Much has been written about the topic of Environmental, Social and Governance (ESG) and Sustainability Reporting and how it impacts tax reporting, but how do you operationalise ESG to ensure your business has an effective tax operating model in place to fully comply with the latest requirements? As with the wider finance function, the tax function has a key role to play in an organisation’s ESG journey, and in helping the group unlock the value that ESG can provide. Governments are increasingly using tax policy to meet environmental and social targets and, whilst incentives, grants and reliefs can provide vital funding, the introduction of new environmental taxes will likely introduce additional complexity to your business and unexpectedly increase operating costs, especially if you’re unable to adapt and penalties are applied. So how will you implement the necessary structure, systems, processes and controls to meet these new obligations?
Setting the guide rails
The challenges posed by ESG, and the additional complexity it brings for tax functions, means that a clear and effective strategy for ESG and sustainability reporting is crucial to success.
A tax function’s strategy underpins the entire function, setting the approach across all the elements of its operating model. Market leaders have embraced transparency reporting to differentiate themselves from their competitors, demonstrating their commitment to the transparency agenda. However, if this is the approach a group chooses then the reporting burden increases, which will have a direct impact on the tax function’s resource requirements.
By including the tax strategy as part of their sustainability report, such as Total Tax Contribution (TTC) reporting, it allows groups to highlight their approach to tax and the positive contributions made to society. However, varied ESG reporting metrics can mean that companies are reporting different facts and figures to different stakeholders, which can increase their tax and reputational risk.
There are hundreds of sustainable tax incentives globally used by governments to try and promote sustainable business activity and groups must navigate through these to determine which ones will be used and which will be foregone. Again, this strategy will have an impact on the overall operating model.
Governing the right approach
Key to ensuring group’s have meaningful disclosures, as well as meeting any compliance obligations, is a robust tax governance and control framework. Lack of effective tax controls could result in increased tax risk both financially and reputationally. This is no different when adapting to ESG related requirements, and with the increasing focus on ESG topics the reputational risks of making errors could be large. The tax control framework should extend across the end to end processes as they adapt and change. Tax risks and controls should be communicated, understood, documented as well as tested on a regular basis to allow comfort over the framework.
People first
An effective tax operating model ensures that the people within the tax function have the skills and support they need to deliver. With the growth of ESG, additional upskilling will likely be required so the function is able to fully understand current and evolving requirements, as well as being adaptable to future changes.
Recent trends require tax professionals to be comfortable with technology tools, as functions move away from an over-reliance on spreadsheets, as well as ‘soft’ skills that enable effective business partnering and stakeholder management. The impact of ESG will only increase this trend, as volumes and complexity of data increases alongside the number of ESG requirements, whilst tax functions will increasingly need to work collaboratively with other functions, such as Sustainability, so that requirements are understood and responded to. Leading tax functions are looking to nominate ESG champions, or appoint an ESG lead, to put a particular focus on ESG and the reporting associated with it. This is often coupled with a reassessment of function wide KPIs, as well as personal objectives, to include ESG.
Tax functions also need to consider the structural implications of managing ESG reporting and compliance. The often complex reporting requirements for ESG can reduce availability of personnel for other tasks. When managing resources how do you ensure people are focusing on the value add activities rather than data processing? If technology isn’t effectively being used then the additional requirements could result in the need for additional tax headcount, but this can only be quantified where it can be clearly shown what is being, or needs to be, done.
Setting yourself up for success
To date there has been a clear lack of consensus on who should take responsibility for key ESG issues relating to tax. Part of this relates to the cross functional complexity of sustainability reporting, with true taxes (eg. Plastic Packaging Tax), pseudo taxes (eg. Deposit Return Schemes) and regulatory or financial reporting requirements (eg. Extended Producer Responsibility or the Carbon Border Adjustment Mechanism (CBAM)) all often grouped together, under the ESG banner, and all requiring action from different parts of organisations.
An optimal organisational structure needs to be defined and documented, so there is a structure in place, and proactive decisions made, to enable delivery under ESG globally and locally. This could include the use of shared service centres to help process large volumes of data, consolidate or manipulate data to enable reporting or if the skills do not exist internally, the use of outsource providers or managed services to help groups deliver and navigate their way through these complex requirements. Whatever approach is taken, roles and responsibilities must be clearly defined and if it is determined that true taxes and pseudo taxes won’t be managed by the tax function, what level of oversight and responsibility will the tax function have over this reporting? Tax reporting being managed by non-tax resources with limited oversight poses a potential headache for the Head of Tax if things go wrong.
Get your processes in motion
Groups will need to establish and maintain new reporting processes and systems to capture appropriate data required to report internally and externally, as well as meet compliance obligations.
This will involve assigning responsibility, which may not necessarily be the tax function’s responsibility, for those processes, as well as ensuring those processes meet compliance and audit obligations. These processes are often complex and have to be set up quickly, so groups need to be flexible and adaptable to ensure the ever changing requirements are being properly captured. This can be, again, a huge drain on current tax resources. Global tax process owners are on the rise, should ESG be incorporated into this role?
Data is key
Despite the huge increase in focus on ESG initiatives, and the accompanying regulatory burden, many groups are still taking an elusive approach to dealing with ESG. A major cause for this is the increased data burden that sustainability reporting often places on Tax functions. Whether it is calculating the percentage of recyclable plastic within plastic materials, or the carbon impact of transporting raw materials to factories, sustainability reporting requirements have increased the existing trend that tax functions need to have increasingly better knowledge and ownership of data and data quality. The EU Corporate Sustainability Reporting Directive ("CSRD") will require levels of detail in sustainability reporting that goes beyond any regulation currently in place. As disclosures become more extensive, and require data from sources of non-financial data, this will likely become less structured and more inconsistent.
Further to this, is the growing requirement for and increasing levels of assurance being required for ESG and climate related information. This further drives the need for more robust data, as this data comes under new levels of rigour. Poor quality, or availability of data, will increase tax risk and result in additional valuable time being spent by the tax team on sustainability reporting, which tax functions can ill afford.
Market leading functions are responding by leveraging legislative requirements to contribute to a business case for change in regards to data. The nirvana for tax functions is better quality data that has greater accountability to the owner on its quality and assurability, and the sustainability agenda is supporting them in achieving these outcomes. Projects are now being undertaken that help to define data requirements, build tax data strategies or data dictionaries and incorporate tax data design into ERP and enterprise technology platforms, all supporting the ESG and transparency agenda.
Technology the empowerer
As with the general trend of modernisation that tax functions are facing, only through leveraging the power of technology can tax functions fully master the demands being made of them by the growth in ESG. Aligned to other reporting requirements, tax functions must make a strategic decision with regards to the technology tools and systems that they will leverage to keep on top of sustainability reporting requirements.
Tools that help to manage and visualise the large quantities of data, whilst maintaining or helping to improve its quality, will likely be a great starting point for most tax functions. ERP and tax reporting and compliance technology vendors are reacting to the market demands for technology which helps groups to keep up with, and respond to, sustainability reporting requirements. Decisions will need to be made by the tax function in regard to ownership and maintenance of these tools, which to invest in, whether these will be owned and managed by Tax or another function, or whether it is better to rely on the investment of a third party provider. If Tax isn’t the ultimate owner, ensuring that tax requirements are considered in design and maintenance will be critical. This will begin to enable a move towards utilising enterprise architecture enabled sourcing and reporting of data, which can be embedded by technology enabled risk controls.
As with other reporting requirements the future landscape for sustainability reporting will be integrated reporting requirements, including real-time reporting, which will need to be enabled by a central data repository or single source of truth. With ESG so high up the Executive agenda currently, sustainability reporting requirements can be a great catalyst or supporting pillar for a business case for investment in the tax function as a whole. Current manual processes for dealing with ESG increases the group, and tax function’s, risk profile and provides little transparency for assurance for internal and external stakeholders.
Shaping the future
Responding to the ESG agenda is a huge ask of already stretched tax functions, but it is also critically important that tax functions are inputting into the strategy as organisations look to meet their obligations under ESG. Failure to do so could be missed opportunities. It is also an opportunity to enhance the status and influence of tax across the organisation and externally. The earlier and more decisively you act, the more tax can influence the overall strategy and enable the benefit that ESG can bring organisations.
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