Changing Corporate Culture is Reshaping Tax Transparency

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2020 Issue One
CapitalMasthead

Changing Corporate Culture is Reshaping Tax Transparency

By: Bruce Hendrick

For the first time, Royal Dutch Shell Plc (“Shell”) has voluntarily disclosed details to the public on how it paid tax around the world. Royal Dutch Shell Plc: Tax Contribution Report 2018. The Wall Street Journal declared Shell’s disclosure The Beginning of the End of Tax Secrecy. As examined below, the Shell report is a signal of a growing trend of tax transparency that is part of a greater change in corporate culture.

Corporate Culture. Shell’s tax transparency correlates to changes in corporate culture including: (1) improved environmental, social and governance (“ESG”) responsibility; and (2) a more sustainable, more equitable form of capitalism. This new capitalism is intended to benefit all stakeholders, not just shareholders. According to Business Roundtable, maximizing shareholder profits can no longer be the primary goal of corporations. Corporate greed, at the expense of everyone and everything else, has fallen out of favor. For example, Blackrock, the world’s largest asset manager, avoids investments with high ESG risk, instead investing with environmental sustainability as a core goal. Blackrock pushes companies to report on ESG metrics and votes against those that do not make ESG disclosures. Changing corporate culture is pushing companies to make more ESG disclosures, and better manage ESG risks.

ESG/Tax Rankings. Companies are now ranked on their sustainability performance (i.e., ESG risk management). See Sustainalytics ESG Risk Rating Reports. The purpose of ESG analytics is to assess the risk of a company experiencing a material financial impact from ESG factors. Dow Jones Sustainability Indices (DJSI) evaluates the sustainability of thousands of public companies. These indices are key reference points for investors and companies. For example, the DJSI North American Index captures the top 20% of the largest 600 stocks in the S&P broad market index based on their ESG practices. The index currently includes seven US energy companies (Chevron, Conoco, Devon, Hess, Marathon, ONEOK and Schlumberger). Shell recently dropped off the index presumably because of lower ESG scores. In Europe, the Tax Transparency Benchmark ranks Dutch companies on tax transparency. In Australia, the tax authority has proposed a tax code of ethics. As these sources demonstrate, the clear global trend is for increased transparency, including on tax matters.

ESG/Tax Scores. The overall ESG score can be broken down into three underlying dimension scores that each measure their separate ESG performance. The governance score is referred to as the economic dimension score (EDS). There are eight specific EDS criteria, including tax (which consists of tax strategy, tax reporting and tax governance). The tax criteria examine the degree to which a company has a clear policy on its approach to tax issues and an awareness of the incremental financial risks associated with the company’s tax practices. The Shell report is designed to squarely address these EDS metrics on tax governance.

Tax Disclosures. The Shell report is modeled after the tax transparency reporting standards promulgated by the Global Sustainability Standards Board (See GRI 207: Tax 2019). The Financial Accountability & Corporate Transparency (FACT) coalition’s report, Trending Toward Transparency: The Rise of Public Country-by-Country Reporting proposes applying global standards to US multinationals. The Shell report provides 80 pages of tax data. Most of the report details specific tax data on a country-by-country basis (e.g., number of employees, business operations, revenues, profits, taxes paid, tax accrued, and accumulated earnings), with Shell disclosing this data for 99 countries. The report also explains Shell’s tax policies and practices, core tax principles, and tax governance procedures. Companies that provide tax transparency can expect higher ESG scores and rankings.

Tax Responsibilities. Tax responsibilities are adjusting to reflect the changes in corporate culture. According to the report, Shell supports an approach to taxation that allows companies to create a sustainable society. The goal is to “pay the right amount of tax at the right time.” The “right amount of tax” means tax minimization is no longer the primary goal. At the “right time” means less tax deferral strategies. The report outlines the Shell Responsible Tax Principles that guide its decisions on tax matters, emphasizes accountability, transparency and, most importantly, trust. In fact, trust is the cornerstone in the new capitalism model. If trust is not a company’s highest value, then the company is going to be in a crisis of trust.

Tax Risk. For most companies, the greatest tax risk is the creation of franchise or reputational risk. Sometimes a company’s tax affairs become headline news resulting in franchise risk. Amazon reported about $11 billion in GAAP earnings, but paid no income tax for 2018. Outraged NY officials responded by objecting to subsidizing (with tax incentives) Amazon’s second headquarters in Long Island. Better tax transparency can allow companies to better control these political and public relations problems.

Takeaways. There is a paradigm shift to hold companies to higher standards, including heightened tax transparency and less tax secrecy. To date, US companies disclose sustainability, but no US multinational has yet released a tax transparency report. It’s likely just a matter of time until we see more tax transparency. Tax transparency will empower US companies to proactively control the narrative about taxes and better manage franchise risk. Better ESG risk management, including tax transparency, will also likely result in improved business fundamentals, as well as stock performance. Although tax transparency is a cultural change for most companies, it should be embraced as a new way to increase value to all stakeholders, even shareholders.