Tax: A cornerstone of the ESG equation

ESG as a value creator

ESG is all about finding a balance between financial returns, transparency, social interests and the environment. This balance can lead to better results for both businesses and society. There is a broad consensus that ESG objectives ultimately create value for companies.

The impetus for businesses to address ESG issues and opportunities will continue to grow, spurred by investors, policymakers, employees, suppliers, customers and citizens more broadly. Indeed, corporations that successfully integrate ESG into their core values and strategies can run a stronger business while building a better world.

So, where does tax fit into the ESG equation?

Tax as a contribution to society

The perception of tax has changed. Tax is no longer viewed as a short-term cost to a company. Rather, it is seen as a company's contribution to society, one that creates environmental value and socio-economic cohesion. The unprecedented amounts that governments have spent on COVID-19 support packages has only fuelled expectations that companies are responsible taxpayers and pay their "fair share" of tax.

Stakeholders are now factoring tax into their considerations when assessing the sustainability profile of companies. For example, a number of institutional investors have released codes of conduct setting out principles to promote responsible tax practices in respect of their investments.

Tax governance and controls

To ensure that companies adopt a responsible approach to their tax affairs, they are expected to have a robust tax governance and control framework in place. This means having a tax strategy that documents the company's risk appetite, approach to tax and engagement with tax authorities. It also means formalising governance and risk management procedures relating to tax to ensure sufficient board oversight and that those with day-to-day responsibility for tax implement the tax strategy in line with its core principles.

Tax transparency

Governments and regulators are increasing the level of required tax transparency in respect of taxpayers, and this continues to evolve. Both the OECD and European Commission have long called for greater transparency, resulting in the introduction of a number of initiatives that facilitate the exchange of information between tax authorities. This includes initiatives such as Country-by-Country Reporting and the Common Reporting Standard. We have also seen the introduction of legislation mandating greater public reporting of certain tax data. Most recently, EU member states reached agreement on a Directive that will require large multinational groups to publicly disclose details of corporate tax paid (public Country-by-Country Reporting).

Although non-financial ESG reporting is voluntary, many businesses are preparing for a future in which it becomes a legal requirement. They see it as an opportunity to build trust with society and provide stakeholders with assurance that they are adopting responsible tax practices.

More than 10,000 organisations globally, including many Irish businesses, use the Global Reporting Initiative (GRI) standards as a framework for their sustainability reporting. GRI 207, which is effective for reports published from 2021, is the first global standard for comprehensive tax disclosures. It has already been widely adopted by companies, including some Irish multinationals. It includes disclosures on:

• the approach to tax
• tax governance, control and risk management
• stakeholder engagement and management concerns related to tax
• country-by-country reporting of tax data

Tax as lever to support the net zero transition

Climate change is one of the greatest challenges of our generation, requiring wholescale transformation of every sector of our economy, unprecedented innovation and committed leadership. The tax system is being used as a mechanism to influence better behaviours in a move towards a more sustainable economy. For example, environmental taxes such as excise act as a key deterrent to behaviours that are contrary to our climate action goals. On the other hand, environmental tax incentives such as accelerated capital allowances for energy efficient equipment are a very valuable cash flow benefit for businesses.

Considering the tax implications of transformational change

ESG considerations are reshaping the actions and strategic direction of businesses. As companies restructure their operations to meet their ESG commitments, the tax implications will need to be considered. For example:

• the implementation of a more sustainable supply chain could give rise to VAT, customs and transfer pricing considerations.
• with sustainable finance more in focus, lenders are now factoring ESG considerations into their lending decisions. This could have an impact on the benchmarking used by companies to determine the arm's length terms attached to related-party financing. It may also impact many aspects of intercompany financing transactions, including the credit rating, quantum of debt and the interest rate.
• as companies become more sustainable through business investments and divestments, the tax implications of these transactions will need to be assessed.

Three imperatives for an ESG-driven future

As businesses advance on their ESG journey, it is important that tax becomes part of the conversation. The tax function is critical in driving that dialogue.

1. Collaborate and consult

Tax departments need to engage across the entire business to align the tax strategy with broader corporate strategy. The ESG revolution will change how businesses operate in all sectors, leading to changes in where businesses operate, in their supply chains, and in their acquisitions and disposals. Almost every ESG-centric business decision has a tax impact.

2. Understand your own facts

Boards, leadership teams and heads of tax need to understand their company's tax position not just from a shareholder's point of view, which focuses on consolidated financial statements, but also from the perspective of investors, employees, civil society and tax authorities. This requires time and resources.

3. Communicate clearly

Tax disclosures are often read by people who are not steeped in the complexities of tax and compliance, so taking the time to develop and communicate a clear tax narrative can prevent misunderstandings. Doing so also builds trust. It's essential to consider how your company looks when its tax decisions are viewed through ESG and stakeholder lenses.

We are here to help you

The importance of ESG will continue to grow as stakeholders demand change from businesses. Incorporating ESG into the values of your business will undoubtedly create certain challenges; the priority is to ensure that your business can progress alongside its ESG strategy.

Tax considerations must form part of that strategy, and tax practices must also be aligned with broader ESG principles.

We are ready to help you as you face the future. Contact us today.