Why tax should be part of your ESG strategy

Potential tax implications should be front of mind when considering a business’s environmental impact.  For example, a business which seeks to lower its carbon footprint by localising supply chains may find that this has consequences not only for its indirect tax liabilities (e.g., import taxes) but also for its existing functional analysis under transfer pricing rules (amongst other potential tax issues).  

Businesses should also be aware of the potential impact of legislative changes which may be implemented to help drive environmental behaviours.  In the short to medium term, this might include taking advantage of tax reliefs or exemptions made available for ‘green’ or sustainable behaviour.  

In the longer term, the transition to net zero is expected to have significant fiscal implications.  As the economies of the UK and other jurisdictions decarbonise, traditional tax revenues from fossil fuel-related activities will inevitably decline.  Businesses operating in the life science and healthcare sector may, therefore, want to plan for the jurisdictions in which they operate moving towards a ‘polluter pays’ model focused on alternative sources of revenue derived from carbon emissions, water usage, plastic creation/usage and otherwise.  For example, the UK’s Plastic Packaging Tax, in force from 1 April 2022, applies to plastic packaging manufactured in, or imported into, the UK that does not contain at least 30% recycled plastic.  Even those not strictly liable to pay the tax may find that they are paying higher prices as costs are passed through to consumers.  The life science and healthcare sector may see prices rise despite an exemption for certain medicinal products which is limited to ‘immediate’ packaging and, in any case, the packaging would still count towards a manufacturer or importer’s 10-tonne registration threshold.  Businesses will need to be alert to these types of development, both current and future, in each jurisdiction in which they operate and adapt accordingly. 

Tax avoidance is increasingly viewed as not just as an economic issue, but as a moral one too with tax becoming a fundamental part of the ESG agenda.  In light of current economic circumstances, businesses need to be more vigilant than ever to any tax issue that might cause unwelcome publicity or significant reputational damage.

A particular issue for life science businesses is the approach taken to intellectual property (“IP”).  Many life science businesses derive a large part of their value from IP, often with IP rights held in one jurisdiction but licensed or developed elsewhere, which has led to the creation of IP ‘hubs’ (i.e., the concentration of profits from the exploitation of IP in low tax jurisdictions).  International developments and domestic legislation (such as the UK’s Diverted Profits Tax) are already targeting these types of structures that erode the tax base of those jurisdictions in which the relevant work on research and development is taking place.  Multinational groups that hold valuable IP portfolios should review their current tax planning arrangements to assess not just the risk of challenge by tax authorities but also the potential perception by stakeholders and the public.

The global tax landscape has radically changed in recent years.  In the face of public pressure to crack down on perceived tax avoidance, in particular by multinationals, tax authorities are becoming increasingly proactive.  Moreover, international initiatives have seen unprecedented levels of transparency and cooperation between tax authorities.  

For example, country-by-country reporting was designed as part of the OECD Base Erosion and Profit Shifting (BEPS) project to provide tax authorities with an overall picture of the global profit and tax position of multinational groups operating in their jurisdictions.  Notwithstanding these developments, there are increasingly calls for information on country-by-country reporting to be made more publicly available.  In 2019, the Global Reporting Initiative issued the first global standard for public country-by-country reporting and the EU has also approved a new directive requiring member states to introduce legislation by June 2023 for public country-by-country reporting for certain large companies.

As a result of social attitudes to tax (and particularly in light of greater transparency), businesses will, of course, need to ensure that they are compliant with the tax rules of any jurisdiction in which they operate, reviewing tax policies and responsibilities where appropriate.  There is the potential for all businesses to embrace the developments towards greater tax transparency and accountability in order to showcase their ESG credentials, reassuring investors that a sustainable and responsible approach is being taken in relation to the tax affairs of the business.

• Ensure that all potential tax consequences are considered before implementing any decisions in relation to the broader ESG strategy.
• Monitor potential environmental policy and legislative changes that may impact the use of any environmental reliefs or affect business models more broadly to ensure that these are factored into ESG strategy.
• Review existing tax structures, policies and responsibilities to ensure that the risk profile for tax is aligned to the broader ESG strategy and that tax compliance is made a priority.  Complex or potentially aggressive structures should be assessed not just for the potential risk of challenge by tax authorities but also the potential perception by stakeholders.
• Consider greater levels of tax transparency and reporting to communicate ESG credentials to stakeholders.