Tax Avoidance (TA) is described as a tax planning activity designed to bring about a reduction of explicit taxes. When TA is carried out by a company, it will have an impact on that company’s business. If TA is being implemented, the taxpaying company takes advantage of loopholes in tax regulations to avoid obligations that could burden it, which means the amount of tax owed is lower and the profits for shareholders are increased. In other words, TA optimizes taxpayer profits without cheating in the field of taxation. Although TA is permissible in the eyes of the law, it is nevertheless detrimental to the state, because it causes a decrease in the revenue that it derives from the taxation.

Many cases can exemplify the occurrence of TA practices in Indonesia. For example, PT RNI, an affiliated healthcare company in Singapore, in 2016 identified TA practices with many variations in ways, namely recognizing affiliate debt as capital, reporting considerable losses in the company’s financial statements, and reporting company turnover remains below 4.8 billion rupiah per year with the aim of utilizing Government Regulation 46/2013 on UMKM-specific Income Tax,  in order to get the final PPh rate facility of 1%. Another example, in 2019, the coal company, PT Adaro Energy Tbk, conducted TA with a transfer pricing scheme through its Singapore subsidiary, Coaltrade services International Pte Ltd. PT Adaro Energy Tbk allegedly conducted transfer pricing practices to avoid domestic tax obligations to provide higher income for the company’s shareholders. Indications of misuse of transfer pricing carried out by the company are identified in the financial statements containing non-arm’s length price transactions conducted between PT Adaro Energy Tbk and Coaltrade services International Pte Ltd, which shows the imbalance in transfer prices when compared to the global coal market price.

From the cases mentioned above, it can be concluded that TA identification can come from the company’s financial statements. This is because the financial statements become files that are also attached in tax reporting in Indonesia. As in Undang-Undang Number. 16 of 2009 concerning the fourth amendment to Undang-Undang Number. 6 of 1983 on General Provisions and Procedures of Taxation in Article 4 paragraph (4) states that the Annual Notice of Taxpayer Income Tax that must hold bookkeeping must be accompanied by financial statements in the form of balance sheets and income statements and other information needed to calculate the amount of Taxable Income. In other words, tax reporting that includes the company’s financial statements as responsibility for reporting income indirectly provides the probability of the tax authority in identifying TA activities. Therefore, the strategy of the management of a company seeking to engage in TA is to deliberately obfuscate the information in the FS by making them less easy to read. This aims to reduce the risk posed by tax audits where the company may be assessed as non-compliant with regard to the taxes it pays (Nguyen, 2020).

The element of understandability itself in a financial report plays a major role in making financial statements useful for its users. The level of understandability of an FS (Financial Statement) has an impact on the understanding of those using it to determine the value and business of the company, which will indirectly determine what actions will be taken by users of financial statements in responding to the pace of the company’s business after understanding the company’s financial statements. An understandable FS is synonymous with an easy-to-read FS. This statement is in line with research by Baskerville and Rhys (2014) who stated that the understandability of a financial report is linked very closely to its readability. The definition of readability is the ease with which readers can process and understand the information presented in writing (et al., 2017). Therefore, readability can be identified as a prerequisite for the understandability of a financial report.

Obfuscating the understandability of FS can make it difficult for outsiders to detect corporate tax planning (Beuselinck et al., 2018). In the research by Balakrishnan et al. (2019), they stated that companies that engage in TA have lower transparency. In other words, the readability of reporting is replicated as a tool used by the company to successfully implement TA measures in the context of corporate tax planning.

In order to prove the premise, Pratama, Narsa, and Prananjaya (2022) examined whether there is a relationship between TA and FSR (Financial Statements Readability) in companies listed on the Indonesia Stock Exchange. Using a research sample of 278 company data listed on the Indonesia Stock Exchange 2017-2019, the results showed a negative relationship between two main variables, namely TA and FSR., Thus, when companies engage in tax avoidance, it has been demonstrated empirically that companies tend to reduce the credibility of their financial statements in terms of their readability. In other words, the results suggest that companies tend to obfuscate understanding of financial statements in their efforts to cover up tax avoidance practices that companies run.

Author:  Niluh Putu Dian Rosalina Handayani Narsa,

Article title: Tax Avoidance and the Readability of Financial Statements: Empirical Evidence from Indonesia