Linking the ESG strategy to supply chain, transfer pricing and tax-related considerations is crucial to better avoid unexpected tax costs and risks.
Is tax-related ESG reporting the next challenge?
ESG is integral to investment decisions and capital allocations. Companies that fall short of ESG standards and ratings or are not equipped to collect the relevant information and data for reporting will likely see challenges in raising capital.
Adding to the complexity, there is currently no single set of standards for measuring and reporting ESG data in the reporting frameworks. Various rating agencies have also adopted different ESG reporting metrics.
Tax-related ESG reporting has also been introduced increasingly. The World Economic Forum released a universal set of ESG metrics and disclosures for use in annual reports. Included in the framework are core metrics focused on reporting both taxes paid by companies as well as their economic contributions. These core metrics of focus include reporting of total taxes paid by the company globally to demonstrate contribution to governmental revenues. The reporting of economic contributions covers the disclosure on direct economic value generated and distributed as well as any governmental financial incentive and assistance received.
Several rating agencies also evaluate tax criteria when issuing sustainability ratings. Investors rely on ESG ratings from these rating agencies — such as Institutional Shareholder Services, Morgan Stanley Capital International, Sustainalytics and Dow Jones Sustainability Indices — to make investment decisions. Some examples of the tax criteria considered by these agencies include effective tax rates, tax policies, governance disclosure on commitment to and compliance with transfer pricing and tax laws in jurisdictions and disclosure of financial assistance received from governments (such as grants and tax reliefs).
Getting it right
In the context of tax criteria for ESG metrics, organizations will need to understand the tax implications of their ESG-related decisions and how they will be measured and translated into these metrics.
With much at stake, organizations should engage tax advisors and in-house tax personnel in their ESG strategy so that they are well-covered to score high on the ESG-tax criteria.
A common theme across the ESG-tax criteria appears to be tax transparency and governance. As an immediate step, organizations should review their existing tax policies and governance frameworks so that they will be robust and comprehensive enough to withstand the scrutiny of relevant stakeholders.
Summary
The ESG agenda is gaining greater prominence in investment decisions and capital allocations. Companies therefore need to also address and meet tax-related ESG reporting requirements to raise capital more easily.