Putting tax policy at the heart of ESG
A Thinking Business publication
With investors, customers and employees putting so much more focus on the environmental, social and governance (ESG) credentials of the companies with which they engage, the need for management boards and wider stakeholders to put good corporate citizenship at the heart of everything they do is increasingly apparent.
In this context, rarely have management teams and stakeholders appreciated or considered the interaction between ESG policies and a particular organisation's tax strategy, even though all three ESG levers directly and indirectly cross over in to all things tax.
Taken individually, there is nothing particularly new in the three ESG pillars when it comes to tax, such as the way in which a government may employ fiscal tools to change behaviours in relation to the environment (whether those are tax incentives to drive investment in clean tech or the imposition of higher levies on polluting fuels or products). Or the debate around what is one's fair share of tax as a contribution to society versus the amount of tax that is properly due as well as an organisation's tax compliance record being used as a measure of good (or bad) corporate governance.
But the mood music around tax has changed over the last decade, and now more than ever stakeholders and the media are taking a greater interest in the tax that businesses pay (or don't pay).
Nathan Williams, a partner specialising in corporate tax at Trowers & Hamlins, says: “Businesses have to take their customers' views into account, not to mention those of their investors, suppliers and other stakeholders, and those views are changing when it comes to tax. The direction of travel is that an organisation's attitude to tax compliance and strategy is seen as a key part of good business governance, and also arguably a marker of one’s social values. That includes paying the appropriate amount of tax and not taking unnecessary risks or engaging in aggressive tax planning. All of which has the potential to feed in to the ESG credentials of a business."
A case in point is Starbucks, which following media speculation over its UK corporation tax affairs it was reported to have 'voluntarily' paid additional tax to HMRC. It and other global organisations were historically held up as businesses that did not pay material amounts of tax in all the jurisdictions in which they generated their profits and that was understood (by those businesses and often the tax authorities) to be the way things were done.
But then the tide started to change, with consumers taking the view that those organisations were not paying their fair share of tax and failing to contribute to the communities in which they operated, with tax changes at the international level also being implemented to address certain tax planning arrangements.
Plenty of other companies and individuals have suffered a similar fate in the years since, with media scrutiny of how much tax is being contributed by high-profile taxpayers reaching fever pitch – just look at the spotlight shone on the tax bills of Prime Minister Rishi Sunak and former Chairman of the Conservative Party, Nadhim Zahawi.
The huge government support paid out during the pandemic, and the extent to which highly profitable businesses took advantage of certain tax breaks, intensified the sense that a corporate tax strategy focused on aggressive tax planning and paying as little tax as possible may no longer be the right approach in any context let alone an ESG one.
“When we look at ESG through the tax lens, it becomes clear that what is changing is the attitude to tax and tax risk, both inside and outside the organisation. An organisation’s approach to tax is no longer about paying the minimum, although some will still aim for that,” says Williams. “Neither is it just about compliance and paying the tax owed. Tax is increasingly becoming an indicator of how a business views its role in society and how it demonstrates its commitment to sustainability and social responsibility, alongside its commitment to its purpose. This is not totally altruistic of course. A business will want to demonstrate this to its existing and future customers, stakeholders and investors which is ultimately for the benefit of the business".
If the tax policy is properly aligned to a company’s ESG strategy, a positive outcome is to enhance transparency and make use of tax reporting disclosures as a means to gain trust. An ESG-based approach to tax reporting is about more than just publishing data though – it is about having a clear tax strategy and having a narrative around that strategy that is aligned to the organisation’s core values.
Williams says: “What we are seeing with our larger clients, such as the property investment funds, PLCs and multinationals, is much greater transparency on tax strategy and reporting with the expectation that the wider business and its suppliers adhere to that tax strategy going forward.”
That means all the managers in a business need to understand the tax policy and any tax risks that the business faces, in order to make sure they are not entering into transactions that run counter to the stated position. Some of the large property investment houses now expect a tax checklist to be signed off, and their tax team to be notified, every time managers sign up to real estate transactions that may create a tax exposure, for example.
Williams adds: “Our smaller clients – such as the start-ups, entrepreneurs and owner-managed businesses – may not have a tax strategy themselves right now, nor may they want one. But if they are suppliers to, or seeking investment from, larger organisations it will become relevant to them down the road whether they like it or not.”
Admittedly, businesses will not necessarily think 'tax' when it comes to ESG reporting, but at a minimum it is about good governance: being tax compliant and managing risk. Whether having a policy in place to deal with specific tax issues affecting the business (such as the Criminal Finance Act offences) or an overall tax policy governing its own tax affairs – now it is not just about what the business does or doesn't do in respect of its own tax affairs.
“One trend we see is a greater emphasis on having to police your own supply chain for tax non-compliance, evasion and fraud,” says Williams. “We see this in the context of VAT and PAYE compliance with clients and sectors heavily reliant on labour supply chains, for example, whether that is dealing with construction companies seeking labourers, the logistics businesses recruiting drivers, the care home operators seeking care staff or the recruitment agencies supplying those sectors.”
He adds: “We also see it with the introduction of secondary tax liabilities passing through the supply chain in new tax legislation, such as with the off-payroll IR35 rules and the plastic packaging tax.”
This then comes full circle as these new exposures feed into tax risk management and the wider allocation of risk under terms and conditions, transaction documents and due diligence.
The key takeaway is a company’s approach to tax matters to others a lot more than it used to and failing to walk the walk on promises made creates serious exposure to reputational risk.
Aligning an organisation's tax strategy with the wider ESG reporting does come with significant potential upside though. “By reporting and having transparency on the tax policy, a business can show to the wider world, including investors, clients, suppliers, employees and future recruits, that it really operates in a responsible way,” says Williams. “We can see that going forward organisations will be much more open about what they are paying and why they are paying it. It will no longer be enough just to have a tax strategy – one will need to make sure it is being implemented and that it is balanced and fit for purpose. If it is, it can become an impactful part of your ESG story.”