Regulating strategic expense relabelling in R&D tax incentives by mandatory information disclosure

Tax incentives are commonly used to stimulate business R&D, but a significant threat is that firms can relabel other expenses as R&D to abuse these incentives. This paper investigates whether mandatory information disclosure is effective in reducing tax-motivated expense relabelling. We study a Chinese R&D tax incentive program that provides preferential tax treatments for firms with R&D intensities above a specified threshold. Graphic evidence indicates that firms strategically relabel non-R&D administrative expenses as R&D to beat the R&D intensity threshold. We estimate the causal effects of a mandatory information disclosure policy and find that it significantly reduces tax-motivated expense relabelling. The policy serves as a regulatory mechanism by increasing the penalty risk for firms suspected of engaging in expense relabelling and decreasing their likelihood of participating in the tax incentive program. The inhibitory effects are more pronounced for firms with greater incentives to engage in expense relabelling. Our study suggests that mandatory information disclosure can act as a regulatory mechanism to maintain the integrity and effectiveness of R&D tax incentive schemes.