ESG update: tax disclosure in the spotlight

Tax is increasingly seen by investors and company boards as an important corporate governance matter and one of the environmental, social and governance (ESG) issues which can affect the performance of companies and investment portfolios. Companies should expect increased scrutiny of tax disclosure and risk management as the world emerges from the Covid-19 pandemic.

The most recent insight into the direction of travel for investors’ approach to tax comes by way of a report published by UN principles of responsible investment (PRI) which summarises the outcomes of a 2017-2019 engagement project on corporate tax transparency. Much like the current attention on the disclosure of climate risk in line with the recommendations of the task force on climate-related financial disclosures, the focus of this exercise is the extent and quality of companies’ tax disclosures. 

In the engagement exercise, 36 institutional investors (representing US$2.9trn AUM) requested improved disclosure from 41 of their portfolio companies in the healthcare and tech sectors to clarify investor expectations and identify best practice on:

• publication of a global tax policy which sets out the company’s approach to responsible tax practice;
• reporting on tax governance and risk management; and
• country by country tax reporting (CBCR).

The report’s key findings are that:

• most companies published a global tax policy (and this increased from 7 to 23 from 2017 to 2019), though the quality of disclosure is hugely variable;
• tax issues were a board-level responsibility for 75% of companies, though more detailed practices varied;
• few companies (less than 20%) were willing to disclose details about transactions that they deemed unacceptable, but some disclosed the approach taken to specific high-risk transactions; and
• CBCR was not provided by any of the companies in the exercise – this is the most challenging area for investor scrutiny and dialogue.

The depth and quality of tax disclosure is a recurring theme, which can make it hard for investors to compare companies or reach judgements about the true quality of tax governance. Companies fear over-disclosure will put them at a competitive disadvantage.

Although mandatory disclosure regimes, such as the 2016 UK Finance Act’s requirement for certain multinationals to publish a UK tax strategy, help establish disclosure practices, some companies take a minimal approach to compliance and reports can lack granularity and detail. Tax governance has not yet seen the proliferation of voluntary disclosure standards companies and investors can choose from in relation to climate risk. 

PRI recommend that investors make consistent disclosure requests, asking companies to meet the GRI tax standard for comprehensive tax disclosure. This will encourage more thorough and consistent scrutiny by investors. Companies should be prepared for this to become mainstream.

In PRI’s recent webinar presenting the results of the report, panellists drew an explicit link with Covid-19. Tax will be a hot topic as the world emerges from the pandemic and investor scrutiny of corporate tax practice is likely to increase. Although the UK has not yet made financial relief contingent on responsible tax practice (unlike Denmark, France and Poland, which have ruled out support for companies registered in perceived tax havens), companies that survive the crisis by furloughing staff or benefitting from government finance but later return large profits or pursue aggressive tax practices may not be viewed favourably by investors or the public.

Even so, interpreting large volumes of tax reporting, disclosure and corporate financial data and making judgements about which tax reliefs are “acceptable” will remain difficult for investors trying to make the link between the value chain of a business, its tax burden and the strength of its governance approach.