Including tax in the ESG agenda

For businesses, there will be both risks to consider and opportunities to capitalise on. Hence it is important for organisations to immediately include tax in their sustainability and ESG strategies.

THE topic of sustainability and environment, social and governance (ESG) has become increasingly fundamental and embedded in our lives.

From consumers and investors making choices based on environmental impact to businesses focusing on sustainability as a core tenet to long-term value creation, and to governments aiming to design and implement effective laws, regulatory frameworks and policies to address the Sustainable Development Goals, the topic of sustainability and ESG cannot be separated.

Interest and knowledge development in the areas of ESG have grown substantially and were partly catalysed by the Covid-19 pandemic and developments from the United Nations Climate Change Conference – Conference of the Parties 26 (COP26) held last year.

The idea of an inclusive ESG discussion would not be complete without considering the tax implications across all stakeholders and perspectives, which is a critical and integral consideration.

Environment

Climate change is one of the most important policy issues for governments.

A substantial part of the climate policies is related to the tax framework, in the form of credits, incentives and taxes.

There are two main ways to price carbon emissions; and they are carbon taxes and emission trading schemes.

The Malaysian government announced last year that it is undertaking a study on the implementation of carbon tax, which is still underway.

Bursa Malaysia recently announced the launch of a voluntary carbon markets exchange by the end of 2022, which will enable companies to purchase and sell carbon credits from climate-friendly projects and solutions.

It is imperative for businesses to keep abreast of carbon pricing developments in their countries of operations, their customer markets and in the supply chain.

For example, under the European Union’s (EU) proposed carbon border adjustment mechanism (CBAM), when certain goods (the list of which is pending finalisation) originating from outside the EU are imported into the EU, a “CBAM charge” would be imposed on top of importation duties.

The objective is to embed the price of carbon emissions (from the manufacturing site outside the EU) within the product price.

The charge is effectively paid through the purchase of certificates which corresponds to the amount of emissions generated in the production of such goods.

Given the proposed transitional period implementation date of Jan 1, 2023, and full-fledged implementation from 2026, affected exporters would need to start pricing in the CBAM charge and consider its impact on their business and mitigation steps, including investments in emission reduction technologies.

With many countries still in the process of implementing or considering the implementation of carbon taxes or ETS, businesses should consider taking steps to establish an internal carbon price for a better reflection of their financial position and to aid future investment decisions and business strategies.

For organisations that have set emission reduction targets, they can consider offsetting their emissions by purchasing carbon credits at VCM such as Bursa Malaysia’s proposed VCM exchange.

Businesses undertaking “green” or carbon reduction projects should explore whether the potential and feasibility of generating and monetising carbon credits.

The tax implications of these new carbon credits transactions such as deductibility of the costs incurred and availability of tax depreciation on capital expenditure would need to be considered.

For companies that are exploring emission reductions, energy efficiency or renewable energy options, feasibility or location studies should take into account matters such as the availability of tax incentives or tax credits, or funding (for example grants) and commercial considerations.

Social

In terms of the social aspect of ESG, the tax angle has expanded significantly beyond the basic narrative of tax payments being a contribution to society.

Travel restrictions and mindset shifts kindled by the Covid-19 pandemic have resulted in an evolved workforce and work style, including establishing flexible or remote work arrangements which may allow employees to work from anywhere in the world.

Businesses which adopt these employment policies would want to ensure that among others, such arrangements do not create taxable presences in other jurisdictions and that tax and immigration obligations are complied with.

Governments would seek to ensure that the individuals are lawfully working in their countries and are taxed appropriately on income earned in their respective jurisdictions.

In this regard, local tax frameworks and legislations as well as detection and enforcement efforts may need to be enhanced.

Governance

Corporate governance includes tax governance and tax transparency aspects.

As part of their ESG focus, investors are placing more focus on reputational and financial risks associated with poor tax practices, and it is expected that there will be more demand for information on tax matters in the making of investment decisions.

The FTSE Russell ESG Ratings system, which is adopted in the

FTSE4GOOD Bursa Malaysia Index, includes tax transparency as a key consideration factor from a governance perspective.

Malaysian public listed companies are required to make certain disclosures via a sustainability statement or report but currently, there is no specific public disclosure requirement on tax matters. Bursa Malaysia’s Sustainability Reporting Guide (second edition) provides a list of sustainability themes which are aligned with international sustainability reporting frameworks or guidelines such as the Global Reporting Initiative (GRI) Standards and which should be embedded within sustainability statements or reports.

GRI 207: Tax covers both qualitative disclosures (eg governance, controls and risk management) and quantitative disclosures (eg country-by-country reporting information and total tax contributions.)

The Tax Governance Guide, jointly published by the Malaysian Institute of Certified Public Accountants nd Malaysian Institute of Accountants in October 2021, also provides guidance on disclosures on tax governance and the management of tax matters affecting corporations.

The Inland Revenue Board (IRB) introduced Tax Corporate Governance Framework (TCGF) Guidelines in April 2022 (updated in July 2022) to assist companies in designing and operating their tax governance frameworks.

The IRB also introduced a TCGF programme, whereby participating taxpayers whose tax corporate governance frameworks meet the requirements will enjoy benefits such as reduced scrutiny or fewer tax audits, expedited tax refunds and the appointment of a dedicated tax officer at the IRB as a single point of contact in relation to the taxpayer’s tax matters.

The TCGF programme is currently in its pilot phase until June 2024.

Organisations that are keen to participate can reach out to the IRB.

Taxpayers should assess the adequacy and robustness of their tax governance framework and undertake improvement or remedial steps where relevant.

This helps to reduce tax risks, preparing for future disclosure requirements, or participating in the IRB’S TCGF programme.

Developing a robust TCGF would create alignment within the organisation on its tax strategy, and provide clarity on roles and responsibilities, processes and controls to minimise errors and non-compliance, as well as for escalation and resolution of issues.

This will help direct resources and draw focus to more strategic matters such as the technical application of tax laws on new transactions or business models, monitoring of changes to tax laws and enforcement climate.

The IRB would also be more efficient in tax audits, focusing its resources on technical issues or interpretations, rather than on detailed documentation reviews to weed out issues such as incorrect classification, descriptions or errors.

Through the TCGF programme, the IRB will also gain a better understanding of how businesses run their tax departments, identify and address tax risks and ensure that tax laws are complied with.

A TCGF programme will help develop a more co-operative and collaborative relationship between taxpayers and the IRB.

In conclusion, tax is and will always be an integral part of the ESG agenda.

For businesses, there will be both risks to consider and opportunities to capitalise on.

Hence it is important for organisations to immediately include tax in their sustainability and ESG strategies.