The Effect of Audit Report Lag on Tax-Audit Detection

This study examines the impact of audit report lag, which is the difference between fiscal year-end and audit report date (on-site audit end date), on tax-audit detection risk. Tax adjustments are made on the basis of financial statements, and financial statements are provisionally finalized after the on-site audit. Since domestic corporations are required to submit their tax returns within three months of the fiscal year-end date, the delayed confirmation of financial statements (i.e., increased audit report lag) makes it difficult for tax agents to have sufficient time to prepare for making tax adjustments to file for tax returns. Therefore, a tight tax adjustment schedule triggered by the delayed confirmation of financial statements would increase the possibility of being caught in a tax audit because it would not be possible for tax agents to conduct an accurate and close review of the impact of the company's transaction details on corporate taxes. We expect that the longer the audit report lag (the shorter the tax report lag), the higher probability of tax-audit detection by tax authorities. This study uses December year-end, non-financial listed companies that disclosed significant tax assessments due to an unfaithful tax reporting from 2002 to 2017 and matching firms. In empirical analhysis, consistent with our expectation, we find the positive relationship between audit report lag and the probability of tax-audit detection. However, this relationship is not affected by auditor-provided corporate tax filing services. This study provides empirical evidence that audit report lag affects not only the quality of financial reporting but also the quality of tax reporting. It provides an important policy implication that the tax authorities need to be more concerned with the audit report lag in assessing the quality of a firm's tax reporting.