To Shift or Not to Shift? Intertemporal Income Shifting As a Response to the Risk Capital Allowance Introduction in Belgium

This study examines how firms shift profits from one period to another in response to the introduction of an allowance for corporate equity (ACE). We focus on the introduction of the risk capital allowance (RCA) in Belgium by the law of June 22nd, 2005. We predict and find that firms with relatively low (but positive) earnings in 2006 have incentives to defer profits in 2005 and that this effect is stronger for firms with higher equity ratios. Conversely, we predict that firms that are highly profitable in 2006 and have large net operating loss carryforwards in 2005 have incentives to accelerate profits. We find that only subsets of firms react to the latter incentive, in particular firms with higher equity ratios. Our findings show that tax-related benefits motivate firms to engage in conforming tax avoidance and provide evidence of cross-sectional variations in their reaction to these incentives. These insights contribute to the literature outlining the costs and benefits of changes in tax regimes and documenting earnings management in response to tax incentives in a high book-tax-conform environment