What is ESG and why corporate tax departments should care

Sixteen years ago, a group comprised of financial institutions, global consultants, government bodies, regulators, and research analysts came together to examine what role environmental, social, and governance (ESG) factors play in long-term investments.

That meeting led to a report, endorsed by the United Nations, stating it was, in fact, important for businesses to consider how to integrate ESG value drivers “into financial market research analysis and investment.” Shortly, ESG became commonly used as a generic term by investors, regulators, and activists to evaluate corporate behaviors and hint at companies’ future financial performance. Europe has the led the charge, incorporating ESG into requirements for company transparencies; and as a new administration takes the helm in the U.S., there is some expectation that some ESG standards may come into play. (The U.S. may have signaled as such by already rejoining the Paris Agreement on climate.)

Much of the focus among ESG proponents has been on environmental factors, and rightfully so. This focus includes six objectives as defined by E.U. Taxonomy Regulations:

1. 1. 1. 1. pollution prevention & control;
         2. climate change adaption;
         3. the sustainable use & protection of water and marine resources;
         4. climate change mitigation;
         5. the transition to a circular economy; and
         6. the protection & restoration of biodiversity and ecosystems.

Now, however, there has been an increased focus on social factors as many consumers emphasize social and ethical integrity as a determining factor for which company products and services they purchase and support.

How corporations must respond

Over the last 10 years, there has been an increase in the way consumers, investors, and almost all stakeholders make decisions on whether to interact with a business or not. This goes beyond a company’s product and services as organizations increasingly are being judged by their ESG standards. For multinational organizations, ESG considerations are not optional. In France, for example, the AMF, the country’s main stock market regulator requires institutional investors and asset managers to explain how they have incorporated ESG criteria into their investment policies.

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You can download a copy of the new Thomson Reuters report, Insights for Tax Professionals 2021, here.

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Further, the French and Dutch investment market authorities have proposed a framework for European regulations of ESG data, ratings, and related services. And in the U.K., some industries are required to publish their tax strategies, which include how they manage tax risk.

Additionally, global governing bodies such as the Organization for Economic Co-operation and Development (OECD) and the U.N.’s Principles for Responsible Investment (PRI) have provided frameworks and guidance for corporations and investors. In many of these, ESGs has become a pillar in companies’ value statement and reporting.

The role of the tax department in ESG

Dave Ruebzaet, director of Tax Governance & Sustainable tax at PwC, notes that corporate tax departments will be expected to play an increasingly important role in determining ESG standards. “Taxation is being placed more and more in the context of companies’ corporate strategy and sustainability objectives,” says Ruebzaet, adding that this speaks to tax departments’ stronger role in companies’ boardrooms as well as the increasing need for companies to embrace ESGs into an overall tax strategy.

As part of this shift, tax departments are being tasked with creating tax strategies that include governance and other priorities. “Tax policies are no longer in the tax department but on the boardroom agenda,” Ruebzaet adds.

Organizations such as the OECD that work to redesign the international tax system that covers more than 135 countries recognize the need for corporate tax to become more transparent. Indeed, tax transparency is and will be the new norm, being supported by the OECD, the U.N., and other bodies. Having a tax governance strategy gives corporations the necessary transparency which should be the bedrock of the company’s tax strategy and related policies.

Four considerations that corporate tax departments should understand when creating an effective tax governance strategy are:

1. 1. 1. 1. Review and align the tax strategy with the corporation’s sustainability strategy, which itself should include elements of the U.N.’s Sustainable Development Goals.
         2. Be transparent — transparency doesn’t mean revealing anything that comprises the company’s business or competitiveness. However, volunteering information such as a list of risk management initiatives or tax contribution figures is worthwhile. And it should, of course, be in alignment with the corporation’s overall approach to transparency.
         3. Have a practice of tax integrity— which can be defined as  a “willingness to adhere to both the law and society’s unwritten rules as it relates to corporate tax.” Leveraging technology also can provide accurate recording and reporting of taxes.
         4. The overall risk management efforts of the corporation and the corporate tax department should include factors such as environmental and social issues that impact the business.

As tax issues continue to be a focus for governments and international regulators (likely adding to increase compliance requirements for multinational companies) stakeholders, including investors, employees, and customers will continue to ask for more transparency in how businesses operate.

A tax strategy that proactively provides accurate tax risk management but also includes attention to environmental, social, and governance considerations can best position the company as an integral member of the societies, markets, and countries in which the company does business.