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ESG and taxation

The changing landscape of taxation

Simon Crookston, Partner, Corporate Tax
10/01/2022
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Over recent years there has been greater emphasis on the processes and controls in place to ensure good tax governance.

Tax has also become a reputational risk to businesses. Organisations now operate in a world where tax is considered a moral issue with headlines frequently appearing on social media or in the news with regard to how a business manages its tax affairs. Consequently, many boardrooms and owner managers are focused on ensuring that they do not face negative publicity from their tax affairs.

This trend is expected to continue as a consequence of environmental and sustainability matters becoming everyday topics of conversation. The increased scrutiny by the media as to the level of taxes paid by worldwide groups and tax relief claims made by businesses in the wake of the COVID-19 pandemic, are also leading to an increased social interest in taxation and whether organisations are acting in a socially responsible way in the current environment in which we all find ourselves.

ESG (Environmental, Social and Governance)

ESG is the term that is now commonly being used as the banner under which environmental, social and governance matters are now being considered. With organisations needing to be seen to be taking an active interest in, and having policies in relation to, all of these areas. ESG is now definitely a boardroom agenda item and one with which organisation’s need to actively engage, as ESG activities become ever more important to investors, shareholders, consumers and the wider communities in which businesses operate.

Tax is becoming pivotal in the ESG debate as the majority of actions which an organisation undertakes will have a tax consequence. Below we have set out some of the common themes we are seeing and which will increase in importance in 2022 and beyond.

Investors

Institutional investors and private equity investors are now seeing ESG as being one of the criteria used to inform their investment decisions. With some institutional investors starting to exclude companies from their selection criteria who they perceived to be non-complaint from an ESG and tax transparency perspective. While others, not wishing to be associated with any negative media publicity, are publicly divesting of businesses who have weak tax reporting strategies or are perceived to not be paying the right amount of tax in the territories in which they operate.

Recognition of this trend in tax governance scrutiny and social responsibility will become of increasing importance not only to multi-national organisations, but also to SME businesses that are seeking to expand and grow through private equity investment or through capital investment from other investors.

Environmental

As with many countries the UK Government has introduced a range of taxes, levies and other measures over the last couple of years as a mechanism to incentivise businesses to adopt improved environmental and sustainability strategies. The measures largely consist of additional taxes and reporting obligations as well as additional incentives to encourage businesses to adopt greener practices.

Environmental taxes

  • Climate Change Levy.
  • CRC Energy Efficiency Scheme.
  • Emissions Trading Scheme (UK ETS).
  • Increased taxes in relation to Landfill Tax and Aggregates Levy.
  • Plastic Packaging Tax (from 1 April 2022).

The Government released its Net-Zero Strategy: Building Back Greener following COP26 in Glasgow. The Prime Minster outlined the UK’s ten-point plan for a ‘Green Industrial Revolution’ to ensure that the UK meets its climate change objectives by 2050, by focussing on cleaner energy sources, transport, nature and innovative technologies.

In order to meet these objectives, we can expect further environmental taxes to be implemented over the next few years. Businesses and finance functions therefore need to be prepared and have adaptable processes to be able to manage the additional compliance burden these will bring, along with how any new taxes will impact their operating profits, pricing, cashflow and forecasting models.

Tax incentives

The other way to change behaviours is to offer tax incentives, whether that be by providing incentives through, for example, the capital allowances regime, R&D tax credits, or through the operation of a company’s salary sacrifice and benefits in kind regime.

Successive Governments over recent years have provided tax incentives for electric and low-emission company cars. With the Government’s plan to ban the sale of new petrol and diesel cars and vans from 2030 and the media and environmental campaigners focussing on this area, we can expect to see further changes in this area and others in the Chancellor’s 2022 Budget and beyond.

Overseas expansion

As companies continue to operate and establish operations in overseas countries they are going to need to proactively monitor and adapt to the ESG related taxes in each overseas territory in which they operate. As there is no uniform set of ESG taxes that are being applied across all jurisdictions. 

Each country is making its own commitments in relation to meeting its environmental, sustainability and social responsibility obligations for its citizens, although each will potentially be taking a different route in the way that they achieve their objectives depending on the socio-economic factors that are relevant to their countries’ population.

Reporting and transparency

Large companies already have a requirement to consider and publish their tax strategy and provide transparency around their taxation affairs. We are seeing a shift away from not just being compliant and reporting a tax strategy, to organisations seeking to demonstrate as to why an approach has been adopted and how this interlinks to their wider ESG strategy.

This approach is also starting to be mirrored by some SME organisations, who may not have an obligation to report, but wish to disclose their approach in order to be able to demonstrate their sustainability and social capital credentials within the community in which they operate. Such an approach is also seen as good governance from a morality of tax perspective, in so far as they are demonstrating they are paying the ‘right amount of tax’.

What should companies do?

As a consequence of the shift in ESG considerations, many large and owner managed businesses are increasing their focus on tax risk and tax governance, ensuring robust processes and controls are in place.

ESG needs to start to become an embedded part of any Board’s strategy towards tax. In our experience, actions that can be taken and questions that the Board should seek answers to, include:

  • Does the business have a process for the identification and implementation of new taxes which will have an impact on the business?
  • What is the organisation’s appetite for tax planning and tax risk?
  • Is the tax finance/ tax department adequate staffed or, if not, has the tax compliance work been appropriately outsourced?
  • Is there a risk aware training programme throughout the organisation?
  • Does the company have a tax risk statement?
  • Are tax risks adequately disclosed in tax returns and other documents?
  • Is tax risk considered as part of the Board’s overall strategy towards risk management?
  • Does the business use complex (tax) structures and could the affairs of the organisation be simplified?
  • What voluntary reporting frameworks, like the GRI (Global Reporting Initiative), should the organisation be reporting under and what are the tax disclosures required under those frameworks?

As the pace of change increases as environmental, sustainability and governance matters continue to increase in importance, it will be important for companies to have robust processes and controls in place so that they can identify and monitor the changes that are likely to affect their business, and ensure they adapt to those change in terms of new procedures, payment of additional taxes or compliance obligations.

This could, for example, be changes within the business such as new supply chains, adapting systems to deal with tax authority digitalisation, handling new environmental taxes or increased compliance requirements from entering new markets.

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Summary

Overall, ESG is a relatively new banner within the area of corporate governance, although it is one that is going to become even more prominent and important over the next few years. What we do know is, there will certainly be a lot of change in this area. Some of it is likely to move at quite a pace driven by the media and campaigning by interested stakeholders.

Tax will be a critical tool in the development of ESG governmental policies. Not keeping abreast of changes in this area is likely to lead to organisations being on the backfoot compared to their competitors, and they may also suffer potential operational and reputational damage from adverse publicity.

For any further help and assistance for your business, please do contact Simon Crookston or your usual Crowe contact.

Contact us

Simon Crookston
Simon Crookston
Partner, Corporate Tax
Kent