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Investors Fight Back Against Tax Avoidance 

While not illegal, aggressive tax planning by corporates threatens to undermine responsible investing.

Everyone dreads the moment when the tax inspector comes knocking at the door, but the importance of paying taxes and contributing to public spending is mostly acknowledged and accepted. Mostly.

There are a number of examples of big multinationals cutting corners, taking advantage of lax tax rules in countries far from their customer base and finding loopholes that allow them to operate in a morally grey area. Are they technically breaking the law? Not usually. Does it go against the spirit of contributing to tax revenues where their customers and operations are based? Yes.

Three of the biggest companies in the world – Google, Facebook and Microsoft – have avoided paying US$2.8 billion in corporation tax in developing countries, according to a 2020 report by charity ActionAid, which noted the revenue could have been used to tackle the effects of the pandemic. The lost revenues could have paid 729,010 nurses, 770,649 midwives or 879,899 primary school teachers annually in 20 countries across Africa, Asia and South America.

That is only the tip of the iceberg. Aggressive tax practices such as domestic tax base erosion and profit shifting currently cost governments between US$100-US$240 billion in lost tax revenues annually, which is the equivalent of 4-10% of the global corporate income tax base, according to the Organisation for Economic Co-operation and Development (OECD).

Good governance indicator 

The pandemic certainly put things into perspective for institutional investors, many of which have been increasing their scrutiny of investee companies’ tax practices and policies.

A company’s approach to tax is often a good indicator of its overall governance, according to Jens Christian Britze, Tax Specialist for Danish pension fund provider PKA.

“We first confirmed our focus on corporate tax strategies in 2019 and began increasing our engagements with portfolio companies,” he says. PKA operates four pension funds for 335,000 members spanning healthcare and social services, with overall assets under management (AUM) totalling €47.1 billion.

With the majority of its membership base receiving their salaries through tax revenues, Britze emphasises that, for PKA, it is “especially important that the government is receiving the taxes it should”.

“More investors are interested in tax governance from an ESG perspective; they want to invest in a company that has a responsible tax approach,” agrees Chris Morgan, Global Head of the Responsible Tax Programme at Big Four accountancy firm KPMG. “One pension fund told us that they don’t want to generate financial returns from aggressive tax avoidance.”

But tax is complicated. Understanding exactly how much tax a global company should pay, not to mention what they are actually paying, is headache-inducing and requires a lot of time and resources.

Institutional investors are calling for companies to be more transparent, but, as recent research by the UN-convened Principles for Responsible Investment (PRI) highlighted, frameworks to measure tax transparency are thin on the ground and information disclosed by corporates “is often incomplete and lacks uniformity”.

Tax reporting requirements also receive “limited attention in key sustainability reporting standards”, the report noted. For example, responsible tax is not included in the Sustainability Accounting Standards Board (SASB) framework.

“This is surprising given that, perhaps more than any other sustainability issues, poor tax practices can have an immediately quantifiable impact on corporate profits,” the PRI said.

Unless responsible tax reporting guidelines are introduced by disclosure bodies and mandated through legislation, or companies displaying best practice are identified, investors will continue to struggle securing the information they need to assess investee companies’ approaches to tax planning.

Rewarding good behaviour

The Fair Tax Mark accreditation scheme was launched in 2014 by a UK-based not-for-profit social enterprise, the Fair Tax Foundation, to identify companies that pay the right amount of corporation tax at the right time and in the right place. To qualify, companies must also disclose sufficient public information to help stakeholders analyse their tax conduct and financial presence and impacts around the world.

“You can’t move for the number of ethical accreditation schemes for sustainable forestry, fishing or agriculture, and yet there was nothing for responsible tax,” says Paul Monaghan, CEO of the Fair Tax Foundation.

The Fair Tax Mark’s outline of best practice is in line with the tax disclosure recommendations since published by sustainability reporting body the Global Reporting Initiative (GRI) in 2019. “We didn’t want to add to confusion by introducing something entirely separate from existing offerings,” Monaghan says.

So far, the Fair Tax Mark has been awarded to around 70 companies in the UK, including energy provider SSE and retailer the Co-Operative Group. The foundation is now responding to institutional investors’ demands to expand their scope.

“Global institutional investors have told us that they want to be able to apply the standard across their portfolios, not just on UK-based companies and equities,” Monaghan says.

Last week, the foundation launched its Global Multinational Business Standard, further announcing its first international accreditation had been awarded to European energy company Vattenfall.

Running out of road

An industry has built up over decades to increase large firms’ tax efficiency. But recent developments suggest companies with aggressive tax policies and practices can’t outrun the tax inspector forever.

“We have seen a lot more political agreement on how to regulate multinationals when it comes to tax, so that will be a concern for companies with aggressive tax strategies,” says PKA’s Britze. “Being too aggressive on tax planning is not sustainable in the long term. The regulatory environment will catch up,” he notes.

Increasingly strict tax regulations also leave investors open to financial risks if they are investing in tax-aggressive companies, according to Vaishnavi Ravishankar, Senior Specialist on Governance at the PRI.

“Tax regulations can have an immediate impact on company earnings and profits, which will affect investors,” she says. Investors therefore need visibility of instances where a company is reliant on tax incentives, she warns.

“Tax rules don’t always work in the way they were originally intended to or the public might expect them to – and that’s the fault of policy and legislation, not the companies,” KPMG’s Morgan tells ESG Investor. For example, a US-based company may be selling product into Europe, but won’t have to pay taxes in Europe because their sales are being made outside of the jurisdiction.

“Politicians or the public may take note of the fact that no tax is being paid, which could then prompt calls for a change in the law, but until then companies are within their rights. Transparency helps create an open and informed debate,” Morgan says.

Nonetheless, the smell of change is in the air.

End of an Era

In Europe, multinational companies will be required to publish reports on their income tax by the mid-2020s, including disclosing tax payments made by any multinational and its subsidiaries in each EU country and in jurisdictions considered to be ‘tax havens’.

In the US, President Joe Biden’s US$1.2 trillion bipartisan infrastructure bill also includes specific tax reporting provisions for digital assets.

Most notably, almost 140 countries have agreed to the OECD’s plans for a two-pillar global tax reform, including all 38 OECD member countries and the G20.

Pillar One aims to ensure a fairer distribution of profits and taxing rights among countries, re-allocating some home country rights to markets where multinationals have business activities and earn profits, regardless of whether the company has a physical presence there. This is specifically targeting companies with global sales above €20 billion and profitability above 10%, the OECD noted, adding that 25% of profit above the 10% threshold will be reallocated to other market jurisdictions.

Pillar Two introduces a global minimum tax rate of 15% by 2023, which would generate an extra US$150 billion for governments around the world each year.

“We will be keeping a watchful eye on this to see whether companies are responding with increased tax transparency and compliance,” says Britze. “It will be interesting to see how this minimum threshold will actually be implemented around the world – it’s going to be hugely complex,” he adds.

A number of the largest multinationals impacted by the OECD’s two-pillar reform are in the tech sector. Asset owners heavily invested in the biggest tech conglomerates will also be affected by this, Monaghan warns. “It may precipitate a degree of toxic assets on an investor’s book in the same way as we’re beginning to see with fossil fuels,” he says.

Reading the fine print

The prioritisation of tax-related engagement varies amongst asset owners, PKA’s Britze notes, with institutional investors in the Scandinavian market increasingly focused on the topic. “Elsewhere, it’s in the earlier stages,” he says.

A lack of resources and understanding of tax-related issues limits progress. “It was an issue for PKA in the beginning,” Britze admits, adding that institutional investors need to bolster their in-house resources, such as internal tax teams, as well as educating themselves on where the main tax-related risks lie.

PKA screens for information on taxes paid by investee companies, covering both larger companies and smaller companies not yet listed. If a company is not meeting expectations, the pension provider starts a dialogue to secure more information or an explanation.

“We ask companies: Do you have a tax policy? How is that policy anchored in the organisation? Who is responsible for ensuring the tax policy is followed? Do you report on your tax practices? What are your plans on increasing disclosure on tax-related information?” says Britze.

But screening is not a perfect system because it depends heavily on the information companies are publicly disclosing.

“Institutional investors need a more effective way of assessing tax compliance and planning,” he says.

As an early step, asset owners should identify whether a company has a global tax policy, notes PRI’s Ravishankar. “This will show an investor the company’s position on tax practices, including which practices they say are unacceptable. Investors can then see if they follow this policy in practice. If not, why?”

Investors can also compare an investee company’s tax rate with its peers, she adds. “If the tax rate is considerably lower over a prolonged period of time, then investors need to be asking companies why this is the case,” Ravishankar says.

Monaghan says that institutional investors need to look at the cash taxes paid, as disclosed in a company’s cash flow reports, in order to get the clearest idea of how much tax a company is actually paying.

“Total tax, which is the number most companies want people to focus on, isn’t a solid number. Cash tax paid shows investors how much money a company has physically handed over in the preceding 12 months,” he explains.

For investors that are struggling to wrap their heads around it all, organisations such as Engagement International are able to assist in getting their concerns across to investee companies.

The ESG service and engagement provider started its tax focus by engaging with ten companies on responsible tax, including Apple, Shell and Deutsche Bank. The ten were selected because they had the greatest number and severity of corporate tax controversies at the time, Engagement International said.

Dialogue centred around 25 KPIs and five corporate tax-related milestones: recognition and commitment; strategies; risk management and governance; performance; and transparency. If companies didn’t engage, the provider was prepared to escalate, either by raising concerns with the company’s board in public, or coordinating with investors to vote.

Engagement International now has plans to expand its list of tax-related engagement cases from ten to 25.

“Corporate tax-related risks aren’t going away,” Ravishankar says. “These risks have big implications for an investor’s overall portfolio. Although it may seem like one issue in a long list that requires their attention, tax is interrelated to their sustainability work, particularly in developing countries which are missing out on tax revenues.”

Negative sentiment over tax practices
Corporate tax issues have had a high profile in the news and social media in recent years, as reflected in this analysis by Mettle Capital, a data solutions provider which tracks the daily sentiment and volume of discussion about 2,500 US and European equities related to key aspects of sustainability. As shown above, a number of major firms have continued to attract negative sentiment on tax issues over the past two years. Royal Dutch Shell has been in a well-known tax dispute with Dutch authorities for some time which has come to a head with its recently announced plan to move its HQ to the UK, which has generated high volumes of comment, with an increasingly negative net sentiment. Many US firms are suffering increasingly negative sentiment over tax practices (e.g. Amazon and Alphabet), while others have managed to put their tax avoidance issues behind them, including Starbucks and, to a lesser extent, Apple and Tesla, where negative sentiment has at least stabilised and started to tick up. While US tech giants have become closely associated with tax avoidance practices, the issue is much wider. This is reflected in the scores of Merck and General Electric, as well as the fact that sentiment is materially negative for the UK, European and US stock indices as a whole and continuing to deteriorate for the FTSE350 and the STOXX600 while the S&P500 has stablised.

On methodology, the analysis was generated by Mettle Capital running a query on ‘tax avoidance/optimisation’ across 2,500 entities in local language across 1 Jan 2019 – 28 Nov 2021. Mettle isolated the tax conversation, picking out the top 25 entities by daily frequency and overall volume per year, then compared over time to see which entities were consistently discussed across the period. Mettle analysed sentiment in 2019 vs 2021 and computed total volume in 2021, also backtest to rule out anomalies thrown up by extreme events. The firm sources traditional, social, and trade media in local language across Europe and US.

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