The role of Outside Directors in Tunnelling-related Tax Avoidance: Evidence from Indonesia

Abstract

Abstract Indonesia relies heavily on taxation revenues thus tax avoidance in corporations needs to be minimised. We explore the relationship between tax avoidance and tunnelling, and specifically whether the presence of outside directors as board members affects this relationship by examining a sample of non-cyclical consumer firms listed on the Indonesia Stock Exchange (IDX) from 2016 to 2020. When the tunnelling approach is used through normal business operations, we find that tax avoidance enables tunnelling activities, which benefit the controlling shareholders. Tax avoidance affects tunnelling in three ways: by providing additional cash flow from tax savings that can be tunnelled to controlling shareholders, by creating accounting opacity from the complex tax strategies that can obscure the tunnelling activities, and by using the related party transactions for both tax avoidance and tunnelling purposes. The results further show that the existence of outside directors as part of the governance mechanism can moderate the tax avoidance-tunnelling relationship.