For the most part, tax has traditionally been an afterthought in fund managers’ conversations around ESG. However, as governments around the world scramble for revenue and desperately try to close tax loopholes, and civil society groups increasingly put tax avoidance in their crosshairs, that trend may be changing.
Governments from 136 countries reached a deal in October 2021 to impose a minimum corporate tax rate of 15 percent under the Organization for Economic Co-operation and Development’s BEPS 2.0 initiative. Although private equity firms will not necessarily be directly affected by these changes, ignoring stakeholder pressure on tax appears increasingly unwise.
“Tax transgressions (however these are defined) can have real reputational consequences,” says Lucy Urwin, tax associate at law firm Macfarlanes. “The rise of ESG as a mainstream topic has been a catalyst here, with the ‘G’ attracting an enhanced focus on businesses’ decision-making, risk management and systems and delivery – including on tax.”
Meanwhile, industry groups are pushing back on the perception that PE firms routinely employ legal but nefarious accounting tricks to avoid tax. A spokesperson for the British Venture Capital & Private Equity Association says: “There are a lot of misconceptions about the role of tax planning in our industry,” adding that “the primary objective is to ensure that external investors are not in a worse position investing through the fund than if they had invested in a portfolio company directly.”
Lack of clarity
So far, only a handful of LPs have publicly identified tax fairness as an ESG priority. But Shailen Patel, Macfarlanes’ head of corporate advisory, says there has been a “general shift away from imposing overarching obligations on GPs to minimise tax, which in the current climate are often seen as inappropriate, aggressive and liable to encourage the taking of risky tax positions.”
Some large PE firms have sought to get ahead of the game by publishing tax transparency reports. But there is confusion over exactly what is expected of GPs. As Urwin points out: “Tax fairness is likely to mean different things to different stakeholders” in the absence of “definitive or pragmatic guidance.”
The UN Principles for Responsible Investment published a discussion paper on tax fairness in 2021, while the Global Reporting Initiative produced a standard for tax disclosure in 2019. However, tax is not covered by other ESG reporting standards, including the Sustainability Accounting Standards Board framework.
Delilah Rothenberg, co-founder and executive director at The Predistribution Initiative – a group advocating for reform of the financial industry – notes that frameworks that cover tax tend to focus on portfolio companies rather than funds themselves. “Investors are starting to pay attention to responsible tax when it comes to portfolio companies, [but] not when it comes to how investors are structuring their investment vehicles.”
The Predistribution Initiative is one of several groups helping to develop the Taskforce on Inequality-related Financial Disclosures, which Rothenberg says will aim to provide guidance for investors on responsible tax practices, along with measurement and management tools. “We need to figure out how to price in externalities moving forward,” she says, emphasising that an unstable tax base, and the inequality it generates, poses a “systemic risk” to investors.