ESG: The “G” of taxation

Victor Sturgis, Mike Gumbleton
| 1/26/2023
ESG: The “G” of taxation
In summary
  • Tax is an important area that should be informing a company’s environmental, social, and governance (ESG) policies.
  • Tax policies and reporting standards inform the governance piece of ESG and offer an opportunity for companies to build transparent and reliable models for disclosure.

While ESG topics collectively might seem relatively new, governance arguably has been an area of focus much longer than environmental and social justice considerations, although perhaps through a different lens.

Corporate governance is the set of rules, processes, and policies that guide and govern a business as it operates and manages risk. Tax laws have existed since the 1800s, and the history, scope, and heavy regulations put in place to enforce these laws have affected the processes and controls that are part of any organization’s overall governance strategy.

Areas of tax that can inform the governance structure and ESG strategy of an organization include:

  • Tax strategy, including a tax risk policy
  • Tax transparency and reporting
  • Tax process optimization
  • Tax integrity
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Tax strategy and risk policy

An organization’s tax strategy should be integrated as a part of its overall ESG strategy. It should guide a tax department’s approach to regulatory compliance, interactions with tax authorities and other stakeholders, and identification and assessment of tax risk (both ongoing risk and new risk from law changes), and it should give consideration to the company’s perception of tax in a broader societal context.

Crowe observation

A company’s tax strategy should be reviewed regularly and updated based on new regulations and societal definitions of tax compliance, risk, and transparency.

Tax transparency and reporting

Stakeholders have started to consider information beyond a company’s overall effective tax rate to gain insight into how it contributes to society through tax. Some international standards have gone as far as requiring country-by-country reporting of effective tax rates and tax payments. While this type of reporting is not currently a requirement in the U.S., tax departments should consider the value of increased transparency in tax reporting. What to report and how much detail to provide should be guided by an overall assessment of what is material to an organization’s stakeholders. Each company likely will have a different answer.

Tax process optimization

Tax compliance, as just one function of an internal tax department, is a massively complex process on its own. Effectively gathering financial information and transforming that information to comply with federal, state, and local tax laws and regulations can be a cumbersome process, rife with potential gaps and errors. Those responsible for an organization’s tax function should continually consider ways to reshape existing processes or create new processes to minimize risk in this area. Working with external partners might be a good way to get an outside perspective to help with processes. Bringing in new technology also is a potential solution.

Tax integrity

Companies should consider tax integrity as an important component of tax governance. It represents an organization’s willingness to consider the spirit of tax law and to balance that with societal expectations.

Crowe observation

A statement on tax integrity should be a part of every organization’s tax strategy and policy and needs to be considered as a value instilled in a tax department’s operations.

For organizations adopting an ESG strategy, its sole purpose no longer is to simply maximize shareholder profits. Under ESG principles, companies should consider taking advantage of tax opportunities to balance shareholder profits with the needs of other stakeholders like customers, employees, supply chains, and local communities. Participating in tax credits and incentives, which can decrease a company’s effective tax rate, essentially is a way for companies to repurpose tax payment dollars to invest in their ESG goals and have a positive impact on the community.

Rating agency and investor perspective

Rating agencies such as S&P Global have different focus areas for the “E,” “S,” and “G” components of their ESG scoring model. For the governance portion, S&P Global rates a company on some traditional criteria such as corporate governance, business ethics, supply chain, and risk management, but it also includes tax strategy. Effective tax strategy might be subjective as tax optimization has a positive financial impact, but a tax policy that is too aggressive or one that does not appropriately consider risks might be considered problematic in the mid- to long term.

Large institutional investors and private equity groups increasingly are focused on the governance structure of organizations. Having quality processes and strong controls can help increase interest to invest capital in an organization and mitigate risks. Tax is an area in which organizations likely already have quality processes and strong controls that can meet this stakeholder need up front.

Looking ahead

As an organization continues its journey with ESG, tax should play a prominent role when considering and reporting on its governance structure. While ESG rules, frameworks, and obligations continue to evolve, tax offers a reputable template for disclosure that can reliably inform key stakeholders.

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The IRS recently finalized regulations related to the partnership examinations and audit rules in the Bipartisan Budget Act of 2015.

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Victor Sturgis
Victor Sturgis
Partner, Tax
Mike Gumbleton