Tax is not a topic that generally grabs the imagination. Indeed, when the world entered a new ice age in the climate disaster movie “The Day After Tomorrow” and everyone huddled for warmth in the New York Public Library, the books on tax law were the first to be thrown onto the fire.
But tax transparency, within the broader push for global financial transparency, has been rising up governments’ and investors’ agendas at an accelerating pace since the global financial crisis. And as governments urgently look for ways to recoup unprecedented levels of pandemic-driven spending, tax transparency takes on a new level of significance. The topic even made a 2022 proxy ballot recently as shareholders asked Amazon.com (AMZN) for greater tax transparency. Expect more such proposals to follow.
Tax transparency requires that multinational companies report their country-by-country tax payments and explain their corporate tax strategy and governance arrangements. Tax transparency is a critical issue in environmental, social, and governance based investing because shifting profits to low- or no-tax jurisdictions reduces tax revenues and therefore reduces governments’ abilities to address urgent environmental and social issues through the funding of public services and programs.
One of the main drivers of the tax transparency push is the “global tax race to the bottom.” Hoping for an influx of investment, countries and territories have vied with each other to be “business-friendly” domiciles, offering lower or no taxation along with lax reporting and governance requirements. The result has been a decades-long decline in average statutory and effective corporate tax rates, as multinationals avail themselves of the myriad profit-shifting opportunities offered by Ireland, Luxembourg, Switzerland, Singapore, the British Virgin Islands, and the Cayman Islands, among others. As a direct consequence, while tax avoidance–”tax optimization”’ as some companies prefer to call it–is by its very nature difficult to measure, estimated global annual tax revenue losses are between $240 billion and $650 billion, according to the EU Tax Observatory. Lower- and middle-income countries are most out-of-pocket relative to their gross domestic product.
Tax avoidance exacerbates global economic inequality and undermines sustainable development, notably as companies use local infrastructure and locally trained labor to benefit from a local tax regime without necessarily contributing proportionately to the local economy. Consider how online buying delivers parcels to your door thanks to physical and institutional infrastructure built and maintained out of public coffers. Yet the profits from those sales may be protected from taxation under elaborate, yet perfectly legal, profit-shifting schemes that exploit the mismatch between traditional tax rules and the realities of global e-commerce.
From the point of view of some investors, shareholders may benefit in the short term from aggressive tax planning. But many are invested globally. The benefit from an individual company’s tax practices is lost in this wider context: not only does tax avoidance undermine competitiveness within an economy, but short-term tax benefits also come at the cost of long-term deterioration of countries’ infrastructure, investments, development, and public sector employee income. When companies pay their fair share of tax, the odds that economies operate more effectively and more competitively are higher.
The good news is that, in October 2021, 137 countries reached a two-part deal to coordinate and try to curb tax avoidance and reform the international tax system to reflect the modern economy, led by the Organization for Economic Co-operation and Development and the G20. The highlights of this reform are that multinationals will be subject to a minimum 15% tax rate (Pillar Two) and that they will be required to pay tax in the countries where they make sales, irrespective of whether they have a physical presence in that country (Pillar One). The initial implementation was scheduled for 2023 but, owing to the complexity of the deal, this very ambitious deadline has been recently delayed by at least a year.
While some observers believe the complex tax reform is destined for failure, some significant progress has already been made since the October 2021 OECD/G20 agreement. At the end of last year, the European Union published a proposal aimed at implementing Pillar Two in the EU Member States. Furthermore, in his first State of the Union Address earlier this year, President Joe Biden expressed support for a 15% minimum tax. That raises tax risk as an issue that is likely to garner substantially more investor attention.
However, even before all these developments, investor action had already been set in motion. In 2015, the Principles for Responsible Investment published engagement guidance on corporate tax responsibility, which highlighted the increasing expectation from investors and beneficiaries that companies pay a fair share of tax, and also emphasized the reputational, legal, and financial risks posed by aggressive tax planning. Furthermore, between 2017 and 2019, the PRI established a collaborative engagement initiative on corporate tax transparency, which supported investors who were looking to engage with their investee companies to encourage more responsible tax practices. This initiative established that investors have a key role to play in supporting tax disclosure frameworks. One such framework that emerged in 2019 is the Global Reporting Initiative Tax Standard, the first global standard for comprehensive tax disclosure at the country-by-country level. It supports public reporting of a company’s business activities and payments within tax jurisdictions, as well as their approach to tax strategy and governance.
Globally, the pandemic moved a lot of consumer buying online, increasing the profits of online retailers and therefore accentuating the gains to multinational companies that profit shift between tax jurisdictions, and accentuating the revenue losses to governments limited to taxing only economic activity recorded within their borders. Companies whose business models involve aggressive tax planning may face significant challenges as a result of tax system reform.
At Amazon’s annual general meeting on 25 May, some 21% of independent shareholders supported a proposal asking Amazon’s board to issue a tax transparency report involving country-by-country reporting in line with the GRI Tax Standard–a motion the board opposed. The proponents, including Oblate International Pastoral Investment Trust and The Greater Manchester Pension Fund, publicly supported by Nordea, Royal London, and a number of large pension funds in Europe and the United States, stated that Amazon does not disclose revenues, profits, or tax payments in non-U.S. markets, which presents a challenge to investors’ ability to evaluate the associated risks, the robustness of the business model, and whether Amazon is engaged in responsible tax practices that ensure long-term value creation for the company and the communities in which it operates.
Morningstar Sustainalytics’ ESG Voting Policy Overlay service recommended a vote in favor of this shareholder proposal, as Amazon does not provide the level of disclosure that the proponent seeks, and we believe that the shifting societal expectations around companies paying their fair share of tax, as well as the significant ongoing regulatory changes, show that this issue represents a substantial business risk to Amazon and others.
With a compelling investor case and 21% support (adjusted to exclude Jeff Bezos’ 12.7% shareholding) for what is nearly a first-time resolution (tax transparency was voted on once before, in 2014 at Alphabet (GOOGL), and earned just 3% support), it seems highly plausible that this may just be the beginning and that similar resolutions will follow.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.