TAX PLANNING AND FIRMS’ LIQUIDITY

Abstract

Tax expense is a significant cost to organizations as it affects their cash flow and working
capital. As a result of this, organizations all over the world adopt tax planning strategies targeted
at minimizing their tax liability without adversely affecting the overall financial liquidity of the
firm. Thus, this study empirically examined the effect of tax planning strategies on firms’
liquidity. Various tax planning strategies were discussed but the strategies of Capital Intensity
(CAPINT), Thin Capitalization (TINCAP), Lease Option (LOPT) and Industry sector incentives
(IND) were selected as the independent variable. The Criterion variable used was firms’ liquidity
measured in this study by the Current Ratio (CR) while firm size (SIZE) was adopted as the
control variable. Data obtained from 154 firm- year observations were described and regression
analysis was used to test the hypothesis developed. The results reveal that tax planning strategies
of Capital Intensity (CAPINT), Thin Capitalization (TINCAP), and Lease Option (LOPT) exert
negative effects on firms’ liquidity while tax planning strategies of Industry (IND) and firm size
(SIZE) have positive effects on firms’ liquidity. This implies that tax planning as a balancing act
requires possession of specialist knowledge and skills to effectively craft in order for it to
positively impact firms’ liquidity as well as enhance firm value. Thus, it was recommended that
appropriate measures and skill should be applied in determining appropriate mix of strategies to
adopt for tax planning purpose as some strategies if not properly designed and applied may
reduce tax liability at the expense of firm’s liquidity.