Why tax should feature prominently on the ESG agenda

Interest in environmental, social and governance (ESG) issues has grown exponentially over the last two years, notably catalyzed by the COVID-19 pandemic that has exposed the vulnerabilities and inequalities in economics and societies.

The 2021 EY Global Institutional Investor Survey (EY investor survey) found that ESG drivers and climate change are increasingly central to investment decision-making. Evidently, private funds are targeting investments that have clear ESG positioning. 

NextEnergy Capital, for instance, raised US$896m for its latest ESG fund that focuses on solar infrastructure investments in Organisation for Economic Co-operation and Development countries.1 This achievement was way above the targeted US$750m. 

Blackstone also announced the launch of Blackstone Credit’s Sustainable Resources Platform to focus on investing in renewable energy companies and those supporting the energy transition and lending to them.2

The term ESG has a very wide scope. It encompasses an extensive range of considerations, including tax. Broadly, ESG components can include the following:

• Environmental: climate risks, carbon emissions, energy efficiency, pollution and waste management, use of natural resources, clean energy and technologies
• Social: labor relations and working conditions, diversity and inclusion agenda, human rights, employee safety, tax and economic contributions to communities
• Governance: board diversity, business ethics, risk tolerance, tax strategy, policies and reporting

The EY investor survey also found that there is a dearth in companies’ ability to assess ESG risk effectively and to meet the increasing stakeholder emphasis on social issues. 

What role does tax play in ESG disclosure? 

Within the ESG agenda, tax is featured across various components. In the environmental aspect, tax is often used as a fiscal tool to drive sustainability activities in businesses.

Carbon pricing measures (in the form of carbon taxes and the carbon border adjustment mechanism), environmental taxes such as plastic and packaging taxes as well as resource and pollution taxes are imposed to send clear signals to organizations to be mindful of climate sustainability.

In Singapore Budget 2022, the announcement of a significant increase in Singapore’s carbon tax to S$25 per ton in 2024, and to S$45 per ton in 2026, with a view to arriving between S$50 and S$80 per ton in 2030, clearly sets the country in the right direction to move into a low-carbon economy.

Governments are offering environmental incentives, grants and credits to further accelerate the pace of change as well as lessen the financial burden on businesses adopting green technology. In Singapore, there is a slew of incentives under the Singapore Green Plan administered by various Government agencies, ranging from tax depreciation to grants.

Schemes — such as Green Investment Tax Allowance Projects and Green Income Tax Exemption Services — in Malaysia seek to encourage the purchase and use of green technology as well as green technology services and systems.

In Vietnam, there are also tax incentives for renewable energy projects, which include lower tax rates, exemption from import duties and land-related incentives.

On the social front, among others, organizations must be aware of tax considerations arising from a remote and digital workforce and the “gig” employment model. These include employment reporting obligations and contributions in local jurisdictions as well as potential taxable exposure resulting from a highly mobile and remote workforce with decentralized management.

For example, apart from general incentives covering a range of projects, including those of Bio-Circular-Green (BCG) companies, Thailand also provides renewable smart visas for BCG companies to allow international talent and investors to work and stay in the country.

The Philippines also provides enhanced tax deductions for the R&D of green projects and labor force training for green jobs.

For governance, organizations need to clearly articulate their tax strategy, policies and governance surrounding sustainability. More importantly, they need to also be able to provide reliable tax information that is required for ESG ratings.

The list is non-exhaustive and may include building a sustainable supply chain with an optimal carbon footprint using available tax incentives and credits. It may also include understanding the tax criteria in ESG metrics covered by voluntary frameworks or independent metric agencies. What could be the repercussions if businesses fail to see such linkages?

Fifty-three percent of respondents in the 2021 EY International Tax and Transfer Pricing survey recognized that ESG pressures will have an “extremely high” or “high” impact on their approach to transfer pricing over the next three years as businesses evolve. 

Businesses that fail to connect the ESG strategy to supply chain, transfer pricing and tax-related considerations may find themselves dealing with unexpected tax costs and risks in awkward and unpleasant situations.