ESG tax in the oil industry: a Brazilian perspective

November 2022  |  SPECIAL REPORT: CORPORATE TAX

Financier Worldwide Magazine

November 2022 Issue

World-famous economist Milton Friedman published the article ‘The Social Responsibility of Business is to Increase its Profits’ in 1970. That article and Friedman’s thoughts shaped generations of businesspeople around the globe, and delayed what was inevitable: the realisation that businesses do have responsibility to the societies and communities they are part of.

In today’s world, companies are corporate members of society and most responsible businesses adopt ‘stakeholder capitalism’, seeking long-term value creation by taking into consideration the needs of a multitude of stakeholders. Those stakeholders include society, customers, employees, communities and suppliers, among others.

While Friedman’s shareholder capitalism in the 1970s heavily influenced the business ethics of the day, in the 1980s the world witnessed the development of stakeholder capitalism envisaged by Robert Edward Freeman in his book ‘Strategic Management: A Stakeholder Approach’.

Deriving from the stakeholder theory, corporate social responsibility (CSR) seeks to operate not only within the letter, but also the spirit of the law. Further, the catalogue of business principles enshrined in CSR include ethical standards and international norms that function in a self-regulating way as a company strives for long-term value.

Pushed by Kofi Annan, former secretary of the United Nations (UN), the report ‘Who Cares Wins’ helped bolster the term environmental, social and governance (ESG) in 2004. The case for adopting an ESG approach was a moral, but also a financial one.

The connection between ESG and tax was not clear until the 2008 global financial crisis, however. Until then, tax was seen as a complex and unwelcome subject – not a topic of everyday conversation for the common citizen. That began to change in the wake of the 2008 financial crisis, especially in Europe. When asked to ‘pay the bill’, common citizens questioned why they should have to pay for the crisis when certain multinationals were operating in their territories without paying corporate taxes. That moment was marked by the ‘Fair Share’ movement and caused popular unrest.

In the UK, Margaret Hodge, member of the UK parliament, hosted a series of parliamentary hearings with multinationals where she denounced: “We are not accusing you of being illegal, we are accusing you of being immoral.”

The issue of tax morality gained momentum, with strong political support in Europe. The Organisation for Economic Co-operation and Development (OECD) took advantage of the momentum to bring back some of the concepts it defended since the 1990s with its report ‘Harmful Tax Competition, An Emerging Global Issue’. With that, the base erosion and profit shifting (BEPS) project was born, seeking to tackle loopholes in the international tax framework.

BEPS was completed and with that, the question arose: what comes next? By this point it was clear, especially in Europe, that tax had become a subject on which everyone had a say, not just experts. By the second half of the 2010s, society in certain countries demanded further tax transparency and responsibility. CSR and ESG had intersected with tax matters.  

A couple of interesting trends followed. First, acting with a social mandate, European Union (EU) politicians strengthened tax avoidance countermeasures through the European Anti-Tax Avoidance Directive (ATAD) I and II. Second, socially conscious consumers, employees and investors began gravitating toward companies that embraced ESG standards, including tax transparency.

Companies responded by seeking to raise the bar in their tax strategies, standards and transparency. Beyond applying the law, responsible multinationals now seek to elevate their practices to alignment with moral principles, and are more transparent about how much, where and how they pay tax.

The case for ESG tax adoption

ESG tax, transparency and tax morality could evolve into the greatest tax revolution since the BEPS project. It may even reshape international tax practices established under the League of Nation’s Committee of Technical Experts on Double Taxation and Tax Evasion, back in 1927.

The economic and social consequences are relevant. ESG tax may lead to greater scrutiny from consumers and society. Further, companies seeking investment will need to take the ESG tax agenda into account. Indeed, Reuters recently reported: “For first time, Norway's wealth fund ditches firms over tax transparency”.

KPMG’s report ‘ESG and Tax: Increasing importance to Institutional Investors’ highlights that  “regardless of level of investment or control, institutional investors could be criticized for investments in entities that do not follow ESG principles as they apply to tax. Therefore, it will be important for investors to carefully consider the consequences of investing in entities that are less than fully transparent about their tax risk profile”.

In another report, ‘Corporate tax: a critical part of ESG’, KPMG further points out that “Increasingly, corporate tax has become a leading governance consideration, specifically tax transparency and corporate income tax responsibility”. Evidently, tax plays a crucial role in all dimensions of ESG.

Though ESG tax is largely visible among European multinationals, it is still rather scarce in other parts of the world. The 2021 ‘VBDO Tax Transparency Benchmark report’ shows that while 50 percent of European companies already publish country-by-country reporting (CbCR) data on a voluntary basis, the global benchmark is only 7 percent.

In the oil industry, while European multinationals are leading the way, some Brazilian companies are also rising to the ESG tax challenge. One example is Petrobras, which reported its tax data for 2019, 2020 and 2021. The company has moved the needle on transparency in recent years, receiving several independent awards in recognition of its impressive efforts to enhance tax and accounting governance.

In practice, ESG tax comprises a group of principles to self-regulate an organisation’s approach to tax, covering items such as governance, corporate structure, relationship with authorities, and transparency, among others.

On enhancing the relationship with authorities, the OECD’s ‘Co-operative Compliance: A Framework’ report outlines the following key advantages: (i) mutual trust; (ii) increased commercial awareness and predictability; (iii) risk management and the ability to address issues sooner and faster; (iv) certainty in advance; (v) reduced administrative burden; (vi) better resource allocation; and (vii) better public reputation.

The Brazilian tax authority, known as RFB, is attuned to this trend. In 2021, RFB established a pilot cooperative compliance programme named Confia. Key companies were invited to join the programme, so that, together, tax authorities and taxpayers would design the framework for the Brazilian model.

ESG tax continues the evolution of stakeholder capitalism taking shape since the 1980s. Hence, it should assumed that ESG tax will expand beyond Europe to all countries as societies, consumers and employees better understand it.

Practices that were once considered ‘nice to have’, best practice or soft law have turned into hard law over time.

So too, some of what is currently observed as soft law in the ESG tax space will eventually be converted into hard law. That seems to be the case already, with CbCR one example.

In 2015, the OECD published its ‘BEPS Action 13’ report setting forth reporting standards for CbCR (soft law). Over subsequent years, several countries enacted domestic CbCR laws to which their taxpayers are bound (hard law). CbCR data was at this point privileged, with tax administrations held to confidentiality.

However, by 2019, a handful of multinationals had decided to voluntarily publish their CbCR numbers in line with ESG tax principles (soft law). And in December 2021 the EU enacted Directive 2021/2101 to impose mandatory disclosure of income tax information to the public (hard law).

From myriad angles, ESG tax appears to be here to stay. As a result, companies need to carefully consider it as part of their overall tax strategy.

Final remarks

Tax compliance is an obligation. However, companies have an opportunity to go beyond mere obligation and act as responsible corporate citizens that contribute to society with a long-term view – one aligned with stakeholder capitalism. Benefits may be derived from greater consumer and staff loyalty, resulting in better business and better prospects for investment.  

The oil industry is naturally highly scrutinised by stakeholders. Greater transparency may expose oil companies to disproportionate risks. But potential benefits include trust and a shared purpose as consumers, employees, communities and investors realise that some of these companies have decided to step up their contribution to society in myriad ways, including through ESG tax.

If these reasons are not enough to support the case for ESG tax adoption, there is one final reason: it is the right thing to do. Much of what today is soft law will eventually become hard law. If corporates ignore the opportunity for voluntary adoption, at some point they will be forced into mandatory compliance. As Jack Welch put it: “change before you have to”.

 

Fabio Luiz Gomes Gaspar de Oliveira is a tax lawyer and tax law lecturer.

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BY

Fabio Luiz Gomes Gaspar de Oliveira

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