For many years, sustainability was little more than a footnote in corporate strategies – written on paper, but disconnected and low on the priority list. Yet the case for sustainable business was steadily building, underpinned by the belief that how companies manage environmental, social and governance (ESG) issues influences long-term resilience, reputation and ROI.
For many, ESG reporting will soon escalate from a best practice to the ordinary course of business. Organizations with international operations most likely already face mounting sustainability reporting requirements. At the core of sustainable business is transparency. Stakeholders now demand that organizations disclose data that tracks their ESG programs and progress toward targets. Even absent regulation, ESG reporting is critical to achieving the level of confidence that the market desires. Organizations that do not disclose ESG information receive low ESG scores from ratings agencies, which can impact everything from customer loyalty to capital access.
Sustainability strategies anchored in ESG measurement and reporting will not only advance corporate social responsibility and address the environmental and social impacts of the organization, but also mitigate potentially damaging ESG-related risks. As organizations evaluate their operations through an ESG lens, they must integrate these risks into overall enterprise risk management.
Although tax credits as subsidies have been a foundational catalyst for advancing many ESG policies and technologies over the last several years, tax is often forgotten or minimized in the process of creating and implementing corporate ESG and value creation strategies. Ignoring the symbiotic relationship between tax and ESG is a losing strategy, given increased awareness of the importance of tax transparency among shareholders and other stakeholders as a mechanism for holding companies accountable to their stated ESG commitments. The increased importance of tax transparency has been driven by the increased scrutiny and reputational risk that companies often face regarding whether they pay their fair-share of taxes. A rise in media and rating agency reports on the topic indicate tax will continue to be under scrutiny in the future and may increasingly have significant corporate reputational impacts as well.
As leaders of an organization’s tax function, Vice Presidents of Tax, Tax Directors and CFOs are the stewards charged with ensuring tax strategy and operations appropriately intersect with the corporate sustainability vision and meaningfully advance ESG commitments. Tax has a critical – but often underutilized – role to play in developing an organization’s ESG strategy. Every business decision has a tax implication. Minimizing or forgetting tax regarding strategy puts a company at risk, given the increased demand for total tax transparency among shareholders and other stakeholders.
How Does Tax Overlap with ESG?
Because there is often misunderstanding about how tax relates to ESG issues, tax may not be incorporated in responsible business strategy and planning. Although not reflected in the ESG acronym, there is an element of tax that is central to each of these principles.
Consider environmental behavioral taxes and incentives, such as carbon taxes on greenhouse gas emissions and tax incentives for green energy adoption. These are crucial to driving behavior change toward more sustainable practices in the near term while many impacts of climate change are still experienced indirectly.
In terms of the social element, taxes are a key mechanism for companies to contribute to the societies in which they operate and to build trust among members of the public as responsible corporate actors. Tax-deductible donations have been a longstanding part of the economy in the United States, supporting thousands of nonprofit organizations that support our social structures. Tax incentives also support the gig economy, work flexibility and equitable pay.
Finally, proper tax governance can ensure that there is appropriate oversight over an organization’s tax strategy and decisions, assuring alignment with corporate purpose and stakeholder expectations. Good governance aligns overarching business objectives and stakeholder communications around tax reporting.
Unlock a Successful ESG-Driven Tax Strategy
Aligning the tax function with an overarching sustainability and ESG strategy across the business is a heavy lift. Building and implementing a responsible tax program will take time and require careful consideration of an organization’s overall approach to tax, tax governance and total tax contribution. Each company will have a unique tax strategy based on its business and stakeholder considerations and may be at varying points along its responsible tax journey.
Maybe you are just getting started. Maybe you are reassessing your approach based on changing market conditions, new regulations or updates to your ESG strategy. In either case, a good example is the BDO Tax Cypher below that can be used to guide critical considerations and help ensure tax is meaningfully incorporated in ESG strategy. The process should be iterative over time and when implemented successfully, will drive improved decision-making on risk mitigation, strengthen risk awareness and increase transparency and accountability.
Core Principle 1: Approach to Tax
The first step to meaningfully incorporating tax in ESG strategy is understanding and articulating the purpose and values that guide the tax function. This process includes defining the organization’s approach to regulatory compliance and the interaction with tax authorities. Writing a tax policy and strategy is an important way to articulate the company’s tax priorities and educate all team members across the organization about the function’s principles. The statement may include commitments to communicate transparently with regulators and disclose more information than required by law in some cases.
The tax strategy should not be static over time. As the organization evolves with changes in the industry, overall ESG commitments and sustainability strategies, the tax strategy statement should be updated accordingly. Regulatory changes will also necessitate continuous assessment and consideration of whether the strategy meets the current understandings of transparency, risk mitigation and accountability based on new information. Through this set of guiding principles, the tax function should always seek to improve decision-making and reporting actions to align with changes in the broader corporate ESG strategy, purpose and values.
Core Principle 2: Tax Governance and Risk Management
Establishing a robust governance, control and risk management framework provides comfort and assurance that the reported approach to tax and tax strategy is well embedded in an organization’s substantiable business strategy and that there are mechanisms in place to effectively monitor its compliance obligations.
It’s important to remember that tax governance and risk management are much broader than the SOX 404 tax internal control framework, which can be a common pitfall for many narrowly focused governance strategies. Generally, the SOX 404 tax internal control framework has a limited focus on accurately reporting financial statements. While this is an important area of governance, it does not account for or represent the many objectives included in a tax ESG control framework. The tax ESG control framework is typically broader as it focuses on how decisions on tax positions are made, within the practices outlined in the Approach to Tax statement.
Core Principle 3: Total Tax Contribution
Quantifying and providing necessary qualitative context around an organization’s total tax contribution is not an easy task. Today, stakeholders from employees and customers to investors and regulators expect transparency around tax strategies, tax-related risks, total tax contribution and country-by-country activities. Recently, tax has received increased scrutiny from these stakeholders because it is a core component of many ESG metrics used to evaluate a business’s tax behaviors and ensure there is accountability across its tax practices. How a company shares tax information with stakeholders and what it includes in reports has a significant impact on reputation and perceptions of corporate ESG statements.
The increased demand for tax transparency is not without its challenges. Nearly two-thirds of respondents in BDO’s 2022 Tax Outlook Survey (62%) said data collection and analysis (the quantitative component of ESG-focused tax) is the greatest challenge of tax transparency reporting efforts, pointing to an underlying issue of tax data governance and fragmented systems. Often, this is an area where tax leaders require outside assistance to establish automated processes that can collect tax data on a periodic basis for regular analysis. The importance of ESG and attention around the topic will only continue to increase over the next several years, so it is critical to begin thinking about adequate data collection and analytic capabilities for tax leaders looking to incorporate tax in ESG practices and strategy.
Although this task can be a heavy lift, it reaps significant business advantages. The data and information gathered will help tax leaders further define and evolve ESG-driven tax strategies through tax monetization structures and company core value items, among other benefits. Ultimately, organizations that better understand their total tax contribution across various taxing jurisdictions and country-by-country activities are best equipped to make data-driven tax strategy decisions that are aligned with broader ESG and sustainability objectives, while also avoiding value creation hinderances.
Putting the Pieces Together: Key Reporting Considerations
Once quantitative data have been collected, the next step is to communicate the narrative behind the numbers – the qualitative component of reporting. The narrative should always aim to communicate the company’s approach to tax, values guiding decision making and the impact of the tax strategy to key stakeholders in a straightforward and transparent manner. However, qualitative reporting can vary by organization depending on several factors, from choice of standards to company philosophy.
The 2022 BDO Tax Outlook Survey also found that challenges and variance in tax transparency reporting are driven by a lack of universal reporting standards and clarity around which ESG frameworks to follow. In the meantime, the best reporting framework for any company is one that drives a deep understanding of the organization’s ESG and sustainability philosophy and vision, which may require more investment in terms of time and effort. When determining a reporting approach, it is important to consider the goal of the report or disclosure and which data best demonstrate ESG progress and strategy. Because the ESG-related tax reporting is not a mandated process and is currently a voluntary disclosure in the United States, it can often be helpful to review tax reports related to ESG from other companies already making these disclosures as a baseline.
Keep in mind that one of the main reasons businesses are electing to publish comprehensive ESG and sustainability tax reports and global tax footprints is to articulate their broader total tax contribution to ensure that the tax narrative speaks to the needs and demands of their stakeholders. Each report must be unique and relevant to the company in terms of content and method of disclosure.
Suggested Next Steps for Tax Integration in ESG Strategy
Today, tax is an essential component of the ESG metrics that determine how stakeholders perceive an organization. Despite this fact, the movement to incorporate tax in ESG planning and strategies is still in its infancy. This means leaders of tax functions still have time to begin the process of implementing ESG-driven tax strategies and operations to ensure the function evolves with the importance of ESG. Although there is no simple one-size-fits-all solution, given the nuances and complications of the tax function for each organization, the general framework in a strategy like BDO’s Tax Cipher can help guide tax leaders at any point on the journey. The cipher outlines key considerations to ensure an organization’s ESG vision is well-structured and appropriately includes tax strategies. Although the process requires long-term effort and dedication, it generates high returns in terms of accountability, transparency and reputational and sustainable value.
- If not already involved in ESG strategy, understand who is leading the ESG initiative and educate them on how tax can assist and most importantly add sustainable value.
- If you don’t already have a documented Approach to Tax / Tax Strategy, that is the best place to start, as it lays the framework and provides something that people generally perceive as easy to accomplish.
- Start to evaluate your tax governance framework and whether you have processes and controls to ensure the completeness and accuracy of total tax and not just SOX 404.
- Start the journey of obtaining your data for total tax transparency reporting and evaluating your tax governance framework along the way to make enhancements to incorporate the completeness and accuracy of total tax transparency reporting.
Daniel Fuller, CPA has over 27 years of experience working with clients to solve complex tax problems, including tax accounting method issues, obtaining business credits and incentives and international and federal tax planning. Mr. Fuller’s dual role includes making connections between clients’ tax ESG and innovation strategies and recommend initiatives that advance goals in both areas. A major focus has been helping clients break down data silos to improve tax transparency. Fewer data silos aid ESG reporting and allow tax and business professionals to glean more insights to inform decision-making. As Tax Digital Transformation and Innovation Leader, Mr. Fuller also leads the transformation of how BDO delivers tax services for clients, which includes nurturing strategic collaborations with technology companies. As tax ESG and strategy services leader, Mr. Fuller advises clients on tax ESG strategy, including how to develop policies around ESG in the tax context, manage their relationship with the IRS and develop their social responsibility posture for tax. Mr. Fuller also serves as BDO USA’s UK Tax Desk leader, the interim leader of the tax automation and innovation practice and oversee various other BDO specialty tax practices.
Jonathon Geisen, CPA, is a tax managing director in BDO USA, LLP’s Grand Rapids, MI office. In this role, he serves as a tax advisor to domestic and multinational corporations. He is one of the leads of the firms ESG tax services and focuses on advising clients on how a ‘total tax mindset’ can be a sustainability business strategy. In addition, Jonathon serves as a co-leader of the ASC 740 practice in BDO’s central region, a member of BDO’s Professional Practice group who serve on all ASC 740 technical consultations and a member of BDO’s Tax Risk Services group. Clients and BDO engagement teams rely on Jonathon to assist with accounting for income tax matters, complex mergers and acquisitions and overall total tax planning/management. He can be reached at jgeisen@bdo.com.