In today’s world, governments, investors, society, suppliers, consumers, financiers, employees and media, all being stakeholders, demand a greater corporate responsibility. The integration of environmental, social, and governance (ESG) factors in business operations is therefore becoming increasingly important.

Taxation is an effective tool to encourage behavioural change and address sustainability issues.

As such, (in-house) tax advisors and lawyers have a crucial role to play in ensuring that a company’s tax strategy aligns with its overall sustainability strategy.

In this article, we explore the role of tax in ESG and how (in-house) tax advisors and lawyers can help build a future-proof tax landscape and thereby facilitating a sustainable transformation.

Why is ESG important?

The focus on the environment has been around us for some time and stems largely from a large oil spill in the USA during the late sixties and related social unrest.

However, the current climate crisis is now this century’s biggest environmental challenge, affecting all aspects of the global economy.

The world is changing, and the pace of change accelerates. The environment, sustainability, equality, ethical supply chains and ethical investments are becoming more important key metrics for the various stakeholders. In 2004, the United Nations issued a report with as title ‘Who Cares Wins’ and it is that report that the ESG concept is mostly derived from.

Notably, recent studies have shown that especially APAC investors incorporate ESG in their investment decisions, much more than their counterparts in Europe and USA do, i.e. in a ratio of 68%, 63% and 48% respectively.

ESG is also increasingly becoming an important factor in tax planning decisions. As (in-house) tax advisors or lawyers consider the potential risks and opportunities of their (clients’) tax strategies, they must be aware of the potential environmental, social, and governance-related risks and opportunities associated with their decisions.

By understanding the importance of ESG and taking it into consideration when making tax planning decisions, it can help ensure that companies are making informed and responsible decisions.

What is ESG?

There are many definitions that try to define ESG, depending on who one talks to and which industry they are representing. In fact, all these definitions may be correct.

ESG involves the measuring, managing, and disclosing of environmental, social, and governance-related risks and opportunities of a company. ESG is an important part for having a good organizational health.

Generally, ESG is seen as a corporate framework or strategy in respect of a company’s environmental, social, and governance programs, thereby trying to create a balance of interests between all stakeholders.

Basically, ESG is a set of criteria or components along which a company is valued at by the different stakeholders.

In the past, a company’s focus was only on shareholders’ return, now the balance of interests of all stakeholders must be considered.

What role does tax play in ESG?

Policymakers around the world are using regulatory and market-based tools to facilitate a sustainable transition. One such tool is taxation, which is increasingly used to encourage behavioural change among taxpayers, both individuals and corporations.

Tax advisors, whether part of an in-house tax department or external tax lawyer, can play a proactive role in building a future-proof tax landscape. They can help ensure that a company’s tax strategy aligns with its overall sustainability strategy.

Good tax governance and integral sustainable tax practices (Tax ESG) involve:

• awareness of the amount of taxes paid and to whom, known as the company’s tax “footprint”
• alignment of the tax footprint with policy intent
• implementation of appropriate risk control and management processes
• acceptance of accountability for the company’s actions and consequences

Environmental

Tax is a fiscal tool that can drive sustainability activities by stimulating behavioural change. For example, it can encourage energy efficiency, pollution and waste management, the use of natural resources, and clean energy and technologies.

Governments are increasingly using taxes to address these issues, such as putting a price on carbon emissions and introducing plastic and packaging taxes.

In fact, the European Union (EU) announced in December 2022 the introduction of a ‘carbon border adjustment mechanism’, which would become the world’s first tax (tariff) on carbon content of imported goods and which will impact international trade.

Additionally, tax incentives are in place to reward “good behaviour.” Many companies are building sustainable and ethical supply chains with optimal carbon footprints by taking advantage of available tax incentives and credits.

Social

One of the primary purposes of taxation is to finance the government and the state, which in turn pays for the infrastructure and public services required by a modern society.

Societal attitudes towards paying taxes are changing, with more organisations and individuals recognising the link between paying taxes and social responsibility.

Increasingly, businesses view taxes as a valuable contribution to society, rather than a “burden” to be minimised at all costs.

In fact, there are good commercial reasons for this shift in mindset, as reputational damage, especially from the media, can have a direct impact on earnings. In addition, employees nowadays only want to contribute to a company as long as it is a non-tax evasive or non-tax aggressive company.

Governance

Tax transparency is a common theme across ESG-tax criteria, and it is closely linked with the ‘G’ of ESG: governance.

Organisations are expected to clearly articulate their tax strategy policies, information reporting on tax, country-by-country tax reporting, tax risks, transfer pricing policies and tax transparency.

Similarly, jurisdictions are increasingly demanding that boards oversee the finance and tax planning strategies that management is allowed to conduct, thus discouraging some practices. For example, the pursuit of aggressive tax avoidance, and others that do not contribute to the long-term interests of the company and its shareholders. Furthermore, they can cause legal and reputational risks.

Another underlying tax governance principle is the fair distribution of taxes, which has led to the OECD’s BEPS and Pillar 2 initiatives.

Individual countries also have taken several Tax ESG-related initiatives. The UK for example requires listed businesses to publish their tax strategy, how the businesses manage UK tax risks and their attitude to tax planning.

Similar requirements are now set for countries such as Spain, Denmark and Poland. Within Asia Pacific, many Australian multinational companies have signed up voluntarily with the Australian Tax Office Tax Transparency Code, requiring these companies to disclose their tax strategy.

In addition, organisations should have Codes of Conduct in place as guidelines for responsible tax behaviour, and they need to provide reliable tax information for ESG ratings.

How to measure ESG?

In 2019, the Global Sustainable Standards Board (GSSB) 1977 set the Global Reporting Initiative (GRI) 207 standard, which establishes international requirements for sustainability reporting under tax law.

Further, there is the International Sustainability Board (ISSB) 2021, which also has its own sets of standards on tax reporting.

It is believed that the GSSB standards are more focused on society, whereas the ISSB standards are mostly focused on investors and shareholders.

Apart from the above boards, the EU has created its own social taxonomy, a classification system with metrics to tax transparency and non-aggressive tax planning.

In particular, in 2020 the World Economic Forum agreed on metrics that include a company’s tax contribution, which looks at the tax burden of a company per country plus additional tax expenses such as employment tax, sales or value added taxes and taxes collected on behalf of another party.

Obviously, there are various agencies in place that rate companies on their Tax ESG performance.

Criticism of ESG

One of the criticisms of the ESG framework is that there are many different standards and rating agencies. Every standard and agency approaches ESG from a different angle, thereby focusing on different areas. Not all agencies for example conduct interviews with the subject company.

In addition, the various stakeholders may disagree with the ESG findings and reporting and may consider them subjective.

Greenwashing, exaggerating, or providing misleading information about ESG efforts is another issue. How to monitor these issues and how to penalise companies for this?

At the same time, producing ESG reports take a lot of manpower and many companies simply do not have these resources.

Last but not least, how can smaller companies contribute to ESG without losing to the competition? This is as their competitors may continue their tax-evasive or tax-aggressive programmes, thereby becoming unattractive to their suppliers and customers.

How HKWJ can help

Designing and implementing effective ESG frameworks and governance structures related to tax can be a challenging task. However, it is crucial to start early, address any barriers, and begin analysing your organisation’s approach.

Also, clear communication is equally important in order to avoid any misunderstandings, especially when a company tries to benefit from tax incentives that might not always be clearly ‘understood’ by laypeople.

At HKWJ Tax Law & Partners, we understand the importance of developing a consistent and robust Tax ESG framework. We provide support for modern risk management, which ensures that your organisation’s tax liabilities and tax planning align with ESG policies.

As trusted and leading tax advisers and lawyers, we stay up-to-date with the latest developments affecting our clients and anticipate future trends. Our team can help you prepare for these changes and ensure that you are well-positioned to navigate them.

To learn more about our Tax ESG Due Diligence Services and schedule a consultation, please use the form below or contact us via WhatsApp at +852 5110 3994 or call +852 2804 0889.