Investors want to know their portfolio companies are paying taxes in line with their business activities, as aggressive tax planning costs governments billions of dollars of revenue, and creates market distortions in both developed and developing countries.

Concerns about economic inequality and media scrutiny of controversial tax practices have thrown the spotlight on corporate tax responsibility. As a result, international bodies and institutions such as the European Commission and the Organisation for Economic Cooperation and Development (OECD), among others, are working to clamp down on unsustainable tax practices. 

We were delighted to work with the academic coordinator of the OECD’s Base Erosion and Profit Sharing (BEPS) initiative, Professor Sol Picciotto, to develop a review of the BEPS project for investors (see p25 of Engagement guidance on corporate tax responsibility: Why and how to engage with your investee companies). 

As the tax landscape is changing, there is a need for greater corporate tax disclosure to allow stakeholders to evaluate if companies are striking the right balance between controlling their tax bill and paying their “fair” share. Indeed, PRI signatories have identified tax as a priority issue and are keen to build their understanding around this issue.

Why are investors concerned about aggressive tax planning?

  • Materiality:  Tax is material to the profitability of corporations, and investors want to understand the extent to which companies’ future cash flows rely on the performance of the underlying business and the extent to which they rely on access to subsidies and credits, and on artificially shifting profits to operations in low-tax jurisdictions.
  • Reputation and brand:  By seeking to aggressively minimise their tax bill, companies risk damage to their reputation and the value of their brand, harming their relationship with host and/or home country, and affecting their social licence to operate. Negative media coverage may result in boycotts and consumer backlash.
  • Inequality:  In minimising their tax liabilities, companies deprive governments of resources they need to: fund public services, such as education and healthcare; pay for public infrastructure; and build well-functioning economies. Companies depend on a stable economy and basic infrastructure to generate revenue, so by using aggressive tax planning practices they may contribute to an unsustainable business environment and undermine long-term investment returns.

Global investor collaboration on tax

In 2015, 11 global investors came together with the PRI to explore corporate tax planning in more detail. One of the challenges identified by the group was the high level of secrecy around companies’ practices, which made it difficult for investors to assess tax risks and opportunities in their shareholdings. Moreover, the legal framework governing tax practices varied across jurisdictions and the technical language used in corporate communications regarding tax created barriers to effective dialogue. To address these barriers, and provide a framework for investor-company conversation, the investor group produced a briefing paper, Engagement guidance on corporate tax responsibility.

In 2017, the PRI and the investor group supplemented the guide with Investors’ recommendations on corporate income tax disclosure – a set of recommendations to strengthen corporate income disclosure across tax policy, governance and risk management, and performance . The recommendations (supplemented by explanatory notes) aim to help investors evaluate the maturity of their portfolio companies’ disclosure practices, and to facilitate discussion about how companies can improve the extent and quality of their tax disclosures.

From guidance to engagement: healthcare and technology

To put the guidance and recommendations into practice, a group of 35 institutional investors, representing US$2.9 trillion in assets under management, joined a PRI-led collaborative engagement on corporate tax transparency, focusing on the healthcare and technology sectors. By being part of a collaborative engagement, the investors benefit from collective knowledge and pooled resources and, when opening dialogues with companies, increased influence and enhanced legitimacy.

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Company selection in PRI-collaborative engagements is typically based on factors including market capitalisation, variation of ESG performance, and the size of the shareholding involved. In this engagement, healthcare and information technology (IT) were chosen because of their sector-related risks, including:

  • Dependence on revenues related to intellectual property (IP): the IT and healthcare sectors intrinsically depend on IP-related revenues. Because IP is intangible, and does not usually have a transparent market price, it can enable the abuse of transfer pricing where divisions of a company transact with each other.
  • High tax gaps: Companies in these sectors have been known to have the highest gaps between the statutory tax rate, and the effective rate of tax they actually pay, relative to other sectors. Although these tax gaps may be the result of factors unrelated to profit shifting, a large and persistent tax gap may be indicative of aggressive tax planning and warrant further consideration from investors.
  • Poor tax disclosure: Companies in these sectors often have poor tax disclosure. Given the tax risks associated with the sectors, investors are interested in increasing transparency around their tax practices.

To help investors start a dialogue with their portfolio companies, the PRI commissioned a benchmark study on corporate tax disclosures by 50 companies from the two sectors. Based on this research, the PRI also published a report – Evaluating and engaging on corporate tax transparency: An investor guide– which investors can use to identify areas for further evaluation when assessing their portfolio companies’ data on tax. This will also enable them to conduct a more structured dialogue with investee companies.

The report focuses on engagement dialogue in these key areas:

  • Policy: A clear majority of companies in the research set had not yet published a tax policy that applies to the entire organisation. Investors can therefore encourage companies to formulise their approach on tax.
  • Governance and risk management: Although a relatively large number of companies had published information on tax risks, corporate reporting could be more detailed and organisation-specific. Investors can encourage companies to articulate the process of identification and management of tax risks.
  • Reporting: None of the companies surveyed had published a country-by-country report. Investors could request more meaningful data that substantiates companies’ commitments to avoiding aggressive tax planning.

Recommendations

The international community, including investors, is concerned about the consequences of aggressive tax planning, and want to push for responsible tax practices. With an increased awareness of and interest in collaborating on these issues, investors can use their leverage to drive change in company behaviour.

Some starting points for investor conversations may be to:

  • discuss the board’s view on corporate income tax, and how its approach aligns with the company’s business and sustainability strategies;
  • engage with companies on how they define and manage tax-related risk;
  • discuss the company’s thoughts or concerns around providing a detailed report on operations and corporate income taxes paid, broken down by country level; and
  • ask if the company has ongoing dialogue with stakeholders on tax (e.g. tax authorities, civil society organisations, consumers) and how it has impacted on tax policy.

Investor expertise

To ensure that investors build expertise on tax issues, and to support investors in engagement and ultimately in improving corporate performance on tax, the PRI provides tools and resources to investors on an ongoing basis. These include:

  • Report – the 2018 report informs investors about trends and gaps in corporate tax disclosure;
  • Company research,  such as the benchmark study on individual companies’ tax disclosure, which can be used by investors when going into dialogue with their portfolio companies;
  • Calls with experts  (e.g. practitioners, academics and tax authorities) are regularly held to address topical issues (such as one here covering the OECD’s BEPS Action 13 requirement);
  • Calls with company representatives  to understand what leadership means in relation to corporate tax transparency; and
  • Investor days, which bring together experts on tax to talk with and guide investors on technical material.

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