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Divestitures Highlight Social and Transparency Concerns

Posted on Feb. 15, 2021

Norway’s sovereign wealth fund — the world’s largest — made a surprise move last year: It sold off investments from several companies, citing concerns about aggressive tax planning and opaque tax payments.

We don’t know much about those companies. Nicolai Tangen, the CEO of Norges Bank Investment Management (NBIM), which manages the wealth fund, told Reuters that they are small. But we do know from Tangen that similar decisions could be coming down the pike.

Although those companies may be small, the symbolism is significant for multiple reasons. It’s important because of the fund’s size and influence. The Norwegian Government Pension Fund Global, also known as the Oil Fund, invests in over 9,200 companies. It’s important because it’s the first time that NBIM has divested because of tax. It’s also notable in the broader scope of Norway’s transparency journey.

Norway loves transparency; it’s the country that pioneered public tax returns. It’s therefore no surprise that the wealth fund has, over the years, cast more scrutiny on the companies in which it invests. One of its most public decisions was to create an “expectation document” on how it would like its portfolio companies to address taxation and transparency, and how it would assess them.

The value of that expectation document has been debated over the years. But the decision to divest heralds a new era under Tangen, who just stepped into his role in September 2020 and has made sustainability a key focus of his leadership. Accordingly, the fund recently offloaded its entire portfolio of oil exploration and production companies and wants to plow some of that money into renewable infrastructure. More broadly, Tangen wants to dive into the mechanics of how NBIM’s portfolio companies operate.

NBIM isn’t alone. The fund’s recent offloads feed into an ongoing debate in the environmental, social, and governance (ESG) world over engagement and divestiture. The two are complementary — divestiture happens when engagement doesn’t work — but until recently, divestment was viewed as a somewhat scorched-earth strategy given the potential for lost returns.

Lately, divestiture as an action has been getting more attention, especially in the environmental realm. Investors feel that the risks posed by climate change require heavy handedness, and in some cases automatic divestments. This is particularly true for fossil fuel investments.

NBIM is now making it clear that tax is a potential factor for divestment. That decision comes at a time when both investors and multinationals are mulling what it means to be transparent on tax for both investment and social reasons, how tax fits into ESG, and what the standards should be.

Where Is the Trust?

Attention on tax as a component of ESG is perhaps stronger than it’s ever been, because of several factors. Increasing public and political scrutiny on tax is motivating policymakers to rethink international tax norms at the OECD and U.N., and in countries around the world. Investor interest in taxation is fueling some litigation. In the corporate governance world, tax is being probed as a driver of sustainability as well as a measure of corporate sustainability, according to Manal Corwin, principal in charge for KPMG’s Washington National Tax practice. She shared her thoughts on a January 22 KPMG webcast titled “The Intersection of ESG and Tax.”

Trust — or perhaps the lack thereof — in international tax rules is driving some of this scrutiny in the ESG world. As the OECD’s base erosion and profit-shifting project 2.0 dredges up questions about the proper levels of taxation and the proper level of trust in multinationals to abide by both the letter and spirit of tax laws, shareholders are engaging in their own inquiries. They’re asking whether they trust corporations to be transparent about their tax practices and engage in activity that will not erode shareholder value via tax audits, fines, and litigation.

Over the years, there have been several investor lawsuits in response to corporate tax activity. At the moment, Mattel Inc. and PwC are litigating a securities fraud suit alleging that Mattel incorrectly calculated a 2017 tax valuation allowance, causing a tax understatement, and then defrauded investors by hiding the issue.

Irish drugmaker Perrigo Co. PLC is defending itself in a securities class action filed by investors claiming that the company failed to adequately disclose in its March 1, 2018, Form 10-K and November 8, 2018, Form 10-Q that it was facing a potential $2 billion Irish tax liability tied to some intellectual property and asset sales. A New York federal district court judge in January 2020 dismissed the Form 10-K claim because the filing did mention that it was under audit in Ireland. The litigation is ongoing.

In February 2020 Canadian streaming metals company Wheaton Precious Metals Corp. agreed to pay $41.5 million to settle a securities class action lawsuit filed by a U.S. shareholder that asserted that Wheaton should have disclosed a contentious Canadian transfer pricing issue in its SEC financial statements. The suit alleged that the company’s shareholders bought Wheaton’s shares at artificially inflated prices and suffered losses when news of the potential reassessment broke.

Caterpillar Inc. has been named or implicated in several investor lawsuits filed after its Illinois headquarters and two other offices were raided by IRS Criminal Investigation agents in March 2017. Caterpillar said it may have been connected to a larger IRS investigation into the company’s tax arrangements with its Swiss subsidiary, Caterpillar SARL. In one since-dismissed case, shareholders suing the company asserted that Caterpillar misled the public about its arrangements with Caterpillar SARL, causing the company’s share price to drop after the raids.

Starbucks faced investor scrutiny after the European Commission ordered the Netherlands to collect millions of euros in back taxes from the company. Starbucks also paid millions to U.K. tax authorities following an investigation. This culminated in a since-dismissed shareholder derivative lawsuit in federal court in the state of Washington alleging that Starbucks’ board and now-departed chief operating officer violated their fiduciary duty to exercise good faith and diligence in administering the company’s affairs.

Divestment Raises the Stakes

Divestment adds an unexpected layer. Although NBIM declined to share the specific offenses of the companies it sold off, we know, via its tax expectation letter, what the fund is looking for. The tax expectation document is based on three principles:

  • taxes should be paid where economic value is generated;

  • company tax arrangements are a board responsibility; and

  • public country-by-country reporting is a core element of transparent corporate tax disclosure.

NBIM picked these principles because it feels that they can help build long-term company value and are complementary to broader, international anti-BEPS campaigns. In a letter to the Norwegian Ministry of Finance, NBIM said the end game isn’t to force companies to change their tax behavior, as that’s not possible; rather, it’s to give investors an avenue to become more engaged with tax as a corporate governance issue and to get more information from boards of directors.

“Investors rarely have an opportunity to closely monitor the tax strategies that companies adopt,” the fund said at the time. “We expect companies to be prepared to explain publicly the business case for locating subsidiaries in secrecy jurisdictions or in significantly low-tax environments where any local operations are limited in relation to the economic value attributed to them.”

How are companies evaluated on those three principles? Through a set of nine metrics on appropriate and prudent board policies and transparent reporting. On the board side, NBIM is looking at:

  • careful local and cross-border tax management;

  • board-driven tax policy disclosures;

  • integrating tax policy with core business considerations;

  • whether boards are well informed about their company’s tax affairs; and

  • consistent tax behavior across the entire organization.

On the reporting side, NBIM is looking at:

  • public CbC reporting;

  • whether companies can publicly articulate why they have subsidiaries in low- or no-tax jurisdictions;

  • whether companies are as transparent as prudence allows when dealing with taxing authorities; and

  • whether multinationals are sharing their full tax story beyond corporate tax payments, including their total tax contribution.

When the list came out in 2017, it was among the first of its kind — investors were not really in the business of communicating how multinationals should conduct their tax affairs. Although NBIM says it’s not out to force companies to do anything, it’s hard to see how ditching investments could have any other consequence. Yet with great power comes great responsibility. Taking this stance opens up NBIM to scrutiny of its own metrics and whether they are clear and straightforward enough for companies to follow.

At least one stakeholder has criticized NBIM for maintaining somewhat opaque standards. Transparency group Publish What You Pay Norway has argued that the expectation document should be clearer about what needs to be shared in CbC reporting. The group essentially argues that NBIM could ask for more — it could ask for “extended” CbC reporting, including things like investments, income, costs, and several levels of tax information.

The group has also questioned what economic value creation means to NBIM. That term is undefined in the expectation packet, but then again, what is value creation in the digital economy? It’s a question that has yet to be agreed upon.

On the other hand, it’s easy to envision a reverse scenario in which stakeholders find the information metrics to be too intrusive, or unhelpful in presenting an accurate tax picture; or they may misunderstand the role that tax plays in a broader, corporate sense. These criticisms arose shortly after NBIM released its expectations survey in 2017, with one CEO telling Tax Notes that “tax is an ingredient for a company as much as is the cost of labor and the cost of goods, and you always look for the lowest cost. Why would a CFO pay 30 percent tax when he could legally pay 20 percent?”

The Industry Response

Over 100 global companies have been discussing what an accurate tax picture should look like and have been incubating these ideas within the World Economic Forum (WEF) and its breakout International Business Council (IBC). Those discussions resulted in a new set of ESG metrics — the Stakeholder Capitalism Metrics — released by the WEF and IBC in September 2020. At the Davos forum in January, a number of companies agreed to follow the new set of ESG metrics. It will be worth watching how individual companies interpret these metrics and how investors respond to the disclosures.

Over the past few years the WEF has focused on the concept of “stakeholder capitalism,” the idea that companies must account for the long-term needs of society in addition to the short-term needs of their investors. Part of their focus is on building a more cohesive system around ESG.

Other organizations are interested in building a global system, including five major voluntary standard setters in this area: CDP Worldwide, the Climate Disclosure Standards Board, the Global Reporting Initiative (GRI), the International Integrated Reporting Council, and the Sustainability Accounting Standards Board. They are starting to work on a centralized ESG reporting system and are hoping to roll the WEF’s work into it.

In the meantime, the IBC’s project, prepared with Deloitte, EY, KPMG, and PwC presents a bundle of 21 core and 34 expanded (optional) metrics for mainstream corporate disclosures like annual reports to investors and proxy statements. This is supposed to supplement separate ESG and sustainability reports.

Businesses want their tax activity to be measured through total tax paid, which is one of the 21 core metrics. Total tax paid measures a company’s full tax activity, including corporate income tax, property tax, non-creditable VAT and other sales tax payments, employer-paid payroll taxes, and other taxes that constitute costs to the company.

Why total tax paid? IBC says it is a more realistic and “balanced” metric because it accounts for the fact that different governments rely on different tax mixes, and that different business lines shoulder different types of tax mixes. Multinationals want to get away from the public narrative that business taxation is just corporate tax.

Accordingly, an expanded metric is “additional tax remitted.” It’s defined as the total additional global tax collected by a company on behalf of other taxpayers, including VAT and employee-related taxes. IBC says that these additional tax remittances add to taxing systems by reducing administrative burdens.

Initially, the IBC wanted to focus on public CbC tax reporting and centered those requirements around the GRI’s public CbC reporting metric in GRI 207-4. But that ultimately lost out to the total tax paid metric because the group felt that total tax paid would better reflect corporate contributions. Instead, there’s an expanded metric: total tax paid by country for significant locations. Under that metric, companies may choose to provide country-level information, including additional tax remitted, for the jurisdictions they deem most important to their business.

It’s unclear whether all of this might be acceptable to investors, who increasingly want public CbC reporting. The IBC’s new metrics seem to step around the issue. The IBC initially envisioned that companies would share a laundry list of information via public CbC reporting, including:

  • names of the resident entities;

  • primary activities of the organization;

  • the number of employees and the basis of calculation of this number;

  • revenues from third-party sales;

  • revenues from intragroup transactions with other tax jurisdictions;

  • profit/loss before tax;

  • tangible assets other than cash and cash equivalents;

  • corporate income tax paid on a cash basis;

  • corporate income tax accrued on profit/loss; and

  • reasons for the difference between corporate income tax accrued on profit/loss and the tax due if the statutory tax rate is applied to profit/loss before tax.

The new total and additional tax paid and remitted metrics are looser and are based on the GRI’s economic performance standard 201-1, not its newer tax standard. That matters because of specificity. 201-1 does require information about revenues, operating costs, employee wages and benefits, and payments to government, but 207-4 asks for more granular tax information. Beyond that, it’s unclear what constitutes a significant location and how that is determined. The IBC’s metrics are silent on this.

It remains to be seen how many companies will sign up for this new standard. At Davos, 61 companies said they will follow the new ESG metrics, including Unilever, BP, Nestlé, Royal Dutch Shell, Sony, and Bank of America. It’s not a large number, but it’s also not an insignificant number. As companies continue to figure out how they will address tax and ESG, it’s fair to anticipate that broader messaging, focus, and priorities will evolve in this area as we’ve already seen with NBIM and the WEF’s ESG project. It remains unclear which standards will take root, particularly as investors take more action in the ESG space.

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