Tuesday 31/03/2020

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Corporate taxes: when transparency is a must

Responsible Investment Strategist

As we had already mentioned in our article on the four ESG themes that will dominate in 2016,companies are being confronted with an increased demand for transparency regarding their fiscal policy. This request, which stems from both civil society and regulators, is due to a couple of high-profile affairs (LuxLeaks, inquiries by the European Commission into the fiscal practices of some countries, major multinationals which have been convicted.)

On the one hand, the OECD in October published its Action plan on Base Erosion and Profit Sharing – BEPS. This publication contains fifteen major themes which are based on three domains: the coherence of the international fiscal regime, the important of economic substance in tax ‘constructions’ and tax transparency.

On the other hand, the European Commission has taken this subject on board as well. First and foremost, it has condemned certain tax practices, such as the ‘excess profit rulings’ in Belgium. Moreover, it has prepared a guideline proposal to transpose the OECD recommendations (soft laws) in the legal systems of the various member states.

It is a quite a challenge, but it is a daunting task. After all, it is a thin line between ‘tax evasion’ and ‘legal fiscal optimisation’. Nowadays many fiscal optimisation practices fully comply with fiscal legislation, and are totally transparent towards the competent authorities, raarticular fiscal rulings.

In practice, the success of the OECD’s BEPS plan will depend on the coherence of its implementation on a global scale. How can this objective be reconciled with the fiscal sovereignty of member states? In addition, there is still a fierce competition among member states in order to lure foreign investors, especially through fiscal incentives. Some countries are blowing hot and cold in that regard, by criticizing the practices of some countries while keeping their own incentives.

Another debate is whether or not this information should be publicly disclosed. Although the OECD’s measures advocate an exchange of information with fiscal authorities, the EU may rather aim to publicly disclose certain specific information. Hence, it may create the risk that these data fall into the wrong hands and may be consulted by people who are less apt to interpret them in a relevant and correct manner. Another risk is that the competition may be using this confidential information.

Although the impact of these measures on companies is hard to measure, the initiative has a reason of existence, in particular the country-by-country fiscal reporting. The CRD IV currently obliges the European banking sector to publish data by country, which gives some insight into the disclosure requirements. As of July 2014, EU based financial institutions must report on their income by country, the number of employees and subsidiaries, as well as their profits, taxes and public subsidies they have received in their 2015 tax statement.

We do stress that the country-by-country reporting is the weakest link in aiming to make companies more transparent, which is demonstrated by the annual ranking made by Transparency International.

Furthermore, the reporting standards vary from one jurisdiction to another, which makes comparing apples to apples even more complicated. The country-by-country reporting should provide investors with greater transparency about the taxes paid, but would also improve their understanding of the exposure to specific countries, in particular the ones with sub-par governance, higher corruption risks or even potential violations of fundamental principles such as human and labour rights, and present higher overall ESG risks.

Companies should be encouraged to become more transparent, and may also be assessed based on other criteria than taxes, which remains a complex and highly sensitive matter.

Management transparency on the composition of the board of directors, remuneration processes, the corruption prevention policy or the measures which may be implemented on all levels of the company, including subsidiaries and the subcontracting chain. However, tax transparency is prone to a certain degree of greenwash, as this subject may also be used for marketing purposes. This does not mean that fostering correct tax behaviour should be embedded in a company’s fiduciary responsibility. Moreover, a company’s tax strategy is now an element of the methodology of the sustainable Dow Jones indices.

In view of the integration of ESG criteria, we will also pay attention to the stability of the tax framework in which a company operates. After all, it is sometimes extremely difficult for a company to anticipate to tax evolutions and to plan them accordingly – let alone to optimize them – as the tax framework of countries is constantly changing. Although various countries are taking measures to combat tax erosion, such as the United Kingdom and its notorious Google tax, or Ireland, which is said to attach itself to the OECD initiatives, we should not forget that overall these initiatives entail a decrease of nominal tax rates. Indeed, the UK government pledged to lower corporation tax from 28 to 20% in the 2008-2015 time frame and to 18% by 2020, showing that tax competition remains a hot item in Europe.

As we mentioned before, although the best performing countries have not yet benefited from their sounder practices compared to the others, tax transparency will become an increasingly distinctive factor, and will yield results in the mid to long term.

After all, apart from the financial risk involving fines and other volatile parameters, the reputation risk remains the greatest risk, following the changing expectations of civil society towards major multinational companies in particular.

This article was written with the co-operation of the Tax team from Banque Degroof Petercam.