Tax transparency is here to stay

Tax transparency is here to stay. As anyone involved in the tax arena will be aware, there has been a paradigm shift in the global tax landscape that has resulted in public and political pressure for action to tackle perceived harmful tax practices, particularly by corporate entities.

Information reported under existing ‘non-public’ country-by-country reporting (CbCR) requirements is meant to help tax authorities to gain a better understanding of the corporate tax profile of the business and structure of multinational enterprises (MNEs). However, other key motivations of institutions such as the EU in their work around tax transparency are to ensure public accountability and transparency, and promote a more informed public debate around the level of compliance of certain MNEs. Therefore, in parallel with non-public CbCR, the EU is also introducing public CbCR rules.

The EU country-by-country report will require information on all members of the group (i.e., including non-EU members) within the following key areas:

• A brief description of activities;

• The number of employees;

• Net turnover (including related-party turnover);

• Profit or loss before tax;

• Tax accrued and paid; and

• The amount of accumulated earnings.

The information must be broken down for each EU member state where the group is active and for each jurisdiction deemed non-cooperative by the EU or that has been on the EU’s ‘grey’ list for a minimum of two years. Information concerning all other jurisdictions may be reported on an aggregated level.

While the EU requirements focus on quantitative disclosures, proposed reporting requirements in Australia lean towards Global Reporting Initiative 207 (GRI 207; for more information on this standard, please refer to Country-by-Country Reporting: An overview and comparison of initiatives) and require a description of the group’s approach to tax, in addition to quantitative tax information.

The entry into force of mandatory public CbCR in the EU, the ambitious plans in Australia, and the Financial Accounting Standards Board income tax disclosure proposal in the US are creating momentum for companies to dedicate time and resources to collecting relevant data and consider going beyond the minimum standards and disclosures set by regulators (please refer to KPMG Global’s Country-by-Country Reporting for further details on these initiatives).

In addition to these targeted tax-related disclosures, information on a group’s tax position will also be relevant in the context of the EU Corporate Sustainability Reporting Directive (CSRD). Under the CSRD, companies operating in the EU will need to prepare extensive sustainability reports as part of their management reports. The CSRD is intended to ensure that companies report reliable and comparable sustainability information necessary for stakeholders to evaluate companies’ non-financial performance, with the main goal of improving transparency for all stakeholders. For tax, this will likely represent a step beyond the quantitative data required under EU public CbCR and towards a focus on qualitative information.

This article aims to highlight where tax sits in the context of the new EU sustainability reporting requirements under the CSRD.

The CSRD requires all large companies (including those that are not listed) and all listed companies (except listed micro-enterprises) to disclose information on what they see as the risks and opportunities arising from social and environmental issues, and on the impact of their activities on people and the environment.

Listed and non-listed companies are considered large and therefore covered by the CSRD if they fulfil two of the following three criteria:

• A balance sheet total of more than €20 million;

• Net sales of more than €40 million;

• Having more than 250 employees.

Micro-undertakings are undertakings that on their balance sheet dates do not exceed the limits of at least two of the three following criteria:

• Balance sheet total – €350 000;

• Net turnover – €700,000;

• Average number of employees during the financial year – 10.

The new disclosure requirements also apply to third-country companies if they have a significant presence in the EU (the rules apply to third-country undertakings that generate a net turnover of more than €150 million in the EU and that have in the EU a subsidiary that meets the above-mentioned criteria; i.e., it is a large undertaking or small or medium-sized (except micro undertakings), whose securities are admitted to trading on a regulated market in the EU, or a branch that has a net turnover of more than €40 million).

Qualifying EU subsidiaries and branches of non-EU companies will be responsible for publishing the sustainability report of the third-country undertaking, in accordance with standards to be adopted by June 30 2024 by the European Commission through delegated acts.

The CSRD is meant to build on and expand the Non-Financial Reporting Directive. The enhanced level of disclosure is considered to help stakeholders – such as investors, civil society, and consumers – to evaluate the sustainability performance of companies. Disclosures will be required in a harmonised, machine-readable format, which will assist stakeholders in comparing the performance of in-scope companies.

The CSRD is part of the European Green Deal, which aims to transform the EU into a modern, resource-efficient, and competitive economy.

The CSRD also makes it mandatory for companies to have an audit of the sustainability information that they report. The initial standard will be limited assurance, but there is an expectation that reasonable assurance (more stringent) will be required in future.

The first companies will have to apply the new rules for the first time in the 2024 financial year, for reports published in 2025.

The disclosures will be included in a dedicated section of the entity’s management report and will include information on:

• The entity’s business model, strategy, and policies in relation to sustainability;

• Any time-bound targets that the entity has set in relation to sustainability matters (for example, greenhouse gas emission reduction targets);

• The role of the administrative, management, and supervisory bodies with regard to sustainability, as well as any incentive schemes linked to sustainability matters offered to members of those bodies;

• Any due diligence processes implemented by the entity around sustainability matters; and

• The main risks to the entity related to sustainability matters.

Information on the entity’s value chain will also be required if appropriate.

The directive requires reporting on the impacts of its activities on people and the environment, and on how sustainability matters affect the entity. That is referred to as the ‘double materiality’ standard, in which the risks to the undertaking (how sustainability issues affect the entity – financial materiality) and the impacts of the undertaking on society and the environment (impact materiality) each represent one materiality perspective.

Companies subject to the CSRD will have to report according to the European Sustainability Reporting Standards (ESRSs), which cover all sustainability matters from a double materiality perspective.

Draft standards were developed by the European Financial Reporting Advisory Group (EFRAG), an independent body that brings together various stakeholders. The standards were finalised and adopted by the European Commission on July 31 2023, in the form of delegated acts, which have been submitted to the European Parliament and Council for scrutiny. The scrutiny period runs for two months, extendable by a further two months. The European Parliament or the Council may reject the delegated act, but they may not amend it (Questions and Answers on the Adoption of European Sustainability Reporting Standards).

The first batch of standards includes 12 sector-agnostic standards comprising 82 disclosure requirements, which include general principles and disclosures (cross-cutting standards) and information related to the environmental (ESRSs E1–E5), social (ESRSs S1–S4), and governance (ESRS G1) impacts of the entity.

Disclosures are subject to the double materiality test, with the exception of those required under ESRS 2: General Disclosures, which includes mandatory disclosure requirements.

Additional standards will be developed for SMEs and for non-EU groups, as well as 40 sector-specific standards. Where a topical ESRS is not available for a specific topic, the ESRSs mention the possibility for entities to use the Global Reporting Initiative (GRI) standards to report on material topics. This approach was confirmed in an August 2023 joint statement from EFRAG and GRI on the interoperability between ESRS and the GRI standards, which notes that “the ESRS allow entities to use the GRI Standards to report on additional material topics covered in GRI Standards that are not covered by the ESRS, such as tax.”

The EU Taxonomy is a common classification of economic activities significantly contributing to environmental objectives, developed by the EU.

Under the CSRD, in addition to the ESG items that meet the double materiality standard and that will be reported based on the ESRSs, companies are required to report the percentage of their current revenues coming from activities aligned with the EU Taxonomy and the percentage of their future revenues (capital expenditure) coming from activities aligned with the EU Taxonomy.

The Minimum Safeguards are part of the EU Taxonomy Regulation and have been developed at the request of the European Parliament and based on recommendations from the Technical Expert Group to ensure that entities that carry out environmentally sustainable activities also meet certain minimum governance standards and do not violate social norms, including human rights and labour rights.

In other words, the Minimum Safeguards are meant to ensure that activities that are labelled as Taxonomy-aligned (i.e., sustainable) are not only ‘green’ but meet a broader set of criteria around:

• Human and workers’ rights;

• Corrupt practices and bribery;

• Taxation; and

• Fair competition.

The Taxonomy Regulation clarifies that in the context of the Minimum Safeguards, economic activities are to be considered as Taxonomy-aligned if they do not violate the standards for responsible business conduct mentioned in:

• The OECD Guidelines for Multinational Enterprises on Responsible Business Conduct (the OECD MNE Guidelines);

• The United Nations Guiding Principles on Business and Human Rights (UNGPs), including the International Labour Organization Declaration on Fundamental Principles and Rights at Work and its Follow-up; and

• The International Bill of Human Rights.

Currently, the only source of interpretation on the application of the Minimum Safeguards is available in the Final Report on Minimum Safeguards published by the Platform on Sustainable Finance in October 2022. The report provides useful practical information on applying the Minimum Safeguards and is being used as a source of interpretation in the context of compliance with the CSRD as well, to which it specifically refers.

However, the report only represents the view of the members and observers of the Platform on Sustainable Finance and is not an official European Commission document. Its contents are therefore useful in setting guiding principles but are not binding.

Questions therefore remain with regard to the content and depth of tax information required to obtain the ‘Taxonomy-aligned’ label.

Where tax meets the double materiality test and is therefore considered a material topic, the reporting entity is required to include tax-related information in the CSRD report, in accordance with the ESRSs.

Where a topical ESRS is not available to prescribe specific disclosures, the ESRSs provide for the possibility for entity-specific disclosures to be based on available and relevant frameworks, initiatives, reporting standards, and benchmarks, including technical material issued by the International Sustainability Standards Board or the GRI (see Appendix A: Application Requirements – AR4).

With regard to reporting on tax, this implies that the GRI 207 tax reporting standard can be used to transparently report on tax. In short, GRI 207 includes disclosures on:

• The management approach to tax (e.g., tax strategy, approach to regulatory compliance);

• Tax governance, control, and risk management (including a description of the tax governance and control framework);

• Stakeholder engagement; and

• The management of concerns related to tax.

It is important to keep in mind that tax-related impacts, risks (e.g., carbon taxes, plastics taxes), or opportunities (tax incentives for green investments or R&D activities) may also be relevant to the assessment of other material topics.

For example, according to paragraph 8(a) of ESRS S3 on affected communities, companies must disclose “whether and how actual and potential impacts on affected communities [...] (i) originate from or are connected to the undertaking’s strategy and business models, and (ii) inform and contribute to adapting the undertaking’s strategy and business model”.

In addition, paragraph AR.5 of the same standard provides examples of impacts on affected communities that could originate from the company's strategy or business model, such as “impacts [...] related to the undertaking’s value proposition [...], its value chain [...], or its cost structure and the revenue model (such as, aggressive strategies to minimize taxation, particularly with respect to operations in developing countries)”.

As mentioned above, the Minimum Safeguards require alignment with the OECD MNE Guidelines. The guidelines include a separate chapter on taxation, which prescribes that companies should comply with the letter and the spirit of tax laws and regulations under which they operate.

Companies should treat tax governance and tax compliance as important elements of their oversight and broader risk management systems; in particular, corporate boards should adopt tax risk management strategies to ensure that the financial, regulatory, and reputational risks associated with taxation are fully identified and evaluated.

Furthermore, the OECD MNE Guidelines also refer explicitly to compliance with transfer pricing through the “arm’s length principle”.

Given the lack of strict implementation and interpretation guidance from the EU’s institutions and the member states, it will be up to each reporting entity to determine the extent to which they include tax-related items in their CSRD reports. However, the GRI 207 and the OECD MNE Guidelines refer to qualitative issues such as those related to the existence of an appropriate tax control framework and adequate tax governance.

Reporting entities seeking to prepare for, and ensure compliance with, the CSRD will therefore want to look beyond the quantitative tax-related disclosures that are required under, for example, EU public country-by-country rules and prepare narrative explanations on their approach to tax and tax governance.

In addition to the CSRD, two other initiatives are relevant in the context of the EU’s sustainability reporting framework:

• The Sustainable Finance Disclosures Regulation (SFDR), which sets out disclosures relating to financial market participants and their products; and

• The Corporate Sustainability Due Diligence Directive (CSDDD), which requires due diligence on certain aspects of an organisation’s value chain.

The SFDR requires the disclosure of social and environmental aspects by participants in EU financial markets at entity level (e.g., asset managers) and financial product level (e.g., funds). Disclosures under the SFDR relate to three key concepts:

• Sustainable investment;

• Sustainability risk; and

• Sustainability factors.

With respect to financial products, disclosures will be required for products that:

• Have a sustainable investment as their objective (Article 9) – activities aligned with the EU Taxonomy; or

• Promote environmental or social characteristics (Article 8) – these may partially pursue ‘sustainable investment’ as an objective (so-called light green products).

Sustainable investment means an investment in an economic activity that contributes to an environmental objective and where the investee companies follow good governance practices, “in particular with respect to sound management structures, employee relations, remuneration of staff, and tax compliance”.

The SFDR also introduces the concepts of:

• Sustainability risks, defined as ESG events or a condition that, if it occurs, could cause an actual or a potential material negative impact on the value of the investment – which could include tax-related risks; and

• Principal adverse impacts of investment decisions on sustainability factors, which includes testing against the OECD MNE Guidelines.

Furthermore, proposed amendments to the Sustainable Finance Disclosures Delegated Regulation would require a new, specific indicator on earnings accumulated by investee companies above a certain size in non-cooperative tax jurisdictions (which is not an existing ESRS disclosure). This indicator is considered relevant when assessing the social adverse impacts of investment decisions. It may be the case that further tax-related indicators will be added in future.

This factsheet explains how the EU Taxonomy fits within the sustainable finance framework.

The CSDDD proposal aims to “foster sustainable and responsible corporate behaviour and to anchor human rights and environmental considerations in companies’ operations and corporate governance” (Governance policies on corporate social responsibility). This will be achieved by requiring businesses to address adverse impacts of their actions, including in their value chains inside and outside Europe.

There are similarities between the CSDDD proposal and the EU Taxonomy; specifically relating to reporting on compliance with the Minimum Safeguards. The European Commission sees the two as being complementary and the proposal aims to reinforce the UNGPs and the OECD MNE Guidelines by introducing human rights and environmental due diligence obligations for selected companies.

A KPMG survey of nearly 300 chief tax officers (CTOs) across major industries revealed that 56% of CTOs are more interested in being perceived as a good corporate citizen than reducing the tax burden. The 2023 CTO Outlook also notes strong evidence of shifting attitudes toward taxation and information sharing. While about half of CTOs (51%) say their approach towards tax transparency in the past five years was to be fully compliant, today an almost equal number seeks to be fully transparent (49%).

Increasing tax transparency can also help CTOs to defend their organisations in a difficult enforcement environment, gain some goodwill, and get fairer treatment equal to domestic competitors in the market. Reframing political discussions to focus on societal benefits of company activities beyond collecting tax can help to show external stakeholders the value the organisation adds to the ecosystem and economy.

CTOs responding to the KPMG survey said that ESG-related risks – ranging from enhanced environmental reporting requirements to increased tax transparency – are the tax risks that pose the single greatest threat to their organisations’ growth over the next three years. With regard to ESG, tax is both a driver of sustainability and a key measure of it. More tax data collection will be required to meet calls for transparency about downstream impacts of the business on society and the environment.

Steps that tax departments can take to address ESG-related risks and opportunities and prepare for enhanced disclosures under the CSRD include:

• Enhancing their tax control framework, including drafting a tax risk management policy;

• Seeking to work more closely with business units to ensure compliance with ESG-driven tax credits and grant terms;

• Defining their tax principles and publishing a global tax strategy document, or updating/refreshing your principles and strategy;

• Increasing transparency regarding the tax strategy, governance, or global tax payments; and

• Evaluating the supply chain against potential ESG-related tax risks and opportunities.

Given the key role that tax plays in ESG, tax departments will see a step up in their involvement in ESG strategies; in particular, in exploring ESG risks and opportunities.

Existing and upcoming public tax disclosure requirements are only the first stop for the tax transparency train. While current requirements focus on quantitative information, the CSRD will add an extra layer of complexity by focusing on qualitative indicators, including the existence of a robust tax control framework and well-defined tax principles and strategies, as well as opportunities arising from ESG-driven tax credits and grants, and the ESG-related tax risks and opportunities across the supply chain.

As the influence of corporate citizenship and ESG themes on tax departments increases, CTOs will be looking to step up their involvement in ESG strategies. KPMG professionals are here to help CTOs to take steps to help their organisations tackle ESG-related challenges.

Read the original version of this article on KPMG’s website: Tax transparency is here to stay.

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