An increasing number of institutional investors and asset managers worldwide are urging multinational companies to embrace responsible tax conduct and tax transparency.
Long gone are the days when investing in a business responsibly meant turning a blind eye to, or even encouraging, the reduction of corporate tax contributions as long as they adhered to the letter of the law. Now, for example, investors have requested new accounting rules in the US that will see the black box of overseas tax payments opened up for the first time.
Aggressive tax avoidance negatively distorts national economics and undermines the ability of businesses to compete fairly. It creates reputational and earnings-related risks as well as raises a red flag for an overly negative attitude to compliance in general, and of weak corporate governance.
Meanwhile, tax contributions help the communities in which they operate to deliver valuable public services and build vital infrastructure. As the Principles for Responsible Investment (PRI) argues: “It is in investors’ interest to ensure that corporate taxes contribute to stable, well-functioning socioeconomic systems that are conducive to achieving investment returns and the Sustainable Development Goals.”
Investor action
While shareholder resolutions remain a popular way for investors to encourage responsible corporate tax behaviour, many are going further.
Norges Bank Investment Management has set out comprehensive expectations for multinationals to exhibit tax transparency, and in 2020, seven of Denmark’s biggest pension funds signed a tax code for appropriate corporate behaviour.
At the end of last year, a group of 11 UK asset owners, including Brunel Pension Partnership, Church of England Pensions Board, Friends Provident Foundation, Nest, People’s Partnership, Railpen, Scottish Widows and Universities Superannuation Scheme, proposed considering whether a business is Fair Tax Mark accredited in their Fair Reward Framework – a compilation of remuneration indicators.
The Fair Tax Mark is the gold standard responsible corporate tax conduct accreditation scheme. Organisations of all sizes in many jurisdictions are assessed against a high-bar set of standards in areas such as transparency, governance, robust disclosures and reporting, and actual tax contributions.
For investors, a Fair Tax Mark is a clear indicator of responsible tax conduct, and our accredited investment firms – such as Jupiter Asset Management and Epworth Investment Management – encourage their portfolio holdings to seek it out.
In fact, FTSE-listed housebuilder Gleeson successfully sought accreditation after it was recommended by one of its investors – Epworth. The London-based investment firm also recently expanded its tax engagements to seven European-headquartered companies.
Five signs of good corporate tax behaviour
But there are of course other ways for investors to identify responsible corporate tax behaviour.
Full financial statements
The first is whether a business publishes a full set of financial statements. This might seem like a low bar, but there are many businesses that do not do this. Sometimes tax paid, as well as income and profit, is obscured, which may amount to ‘tax cloaking’.
Robust tax policy
The second thing investors can look for is a robust public tax policy. This should explicitly commit the company to shunning aggressive tax avoidance and the artificial use of tax havens, declaring profits in the places where their economic substance arises, and adhering to the spirit as well as the letter of the law.
It’s no longer enough to adhere to just the letter of the law. Even the OECD Guidelines for Multinational Enterprises explicitly state the importance of demonstrably complying with the spirit, as well as the letter, of tax laws.
The policy should apply to the parent company and all entities therein, as well as be publicly “owned” by a named board director, with compliance confirmed annually.
Public country-by-country reporting (pCbCR)
Publicly reporting tax and economic contributions in the countries where businesses operate has been shown to reduce the use of tax havens and profit-shifting, and increase effective tax rates and domestic tax revenue mobilisation.
For investors, a pCbCR report can also be a good indicator of emerging financial and reputational risks at the company as well as, crucially, proving whether the business is complying with the commitments in its tax policy.
If nothing else, it’s also simply good practice to get ahead of upcoming legislation, as pCbCR will soon be mandatory for multinationals with large operations in Europe and Australia (albeit the legislation has some rather large loopholes).
Disclosure of uncertain tax positions
When a business files its corporate income tax returns, it may sometimes apply judgements relating to the tax treatment of specific elements. An uncertain tax position (UTP) arises where there is uncertainty over the tax treatment applied. It can be an indicator of aggressiveness, or it can be a genuine uncertainty in law.
If investors do not have clarity on UTPs the business has taken and why, or how they have been accounted for in the financial statements, it is difficult to determine the impact (both financial and reputational) of this uncertainty.
Businesses should include a full numerical and narrative analysis of UTPs and the actions taken to minimise uncertainties.
Cash taxes paid over a five-year period
Over time, corporate cash taxes paid are a far more accurate means of measuring “contribution” than total tax accounting accruals, not least as the latter includes deferred tax accounting adjustments that may never materialise as cash taxes paid. Therefore, where available, we recommend investors look at cash taxes paid over a five-year period.
At the moment, although this varies by sector, an average tax rate above 20 percent would be a green flag and indicate that the business is contributing taxes close to the average headline rate for corporate income tax around the world.
Less than 7.5 percent would be a red flag – although again, higher thresholds may be applicable within sectors where intangible assets are characteristically booked in low-tax jurisdictions.
Businesses that invest heavily in capital equipment would have a lower cash tax rate, and this should be considered when determining whether a business is making a fair contribution.
Looking ahead
Red flags in these five areas aren’t necessarily a cause for divestment but they can be cause for engagement, and we’ve increasingly seen investor engagement teams delve into areas such as pCbCR and cash taxes paid.
Corporate tax behaviour will only continue to grow as an area of interest for responsible investors – so whether it’s filing resolutions, due diligence and engagement, or outlining expectations, this is an area ripe for sophistication.
