Banks traditionally deliver two main financial services to corporations: cash management and lending. But tax-savvy clients can also pick up some tax-planning moves from their banks, research suggests.
“We find that the tax planning of a given client is strongly associated with the average tax planning of its bank’s other clients,” write Chicago Booth’s John Gallemore, Stanford’s Brandon Gipper, and University of North Carolina’s Edward L. Maydew. The relationship is amplified when bank clients operate in the same industry.
The researchers studied corporations that had a borrowing relationship with a given bank, drilling down on two tax-planning metrics: the average cash effective tax rate (ETR) a company paid over rolling three-year periods, and the company’s unrecognized tax benefit (UTB). The former is a basic tax-planning measure, and the latter a lens into a firm’s aggressiveness (or not) in tax planning. The study includes nearly 65,000 ETR data points from more than 4,400 bank clients spanning 1993 to 2014, as well as more than 37,000 UTB data points covering 2006–14.
All else equal, if a company were to move from a bank with an average client ETR in the highest quartile to a bank with client ETRs in the lowest quartile, the company could reduce its ETR by 88 basis points.
There was wide divergence in what corporations forked over to the US government. Among clients of the 25 largest banks in the study, the average rate ranged from a low of 19.5 percent to a high of nearly 32 percent.
The right bank could save companies significant amounts. All else equal, if a company were to move from a bank with an average client ETR in the highest quartile to a bank with client ETRs in the lowest quartile, the company could reduce its ETR by 88 basis points. That translates to a 3 percent savings over the study’s average ETR. The equivalent bump provided by a better UTB would be 7 percent.
Banks with lending relationships are privy to detailed financial information, and they have the services and products to help clients lower their taxes, the researchers argue. Of course, banks can generate fees from implementing specific tax strategies for clients.
The study also offers empirical evidence that moving to a bank with tax-focused clients can pay off. When a corporation moved to a bank whose existing clients engaged in above-median tax planning, its typical three-year ETR declined 3.5 percent and the UTB benefit increased more than 12 percent. The savings were even greater when a client had foreign operations (shifting income to lower-rate jurisdictions being a time-honored tax strategy) and the bank had a significant investment-banking arm. Larger lending agreements and longer banking relationships also contributed to increased tax planning.
“Overall, our results suggest that banks, in addition to being financial intermediaries, also act as tax planning intermediaries in facilitating corporate tax planning,” the researchers note.