Amid the trials and challenges of the COVID-19 crisis, there was a silver lining. Quieter roads, clearer skies and more flexible working arrangements were a direct result of COVID-related restrictions.
The global pandemic taught businesses and society at large that ambitious environmental, social and corporate governance (ESG) policies are achievable, pushing expectations even higher. COVID was not a distraction for the ESG movement – quite the opposite: it supercharged the agenda.
Moreover, elevated green policies in countries around the world have brought climate change into sharper focus. The UN Climate Change Conference (COP26) in Glasgow in November 2021 this year has already focused additional emphasis on green issues and sustainability worldwide. At the same time, the Black Lives Matter movement has brought more attention to diversity and the importance of acting against unconscious bias and prejudice.
While most businesses welcome greater attention to ESG priorities, it provides a heavier burden of responsibility for management, compliance professionals and in-house legal departments.
Munir Hassan, Head of the CMS Energy & Climate Change Group, talks about the focus on ESG
Balancing innovation and regulation
ESG efforts are encouraging innovation and creativity. Munir Hassan, Head of the CMS Energy & Climate Change Group, points to the ongoing evolution of most of the big oil companies. They have recognised the limited lifespan of hydrocarbons and are actively investing into greener products and renewable energy and implementing their own climate transition plans.
Alongside this, Munir Hassan notes that governments and regulators are promoting a raft of new rules and laws, which sit alongside a large number of voluntary arrangements that corporates and institutions are signing up to in their relevant sectors or areas of activity.
Transformational technologies are also on the horizon, such as the emerging areas of carbon capture and green/blue hydrogen networks, and these are creating new opportunities for accelerating the energy transition.
While regulators and authorities are doing their best to develop the rules of the game as quickly as they can, one risk for corporates is in properly understanding how best to work within new, untested, changing or ambiguous areas of law, regulation and practice. Good relationships with public bodies and the ability to draw on parallels from more mature parts of the ESG agenda are often key to being a successful first mover in this space.
The lawyers advising these pathfinder businesses are having to practice at the intersection of existing laws, new and proposed rules, public sentiment and a raft of government policies, while also helping clients to understand risk allocations and commercialisation models in emerging business lines that are often radically different to those they are familiar with.
Profit versus purpose
Businesses, large and small, must also address the shift away from shareholder value being the primary guiding principle for corporate strategy. The notion that organisations must balance profit versus purpose has evolved rapidly, with many corporate leaders recognising that purposeful businesses are often more profitable. Oil majors opting to move into renewable energy is a prime example, given greater impetus by shareholders, investors and financiers who are paying more attention to environmental accountability.
Although shareholders remain hugely influential, organisations are listening more acutely to a wider group of stakeholders, notably employees and customers. The reason is simple: employees who feel valued perform better; responsible businesses retain clients and attract new ones. Any ESG failures could severely damage relationships with all these groups.
Kristy Duane, Co-Head of the CMS Infrastructure & Projects Group, talks about the focus on ESG
Managing compliance
For general counsels, legal and compliance departments and management boards, this raises important concerns and impacts operational priorities. Business leaders face a deluge of regulation across the entire spectrum of ESG criteria on a national and global level, though these rules are rarely aligned from one country to the next. It is never easy to adhere to a complex patchwork of regulations such as has emerged over the last years.
Kristy Duane, Co-Head of the CMS Infrastructure & Projects Group says, “There’s an expectation that management should be on top of these topics – energy and climate change in particular, but also other ESG aspects. This has filtered into boardrooms. They now appreciate that compliance is more than simply a stakeholder expectation. Now, serious risks can arise from a failure to comply with ESG regulations.”
The expansion of compliance teams in many businesses is an indication of the mounting importance of such matters, including corporate governance. Accounting standards and financial reporting are expected to integrate ESG elements over the next few years, making it possible to assess financial performance against ESG commitments.
Kristy Duane believes that this will drive a different way of thinking, with greater emphasis on up-front public disclosure rather than end-of-year financial reports: “There’s a number of disclosure obligations for listed companies, fund managers and all sorts of operators. And now it’s just not possible for businesses to keep their ESG performance to themselves. There’s quite a number of stakeholders who will be demanding extra information over the next two to three years. And that puts a lot of pressure on organisations. As soon as they have to tell people how badly they’re doing, then they really are exposing themselves to greater and greater risks.”
For management and in-house legal departments, this development means a move towards reskilling and retooling, along with a willingness to learn from other sectors. At CMS, practice and sector groups collaborate to assess the regulatory landscape and recognise how the rules in one sector may apply to others. “We’re seeing disruption and innovation, and the need for cross-disciplinary teams. You don’t say this is an energy project or this is a telecommunications project any more, you have both experts at the table. So, you can actually bridge that divide,” Munir Hassan says. “And the in-house teams obviously need to try and figure out the best way of doing that as well.”
César Navarro, Head of the Employment and Pensions Group at CMS in Madrid, talks about the focus on ESG
Being socially responsible
One key area of the ESG movement to be energised by the COVID pandemic is employment. Setting up flexible working arrangements, for example, has helped many businesses to navigate the COVID situation successfully.
César Navarro, Head of the Employment and Pensions Group at CMS in Madrid, comments, “We are seeing new regulations on diversity and inclusion, gender equality and a general improvement of employees’ rights. Achieving a balance between personal and working life especially is becoming really important.”
Because of the increased focus on employee rights, César Navarro believes that many businesses are not only complying with regulation but are going beyond: “There’s lots of regulatory pressure, but many companies and corporations want to stay ahead of that wave. So, we are working on new policies and new assessments, with companies wanting to have certificates in place to show that they are at the forefront of ESG.”
Risking your reputation
Exceeding the minimum ESG obligations is reputationally expedient, particularly in an era when social media and a relentless news cycle ensure that mistakes and poor judgement are frequently brought to light.
In addition to the court of public opinion, another risk is emerging: climate change litigation. In May 2021, for example, a court in the Netherlands ordered Shell to reduce its emissions following a case brought against it by Friends of the Earth which cited the oil giant’s obligations under the Paris Climate Agreement.
In such cases, the reputational damages are potentially far more severe than financial penalties.
Kristy Duane concludes that businesses must constantly engage with the ESG agenda and all stakeholders: “We have moved from this being a discussion topic to requiring action, none more than in light of the IPCC’s recent report [Intergovernmental Panel on Climate Change Working Group report]. And your employees will be keen to understand more – how they can, individually and as part of your business, make a difference.”
According to the European Commission’s figures, buildings are the largest energy consumer in the EU, responsible for about 40% of energy consumption and 36% of carbon dioxide emissions. The real estate sector therefore has an important role to play in striving towards our net zero targets.
The COVID-19 pandemic has also focused the industry’s attention on the social impact buildings can have on a community: the buildings we live and work in; retail, leisure and public spaces; and buildings used for healthcare and education.
ESG has therefore risen on the agenda over the last year, and many property investors and developers have announced their own ESG targets.
The ESG impact of a building needs to be considered both in connection with its initial construction and also its ongoing operation. We may see fewer complete redevelopments in the future, with a focus more on refurbishments or retrofitting. Where sites are completely demolished and rebuilt, modern construction methods may be employed to reduce the carbon impact of that development.
Using more sustainable materials in developments is likely to impact the appearance of our buildings of the future. Modular construction, as well as the use of tech in the construction process, can both assist in the knowledge of the in-built carbon and other sustainable data features of a building.
The planning regime will often impose both green and social requirements for a redevelopment or refurbishment (such as minimum BREAAM[1] certification or the requirement for the contractor to employ a certain number of local people). However, many developers are going further than the planning requirements, ensuring that their buildings are designed and built taking their environmental and social impact into account alongside the financial appraisal.
Wellbeing has also risen up the agenda for employers. If employees can work in a building that benefits an individual’s wellbeing (whether through appropriate lighting and heating/cooling design or through the facilities offered), this is an advantage. Therefore, designing and building workplaces which improve wellbeing will attract occupiers.
In terms of the operation of a building, this goes hand in hand with the trend towards a more operational real estate model. Occupiers of multi-let buildings are increasingly looking for more flexible leases with an increased level of services being provided by landlords, while occupiers of whole buildings (or a substantial part of a building) want more control of the buildings themselves. Many occupiers want to be in a sustainable building, so focusing on the ESG performance of a building can attract tenants. Data collection and control over air conditioning, cleaning products, refuse and recycling and social engagement with the local community are all things that require cooperation between landlord and tenant. The pandemic has necessitated conversations between landlords and tenants and it is hoped that these dialogues will continue to encourage collaboration on ESG issues.
There was a time when tax planning was an acceptable way for corporations to mitigate costs. Cost-cutting, profit maximisation and shareholder value aligned with the Friedmanian ethics of the day. That time has long gone. Over the past ten years, tax planning – or at least a certain interpretation of tax planning – has been deemed morally wrong.
Ever since the OECD (Organisation for Economic Co-operation and Development) tagged the emotive – and very subjective – “aggressive” on to tax planning, there has been much hullaballoo over corporate tax policies and practices. Indeed, “aggressive” implies moral appraisal of tax planning – and when moral appraisal comes to the fore, ethics and all their accompanying grey areas are not far behind.
Corporates as moral actors
In a post-financial crisis world, corporations are being urged to behave ethically which, according to the Merriam-Webster dictionary, means in a way “conforming to accepted standards of conduct”. So, for want of clarity and sharpness in the definition – along with fear of reputational damage – companies focused on corporate social responsibility (CSR) and included tax planning practices in the process. The public outcry over the Starbucks case is a perfect case in point: where one claims to feel embedded in society and therefore attaches great interest to trust at all levels – with trade partners, customers and the wider society – one cannot indulge in aggressive tax planning.
It does make sense to consider companies as moral entities rather than mere legal entities. They act according to their specific organisation, making their own decisions that may have an impact on other stakeholders. Therefore, considering that “tax revenues provide governments with the funds they need to invest in development, relieve poverty, deliver public services and build physical and social infrastructure for long term growth”, 1 corporations must plan their tax affairs to the extent that they contribute to society through payment of their fair share of taxes.
As part of their CSR approach, multinational corporations may endorse a ‘tax code of conduct’ describing the principles and general framework that guides their group tax affairs and relations with their clients and the tax authorities. The general idea is to highlight that the group does not encourage or promote tax evasion and is very much concerned with paying its fair share of tax.
Ethical debates are brought to fever pitch where the corporation enshrines a “main purpose” test rule in the tax code, sometimes long before its introduction in legislation. But what if the code does not include internal procedures to be carried out when a member of staff fails to comply with its provisions? If so, the whole code fails to make sense and remains mere wishful ‘ethical’ thinking.
Paying a fair share of tax: a shared responsibility
Corporations cannot be the only ones to be held morally responsible for their actions, however. Determining a fair share of tax is a matter of shared responsibility with the state, as the appropriate amount of tax to be paid by corporations is initially set in law.
The concept of paying a fair share of tax is a key element in the implementation of CbCR (country-by-country reporting). CbCR was introduced by the OECD as an addition to transfer pricing documentation, but it has nothing to do with the arm’s length principle for information provided in the country-by-country report. It is based on consolidated information, which by definition eliminates all intercompany transactions within the scope of transfer pricing rules.
CbCR is nothing more than a means to identify situations where profits have been allocated to low substance or low tax countries – and therefore fosters the assumption that those situations are not compliant with applicable tax rules. Furthermore, country-by-country reports filed by multinational corporations should soon become public information in Europe further to a draft directive currently being hotly debated in many European counties. This may lead to misinformed finger-pointing, as the public would have access to rough data collected for review and use by tax authorities and not for the public eye. Each and everyone’s take on ‘ethics’ would then become overwhelming.
Impartiality and equal treatment should be the cornerstones of any tax legislation. States have the option of using taxation to attract non-resident companies to create employment and tax revenues. But they do so at the expense of the integrity of the international tax system as they create harmful competition. Where the OECD and the EU have got to grips with aggressive corporate tax planning, their ongoing works mostly fail to acknowledge the part played by governments in deliberately reducing some corporations’ tax burdens.
More legislative consistency and clarity, fewer ethical grey areas
The fairness of the system should also be guaranteed by tax legislation. In this respect, further to the OECD/G20 base erosion and profits shifting (BEPS) initiative, lawmakers have implemented provisions challenging transactions deemed unethical in the wake of the 2008 financial crisis.
The restrictive rules on interest deduction included in the EU’s ATAD directives 2 offer a prime example: when these were introduced in 2016-2017, the use of hybrid entities and instruments was then one of tax planning’s key elements, as it relied on differences in analysis of legal agreements between States. Where tax legislation was by nature based on a unilateral approach to transactions, skilled tax professionals would use their multijurisdictional knowledge to structure tax-efficient financing which complied with two or sometimes three countries’ tax rules, and general anti-abuse rules would typically not apply to such transactions. To counter this, both the OECD and the EU designed specific anti-abuse rules, and therefore made illegal what was up to that point merely unethical.
But legislation may lack consistency and certainty, leaving taxpayers with the responsibility of deciding how they use the rules. Taxpayers should be able to abide by the letter of the law to plan their tax liability. This would be fair all round – and provide a good measure of the fair share of tax to be paid. But as law is so often poorly drafted, it leaves room for tax planning approaches that are labelled aggressive.
To counter these practices, lawmakers and courts have relied on the spirit of the law or the intention behind the letter of the law. The scope of tax planning is then broadened to ethics as it implies a moral evaluation of any business operation.
General anti-abuse provisions which have flourished in both domestic and international tax rules 3 in recent years set an example. According to such provisions, a business operation may be disregarded if it has been set up not only with the sole purpose, but with the main purpose or one of the main purposes, of obtaining a tax advantage that defeats the object or purpose of legislation. The tax authorities are then allowed to disallow any arrangement that has resulted in a lower level of taxation than the one they deem to be acceptable. While case law shows that it is an ordeal in itself to determine the sole tax purpose of an operation, how can the “main” purpose – let alone “one of the main purposes” – of an operation be safely assessed? How then can taxpayers determine their fair share of tax where legislation fails to be consistent enough to do so itself?
Tax advisers may have an answer. But where do they stand, torn as they are between their commitment to their client and their own moral and legal responsibilities?
Tax advisers: walking the fine line between planning and aggressive planning
The time when tax advisers could indulge in a tasty “double Irish with a Dutch sandwich”, a tax avoidance technique employed by certain large corporations, is over. Clients have probably not changed: they still call on their tax adviser to reduce their tax liability. But tax advisers have had to change because they were cast as the villains of the story. They used to be ethically and legally able to help their clients to deal with their tax affairs to any extent. They can still do so today, but under the shadow of legal penalties if their tax planning is branded as aggressive by the tax authorities.
At the end of the day, tax advisers are left with the responsibility of determining the degree of morality that separates tax planning from aggressive tax planning. In so doing, they may face a breach of the attorney-client privilege which is the essence of their profession – rather unethical indeed.
The mandatory disclosure of cross-border tax arrangements by European intermediaries provided by the 25 May 2018 “DAC6" 4 directive became effective on 1 July 2020. The whole system, sophisticated yet highly complex, requires intermediaries, and in some cases taxpayers, to report a wide range of “potentially aggressive tax planning arrangements” to tax authorities. It was implemented into local law in all EU countries in 2019 and 2020. Cross-border tax arrangements, which could be labelled as “potentially aggressive” according to general or specific hallmarks set up since 1 January 2021, must be reported within 30 days. Tax authorities of most EU countries issued guidelines on the DAC6 reporting obligations. Sadly, they do not provide intermediaries and taxpayers with the much-expected clarification. If they fail to report a “potentially aggressive” cross-border tax arrangement, tax advisers could face penalties, varying from country to country, of up to several million euros in the Netherlands and Poland, for example. This provides another example of the fact that lawmakers are keen to rely on ethics without clearly integrating the concept into law. |
Through its Identification for Development or ID4D programme, the World Bank, partnered by the Bill & Melinda Gates Foundation, has been working for a number of years to create an environment in which the increased use of reliable digital identity systems allows and supports faster and more wide-ranging development in the developing world.
Among the benefits of digital ID are that low-cost and reliable identification can be made available in jurisdictions where any form of identification itself has been hard to come by. This has a number of beneficial consequences for individual participation in society including in governmental and social programmes, but extending more generally into the world of employment and other forms of economic participation.
One of the aspects of digital ID which the World Bank has been particularly energetic in supporting is that of the legal systems required for digital ID itself to be reliable and secure, respecting the rights of the individual and interoperable with other systems and countries. This is a fundamental part of a reliable digital ID infrastructure.
CMS has worked with the World Bank on a number of such projects spanning three continents. Most recently we have worked in Bolivia and Russia, and before that in Madagascar, Brazil, Lesotho, Sudan, eSwatini and Zimbabwe.
More information here.
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