How taxation is important component of ESG strategy

By Stivin Elias

ESG, the acronym for Environmental, Social and Governance, is an increasingly familiar term for three non-financial metrics that measure how a company is responding in terms of actions relevant for environment, society and governance so as to ensure sustainable growth of an organisation.

The “E” (as in environment) focuses on, among other things, the organisation’s attitude towards climate change, how it controls carbon emissions, deforestation, waste management and conservation of biodiversity. The “S” (for social) considers the relationship between an organisation and employees, customers, suppliers, and the society where it operates, as well as how it promotes gender and diversity and data protection and privacy. The “G” (namely, governance) addresses a company’s leadership structure, board composition, executive compensation, and whistle-blower scheme.

ESG has become an increasingly important agenda in recent years. Before an investment decision is made, investors who want to achieve long term value and sustainable growth are likely to incorporate ESG factors in the investment analysis in addition to the financial metrics. Various bodies such as the European Union (EU) and the United States Securities and Commission Exchange (SEC) require some public interest companies to disclose ESG related information in their reported statements. Closer to home, the Dar es Salaam Stock Exchange (DSE) requires all listed companies to incorporate ESG disclosures in their reported statements.

Since investors and other stakeholders are interested in the sustainable results of their investments, many organisations no longer consider the ESG as an option agenda but rather as one of the necessary key factors to achieve sustainable growth of any company. Furthermore, some companies incorporate ESG factors in their operations to ensure that they comply with regulations relating to ESG as established by relevant bodies and institutions.

To successfully implement an ESG program it is important to ensure that such a program is embraced by all departments within the organisation. Consistent with this, those in the finance function who oversee tax related matters have a key role to play in ensuring appropriate attention to taxation when formulating and then implementing ESG policies. One aspect of taxation to be considered is the tax implications of running the ESG program. For instance, as part of such a program (social aspect) a company may consider initiatives to benefit society (for example, by making certain donations), to improve staff welfare (for example, by improving staff benefits). Whilst such initiatives are commendable from a social perspective, before these are implemented the company should ensure that the related tax implications (income tax deductibility, VAT, payroll tax considerations) are understood to the management.

Perhaps the most important aspect relates to transparency in relation to contributions made in the form of taxes, but also the wider economic impact of a company’s activities. Against a background that the funds used by the government to serve communities come from tax revenues, stakeholders are interested to see how companies are contributing to the society including through the taxes paid or generated. In this context, and subject to relevant confidentiality considerations, a company (particularly if high profile) should consider how best it communicates relevant tax related information whether through disclosures in annual reports, or ESG specific reports. Increasingly, taxpayers are realising the importance of more expansive disclosure so that stakeholders can understand not just the corporate income tax generated (which is easily identified in financial statements), but also other taxes borne or generated (whether in the form of employment taxes, withholding taxes, import or consumption taxes) as well as the tax strategy of the company (including its approach toward tax risk management and control).

Those charged with a tax responsibility in the finance department can play an important role in providing input to help formulate and implement ESG policies. With their input, management can better understand the tax implications of ESG related decisions and have greater comfort in relation to the tax transparency of the company.

Stivin Elias is a manager, Tax Services with PwC Tanzania. Stivin spent three years working on secondment with PwC Zambia.