The effect of Taxation on financial performance: the case of Tunisian companies

doi:10.21203/rs.3.rs-2359367/v1

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The effect of Taxation on financial performance: the case of Tunisian companies

https://doi.org/10.21203/rs.3.rs-2359367/v1

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This article presents an empirical study of the effect of taxation on the performance of Tunisian companies. The study is based on a sample of 122 large Tunisian companies over the 2015-2019 period. The econometric method used is that of panel data. The results show that corporate income tax, tax incentives, firm size, liquidity, and leverage have significant (negative/positive) effects on the financial performance of Tunisian companies. These results may interest investors, practitioners, and regulators who wish to discover the investment climate in Tunisia. Tax policymakers are urged to lower corporate income tax and maximize the tax incentives to attract domestic and foreign investors. Finally, this paper extends the existing literature by examining the effect of taxation on firm performance in the Tunisian context.

JEL Classifications L25; H25; C23.

Financial performance

corporate income tax

tax incentives

Tunisian companies

Panel data

Investment is a significant engine of growth for any economy. Its contribution to economic growth is visibly reflected in creating jobs and financing the infrastructures necessary for a country’s socioeconomic development through taxation. The liberalization of the Tunisian economy through various national policy prescriptions has changed the structure of the economy in Tunisia.

Taxation is now attracting national and international scholars’ attention as it influences every country’s economic activities. Tax policies provide a mechanism to influence consumer demands and incentives for production, investment, and savings. If taxes are a significant element of macroeconomic policies, they are no less so for the strategic decisions companies take. Tabet and Onyeukwu (2019) discussed the impact of taxation on the financial performance of small and medium enterprises in Nigeria. As taxation constitutes a cost for a company, it necessarily affects its performance. Therefore, every company is looking for ways to reduce the tax burden. Several studies have been conducted to measure the effect of the tax variable and other factors on the financial performance of companies (Turakpe, 2020; Liu and Mao, 2019).

This study differs from previous studies and contributes to the existing literature in several ways. Firstly, Tunisia is considered an appropriate case study because tax revenues finance more than 74% of the state budget in 2022. Policymakers must focus on ensuring business stability and attracting domestic and foreign investors. Second, unlike previous studies, this study tested the interaction between corporate taxation, tax benefits, and other factors and their impact on the financial performance of Tunisian companies.

The remainder of this article is structured as follows. Section 2 focuses on the literature review and is dedicated to generating research hypotheses. Section 3 presents the sample, variables, and research model. The object of Section 4 is to introduce and discuss the empirical analysis. A summary of the main findings is in Section 5.

2.1 Financial performance

The health and survival of a company hinge upon its financial performance. Financial performance reflects its effectiveness and efficiency in managing the resources required for operational, investment, and financing activities (Kurawa and Saidu, 2018). It is at the heart of the managerial function of an organization. Ilesanmi (2011) defines financial performance as the yield or results of activities carried out in relation to the objectives pursued. Its purpose is to strengthen the extent to which organizations achieve their goals.

In this sense, performance encompasses three areas of business results: financial performance, product market performance, and shareholder return. Several measures have been used to assess financial performance. The most common combine stock and accounting measures, such as Tobin's Q, return on equity (ROE) and return on assets (ROA) (Jyoti and Khanna, 2021). Therefore, performance could be measured objectively or subjectively. While objective measures are typically based on financial data, subjective measures rest on management assessments.

Accounting measures such as sales, earnings per share, and growth rate can effectively evaluate business performance. Most studies use accounting data to measure financial performance. The primary accounting measures of performance are return on assets (ROA), which is an indicator of a company's profitability relative to its total assets. Return on equity (ROE) is the net income returned as a percentage of shareholders. The measurement of asset profitability by ROA has been cited in various studies (Jyoti and Khanna, 2021). Thus, this ratio measures the company's profitability as perceived by the owners and in accordance with its financial structure. Given the above, we study the relationship between tax factors, financial performance, and other factors. Financial performance per se will be measured by the return on assets (ROA).

2.2 Corporate income tax

In their study, Sebastien and Costel (2018) examined the effects of corporate income tax on two main drivers of growth: profitability and business investment in European OECD member countries from 1996 to 2004. The results suggest that high corporate taxes reduce investment opportunities because investors tend to be dissuaded from paying high taxes. This means that increasing corporate income tax has adverse effects of on financial performance and the investment climate in a general sense.

Similarly, Kayode and Folajinmi (2020) studied corporate tax and found a correlation between corporate income tax and firm profitability. This study focused on the impact of a company’s tax obligations on different variables, such as gross margin, cost of sales, and expenses. The conclusion was that corporate income tax harmed the firm’s financial performance but had a positive relationship with firm size and age. Other authors have found a negative relationship between corporate taxation and financial performance (Nwaorgu et al., 2020). Based on these findings, we can put forward the following hypothesis:

There is a negative and significant association between corporate income tax and financial performance.

2.3 Tax incentives granted by the State

Ugwu et al., (2020) define a tax incentive as a deduction, exclusion, or exemption from tax liability offered to investors to encourage them to invest in privileged sectors of the economy for a certain period. According to Fletcher (2002), tax incentives are any tax provisions granted to a qualified investment project that demonstrates a favorable deviation from the general requirements applicable to investment projects.

Empirical studies have reported different views on tax incentives as a catalyst for economic development. One school of thought (Gregova et al., 2021) holds that many developing and transition countries worldwide provide investment incentives. Likewise, Kilika (2018) argues that tax incentives constitute a cost to the government and can drain government revenue if they are not well-targeted. This is because the government would have deprived itself of the revenue that the tax would have generated.

In Tunisia, Investment Law No. 2016-71 of September 30, 2016, aims to promote investment, create jobs, form new businesses, consolidate regional and agricultural development, support exports, and otherwise increase production and wealth according to the priorities of the national economy. Similarly, Law No. 2017-8 of February 14, 2017, on revamping tax advantages, aims to reduce taxes and duties (personal income tax, corporate tax, customs duties, value taxes added taxes, registration fees, etc.). This law grants various advantages under the exploitation and reinvestment of the initial capital or its increase to support and attract investors to invest in different activity sectors and Tunisia's other regions.

The tax incentives granted by the State to companies have a positive and significant impact on their financial performance.

2.4 Firm size

The relationship between firm size and financial performance has received considerable attention in the literature. Goh et al., (2020) argue that larger companies can achieve higher performance. They are more likely to exploit economies of scale and enjoy greater bargaining power over their customers and suppliers. In addition, large companies have less difficulty accessing credit for investment, employ qualified human capital, and can achieve greater strategic diversification. On the other hand, small firms exhibit specific characteristics that may counterbalance the handicaps accruing from their small size. They suffer less from bureaucracy and red tape and are characterized by more flexible, non-hierarchical structures, which may be the appropriate organizational forms to change business environments. Along the same lines, Kijkasiwat and Phuensane (2020) state that the assets of large companies are considered less risky than those of small companies. Oyelade (2019) states that companies of different sizes run various occupational risks. Larger companies run lower risks than smaller ones, as they can quickly enter the capital market and obtain additional financing.

2.5 Liquidity

Saha (2021) examined how liquidity influences corporate financial performance in 6 OECD countries. Their paper aimed to analyze how firm size affected return on assets. Since there is a general agreement that companies have a limited return on assets, they emphasize internal investments. Companies operating in a variety of countries were examined, regardless of size. Multiple regression analysis was used to test the relationship between variables. The results show that company size and liquidity have positive effects on and highly significant relationships with internal investments.

Liquidity is one of the most important goals of working capital management. It is measured by the current assets ratio to gauge the company's ability to pay its current liabilities. Research by Sundas and Butt (2021) reveals a positive correlation between liquidity and firm value and that this correlation is weaker in developing country markets. Similarly, Waitherero et al., (2021) analyze the relationship between liquidity, solvency, and performance, which play a vital role in the return on assets of the chemical sector in Pakistan. The analysis is carried out on the data of 10 chemical companies from 2000 to 2009. The conclusions drawn are that the liquidity ratio positively affects the ROA. However, it has a negative impact on solvency. In a recent study, Pham and Nguyen (2020) found a strong correlation between liquidity and performance. The study further found that liquidity is a conduit for better performance.

2.6 Leverage

Jamal (2020) has shown that leverage negatively correlates with firm performance. Financial experts such as Mamaro and Legolto (2020) state that the higher the debt of a company, the more the company has the potential to suffer financial losses leading even to bankruptcy. Aziz and Abbas (2019) attribute the high cost of borrowing to relationships between capital structure and firm performance. Companies with high leverage are significantly less profitable than companies with a higher level of equity in the debt structure. Along the same lines, Pham and Nguyen (2020) found that the overall cost of capital is reduced, and firm value increases as the debt ratio in a firm's capital structure increases.

Other authors (Gregova et al., 2021; Sunardi et al., 2020) predict the effects of debt on firms and conclude that a moderate level of debt improves growth, but high levels can lead to a decline in business growth. Thus, there is a relationship between debt levels and financial performance. Jamal (2020) examined the optimal level of capital structure that allowed a firm to increase its performance. The study indicates that there was a relationship between the company's debt ratio and performance as measured by return on assets and return on equity.

2.7 Firm age

Rossi (2016) examined the impact of size and age on firm performance in microfinance institutions. The results indicate that firm size and age affect microfinance performance in terms of efficiency, sustainability, profitability, and revenue-generating capacity. The link between age and firm performance has been widely examined in the financial literature and other disciplines.

Rahman and Yilun (2021) investigated the relationship between firm size, age and profitability in the Chinese stock market using data from all public companies in the Chinese stock market from 2008 to 2018. The results show a positive relationship between firm size and profitability. On the other hand, the age of the company has a negative effect on profitability. Similarly, Nawaz and Iqbel (2020) show that young firms earn higher profits than older firms.

2.8 Growth

According to Kim (2022), business growth remains an elusive problem. There has been little progress in identifying the main drivers of firm growth, and recent empirical models have low predictive power (Van Witteloostuijn and Kolkman, 2019). Similarly, Dugguh and Isaac (2018) analyzed the effect of taxation on corporate profitability. Investment, taxation, liquidity, and business growth were the main variables.

Diaye and Oueghlissi (2022) used the "GROWTH" variable, which measures variation in the company's turnover, to show that the level of accruals positively controls a company’s evolution. In this study, we present the impact of the variation of turnover on company performance.

2.9 Independence of board members

The independence of board members is one of the control mechanisms that emerged after the economic crisis of the 1930s. Independent directors essentially play two roles on a board. First, they hold an advisory role in which they share their expertise with the board of directors (Livnat et al., 2019). Second, they mitigate agency costs by overseeing business management. The agency's perspective is that steering aims to align the objectives of the CEO with those of the shareholders.

Many studies have empirically tested the impact of board member independence on financial performance and firm value in the Swedish market. The general trend is that board independence affects firm value and performance (Moursli, 2019). Similarly, Khan and Abdul Subhan (2019) studied the relationship between board independence and operational performance in American companies and came to the same conclusion.

Jaidi et al., (2022) found that, together with other variables, board independence has a positive synergistic effect on a firm’s financial performance. They argue that board independence is essential for the growth of its performance. Similarly, Tuling and Ramdani (2018) argue that independent members are crucial in monitoring board effectiveness since large shareholders may have more power than minority shareholders. Likewise, Bouaine and Hrichi (2022) affirm the positive role of board independence in protecting shareholders. They report that the proportion of independent directors within the board influences companies’ financial performance.

3.1 Sample

The starting population of our study includes all large Tunisian companies. According to Article 5 of Decree n ° 2017 − 1157 of October 27, 2017, large companies achieve a gross annual turnover equal to or greater than 20 million dinars. However, several companies were eliminated from the sample because specific data were unavailable. Similarly, companies that are financial or are regulated by public authorities are excluded from the analysis sample. The accounting and financial data of our econometric model were extracted from the Official Journal of the Republic of Tunisia and annual reports. We obtained the tax data of the companies studied from the tax administration, which is the corresponding governmental tax control authority in Tunisia. Our final sample comprises 122 companies, i.e., a total of 610 company-year observations from 2015 to 2019.

3.2 Research model and variable measurement

We estimate the effect of corporate income tax and the tax incentives granted by the State on the financial performance of companies using the model below. We introduced control variables such as firm size, liquidity, firm debt, firm age, growth, and independence of board members.

The general form of this relationship is expressed by:

ROA _it = α₀ + β₁ CIT_it + β₂ TAX_INC_it + β₃ SIZE_it + β₄ LIQ_it + β₅ LEV_it + β₆ AGE_it + β₇ GRO_it + β₈ BO_IND_it + ε_it

The subscripts i and t denote companies and year, respectively. α is the constant term, β1 to β8 are slopes to be estimated, and εit is the error term of the model. The dependent, independent, and control variables are described below.

Table 1

Definition of the variables of the study and the presentation of the expected signs
Variables	Symbol	Measures	Expected signs
Dependent variable
Financial performance	ROA	Return on Assets measured by the ratio (Net Result/Total Assets).
Independents variables
Corporate income tax	CIT	The ratio of corporate taxes to operating income.	(-)
Tax incentives	TAX_INC	Equal 1 if the firm has benefited from the tax incentives granted by the State, 0 otherwise.	(+)
Control variables
Firm size	SIZE	Ln (firms’ total assets).	(+)
Liquidity	LIQ	The ability of the company to meet its short-term debt using current assets (current assets ÷ current liabilities).	(+)
Leverage	LEV	Ratio of total liabilities to total assets in year t for company i.	(-)
Firm age	AGE	This variable is measured as the logarithm of the number of years since the firm started operating.	(+)
Growth	GRO	It is the variation of the turnover between (t) and (t-1) divided by the turnover (t-1).	(+)
Board independence	BO_IND	This proxy detects the independence of the board of directors as measured by the ratio of the number of independent directors to the total number.	(+)

4.1 Descriptive Statistics and Correlation Matrix

Table 2

Descriptive Statistics
Variables	Observations	Mean	Minimum	Maximum	St. deviation
ROA	610	0.5705	-0. 3627	1	0.1755
CIT	610	0.3891	-3	0.0904	0.2641
TAX_INC	610	0.6746	0.0034	1	0.6690
SIZE	610	3.3783	1.5087	5.4083	1.0905
LIQ	610	0.7736	0.3247	6.2291	1.4169
LEV	610	0.5874	0. 0272	1.5087	0.2031
AGE	610	0.1536	0.9581	3.7364	3.2560
GRO	610	0.3720	0. 00007	3	0.5322
BO_IND	610	0.3365	0.25	0.8	0.1687

For each variable, the number of observations is 610. Table 2 shows the mean of 0.5705 for the return on assets (ROA) with a minimum and a maximum of -0.3627 and 1, respectively. This indicates that, on average, the sampled companies earned 0.570 dinars as a return per dinar of the value of their assets, with a maximum loss of 0.3627 dinars and a maximum profit of 1 dinar. On average, the dependent variable (ROA) shows that 57% of the companies constituting our sample are financially efficient.

Likewise, the study records an average of -0.3891 for corporate income tax (CIT), which means that almost 39% of companies for the period studied bear high tax burdens with a minimum and a maximum of -3 and 0.0904, respectively. In addition, we noticed that, on average, 67.46% of companies benefited from tax incentives (TAX_INC) during the study period, with a minimum and a maximum of 0.0034 and 1, respectively. This result shows that to attract and maintain investments, the Tunisian State must grant different forms of advantages.

The observation statistics of the variable size (SIZE) are in the order of 3.3783, 1.5087 and 5.4083, respectively. We note that the companies covered by our study are under the control of the management of large companies with a gross annual turnover equal to or greater than 20 million dinars. The mean of the variable (LIQ) is 0.7736. This shows that the current assets of more than 77% of the companies in our sample can cover current liabilities. Debt-wise, it seems clear that most companies have high debt ratios, on average, 58.74%. These debts can be explained by the weight of bank financing, which is relatively high for most companies in our sample.

Other variables show that the companies constituting our sample have been established for a while (over 15 years of age). In addition, 37.20% of companies experienced an increase in turnover during the studied period. Finally, on average, 33.65% of the companies in our sample opted for an independent board of directors.

Table 3

Correlation Matrix
	ROA	CIT	TAX_INC	SIZE	LIQ	LEV	AGE	GRO	BO_IND
ROA	1.000
CIT	-0.5949	1.000
TAX_INC	0.2088	-0.1701	1.000
SIZE	0.4981	-0.6077	0.2480	1.000
LIQ	0.6457	-0.6040	0.3683	0.4539	1.000
LEV	0.2763	-0.2402	0.2086	0.3499	0.2616	1.000
AGE	-0.0425	0.0374	0.0394	0.0010	-0.0382	-0.0108	1.000
GRO	0.6124	-0.5837	-0.1523	0.3818	0.5190	0.1151	-0.0736	1.000
BO_IND	-0.1086	0.0951	-0.0338	-0.1075	-0.1210	-0.1198	0.0300	-0.1069	1.000

Table 3 presents the correlations between the different variables, which imply the absence of strong multicollinearity that could bias our results.

4.2 Multivariate results

Table 4

Econometric regression
Variables	Predicted sign	Coef.	z	P>\|z\|
constant	+/-	0.0986	2.76	0.006***
CIT	-	-0.0444	-2.69	0.007***
TAX_INC	+	0.0110	1.71	0.087*
SIZE	+	0.0104	2.63	0.009***
LIQ	+	0.0083	2.32	0.020**
LEV	-	-0.0907	-3.20	0.001***
AGE	+	0.0013	2.25	0.024**
GRO	+	0.0615	4.80	0.000***
BO_IND	+	-0.0699	-1.51	0.130 (n/s)
Number of companies 122 Number of observations 610 Wald chi2 78.25 Prob > chi2 0.0000
, , **: the coefficients are significant at the thresholds of 10%, 5% and 1%, respectively

We have found in our analysis that the level of taxation of Tunisian companies constitutes a significant burden. Taxation is a burden every natural or legal person has to bear to support their government, so the latter performs its functions and obligations adequately. The results reveal that the variable (CIT) seems to be negatively significant at the 1% risk threshold (Coef. = -0.0444; P>|z| = 0.007). The Tunisian national tax policy assumes that taxation is an essential source for the State’s revenues. It is also a pecuniary charge imposed on individuals or property owners to fund government expenditure. Corporate tax applies to legal persons, permanent establishments of foreign companies established in Tunisia, and certain incomes paid to foreign legal persons not established in Tunisia. This suggests that as companies pay more taxes, their financial performance declines because taxation lowers the companies’ profit levels. Consequently, companies seek to minimize tax charges which negatively and significantly affect their financial performance.

Variable (TAX_INC) is positive and significant to the order of 10% (Coef. = 0.0110; P>|z| = 0.087); the tax benefits granted by the Tunisian State affect most sectors of economic activity. This investment incentives policy makes it possible to attract national and foreign investors to invest in Tunisia. In addition, the Tunisian tax system offers companies various types of allowances and several tax incentives, subject to certain conditions. Overall, Tunisian tax incentives significantly affect the determination of tax benefits in two ways. Firstly, allowances influence profits and tax allowances for exempt reinvestments. It follows that obtaining tax incentives improves the financial performance of companies.

The regression coefficient of the variable (SIZE) is positive and significant at the rate of 1% (Coef. = 0.0104; P>|z| = 0.009). Regarding the company's characteristics, we find that the larger a company, the better its financial performance. This is because as companies increase in size, they turn to implementing strategies that increase market share, which means they sell to a broad spectrum. If so, their financial performance should increase in proportion to their size. Moreover, although tax incentives of any kind are not granted based on the size criterion in Tunisia, large companies are the most likely to benefit from them thanks to their large size and resources.

Similarly, liquidity (LIQ) is positively significant (Coef. = 0.0083) at around 5% (P>|z| = 0.020). In this sense, the relationship between performance and liquidity is limited to certain stocks. For example, institutional investors tend to invest in large companies. Likewise, financial analysts show greater interest in large companies. Therefore, on average, large companies have a more advanced information environment than small ones. In such environments, liquidity plays a more prominent role as a channel for revealing information.

Our results support our previous findings of a significantly positive relationship between liquidity and firm financial performance. In this way, the companies in our sample have been able to cover their operating expenses.

The variable (LEV) is negative and significant (Coef. = -0.0907; P>|z| = 0.001). This variable is associated with debt as one of the engines of development. A company’s essential mission is to support the improvement of business performance. As an engine of growth, debt allows companies to finance their day-to-day operating needs. It generates costs and difficulties accruing from the payment of sometimes serious financial charges. As a result, a company's debts are subject to a fixed repayment schedule. The results suggest that the more debt a company holds, the less information it will disclose in its annual report. Thus, indebtedness can reach levels where the company can no longer meet its commitments to creditors. This inability decreases the financial performance of companies.

The variables (AGE) and (GRO) turned out to be positive and significant in the order of 5% and 1% respectively (Coef. = 0.0013; P>|z| = 0.024; Coef. = 0.0615; P >|z| = 0.000). The increase in the age of Tunisian companies positively reflects their financial performance so that companies increase their clientele and operational efficiency by improving production and sales, with a visible impact on financial performance. Consequently, it appears that variable (BO_IND) (Coef. = -0.0699; P>|z| = 0.130) is particularly, is non-determining of financial performance in the Tunisian context. The absence of impact can be explained by the overlap between the functions of the members of the board of directors and the general management. This double “hat” makes for better alignment with the interests of the managers than those of shareholders, with leaves the latter with little power to control.

This study was designed to determine whether corporate income tax and tax incentive benefits affect the financial performance of Tunisian firms. Based on a sample of Tunisian companies over the 2015–2019 period, we conducted a regression analysis to test the hypotheses that corporate income tax and tax incentives impact companies' financial performance. This study has theoretical, practical, and political implications. We have found that better financial performance hinges on minimizing tax burdens and obtaining maximum tax incentives. In addition, the availability of liquidity to cover operating costs, rather than recourse to debt, allows Tunisian companies to improve their financial performance significantly. This study should interest tax policymakers concerned about lowering corporate tax rates. Its main finding is that the Tunisian state must grant more tax incentives to encourage investors to invest in Tunisia.

Our study is subject to several limitations. First, our sample is limited to large Tunisian companies, so we cannot generalize the results to all Tunisian companies. Another limitation is the lack of published data on tax variables and the difficulty of obtaining data from companies or the tax administration. That said, our study clears the ground for interesting future research questions. This work can be extended internationally by using comparative samples from countries such as Morocco and Egypt.

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No competing interests reported.

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The effect of Taxation on financial performance: the case of Tunisian companies

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Abstract

1 Introduction

2 Theoretical Background And Hypotheses Development

2.1 Financial performance

2.2 Corporate income tax

2.3 Tax incentives granted by the State

2.4 Firm size

2.5 Liquidity

2.6 Leverage

2.7 Firm age

2.8 Growth

2.9 Independence of board members

3 Research Design

3.1 Sample

3.2 Research model and variable measurement

4 Empirical Results And Discussion

4.1 Descriptive Statistics and Correlation Matrix

4.2 Multivariate results

5 Conclusion

References

Additional Declarations

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