ESG and Tax: An organisation’s solution to long-term value creation | The Financial Express

ESG and Tax: An organisation’s solution to long-term value creation

Business leaders should consider ESG initiatives holistically to help fulfil their purpose, achieve their goals, and position themselves for future growth. As these factors gain increased importance, tax practices and regulation have emerged as the key considerations in this journey.

ESG and Tax: An organisation’s solution to long-term value creation
The growing climate crisis is driving increasing demands and pressures on businesses to implement sustainable initiatives and turn their environmental, social, and governance (ESG) practices into action. (Photo Credits: PTI)

By Shivananda Shetty

As climate issues around the world continue to pose a serious threat to the safety of the planet and its people, responsible corporate governance has become a renewed priority. The growing climate crisis is driving increasing demands and pressures on businesses to implement sustainable initiatives and turn their environmental, social, and governance (ESG) practices into action. Business leaders should consider ESG initiatives holistically to help fulfil their purpose, achieve their goals, and position themselves for future growth. As these factors gain increased importance, tax practices and regulation have emerged as the key considerations in this journey.

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ESG and Tax: Increasing importance to institutional investors

Due to the deepening relationship between strong ESG practices and corporate performance, institutional investors are integrating ESG factors into their stakeholder discussions and institutional policies. In fact, they are also starting to use this information to make informed investment decisions. Investment managers and portfolio companies are also adopting sophisticated ESG practices as a critical part of risk management and to differentiate their business. Tax is playing a critical role in these developments. Findings of the KPMG 2021 CEO Outlook report show that 69% of CEOs are feeling increased pressure to report their tax contributions publicly as part of their broader ESG commitments as businesses aim to build back better.

The tax considerations of establishing an ESG program often begin with the evaluation of the investor’s tax framework as well as that of investee companies and their third-party investment managers. Creating a tax risk appetite statement is a starting point and can often be part of a broader, enterprise-wide, risk governance framework. The potential benefits of a tax risk appetite statement are increasing transparency and accountability of the investor’s current and future risk profile, improving decision-making on risk mitigation and performance management and strengthening risk awareness as part of an enterprise-wide risk culture.

The recent EU proposal to introduce the Cross Border Adjustment Mechanism (CBAM) which is aimed at ensuring that the imported product reflects the Carbon price in Europe will have a material impact on the profitability of the Indian companies exporting to the EU. CBAM is a part of the EU Green deal which is a set of initiatives by the European Commission with the aim of making the EU climate neutral by 2050. With ESG factors becoming a core part of the investment process, institutional Investors must stay ahead of the curve to avoid tax, reputational and other risks that might arise. As the journey will vary by institution, each investor will need to determine the aspects of ESG that are relevant to its investment strategy and material to potential investment companies and managers. Understanding the emerging changes to the tax and legal sustainability landscape is the key to navigating it skillfully.

Table – Tax Measures in EU Green Deal.
(Source -KPMG International- Carbon Border Adjustment Mechanism (CBAM), June 2021)

Improving ESG tax and legal governance and reporting

Businesses today are navigating an ever-changing tax transparency landscape – the introduction of new regulations, changes to voluntary disclosure standards and the emergence of new standards and shifts in quality or disclosures within industries. Differing approaches to tax transparency will be adopted and will flex over time. Being transparent about the journey you are on and engaging in a dialogue with stakeholders, can build trust in the business. As trust and transparency become ever more interlinked, it is important that businesses know what is required of them, explore possible voluntary disclosure options, and understand the implications of the approach taken and goals set. Working towards achieving these goals can be filled with hidden complexities, as businesses must first ensure it has a tax risk management and governance framework which is underpinned by robust controls and widely implemented policies. Tax impact reporting with the support of progressive technologies and solutions can help companies explore and achieve their ESG tax transparency, risk management and governance goals and help drive other ESG tax initiatives.

Leveraging ESG for long-term value creation

A business’s performance, which was traditionally linked to pure-play financial and economic metrics, is now also taking full cognizance of the potential ESG value erosion it can lead to. Many business leaders are now aware of the risks and opportunities that ESG brings with it. As per the KPMG 2021 CEO Outlook, 75% of CEOs believe that the pressure put on public finances by the pandemic response has increased the urgency for multilateral cooperation on the global tax system. Not only has this given rise to ESG integration in mainstream financial instruments, but also in various equity-linked and fixed-income instruments which are paving the way for a new world order.

With long-term value creation becoming business as usual, the challenge now lies in quantifying ‘long-term’ given the fact that a host of ESG risks have already started materialising. ‘Value realisation’ is the next step towards making sense of this. The complex process to realise the ‘true’ value of ESG practices begins with adopting the right approach towards them. Once implemented, it needs the right set of metrics to measure the impact that it creates. In the larger context, collaboration at various levels with different stakeholders will also pave the way to develop a common language for communicating impact and leveraging the ESG agenda for sustainable value creation.

(Shivananda Shetty is the Partner & Practice Lead- ESG at KPMG in India. The views expressed are the author’s own and do not reflect the official position or policy of FinancialExpress.com.)

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First published on: 09-10-2022 at 09:32 IST