As ESG issues become increasingly important to many companies, their internal tax function has a big role to play in how such issues are reported and funded
Tax is increasingly intersecting with environmental, social & governance (ESG) issues, particularly with respect to a company’s tax transparency reporting and funding of new sustainability initiatives through tax incentives and credits.
In fact, the top three priorities for the corporate tax function when implementing organizational sustainability are increased regulatory compliance, increased business resilience, and meeting investor expectations, according to participants of a recent EY survey. Because of the increasing regulatory requirements and momentum of ESG across the globe, tax directors should seize the opportunity to provide guidance to key decision-makers and assist their organizations with important ESG initiatives like the use of tax credits and incentives to reduce tax liabilities and any issues with tax transparency reporting, among others.
Use of credits and incentives
The corporate tax function is uniquely qualified to address global regulatory initiatives on an array of climate-related taxes as well as on green incentives and related tax credits. For example, the European Union (EU) has imposed tax on plastics and is implementing a Carbon Border Adjustment Mechanism (CBAM) aimed at taxing imported goods that do not meet certain carbon leakage standards (for carbon-intensive industries). The CBAM intends to create a level playing field by ensuring that imported goods are subject to similar carbon pricing as those produced domestically within the EU. The CBAM would require importers of certain goods into the EU to purchase carbon certificates, reflecting the amount of embedded emissions associated with the production of those goods.
The tax function needs to have a discussion with the manufacturing and production groups to determine if products meet the EU’s carbon leakage standards and what potential exposure of CBAM tax risk may exist for goods set to be sold to the EU.
Domestically in the US, the Inflation Reduction Act and the CHIPs Act include numerous new green tax incentives and credits to entice organizations to reduce carbon emissions, as well as incentivize businesses to manufacture semiconductor chips and fund other new sustainable technologies. Some of the recently enacted green incentives include:
- the sale and use of biodiesel, renewable, and alternative fuels credits;
- investment in qualifying clean energy facilities and bonus credits for facilities located in energy communities; and
- use of renewable energy production credits.
Many of these credits are enhanced and increased if a company meets certain wage and apprenticeship requirements, places qualified facilities in energy communities, or uses domestically sourced products. A tax representative should communicate with a human resource representative to ensure wage and apprenticeship requirements are met to take full advantage of available credits.
Tax transparency reporting
Today, organizations are facing increasing pressure to disclose more tax information to stakeholders. And two important documents should be considered for ESG tax policies, particularly with respect to country-by-country reporting and the documentation of tax strategy.
The first document, Best Practices for Good Tax Governance, was issued in 2022 jointly by the Tax Executives Council of the Conference Board, The B Team, and the European Business Tax Forum. The second, Evaluating and Engaging on Corporate Tax Transparency, was issued by the Principles for Responsible Investment under the auspices of the United Nations Global Compact. Both are important touchstones for ESG and tax because they represent ESG thought leadership from important global actors.
The Evaluating and Engaging on Corporate Tax Transparency report provides guidance to investors when requesting information from an organization and analyzing a corporation’s compliance with tax laws. Companies complying with the recommendations outlined within this report will provide investors with an overview of the company’s policy and approach to tax, including how the company balances the letter of the law with the intent of the law.
For organizations that may be concerned with societal expectations on tax, presenting a full report as recommended can provide reassurances that appropriate governance and risk management measures are in place. Any data and examples to ascertain future financial, legal, operational, and reputational risks, as well as data and examples to determine if a firm’s tax practices reflect its tax policy and framework, can go a long way to easing the minds of stakeholders and investors.
In formulating an approach to dialogue and next steps, the corporate tax function should consider tax policy, tax governance, risk management, and tax reporting when sharing information with stakeholders and investors. Organizations also need to consider the level of transparency and disclosure they provide regarding their ESG data. Insufficient disclosures, as well as greenwashed disclosures — those that present an organization’s ESG efforts in a misleading way, or as more substantial or more effective than they truly are — may be met with criticism and could result in reputational harm to the brand.
Meeting expectations of the moment and future
Heads of corporate tax functions are facing a rapidly evolving landscape. ESG considerations have become increasingly central to business operations and investor expectations. To effectively prepare for this shift, these leaders must proactively integrate ESG principles into their tax strategies. This entails not only ensuring compliance with emerging ESG-related tax regulations but also requires aligning their organizations with broader sustainability goals.
Heads of corporate tax functions must position themselves as strategic partners in driving the ESG agenda within their organizations, recognizing for themselves and pushing others to recognize that ESG isn’t just some kind of moral imperative, but rather a crucial element of long-term business success.
For more on this subject, you can read this special report about what tax directors need to know about ESG here.