No matter your ESG ambitions: Here are 7 key areas for any tax department to check

The ESG ambitions of tax functions come in different shapes and sizes. From integrated drivers of change to a minimum to stay compliant. Either way a proactive and strategic approach coupled with efficient data capture is at the heart of it all.

Your focus depends on which industry your company is in. Sectors that directly emit large amounts of greenhouse gas (GHG) or sell products that emit GHG are forced to think more strategically and take transformative and operational actions. In sectors with less direct exposure, the way ahead is different. But this advice is universal.

We see namely 7 key areas impacting the tax function from an ESG perspective.

Sustainability measures lead to compliance and reporting requirements which require cross-functional processes. Tax functions must be able to determine the extent to which they are responsible for complying with and reporting on new sustainability measures. Harmonising the communication across functions is important to get the right input.

Decarbonisation and net zero policies drive business change. The impact of this change is absorbed and managed by the tax departments.

Setting up ESG business units and development of new assets and products driven by decarbonisation and net-zero policies will often be located within tax. Management of any new revenue streams from a transfer pricing perspective and impact of newly developed intellectual property (IP) is also an added challenge together with de-commissioning of any obsolete units and structures.

Decarbonisation and net-zero policies are impacting groups’ supply chains. It is important for tax departments to understand such changes as there will often be tax consequences. Examples include:

• Circular economy – new transaction flows and new revenue streams
• Shortening of supply chains – winding down/outsourcing of operations 
• Selling services rather than products – new revenue streams and asset ownership profiles
• Supply chain visibility – requirement to have full visibility over supply chain for reporting requirements and impact on responsible tax and legal agenda
• Internal carbon price and purchase of carbon offsets – impact on transfer pricing model.   

Tax functions are well positioned to identify and unlock funding opportunities which are designed to support companies in their green and sustainable investments, from the EU Green Deal Industrial Plan and the US Inflation Reduction Act to the CHIPS Act. Realising these opportunities can drive billions of dollars through increased cash flow and potential ETR benefits to fund and improve business cases for investments. 

Tax departments must be ready to comply with ongoing and new environmental or windfall type taxes. There has been a proliferation of such taxes and fees in recent years including:

• Plastic packaging taxes
• Windfall and excess profits taxes
• Waste taxes
• Fuel taxes
• Carbon taxes and other carbon pricing mechanisms (e.g., emission trading systems and carbon border adjustment mechanisms).

Tax transparency reporting and other public disclosures on tax affairs started as a voluntary effort by some leading companies. This initiative is now being codified in corporate governance standards (e.g., in Denmark and the Netherlands), accounting standards (FASB decision on income tax reporting), and hard law (from CSRD to the EU Directive on Public CbCR, as well as the proposed Australian law on public CbCR).

Tax functions therefore have had to put the management of tax and tax risks on their boards’ agendas and must help their companies report on their tax affairs and tax contributions, on a country-by-country basis, and may have to explain complex tax rules and technical issues to non-expert readers.

As reporting standards evolve, underlying data is increasingly scrutinised by stakeholders, calling for organisations to ensure their data is secure, available, and accurate. Trustworthy data provides a foundation for correct interpretation and helps to ensure alignment between various reports.

Besides stressing the quality of data itself, the ESG agenda also challenges the ability of tax functions to combine expert tax knowledge with data interpretation skills. Tax departments may need to specify and harmonise new data requirements, affecting systems and processes throughout the organisation.