In recent years, the measurement of a business’ tax performance has gradually expanded beyond traditional metrics such as effective tax rates to include qualitative factors such as responsible tax policy and tax risk management. This trend has continued with increased focus on ESG, in which tax plays an important role.
Tax intersects with all three pillars of ESG:
It is important for businesses to have regard to ESG when managing their tax affairs as stakeholders are increasingly viewing a business’ approach to tax through an ESG lens.
Investors, including institutional investors and fund managers are increasingly having regard to ESG principles in their investment decisions, recognising that businesses which do not appropriately manage tax risks and / or engage in aggressive tax planning can expose both the business and its investors to reputational and financial risks. ESG in a tax context can be particularly important to foreign investors because factors like tax compliance history, past behaviour and the way that a business approaches decisions with regards to tax are considered by the ATO when advising the FIRB of the tax risks associated with a foreign investment. This can directly impact on the type of tax conditions imposed by FIRB, resulting in additional and lasting compliance obligations for the business.
Similarly, the general public is also placing increasing emphasis on ESG factors, with consumers being attracted to products and brands which are perceived to be behaving in a responsible fashion and with integrity. By contrast, businesses which are perceived to be not paying their “fair share” of tax can find themselves on the wrong side of public sentiment.
Tax regulators have always been concerned with promoting good tax governance and discouraging harmful tax practices.
Ultimately, if taxpayers do not, or are not perceived to, approach tax in a responsible manner, regulators will respond (for example Australia’s Senate Inquiry into corporate tax avoidance). In recent years, this response has increasingly been globally coordinated and directed to protecting the global tax base, rather than an individual country’s position. For example, the OECD’s Base Erosion and Profit Shifting project, and more recently negotiations, led by the OECD, with more than 135 countries agreeing to a global minimum corporate tax rate of 15 percent.
A business’ tax strategy is a good place to start when considering how tax fits within the broader ESG agenda. It is useful to consider the business’ overall tax strategy, core tax principles and values within the broader context of the business’ approach to sustainability and enterprise risk management.
An ESG-focused tax strategy may include the business’ approach to tax risk management and governance, recognising that the application of tax laws can be complex and uncertain and that these risks should be subject to suitable controls and evaluation at an appropriate level within the business’ governance structure.
A prudent tax strategy should canvas the business’ approach towards tax planning and what the business’ tax risk appetite is. The strategy may also canvas the business’ approach to engaging with revenue authorities and other key stakeholders.
Having defined its tax principles and strategy, the business needs to ensure that it has the governance and risk management frameworks in place to ensure that its strategy is implemented and adhered to.
In Australia, the ATO places a heavy emphasis on tax governance, particularly in its large market compliance programs, as they see it as a critical component in their endeavor to achieve ‘justified trust’. It is typical for their compliance activity to examine the existence, design and operational effectiveness of the business’ internal tax controls and governance framework. Accordingly, it is advisable to give due consideration to the ATO’s expectations when developing a tax governance framework. That said, there is no ‘one size fits all’ approach to governance and it is important that the framework adopted is appropriate for the individual business and its unique circumstances.
Globally there is a push for greater transparency around tax, both in terms of mandatory transparency with regulators (for example, country-by-country reporting requirements) and public transparency (for example, the Board of Taxation’s Voluntary Tax Transparency code).
Increasing compulsory transparency with regulatory authorities, coupled with automatic exchange of information regimes such as the OECD’s Common Reporting Standard, not only adds to the ever growing compliance burden (both in terms of time and complexity) for taxpayers but also means that tax risks which have not been properly managed are more likely than ever to be subject to regulatory scrutiny.
However, tax transparency creates both risks and opportunities for businesses. Public tax transparency, particularly where information is published with no or limited context, can lead to misinterpretation and misrepresentation. On the other hand, voluntary tax transparency reporting provides business with an opportunity to drive and demonstrate its ESG tax credentials by providing context and further information about its broader tax and social contributions.
It is clear that tax has a key role to play in a business’ ESG goals.
Tax strategy, tax governance and tax risk management are not new concepts for tax functions or tax administrators. The challenge of increasing mandatory disclosures of information to tax authorities and the exchange of information between regulators are also not new. Increasing tax transparency, including public tax transparency, has also been in the works for a number of years now.
However, with the increasing focus on ESG, a broader range of stakeholders are looking more closely at the tax strategy, governance and risk management behaviors of business. Stakeholders now expect that businesses not only approach tax in a responsible way, but that they do so in an open and transparent manner. An organisation’s approach to tax is no longer solely the concern of the business and the relevant tax authorities or something that can be kept behind closed doors. Indeed, it is probably true to say that merely complying with the technical requirements of the law is no longer sufficient. Many stakeholders now expect more. By proactively reviewing their approach to tax through an ESG lens, businesses may be better placed to meet those expectations.
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