Corporate tax departments will be facing challenges on the ESG front — concerning environmental taxes, data governance, and more — much like other business units
Many companies publicly communicate their environmental, social, and governance (ESG) commitments — by, for example, announcing climate and diversity targets. Yet, increased litigation and regulatory enforcement activity suggests that sustainability targets continue to exist as no more than values signaling, which is when companies publicly demonstrate support for certain viewpoints that are widely deemed to be moral or good, and then, use it as a way to connect or align with consumers, investors, employees, and other stakeholders.
In reality, there needs to be a wholesale shift in sustainability beyond making it a simple branding exercise, says Mark Grider, a partner at international law firm Brown Rudnick. Grider, counsel Jessica Lu, and associate Honieh Udenka serve as ESG advisers to companies on legal issues. Corporations that wish to focus on sustainability need to shift their practices by embedding their values into their core business and corporate culture, the three say.
Indeed, even traditional compliance activities have led to values signaling when the public attention to ESG makes it necessary to “make sure that an ESG strategy is built in and not bolted on” during the implantation process, Udenka states, adding that this “bolted-on” strategy ultimately fails “because ESG values were only loosely coupled with business objectives and operations [and often] added on as an afterthought.”
Instead, Lu states, when sustainability is built in, commitments “go from a moral-value orientation to a value-derived orientation, which can drive the creation of business value.”
ESG’s tax factor
Many factors at play are driving this change, but there is one area that does not seem to be getting enough attention — corporate tax departments. Indeed, the role of sustainability cuts across a corporation as data sets containing ESG information sit in siloed databases across the organization’s finance, legal, and sustainability functions, among others.
However, corporate tax leaders too often are not part of these efforts. In fact, the 2022 BDO Tax Outlook Survey found that three-quarters of those responsible for tax matters were not currently involved in their organizations’ ESG strategy, despite the ongoing attention ESG is getting by cross-jurisdictional regulators.
What does tax have to do with ESG?
Tax incentives and requirements are often used as a financial tool to drive sustainability activities in businesses; for example:
- As part of the environmental part of ESG, carbon pricing in the form of environmental taxes has emerged as a popular way to send clear signals to organizations that they need to be aware of how their operations impact the areas in which they operate. In addition, governments have offered grants and credits to encourage the adoption of more green technology in corporations’ operations.
- As part of ESG’s social aspect, taxes are often used as a key method by which companies can contribute to their local communities. In addition, more commonplace remote work scenarios also have tax implications concerning in which jurisdictions the work is being done and the employees live.
- As it relates to the governance, a clear definition of tax strategy, process controls, and compliance are critical parts of corporate governance. Further, tax reporting around sustainability is important to comply with rating agency requirements. In fact, a rise in rating agency requirements around ESG indicates that tax matters will continue to be under scrutiny in the future and will have significant reputational impacts as well, according to a BDO report.
Given all this, forward-thinking executive leaders now have the opportunity to use tax reporting through an ESG lens to better share a holistic narrative about the organization’s purpose. This also demonstrates transparency and builds trust among a growing audience of stakeholders, including customers, investors, and the local community in which the company has operations.
The massive paradigm shift around sustainability by customers and employees, for example, increasingly requires tax reporting and disclosure to consider a wider audience. As a result, corporations — and more specifically, corporate tax leaders — have their work cut out for them, despite the already overwhelming and ever-expanding cross-jurisdictional tax requirements. Indeed, there is already more than 1,000 environmental taxes levied by the 38 member countries of the Organisation for Economic Co-operation and Development, according to a PwC report.
Define how your specific tax function fits into the corporate ESG strategy
To report accurately and with transparency on ESG, corporate tax leaders need to first understand the evolving landscape around ESG, the implications for tax departments and how tax reporting requires action beyond just publishing data. Then, leaders of corporate tax functions need to crystallize and communicate the purpose and values that guide their tax function and how that function contributes to ESG, according to BDO.
The narrative on how the tax strategy fits into ESG is important — and without a story around a tax strategy, negative assumptions can be easily made. For example, if a company takes advantage of a new tax incentive to invest in a climate-friendly technology solution, it could easily be accused of tax avoidance unless a strong narrative is offered. Likewise, efforts by corporate tax leaders need to be made to spell out the tax implications of corporate operations around ESG based on the analysis of what frameworks the organization will use to define the separate components of ESG.
Make efforts to fix fragmented systems now
Recently, corporate tax functions have received increased scrutiny from corporate stakeholders because of the need for transparency in ESG metrics and for greater accountability across a company’s tax practices.
However, the increased demand for tax transparency is a huge challenge. Nearly two-thirds (62%) of respondents in to the BDO Tax Outlook Survey said data collection and analysis is the biggest challenge their departments face in successfully leveraging this data, underscoring the need for increased investment in addressing data governance and fragmented systems among an organization’s various functions.
Clearly, ESG is not going away. Such initiatives and strategies strengthens the case that corporate tax leaders can make to their superiors for additional corporate investments in talent and technology.