What is tax fairness and what does it mean for investors?

This paper explores the concept of tax fairness, outlines the rationale for investor action and the steps that the PRI intends to take to support signatories on this issue

Investors have a spectrum of views on tax issues, depending on their investment beliefs, risk appetite and culture. Our role is to enable investors to move towards practices that align with tax fairness.

We welcome inputs to this paper as we embark on a long-term programme on this topic. Our tax fairness programme seeks to increase the resources available to governments to address sustainability goals (including those related to climate change) and protect the public goods on which investment value relies. We will do this by encouraging investors to adopt and embed fair tax principles in their own operations, advocate for fairer public policy on tax, and support their efforts to achieve fairer tax arrangements amongst their investees.

Figure 4_Shift to tax fairness

Download the full report or read the key messages below.

The full report also includes:

the impetus for change and the implications for investors
the key issues in the international tax system that need to be addressed to achieve tax fairness
examples of investor action
a summary of our previous work on tax

What is tax fairness?

Tax fairness means different things to different stakeholders. In general, tax fairness could be understood as the effectiveness of public policy design in reconciling taxation objectives with economic and societal objectives and ensuring tax costs are distributed fairly in society. This is by no means straightforward. However, tax fairness is crucial to ensure that rising inequality can be addressed; that there is reliable access to basic public services including health and infrastructure; and there is sufficient revenue to address sustainability goals – all issues that the pandemic has brought into sharper focus.

Despite public policy being an integral part of the solution, the question of fair taxation cannot be a matter for individual governments alone or even intra-governmental organisations to resolve. We need a system-wide change and action from a wide range of stakeholders.

Companies and investors need to recognise that externalising costs onto others while aggressively reducing their own corporate tax payments is detrimental to broader society. Civil society organisations should not be the only group highlighting the misalignments between tax practices and broader stakeholder interests. Tax advisers, lawyers and industry associations must advise against aggressive forms of tax planning that are not in line with the spirit of the law. Regulators and standard setters also need to bring stakeholders together to reach much-needed agreements on a new set of tax norms and transparency.

In summary, tax fairness calls for a realignment of tax practices in a way that serves global goals – rather than just shifting the actions of individual governments, companies, investors, or their agents.

The PRI proposes that tax fairness can only be realised when:

sustainability goals and economic prosperity are achieved through effective tax revenue collection and distribution;
opportunities for corporate tax abuse (evasion and avoidance) are eliminated; and,
new global norms on tax that promote integrity, transparency and accountability are established, within and among all participants in the system.

Figure 1: Average statutory corporate tax rates across regions (OECD), p 14

Figure 1_Average statutory corporate tax rates across regions (OECD), p 14

Tax: An asset-level and systemic issue

Tackling corporate tax abuse and ensuring better corporate tax standards are increasingly seen as integral to tax fairness.¹ A growing number of investors are integrating the risks posed by tax issues in their investment decisions. Others are also beginning to consider tax issues from an impact perspective,² for example as part of shaping sustainability outcomes.

Tax risk is financially material at the individual asset level. With tightening regulations and shifting societal expectations, tax avoidance activities of multinational enterprises have attracted large fines and highlighted growing reputational, governance and earnings risks.³ Although artificially shifting profits to low-tax jurisdictions or restructuring for tax purposes could enable companies to reduce their tax liabilities in the short term, such activities have the potential to adversely impact corporate culture and financial integrity, which could have long-term impacts on business and financial success. Also, volatile approaches to tax management and unpredictable tax rates could compromise the sustainability of a business model. Therefore, the view that companies’ tax avoidance activities may serve investors’ interests is, at best, questionable.⁴

Tax is also a macro financial or systemic issue that, if not properly managed, could undermine market performance and jeopardise overall portfolio returns.

Several leading organisations have documented the adverse impact of tax abuse on competition, economic growth and sustainable development. Analysis by Kepler Cheuvreux highlights that large cap companies can lower their effective tax rates via favourable tax treatment thanks to artificial profit shifting, complex group structures and aggressive tax planning, compared to small and medium enterprises, as seen in Figure 2. This fact unfairly tilts the competitive balance in favour of large corporates and away from small and medium-sized businesses, which are a key engine of economic growth over the long term.

Figure 2: Comparison of average five-year effective tax rates of large cap and small and medium-sized businesses Source: Kepler Cheuvreux, (2020), 360 Tax risks, ESG research, p 14

Figure 2_Comparison of average five-year effective tax rates of large cap and small and medium-sized businesses

Tax revenue losses also widen the financing gap for the SDGs. According to the OECD, the shortfall for developing countries to achieve the SDGs following the pandemic could be as high as USD1.7 trillion. This not only leads to cascading effects on provision of healthcare and social protection but could also create greater susceptibility to other crises created by environmental issues such as climate change and political turmoil. Therefore, action to address tax base erosion and profit shifting becomes doubly important in developing countries that bear a disproportionately higher cost from tax avoidance activities.

Unsustainable tax practices also exacerbate inequality by shifting wealth from poorer to richer sections of society which can have a knock-on effect on the economy. The consequences of inequality have become particularly acute and visible following the fiscal pressures posed by the COVID-19 crisis and the confluence of risks that we urgently need to tackle, from climate change and corruption to human rights issues. Rising inequality could have serious implications for social stability – a risk that cannot be mitigated through diversification of the portfolio.

Impacts are particularly relevant for large universal (long-term, diversified) owners. Given that these investors derive most of their value from market performance, there is a strong case to protect the value of their investments, even when there is a trade-off with firm-specific performance. This means prioritising a robust tax system that fuels economic growth and stability over short-term financial returns achieved by companies through regulatory arbitrage.

Such an approach would also be well aligned with beneficiaries’ preferences and expectations in the current environment. Various global surveys indicate that beneficiaries expect their money to be invested responsibly, considering sustainability impact alongside financial returns.⁵

Spectrum of investor views

Based on our research and conversations, investors have a spectrum of views on tax issues, depending on their investment beliefs, risk appetite and culture.

Some investors have a stronger focus on tax efficiency i.e., ensuring that they and their portfolio companies stay compliant with tax laws, while making use of legitimate tax reliefs and reductions to minimise tax costs. Such an approach could become problematic when certain aggressive, potentially unethical tax strategies are tolerated simply because they exist in a legal grey area.
Some investors believe that tax avoidance practices have a negative impact on long-term shareholder value and therefore consider it undesirable from the perspective of good risk management and governance.
Other investors recognise the systemic nature of tax issues, and the impact tax avoidance has on the real economy and the potential to reach global goals. These investors may still undertake prudent tax planning and assess tax risks in their portfolio; however, they would also give due consideration to the societal consequences in judging a business’s tax rate and financial success.

Figure 3: Spectrum of views on tax

Figure 3_Spectrum of views on tax

Next steps

Below are specific steps that the PRI intends to take to support investor action on tax fairness, enabling a step change in global tax norms and practices.

Supplement guidance on stewardship

We have published a range of materials to enable investor engagement with companies on corporate tax responsibility. In 2021, we also published a snapshot on global corporate tax disclosure trends. We will supplement this with recommendations for investors on how they can integrate tax issues within their responsible investment and voting policies. We will also consider how tax fairness can be incorporated into wider collaborative engagements such as human rights.

Strengthen policy engagement

We have contributed to several policy consultations and regulatory developments on tax transparency in the US and EU. For example, this year, we coordinated an investor letter to encourage the EU to mandate a full, public CbCR, securing 37 signatories and representing USD5.6 trn in assets under management. We will increase resources for signatories to contribute to the policy debate on tax transparency and other tax issues.

Develop a model investor policy on tax

Investors are increasingly under scrutiny in terms of their approach to taxation of listed and unlisted investments, and their own operations. We believe a clear commitment and transparent reporting from investors will reduce reputational risks and demonstrate consistency in their responsible investment approach. To facilitate this, we will work closely with a group of leading organisations in this space to develop a model investor policy on tax that other investors can choose to adopt over time.

We will also strive to identify metrics to allow investors to better measure progress in their work towards tax fairness.

We welcome contributions from signatories and other stakeholders as we develop this programme.