Tax integration in private equity's sustainability strategy

However, understanding why tax is a sustainability matter is not enough. Private equity firms need to take concrete actions to integrate tax into their impact management and measurement frameworks, and to demonstrate how they contribute to sustainability through their tax decisions and behaviours. This is a topic we are currently discussing with a number of our private equity clients.

In this article, we will show how the SDG Impact Standards for Private Equity, developed by the United Nations Development Programme (UNDP), can provide practical guidance for private equity firms to address tax as part of their sustainability strategy.

Sustainability has been a key focus in every industry for some time now. But tax is an aspect of sustainability that has only arrived relatively recently on businesses' radar. Tax plays a crucial role in the field of sustainability as it makes a direct contribution to governments’ budgets for financing progress to sustainability goals, redistributes wealth in society (reduction of poverty) and steers behaviour (such as green behaviour, e.g. through carbon taxes). Tax transparency and reporting is a way to demonstrate to stakeholders the tax behaviour and governance of an organisation. This enables investors to assess the alignment of businesses' tax behaviour and sustainability claims, identify any gaps and inconsistencies and make informed decisions on capital allocation.

Measuring and managing the impact of tax goals for sustainability is challenging. That’s because there’s no universally agreed definition or framework for tax transparency and reporting. Particularly for private equity, there may be many different regulatory frameworks to which private equity houses, the funds they manage, and their portfolios are subjected. On top of that, the houses and funds, the funds’ investors and the funds’ portfolio companies may also have their own principles and policies to which they wish to adhere.

For many companies, the UN’s Sustainable Development Goals (SDGs) provide a key platform for collaborative dialogue and progress towards sustainable capital, responsible business and sustainability innovation. Covering a range of environmental, social, and governance issues, these 17 sustainability global goals were adopted by the United Nations in 2015. Their aim is to end poverty, protect the planet, and ensure peace and prosperity for all by 2030. 

The SDGs are widely endorsed by governments, businesses, civil society, and academia as a common framework for measuring and reporting on sustainability performance. To help private equity align decision-making and reporting around sustainability, the United Nations Development Programme (UNDP) developed the SDG Impact Standards for Private Equity. 

It’s important to underline that the SDG Impact Standards for Private Equity (the Standards) are not the only way for private equity to address sustainability issues in their business models. There are many other sources of support when it comes to reporting on sustainability performance and improving their impact on society. 

The Standards are divided into four parts: strategy, transparency, management approach and governance. Below, we examine how each of them can be applied in the context of sustainable tax behaviour.

1. Strategy

The first step towards sustainable tax behaviour is to set a purpose and strategy. This step should include creating an impact thesis for optimising contributions to sustainable development and achieving the SDGs. The strategy should be translated into realistic goals, to which proper resources need to be allocated.
The Standards recommend using SMART goals: specific, measurable, achievable, relevant and time-bound. They also recommend considering all material impacts and the perspectives of any stakeholders that will be affected. Material impacts are often categorised in ABC-categories: Act to avoid or reduce harm; Benefit stakeholders in relation to the SDGs; and Contribute to solutions for achieving the SDGs. Once it has been set, the strategy – and any related impact thesis and impact goals – needs to be periodically reviewed.
When dealing with sustainable tax, the impact thesis could include:

• Compliance with tax laws
• Transparency and disclosure
• Support for public services 
• Avoidance of artificial or aggressive tax planning
• Collaboration with tax authorities
• Alignment with SDGs
• Stakeholder engagement and
• Education and advocacy.

2. Management approach

In practice, and building on the above example, this management approach can be applied to taxes by creating a tax policy, a robust governance and leadership framework, compliance mechanisms, and employee training programmes.
In particular, this management approach can address whether and how tax sustainability commitments towards investors, made at fund level, are pushed through at portfolio level and how sustainable tax is included in the scope of due diligence processes when acquiring new portfolio companies.

3. Transparency

Once the management approach is implemented, the Standards recommend a third step –transparency – which includes being transparent about the policies that have been decided upon, by progressing towards achieving them and addressing any impacts. This means focusing on information that will be relevant for stakeholders (e.g. for investor decision-making on SDGs), as well as for public reporting on impact performance.
For an impact thesis, this could mean disclosing the company’s tax policy and reporting on tax responsibility, as well as involving third parties to verify those reports. However, it is also important to consider which flows of information can practically be requested from investee companies, and how this information will be shared with the fund’s investors and other stakeholders.
Our study sets out key initiatives in relation to tax transparency.These include Total Tax Contribution, as well as the environmental, social and governance (ESG) tax metrics for the International Business Council (IBC) and the World Economic Forum (WEF).

4. Governance

The last step recommended by the SDG Impact Standards is governance. This requires active oversight and governing bodies that have the right skills and competencies around SDG strategy and management approach.

It will be largely dependent on the internal operational structure of a private equity house how this can be organised, but it is important to recognise that this requires both tax expertise and sustainability expertise. Governance may need to cover responsibilities for investors or investor reporting as well as portfolio management and the structuring of the funds.
Because the requisite specialist expertise and responsibilities are unlikely to be found in a single individual and/or department, securing access to them may require a new way of cooperating within private equity houses.

Private equity firms stand at a crossroads. Integrating tax strategy with sustainability is no longer a choice. It’s now an imperative. The SDG Impact Standards for Private Equity, as developed by the UNDP, offer a comprehensive framework for firms to navigate the complexities of tax as a sustainability issue. By embedding tax considerations within the broader context of their sustainability strategies, private equity houses can contribute meaningfully to the achievement of the Sustainable Development Goals.

The journey towards sustainable tax behaviour begins with a clear strategy that aligns with the SDGs, ensuring that tax practices are transparent, lawful, and equitable. The management approach must then operationalise this strategy, embedding it into the very fabric of decision-making processes, from due diligence to ongoing compliance.

Transparency is key to building trust and accountability, allowing stakeholders to assess the real impact of tax practices on sustainable development. Finally, robust governance structures must be in place to oversee the integration of tax and sustainability, requiring a blend of expertise in both domains.

Summing up, the SDG Impact Standards for Private Equity provide a valuable blueprint for firms to address tax as a critical component of their sustainability approach. By adopting and implementing these standards, private equity can lead by example, showing that financial success and social responsibility can go hand in hand.

The call to action is clear: it is time for private equity to embrace tax as a pillar of sustainability and, in doing so, help to shape a more equitable and sustainable future for all.

Please contact us to find out more about how we can assist you to align your tax and sustainability disclosures and integrate tax within your sustainability strategy.