A tax system reset: what are the implications for investors?

Political priorities seem to have shifted as a direct consequence of the devastating human and economic shocks from COVID-19. Tax topped the headlines recently as a group of world leaders deliberated on new norms around the international tax system at the G7 summit, outlining a plan to tax large global companies with a profit margin of 10% and endorsing a global minimum corporate tax of at least 15%. The move is radical for governments that let competition shape tax policy for several decades, leading to declining corporate tax rates and increasing corporate tax avoidance practices.

Building back better

The winds of change appear to be driven by the urgency to ”build back better” from a crisis that warranted unprecedented public spending, leaving national budgets in the red, as well as an emerging recognition that societal impacts of tax avoidance matter. As several experts have reiterated, this is an important milestone when tackling a complex and deeply entrenched issue such as corporate tax avoidance.

The implications of this reform could be significant. From a corporate perspective, companies could be facing a larger tax bill in countries where they sell products or services. Although the scope of the regulation is yet to be determined, it would be fair to say that companies that have historically enjoyed single digit effective tax rates will likely see it rising and companies that have been disadvantaged due to a patchy tax framework and tax avoidance practices of peers will benefit from greater tax certainty. Importantly, a global minimum tax could disincentivise multinationals from shifting profits to low tax jurisdictions by requiring companies to “top up” their payments to the minimum tax rate. The measure could also boost tax revenues for governments. However, it is yet to be seen by how much and in which countries—these details will depend on the form that the final agreement between global governments takes.

Risks and opportunities

In such a dynamic environment, enhanced tax transparency will be of prime interest to investors assessing tax risks and opportunities in their portfolio or actively seeking to manage (positive and negative) impacts relating to tax. They will expect companies to demonstrate that their taxes paid are aligned with commercial operations and to explain any perceived inconsistencies with clarity.

The data, however, suggests that companies will need to play catch-up to respond to these expectations. Recent PRI-commissioned FTSE Russell research, covering 1,300 large, listed companies across developed and emerging markets found that over half of companies globally make no material disclosures at all; and less than 10% disclosing country-by-country breakdowns of taxes paid . Although modest improvements have been observed in relation to companies publishing a commitment against tax avoidance, reporting is nowhere near the levels we see on other sustainability topics.

PRI-commissioned research covering 1,300 large, listed companies across developed and emerging markets found that over 50% of companies globally make no material disclosures on tax at all 

So, it is positive to note that regulators are no longer watching silently. Recently, there was a breakthrough in the EU negotiations on a public country-by-country reporting (CBCR). file that had been in limbo for nearly five years. In the first week of June, the trialogues between the European Commission, the European Parliament and EU council concluded and new rules on enhanced tax transparency were agreed upon. Under the new rules, multinational companies and their EU-based subsidiaries with annual global revenues over €750 million will have to publicly publish a report with their relevant tax information, including their net sales and profits, number of employees, income taxes paid and accumulated earnings, country by country. The reporting could start as early as 2023.

Although these requirements could be conceived as a step in the right direction, the Directive will not demand a full public CBCR by companies in scope—so, companies will not be required to produce disaggregated information on all countries of operation, just those within EU members states and EU black and grey list of non-cooperative jurisdictions (where countries have been listed as such for more than two consecutive years). Additionally, companies that are concerned about commercial sensitivities are protected via a safeguard clause that will allow them to defer reporting for up to five years. This could present new challenges for investors that were hoping for consistent and comparable information from companies on tax and other economic data related to all operations. Key concerns are outlined in this letter signed by 37 investors/investor groups representing US$5.6 trillion in AUM.

Next steps

So, what should investors do next? Firstly, they should continue to engage with companies to improve tax transparency with a minimum requirement of publication of a global policy. Escalation should be promptly employed where companies are failing to show sufficient progress. In the next few months, the PRI will be providing guidance on how tax can be incorporated into voting. Secondly, investors should leverage the momentum and advocate for ambitious reforms of the tax system. This is the time to make the case that tax fairness matters to investors as much as to other stakeholders. Afterall, realising the SDGs, achieving progress on addressing climate change as well as a green recovery is reliant on the tax revenues that can be allocated to these programmes by governments.

This blog is written by PRI staff members and guest contributors. Our goal is to contribute to the broader debate around topical issues and to help showcase some of our research and other work that we undertake in support of our signatories.Please note that although you can expect to find some posts here that broadly accord with the PRI’s official views, the blog authors write in their individual capacity and there is no “house view”. Nor do the views and opinions expressed on this blog constitute financial or other professional advice.If you have any questions, please contact us at [email protected].