Death and Taxes are the Only Constants - But Not for Everyone

Major global companies such Google, Amazon, Facebook and Apple (known as “GAFA”) have come to dominate not just the tech industry but increasingly global commerce as well. The OECD estimates that companies like these avoid USD 100-240 billion in taxes annually, representing roughly 4-10% of global corporate income tax revenues. Attention paid to corporate taxation has also risen sharply in recent years, with increasingly heated debates on what constitutes “companies paying their fair share.”

Why Stakeholders Still Care About Corporate Taxation

The contentiousness and complexity of the topic is highlighted in recent high-profile cases involving Amazon, Google and Starbucks. These companies’ tax structures enable them to avoid paying tax in the U.K. despite reporting high profits in the U.S. Recent discussions between the U.S. and France over France’s digital tax (nicknamed the “GAFA” tax), have also put the issue in the spotlight. Stakeholders’ interest in corporate tax structures have also been greatly influenced by events such as the 2008 financial crisis; major tax controversies in 2016 and 2017 such as the Panama Papers Leaks, Bahamas Leaks, and Paradise Papers, which provided evidence of the complex tax arrangements undertaken by many corporations; and the aggressive use of tax loopholes, such as the cum-ex transactions in Germany in 2017.

Tax avoidance by multinational corporations can cause economic and societal distortions and perpetuate inequality. Tax payments from corporations are an essential revenue stream for governments and are a key source of investment in infrastructure and social programs. Tax avoidance can also create corporate governance risks; companies that are overly reliant on tax strategies are more exposed to tax regulation changes, face increased risks of investigations and penalties, increased legal and compliance costs, as well as delays to mergers, requirements to restructure, and more.

Finally, companies that engage in aggressive corporate tax planning can damage their reputation and profitability. Some companies argue that they have a fiduciary duty to investors to minimize tax payments. However, governments are now changing regulatory and legal frameworks and stakeholders are increasingly approaching a company’s tax arrangements as a corporate governance and risk management issue.

Strengthening Regulation and International Standards Driving Change

Increasingly, government regulators and international bodies that set standards have been scrutinizing aggressive tax planning and avoidance, with many taking steps to tighten regulation. Examples include the OECD’s Base Erosion and Profit Shifting (BEPS) action points and the European Parliament’s consideration of requiring public country-by-country reporting of taxes paid.

Sustainalytics’ Taxation Engagement

Sustainalytics has been engaging proactively over a two-year period with 12 companies in the pharmaceutical, food and retail, and technology sectors as part of the Taxation Stewardship and Risk Engagement, with key findings to be released in late 2019. The objective of the engagement is to encourage companies to approach tax proactively as a governance and risk management issue, and to ensure that these companies have an appropriate tax policy in place that preserves and enhances shareholder value. Rather than focusing on the overall amount of taxes paid by a company, the emphasis is on whether the company publishes a comprehensive tax strategy, whether the board has proper oversight of tax-related risks, and whether the company can transparently explain its tax rate. This is reflected in our key performance indicators (KPIs).

We are planning to launch a second phase of the Taxation Stewardship and Risk Engagement in early 2020. It will run over a period of three years and target approximately 20-30 companies in the  IT/internet, extractives and pharmaceutical sectors. As part of the program, we will be benchmarking company results versus their peers and suggesting actions for improvement. Separately, Sustainalytics also offers screenings on tax that provide more detailed assessments on where companies pay taxes, the level of companies’ tax disclosure, and flags companies with severe tax controversies.

We note that taxation has been high on Nordic investors’ agendas for many years, led by some Danish and Finnish pension funds and asset owners that actively included tax practices in their ESG policies and active ownership work. Their focus ranged from actively excluding companies that do not have sufficient policies and disclosure, to engaging with companies to improve on KPIs.

Early Takeaways from the Taxation Engagement

Although we are still a few years away from completing this round of engagements, we have noticed some trends. European companies generally have better disclosure than U.S. companies related to taxation, probably because of greater investor pressure and public attention as well as more stringent legislation. While most companies understand that tax is a material issue, they do not provide much disclosure. Finally, discussing the topic of tax with investors appears to be new territory for most companies, and some have been apprehensive to speak about the issue. In these circumstances, we find that taking a collaborative approach, emphasizing investor interest in the issue and indicating that we aim to share best practice, has been beneficial.