EFFECT OF DEBT-EQUITY TAX BIAS ON THE WACC OF OIL AND GAS COMPANIES IN BRICS COUNTRIES

The global financial crisis, highlighted companies’ vulnerability to debt that led to an intensive effort to reduce leverage. The debt-equity ratio points towards financial leverage and therefore has a direct impact on a company’s long-term sustainability. The literature review highlights the fact that tax systems allow for interest payments to be deductible for income tax purposes, while denying such payments on equity. This tax treatment leads to a tax bias towards debt finance. The purpose of the study is to determine the potential tax bias risk of oil and gas companies in BRICS countries exploring the effect of debt-equity tax bias on weighted-average cost of capital (WACC). The annual financial statements of five oil and gas companies in BRICS countries were analysed to determine the effect of debt-equity tax bias on WACC for the period of 2009 to 2016. Evidence of tax biasness related to debt-equity finance is clearly visible in the annual financial statements. The WACC is directly influenced through this phenomenon. The results indicated a significantly inverse relationship between debt-equity and the WACC of oil and gas companies in BRICS countries. The annual financial statements revealed in all cases a tax bias trend. Which can potentially increase risk for the said companies, due to the over exposure to debt, especially in times of financial hardship. Although many of the companies adjusted the WACC based on the lessons learned from the global financial crisis, this still remains a concern. The study proposes that debt-equity tax bias influences WACC and provides some evidence to suggest that managers, directors and shareholders should consider reducing the debt-equity ratio. The study could potentially help regulating authorities to gain insights into debt-equity decisions and how these decisions could potentially influence long-term sustainability and the wealth earning ability of companies in BRICS countries.

Keywords:

Debt-equity ratio, Capital structure, Taxation BRICS, Weightedaverage cost of capital,

PDF

___

Barclay, M.J., Heitzman, S.M. & Smith, C.W. (2012). “Debt and taxes: Evidence from the real estate industry. Journal of Corporate Finance, 20, 74-93.
Beech, G. & Thayser, D. (2015). Analysis: The WACC Conundrum. http://www.accountancysa.org.za/wordpress/analysis-the-wacc-conundrum/. Accessed 2017/07/12.
Berry, S.G., Betterton, C.E. & Karagiannidis I. (2014). Understanding Weighted Average Cost of Capital: A Pedagogical Application. Journal of Financial Education, 40(1), 115-136.
Borad, S.B. (2017). Market vs. Book Value WACC. https://efinancemanagement.com/investment-decisions/market-vs-book-valuewacc/. Accessed 2017/07/09.
Bremus, F. (2016). Corporate taxation, leverage, and macroeconomic stability. https://www.diw.de/de/diw_01.c.530311.de/presse/diw_roundup/corporate_taxati on_leverage_and_macroeconomic_stability.html/. Accessed 2017/07/05.
Canuto, O., Crain, J. & Davig, T. (2016) The impact of oil price volatility on the economy. Panel discussion. San Francisco: Allied Social Sciences Association Annual Meeting.
Chowdhury, A. & Chowdhury, S.P. (2010). Impact of capital structure on firm’s value: Evidence from Bangladesh. Business and Economic Horizons, 3(3), 111- 122.
Clayman, M.R., Fridson, M.S. & Troughton, G.H. (2008). Corporate Finance: A Practical Approach. United Kingdom: John Wiley & Sons.
Cordes, J.J. & Sheffrin, S.M. (1981). The tax advantage of debt finance. National Tax Association, 74, 44-49.
Correia, C., Flynn, D., Uliana, E., Wormald, M. & Dillon, J. (2015). Financial Management. 8th ed. Cape Town: Juta & Co Ltd.
Das, S. (2016). A banquet of Consequences: The reality of our unusually uncertain economic future. Edinburg, UK: Pearson Education Limited.
De Mooij, R.A., 2012. Tax biases to debt finance: Assessing the problem, finding solutions. Fiscal Studies, 33(4), pp.489-512.
De We, J. & Dhanraj, K. (2007). Unlocking shareholder value by moving closer to the optimal capital structure. Accountancy SA, 28-32.
Deloitte International Tax Source (2017). Taxation and Investment in China 2017. https://dits.deloitte.com. Accessed 2017/07/12.
Dubay, C. (2015). Taxation of Debt and Equity: Setting the Record Straight. http://www.heritage.org/taxes/report/taxation-debt-and-equity-setting-the-recordstraight/. Accessed 2017/07/09.
Esposito, M., Kapoor, A. & Mathur, D. (2016). What is the state of the BRICS economies? https://www.weforum.org/agenda/2016/04/what-is-the-state-of-thebrics-economies/. Accessed 2017/07/09.
European Commission (2015). EU Commission to tackle debt-equity tax bias. http://mnetax.com/eu-commission-tackle-debt-equity-tax-bias-11097/. Accessed 2017/07/12.
Farrokhi, F. & Mahmoudi-Hamidabad, A. 2012. Rethinking convenience sampling: Defining quality criteria. Theory and practice in language studies, 2(4):784-792.
Fatica, S., Hemmelgarn, T. & Nicodème, G. (2012). The Debt-Equity Tax Bias: consequences and solutions. Working paper 33. Luxembourg: European Commission.
Field, A. (2009). Discovering statistics using SPSS. 3rd ed. London: SAGE Publications.
Gazprom (2017). About Gazprom. http://www.gazprom.com/about/. Accessed 2017/07/11.
GrantThornton (2016). Deductibility of interest expenses. http://www.taxplanningguide.ca/tax-planning-guide/section-3- investors/deductibility-interest-expense. Accessed 2017/07/0.
Heider, F. & Ljungqvist, A. (2015). As certain as debt and taxes: Estimating the tax sensitivity of leverage from state tax changes. Elsevier, 118, 684-712.
India Oil and Natural Gas Corporation Limited. (2016). http://www.oilindia.com/Document/Financial/Annual_Report_15_16_For_Mail.pdf. Accessed 2017/07/07.
Kazemian, S. & Sanusi, Z.M. (2015). Earnings Management and Ownership structure. Elsevier, 31, 618-624.
King, M.A. (1974). Taxation and the cost of capital. Review of Economic Studies, 41(1), 21-35.
Laerd Dissertations. (2015). Convenience sampling. http://dissertation.laerd.com/convenience-sampling.php. Accessed 22/05/2018.
Levin, R.I. (1987). Statistics for management. 4th ed. North Carolina: Prentice Hall International.
Lewellen, J. & Lewellen, K. (2005). Taxes and Financing Decisions. Meetings Paper. Philadelphia: American Finance Association.
Maheshwari, S.N., Maheshwari, S.K. & Maheshwari, S.K. (2012). A textbook of Accounting for Management. India: Vikas Publishing House PvT Ltd.
Maheshwari, S.N., Maheshwari, S.K. & Maheshwari, S.K. (2013). An Introduction to Accountancy. India: Vikas Publishing House PvT Ltd.
McConnel, J. & Servaes, H. (1995). Equity ownership and the two faces of debt. Journal of Financial Economics, 39, 433-443.
Mitra, S.K. (2011). Revisiting WACC. Global Journal of Management and Business Research, 11(11), 89-95.
Modigliani, F. & Miller, M.H. (1958). The cost of capital, corporation finance and the theory of investment. The American Economic Review, 48(3), 261-297.
Modigliani, F. & Miller, M.H. (1963). Corporate income taxes and the cost of capital: a correction. The American Economic Review, 53(3), 433-443.
Oliveira, A.C.F. (2016). Debt Bias in Corporate Taxation: Possible Consequences and Solutions. Master Dissertation. Braga: University of Minho.
Pallant, J. (2016). SPSS survival manual: a step by step guide for data analysis using IBM. 6th ed. United Kingdom: McGraw-Hill Education.
Peavler, R. (2017). Financial Leverage Ratios to Measure the Solvency of Your Business. https://www.thebalance.com/financial-leverage-ratios-to-measurebusiness-393195/. Accessed 2017/07/09.
PetroChina Company Limited. (2016). PetroChina Company Limited. http://www.petrochina.com.cn/ptr/ndbg/201404/3a1fc185862b41d5bb207eed40e0 465b/files/8972ab188a11483da283d1c25640db48.pdf/. Accessed 2017/07/07.
Petroleo Brasileiro SA Petrobras. (2016). Petroleo Brasileiro SA Petrobras. http://www.investidorpetrobras.com.br/en/financial-results/holding/. Accessed 2017/07/07.
PKF (2013). Brazil Tax Guide 2013. http://www.pkf.com/media/1954326/brazil%20pkf%20tax%20guide%202013.pdf /. Accessed 2017/07/12.
Pozen, P.C. (2015). Reducing tax rates by reducing tax bias. https://www.brookings.edu/opinions/reducing-tax-rates-by-reducing-tax-bias/. Accessed 2017/07/09.
Gazprom. (2016). Gazprom financial reports. http://www.gazprom.com/f/posts/44/307258/gazprom-financial-report-2016- en.pdf/. Accessed 2017/07/07.
PWC (2016). South Africa Corporate – Deductions. http://taxsummaries.pwc.com/ID/South-Africa-Corporate-Deductions/. Accessed 2017/07/12.
PWC (2017). India Corporate – Deductions. http://taxsummaries.pwc.com/ID/India-Corporate-Deductions/. Accessed 2017/07/12.
Reuters (2017a). Profile: Petroleo Brasileiro SA Petrobras (PBR). http://www.reuters.com/finance/stocks/companyProfile?symbol=PBR/. Accessed 2017/07/11.
Reuters (2017b). Profile: Oil and Natural Gas Corporation Ltd. http://in.reuters.com/finance/stocks/companyProfile?symbol=ONGC.BO/. Accessed 2017/07/12.
Sasol Limited. (2016). Annual financial reports. http://www.sasol.co.za/sites/sasol/files/financial_reports/Annual%20Financial%2 0Statements,%2030%20June%202016.pdf/. Accessed 2017/04/16.
Saunders, W. (2016). Identifying the Optimum Ownership Structure as a Tax Avoidance Strategy of Multinational Entities: A JSE Top 40 Perspective. Masters Dissertation. Vanderbijlpark: North-West University.
Sinha, P. & Bansal, V. (2014). Interrelationship between taxes, capital structure decisions and value of the firm: A panel data study on Indian manufacturing firms. https://mpra.ub.uni-muenchen.de/58310/. Accessed 2017/07/16.
Stiglitz, J. (1973). Taxation and leverage in international banking. Public Economics, 2(1) 1-34.
Subbareddy, K. and Reddy, M.K.K., 2017. Sustainable Growth Rate and Firm Performance. http://www.aims-international.org/myconference/cd/PDF/MSD4- 406-Done.pdf/. Accessed 2017/08/13.
Vernimmen, P., Quiry, P., Dallocchio M., Le Fur Y. & Salvi A. (2014). Corporate Finance: Theory and Practice. United Kingdom: John Wiley & Sons.
ZAO Mazars (2011). Business and Taxation Guide to The Russian Federation. http://www.praxity.com/client-service/Tax%20Guides/Tax%20Guide%20- %20Russia.pdf/. Accessed 2017/07/12.