A company’s approach to tax is no longer just a question of compliance. In the context of the environmental, social, and governance (ESG) imperative, it is becoming a powerful indicator of how a business views its role in society and its commitment to its purpose. It is a critical element of a business’ social contribution - part of the “S” in ESG.
There are significant upsides to getting this narrative right. Looking at tax reporting through an ESG lens has the potential to tell a more holistic and relevant story about a business’ purpose, thereby building trust. And unlike, say, a commitment to net-zero emissions, which might take years to document and achieve, a company’s tax “footprint” (how much taxes are paid, and to whom) is something stakeholders are increasingly asking a company to report on today.
As a result, we are increasingly seeing investors looking at how businesses manage their tax affairs as an early indicator of how they might manage other aspects of the ESG agenda.
It wasn’t so long ago that tax disclosures were aimed at investors and centred primarily on the effective rate of corporate income tax. That has changed because the context has changed. Today, tax disclosures increasingly need to speak to a wider audience, including customers and employees, and can cover topics such as strategy and governance as well as numbers. It is a complex topic, and businesses should not underestimate the time it can take to gather and analyse the tax data and then explain that data in a way that builds trust and is meaningful for their investors and wider stakeholders. Within this context, we present four tips to get this right.
To ensure that reporting is genuinely informative, businesses will need to determine what information, qualitative as well as quantitative, is most relevant to its stakeholders. Gathering, verifying, and understanding this information, and then deciding which parts to include in disclosures, takes time and effort, but businesses that fail to start this process early enough will find themselves at a disadvantage when the time comes to answer key questions from investors and customers. Businesses seeking to build a narrative connecting tax practices to values and strategies, while also demonstrating to stakeholders a commitment to ESG imperatives, should consider the following:
Boards, management leadership teams, and heads of tax need to understand their companies tax position not just from a shareholder’s point of view, which focuses on consolidated financial statements, but also from the perspective of investors with a focus on ESG, as well as that of employees, civil society, and national tax authorities. This requires a commitment of time and resources because, as noted above, taxes are complicated and are changing all of the time.
Tax departments need to engage across the entire business to align tax strategy with the broader corporate strategy. The ESG revolution will change how businesses operate in all sectors, leading to changes in where businesses operate, in their supply chains, and in their acquisitions and disposals. Almost every business decision has a tax impact, and those impacts will take on increased visibility in the more extensive tax disclosures that are likely to figure more prominently in ESG reporting. Considering tax impacts early will help companies understand and develop the tax narrative that accompanies such longer-term transformations.
Tax disclosures are often read by people who are not steeped in the complexities of tax and compliance, so taking the time to develop and communicate a tax narrative can prevent misunderstandings. Doing so also builds trust. It is essential to consider how your company looks when its tax decisions are viewed through ESG and stakeholder lenses.
Business leaders should think about how they compare over time to their peers and factor that into how they develop their tax reporting. Only a few businesses will want to be the leaders in tax reporting, but even fewer will want to be left behind. Leaders also must pay attention to the changing views of stakeholders and to new metrics and reporting requirements, for example, the inclusion of tax in rating agencies ESG scores and the EU’s Corporate Social Responsibility Directive.
Given the complexity of the subject, a narrative that explains the concepts behind a business’ tax strategy is very important, especially given the likelihood of future tax incentives for environmentally sustainable growth. As a result, a considered approach to tax transparency and tax governance can have an important role to play as businesses look to engage with ESG issues, build trust, and realign with their wider stakeholders.
