Back to the social contract

Definition of Taxes
Photo by Alan Cleaver

When it comes to corporate tax payments, the conventional wisdom suggests that companies should minimize tax payments. This makes sense from a financial point of view: If a company is able to minimize tax payments, cash outflows are minimized such that more cash is available for value-creating corporate expansion projects. Corporate Knights’ clean capitalism rating methodology, however, rewards companies that make larger cash payments for taxes as a proportion of earnings before interest, taxes, depreciation and amortization (EBITDA). This approach is used in both the Global 100 Most Sustainable Corporations, as well as the Best 50 Corporate Citizens in Canada rankings. So why are we bucking the trend?

Corporate Knights applies a broader corporate sustainability lens to company tax payments. By measuring cash payments for taxes as a proportion of EBITDA, Corporate Knights is seeking to identify companies engaged in aggressive tax minimization strategies. Those avoiding paying their fair share of taxes are penalized for not upholding their end of the social contract. Facing increased government efforts to clamp down on tax minimization strategies, companies that are structured to minimize tax liabilities are facing increasing risks and may find themselves in an uncomfortable position should they be required to unwind their tax-efficient set-ups. The financial consequences of such an event would likely be harder to bear, compared to companies that do not need to significantly alter their organizational structures.

It is no surprise that the link between corporate tax payments and corporate sustainability has attracted the attention of the academic world. Dr. Prem Sikka of the University of Essex noted in a 2010 paper that there are considerable gaps between corporate claims of ethical and socially-responsible conduct and tax practices. Where such gaps exist, it is possible that those companies will also be engaging themselves in other non-ethical and socially-unacceptable behaviours such as paying bribes or industrial espionage. This topic is beyond the scope of this article, but may be an interesting area for future research.

When such “hypocritical” behaviours are exposed the company faces fines, imprisonment for some company executives and hostile press coverage. A company’s payment of its fair share of taxes can be viewed as a litmus test for claims of social responsibility. “The possibilities of social responsibility rest on the alignment of corporate culture with the social expectations that companies will honour their publicly espoused goals”, argued Dr. Sikka. While a number of companies fulfil their social commitment by paying their share of taxes, the majority of companies continue to not live up to social expectations when it comes to tax payments.

Roman Lanis and Grant Richardson, from the University of Technology – Sydney and the University of Adelaide examined 408 Australian corporations for the 2008/2009 financial year. Using regression analysis, they found that the higher the level of CSR disclosure by a corporation, the lower the level of corporate tax aggressiveness was. The underlying assumption made here is that CSR disclosure is a proxy for the quality and level of commitment of the corporation’s CSR agenda. Other research papers conducted on the subject have displayed more mixed results. Perhaps the initiative by the Australian tax authorities in the early 2000 may in part explain the findings by Lanis and Richardson. Australian corporations were encouraged to embed a consideration of risks associated with tax and their effects into strategic decision-making at the board of directors level.

Corporate boards are increasingly intensifying their involvement in the corporation’s CSR activities, making it possible to infer that board influence may have impacted CSR activities, disclosure and attitude towards tax risks. “The linking to corporate governance and the enhanced involvement of the board of directors in the company's tax strategy result in its becoming more sustainably geared to the longer-term corporate goals and being less aligned with short-term tax minimization,” argued Urs Landolf, Leader of PricewaterhouseCoopers tax and legal practice in Europe in 2006.

Efforts to establish the drivers of socially-responsible corporate tax payments have led to inconclusive results so far. What has become clear is that the traditional idea where corporations should adopt tax minimization strategies to satisfy short-term financial imperatives is increasingly being challenged by an emerging view that corporations should consider the long-term impact of their tax risk profile in order to ensure sustainable growth. Corporate Knights’ attempt to reward the socially-responsible corporate tax payer by measuring payments for taxes against EBITDA is a testament to that emerging wisdom.

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