Deloitte: Is Tax on your ESG agenda?

“LIFE’S most persistent and urgent question is, what are you doing for others?” – Martin Luther King, Jr.

A famous quote probably not meant to be read in context of corporate governance.

Yet here we are today, with environmental, social and governance (ESG) factors playing an important role in how investors evaluate corporate behaviour in terms of sustainable, responsible and ethical participation in the market.

Investment is no longer solely valued in terms of financial returns, but also its impact on society at large.

The interaction between ESG factors and the performance of businesses is not new on the corporate agenda.

However, like digitalisation, the ESG theme gained significant prominence over the last year amid the economic uncertainties triggered by the global pandemic.

Generally, corporates holding themselves to high ESG standards are regarded by stakeholders as more resilient in navigating unchartered waters.

ESG-themed funds in western countries have become an attractive asset class among investors hunting for higher yield as they outperformed their traditional counterparts.

Locally, ESG has been around for some time, although it may not have garnered as much weightage as financial performance.

The FTSE4Good Bursa Malaysia Index was launched in December 2014 to recognise listed companies that have implemented measures to enhance ESG practices and disclosures over time.

The increase of index constituents shows that ESG is gaining momentum in keeping with global trends.

It is especially prevalent among millennial investors. Listed companies are also allocating significant resources into walking the ESG talk and documenting them in their publicly available annual sustainability reports.

Interestingly, tax has become a material component of the “governance” aspect of multinational companies (MNCs) in developed economies and disclosures are made to stakeholders.

In Malaysia, listed companies that are part of global MNCs have some form of tax transparency report published by their global headquarters.

However, those with local presence only either make mere general statements on tax transparency in their sustainability report or nothing at all.

This is not entirely surprising since tax affairs tend to be sensitive information and the mindset generally adopted by Malaysian corporates is that any disclosure over and above statutory requirements may attract unnecessary attention from the tax authority.

Tax has also become an important component of the “social” aspect.

After all, taxes are used to fund the fiscal and economic policies of the Government.

This includes the social infrastructure benefitting the public such as the education and healthcare systems.

With a world in crisis, this we have seen socio-economic benefits financed in part by taxes with the announcement of various stimulus packages and aid for those impacted.

Tax policies come to the forefront of the conversation with public debate becoming more focused on the morals and fairness of how much taxes companies pay, particularly when certain large profitable companies seemingly do not pay any taxes at all in jurisdictions they operate in.

Where it becomes public knowledge that aggressive tax planning is involved and that these companies capitalise on mismatches of tax laws or use tax havens to shield their profits, there is a negative perception.

Responsible tax policy becomes essential to the ESG agenda.

With the spotlight directed at large MNCs coupled with pressure to replenish national coffers after many rounds of fiscal stimulus to shore up the economy amid the pandemic, tax authorities can be expected to place greater scrutiny on how tax liabilities are impacted by certain business transactions to ensure no base erosion and profit shifting has occurred.

As such, embedding robust tax principles and code of conduct into the wider corporate governance and risk management framework as well as making them publicly available forms the first line of defence for corporates as it demonstrates to tax authorities that there are no hanky-panky arrangements when it comes to tax.

Hopefully, this will reduce the company risk profile in the eyes of tax authorities when prioritising resources for an audit or investigation.

Other stakeholders obviously benefit too. When good tax governance is combined with existing sustainability practices, it could improve the company’s attractiveness among investors and ESG fund managers, hence enhancing shareholder value through share price appreciation.

The ringgit also stands to strengthen where there is substantial inflow from foreign funds into the local bourse.

For creditors and employees, they can take comfort that, to a certain extent, the risk of the company becoming insolvent and defaulting on payments due to proceedings being initiated by tax authority to recover overdue taxes should be low.

With ESG’s growing importance, it is timely that Malaysian corporates up their ante on strategic tax stewardship.

Having a responsible tax strategy makes good business sense.

Tax should no longer be regarded as a mere back-end, check-the-box function. Instead, it should be given sufficient attention by C-suite and board of directors.

Conversations should not be only restricted to timeliness of tax filing and payment as those alone do not carry the company across the finish line.

Instead, difficult questions like “have we implemented structures which are purely motivated by tax benefits?”, “have we adopted any contentious tax positions?” and “what are our tax risk management procedures?” should be deliberated and documented.

If the aim of having commendable ESG practices is to be recognised as a good corporate citizen, then being a responsible taxpayer by paying a fair share of taxes at the right place and time is certainly part of that.

We have read prior announcements of prominent listed companies being issued hefty notices of assessment by the tax authority which, undoubtedly, would have caused anxiety among interested stakeholders.

With the increase in frequency of such announcements, listed companies may have to consider improving their reporting to show that their tax risk management and governance is not lacking.

The importance of the company’s actual conduct being consistent with its written principles must be emphasised to avoid being a NATO case – No Action, Talk Only. – Aug 2, 2021.

 

Lee Boon Siew and Shiranee Niles are Associate Directors at Deloitte Malaysia.

The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.

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