No. 101: Tax Disputes – The Role of Technology and Controversy Expertise

This study investigates how two practices to manage tax risk in firms, namely the use of tax technology for internal information provision and the use of a controversy manager who offers specific expertise in tax disputes, affect two key tax metrics for firms: the probability of unfavorable dispute outcomes and low final tax payments. Building on a Bayesian persuasion model, we find that the controversy manager has a tax reassurance and a tax planning effect. In a given dispute with a strategic tax authority, she directly decreases unfavorable dispute outcomes, which shields the tax manager from the costs of unfavorable outcomes. In equilibrium, the tax manager thus increases his tax planning effort, indirectly increasing the tax dispute probability and making the net effect on unfavorable outcomes ambiguous. Although we show that the controversy manager consistently enhances the probability for low final tax payments, the same is not true for tax technology quality. Taken together, our results indicate that using a controversy manager combined with an intermediate-quality tax technology is often beneficial for firms. Ultimately, the preferred quality depends on the firm’s favored metric, tax manager characteristics, and the litigation-friendliness of the tax environment.