Stripped of all its complexity, the fundamental question of corporate tax is whether investors want increased profitability by avoiding tax, which is a race to the bottom. Many investors have joined this race, mostly passively. But big changes are underway and EU investment professionals would be unwise to ignore them.
Jason Ward, Founder and Senior Analyst of CICTAR, an NGO that advocates national and global tax reforms, talks about how he raised a tax issue with a large asset owner in 2012; the fund said lowering taxes was integral to how the investment managers generated good returns. This fund now supports responsible tax practices. Materiality is, most certainly, a dynamic concept!
Why this change?
There has been a growth and expansion of big tech companies including Google (Alphabet), Amazon, Facebook and Apple, whose aggressive tax evasion is rampant. These companies have learned from the big oil companies, benefit from the advice of the Big Four Global Auditors, and with intellectual property and digital transactions, it is even easier to transfer profits than with more tangible products.
The Biden administration has launched talks to introduce a global minimum tax rate, now endorsed by the G7 and headed for the OECD. The EU has approved a limited version of public country-by-country reports within member states and comprehensive legislation has been introduced in the US Congress. These are major changes.
This coincides with levels of inequality not seen since the 1930s, but now governments are facing large new bills because of COVID-19 and even bigger because of climate and biodiversity crises. With businesses sitting on huge assets in tax shelters, government action was inevitable after Donald Trump was defeated, and it’s easier, politically, to tax businesses than individuals.
The United Nations Principles for Responsible Investment (PRI) are also worth highlighting. He started working on taxation in 2015 and his global collaborative engagement was the first on this topic. According to Vaishnavi Ravishankar, senior analyst for ESG at PRI: “This was the first time that several companies had discussed taxation with investors. One thing we’ve learned: One-off conversations alone aren’t enough to get the results we’re looking for. Investors should systematically engage with companies, scale up where appropriate, and use other levers for change, such as policy advocacy. ”
Cue PRI’s recent lobbying of EU policymakers which brought together a coalition of investors with around $ 6 billion (€ 5 billion) in assets under management.
Some G7 countries lagging behind in taxes, such as the UK, are arguing for exemptions. Several poor countries fear that their tax revenues will not increase. There is active resistance from many private sector elites – some CEOs, some audit partners and investors who take a short-term and narrow perspective. And how should investors – who have largely focused on transparency – now relate to the 15% minimum debate.
Why Should Investors Care?
Active investors cannot ignore the many instances of aggressive tax avoidance associated with hidden risk. At a minimum, there is reputational damage as Amazon, Apple, BUPA, Facebook, Google, and Uber have all discovered. Indeed, Vodafone is a good example of a company that has gone from sinner to saint because of this pressure. Active investors take pride in understanding how a business works, but it is bogus marketing if critical tax structures are hidden.
Eleco van der Enden, partner of PwC and member of the technical committee that developed the Global Reporting Initiative (GRI) standard, is convinced that “the reconciliation of financial account data and tax data provides a wealth of information on the quality of risk management ”.
He asks, “Would the Wirecard have happened if quality tax reports had been available in one form or another to investors?” ”
According to Professor Ronen Palan of City University of London, the same opacity techniques that are used in tax evasion also ensure the opacity of the accounts for the investor. Based on his experience with Amazon, he says analysts may be unable to verify what management is telling them before it’s too late. In short, the consolidated accounts are a “story” presented by management.
Index investors don’t really have the same business model reasons for worrying about occasional corporate implosions. But today, they cannot afford to be seen as disengaged. More importantly, index investors and other large owners of diversified assets are more dependent on beta (market returns) than alpha. Thus, sufficient tax revenue – which is essential for sufficient education, health and infrastructure – is an essential precondition.
Who are the solution?
The glass is not quite half full, but there are still a lot of good guys. They include: the $ 10 billion alliance which supported the GRI tax standard, the numerous pension funds (such as UK local authorities and Ethos in Switzerland) which supported PRI’s lobbying of the EU, a coalition similar in the United States (The Financial Accountability and Corporate Transparency Coalition) and some funds that act independently (NBIM announced in 2021 that it had divested from seven companies due to tax evasion).
And who is AWOL? Unfortunately, the list includes most asset owners, even in the EU, most investors in some powerful countries (Germany), most of the big EU fund managers (congratulations to Amundi and LGIM to be the exceptions) and all the major US fund managers that are active in the EU.
American attitudes on tax matters seem to work even when they work elsewhere. Richard Murphy, a tax activist, tweeted about the Big Four Partners who see good opportunities to help more businesses replicate the success of Google, Amazon, Facebook and Apple. And, of course, corporate tax laggards.
What can investors do?
Asset owners can make sure their managers are pushing companies to do country-by-country reports. Hopefully PRI, which makes taxation a top priority, will put in place mechanisms to do this – fund managers love to use excuses – “you’re the only client to mention it” – or work in partnership with an agency that can. It is especially important that European asset owners who use US-based fund managers show this supply chain responsibility.
Adhering to the GRI tax reporting standard is a good start. This voluntary standard responds to the EU obstacle but anticipates future international developments – it is an effective prospective solution.
Asset owners and managers should lobby EU governments to demand country-by-country reporting and resist exemptions. The PRI letter to the EU is good to sign.
And while transparency is essential – as Ward says, “you cannot reform the tax system without greater transparency, it is an absolutely essential precondition” – investors must adopt an effective global minimum tax. In Ravishankar’s view, “the global minimum tax is about removing the incentives available to companies to shift their profits and increasing the tax base for governments. The strength of this reform will depend on the details that remain to be seen: if the rate is too low, it may not have the desired effect of curbing corporate tax avoidance practices ”.
And finally, investors should follow their rhetoric in their own sphere of control. It’s not as difficult as it sounds, but it takes decent leadership and good governance. Is this such a bad thing?
Raj Thamotheram is a member of the Nordic Institute for Finance, Technology and Sustainability (NIFTYS)