Tax as an essential component of the ESG Framework (3)

Part 3: institutional investors’ expectations on tax transparency

In a series of three articles we discuss the topic of "taxes and ESG". This third article focuses on the expectations of institutional investors regarding tax transparency.

As outlined in the previous two articles on this subject (see sidebar), within their overall investment decision-making processes, more and more institutional investors are taking steps to integrate responsible tax issues within their ESG Framework. It goes without saying that it is investors’ responsibility to develop an ESG Framework in which it integrates responsible tax strategies and tax payments of its (potential) investees. However, to enable or improve the integration of responsible tax within institutional investors' ESG Framework, investors are dependent on meaningful disclosures on company’s tax positions.

Institutional investors’ expectations on tax transparency

Lack of disclosure around a company's tax affairs is however one of the key impediments for investors to integrate responsible tax within their ESG Framework. It is therefore important that (potential) investees provide, forward looking information on taxes, preferably in the annual report, on how the future effective corporate tax expense rate and the effective corporate taxes paid rate are expected to develop. Moreover, it is important that companies additionally report on the following matters:[1]

• Elaborate in more detail on the tax risks and provisions for uncertain tax positions using publicly available documentation. This elaboration should be complemented with a detailed description of the company's tax risk appetite and response to risks, as well as the company's approach to managing and addressing these risks.
• Show investors that the company's tax function is an integral part of the business. The company must therefore align its tax strategy with its organisational values and their business and sustainability strategies.
• Present data on a country-by-country basis, from which it can be determined where value has been created and in which jurisdictions taxes are paid. More specifically information which is not covered by the EU Directive on Public CbCR, such as information on government subsidies and ESG taxes.
• Engage in dialogue with investors regarding tax values, corporate tax behaviour, tax disclosure and their expectations with regards to tax transparency.

Suspicion of aggressive tax planning structures or lack of sufficient tax disclosure may lead investors to:

1. Address the situation using voting rights during the annual general meetings (AGMs);
2. Discuss the specific issue with the investee company through engagement and dialogue.

However, institutional investors may also divest from companies due to a lack of tax transparency. In 2021 for example, several investments were dropped by Norway's sovereign wealth fund due to a lack of tax transparency.[2]

Lack of sufficient tax disclosure

Over the course of three articles on Tax and ESG, a clear observation has emerged: due to societal expectations, tightening regulations and weakened public finances, tax avoidance activities of multinationals have come under increasing scrutiny in recent years. Among the many stakeholders within this landscape, institutional investors increasingly assess the tax risks (reputational, governance, and earnings risks) in their portfolio and implement tax issues within their ESG Framework. Tax issues are therefore increasingly part of institutional investors’ ESG Framework and investors demand greater transparency from their (potential) investees.

However, there are still certain gaps between current corporate tax disclosures and investors' expectations, to ensure that the latter is able to fully integrate tax issues within its ESG Framework. It is therefore important that companies disclose detailed information on their tax governance and risk management processes, for investors to understand companies' positions on tax issues and assess tax risks in their ESG Framework.

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[1] See Tax Transparency Benchmark 2018-2023: A Comparative Study of 68 Dutch Listed Companies. VBDO.

[2] See G. Fouche (February 1, 2021). For first time, Norway's wealth fund ditches firms over tax transparency. Reuters (online).