As Benjamin Franklin once said, “in this world nothing can be said to be certain, except death and taxes.” He was referring to the world in 1789. In today’s world, death remains a certainty. Taxes on the other hand, are less certain as companies, accountants and lawyers have found ways to reduce tax obligations.
Why tax (avoidance) matters
Arguably not many people like to pay taxes. However, taxes are necessary to fund public services, from infrastructure to healthcare and education. Moreover taxes, in theory, provide a tool to redistribute wealth within a society. Yet, rising income inequality around the world is spurring concerns. Billionaire Warren Buffet has repeatedly said he pays a lower tax rate than his secretary.
In many countries, the household income tax rate is higher than the corporate tax rate, and many people feel companies do not pay their fair share. The most striking example is perhaps Amazon, one of the world’s largest companies by market cap and whose founder is the wealthiest man on Earth. In 2018, Amazon paid no US federal income tax and received a USD 129 million tax rebate. Amazon is not alone, as the list of companies employing aggressive tax planning and avoidance strategies is unfortunately long.
Data from the Australian Taxation Office shows that one-third of large Australian companies paid no tax in 2018. In many cases the reasons for not paying taxes are legitimate (such as sensitivity to economic conditions, reinvestments back into the business, tax deductions and tax offsets), while in other cases the reasons are legal, but less ethical. Advocacy groups have called for reforms to close tax loopholes, pointing out that ordinary working people and middle-class earners bear a disproportionate share of the tax burden.
Even more concerning, a recent report by Oxfam, the Tax Justice Network and the Uniting Church in Australia estimated that AUD 8 trillion (USD 5.5 trillion) in financial wealth was hidden in tax heavens, meaning AUD 190 billion (USD 130 billion) a year in tax revenues was lost to governments around the world. The report also estimated that Australian mining companies used tax havens to shift AUD 1.1 billion (USD 750 million) in profits out of African countries in 2015, depriving governments of AUD 290 million (USD 198 million) in tax revenues.
Tax avoidance imposes a double burden on society, as it fuels poverty and inequality while draining tax revenues that could otherwise fund public services. Moreover, from a market efficiency perspective, tax avoidance distorts competition and gives unfair advantages to companies that don’t pay full taxes.
Tax transparency: insights from our research
As part of our ESG research, Sustainalytics assesses companies’ overall tax disclosure and transparency. As shown in the graph below, more than half of the top ASX-listed companies provide weak transparency – meaning companies’ tax reporting meets minimum regulatory compliance and does not provide insights on, for example, taxes paid on a country-by-country basis.
This is particularly concerning for multinational companies operating in different jurisdictions. They may employ aggressive tax planning to exploit low-tax systems and minimize their tax liabilities in certain countries. While poor transparency does not equate to dodgy tax practices, it does raise flags about potentially questionable practices.
Some companies provide moderate visibility, such as aggregate amounts of domestic vs foreign taxes, and 83 companies (or 40 per cent of the sample) demonstrate strong transparency by providing dedicated disclosure and details on the types of taxes paid (e.g., income, payroll, GST, royalties, etc.) as well as a breakdown on a country or project basis, if applicable. Energy and extractives companies stand out: two-thirds of Australia-listed resource companies in our coverage disclose highly transparent information on taxes and payments to governments.
Level of Tax Transparency of ASX-listed companies (percentage)
Source: Sustainalytics ESG Research
Controversies and scrutiny
A company may be very transparent on the taxes it pays, but still employ mechanisms to reduce those taxes.
For example, mining companies Rio Tinto and BHP pioneered country reporting because of their dual-listing in the UK, which requires such reporting. However, both companies have been involved in tax disputes. In 2018, BHP paid over USD 550 million to settle tax disputes in Australia. Rival Rio Tinto is facing tax investigations in Mongolia and Australia, as well as scrutiny for employing tax schemes involving subsidiaries in countries with low taxation.
Aside from these higher profile cases, our Controversy research picked up 81 incidents on taxation matters in Australia since 2016. This represents approximately seven per cent of recorded incidents in our database (see graph below).
Number of Tax Incidents
We rate the majority of these controversies at Category 1 and 2 (low to moderate), which we believe are the most meaningful to track as they can signal emergent issues that may escalate.
Jason Ward, Principal Analyst at the Centre for International Corporate Tax Accountability and Research (CICTAR), noted that while resource and tech companies typically come to mind for aggressive tax avoidance (because of the nature of those industries), the practice is much more widespread and affects sectors from healthcare to restaurant chains to commercial services.
“Transfer pricing is the number one tactic,” he said, and it can involve goods and services, intellectual property (“The IP of a Big Mac”), debt and so on. Subsidiaries in tax havens enable transfer pricing by allowing corporations to shift profits from high to low tax jurisdictions. Such practices are particularly galling for companies in health and aged care, since they are often the recipients of government funding.
There are signs that things are changing. Mr. Ward expects regulators in Europe will continue to focus on big tech companies. In Australia, he noted that since July 2019 companies with over AUD 4 million in government contacts must produce a tax health report showing a clean record. Moreover, relationships among companies, auditors and tax consultants are being scrutinized by parliamentary inquiries, while in the UK there are talks of separating the divisions of the big four accounting firms.
Effects of tax avoidance on investors
While tax minimization may seem like a good strategy to bolster shareholder returns, these practices are not sustainable in the longer term. Regulators around the world are tightening oversight on tax practices, thus companies that engage in aggressive tax planning may attract unwanted regulatory attention, potentially affecting future earnings if tax disputes arise.
From the perspective of universal investors such as pension funds, companies’ use of aggressive tax planning also has potentially negative knock on effects. These investors hold companies in many jurisdictions, effectively owing a piece of the global economy, and may be ultimately worse off given the adverse effects of tax avoidance. The fortune of a tech company’s low tax bill may be the disgrace for a construction company that doesn’t receive a government contract to build needed infrastructure because of a public budget crunch.
What companies and investors can do
Aside from fulfilling their obligations and paying their fair share of taxes, there are several initiatives companies and investors alike can join to ensure effective tax governance and risk management, provide transparency, and stimulate similar behavior across sectors and geographies.
- Adopt formal company policies with clear governance, accountability and risk management systems for taxation matters, as well as commit to not using aggressive tax behavior
- Adopt and encourage the adoption of the revised GRI Standards on tax and payments to governments, which in March 2019 received strong support from the investment community
- For multinational companies, report taxes paid on a country-by-country basis, as per OECD guidelines
- For resource companies, report on a project-by-project basis, in accordance with the Extractive Industries Transparency Initiative standards (notably, Australia has yet to implement EITI into federal law)
- For Australian companies, adopt the principles of the Voluntary Tax Transparency Code and report accordingly
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