As Google, Amazon and other multinationals face scrutiny over their tax affairs, Jonathan Williams assesses the case for asset owners to engage on the issue
Corporate taxation has been a topic widely debated in recent months. Following the appointment of Margrethe Vestager as EU competition commissioner in 2014, the Commission started to scrutinise the tax arrangements of multinationals with individual member states. Google, Amazon and Starbucks – all companies with significant revenue generated across the EU and all employing carefully considered mechanisms to keep their tax bill low – came under pressure to explain their activities.
Where do questions of tax planning leave pension investors? Should they be satisfied that firms are structuring their affairs in such a way as to ensure dividend payments remain high and constant, or should they consider the longer-term impact of some of the world’s largest companies avoiding tax?
This amounts to a judgement call: do those managing the pension assets view scrutiny of tax affairs as an area where debates of ‘fairness’, a hard-to-measure metric, are appropriate, or should they focus on the potential financial impact of firms only complying with the letter and not the spirit of the law.
The Council of Institutional Investors, representing the interests of US asset managers and owners, put the risk of aggressive tax planning bluntly when it in 2015 urged pension investors to take action: “Ultimately, ordinary citizens, including pension fund beneficiaries, pay the price.”
Matthias Müller, senior sustainability analyst at RobecoSam, says it is right for companies to consider corporate tax rates when economic decisions are made, and cites the example of a firm considering the overall cost of setting up a new office or factory in low-tax Ireland compared to higher-tax Germany. “It would probably make sense to set up the factory in Ireland,” he says. “But if they just set up a letterbox somewhere to draw benefits from a tax perspective, then this is what we would call aggressive tax optimisation.”
Müller argues that such aggressive tax planning is unsustainable and should therefore not be considered by listed companies in which RobecoSam invests. “We see a risk of companies that are too aggressive in tax optimisation seeing a financial impact in future.”
One such financial impact is the issue of outstanding tax payments. National settlements have recently seen Google agreeing with the UK make payments to address tax dating back to 2005, while the European Commission has been more aggressive and declared a number of national tax arrangements illegal. A decision in January saw 35 Belgian-based firms ordered to pay the national revenue office €700m after an excess profit scheme dating back a decade was declared unlawful state aid.
Of course, such arrangements are made possible by the ease with which capital now moves between countries. Many US firms, such as Amazon, base their European operations in Luxembourg, allowing them to benefit from the Grand Duchy’s lower sales-tax rates.
A more assertive Commission is now trying to address the lack of transparency with new anti-avoidance powers it hopes will prevent aggressive tax planning by companies, partially by increasing the quality of disclosures available to tax authorities. Calls are also growing for a country-by-country tax disclosure system for listed companies.
The world’s largest economies have also come together at the G20 to endorse work by the OECD setting out principles to ensure tax is paid in countries where business activity occurs. The OECD’s Action Plan on Base Erosion and Profit Shifting (BEPS) has been welcomed by finance ministers, and the Commission argues it will result in a more consistent taxation system.
A second, softer financial argument in favour of pursuing companies responsible for aggressive tax planning is made by the French supplementary civil service pension fund ERAFP. Emphasising that its members are “naturally attached to public service”, the fund says another reason institutions can cite for tackling aggressive tax avoidance is that it denies governments essential revenues.
Pauline Lejay, socially responsible investment officer at the €20bn fund, says ERAFP considers tax-related issues an engagement “priority”, as it hopes to bring about greater transparency of tax affairs that will enable investors to better address any outstanding concerns.
The fund’s guidelines on shareholder engagement challenge the need for “legally abusive structures” that allow firms to avoid tax, and also question the need to relocate company offices if it could be seen as a bid to minimise tax. The fund says that changes to a company’s headquarters should be examined for whether they foreshadows a move “with a view to aggressive tax optimisation”.
The economic development risk is particularly important for firms based in emerging markets, RobecoSam’s 2015 Sustainability Yearbook argues, while recent research by the Principles for Responsible Investment urges firms not to view the lowest tax bill as the best outcome, where it impacts a government’s ability to invest.
Müller says RobecoSam echoes the economic risk as a long-term one that could hamper governments’ ability to build necessary infrastructure or lead to under-investment in education. Underpayment today could see companies of tomorrow left without the appropriately skilled workforce.
A less tangible impact is that of reputational damage. Firms publicly questioned over their tax affairs, either in the press or by parliamentarians, can suffer either temporary or permanent reductions in sales due to boycotts.
There are also wider reputational risks, ones that are more measurable, according the PRI report, which offers asset owners guidance on how to tackle the matter. “For sectors reliant on government licences to operate (eg, mining), reputational damage may harm the relationship with the host and/or home country, hitting existing projects and affecting the ability to win future licences.”
For example, a focus on extractive companies would help ensure they are not denied mining licences required to continue operation, while telecoms giants should be aware of the dual risk of being denied a licence, and the risk that a state might not be able to complete vital infrastructure needed for a modern telephone network.
There appear to be numerous financial reasons for pension investors to question the tax arrangements of companies in which they invest. Left to their own devices, companies may cite their duty to maximise shareholder value, so concerned investors ought to consider making the case for a longer-term view and a wider perspective beyond quarterly dividend payments.