Research on the Impact of Tax Evasion on Audit Fees of Companies

in China

Yuwei Wang

Beijing Jiaotong Univerity, China

Keywords: Tax Evasion, Tax Differences, Audit Fees.

Abstract: Based on the value effect and agency effect of tax evasion, this paper discusses the relationship between tax

evasion and audit fees by using the method of large sample study and least square regression. The regression

results of this paper show that tax evasion increases the risk of the auditors, so they will increase the audit

fees as a compensation, and the audit fees are positively related to the degree of tax evasion. This paper

enriches the research on the effect of corporate tax avoidance from the auditor's perspective, and also provides

institutional investors with countermeasures for corporate governance under different risk levels. For listed

companies, they should establish a correct concept of tax evasion; and for accounting firms, they need not

only to rely on the positive effect of tax avoidance under low tax evasion, but also to prevent and resolve the

risk of management's opportunistic behavior under high tax evasion.

1 INTRODUCTION

Tax risk is usually a risk that an enterprise's tax related

behavior fails to correctly and effectively comply

with the provisions of the tax law, which may lead to

the loss of future profits of the enterprise. Enterprises

need to pay taxes according to laws and regulations.

However, with the increasing pressure on enterprises

to operate, in order to maintain normal operation,

enterprises have reduced expenditure in various ways,

and tax expenditure accounts for a large proportion of

total enterprise expenditure. Therefore, companies

have the motivation to delay this part of expenditure

as much as possible through the activity of tax

evasion. Due to the differences between China's

accounting system and tax system, information

asymmetry and insufficient policy implementation,

enterprises have provided operating space for tax

avoidance, It makes tax avoidance feasible (Li

Yinxiang and Xu Wenjing, 2022). However, tax

evasion is an activity that is divorced from the edge of

laws and policies. The tax risks generated by tax

evasion are very important for enterprise risk

management. Although tax expenditure has been

saved to a certain extent, improperly handled tax risks

will cause great trauma to the enterprises, seriously

https://orcid.org/0000-0003-0031-7051

interfere with the normal operation of enterprises, and

even lead to business crisis and even bankruptcy of

the entire enterprise, Therefore, tax evasion is also an

important source of audit risk.

The audit fee is a certain amount of fee charged

by the certified accountant to the auditee to make up

for the cost paid in the audit process after providing

audit services. Therefore, to some extent, audit fees

reflect the compensation required by certified public

accountants for audit risks, that is, the greater the

audit risks undertaken by certified public

accountants, the higher the audit fees. When a

company conducts tax evasion activities, there are

chaotic and uncertain transactions within the

company, which improves information asymmetry in

tax related aspects of the enterprise, blurs the true

accounting information of the enterprise, and may

even create conditions for management fraud or urge

the management to purchase audit opinions to cover

up some negative information. At this time, the

certified public accountants may need to spend more

time and energy to understand the audited entity and

assess the risk of material misstatement of the

financial statements. The certified public accountants

are faced with greater audit burden and risk, so they

will increase audit fees as appropriate. Most of the

existing scholars believe that tax evasion increases

Wang, Y.

Research on the Impact of Tax Evasion on Audit Fees of Companies in China.

DOI: 10.5220/0012029000003620

In Proceedings of the 4th International Conference on Economic Management and Model Engineering (ICEMME 2022), pages 257-262

ISBN: 978-989-758-636-1

 2023 by SCITEPRESS – Science and Technology Publications, Lda. Under CC license (CC BY-NC-ND 4.0)

257

the risk of the auditee, and the CPA will increase the

audit fees as a compensation, which means that tax

evasion has a negative impact on enterprises. By

analyzing the impact path of tax evasion on audit fees,

this paper theoretically explores whether the tax

evasion of the auditee will have different mechanisms

on audit risk and audit fees.

The structure of the following parts of this paper

is as follows: The second part is literature review and

theoretical analysis. Through literature review in

related fields, research hypotheses are proposed; The

third part is the research design; The fourth part is

empirical regression, descriptive statistics and

regression results; The fifth part is the conclusion and

related discussion.

2 LITERATURE REVIEW AND

THEORETICAL ANALYSIS

2.1 The Mechanism of Corporate Tax

Evasion

Summarizing the research of relevant scholars at

home and abroad, corporate tax evasion can form two

different mechanisms: the value effect and the agency

effect of tax evasion.

2.1.1 The Value Effect of Tax Evasion

Cai and Liu (2009) thought that tax evasion could

decrease the tax payable of companies, retain more

cash flow, ease the financing burden and enhance the

sustainable operation ability of enterprises. Chen

Shenglan and Jia Siyuan (2016) believed that tax

evasion had a significant positive net effect on the

cash holding value of enterprises. The cash saved by

tax evasion for enterprises was conducive to reducing

leverage, reducing enterprise capital costs, capturing

investment opportunities, and even distributing it to

shareholders. Song Hang and other scholars (2019)

believed that tax evasion reduced the possibility of

enterprises falling into financial difficulties and was

conducive to dealing with the uncertainty of the

business environment.

2.1.2 The Agency Effect of Tax Evasion

However, the complexity and concealment of tax

avoidance also provide an opportunity for the

management to seek rent, which leads to tax avoidance

becoming a "black box" that causes agency problems.

The agency effect mechanism believes that tax evasion

has certain risks, which will weaken the effectiveness

of the contract. Normal remuneration cannot

compensate for the risks brought by tax avoidance,

which will worsen the principal-agent problem. In

addition, for tax evasion, enterprises need to design

complex and vague economic exchanges to support

their tax avoidance arrangements, which reduces the

transparency of enterprise information and makes it

more difficult for shareholders to supervise the

management. Considering their own interests or

reputation and other factors, the management does not

arrange tax evasion activities with the goal of

maximizing enterprise value, resulting in enterprises

failing to make full use of preferential tax policies to

pay more taxes, Or make too radical tax avoidance

strategies (Desai, 2006).Graham and other scholars

(2012) believe that tax evasion is often related to

abnormal accounting estimates, accounting

judgments and related transactions, which reduces the

credibility of financial statements, blurs the true

performance of enterprises, increases the risk of

financial restatement, increases the workload of

auditors and raises the potential litigation risk. This

tax avoidance behavior that damages the quality of

enterprise accounting information obviously increases

audit costs. Liao Xinxin (2016) believed that in order

to avoid being reviewed by the tax authorities, the

management would usually construct complex and

opaque transactions to cover up their tax avoidance

behavior. This aggravates the information asymmetry

between the internal and external of the enterprise,

making the management have the opportunity to use

the complex and hidden tax avoidance activities to

engage in profit manipulation, tunneling and other

self-interest behaviors to erode shareholder wealth.

2.2 The Effect of Tax Evasion on Audit

Fees

2.2.1 The Value Effect of Tax Evasion on

Audit Fees

Beck et al. (2014) believed that tax evasion enhances

the sustainable operation ability of enterprises,

mainly because tax evasion saves the expenditure that

should be handed over to the tax collection and

management authority, and converts these

expenditures into the operating cash flow of the

company, thus reducing the possibility of enterprises

suffering from financing difficulties, high financing

costs and other difficulties, and also reducing the

probability of enterprises facing financial constraints

or going bankrupt, thus making it possible for

auditors to reduce the risk assessment value.

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2.2.2 The Agency Effect of Tax Evasion on

Audit Fees

Desai and Dharmapala(2005)believed tax evasion

may aggravate the agency conflict, which is mainly

because after tax evasion becomes a financial

adjustment tool, the management may no longer be

responsible, fair and honest, but instead hope to fulfill

the compensation contract concluded with the board

of directors through tax evasion and other

manipulation behaviors, which helps to fufill the

requirements of the compensation contract in a

disguised way, reduces the effectiveness of the

compensation incentive, even induces the manager to

commit fraud opportunistic behaviors such as rent-

seeking and defensive behaviors that seek their own

interests increase the incentive and supervision costs

of the board of directors, thus making the

management have the motivation to purchase and

manipulate audit opinions in the form of increasing

audit fees to send a positive signal to the outside

world.

2.2.3 The Influence of Accounting

Information Quality on Audit Fees

Hope and other scholars (2013) believe that tax

evasion may increase the risk of information

disclosure of enterprises. This is mainly because

companies, in order to avoid tax evasion from being

exposed to the vision of tax collection and

management departments, will implicitly disclose

transactions related to tax evasion, increasing the

degree of information asymmetry, reducing the

credibility of financial statements, blurring the true

performance of enterprises, and increasing the risk of

financial restatement, increased the audit resource

input of firms and potential legal litigation risks.

Based on the review of the above theories, this

paper proposes two opposite research hypotheses:

H1: The degree of tax evasion is negatively related

to audit fees

H2: The degree of tax evasion is positively related

to audit fees

3 RESEARCH DESIGN

3.1 Data Source

The financial data of this paper is selected from the

CSMAR database, using A-share listed companies as

empirical samples, with the annual distribution

interval of 2011-2020, and the following data

screening and cleaning procedures are implemented:

(1) eliminate the enterprise samples with missing

values; (2) Clear ST or * ST company; (3) Remove

the sample with negative income tax expense and pre

tax profit. A total of 67275 sample observations were

obtained after data cleaning. In order to eliminate the

interference of extreme abnormal data on the

empirical results, this paper implements a 1% tail

reduction for all variables.

3.2 Variable Definition

At present, the commonly used indicator of tax

evasion degree is the difference between accounting

and tax. The difference between tax and accounting

has the function of signal transmission, which can

reflect the tax related behavior of enterprises to the

stakeholders in the capital market. The difference

between tax and accounting is significantly and

positively related to the tax adjustment made by the

tax authorities, indicating that under the background

of the existing tax collection and management

system, the difference between tax and accounting

has become the key basis for the tax collection and

management departments to study and judge the size

of tax evasion suspicion of listed companies. This

paper uses the accounting tax difference (Btd) to

measure the degree of tax evasion. Btd is equal to (pre

tax accounting profit taxable income)/total assets at

the end of the period. The larger the Btd, the greater

the difference between the accounting profit and the

taxable income, so that enterprises are more likely to

engage in tax avoidance activities.

Referring to the practice of existing literature, this

paper takes the natural logarithm of the total annual

audit fees of listed companies to obtain the audit fee

index (lnfee).

In the selection of control variables, this paper

uses the existing research literature for reference to

control the company size, business complexity

(Arlnv) and return on assets (ROA). Therefore, the

fixed effects of year and industry classification are

added to the model to control the potential factors

affecting audit fees. We can see Table 1 for the

detailed definition methods of the above variables.

Research on the Impact of Tax Evasion on Audit Fees of Companies in China

259

Table 1: Variable definition.

e Variable Variable name Variable definition

Explained variable lnfee Audit fees

Natural logarithm of audit

fees of listed companies

Explanatory

iable

Btd Tax evasion

Accounting - tax

differences

Control variables

Size Company size

The natural logarithm of

the company's annual total

assets

Arlnv Business complexity

Proportion of the sum of

accounts receivable and

inventory in total assets

ROA Return on assets Ratio of net

rofit to assets

3.3 Econometric Model

In order to verify the link between tax evasion and

audit fees, this paper uses OLS regression method to

test and control the two fixed effects of year and

industry. The model is as follows:

Lnfee

i,t

= β

＋β

Btd

i,t

+controls+ε

i,t

(1)

3.4 Research Method

This paper establishes an empirical model and

constructs a multiple linear regression equation by

computer, uses stata 15 and excel forms as the tools

to sort out the data of the paper. Stata is a complete

and integrated statistical software that provides users

with data analysis, management and professional

charts. According to the established model to regress,

and draw the conclusion of this paper based on the

analysis of empirical results.

4 EMPIRICAL REGRESSION

4.1 Descriptive Statistics

Table 2 shows the results of descriptive statistical

analysis of variables. Among them, the average value

of audit fees (lnfee) is 13.659, the maximum value is

19.403, and the minimum value is 9.210, indicating

that there is a large difference in audit fees between

different enterprises, and there is no obvious

distribution in the explained variables. The average

value of tax evasion (Btd) is 0.03, the standard

deviation is 0.994, and its standard deviation is 30

times of the average value. It can be seen that the

volatility of tax evasion is large, and its maximum

value is 7.518, indicating a considerable proportion

of enterprises are engaged in tax evasion, and tax

evasion is universal in the market.

Table 2: The outcome of descriptive statistics.

Variable Obs Mean Std. Dev. Min Max

lnfee 67275 13.659 0.779 9.210 19.403

Size 67275 21.901 1.316 15.233 28.843

ARLNV 67275 0.218 0.160 5.801 0.976

ROA 67275 0.033 0.241 -30.806 7.964

Btd 67275 0.030 0.994 -252.519 7.518

Note: Table 2 is the descriptive statistical results, which is formed after inputting relevant instructions using the data

processing software called Stata in the computer.

4.2 Correlation Analysis

Based on the value effect of tax evasion, the quality

effect of accounting information and the agency effect

of tax evasion, this paper believes that there is a non-

linear multi-dimensional relationship between the

degree of tax evasion of the auditee and audit fees.

Therefore, the samples are divided into two

categories: the low tax avoidance sample (L-sample)

and the high tax avoidance sample (H-sample). The

audit fees, tax evasion and other variables in the

samples are analyzed for correlation. The test results

are shown in Table 3:

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Table 3: Group correlation test results

Va ri ab le

L-sample H-sample

lnfee Btd lnfee Btd

lnfee 1 1

Btd -0.039

***

1 0.045

***

Note: Table 3 shows the statistical results after inputting the correlation analysis instruction by using the data processing

software in the computer. And *** indicates a significant correlation at the 0.01 level (bilateral).

Among them, in the L-sample with low tax

evasion, there is a significant negative correlation

between audit fees (lnfee) and tax evasion (Btd) at the

level of 1%, which is consistent with the assumption

H1. In the H-sample with high tax evasion, there is a

significant positive correlation between audit fees

(lnfee) and tax evasion (Btd) at the level of 1%, which

is consistent with the assumption H2. The results of

correlation analysis show that there is a nonlinear

relationship between the degree of tax evasion and

audit fees. When the degree of tax evasion is low, the

audit fees decrease with the increase of tax evasion;

When the company has a high degree of tax evasion,

the audit fees will increase with the increase of tax

evasion.

4.3 OLS Regression Results

The following is the OLS regression results after

regression in this paper, as shown in Table 4:

Table 4: Regression analysis results

Var (1) (2) (3)

Cons

13.660

***

（6.780）

3.827

***

（2.539）

3.891

***

（2.914）

Btd

0.005

（1.597）

0.019

***

（1.710）

0.012

***

（1.672）

Size

0.449

***

（56.340）

0.449

***

（56.340）

ARLNV

0.231

***

（0.781）

ROA

-0.118

***

(-1.450)

Grow

1.780

(

1.741

)

Year control control control

Industry control control control

Note: Table 3 shows the regression results formed by inputting multiple regression analysis instructions with the data

processing software in the computer. And *** indicates a significant correlation at the 0.01 level (bilateral).

Column (1) is a regression between the audit fee

of the explained variable (lnfee) and the degree of tax

evasion of the explanatory variable. The regression

result is positive at the 10% significance level,

indicating that the higher the degree of tax evasion,

the higher the auditor's fee will be; Column (2) shows

that on the basis of regression of audit fees (lnfee) and

tax evasion, plus the control variable size, the

regression results are significantly positive; The last

column (3) is a regression of all control variables with

the control variables ROA, Grow and ARLNV. The

regression results show that the larger the enterprise

is, the higher the business complexity is, the higher

the audit fees will be. Therefore, it supports the above

hypothesis H2: tax evasion is positively related to

audit fees.

5 CONCLUSION

The research finds that when the tax evasion degree

is low, the value effect of tax avoidance dominates,

and tax evasion is significantly negatively related to

audit fees. With the improvement of the tax evasion

degree of the auditee, accounting firms reduce audit

fees; When the degree of tax evasion is high, the

agency problem caused by tax avoidance is dominant,

and tax evasion is significantly positively related to

Research on the Impact of Tax Evasion on Audit Fees of Companies in China

261

audit fees. With the improvement of the degree of tax

evasion of the auditee, accounting firms require

higher audit fees.

The empirical analysis process of this paper

discusses the auditor's pricing decision under the risk

of tax evasion. There are some suggestions for

helping enterprises to formulate reasonable tax

evasion policies. Firstly, companies should establish

a correct concept of tax evasion. When conducting tax

evasion, managers should not aim at minimizing the

actual tax rate, but they should give consideration to

the relevant costs and benefits, treat tax evasion

rationally and be alert to the managers' self-interest

and irrational short-sighted behaviors. Secondly,

managers should not only rely on the positive effect

of tax avoidance under low tax evasion, but also

prevent and defuse the risk of managers' opportunistic

behaviors under high tax evasion. In particular, we

should judge whether tax evasion has exceeded the

internal control system framework of enterprises. In

addition, the audit firm should fully identify and

absorb tax related information released by

institutional investors, form two groups of external

supervision forces, and jointly improve the

governance effect of external supervisors. Third, the

government should improve the listed companies and

the implementation regulations, specifically require

enterprises to report tax adjustment related

information in the financial statements and their

notes, and supplement institutional investors' research

information related to intervention tax.

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