A guide to tax and ESG for in-house Heads of Tax

Environmental, social and governance (ESG) issues are increasingly influencing the decisions and expectations of businesses, investors and consumers. In-house Heads of Tax need to be conscious of the growing importance of ESG for their role and the challenges and opportunities it presents. In this article, we provide some guidance on how to navigate the complex and evolving landscape of tax and ESG.

Keeping on top of ESG tax incentives

In recent years, there has been a surge in governments turning to tax incentives as a way to encourage businesses to adopt more sustainable behaviors. The US Inflation Reduction Act (IRA), in its expansion of existing tax credits for renewable energy assets and creation of new tax credits for emerging asset classes, particularly caught people’s attention. This has undoubtedly spurred some tax administrations to consider whether there might be additional tax measures they could use to support their policies in this area. We recently saw the introduction of new French tax credits for investments in green industry. This came off the back of a relaxation of the EU state aid rules under the Temporary Crisis and Transition Framework for certain measures that foster the transition to a net-zero economy. And it is not just about investing in green technologies. Tax incentives are also being used to encourage social change; examples of this can be seen in both the US IRA and the recent expansion of the UK’s Community Investment Tax Relief.

What you need to do

In-house Heads of Tax have a chance to shine by keeping on top of the developments in ESG tax incentives, both in your own jurisdiction and in the markets where your group operates or invests. See key takeaways from our recent webinar on global trends here. This will help you bring new opportunities to the table in terms of reducing the group’s tax burden, enhancing cash flows, or tapping into new sources of funding.

Being aware of the bigger picture

Whilst new tax incentives often grab the headlines, the interaction with other rules may not. Heads of Tax will need to consider how ESG incentives interact with the group’s wider tax position. For instance, are any relevant incentives that the group wants to rely on structured in such a way that they will be respected under the OECD’s rules for a global minimum tax (‘Pillar Two’)? Could EU tax incentives be susceptible to challenge under EU state aid rules? For non-EU businesses looking to invest in the EU, could any non-EU tax incentives trigger an obligation to notify under the EU’s new foreign subsidies rules as foreign financial contributions? 

What you need to do

Be aware of any ESG tax incentives that your teams are looking to rely on and make sure that you (and they) understand how these interact with both new and existing legislation that could impact the financial benefit that the group can obtain from the incentives, as well as any additional reporting or compliance obligations that might be triggered.

Remember there are sticks as well as carrots!

Although some governments are using tax as a positive mechanism to incentivize ‘good’ behaviors, there is a veritable assortment of measures which introduce tax costs for activities that are considered detrimental to ESG goals. These can take the form of new or additional taxes, levies, fees or penalties for a range of ‘bad’ behaviors, such as emitting greenhouse gases, using plastic packaging or consuming fossil fuels. Some of these are not new measures: for instance, the UK has had a climate change levy on non-renewable energy use since 2001. But there has been a sharp increase in such measures in recent years. For example, the EU’s new Carbon Border Adjustment Mechanism (CBAM) imposes a charge on the carbon content of imports from countries that do not have equivalent carbon pricing regimes, and the UK is currently consulting on introducing its own version of this. The UK and Spain, among others, have now introduced plastic packaging taxes. And there is mounting pressure globally to align existing taxes such as fuel duties and aviation duties with emissions. 

What you need to do

These additional tax costs could impact your group’s business model, supply chains and products. They will need to be factored into planning and pricing decisions. Could there be an impact on profitability or even the group’s reputation if the group is engaging in behavior that triggers such taxes? It will become ever more important for a cross-function approach to be taken when considering these extra costs. Could there be ways for the group to mitigate them, by modifying its own behaviors, or even by encouraging changes in respect of suppliers or their practices? New measures are being introduced at a rapid rate in this area: keeping up to date with the latest position will be key.

Non-tax ESG policies with tax implications

In-house Heads of Tax need to be involved in the development and implementation of non-tax ESG policies in their organizations that could have tax implications. For example, adopting a policy on hybrid working, which allows directors or employees to work remotely, may have repercussions for the business in terms of the tax residence of the company, permanent establishment risk, employment taxes, as well as employer and employee social security contributions.

What you need to do

Ensure you are integrated in cross-functional teams that are involved in ESG policy-making. Being able to identify and factor in tax implications of policy choices early on can help prevent unpleasant surprises later. Close collaboration should help make sure any new policies are consistent with the group’s overall tax strategy.

Developing a tax strategy: could your approach to tax be a selling point for the group?

In some jurisdictions, publishing the group’s tax strategy can be a legal requirement. For instance, large businesses in the UK must, amongst other things, publish information on their attitude to tax planning, how they manage UK tax risks and how the business works with HMRC. But, even where it is not compulsory, it can be beneficial to articulate the group’s tax strategy. It can be relevant to sustainability reporting, for instance, in evidencing the group’s approach to tax for the purposes of Global Reporting Initiative (GRI) 207.

Some groups are going a step further and using their responsible approach to tax as a selling point to differentiate themselves from competitors. For instance, the Fair Tax Mark is a voluntary accreditation for businesses to demonstrate they have met the ‘gold standard of responsible tax conduct’. Similarly, the B-Team developed Responsible Tax Principles together with Heads of Tax from nine multinationals to help restore public trust and to encourage others to raise standards when it comes to tax.

What you need to do

In-house Heads of Tax should be clear on legal obligations as regards publishing a tax strategy. Going beyond this, consider whether it would be helpful to publish a strategy on a voluntary basis. In developing a tax strategy, care should be taken that this reflects the group’s values and is consistent with its wider ESG strategy and policies.

Crucially, avoid ‘tax greenwashing’. It will be critical to verify that the group’s actions in practice match the published policy and that any gaps or inconsistencies are promptly identified and addressed. If a group’s policy is that it does not engage in aggressive tax planning, but the press runs with a story which suggests that it has, it may be difficult to recover from the resulting adverse publicity and reputational damage.

On a more positive note, could your group’s approach to tax be a selling point for the business? Can your tax contributions and responsible tax practices be used to demonstrate the group’s positive impact on society? If so, consider how you can communicate your tax strategy to investors and consumers most effectively.

Do you have procedures in place to ensure good tax governance?

Having appropriate procedures and policies in place to ensure that the group complies with tax laws and regulations may be required in some jurisdictions to prevent criminal liability. The UK’s Corporate Criminal Offence (CCO) which makes companies liable for failing to prevent the facilitation of tax evasion by employees or associated persons and the Belgian criminal liability for laundering proceeds of tax fraud are examples of this. In the UK, the Senior Accounts Officer (SAO) rules can lead to personal penalties if the SAO fails to establish and maintain appropriate tax accounting arrangements.

In other cases, having appropriate tax governance systems may be necessary to satisfy sustainability reporting standards. For instance, GRI 207 requires a description of how tax risks in the business are identified, managed and monitored, what tax governance and control frameworks are in place and how compliance with the framework is evaluated.

There can be other advantages of having good tax governance processes. It may lead to a more cooperative, lighter-touch approach being taken by local tax authorities and, in some cases, there are benefits specifically provided for by law. The German implementation of DAC 7 provides that having an approved tax compliance management system in place can result in simplified tax audits. In Italy, legal decrees provide that larger businesses with appropriate cooperative tax compliance systems can see benefits in their dealings with the tax authorities, including lower penalties and shorter deadlines to get rulings.

What you need to do

It is essential to understand any legal requirements around tax governance in the jurisdictions in which the group operates. In addition to those required by law, consider whether there are policies which could be best practice to adopt in terms of managing tax risks. To the extent that the group already has policies in place, these may still need to be monitored and reviewed. In the UK context, the lack of convictions under the CCO since it was introduced in 2017 has led to pressure on HMRC to take a tougher approach on this. Concerns such as these could potentially mean that policies that were previously thought compliant may need tightening up to reflect the changing tax environment and the evolving expectations of tax authorities.

Managing the implications of tax transparency

Transparency is a key feature of ESG in terms of demonstrating how a company is meeting its ESG goals and helping build trust. In a tax context, alongside being transparent around your group’s approach to tax, this also involves making information available about the taxes the group is paying.

The scale and breadth of tax reporting requirements, even outside an ESG context, has been growing exponentially in recent years. The OECD’s Base Erosion and Profit Shifting (BEPS) project has led to over 100 jurisdictions introducing country-by-country reporting (CbCR), requiring multinationals to report data on their global allocation of income, taxes and economic activities to tax administrations. Each of the eight iterations of the EU Directive on Administrative Compliance has added to the pile. And, perhaps most significantly, the EU’s Directive 2021/2101 provides for public disclosure of CbCR information. Under this directive, multinationals operating in Europe with a turnover over €750m must publish their tax information on their websites by 2024/25. Australia is looking to follow suit and it may not be long before others join them.

What you need to do

The first fundamental step is understanding your obligations and making sure you can comply with these. Do you have the right systems in place to capture and report the required information? The tricky next step is getting to grips with what is in the data that you have to report. Do you have the right team and technology to analyse the data and understand the information that has to be reported and/or published?

Tax administrations are increasingly using technology and artificial intelligence systems to analyse the vast quantities of information that they are now required to collect. Do you have equivalent tools to enable you to be ready for potential audits? Are you able to identify and mitigate any potential tax issues or inconsistencies that may be lurking in the data that has been collected?

In a world where paying tax has taken on a moral angle as opposed to a purely legal one, those who have to publish their data will inevitably be subject to additional scrutiny from the media and activists, as well as investors and consumers. Does the information that has to be published cover any tax topics that might be sensitive, acknowledging that simply stating that the group has acted in accordance with the law may no longer be a good enough response? Anticipating the public reaction, having a robust strategy for addressing challenges and being proactive in explaining your position will enable you to get on the front foot in handling this.

Attracting investors, consumers and talent

Investors and consumers are beginning to factor in a group’s approach to tax as part of their investment or purchasing decisions. Customers may not want to be involved with a company that has been associated with aggressive tax planning by the media (however unfairly). Given the negative press coverage around the Panama Papers and LuxLeaks scandals, investors will have concerns about suffering reputational damage as a result of the attitude to tax of the businesses in which they invest. Ewan Livingston-Docwra of the B-Team, speaking at a tax symposium hosted recently by the International Finance Corporation, noted that this could have real financial as well as reputational consequences: if you invest in a company engaged in aggressive tax structures, it could impact financial performance if there is a crackdown on the loopholes these rely on.

Pascal Saint-Amans, former OECD Tax Director, acknowledged at the same event this shift away from a pure legal approach to tax. Paying the right amount of tax, he noted, is about being a good corporate citizen and this can be relevant when engaging with local communities. So, the group’s approach to tax, and whether you are acting sustainably and ethically on tax matters, can be a relevant factor when it comes to recruiting and retaining people, especially from younger generations who may be more focused on ESG considerations.

What you need to do

It is important to think holistically about the group’s approach to tax risk. Tax is becoming a boardroom issue and one that needs to be discussed and considered beyond the tax function. Whilst shareholders will expect tax efficiency, there may be broader implications in terms of encouraging investments, reassuring consumers and attracting talent. Working closely with colleagues in other group functions will be critical to addressing these considerations effectively.

This article first appeared in Tax Journal on 11 April 2024.