Why tax needs to feature prominently on the ESG agenda

BY TOH SHUHUI & CHAI WAI FOOK

INTEREST in environmental, social and governance (ESG) issues has grown exponentially over the last 2 years, notably catalysed by the Covid-19 pandemic that has exposed the vulnerabilities and inequalities in economies and societies. 

The 2021 EY Global Institutional Investor Survey (EY investor survey) found that ESG drivers and climate change are increasingly central to investment decision-making. Evidently, private funds are targeting investments that have clear ESG positioning. 

NextEnergy Capital, for instance, raised US$ 896 million for its latest ESG fund that focuses on solar infrastructure investments in Organisation for Economic Co-operation and Development (OECD) countries. This achievement was way above the targeted US $750 million. 

Blackstone also announced the launch of Blackstone Credit’s Sustainable Resources Platform, which focuses on investing in and lending to renewable energy companies and those supporting the energy transition.

The term ESG has a very wide scope - it encompasses an extensive range of considerations, including tax. Broadly, ESG components can include the following:

• Environmental: climate risks, carbon emissions, energy efficiency, pollution and waste management, use of natural resources, clean energy and technologies;
• Social: labour relations and working conditions, diversity and inclusion agenda, human rights, employee safety, tax and economic contributions to communities;
• Governance: board diversity, business ethics, risk tolerance, tax strategy, policies and reporting.

The EY investor survey also found that there is a dearth in companies’ ability to assess ESG risks effectively and to meet the increasing stakeholder emphasis on social issues. 

Why tax matters

Within the ESG agenda, tax is featured across various components. In the environmental aspect, tax is often used as a fiscal tool to drive sustainability activities in businesses. 

Carbon-pricing measures in the form of carbon taxes and the carbon border adjustment mechanism, environmental taxes such as plastic and packaging taxes, as well as resource and pollution taxes, are imposed to send clear signals to organisations to be mindful of climate sustainability. 

In Singapore's Budget 2022, the announcement of a significant increase in Singapore’s carbon tax - to S$25 per tonne in 2024, and to S$45 per tonne in 2026, with a view to arriving between S$50 and S$80 per tonne in 2030 - clearly sets the country in the right direction to move into a low-carbon economy. 

Governments are offering environmental incentives, grants and credits as carrots to further accelerate the pace of change and to reduce the financial burden on businesses adopting green technology. In Singapore, there is a slew of incentives under the Singapore Green Plan administered by various government agencies, ranging from tax depreciation to grants.

On the social front, among others, organisations must be aware of tax considerations arising from a remote and digital workforce and the “gig” employment model. These include employment reporting obligations and contributions in local jurisdictions, as well as potential taxable exposure resulting from a highly mobile and remote workforce with decentralised management. 

For governance, organisations need to clearly articulate their tax strategy, policies and governance surrounding sustainability. More importantly, they need to also be able to provide reliable tax information that is required for ESG ratings. 

Businesses need to understand the connections between building a sustainable supply chain with an optimal carbon footprint using available tax incentives and credits, and understanding the tax criteria in ESG metrics covered by voluntary frameworks or independent metric agencies.

Fifty-three (53) per cent of respondents in the 2021 EY International Tax and Transfer Pricing survey recognised that ESG pressures will have an “extremely high” or “high” impact on their approach to transfer pricing over the next 3 years, as businesses evolve. 

Businesses that fail to connect the ESG strategy to supply chain, transfer pricing and tax-related considerations may find themselves dealing with unexpected tax costs and risks in awkward and unpleasant situations. 

Tax-related reporting

ESG reporting is integral to investment decisions and capital allocations. Companies that fall short of ESG standards and ratings or are not equipped to collect the relevant information and data for reporting will likely see challenges in raising capital. 

Adding to the complexity is the fact that there is currently no single set of standards for measuring and reporting ESG data in reporting frameworks. Various rating agencies have also adopted different ESG reporting metrics. 

Tax-related ESG reporting has also been introduced increasingly. The World Economic Forum released a universal set of ESG metrics and disclosures for use in annual reports - included in the framework are core metrics focused on reporting both the taxes paid by companies, as well as their economic contributions. Their focus includes the reporting of total taxes paid by the company globally to demonstrate contribution to governmental revenues; the reporting of economic contributions covers disclosure of direct economic value generated and distributed, as well as any governmental financial incentive and assistance received. 

Several rating agencies also evaluate tax criteria when issuing sustainability ratings. Investors rely on ESG ratings from these rating agencies - such as Institutional Shareholder Services, Morgan Stanley Capital International, Sustainalytics and Dow Jones Sustainability Indices - to make investment decisions. Some examples of the tax criteria considered by these agencies include effective tax rates, tax policies, governance disclosure on commitment to and compliance with transfer pricing and tax laws in jurisdictions and disclosure of financial assistance received from governments, such as grants and tax reliefs.

How to get it right

In the context of tax criteria for ESG metrics, organisations need to understand the tax implications of their ESG-related decisions and how they will be measured and translated into these metrics. 

With much at stake, organisations should engage tax advisors and in-house tax personnel in their ESG strategy so that they are well-covered to score highly on the ESG-tax criteria. 

A common theme across ESG-tax criteria appears to be tax transparency and governance. As an immediate step, organisations should review their existing tax policies and governance frameworks so that they will be robust and comprehensive enough to withstand the scrutiny of relevant stakeholders.

Toh Shuhui and Chai Wai Fook are both partners, Tax Services, at Ernst & Young Solutions