ESG and Taxes

June 16 2020 - ,

The Covid-19 pandemic has brought to light the effects of years of cuts to public services in the wake of the 2008 financial crisis, while at the same time highlighting the importance of the safety net that only the State is in a position to provide.

Recovery packages and tax

In the UK alone, the Financial Times calculates that the combined effects of the lockdown and the expected economic recession could create a budget deficit exceeding £337bn. While increased government borrowing could cover much of the shortfall, governments seem understandably wary of starting a new wave of cuts to public spending. This leaves only one major way to raise the necessary funds: taxes.

Although this is a generally unpopular solution, people have experienced first-hand the importance of reliable and well-equipped public services, from hospitals to public transport. This could mean a shift in attitude towards taxation, as shown by a recent poll by YouGov, claiming that the majority of the UK public would welcome a windfall tax on companies such as food retailers that have thrived during the coronavirus crisis, and 61% would approve of a wealth tax for those with assets of over £750,000. 

Interestingly, in early 2019 voices had already been raised against the proposed slashes to corporation tax in the UK, in light of a staggering £20bn shortage in funding for the NHS.  

This shift would combine with a sentiment of dissatisfaction towards big economic actors exploiting loopholes to avoid paying what is perceived by the public to be their due, which was already growing before the pandemic. A 2017 poll commissioned by Christian Aid showed that, at the time, 89% of British adults thought that tax avoidance by large companies is morally wrong even if it's legal. It's not too far-fetched to think that the percentage might have increased, in light of the recent events.

As a response to these developments, a number of governments around the world have started including provisions related to this issue in the proposed post-crisis recovery packages. For example, France, Poland, Belgium and Denmark have all announced measures designed to exclude from taxpayer-funded relief programs companies operating in jurisdictions that the EU considers uncooperative for tax purposes. 

On a different note, the UK-based Tax Watch argued in a recent report that such measures would most likely be ineffective, and that the solution lies in a more comprehensive package of reforms, including the like of making tax exiles liable for dividend income tax on profits derived from UK based companies; making government support for business repayable if a company is found to be engaging in tax avoidance; and mandating the publication of tax data by large, multinational companies, among others.

Tax as an ESG issue

Together with more mainstream issues, such as GHG emissions and labour standards, a company's performance around tax transparency is becoming an important factor driving investment decisions. In addition, the constantly increasing number of regulatory requirements for investors to identify their ESG management processes means that tax is getting a new role. Financing transformational financial packages such as the proposed Green New Deal in the US, or the European Green Deal in the EU, will most likely entail a new focus on taxation. As an example, among many, in September 2019 the EU Commission published the evaluation of the Energy Taxation Directive, concluding that it is no longer in line with EU climate objectives, and that it needs to be modernised. Suggested amendments are expected by June 2021, with a dedicated public consultation to be launched in mid-2020.. 

Tax-related ESG risks can be connected to both fraudulent and legal activities. Of the first kind, the recent “cum-ex scandal”, originally involving the German Deutsche Bank and Commerzbank, but quickly spreading to a number of financial institutions across the continent, is bound to have long-lasting repercussions on the companies involved, including (but not limited to) the spectre of massive fines. 

However, legal business practices such as selecting a more convenient country of incorporation can also bring reputational risks to a company. For example, recently Fiat Chrysler Automobiles (FCA) has been at the centre of a controversy regarding its access to a 6.3 billion-euro state-backed loan in Italy, despite being incorporated in the Netherlands, a country that many consider (rightly or wrongly) to be a tax haven. Although the controversy was complicated, and tied to political reasons (such as the Dutch refusal to support the creation of the so-called “Euro Bonds), it is clear how issues around tax can be a risk for companies, even just in the court of public opinion. 

This also shows one of the sticking points of the discussion around tax havens: the definition of the term. For example, while the EU does not include any of its members in its "blacklist", claiming that all member states are fully compliant and held to a higher level of scrutiny than other countries across the globe, expert groups such as the Tax Justice Network claim otherwise. The Network's annual Corporate Tax Havens Index includes the Netherlands and Luxembourg in 5th and 6th position, respectively. Both countries also occupy places in the top ten of its Financial Secrecy Index (which ranks jurisdictions according to their secrecy and the scale of their offshore financial activities). The issue has been the object of discussions among academics and policymakers, and is highly complicated and technical, making it really difficult for investors to take account of the risks. 

A number of tax initiatives are being developed at government and inter-government level. For example, the UK requires certain businesses to publish a 'tax strategy', including information on how the business manages its UK tax risks, its attitude to tax planning and level of risk the business is prepared to accept. At supranational level, the OECD's Action Plan on Base Erosion and Profit Shifting (BEPS) addresses many aspects of aggressive tax planning, including treaty shopping, hybrid structures, earnings stripping, transparency and substance. Some of the most promising provisions of BEPS are those regarding Country by Country Reporting (CbCR). While CbCR was intended to be a disclosure to tax authorities, there is rising sentiment in favour of public CbCR, with actors the French government viewing it as a step forward in terms of tax transparency.

The EU is also taking steps towards more tax transparency, having recently introduced requirements for tax intermediaries to disclose qualifying cross-border arrangements to tax authorities. The new mandatory disclosure rules require that intermediaries and relevant taxpayers disclose potentially aggressive tax planning arrangements. This information will subsequently be exchanged among tax administrations. The provisions, which came into force on 25 June 2018, should have been implemented by member states before 31 December 2019, and will apply from 1 July 2020. 

As of many of these problems, the solution should be global. Just last February researchers from the World Economic Forum were calling for an end to tax havens (citing data suggesting that they cost governments $200 billion per year). Suggested solutions would include a globally agreed, minimum corporate tax rate, and treating a multinational as one firm, not a collection of national entities. However, finding the political will to put in place such aggressive measures is an uphill battle, as many states are ready and willing to turn a blind eye

Investors can rely on a number of instruments, either developed or in development, to help them ensure that they are not invested in companies that might end up involved in tax-related scandals:

  • The PRI has developed guidance documents for investors to support engagement with investee companies on tax policy and transparency. They also provide investor recommendations for disclosure by companies. 
  • The Global Reporting Initiative (GRI) is in the process of developing a new standard: GRI 207: Tax 2019. According to the GRI, the Tax Standard "is the first global standard for comprehensive tax disclosure at the country-by-country level. It supports public reporting of a company's business activities and payments within tax jurisdictions, as well as their approach to tax strategy and governance. 
  • Last but not least, companies can work to achieve the Fair Tax Mark certification. The Fair Tax Mark certification scheme was launched in February 2014 and seeks to encourage and recognise organisations that pay the right amount of corporation tax at the right time and in the right place. 

At Ethical Screening, we are working on these issues to ensure that our clients know where the risks lie. We have incorporated taxation as one of the research areas in our ESG company assessment, and are in the process of incorporating the GRI Tax Standard information into our research KPIs.

In addition, to show that we practice what we preach, since 2018 we have held Fair Tax Mark accreditation, and participate in the organisation's events and activities, to show our support for this fantastic initiative. 


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