Luxembourg: Mapping the EU’s path to sustainable tax governance

Tax became a focal point for European public opinion in the aftermath of the 2008 financial crisis. Since then, transparency towards tax administrations has grown continuously in the EU. With the shift towards sustainable economic growth - the main pillar of the EU policy agenda - tax has become a fundamental part of corporate sustainability strategies.

The success of this EU strategy is dependent on the measurement of sustainability. There are few legal requirements for businesses to be publicly transparent regarding taxes (such as in Australia, Spain, and the UK, or in the extractive and banking sectors) beyond pure financial reporting obligations like the international financial reporting standard (IFRS) or the Sarbanes-Oxley Act (SOX) in the US. However, a significant number of voluntary best practices exist as put forward by bodies such as the B Team and the Global Reporting Initiative (GRI).

From 2021, the EU will enhance sustainability reporting by connecting it to financial reporting and creating tax transparency obligations. Taxation will become embedded in sustainability reporting aimed at measuring business performance based on environmental, social, and corporate governance (ESG) criteria. Businesses will have to report about tax twice - once for financial reporting purposes to their shareholders, and a second time for sustainability reporting purposes to a much wider base of stakeholders, including tax administrations, governments, regulators, investors, clients, and the general public.

For example, under the EU Sustainable Finance Disclosure Regulation, financial market participants and advisers must disclose sustainability risks in all investments, notably with respect to companies’ good governance practices and in particular tax compliance, while the revised Non-Financial Reporting Directive will probably include a tax dimension in 2021. The challenge posed by sustainability in relation to tax requires businesses to anticipate, adapt and act proactively by developing and mastering tax policy, tax governance, and tax communication, which are interdependent.

In this evolving and complex environment, where the costs of cross-border business are rising due to increasing tax risks and double taxation, businesses are facing growing pressure for tax transparency. Society requires them to explain and demonstrate the sustainability of their tax governance and control framework for fulfilling their tax obligations (i.e. to explain their strategy and approach to tax management).

Businesses are also expected to explain the outcome of this sustainable governance (the taxes paid and collected) based on data that is not yet available. Communication regarding taxation is an important and constituent part of sustainable governance, but it is a highly technical subject that may be difficult for stakeholders to understand. As a result, tax transparency will continue to evolve.

Anticipation is key on tax matters, especially to adapt and align communications about tax to sustainability expectations regarding appropriate oversight and control of tax risk. Businesses must adopt a forward-looking attitude to understand future regulatory and tax policy trends. Mastering tax policy is a pre-requisite for creating sustainable tax governance. This implies developing the resources to monitor the tax policy agenda of national, EU, and international institutions in order to be part of the tax policy discussion, rather than being its subject.

Growing pressure is placed on businesses to better manage tax and related risks by strengthening the control environment governing reporting processes and by facilitating real-time compliance and data-oriented auditing by tax administrations. It is time for companies to assess the sustainability of their tax governance and control framework in order to adapt and meet sustainability expectations and reporting obligations. This will take time and require significant resources. Clearly, sustainable tax governance can no longer be considered in isolation from a broader business governance and sustainability strategy.

Businesses taking pre-emptive action to understand the landscape, and creating a tailored tax governance and control framework, will be able to participate in tax policy discussions and share their experience and point of view. They will also be in a position to produce the data needed to communicate effectively about tax and demonstrate the sustainability of their tax governance in fulfilling their tax obligations. Sustainable tax governance should produce many other benefits, such as a reduced tax risk and associated costs, the proactive identification of gaps, enhanced processes, improved tax reporting to the board and stakeholders, evidence of effectively managed tax risk, etc. It will also allow businesses to enter into cooperative tax compliance arrangements, which will evolve further in the EU and improve tax certainty and relationships with tax authorities.

Whatever the form and extent of tax transparency obligations, and regardless of any link to sustainability, there will be an incentive for businesses to voluntarily exceed requirements (especially if public country-by-country reporting is adopted) so that they can deliver their vision of the management of taxation and provide meaningful explanations of highly technical and complex tax information to their stakeholders. They can draw on the growing body of voluntary tax transparency measures, such as the GRI or B Team, to achieve this goal.

Businesses will only be able to successfully address the challenges of sustainability in relation to tax by creating sustainable tax governance.

Grégory Jullien

Senior manager

E: gjullien@deloitte.lu