About ESG and sustainability in taxation

Posted on

21 Dec

2021

Dittmar & Indrenius > Insight > About ESG and sustainability in taxation
Lawyers love definitions. When discussing taxes as part of a company’s ESG policy, my challenge has been the lack of precision. While everyone appreciates the importance of the theme, finding a common language is not always simple.  

Sustainability and long term value creation have attracted more investments than ever, as demonstrated by the record high investment numbers by global environmental, social and governance (ESG) funds. Companies are well aware of the need to comply with and excel in their ESG standards in order to create long term value to stakeholders.

Within the ESG framework, taxes are typically seen as a company’s financial contribution to society. What does that mean?

Multinational groups provide more and more information about taxes under the current reporting standards, transparency requirements, and also to inform all stakeholders about their financial contribution to society. Listed companies typically publish their overall tax footprint annually. While a larger tax footprint is generally deemed a positive marker from a society’s revenue perspective, a single number may not always be that informative.

To provide a simple illustration, corporate income taxes are paid on net profits. Net profits are reduced by costs. Net profits and corporate taxes could be, in theory, increased by cost reductions through e.g. unsustainable supply chains, operations in low cost jurisdictions, ethically compromised behaviour, etc. Another example would be energy taxation, which includes features of a carrot and stick approach resulting in higher taxes being levied on harmful or less desired activities. It seems clear that a higher amount of taxes paid does not, per se, indicate that a company’s tax strategy should be deemed sustainable or that it should be treated as a good corporate citizen. A tax footprint needs to be interpreted based on a broader understanding of a company’s business and its tax strategy.

Some ESG reporting standards regarding tax matters (such as the GRI 207) already exist, but their use is generally voluntary. Further, information disclosed under such standards may be fairly general, “we comply with the prevailing legal requirements”, ambiguous or difficult to interpret even for a tax specialist.

Then there is the issue of perspective. A company that pays all its taxes in Finland may appear as a good tax citizen in Finland, but that may not be the case from a global perspective. In this respect, one would warmly welcome populism being left aside and public discussion being based on more objective criteria, such as the OECD guidance on tax matters (e.g. regarding appropriate profit allocation based on value creation).

Global tax transparency has dramatically increased and, as part of that process, artificial tax planning has become non-sustainable and broadly a thing of past. Increased tax transparency should enable companies to demonstrate their tax strategies and investors to make informed investment decisions based on their ESG criteria.

While it may be argued that in transparent circumstances markets value a company appropriately, the difficulty in defining an appropriate ESG tax metric seems obvious. In a perfect world there could perhaps be an objectively defined measure of a company’s actual tax footprint, which is not based on tax revenue alone, but a sort of weighted score that is publicly available to all stakeholders.

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