6 Conclusions
We examine whether tax uncertainty is a partial explanation for variation in cash holdings across firms. Because of complexity and ambiguity present in the tax laws, tax avoidance often involves some degree of uncertainty. Upon audit of the firm’s returns, the tax authorities may have a different opinion of the firm’s taxes and demand repayment of the tax savings. We posit that firms engaging in tax avoidance will hold additional cash for precautionary purposes to pay the tax claims on their uncertain tax positions. We find that both domestic and multinational firms with tax uncertainty hold significantly larger cash balances than firms that have little tax uncertainty. Finding the effect in purely domestic firms is important because it rules out repatriation tax effects as an alternative explanation, since purely domestic firms, by definition, do not face repatriation taxes. In addition, in the tests using multinational firms we include a longrun repatriation tax measure and find both repatriation taxes and tax uncertainty help explain cash holdings. The magnitude of the effect is economically significant. The average firm in our sample holds 19.8% of their total assets in cash. Controlling for other factors that affect cash holdings, including any direct effects of tax avoidance on cash flow, the data show that moving from the first decile of tax uncertainty to the tenth decile of tax uncertainty is associated with an increase in the assets held in cash of 3.3%.
