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Investors should address aggressive corporate tax planning

Fiona Reynolds
Fiona Reynolds is managing director of PRI Association, London, which oversees the United Nations-supported principles for responsible investment, a voluntary set of six principles for the investment management companies incorporating environmental, social and governance factors into investment decision-making.

Sustainable, well-run businesses should pay a fair level of tax, and avoid the reputational, legal and financial risks posed by aggressive tax planning.

From the shareholder's point of view, every dollar paid in tax is one dollar less available to the business, or to pay dividends. Ostensibly, company management is pursuing its fiduciary duty in minimizing — within the law — their company's tax burden.

But a growing number of investors are becoming concerned about the risks posed by a too-dogged pursuit of tax efficiency.

So what should investors do? These issues are incredibly complex. It can be difficult to differentiate between legitimate tax planning and aggressive practice.

When Benjamin Franklin wrote that nothing in life is certain except death and taxes, it turns out he was only half right — at least as far as a growing number of multinational corporations are concerned. An army of accountants and tax lawyers now exists to help international corporations shift profits around the world, find the most advantageous jurisdictions from a taxation point of view, and put in place corporate and financial structures to ensure as low an overall rate of tax as possible.

And the results can be dramatic.

Take a look at base erosion and profit shifting — which the Organization for Economic Co-Operation and Development defines as “tax planning strategies that exploit gaps and mismatches in tax rules.” It can see some multinationals pay as little as 5% in corporate taxes when smaller businesses, which lack their ability to optimize their tax position across a number of jurisdictions, pay up to 30%, according to the OECD.

To be clear, such arrangements are perfectly legal. Many governments around the world compete to make their jurisdictions as attractive as possible to international business — and corporate tax policy is a crucial battleground. This competition offers numerous opportunities for multinationals to reduce their tax burden.

At the United Nations-supported Principles of Responsible Investment, we are analyzing the results of a new comprehensive reporting exercise. With 814 investor signatories reporting in 2014, these results are a global barometer for what investors are doing to create sustainable capital markets. These investors, who collectively manage more than $40 trillion of assets, have committed to consider environmental, social and governance criteria in their investment decisions, and to report on how they do so.

This first-of-its-kind snapshot shows that tax is high on many of our signatories' agendas, with no fewer than 100 of them including a reference to taxation in their responses.

What are the concerns among investors? The first is that aggressive tax planning crosses the line between avoidance and evasion. This is of particular concern in emerging market jurisdictions, where tax enforcement might be weak, offering temptation for companies to avoid paying their fair share.

However, even unambiguous compliance with the law does not necessarily eliminate risk. In a respected survey of attitudes of the British public to corporate behavior, carried out by the Institute of Business Ethics, tax avoidance last year shot to the top of the list of public concerns. Companies that are perceived as avoiding tax too aggressively risk losing their license to operate — particularly those with consumer brands that rely on public goodwill. The Starbucks coffee chain, for example, reported last October its first drop in U.K. sales after 16 years of strong growth, during a period when it faced a consumer boycott and parliamentary criticism over its tax affairs. Activist groups are already bringing pressure to bear on companies they believe aren't playing by the rules — and this pressure is only likely to increase.

The risk also exists of regulatory backlash — either individually or collectively. Heavy-machinery maker Caterpillar Inc. is one of the latest U.S. companies to come under scrutiny from U.S. senators, who have accused it of moving $8 billion in profits to Switzerland from the U.S. to take advantage of a low corporate tax rate the company had negotiated with the Swiss government. No company wants to find itself the subject of intense scrutiny by tax authorities or legislators.

And surely politicians' patience is likely to be limited in the face of deals such as Medtronic Inc.'s proposed $43 billion acquisition of Covidien Ltd., which will allow the U.S. medical-device maker to shift its tax base to Ireland.

In June, the European Union announced a probe into whether three EU countries — Ireland, the Netherlands and Luxembourg — were offering improper tax breaks to Apple Inc., Starbucks Corp., and the financial arm of Italian carmaker Fiat SpA.

Both the OECD and the G-20 have base erosion and profit shifting firmly on their agenda. If policymakers find themselves compelled to reform corporate tax codes, it is likely that those reforms would be severe. For example, measures that are to the benefit of international companies — such as rules to prevent double taxation of corporate earnings — could be revoked.

Many issues that companies have faced over tax do not lead directly to monetary losses: corporate lawyers and tax advisers tend to ensure their clients stay on the right side of the law. But they are not without cost, in that they serve to distract management from more important issues.

Investors are starting to focus on tax strategy as a material risk; many PRI signatories are engaging with companies on the issue. Engagement on tax is at an early stage — in most cases, investors are simply seeking to better understand management's approach to tax planning and its impact on other business decisions.

But this dialogue is vital. It will serve no one's interests if the debate is conducted with megaphones and rancor, rather than with a mutual understanding of the issues at stake.

Fiona Reynolds is managing director of PRI Association, London, which oversees the United Nations-supported principles for responsible investment, a voluntary set of six principles for the investment management companies incorporating environmental, social and governance factors into investment decision-making.