Tax transparency and social responsibility: managing opportunities and risks of ever-complex tax laws
Report on a session at the New Era of Taxation Conference, presented by the IBA Taxes Committee
3 December 2021
Guadalupe Diaz Sunico Aboitiz Lener Asesores Legales y Economicos, Barcelona
Bruna Marrara Machado Meyer, São Paulo
Lynn Cramer Maples and Calder, Dublin
Michael Orchowski Sullivan & Cromwell, London
Juan Manuel Iglesias Mitrani Caballero & Ruiz Moreno, Buenos Aires
Jennifer Migliori Duane Morris, Miami, Florida
Eva Stadler Wolf Theiss, Vienna
Floran Ponce Lenz & Staehelin, Geneva
Bruna Marrara welcomed everyone and introduced the panel. Guadalupe Diaz Sunico Aboitiz explained that this session was to cover a very broad topic, and advised that it would be split into three sections.
The first section dealt with environmental, social and governance (ESG) factors. ESG factors are non-financial performance indicators for companies. ESG first appeared in the 2006 United Nations report, Who Cares Wins: Principles for Responsible Investment, which contained a proposal to introduce ESG criteria in companies’ financial communications. Initially, companies thought it was a cost and an obligation, but came to understand that it was a way to win social approval. Aboitiz explained that the role of taxes in ESG would be explored, and that Michael Orchowski and Lynn Cramer would give the United States and European Union perspectives.
The second section covered attempts to tax products on the premise that they are ‘poor choices’ for consumers: alcohol, tobacco, sweet, sugary beverages and meat. Jennifer Migliori and Juan Manuel Iglesias explored the role of taxes, whether they are effective (or even constitutional) and whether they impact choices, or are just a way to raise revenue.
The final section looked at taxes and public scrutiny. Eva Stadler focused on conflicts between transparency and privacy for individuals, while Floran Ponce looked at the corporate perspective. The drivers on the corporate side are not necessarily the same as those on the private client side.
Taxes and ESG
Orchowski introduced the topic by saying that he would look at the US perspective. He noted that it may seem like an odd place to start, as the US is perceived as an ‘ESG lite’ jurisdiction. He noted that the US' use of environmental taxes has been minimal – about half the Organisation for Economic Co-operation and Development (OECD) average – and relatively ineffective – eg, a 'gas-guzzler' tax which applies to cars but not to Sports Utility Vehicles. However, the US does use state and local taxes at the individual level for non-environmental purposes, such as a tax on tobacco. Such 'punishment' taxes are not a broad policy in the US.
However, the US makes frequent use of tax incentives; Orchowski pointed to an investment tax credit and production tax credit in the renewable space. He noted that, while it is not possible to sell tax credits in general, one can effectively sell these tax credits, thanks to Internal Revenue Service (IRS) safe harbours, by selling equity investments that carry tax benefits. The reason for this is because project companies (wind projects, solar projects, etc) would not generally have enough profits to benefit from the credits, so the IRS has to allow this structuring to enable them to take advantage of these credits. There are also non-environmental credits, such as tax credits for teachers. These tend to be small, but such credits are a relatively prominent feature of the system.
What can be taken out of this experience is that the US has been very successful at using incentives. Orchowski acknowledged that the use of tax incentives is something of a crude method; the fact that the IRS effectively allows the selling of tax credits in order to make them achieve their intended purpose is indicative of the challenges that using the tax code to incentivise good behaviour can bring. On the other hand, Orchowski noted that there are benefits to using the tax code, such as the fact that tax authorities are effective and experienced at the administration of taxes, and the tax code is generally administered fairly.
Orchowski noted that there is significant demand for sustainable investment in the US and that, while the demand for sustainable investment was lower in 2021, it remained significant. Orchowski pointed to the fact that the Securities and Exchange Commission (SEC, which is controlled to a greater extent by the government than most tax legislation) demands certain climate change disclosures in prospectuses. Orchowski referred to the changes included in the proposed Build Back Better Act, and stated that, while there are some environmental taxes proposed, there is a significant focus on environmental incentives. Some incentives also have a social aspect, such as incentives that are tied to the wages of lower-paid workers, and the provision of apprenticeships and building projects in disadvantaged areas. Orchowski commented that the proposed changes do not mark a massive shift in US tax policy, but would be a significant improvement on the incentives that exist at the moment. Orchowski concluded by acknowledging that, owing to the difficulty of getting legislation through the US Senate due to the current 50:50 split, it is hard to know if, or when, the Build Back Better Act will be passed.
Cramer pointed out that the role of taxes in ESG can be twofold:
- Tax can be used as a tool to incentivise good behaviour or disincentivise bad behaviour – for the most part, this has been individual jurisdictional level policy and has tended to focus on the environmental element of ESG; and
- Tax itself can be an ESG criterion in its own right – tax transparency and responsibility is tied in with the social and governance elements of ESG.
Cramer focused on the use of tax policy incentivising investment. She noted the lack of action on tax policy to date at an EU level, and wondered whether a pan-European approach could be achieved.
Cramer observed that some jurisdictions have implemented tax incentives for ‘good’ ESG-related behaviour. She gave the example of enhanced tax depreciation for investment in energy-efficient equipment. Cramer noted that these types of incentives tend to be individual Member State policies, and they tend to be aimed at individual actions that are not likely to move the needle on the climate crisis to any great degree.
Cramer contrasted this with the EU-wide approach to ESG issues on the financial and regulatory side, where there is a push to put ESG issues at the top of the agenda. For example, the Sustainable Finance Disclosure Regulation and the Taxonomy Regulation were proposed in 2018 and are already in effect, which could be contrasted with the lack of action on the tax side. Cramer remarked that tax is divorced from ESG at the EU level and it is generally left to local governments. This is partially a question of competence because tax legislation is a matter for Member States, whereas financial regulation tends to be developed at an EU level. The result is that there is a well-developed financial and regulatory framework for ESG issues that is not supported or considered by the tax framework. Cramer noted that there seems to have been no thought given at the EU level to aligning tax measures with the economic initiatives necessary to support the EU approach to sustainable finance, the UN Sustainable Development Goals and climate emergency targets.
Cramer went on to ask what an EU ESG policy would look like, and provided some suggestions:
- VAT reform: VAT is harmonised at EU level and can target specific products or activities. There is currently little scope for Member States to use VAT policy for ESG purposes. Cramer gave the example of how VAT could be harnessed for ESG purposes in Ireland: the development of new buildings is subject to VAT at 13.5 per cent but refurbishment is subject to VAT at 23 per cent, even though refurbishment is said to be more eco-friendly;
- Carbon taxes: Cramer suggested that the carbon border adjustment mechanism could be enhanced and extended with a border-adjusted carbon tax; and
- ATAD interest limitation rule: Cramer suggested that the interest limitation rule could be used to support long-term green infrastructure projects.
Cramer asked how we could use existing tax directives and measures to support, rather than hinder, ESG tax policies. She noted that this requires a coordinated approach, without which it would be hard for individual Member States to do anything from a tax perspective to achieve the goals set out in the European Green Deal. Cramer argued that the lack of integration means proposals that are seen as positive, such as profit redistribution under the Organisation for Economic Cooperation and Development (OECD) base erosion profit shifting (BEPS) project, may actually have a negative impact from an ESG perspective. For example, Pillar One includes an exclusion for extractives and aircraft and shipping, and some charities have argued that Pillar One may be detrimental to developing countries with regard to the spread of tax revenues that arise from it.
Meanwhile, Pillar Two may have a negative impact because capital-intensive renewable energy industries rely heavily on tax depreciation and tax deferrals, which are not taken into account in the Pillar Two effective tax rate.
In terms of additional financing required to meet ESG-related goals, Cramer argued that tax must play a role on both the public and private side – such as the use of carbon tax for public funding and the use of tax incentives to encourage green investment on the private side. Cramer concluded by stating that there is an urgent need at an EU level to focus on how tax can play a role in pushing finance into ESG-positive activities.
The role of taxes in influencing taxpayers’ behaviour
Migliori began by introducing selective taxes, which are taxes on unhealthy or poor choices. The idea is to mitigate consumption of particular goods and raise tax revenues. Examples of such taxes in the US are taxes on sugary drinks, tobacco, alcohol, gambling, ice cream and not having health insurance. The US has a long history of excise taxes – in 1791, a tax on manufacturers of whiskey was introduced, and up until the First World War, excise taxes made up 50 per cent of government revenue in the US. Since the Great Depression, the trend has been to minimise excise taxes and raise federal income taxes. Now, excise taxes are 2.8–2.9 per cent of government revenues in the US. These tend to be state-level taxes: in California, for example, there is a tax on sugar sweetened drinks. Other states have taxes on alcohol.
Iglesias gave examples of selective taxes that are imposed in other countries:
- Argentina has a selective consumption tax on wine, beer, tobacco and sugary drinks, with alcohol taxed at 35 per cent and tobacco taxed at 233 per cent;
- Belgium, Chile, Columbia, France, Ireland, the United Kingdom and Uruguay also tax sugar-sweetened drinks;
- Mexico taxes sugary drinks, sweets and nut butters;
- In 2011, Denmark introduced the first 'fat tax', which was abolished within 15 months;
- Hungary has a 'junk' food tax; and
- A meat tax is proposed in the EU to fight the climate crisis.
Iglesias then posed the question: is tax an effective tool to reduce consumption? Studies and research show that taxes produce mixed results. For example, the Danish 'fat tax' was introduced with the intention of reducing consumption. However, a study conducted a few months after its introduction found that, despite an increase in price of 20 per cent, it only reduced consumption by four per cent. It was thus abolished soon after. On the other hand, evidence in Mexico shows that taxes on sugary drinks have reduced consumption by between six per cent and 12 per cent.
Migliori noted that, in the US, studies have shown that a tax on tobacco and a tax on sugary beverages has been effective in reducing their consumption, but only for a sub-set of society: low-income households. These taxes affect low-income households more than other households for two reasons:
- low-income households are more likely to engage in activities that bear these taxes due to a lack of education and a lack of alternative choices; and
- the tax-to-income ratio is higher in low-income households than in other households.
This raises a public policy concern: that a greater part of the tax burden is borne by low-income households. Also, since the tax is effective in reducing consumption, it will also reduce revenues over time. As such, this tax is an unstable source of revenue: the more effective it is, the more revenues brought in by it will reduce.
Aboitiz remarked that reducing taxes on healthy choices does not necessarily increase the uptake of healthy choices. Migliori agreed, noting that this is partially due to a lack of availability of choices other than 'junk food'. In order to choose healthier alternatives to junk food, there might be a need for storage, the ability to plan in advance and access to grocery stores, which may not be available to low-income households. Where the price of one convenience food is increased, certain households are more likely to choose another convenience food, possibly one that is not subject to the tax.
Iglesias noted that the argument has been made that, if the goal of tax is to discourage consumption, the tax should be high enough for the consumer to feel the impact. However, there may also be an argument to differentiate between tobacco and other products such as food. He contended that governments need to understand that the impact on low-income households is greater, as low-income households spend a greater percentage of their house income on food. Iglesias noted that, in Argentina, a constitutional challenge against an increase in tobacco tax had been mounted by a small company on the basis that the tax violated antitrust law, as the tax had a greater impact on smaller companies and had caused the claimant company to leave the market. The Supreme Court rejected the claim.
Migliori noted that there were lots of constitutional challenges at a state level, such as in North Carolina, where the state constitution says the state has the power to tax in ‘a just and equitable manner’. This definition was examined in the context of a tax on the purchase of a mobile home. Mobile homes tend to be purchased by low-income households.
Migliori explained that the reason that the US has a significant quantity of research on these taxes is because of the legislative process in the US. Once a bill is proposed, it can be accepted or rejected. Lobby groups press for these bills to be accepted or rejected, and in doing so carry out a large amount of research to support their arguments. The American Heart Association lobbied for the passing of the soda tax; sugar-sweetened drinks companies lobbied strongly for the rejection of this bill. This process leads to extensive research, on both sides, into the effects of these taxes.
A commentator from the audience noted that, in the EU, one of the things that limits the effectiveness of these taxes is that it can be very easy to move from one country to another. When taxes were raised on alcohol in Finland, purchasers went to Estonia; when Estonia raised taxes, they went to Latvia. Aboitiz agreed that there was a question over how these taxes distort competition and noted that the same issue was seen with taxes on meat.
Taxes and public scrutiny
Ponce opened by noting that there had been many debates recently about companies not paying their ‘fair share’ of taxes, which has led to pressure from the OECD, regional and local authorities and from investors to push companies towards greater tax transparency. In this way, tax can be seen as part of ESG – and in particular, linked to the social aspect of ESG. This is a clear focus for listed multinational companies. It is less clearly a focus for private companies but is becoming more important.
Ponce noted that the drivers for tax transparency come mainly from two forces: regulatory and market forces.
Mandatory regulatory forces include laws, regulations and voluntary disclosures, such as:
- Country-by-country reporting (CbCR), which applies in more than 50 countries. It is not currently public but the fact that it exists is taken into account by multinationals, and it will be public in future;
- The Extractive Industries Transparency Initiative (EITI) – a requirement for extractive industries to publish certain data, including tax data;
- The EU Capital Requirement Directive, which requires banks to publish details regarding taxes paid in EU Member States;
- The UK’s tax strategy document, which a group with revenues over a certain threshold must publish for a UK subsidiary; and
- National regulations – certain jurisdictions publish details regarding taxpayers.
Voluntary regulatory forces include:
- The B-Team initiative, which was founded by Richard Branson to encourage companies to engage in more ESG-friendly behaviours including tax transparency. B-Team responsible tax standards are applied by companies including BHP and Royal Dutch Shell.
Market forces involve stakeholders such as investors, employees and governments. They are mainly driven by investors, especially institutional investors, such as the Ethos Group pension fund’s standards for companies that it invests in, which concern tax transparency and responsible tax behaviour, and the Norges Bank investment management standards on tax transparency.
Ponce looked at the reaction of businesses to these standards of tax transparency. He noted that there is a scale in terms of transparency, which he classed from one to five, with examples of Swiss companies that fall under each of these headings, as follows:
- At the bottom end of the scale is simple compliance with law – these companies tend to be quite small, focused on the Swiss market, or have dual Swiss–US listings;
- Compliance with law and providing public statements affirming compliance;
- Making tax policy public – this is where most companies, particularly in Europe, fail;
- Making tax policy public and making selective consolidated disclosures, such as disclosures on a European basis rather than country-by-country;
- Making tax policy public and making CbCR public – CbCR is often accompanied by a statement of the group’s approach to tax policy. Publication of CbCR is concentrated amongst companies in the financial market – eg, insurance companies – whereas companies with more intangibles are more likely to wait until publication is mandatory before they take the next step.
Under upcoming EU legislation, companies with €750m turnover who are headquartered in the EU or have subsidiaries in the EU will have to make their CbCR public. The first year for which public CbCR will apply will be 2025, with the report to be published in 2026; however, some Member States may decide to move faster than this. This will have an influence on tax transparency.
Stadler added that paying a fair share of tax is also an issue for private clients. There is a perception that high net worth individuals flee taxes. Stadler pointed out that private clients often do not relocate to flee high tax rates, even if they are relocating for tax reasons. Other reasons why high net worth individuals do relocate include:
- legal uncertainty caused by changes in the political environment;
- fear of changes in administration giving rise to raised or amended taxes; or
- lack of clarity on the application of the tax code to them because certain tax authorities do not issue binding rules.
In summary, private clients want certainty and fair treatment when it comes to taxes.
There is a cohort of high net worth individuals who, rather than fleeing taxes, actively ask to be taxed. ‘Tax Me Now’ is a German initiative whereby a group of German millionaires requested the reintroduction of wealth tax and progressive tax rates instead of flat rates for investment income. There is also a group of US billionaires who wrote to the US Presidential candidates regarding the gap between the wealthiest and the general public in the US, and requested the introduction of a moderate wealth tax on the super-rich.
High net worth individuals have concerns when it comes to tax transparency and privacy. Stadler gave the example of a case where an Austrian tax resident had a German bank account with €40 in it. The German authorities automatically exchanged information with the Austrian authorities under DAC2 including the name, address, place and date of birth, taxpayer identification number and account balance of this individual. This case is now pending in the Austrian Constitutional Court, where the individual has claimed that the automatic processing of such sensitive information violated his right to protection of personal data under the EU Charter of Fundamental Rights and has suggested that the Court obtain a preliminary ruling from the Court of Justice of the European Union (CJEU).
The argument is that tax data is personal data which must be processed fairly, for specified purposes, on the basis of the consent of the taxpayer or on another legitimate legal basis. Any limitation on this right must be proportionate and any infringement of this right must be suitable, proportionate and necessary to achieve a legitimate objective. Stadler considered the application of these requirements in the current case as follows:
- In considering whether the automatic exchange of the taxpayer information had a legitimate objective, the objective in this context was combating cross-border tax fraud and tax evasion;
- In considering whether the infringement of the taxpayer’s rights under the Charter was necessary, Stadler argued that it was not necessary to combat tax fraud. Each taxpayer has a tax identification number which is being exchanged; there is no need for the name, other personal data and account balance to be exchanged, as this goes beyond what is necessary. In addition, even if a tax authority has the account balance, they would still need further information in order to take action against the taxpayer and actually tax them;
- With regard to whether the action is proportionate, Stadler commented that:
- the information was processed without any indication that the client was involved in fraud or tax evasion;
- there is no de minimis rule in activating the exchange;
- there is a risk that the data could be used for unlawful processing because there have been hacking attacks on tax authorities; and
- although tax authorities are required to inform tax subjects about the processing of personal data and to allow them to correct it if it is wrong, the Austrian provisions implementing DAC 2 do not provide for such an information obligation by the Austrian tax authorities.
Stadler was of the view that the Austrian legislation implementing DAC2 was not necessary or proportionate, was in violation of the Charter and was unconstitutional. It will be interesting to see if the CJEU will consider this point.
Stadler concluded that everybody should pay their fair share of tax, but they should then be treated fairly, and part of being treated fairly is that there should be some expectation of privacy regarding your tax affairs.
Aboitiz pondered whether, following the 9/11 attacks on the US, tax authorities had taken advantage of the greater transparency based on money laundering and anti-terrorism legislation and used it to access more information. There is a need to question whether this action is proportionate.
Aboitiz opened the discussion by asserting that there was a common theme to the presentations – there is a desire to reduce pollution and unhealthy behaviour, but queried whether this behaviour should be incentivised or penalised by the tax code. She noted that the US and EU have very different approaches. Cramer commented that she was in favour of using taxes as a way to achieve ESG goals. She added that the EU focused on disincentivisation in the form of taxation – eg, carbon taxes – but that there needed to be incentivisation too, such as incentivising investment in alternatives. There must be a just transition, which requires incentivisation of green alternatives. Cramer noted that the US is ahead of the EU on incentivising socially positive action: for example, Ireland previously relied on the government to build social housing but there may be a need to incentivise private interest to build. There needs to be incentivisation and not just penalisation.
Marrara raised the question of whether it is realistic to incentivise socially positive behaviours. Iglesias provided an example from Argentina where there was no limitation for deduction of management fees where there was a female or LGBT person on a board. However, he noted that this conflicts with employment law as one cannot ask a question about sexuality. While there are many socially-focused measures, these can be hard to apply in practice. Orchowski noted that there is a tendency in the US to incentivise behaviours through the use of tax incentives rather than punishing behaviours through the use of taxes. Some are driven by broader policy considerations in the US – namely, to get the private sector to do certain things that may be for the public good. Orchowski pointed to the fact that legislation on incentives is easier to pass than legislation on taxation. Migliori added that the tax code can be used effectively if it both incentivises and disincentivises; for example, the tax on tobacco combined with the ban on smoking in bars resulted in a reduction in tobacco use.
Marrara questioned whether clients are more risk averse as a result of tax transparency. Ponce responded by saying that, anecdotally, some public companies in Switzerland are voluntarily renouncing their tax rulings – they prefer to pay more tax than keep this arrangement in place. Private companies have a different mindset and are still involved in more tax planning. However, this may be changing. Aboitiz wondered whether corporates could be encouraged to voluntarily disclose their tax practices if there was more favourable communication with the tax authority to validate the criteria (ie, in exchange for tax certainty).
Stadler mentioned that there are certain cultures in which neighbours are better tax watchdogs than the tax inspectors. In discussing the use of another taxpayer’s tax ‘misbehaviour’ for your own benefit, Stadler said that some clients in non-tax lawsuits want to point the finger at their opponent to claim that there is a possibility that they have not reported taxes – even where there is no evidence that this is the case, in the hope that this will trigger some investigation by the tax authority. Marrara noted that this concept of ‘misbehaviour’ is open to interpretation, particular by the general public.
A commentator from the audience highlighted that DAC6 may have an impact on behaviours involving transparent reporting. Stadler responded that, because a wide variety of cross-border transactions must be reported, there is a question as to whether it is too broad and may not be the correct strategy to enhance tax compliance. Everybody should be allowed to use laws to do what is best for them, as long as they do not abuse these laws. Orchowski also noted that there is a reportable transaction regime in the US which is narrower than DAC6, which has driven cultural change by causing certain taxpayers to turn away from aggressive tax stances towards a more conservative approach.
Aboitiz closed the presentation by saying that the world is changing and ESG is a growing factor in tax policy. Millennials make up 34 per cent of the workforce, while Gen Z make up another 21 per cent of the workforce: ESG is an important factor for them. It is easy to agree that ‘who pollutes pays’ – however, the devil is often in the detail and unilateral measures to address global matters rarely prove to be the right path.
With advanced technology such as artificial intelligence, machine learning, deep learning and social media, tax authorities do not have to rely as much on voluntary disclosures as they would have in the past. Aboitiz therefore posed the final question: is transparency still a choice?