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Is aggressive tax avoidance a risky game to play?

June 24, 2020

Tax avoidance, which is a legal form of minimising tax liability, may come across as a prudent strategy.  Often lucrative in the short term, aggressive tax strategies – such as treaty shopping, hybrid structures and earnings stripping – carry considerable legal, financial and reputational risks that can have widespread implications in the longer term.

Many high-profile scandals with multinational companies paying not only no tax at all, but possibly also receiving sizeable refunds from the taxpayer money, have largely undermined public trust into businesses that operate on a global scale and the authorities that allow this to happen.  The issue, exacerbated by the lack of transparency due to insufficient disclosure, has caught the attention of international institutions, including the G20, OECD, the UN and the EU. 

This increased scrutiny of tax avoidance is directly linked to the concern about the impact of aggressive tax strategies on human rights.  In many developing countries, where wages are low, corporate taxation often generates much higher revenue compared to personal income taxes.  Losses to profit shifting, which can be as high as 40% of tax revenues, lead to people in those regions being denied quality infrastructure and social services, including education, healthcare and housing, contributing to deepening inequality and social exclusion. However, developing countries are not the only victims of tax base erosion and profit shifting practices.  In fact, every year, estimates are that between US$100bn and US$600bn is lost by governments around the globe due to issuers’ aggressive tax strategies.

The Covid-19 pandemic, which is a social as well as financial crisis, provides an opportunity to address tax avoidance in more systemic way.  As aggressive tax planning fuels inequality and strips authorities of crucial funding, many countries across the world, among them France, Denmark, Poland and Scotland have blocked tax haven-tied corporations from receiving any crisis-linked bailout.

For investors, tax justice is a theme which cuts across all three elements of ESG (Environmental, Social and Governance). Given underlying investment risks and risks to wider portfolio returns, investors regularly engage with companies individually and collaboratively on this issue, with corporate tax policy, governance and risk management, and financial reportingbeing among key themes.  Some institutional investors, for example the Church Investor Group, representing 70 members and £21bn in assets, went a step further and incorporated tax transparency indicator in their voting guidelines, with poor responsiveness to investor engagement efforts as one of the key red flags.

Aggressive tax practices pose governance, reputational and earnings risks for issuers, investors and governments.  As global efforts to address the issue mount, engaging in overly complex and devious strategies to minimise tax liability is increasingly risky, with potential costs outweighing benefits.  A good first step for any board and its risk committee would be to ensure they can grasp and explain their company’s tax affairs, while also asking themselves if their company’s social license to operate might be at risk.

Rafal Budzinski – Corporate Governance Advisor at Velos Advisory. Rafal co-managed the investor collaborative engagement on tax transparency at the UN supported Principles for Responsible Investment

Tags: Rafal Budzinski
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