Corporate tax and ESG

The 2008 financial crisis increased the public perception that corporations were not paying their “fair share” of tax. This was followed by OECD launching the base erosion and profit shifting (BEPS) project to revise the global tax framework. This work continues today, striving to address the challenges posed by the digitalized economy and to reach agreement on a global minimum tax. Increasingly, corporate tax has become a leading ESG governance consideration, specifically corporate income tax responsibility and disclosure targeting aggressive tax strategies.

Since the public interest in corporate tax behavior grows, institutional investors have become increasingly interested in data that reflect corporate tax behavior. Many rating agencies have incorporated tax into their sustainability analyses and ESG rating methodologies. They generally focus on a quantitative analysis of the business’s effective income tax rate and how that rate compares with the rates of other companies and with global or industry averages. To measure qualitative transparency with respect to the governance dimension, rating agencies consider the company’s approach to tax matters, focusing on tax strategy, governance, and controls.

Increasingly, companies are finding that the demands of investors go beyond the scoring metrics of rating agencies. In some instances, companies are receiving requests from investors for detailed information about their tax strategies and governance policies. As with the governance dimension, investors use standard guidelines to exert pressure on companies to share more information about (1) the location of their revenues, (2) their profits, and (3) their tax payments.

In terms of evaluating investments, investors need to assess the impact on tax risk of investing in entities since the entity’s tax situation can impact the investor’s tax position. Regardless of level of investment or control, institutional investors could be criticized for investments in entities that do not follow ESG principles as they apply to tax. Therefore, it is important for investors to carefully consider the consequences of investing in entities that are less than fully transparent about their tax risk profile.

Tax transparency is about reassuring stakeholders that a company’s tax affairs are managed in a responsible and sustainable manner. The focus is both on tax governance and on the location and amount of tax paid. Because of factors unique to each company, the spectrum of tax transparency is wide—from minimally transparent to public, country-by-country reporting. A relatively low-risk form of disclosure that many companies are considering is the publication of a company’s tax strategy (a policy statement articulating the company’s attitude and approach to tax). Such a disclosure can be enhanced by more detail about the company’s risk tolerance and how it manages tax risk. Further transparency can be achieved by full disclosure of the company’s tax governance system and its key tax operational controls. The most tax transparent companies combine this openness with the public disclosure of either total taxes paid (globally, regionally, or, in certain cases, by country) or total economic contribution. The right approach for each company requires a skilled balancing of financial and tax risks with respect to ESG.

And where can KPMG help? We can for example run an ESG focused tax due diligence covering your or the target company.