Tax transparency, especially involving communications around their companies' ESG activities, is becoming a critical challenge for many corporate tax departments
One of the biggest challenges for corporate tax departments in 2023 is navigating the murky environment of communicating their strategy when the risk of misinterpretation of tax data is so high.
More recently, momentum for more tax transparency — which essentially defines whether or not an organization is paying its fair share in taxes (whatever that means) to the communities in which it does business — has accelerated as an important part of tax policy considerations. In part, this push for more transparency has been driven by the increased priority of sustainability among stakeholders.
One aspect of these key tax policy tactics is the use of reward or punishments to drive preferred outcomes. However, as governments require more disclosure around environmental, social, and governance (ESG) issues, the stakes in using the carrot-or-stick approach get higher, as government regulators demand more information. While what to disclose becomes easier with regulation, the potential for blowback and negative reputational issues for companies increases, again because of the expanded potential for misinterpretation of tax data.
Given these risks, companies are spending more time assessing their communications strategies around tax transparency. Brett Weaver, partner and ESG Leader in Tax at KPMG, says that the narrative around disclosure of tax information is something he spends more time helping their clients think through.
Using rewards & punishments to measure progress
Up to this point, tax credits have been a predominant mechanism to spur investment in emerging industries in the corporate tax space, primarily within the U.S. Indeed, the Inflation Reduction Act (IRA) is the most recent example of incentivizing tax policy by using reward mechanisms. Weaver describes it as the most fascinating modern industrial engineering policy of its time because of the Act’s use of “layering” incentives.
The IRA’s baseline investment tax credit is set at 6%, but for companies that agree to pay a prevailing wage and invest in apprenticeship programs, the tax credit can be as high as 30% for the construction of a solar power plant, for example. Also, if raw materials are domestically sourced and equipment is made in the U.S., the tax credit opportunities are even more attractive.
Yet, outside of the U.S., penalties are more common, and Weaver predicts that will continue as a primary practice both in the U.S and in other countries. One of the emerging areas of utilizing penalties is so-called “dirty supply chain taxes,” such as an increased levy on the use of plastics for packaging. California is leading the way in this area, and Weaver says he sees other states likely to follow suit.
Complicating tax communication with sustainability
Tax transparency remains a conundrum for companies and their stakeholders in understanding what it means for their business and how to navigate the complexity of messaging. Weaver says he advises his clients to craft a communications strategy using both qualitative and quantitative components. Going exclusively with a qualitative or a quantitative approach is insufficient and carries too much exposure, he adds.
“Stakeholders are skeptical on stories because there is an assumption that the story is there to make the company look good,” he explains. “This is where the data plays a key role in backing the story up.” Likewise, the intent of the message by just using data, without the story, can be misunderstood.
To help organizations get started in their journey, Weaver uses the global standard for public reporting on tax from the Global Reporting Initiative (GRI) to outline basic standards because GRI requires disclosure of the company’s tax risk management policy, the red-line around tax that the company will not cross, the controls that are in place around how tax decisions are made, and the mechanism to ensure there is transparent reporting to the board and the C-Suite.
The GRI standard and others like it are just the starting point for analyzing the right mix of sharing quantitative and qualitative information in the tax story, however. For example, Weaver also advises focusing on the story first and weaving the data into the narrative. Key ingredients to incorporate in this communication include:
- stating what the organization is doing around sustainability and why;
- outlining how the company is putting capital, both human and monetary, behind the initiatives for the benefit of the planet and the local communities in which the company operates;
- building trust in the fundamental belief that partnering with governments to make progress in mutually beneficial investments is necessary (indeed, governments typically cannot accomplish these planet- and people-related transcendent goals without private sector capital);
- summarizing the impact of these investments on the company’s stakeholders to include how the tax revenue that the company pays benefits the local communities in which it operates; and
- then, reporting the effective tax rate as the results of the company’s investments, partnerships, and joint funding.
It is critical for companies to put context around the tax data through a well-crafted narrative that explains the strategy in laymen’s terms on what the company is accomplishing and then link the tax strategy from there. Only then can the company ensure it is effectively communicating its tax strategy and mitigating the risk of tax data misinterpretation.