As the lasting damage of COVID-19 reveals itself and socially responsible investing continues to boom, companies are facing increased pressure around corporate tax transparency.
Paying a fair share
While the ESG investing boom has increased demands for corporate tax transparency, the cataclysmic effects of COVID-19 have produced a tangible need for multinationals to pay their fair share of tax as economies rebuild.
According to the Tax Justice Network, countries are losing $427 billion every year to corporate tax abuse and evasion. The National Bureau of Economic Research estimates that 40% of multinational profits are shifted to tax havens globally.
There is growing momentum for large companies to use a country-by-country reporting approach; disclosing how much tax they pay, where they house their profits and their tax planning strategies.
In a move to manage the costs of pandemic relief, leaders at this year’s G7 summit agreed to back the Organization for Economic Cooperation and Development’s (OECD) proposal for a minimum corporate tax rate of 15%. U.S. Treasury Secretary, Janet Yellen, said that implementing a global minimum would stop a “race to the bottom” and deter companies from shifting profits to low-tax countries. The plan was backed by 130 countries by the start of July.
The US House recently ramped up its ESG measures when it passed The ESG Disclosure Simplification Act and The Disclosure of Tax Havens and Offshoring Act on June 16, 2021. Until recently, the US had trailed behind Europe and Australia with its corporate tax reporting legislation.
Like Europe’s Sustainable Finance Disclosure Regulation (SFDR), the ESG Disclosure Simplification Act requires public companies to disclose how ESG metrics are considered in the issuers long-term business strategy and the process they undertake to determine the impact they have. This information must be included in any investment, consent or solicitation material. An additional component of the act involves mandating the Securities and Exchange Commission (SEC) to define material ESG metrics and enforce the law.
The Disclosure of Tax Havens and Offshoring Act requires multinational corporations registered with the Securities and Exchange Commission to disclose basic financial data about their operations and overseas subsidiaries. This includes:
- Total accumulated earnings per country (for all subsidiaries)
- Taxes paid
- Tangible assets
- Tax expenses
- Number of employees
The rationale behind the bill is explained in a related congressional report. The document argues that corporate tax practices can impact a company’s short and long-term value in the form of legal or reputational risk. Without standardised, mandatory disclosures the liability of a company cannot be properly assessed and this imposes a direct financial risk to investors. Therefore, public companies should be required to disclose basic tax information to domestic or foreign governments they are operating under.
The report estimates that the practice of offshoring costs the United States around $100 billion in annual tax revenue.
The EU continues to lead the way in tax-related disclosures according to a report commissioned by Principles for Responsible Investment (PRI) – a network of ESG investors backed by the United Nations.
According to the document, European companies outperform the rest of the world when it comes to comprehensive disclosures across tax policy, governance, and quantitative reporting:
- Over 80% have a comittment to tax transparency
- 57% demonstrate evidence that their board oversees corporate tax policy
- 24% provide a country-by-country breakdown of corporation tax paid globally
This is most likely due to the EU’s bold tax transparency legislation. The DAC6 (disclosure of cross-border tax arrangements) directive was implemented in 2018 and came into force in July 2020. The rule requires intermediaries to notify tax authorities of cross-border tax arrangements within 30 days. If the arrangement satisfies certain hallmarks tax authorities will exchange this information with other EU tax bodies to ensure companies pay their fair share of tax in all territories.
In March of 2021, Norway’s $1.3 trillion Government Pension fund updated investment guidelines to include tax evasion as part of its definition of financial crimes. This means any company found to be employing overtly aggressive tax practices will be excluded from the world’s largest sovereign wealth fund.
A critical part of ESG
The surge in ESG investing means that a natural progression towards corporate tax transparency is imminent. A number of companies are adopting initiatives to strengthen their ESG performance and enjoy the long-term benefits that come with it.
PRI lists the following key reasons corporate tax transparency should be considered in their guide for investors, this includes:
- The amount of corporate income tax companies pay is material to their profitability
- Corporate tax avoidance may suggest underlying legal, operational, reputational, financial or governance risks
- Investors need to know their portfolio companies can withstand stakeholder scrutiny and regulatory changes
- Corporate taxes support society’s tangible (i.e. infrastructure) and intangible (i.e. education, governance/legal) needs
Corporate tax has become a leading social and governance consideration. Companies are beginning to shift their focus from purely generating profit for shareholders to contributing to a wider community of stakeholders.
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