Financial constraints and tax planning activity: empirical evidence from the Ghanaian banking sector

What is it about?

This paper focused on investigating the relationship between financial constraints scenario and tax planning activities of banks in Ghana. The study explores how financial constraints could motivate commercial banks in Ghana to pursue tax planning mechanism and the implication on tax revenue mobilisation. Simulation approach is adopted to provide financially constrained bank scenario. This paper is one of the few studies which have extended the tax planning literature to the Ghanaian banking sector. Further novelty is seen from the development of financial constraint scenario from liquidity and solvency. Liquidity and solvency are the anchors for continuity of banking operation and sensitive to regulatory watch and sanctions. Therefore, by applying simulation approach to trigger financial constraints scenarios from these fundamental indicators reveals the extent to which commercial banks rely on tax planning opportunities to mitigate the consequence of financial constraints. The contemporaneous and lagged based sensitivity analysis provides evidence on the time varying effect. The paper found that when banks face financial constraints they exhibit lower cash effective tax rate (CETR). The decomposition analysis also revealed that financially constrained banks are likely to take both short and long term tax planning opportunities as depicted by the significant negative relationship between permanent effective tax rate (PETR) and temporal effective tax rate (TETR) and the financial constraints variables. The paper also found evidence of persistence in the tax planning activities under financial constrained scenario. Government is therefore likely to lose tax revenue when banks in Ghana become financially constrained and would worsen the rather weak tax revenue to gross domestic ratio.

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Why is it important?

This paper is one of the few studies which have extended the tax planning literature to the Ghanaian banking sector. Further novelty is seen from the development of financial constraint scenario from liquidity and solvency. Liquidity and solvency are the anchors for continuity of banking operation and sensitive to regulatory watch and sanctions. Therefore, by applying simulation approach to trigger financial constraints scenarios from these fundamental indicators reveals the extent to which commercial banks rely on tax planning opportunities to mitigate the consequence of financial constraints

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