Tax and ESG Reporting Is a Growing, Undervalued Relationship (1)

Companies are increasingly being asked to identify which environmental, social, and governance matters are important to stakeholders based on two factors—one that looks inward, the other outward.

The internal one focuses on the impact of ESG on the company’s financial performance. The external one focuses on, for example, environmental impacts resulting from the company’s business. Together, these two impacts are referred to as double materiality.

And yet, it seems that in businesses’ materiality assessments, one crucial area of operations is at risk of being ignored—taxation. That could be a big mistake.

Connecting Tax and Sustainability

Taxes have a direct financial impact on businesses from sustainability-related matters, such as carbon border adjustment mechanisms and transfer pricing adjustments arising from changes in the business model to meet net zero commitments and make the supply chain more environmentally friendly.

Businesses need to assess the tax implications of supply chain sustainability changes, such as the allocation of costs and benefits, the valuation of intangible assets, and the potential exposure to double taxation or tax disputes.

Questions about transparency—how much taxes are paid and to whom—are increasing in frequency from stakeholders as a way to measure a company’s contribution to the countries in which it operates.

Tax transparency is also about governance around taxes, how they’re being managed, and the approach to tax risk and relationship with tax authorities. The quality of that governance is an important element in building trust—the “social” element of ESG—to show governments and the public that businesses take their obligations seriously.

Additionally, tax disclosures can cover topics such as strategy and governance, in addition to tax disclosures. Investors often look at how businesses manage their tax affairs as an early indicator of how they might manage other aspects of their sustainability agenda and their business more generally.

A recent consultation paper by the European Supervisory Authorities emphasizes the growing importance of tax in responsible investment policies and practices. It proposes integrating tax avoidance as a mandatory social indicator of “principal adverse impact,” specifically highlighting the disclosure of the “amount of accumulated earnings in non-cooperative tax jurisdictions.”

The European Financial Reporting Advisory Group also issued a statement on the high level of interoperability between the European Sustainability Reporting Standards (which governs the operation of the EU’s Corporate Sustainability Reporting Directive) and Global Reporting Initiative standards. Tax is highlighted in the statement as a topic that can be appropriately reported using GRI standards to comply with ESRS requirements.

While tax is a complex topic, and tax data often needs context and interpretation, they create an opportunity to build trust and offer meaning for investors and wider stakeholders. So why isn’t tax receiving the attention it deserves?

Reality Gap?

Some of our colleagues analyzed the sustainability materiality disclosures of 756 companies in 2022. The results paint a potentially troubling underappreciation of the role of tax in sustainability reporting.

The chart below shows the list of material topics and the respective number of companies that raised them as an issue:

Carbon emissions, understandably, ranked highest as the most widely reported material sustainability topic. Tax, on the other hand, was reported as a standalone topic by just over 100 companies, or 13.5% of the total.

So why isn’t tax showing up as a material sustainability topic more frequently? One reason could be that tax is often seen as a financial matter that’s subject to complex legislation and already covered as a financial metric in the financial statements.

This narrow view of tax overlooks its broader importance in the public trust equation, as tax revenue is a major source of government funding for public services, economic development, and more.

It also ignores public disclosure requirements now coming into force under the Corporate Sustainability Reporting Directive and the EU Taxonomy. As a result, tax often isn’t considered by sustainability teams and other stakeholders who are more focused on climate change, human rights, diversity, and inclusion. This oversight may pose a growing risk to businesses.

Another reason that tax isn’t showing up could be the lack of awareness and understanding among tax and sustainability professionals (as well as their advisers). Tax experts may not be familiar with sustainability and how tax relates to ESG impacts, risks, and opportunities. Sustainability professionals may not have the technical knowledge and language to engage with tax issues.

In this review of materiality disclosures, it was clear that “business ethics” ranks highly as a topic important for businesses and stakeholders. Business ethics and tax compliance are intrinsically related. The contrast between both topics, in our view, indicates a gap in recognizing the materiality of tax within sustainability discussions.

Potential Solutions

Tax and sustainability professionals need to work together and communicate effectively to promote an understanding of tax and its relevance to ESG issues and to ensure that tax is considered appropriately in sustainability reports and assessments.

This requires a shift in the understanding of the definition of tax in the context of ESG, from an important but contained financial matter to potentially a much broader sustainability issue. It also requires a common language and understanding of ESG and tax issues among different stakeholders.

One way to promote an understanding of the sustainability impacts, risks, and opportunities of tax is to ensure that tax is considered within the scope of materiality assessments, and brought to the attention of stakeholders.

Tax might be material for three main reasons—what the data says about the business’s tax contribution to society, what the business’s governance structure says about its risk management, and what its tax strategy says about its view on tax sustainability.

For those reasons, the materiality assessment should consider the external impacts of tax on the environment and society, and the internal impacts of tax on the company’s business model and strategy—that double materiality again.

The world is changing fast, and tax is no longer just a financial reporting matter, but a crucial aspect of the business’s sustainability.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Will Morris is PwC’s global tax policy leader. Andy Wiggins of PwC contributed to this article.