versus
permanent
• Data collection permits drill-down and trend
analysis
7
Mills and Newberry (2001)
Dependent Variable
• Adapt MN definition to new data
• Pretax book income from Schedule M-3 less
taxable income (before the Net Operating Loss
deduction) over total assets
– Equivalent to difference in book return-to-assets
and tax return-to-assets
• Tested sensitivity of results to above definition
• Separated BTD into temporary and permanent
8
Independent variables -MN
Publicly traded
Long-term debt
Foreign tax credit
Capital intensity
Size
Distress
Tax year
Major industry
Income Firms
+
+
?
?
?
Loss Firms
?
NA
?
?
?
9
Income Firms
Table 3: Comparison of Regression Output to
Mills and Newberry (MN)
Variable
MN
Large Firms
Full Sample
0.0008**
0.028**
0.011**
DEBT
0.020**
0.045**
0.001
DEBT*PUBLIC
-0.023**
-0.060**
-0.010
DEBT*DISTRESS
0.185**
0.079*
0.009
FTC
-1.332**
-1.090*
-1.300**
CAPINT
0.010*
0.010
0.001
SIZE
0.001*
0.005**
0.003**
-0.254**
-0.090**
-0.026
PUBLIC
DISTRESS
10
Loss Firms
Table 3: Comparison of Regression Output to
Mills and Newberry (MN)
Variable
MN
Large Firms
Full sample
-0.025**
0.010
-0.023**
0.036
0.013
-0.008
DEBT*PUBLIC
0.040*
-0.035
-0.001
DEBT*DISTRESS
-0.007
0.096
0.026*
CAPINT
0.002
0.061**
0.023*
SIZE
-0.009**
-0.007*
-0.006**
DISTRESS
-0.134**
-0.339**
-0.172**
PUBLIC
DEBT
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Additional Variables
• Dependent variable: BTD
• Independent variables:
Amortization for goodwill
Depletion
Depreciation
Federal deferred taxes
Tax exempt interest
Coordinated Industry Case (CIC) return
Consolidated return
12
Income Firms - Temporary
Table 5: Regression Output for All Firms
and Firms with Assets of $500 Million or
More
Variable
Large Firms
Full Sample
0.159
0.532**
DEPLETION
0.893**
0.836**
DEPRECIATION
0.263**
0.545**
TAX EXEMPT INT
0.232
0.050
DEFERRED TAXES
-0.634**
-0.714**
AMORTIZATION
13
Income Firms - Permanent
Table 5: Regression Output for All Firms
and Firms with Assets of $500 Million or
More
Variable
Large Firms
Full Sample
1.643**
0.816**
DEPLETION
-0.497
0.573
DEPRECIATION
1.686
-0.10
TAX EXEMPT INT
1.639*
0.422**
DEFERRED TAXES
-0.505**
-0.505**
AMORTIZATION
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Income Firms –Remaining Variables
Table 5: Regression Output for All Firms
and Firms with Assets of $500 Million or
More
Variable
Large Firms
Full Sample
PUBLIC
0.027**
0.013**
DEBT
0.045**
0.0004
DEBT*PUBLIC
-0.065**
-0.011
DEBT*DISTRESS
0.044
0.008
CIC
0.007
0.007*
CONSOLIDATED
-0.006
-0.002
CIC * CONSOLIDATED
0.015*
0.023**
15
Conclusion
• Use of Schedule M-3 data for both public and private
firms illuminates book-tax differences
• Broad conclusions of MN persist for more diverse
manufacturing population
• Better insights into corporate taxpayer reporting
behavior with respect to both temporary and
permanent BTD
16
Future Research
• Extend research to longer time series
• Test different dependent and independent
variables
• Specifically account for intangible/tangible
asset differences as possible additional source
of BTD
17