8 minute read
Business aspects of ESG
A sustainability journey
Ganesh Ramaswamy considers the environmental, social and governance agenda and its implication on tax.
Ganesh Ramaswamy Associate, Kreston Rangamani In the past couple of years, the topic of environmental, social and governance (ESG) aspects of a business has been extensively discussed and covered across the global media. The focus on ESG has been particularly expedited by climate change, broken supply chains and the after effect of the Covid-19 pandemic. Businesses around the world are under severe pressure from shareholders, investors, regulators, suppliers, customers and communities, to start charting out their sustainability and wider ESG journey. Moreover, ESG considerations dominate many shareholder discussions and institutional policies.
For businesses, launching a sustainability journey often means they have to make substantial changes to how they operate. This requires a lot of long term planning, as well as changing business systems, processes, procedures and models from a set model which requires a lot of capital. To support the capital requirements, there are substantial amounts of sustainable/ESG funding available in the financial market. Businesses are in a position to tap ‘Use of proceeds’ instruments like green and sustainability bonds and loans where the funds are used to finance specific projects and initiatives with social or environmental benefits, as well as ‘ESG linked instruments’ which are ESG and sustainability linked loans where repayments terms are pegged to certain environmental or social performance indicators.
Value creation from ESG Investors, regulators and other stakeholders have started to demand detailed disclosures regarding the social and environmental commitments of businesses in their periodic reports. Stakeholders are interested in the external impact of the actions of businesses, which will have an effect on both customers and suppliers. Employees want to ensure that their companies focus on
better working conditions and gender equality, as well as various other social and environmental issues. A structured ESG strategy will attract suitable talent and create long term value for the employees and the business.
Businesses have also come to realise that by incorporating ESG parameters into business operations, there are huge opportunities for value creation, as well as risk mitigation. Businesses are now reviewing their product and service mix. They are actively considering launching new sustainable products in order to capitalise on changes in consumer trends and preferences.
The net-zero goals declared by many countries have created huge business opportunities in various sustainable sectors like biofuels, electric vehicles, waste management, green hydrogen and related sectors. This opens up a number of opportunities for the SME sector to come in as disruptors in the sustainability eco system.
If SMEs and start-ups have ESG credentials, their products and services may be preferred over large businesses, which may take a considerable time to switch over from their traditional models to ESG compatible models. This will enable SMEs to enter into new markets and get premium pricing for their products and services. ESG as a risk mitigation model Businesses need to start assessing and adapting their supply chains in order to gear themselves up from the negative impacts of climate change across the globe. If businesses see a risk of shortage in their raw material supplies due to climate change, they will have to immediately look at sustainable alternatives in order to avoid supply chain disruptions. This way the businesses would look at ESG models as a process of risk mitigation for their operating models.
Corporate business houses have to ensure that they have the right social and governance policies for increased transparency and accountability. Instances of corruption, bribery and human rights abuses are now monitored through good corporate governance tools. Most large corporations have started to focus on social aspects like health, safety, employee wellbeing and impact on communities.
Regulators around the world have also brought in tight legislations in the form of penalties and fines. Not promoting ESG models can even lead to a negative impact on brand reputation, leading to a decline in stock prices.
Tax issues in ESG Tax issues have important implications for businesses as they plan their ESG roadmap. Many jurisdictions offer tax incentives to businesses that undertake spending on ESG infrastructure within their businesses. This gives businesses a lot of opportunities to optimise their effective rate of taxation by factoring in the incentive benefits.
It is very important for businesses to have a good tax policy in place, in view of the reputational consequences which come about on account of an aggressive tax structure. Tax is indeed a critical risk for any business enterprise, and has to be managed professionally due to the changes in the tax structure on account of switch over of the business to a ESG model.
Around the world, there is always a call for transparency for disclosure of tax policies by multinational enterprises (MNE). The OECD’s base erosion and profit shifting (BEPS) project and BEPS 2.0 have introduced new disclosure norms. The country-by-country reports which MNEs file in countries where they operate provides data on
Author bio
Ganesh Ramaswamy is an Associate at Kreston Rangamani and is based in Kerala, India. global allocation of revenue, profit and taxes at the respective jurisdictions. In most countries, the regulatory authorities are asking MNEs to disclose their related party transactions in detail. These disclosures provide regulators with sufficient information to make tax assessments in a just and fair manner.
A number of businesses have now started focusing on their carbon footprint, committing to reducing emissions and using other resources more sustainably. This results in consideration of carbon taxes. It also results in ethical sourcing and pricing of intra group transactions which ultimately impact the business’s tax profile. The credits given by various governments for using green energy is considered to be an essential catalyst in this journey.
Tax policy reporting as part of ESG Reporting on tax policies of businesses is also now becoming a very critical factor in ESG. There are a lot of stakeholders – the government, stockholders, employees, creditors and customers of a business who want to know whether the business is paying the right amount of tax or not. The ESG commitments of businesses bring them in the vicinity of tax rebates and tax concessions. There is therefore an increased social interest in whether the business chose the ESG model so as to secure a huge tax concession. Businesses are now required to explain and make clear their tax policies, consequent to their ESG commitments. It is common knowledge that tax plays a very important decision role in framing the ESG commitments of businesses. Public and shareholders require this tax policy to be demonstrated, linking it with the ESG progress. A transparent tax policy will build in a lot of trust for the shareholders and public in the business. Although large listed companies have an obligation to consider and publish their tax strategies in their annual reports, these companies have started to report much beyond their basic compliance requirements, including how their tax strategies connects with their ESG strategies. Many private equity and institutional investors have now mandated that ESG tax issues have to be incorporated into the due diligence exercise that are carried out in target companies. Investors now look at the tax risk rate and want to quantify tax positions which deviate from the investors ESG policy on tax matters. Furthermore, many leading MNEs have started to incorporate a number of reports on the tax issues of their businesses as part of their ESG policy. The following are some of the details incorporated in their periodic reports: a. Details of the effective tax rate for the company as a whole and also details of jurisdiction tax rates. b. Details of the material tax risks faced by the business and how these have been mitigated. c. Details of the structure of the tax department of the business, the staffing pattern and the position within the organisation. d. Details of the country specific tax developments across jurisdictions and how these will impact company. e. Details of the mandatory disclosure requirements in each jurisdiction and the compliance level adhered to by the company. f. Details of the comments by the board on the tax risk, which is part of the board’s oversight function. g. Details of the tax risk policy of the company. h. Details of the monitoring done by the company on it tax risk policy across jurisdictions. i. Details of government incentives, grants, credits for renewable energy project investments, carbon taxes, accelerated depreciation, etc. which have been claimed by the company. j. Details of tax benefits made available to employees through their salary structure.
Conclusion Governments around the world are implementing plans to have a sustainable society and also have set self-imposed net zero target dates. Many governments are also providing incentives for businesses that set up low carbon emissions and also give skilled employment to workers. On the other hand, the government uses taxes to lower emissions and develop an economy by encouraging reusing and recycling of existing products. Against this backdrop, businesses look at how they can develop a tax strategy to bring about transformation in production processes, operations and employment practices.
The momentum in the relevance of ESG is here to stay and is accelerating. Tax will play an essential role in its path. Tax teams within companies must get involved if they are to understand the interplay of tax and ESG factors. Companies need to understand the tax implications of their ESG related choices and how they will be measured and translated into reported metrics. ●
