ESG (environmental, social, governance), sustainability, climate change, inclusive capitalism and stakeholder capitalism are just a few of the phrases permeating the business vocabulary today. There are many ways to describe the seismic shift of the corporate business model moving away from the concept of shareholder primacy to a multistakeholder model.
Why then write another article on sustainability? The purpose is twofold: 1) provide some awareness and understanding of the primary drivers of this shift, and 2) help tax department professionals become versed on the issues. Every transaction in a company has a tax impact, and therefore it’s important for tax professionals to understand how shifts will impact the department and what they can do to prepare.
Historically and presently the value of a company is its market capitalization, and factors in that equation include an estimate of future profits at some multiple, times the number of outstanding shares. Drill down further into how those estimates are developed and you begin to realize that value is subjective despite the volume of objective items that are used as inputs. Ultimately a whole list of difficult-to-quantify items, such as the value of the company brand, factor into total company value. This leads to disparity in the multiple across companies, even those in the same industries, and assumptions are validated or disproven largely through how the components are reflected in actual profits over time.
The shareholder primacy model would indicate that the focus of the company should be on the end result, profits. Under this model, if you undertake projects to make profits higher, the decisions to pursue those projects are, by extension, the right decisions (within the bounds of legality, of course).
The sustainability model would indicate the focus should be on the processes and if the processes are operating to deliver value, then the end result of profits will follow. Under this model, companies focus on sustainability because they believe it will deliver higher value over a longer period of time. Companies adopting this model are more focused on the inputs, outputs and influences (stakeholders) to which their strategies and processes deliver value, and how that value is determined.
Evolving stakeholder expectations and the meaning of value
We see significant activity happening across the market focused on defining and meeting stakeholder expectations for information on how companies are executing on sustainability. Stakeholders want to know the value. This activity is happening across four verticals: regulation, capital, behaviors and metrics.
Regulation: Regulators and nongovernmental organizations are increasingly issuing rules, guidance and frameworks to create consistency and comparability in the information companies communicate to stakeholders. We see this in new requirements being proposed and issued by the EU and the SEC and in new standards boards being created and issuing guidance.
Capital: An increasing number of investors and lenders want to put capital to work with companies that are focused on executing a sustainability model. We see that in the explosion of ESG funds, the number of ESG-focused analysts in asset management teams, and the increase in the sustainable debt market.
Behaviors: From employees to consumers, the growing trend is clear: people want to make choices about where they work, what they buy, and where they shop, knowing that the companies they are supporting are focused on how they impact a broader set of people beyond their shareholders. Employees increasingly want to work at a company focused on their work experience, the work culture, and their mental and physical health. Consumers increasingly want to buy goods and services from companies that ensure their activities don’t negatively impact the environment.
Metrics: With the shift to sustainability, there is now a whole ecosystem of ESG ratings agencies and ESG data providers attempting to provide information and comparability to stakeholders in a synthesized, simple format. Given the immaturity of the sustainability space, the disparity in how ratings are developed and where data is curated has created confusion and uncertainty among companies and stakeholders on what the data is telling them.
In summary, what we have today is a transformational change happening around the idea of how a company generates more value for a longer period of time for the benefit of society. This change will continue to evolve. Companies and stakeholders are working to find ways to reliably and consistently quantify, communicate, validate, measure and compare value.
What does sustainability mean for tax?
Now let’s drill down on what this all means for the tax department. How will these macro pressures impact tax, what is the role of tax in sustainability, and how does a tax department position itself to contribute to the success of this organizational change?
A common answer to those questions generally revolves around tax governance and reporting. More compliance, more forms, more disclosure. Increased reporting is an important component of tax’s role in sustainability, but not the only one. The role of tax in sustainability can be broken down into five components:
- Strategy, policy and economics: Aligning past and future tax planning to company sustainability objectives and keeping pace with increased activity of lawmakers across relevant jurisdictions;
- Finance and funding: Supporting company initiatives and projects through a rapidly developing governmental funding environment across multiple jurisdictions;
- Supply chain: Supporting company initiatives around the decarbonization of supply chain, including potential cost offsets and potential for increased compliance;
- Workforce: Supporting company changes to workforce composition, experience, location and benefits.
In a sustainability model, the ground tax departments will need to cover is expanding and simultaneously becoming more topographically dynamic. Each of these components will waterfall down into governance and reporting.
Governance and reporting are the lenses through which tax value to stakeholders is communicated. Therefore, they regularly serve as the catalyst for tax department action; a regulatory standard is promulgated and change management processes are put into action to address the change. The shift to a sustainability model is ushering in a new age of tax reporting. Three tax reporting trends are driving the change:
- Increased transparency;
- Evolving stakeholder expectations; and,
- Increasing types and volume of taxes.
The trends mean that tax departments are being confronted with new or expanding compliance and reporting requirements and new mandatory or voluntary frameworks across a broader spectrum of transactions. Concurrently, tax departments also have to obtain and sustain tax benefits across more activities. Examples include public country-by-country reporting, digital and real time filings, mandatory disclosure regimes, potential new green taxes, tax policy disclosures, the Organization for Economic Cooperation and Development’s base erosion and profit shifting (OECD BEPS) 2.0 proposals and total tax contribution reporting.
How to take action
What can a tax department do today to successfully contribute to its company’s shift to a sustainability model? There are three key next steps.
- First and foremost, tax needs to have a seat at the company sustainability table. The vast majority of tax governance and reporting impacts are driven by sustainability changes made in company operations outside the tax department, so tax has to be part of the front end discussions. Connecting company strategy, tax strategy and communication strategy is critical.
- Second, an assessment of the current state of people, process and technology capabilities (which are already handling a significant reporting load) should be completed. This would include consideration of the current tax structure product flows, the current reporting and compliance load, the expected impact of future demands and related complexity, new data requirements and resource capacity.
- Third, based on the assessment of current- and future-state demands, a roadmap should be developed that addresses the data, people, process and technology required to effectively manage the changes on a timeline that can be achieved and monitored going forward.
Sustainability is an example of the continued evolution of concepts like long-term thinking. We know from history that focusing on the long-term perspective will create more value for all. This current evolution will continue to require the entire company ecosystem, including the tax department, to make significant changes and adapt. Companies that embrace the change will be the ones that continue to stay in the game and drive value for all. Tax — as the primary arbiter of sustainability incentives and disincentives — will play a major role in how companies provide value to stakeholders. It is critical to appreciate tax’s role, understand how tax is impacted, and prepare for those changes.
