Corporate tax departments have a strong role to play in helping to create and implement their companies' ESG strategies going forward
“Environmental, social, and governance (ESG) fundamentally means being a responsible corporate citizen,” says April Little, national partner-in-charge of the Tax Accounting and Financial Reporting practice at Grant Thornton.
Corporations’ contributions to the communities in which they serve is one of the biggest proactive drivers of a company decision to create and implement an ESG strategy. Indeed, one of the biggest, yet least visible, ways companies achieve this objective is through the payment of taxes to local communities in which they operate.
There are many tax related ESG credits and incentives to reward positive corporate behavior, as well as taxes to disincentivize negative ones. Corporate tax functions are critical to practices that best serve company objectives through the financial support of the communities they serve.
Surprising to many tax novices, there are many elements of an effective ESG policy that can factor into a company’s tax strategy. For the environment, these include water efficiency and curbing emissions; social goals include ensuring human rights, promoting diversity, equity & inclusion (DEI) policies; and governance includes strong business ethics and anti-corruption policies.
Encouraging changes in behavior by taxation and incentives is increasingly common in the environmental area, for example. Across the world, many countries are encouraging movement away from products and practices that cause environmental damage through tax incentives or disincentives. Such taxes can address carbon and other pollutants, plastics, landfill waste,water pollution, and certain chemicals. As a result, there has been a rapidly evolving landscape of new taxes involving carbon, waste, water, plastic packaging, and chemicals. Thus, as governments enhance their focus on measurable improvement in the environment, companies simultaneously are able to take advantage of many credits and incentives in the environmental area.
Under the social category, corporate transparency on how income taxes are paid on a country-by-country basis can demonstrate that corporations are not avoiding, evading, or artificially reducing taxes in any particular geography.
Further, obtaining tax credits and incentives for diversity and corporate giving are common social tax initiatives and can include:
- Hiring & retaining a diverse workforce — For example, the Work Opportunity Tax Credit allows tax breaks for employing targeted segments of the workforce such as those receiving government assistance and individuals who have been unemployed long-term or have a felony conviction. And Opportunity Zone credits incentivize moving a business to a government-designated area that qualifies for renewal efforts.
- Charitable contributions — Tax deductions incentivize corporations to give back to the communities in which they operate by providing funds, community service hours, or donations-in-kind.
Shifts in the regulatory landscape across geographies also are important to determine a corporate tax function’s role in a company’s ESG strategy. Corporate income taxes are one of the most foundational components of the governance strategy, starting with the “tone at the top” and including a strong tax risk management policy.
“A robust tax risk management policy, in line with the board and C-suite’s overall governance strategy for an organization, guides how the tax piece of the organization operates by outlining how decisions are made,” explains Grant Thornton’s Little. When addressing governance strategies, such policies target core investments that an enterprise makes, such as deciding where to locate a facility and finding tax planning opportunities, “while still ensuring that the company is paying the right amount of tax globally,” she adds.
The “tone at the top,” according to Little, guides how tax decisions are made, particularly those that have ESG implications. For example, a company may choose to enter into a transfer pricing arrangement to shift profits from one jurisdiction to another, which is a decision that may be perfectly allowable within the transfer pricing guidelines for the two different jurisdictions. However, to align with governance goals, the tax risk management policy may help steer the company to determine its portion of the global tax base to both jurisdictions rather than minimizing the overall tax.
Typically, tax risk management policies are more detailed and robust in Europe because they are required for public companies across the European Union and in the United Kingdom. “Companies operating in those geographies generally have to post these policies on their website or make them publicly available,” Little says.
Involving tax at the beginning
A company’s ESG journey generally starts with a decision by a company executive to move forward in the ESG space. This declaration is typically followed by a benchmarking exercise to understand what industry peers are doing; a materiality assessment to determine which ESG issues matter most to the company’s stakeholders; and a determination of what data is available for reporting and how to measure progress.
During the ESG strategy formulation, there are important implications for tax. For example, the tax function can help to minimize taxes incurred along the supply chain and increase return on investment by identifying credits and incentives. This is especially important for companies with operations in the EU and UK because these geographies dictate a tax framework for disclosure in that ESG landscape.
The tax function then helps conduct scenario-planning around accounting methods, such as performing a cost segregation study to enhance or accelerate deductions from a tax perspective. To maximize the value of the deduction, depreciation methods can be changed to accelerate or defer a deduction.
Detailed tax decisions such as these that align with a company’s ESG strategy can have a sizable effect on a company’s ability to achieve its twin goals of generating profit and acting responsibly as a corporate citizen.
To get started, recent research shows that forward-looking tax department leaders have already started to uncover their total picture, developing a strategy to embed ESG principles into tax policies and practices, communicate tax impacts as part of regular disclosures, and put governance mechanisms in place to ensure tax decisions are sustainable moving forward.