Here is the T(ax) in ESG

This article is written by Mario van den Broek and Benoni Talahutu.  Mario ([email protected]) & Benoni ([email protected]) are senior advisors in the International Services Team of RSM Netherlands with a focus on Global Tax Policy & Governance

Tax is often viewed purely as a cost of doing business, with many corporations taking the approach that the less they pay the better—and internationally active companies often structure themselves in ways that help them achieve this. But with increased regulation, transparency and scrutiny, such behaviors need to change, and the “traditional” way of doing things is no longer acceptable or even possible. More than ever, internationally active companies are under pressure to show they are acting with integrity and “paying their fair share.”

In a global context, the attention companies devote to sustainability continues to grow in response to consumer demand, consumer behavior and the importance that financial markets have placed on ESG. With its ability to influence investor behaviors and public opinion, ESG is now firmly on the agendas of boards. Earlier in the year, the world’s number one stock investor confirmed that it was planning to accelerate the pace of its divestments by focussing on companies that perform poorly in certain sustainability metrics. With its stated purpose being to “safeguard and build financial wealth for future generations” Norges Bank Investment Management assesses how stocks score based on environmental, social and governance (‘ESG’) goals.

Investors are increasingly using ESG metrics to make portfolio decisions, investing in entities who do well and divesting of those that fall behind. The creation of ESG metrics that combine into an overall score has led to many businesses publishing annual sustainability reports to reflect how they incorporate ESG principles into their activities. In this regard, integrating tax governance into overall sustainability or ESG goals is essential to ensure that internationally active companies are conducting their operations with a focus on sustainability and sound corporate governance.

The 2030 Agenda for Sustainable Development, adopted by all UN Member States in 2015, has inspired institutions like the EU and other international fora to start developing their own tax transparency/ESG standards. Meanwhile a considerable number of different (draft) standards have seen the light of day such as the EU Corporate Sustainability Reporting Directive, the EU Public CbCR Directive and GRI 207 under which a company will be obliged to report its approach to tax, to report on its tax governance, tax control, tax risk management, stakeholder engagement and its management of concerns related to tax.

Going forward

Of the three traditional pillars that make up ESG, it is “governance” where tax plays a key role. Through a combination of policies, practices and principles governance is the way in which corporate entities balance and align interests between stakeholders to support a successful long-term strategy. A large part of achieving this is through adopting and encouraging behaviours that are focussed on doing what is best for an internationally active company in a constantly changing world. This is particularly true when it comes to tax and there is a genuine need for company boards to recognise that well-considered tax policies are essential to achieving good corporate governance and promoting sustainability.

Company executives may not think they are involved in aggressive tax structuring without actually being aware of what now constitutes this type of behaviour as well as the associated tax integrity risks. Society has changed the definition of “aggressive” when discussing tax strategy, with structures and policies that were not deemed to be aggressive when first put in place now having the potential to be perceived as quite the opposite. For example, something as basic as having a holding company with hardly any substance in a group structure would not have previously been a cause for concern but now this could easily be perceived as an obvious sign of aggressive tax planning.

To better demonstrate good corporate governance and manage tax integrity risks there are several steps that boards can take to begin doing this more effectively:

  • Appreciation: Management should seek to gain a better understanding of the differences between tax optimisation, avoidance and evasion as this will allow them to appreciate what now constitute tax integrity risks and how they impact upon their business.
  • Assessment: A company’s management should assess their current tax policies, strategies and structures to determine what level of tax integrity risk potentially exists and benchmark them using the relevant rules, regulations and guidance available.
  • Action: With better understanding and a more complete picture of the current state of the company’s tax integrity position boards can decide what strategy is best for their business and is consistent with the principles of good governance.
  • Observe and update: Once the necessary foundations are in place a company can move forwards with a coherent approach that will be used to effectively monitor, maintain and update existing strategy and policies.

The importance of the role that tax plays within the process of defining corporate governance, and consequently ESG, cannot be understated. Tax is a core part of corporate responsibility and governance, and it should be a priority for any board of directors who want to ensure what they are doing is best for their business and wider society.