Engagement update: Responsible tax

Taxation is a matter of social justice – paying a ‘fair’ share; it is also one of risk, linked to reputational damage, the impact of changing regulation and uncertainty around future profits.

Taxation is a matter of social justice – paying a ‘fair’ share; it is also one of risk, linked to reputational damage, the impact of changing regulation and uncertainty around future profits.

The fundamental ethical principle underlying the concept of ‘responsible tax’ is that residents of a country (whether individual citizens or corporations) have an obligation to pay taxes in order to support elements of our social fabric such as education, transport infrastructure and the judicial system. These, in turn, enable people and companies alike to go about their business in a safe, efficient and profitable manner. Consideration of tax practices is also linked to issues of corruption and international equity and development.

From an investment perspective, opaque and inconsistent disclosure makes it difficult for investors to fully assess the true risk to which they are exposed through a company’s approach to tax management. Reputational risks can arise from negative media coverage and consumer backlash. An over-emphasis on tax considerations can also encourage inefficient allocation of capital by skewing investment towards activities and business structures that may have lower pre-tax rates of return but higher after-tax rates of return. However, perhaps of greatest importance from an investment perspective is the risk posed by changing regulation, which may result in the closure of loopholes or cancellation of so-called ‘sweetheart deals’ on which corporate profits may depend. These risks have been exemplified by the recent decision of the European Commission to investigate whether tax arrangements agreed between Apple and the Irish government, and Amazon and the Luxembourg government, constitute illegal state aid.

At a macroeconomic level, base erosion and profit shifting (BEPS) distorts competition and can result in companies with cross-border operations gaining an advantage over domestic rivals. These distortions undermine the stability and resilience of international markets, creating uncertainty and a multitude of risks that are difficult for investors to properly assess and respond to. Ultimately, aggressive tax management strategies may result in lower levels of public investment, impairing economic growth and undermining long-term investment returns.

Regulatory Developments

There are some quite significant regulatory developments underway with regard to tax:

  • The OECD BEPS project began in February 2013 and has set out 15 priority focus areas, covering issues such as transfer pricing, country-by-country reporting of tax payments and treaty abuse. Consultation documents have already been released in relation to some actions, including the template for country-by-country reporting. The action plan has gained a good level of support, though it remains to be seen what impact lobbying from countries and companies will have on the final output. 
  • The EU Capital Requirements Directive IV introduced requirements for EU financial institutions to report country-by-country tax payments.
  • Similar regulations are increasingly being implemented for mining and oil and gas companies in a number of jurisdictions.
  • The Fair Tax Mark was launched in the UK in 2013 as a voluntary accreditation for companies to demonstrate their tax practices and disclosures meet a set of minimum requirements. To date, the majority of companies to gain accreditation are smaller, unlisted companies. However, Go-Ahead and SSE have also now been awarded the mark.

Rathbone Greenbank's Engagement work

General Engagement

Much of the debate around tax and tax avoidance has focused on fairness, equity and the need for companies and individuals to contribute towards the societies which directly and indirectly support them. However, investor voices have largely been missing from this debate.

During 2013 and 2014, Rathbone Greenbank joined a small group of responsible investors to undertake a collaborative engagement on tax and tax avoidance. From initial discussions within our group, it was apparent that a lack of understanding regarding what is often a highly complex issue made investors reluctant to question companies on tax arrangements.

Our aim therefore was to develop guidance for investors wishing to engage with companies and policy makers on this issue. We took the decision to focus on investment risks rather than ethical considerations in order to make the research relevant to a broad investor audience, not just those with an ethical or responsible investment approach.

Our group met with senior tax or finance department representatives from companies within the mining and consumer goods sectors. These discussions covered aspects of tax policy, governance and disclosure and gave us an understanding of current and best practice, in addition to some of the challenges companies face in increasing disclosure. In order to encourage a frank and open discussion, we agreed to keep the names of participating companies confidential. We also met with representatives from tax advisory firms, NGOs and the OECD to gain different perspectives on this issue. 

A discussion paper, summarising our findings and setting out future disclosure expectations for companies, was launched in July 2014 at an event for members of the investment community. From feedback sessions at the launch event, it was clear that there is genuine interest in this issue, and that investors are keen to learn about tax risks and continue to participate in the debate. Further feedback on the discussion paper has been gathered through the Engagement Clearinghouse of the UN-backed Principles for Responsible Investment (PRI) and at an event on taxation at the annual ‘PRI in Person’ conference in September 2014.

We are pleased that our initial discussion paper has played a role in educating investors and stimulating a wider discussion on the nature of tax risks. The members of the collaborative engagement group are now exploring ways to take the project forward through the PRI Engagement Clearinghouse. The first step will be a webinar, scheduled for later in January 2015, which will launch a shared web space for PRI signatories around the world to share insights on tax from their markets in addition to feeding back on and co-ordinating future engagement work.