Today, environmental, social and governance (ESG) considerations have transcended to vital importance in corporate strategy. This shift in significance is a result of growing recognition that long-term business success is hinged on sustainable practices. As a result, ESG factors have started yielding substantial influence on investment decisions, operational strategies and regulatory frameworks across industries around the globe.
Within the tri-headed ESG spectrum — governance is a key pillar that is critical to how a company is run. Governance pertains to aspects such as corporate ethics, accountability, transparency and stakeholder relationship management. More specifically, tax governance involves strategies employed by companies to ensure compliance with tax laws. However, tax governance is not merely limited to such strategies but also encompasses how such strategies reflect the company’s commitment to corporate social responsibility. Therefore, tax governance has a bi-fold objective.
First, to ensure compliance with tax laws and, second, to signal stakeholders that the company is committed to fair and responsible business practices. The second objective has taken centre stage in a context where stakeholders are increasingly demanding greater transparency and accountability from corporations — not only in terms of how much tax they pay but also their contribution to societal and environmental goals.
The Role Of Tax In ESG
For companies, transparent tax policies play a key role in cultivating trust among stakeholders and the public. Naturally, companies that are open with their tax dealings are viewed as more trustworthy and responsible. This is because tax contributions are fundamental to financing public services such as healthcare, education and infrastructure and therefore a big portion ends up being used for social equity initiatives. Therefore, tax contribution forms a key part of the social pillar of ESG and companies that align their tax practices accordingly demonstrate social responsibility.
Challenges And Opportunities In Integrating Tax And ESG
However, integrating tax strategies within an ESG framework is not without its challenges and complexities. The primary challenge is to find alignment with the intricate requirements of different jurisdictions. These jurisdiction-specific requirements are complemented by evolving global standards, such as the Organisation for Economic Co-operation and Development’s Action Plan on Base Erosion and Profit Shifting (OECD BEPS). While these varying requirements have a common aim to curb tax evasion and ensure fair tax practices — their application and enforcement can vary significantly across jurisdictions.
In addition, given that regulatory dynamics are changing faster than ever, companies are required to continuously adapt tax governance. This includes ensuring adherence
to sustainability-themed indices and frameworks such as the Global Reporting Initiative (GRI), which now includes tax disclosures as a key component.
Despite these challenges, the market dynamics present a significant opportunity for companies to demonstrate leadership in sustainability and enhance their corporate reputation and stakeholder trust. For instance, transparent disclosure of tax contributions supports a company’s claim of positive contribution to society that serves all stakeholders, and not just their shareholders.
Best Practices In Tax Governance For ESG
To effectively integrate tax governance and ESG goals, companies must develop a comprehensive tax governance framework that ensures transparency and compliance in alignment with broader sustainability objectives. Unsurprisingly, such a process would require the board of directors and the senior management to play the crucial role of setting the tone at the top, and overseeing the implementation of tax strategies that are ethical and transparent. This would entail actively monitoring the company’s tax practices and preventing aggressive tax planning that may harm their reputation and stakeholder trust. The leadership should also ensure that tax policies are regularly reviewed to reflect the company’s commitment to responsible business practices.
It is also pertinent to note that the market has led the way in setting the best practices in tax governance. For instance, some institutional investors have started considering responsible tax behaviour as a crucial factor in their investment decisions. A group of investors even developed a tax code of conduct to guide their investment decisions, emphasising transparency and responsibility in tax governance as integral to their ESG commitments.
Additionally, the GRI standards, specifically GRI 207, which focus on tax transparency, have provided a clear framework for comprehensive disclosure about tax practices for companies. These disclosures entail information on tax governance, risk management and contribution, helping stakeholders evaluate how companies have aligned their tax practices with their social responsibility.
Tax Incentives For ESG In Malaysia
Malaysia’s 2024 budget has introduced a slew of tax incentives to encourage widespread adoption of ESG initiatives. Such an approach indicates a decisive policy manoeuvre by the government in furtherance of the ESG agenda. Some of these incentives are:
•Tax deduction of up to RM50,000 a year for ESG expenses
•Tax exemption extension for management fee income from Sustainable and Responsible Investment (SRI) funds
•Tax deduction on issuance costs of SRI sukuk
•Tax exemptions on grants for SRI Sukuk and bonds under Asean Sustainability Linked Bonds Standard
•Tax deductions up to RM300,000 for Measurement, Reporting and Verification related to carbon projects
•Tax deduction for contributions to tree planting, environmental preservation and conservation awareness projects verified by the Forest Research Institute of Malaysia
Future Of Tax Governance In ESG
In the future, tax governance is expected to be significantly influenced by technological advancements and international cooperation. First, technological innovations such as digital reporting platforms and blockchain are expected to enhance the efficiency and overall transparency of tax compliance. This would facilitate more accurate and timelier ESG data collection.
Additionally, the growing trend towards international cooperation driven by initiatives such as the OECD BEPS action plan is expected to eventually harmonise tax regulations. As such cross-border initiatives take off, it will become easier for businesses to comply with ESG-related tax obligations.
Conclusion
In the future, integrating tax governance with ESG strategies will become of vital importance for businesses aiming to build and maintain trust with stakeholders. Therefore, businesses are encouraged to adopt transparent and responsible tax practices as a part of their commitment to sustainability. This will not only help them comply with regulatory demands but also position them favourably in the eyes of investors and the public, who are increasingly prioritising ethical practices and transparency in their engagement with corporations.
This article first appeared in Forum, The Edge Malaysia Weekly on 15 July 2024 – 21 July 21 2024.
4 December 2024