Confidence in resilience: adopting a tax perspective for ESG

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Environmental, social and governance (ESG) practices are gaining ground with campaigns like Plastic Free July drawing the attention of businesses and citizens to contribute to the global movement on ESG. The call for sustainability has, in turn, whetted the appetite for investments that support the environment.

Governments are also taking over to fight climate change. With rising global temperatures and erratic weather patterns, more and more countries are committing to net zero emissions commitments within a certain time frame. The momentum generated by these initiatives has resulted in increased oversight of companies to meet sustainability goals in addition to generating profits and ensuring returns on investment for investors.

In 2019, the European Commission introduced sustainability disclosure regulations that require the integration of sustainability risks into all investment processes and financial products, as well as the consideration of any negative impact on sustainability at product level. In the United States, the House of Representatives recently passed the ESG Disclosure Simplification Act of 2021, which would require publicly traded companies to disclose their commitments to ESG standards that are reflected in their operations, businesses and chains. supply.

In Malaysia, it is currently mandatory for listed companies to disclose their management of significant economic, environmental and social risks and opportunities through a sustainability statement in their annual reports. This is further amplified by the Malaysian Code of Corporate Governance 2021, which calls for board management to incorporate sustainability considerations into their corporate strategy, governance and decision-making.

We can ask ourselves: how does taxation enter the ESG equation and what is the essential role of taxation in ESG? While not normally transparent, tax strategies and corporate tax payments are said to be one of the most important contributions to governments and social causes around the world. Taxation intersects with ESG initiatives, in particular around tax policies, tax strategies, tax incentives and tax reporting. By including tax measures in their ESG initiatives, companies would improve their ability to communicate their contributions to their stakeholders and derive greater value from the investments made.

More transparency in tax policies and strategies

Tax policies and tax strategies should be key considerations as companies chart their ESG journey. The drive for better transparency, which is a key element of ESG, has gained momentum in recent years. One of the first countries to adopt the publication of tax strategies is the United Kingdom.

In December 2016, the UK government introduced significant new tax governance requirements, forcing large organizations to publish their tax strategies with respect to UK taxation. This includes details on compliance with tax law, how UK taxes are managed and tax planning. Failure to publish these tax strategies on time will result in the imposition of sanctions on companies.

Global organizations such as the Organization for Economic Co-operation and Development and the Principles for Responsible Investment have provided various guidance documents to investors to support engagement with recipient companies on tax policy and transparency. These measures have also been introduced and adopted in many European countries.

While tax governance provides a solid foundation for aligning a company’s tax strategies and tax policies with ESG, the other key value factor of ESG strategies is the availability of tax incentives as well as new related taxes. to the environment.

Tax incentives to encourage ESG initiatives

For decades, tax incentives have provided an opportunity for governments to use the “carrot,” in the carrot and stick analogy, to achieve desired results. Tax incentives can be a key value driver for companies, and various governments around the world have introduced tax incentives to encourage companies to pursue ESG-related initiatives.

For example, in the United States, the use of investment tax credits is seen as a key element of strategic ESG integration. A tax credit is a type of government-sponsored tax incentive that can reduce a business’s tax liability and incentivizes corporate taxpayers to invest in certain types of projects that produce economic, environmental, or social benefits. From an investor’s perspective, the tax benefits are in addition to the usual return on investment.

Closer to home, most countries in the Asia-Pacific region have made progress in this area by introducing some form of ESG tax incentive. In Japan, companies that acquire carbon neutral assets or assets that manufacture carbon neutral products are entitled to special tax depreciation or tax credits. Likewise, in China, Hong Kong, Singapore and Malaysia, tax incentives in the form of tax credits or tax exemptions are granted to companies that invest in certain “green” industries or products.

Under Malaysia’s 2020 budget, the existing green investment tax rebate for the purchase of green technology assets and projects, and the Green Income Tax (GITE) exemption on income earned from green technology services, have been extended until 2023. The scope of the GITE has also been extended to companies that undertake solar leasing activities. These incentives offer tax exemptions to businesses and encourage investment in the green technology sector and green assets.

As one of the major centers of Islamic finance in the world, the Malaysian government has also introduced various tax incentives for sustainable Islamic finance activities. This includes the recently expanded Sukuk Grant and Green Sustainable and Responsible Investments (Green ISR) program, which is provided by the Securities Commission Malaysia (SC) to sukuk issuers to fund external review costs incurred in the process. issuing an ISR green sukuk. The extension now covers grants for all types of sukuk and SRI bonds that meet the ASEAN green, social and sustainability bond standards approved by SC through December 31, 2025.

New environmental taxes

While tax incentives continue to be welcomed by the business community, new environmental taxes have also increased in recent years. In the European Union (EU), governments have introduced various environmental taxes. Finland was the first to introduce a carbon tax in 1990 and since then 18 EU countries have followed, implementing carbon taxes ranging from less than € 1 per metric tonne of carbon emissions to over 100 € per metric ton. In 2019, these taxes represented around 2.4% of the EU’s gross domestic product and 5.9% of total government tax revenue.

Recently, in July, the EU presented its proposal for a border adjustment mechanism for carbon, which aims to tax imports by EU importers based on the greenhouse gases emitted to manufacture the imports. . The intention is to prevent polluting industries from moving production outside of Europe to avoid EU emission limits and then re-importing into the EU. This could have an economic impact on imports from countries outside the EU.

Countries like the UK are introducing a tax on plastics which is conceptually similar to the carbon tax. The plastic packaging tax will be introduced by the UK in April 2022 and will affect businesses, including manufacturers and importers, as well as consumers who buy plastic packaging or products in plastic packaging in the UK -United. Recently, the EU passed a tax of € 0.80 per kg on non-recycled plastic waste from January 2021. While this is a start, it may not translate immediately by increasing recycling rates.

Imposing the above taxes, while welcomed by environmentalists, would incur additional costs to do business. Businesses need to be aware of these additional costs, and investors such as fund managers should factor these new environmental taxes into their annual operating and revenue projections.

Conclusion

Governments and investors around the world are seeking greater transparency and governance from companies to answer the call for stricter ESG practices. Businesses, in particular, have a central role to play as their decisions on tax strategies and policies have implications for their business as well as for their stakeholders. This is especially critical at a time when investors such as fund managers, who are key stakeholders for companies, are looking for a greener portfolio.

The 2021 Global ETF Investor Survey estimated that nearly 82% of investors surveyed plan to increase their allocation to ESG this year, and in Europe, 36% of new exchange-traded funds launched in 2020 were ESG funds. . In the bond market, there was a record number of green bond issues last year to fund environmentally friendly projects.

As investors become more ESG-conscious, companies should be aware of the tax incentives available to align their operations to meet demand, as well as environmental taxes that could have a significant impact on bottom line. Fund managers should clearly understand the importance of taxation as part of their ESG investment strategy. Investors who view taxation as part of their ESG strategy would not only be in a better position to manage potential risks, but also to identify opportunities to reap the benefits of their investment.


Jennifer Chang is a partner at PwC Taxation Service Malaysia

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