Environmental, social and corporate governance (ESG) principles have been with us for years, but they are now becoming more than a consideration to companies. Today, ESG is core to business.
With renewed emphasis on sustainability across all industries, transfer pricing leaders will need to take steps to ensure their ESG strategies directly influence every aspect of the business, including their tax departments and, more specifically, transfer pricing.
For instance, supply chain resilience amid unprecedented disruptions may call for shifts in functions and operations within the value chain towards environmentally sustainable practices. Tax departments will need to connect with supply chain, procurement and logistics teams to understand the nature and extent of these changes.
Tax departments will also need to examine the value of investing in social change and workforce improvement. Then, there is the issue of governance and the need to move towards accountable, transparent structures to reduce risk profiles and debt cost.
Given the rapid emergence and broad scope of these initiatives, transfer pricing leaders in tax departments need to:
- Understand ESG-related changes to the business
- Revisit their analyses of what creates value and drives business profit
- Determine the need for changes to transfer price policies
Addressing ESG business changes, step by step
Transfer pricing practitioners can follow these 5 steps to analyse and respond to ESG-related business changes.
Step 1: Determine who is making ESG recommendations and establishing the sustainability strategy
Key ESG decision makers are often listed in multinational companies’ (MNCs) publicly available sustainability documents. It is important to understand where these individuals reside in terms of legal entities and within the management structure.
Step 2: Identify prospective changes in the business
To pursue transformative and meaningful change, tax departments must discuss how the business is evolving and consult the regulatory team for insight into how ESG-related regulations may impact company operations. The information gathered should be reviewed to ensure it aligns with the company’s sustainability reporting.
Step 3: Assess the anticipated impact on business results
Tax departments need to understand the impact current and proposed ESG-related initiatives have on financial results, as well as other areas of the business. For instance, supply chains may have incurred higher operational costs in the past two years to boost resilience and efficiency, but this helped to meet customers’ demands and drive increase in sales volume and prices.
Step 4: Analyse the transfer pricing policies for ESG-related changes
Tax departments should determine how the existing tax and transfer pricing model allocates marginal income or loss associated with ESG projects across legal entities and jurisdictions. They should also assess whether allocation of income is consistent with functions, assets and risks for the relevant entities.
Step 5: Update transfer pricing documentation
MNCs need to include information on how ESG-related changes are impacting functions, assets and risks in their transfer pricing documentation. Local transfer pricing documentation should be updated as needed to reflect changes to transfer pricing results driven by ESG initiatives.
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