Tax loss carryforwards and firm investments

The asymmetric tax treatment of gains versus losses can lead to the creation of a tax loss carryforward (TLCF) in case of prior-period losses. TLCFs shield future income from taxation and can therefore be relevant for investment decisions. The relevance of this tax shield is underlined by the substantial amounts of TLCFs carried forward by U.S. corporations. Despite the theoretically expected positive relation, empirical research on TLCFs and firm-level investments is scarce. We first investigate the TLCF investment relation using simulation analyses and differentiate capital expenditure from R&D expenditure. Our empirical results confirm the positive TLCF investment relation, especially when firms have sufficient financial resources and investment opportunities. Also, the TLCF incentive works differently for capital expenditures compared with R&D. Additional simulation results illustrate how the recent legal changes in carryforward and backward rules affect the investment-enhancing effect of TLCFs and show that it is expected to remain qualitatively comparable.