Tax incentives and upward R&D manipulation - evidence from the R&D tax deduction policy in China

PurposeThis paper investigates whether China's R & D tax deduction policy triggers firms to manipulate their R & D expenditures upward.Design/methodology/approachThis paper employs the ratio of actual tax savings as a proxy for the benefits of the R & D tax deduction policy based on manually collected and systematically cross-checked data. The relationship between tax benefits and abnormal R & D spending is estimated in a sample of Chinese A-share listed companies for the period 2007-2018.FindingsThe findings suggest that tax deductions lead to positive abnormal R & D spending and that this deviation in R & D spending may be attributed to firms' upward R & D manipulation for tax avoidance. The results also indicate that this behavior is more significant for the period after the policy revision, in non-HNTEs (high and new technology enterprises), and in firms with a high ratio of R & D expenses.Research limitations/implicationsIt is difficult to establish a sophisticated and unified model to identify the specific strategy of upward R & D manipulation that firms use to obtain tax benefits.Practical implicationsManagers should take into account upward R & D manipulation when designing governance mechanisms. Policymakers in developing countries may further pursue preferential tax policies that cover every stage of innovation activities gradually; the local provincial governments need to leverage their proximity and flexibility advantages to develop a tax collection and administration system.Originality/valueThis study contributes to the understanding of the complex effect of R & D tax incentives and helps more fully illuminate firms' upward R & D manipulation behavior from the perspective of tax planning strategies, which are underexplored in previous research.