Environmental, Social and Governance are the three pillars for gauging the sustainability and ethical impact of a business. Investors and other stakeholders are now measuring the performance of companies not only by financial metrics but also by reference to these three pillars of ESG.

Consequently, businesses are responding and are making changes to deliver on ESG.  Any strategy that causes disruption to an existing business model will throw off tax considerations and ESG is no different. In this article, Paul O'Brien and John Doran of our Tax team set out the tax considerations inherent but not necessarily obvious for ESG.  

Tax in environmental strategy

Traditionally the most dominant pillar of ESG is the E, the environmental strategy. Under this pillar businesses must assess their impact on the environment and implement initiatives to manage climate risk, waste, and pollution, and how energy-efficient their business and processes are.

So how does tax play a role here? Businesses are dealing with environmental taxes such as Solid Fuel Carbon Taxation and the new windfall taxes on certain energy generators. Businesses are also grappling with the tax impact of their decarbonisation strategies which range from the impact of investments in energy-efficient premises to indirect tax and transfer pricing considerations arising from changes to supply chains for environmental reasons. 

Tax dimension to social responsibility

Post-COVID, we have seen what’s known as “the rise of the S”, the social pillar in ESG. This pillar is all about a company’s policies around workforce engagement, human rights and social impact. Businesses are implementing policies around hybrid working, inclusion and diversity in the workplace and ethical supply chains, all of which have tax implications. A topical example of work in this area is Gender Pay Gap reporting, and we are also helping businesses manage the tax impact of hybrid working which carries tax risks due to changing work practices. 

The role of tax in governance

The Governance pillar is of growing importance in the tax world. Here companies are considering policies around matters like executive remuneration and board diversity, and of course, tax plays an important role. Another component of the Governance pillar is tax transparency which can be placed in two pools – mandatory and voluntary.

Mandatory and voluntary measures

Mandatory drivers include the OECD’s Country-by-Country reporting, DAC 6 mandatory disclosure and the forthcoming EU public country-by-country reporting. 

Voluntary tax transparency drivers include the adoption of the Global Reporting Initiative standard 207.  This is the first tax-related standard within the broader area of sustainability reporting. We are working with companies reporting under this standard which profiles an organisation’s approach to tax from both a qualitative and quantitative perspective. 

What should businesses do about tax transparency?

Tax transparency should be seen as a window through which stakeholders, including investors, have an increased line of sight into how tax is managed within a business. 

Progressive businesses need to invest time in assessing and anticipating what tax transparency means for them. 

Businesses should focus on three areas. Firstly, a business needs to get to a position whereby they can positively state that they have a tax policy. Why? Because not having one is a red flag for stakeholders. From there, tax functions in businesses need to consider how their tax policy benchmarks against peers and best practices – the transparency framework developed by KPMG can help with this benchmarking process. 

Secondly, businesses should take steps to ensure that there is clear board-level oversight of the tax policy. Being able to evidence that proper tax governance is in place is key to assuring stakeholders that a business walks the walk as regards their stated tax policies.

And thirdly, businesses should consider putting some formality around their tax control framework to ensure that tax policies cannot be circumvented. Most businesses will have at least some informal policies and controls in place. However, the process of formally reviewing and benchmarking tax policy, controls, and governance will better position businesses for the increased scrutiny to come. With our bespoke technological solutions, we are helping businesses navigate the process.

Get in touch

Tax is a crucial component of ESG from environmental taxation, the tax implications of changing a business model to implement ESG strategies, tax risks under hybrid work arrangements, right through to tax voluntary and mandatory transparency obligations. It can be challenging for organisations to keep up to date with the continually evolving tax landscape and the nuances of ESG. If you have any queries on ESG, environmental taxes, and transparency reporting, please contact our tax team. We'd be delighted to hear from you.

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