ESG and tax insights for real estate fund managers
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ESG and tax insights for real estate fund managers


Real estate fund managers must consider the tax aspects of environmental, social and governance policy to meet investor expectations, writes Nick Crama, director at Alvarez & Marsal.

Investors increasingly expect real estate fund managers to take an active approach to tax as part of their ESG commitments.

A majority of the large institutional investors in Europe has focused on responsible tax in their investment decision-making. This was a trend well before ESG investing gained the momentum that it has today.

This focus on responsible tax is directly correlated to the role these investors – typically pension funds and insurance companies – play as organisations that people need to trust.

Reputational risks and tax contributions to society need to be carefully managed. This often translates into institutional investors developing their own tax policies and testing their investments against certain tax principles that align with their approach to tax and tax risk appetite.

In case a real estate fund structure contains elements that conflict with these tax principles, the decision is either made not to invest or the identified issues are resolved.

In most European jurisdictions, considering responsible tax when making an investment decision is voluntary, but there are jurisdictions like the Netherlands where this can be subject to regulatory supervision for certain institutional investors.

European real estate fund managers typically have strong experience in dealing with investor expectations from a responsible tax perspective. However, only a minority of real estate fund managers have a formal tax policy.

Evolution of tax within the ESG imperative

Institutional investors are making it increasingly clear that they expect a strong commitment to ESG factors when assessing real estate fund investments. This is not only driven by investors embracing ESG criteria, but also a result of EU regulations and pressure from the media and general public.

Considering the UN’s Sustainable Development Goals, tax policy plays an essential role in achieving those goals. This has led to an increased focus on tax as an ESG item, which has been made clear in publications from the World Economic Forum’s International Business Council, the UN-backed Principles of Responsible Investing and the European Association for Investors in Non-Listed Real Estate.

Within a real estate fund context, tax is featured across all three ESG elements:

· Environmental – Tax is generally a tool to drive sustainable real estate investments, e.g. through fiscal incentives.

· Social – Tax is an important factor to determine how a real estate fund manager views its role and tax contribution to society. This is generally described in a tax policy that includes the fund manager’s tax strategy and tax principles that guide its decision-making and management of items like tax compliance, structuring and transactions, seeking and accepting tax incentives and maintaining relationships with tax authorities.

· Governance – To give a tax strategy and tax principles substance in practice, the governance aspect becomes evident. It is important that tax is properly governed within the fund manager’s organisation. Relevant items in this respect are, for example, the role and accountability of the board of directors, the roles and responsibilities of the fund manager’s tax function, and how key tax risks are timely identified and managed.

Tax transparency, a new dimension

As interest in ESG investing grows, institutional investors are also taking more public positions on tax, such as the publication of tax policies, to help support their goals of responsible tax behavior in their investments and through their investment partners.

A good example is the Tax Code of Conduct designed and voluntarily applied by some of the largest Danish institutional investors. There is also an increase in tax transparency among investees to demonstrate to investors that their approach to tax is responsible and sustainable.

This can range from limited disclosures on one end, e.g. sharing a tax policy with investors, and detailed qualitative and quantitative public disclosures at the other end, particularly how tax policy has been applied in practice. This would include tax contributions and activities in accordance with country-by-country reporting (CbCR).

This development towards more tax transparency is especially witnessed among multinational enterprises. Many companies want to respond to the public perception that they abuse the international tax system to avoid paying their ‘fair share’ of tax. One of the most used voluntary frameworks for tax transparency is the Global Reporting Initiative’s Tax Sustainability Reporting Standard.

There is also a trend towards more regulation in the area of tax transparency. For example, the EU’s Public CbCR Directive and the European Commission’s Communication on Business Taxation for the 21st Century.

The latter includes a recommendation for an EU directive requiring large enterprises to publish their effective tax rates. Meanwhile, the EU’s draft report on social taxonomy suggests standard reporting metrics to enhance tax transparency.

Tax policy considerations and best practices

As the recognition of tax within ESG is growing, real estate fund managers find themselves in a position where they have to actively manage their approach to tax. This is crucial to meet investor expectations.

More investors are reviewing the social aspect of tax, i.e. the fund manager’s tax strategy, as well as the governance aspects of tax in a real estate fund.

Designing or re-assessing a tax policy is the starting point for real estate fund managers that want to implement and integrate the social and governance aspects of ESG into their organisation. In this respect, the following considerations and best practices can be relevant:

1. Role of the board – When tax is considered a core part of corporate responsibility, it is a best practice that tax governance in general is overseen by the board of directors and that the board is accountable for the execution of the tax policy. This does not only serve to ensure that a tax policy has authority and recognition within the fund manager’s organisation, but it also supports the connection of tax to broader ESG initiatives already being deployed and to also ensure that other departments and business units are on board (e.g. the communications department in case of public scrutiny involving tax and the finance department regarding tax disclosures from an accounting perspective).

2. Top-down approach – For most real estate fund managers, the starting point for integrating ESG tax into their organisation is the design of a tax policy. In this regard, it is a best practice to apply a top-down approach. This means designing a tax policy by starting off with defining the organisation’s tax strategy, also commonly referred to as an approach to tax, then defining the organisation’s guiding tax principles to achieve this tax strategy, codification of the tax governance structure, the tax function’s roles and responsibilities, and finally defining the organisation’s key tax risks, control objectives and control measures (to be implemented). A complete overview of tax risks and control measures is typically part of a separate tax risk and control framework document, which goes into a lot more detail and practicalities than a tax policy. The benefit of applying a top-down approach is that it allows for a holistic view on tax that can subsequently trickle down into all relevant tax areas. A bottom-up approach typically starts with identifying all relevant taxes, tax risks and control measures and so on, and from this overview designing a tax policy. However, in practice you can never oversee and control everything in the realm of tax, which means it is pretty much a given that a bottom-up approach will get you stuck in the details, whereas a tax policy should in principle only formulate an organisation’s view on the tax topics that really matter.

3. Tax strategy – It bears no surprise that investors have a spectrum of views on tax issues, depending on their investment beliefs, risk appetite and culture. There are typically three types of investors: those who consider tax efficiency leading, those who consider responsible tax leading and those who also put tax fairness into the equation. These different views warrant careful consideration when defining a tax strategy, as a tax strategy should not only cover the fund manager’s own organisation, but also the approach to tax applied to the real estate funds it manages. A common approach and possibly best practice in this respect is to align the tax strategy with the fund manager’s corporate strategy and core values.

4. Test tax principles – Formally adopting tax principles via a tax policy leads to the expectation that such principles are met throughout the real estate fund manager’s own organisation, as well as the funds and entities that it manages. A common pitfall is the formalisation of tax principles without first considering the practical implications (e.g. without first testing the principles against fund structures). Tax principles that do not capture the fund manager’s actual tax risk appetite can unintentionally restrict commercial transactions. The biggest challenge usually lies in capturing a proper scope of the so-called ‘business rationale’-principle. This principle typically entails that tax should follow the business and not the other way around, meaning fund structures and entities should be driven by commercial considerations and real business activity.

5. Substance in practice – Tax policies often contain tax principles without elaborating how these principles are given substance in practice. An example is the compliance principle, which usually reads ‘we comply with the tax legislation of the countries in which we operate and pay the right amount of tax at the right time, in the countries where we create value’. From an ESG perspective, investors are becoming keener on understanding how tax principles are de facto applied by a fund manager (i.e. the governance aspects of ESG). It therefore adds value to also describe how a tax principle is applied in practice. In a compliance context, this could cover positions, procedures and views on tax filings, disclosures to tax authorities, tax planning, uncertain tax positions and the arm’s-length principle. This does not only demonstrate towards investors how tax principles are applied, but it also helps the fund manager’s own organisation understand the practical implications of the tax principles that have been adopted.

6. Transparency and narrative – Tax transparency can range from the publication of a tax policy to what is commonly referred to as ‘tax contribution reports’. Tax contribution reports typically provide periodical updates on items like the effective tax rate and taxes paid at country level, key issues related to the tax policy, description of the business activities to understand taxation thereof, explanations for changes to the group structure and the existence of entities in low-tax jurisdictions, positions on tax advocacy, and so on. Tax contribution reports are very labour-intensive and especially observed among large multinational enterprises already subject to CbCR and likely to become subject to the EU’s Public CbCR Directive in the near future. As tax is complex and often difficult to understand, multinational enterprises tend to provide a detailed narrative when publishing tax data (e.g. to allow stakeholder to understand the effective tax rates and taxes paid at country level). Among real estate funds, it is a best practice to ensure that a certain level of narrative is included in the annual financial reports of the real estate funds under management. This narrative should allow investors to broadly understand the tax positions and taxes due in the jurisdictions where a fund operates.

7. Re-assess – ESG tax policy is constantly developing. Public opinion of certain tax mechanics can rapidly change. The same holds true for a fund manager’s own views on tax issues and its own tax risk appetite, which are ultimately driven and determined by the people working within its organisation. It is therefore recommended to re-assess a tax policy regularly.

Your company’s tax policy should reflect your organisation from a tax, strategic and governance perspective. Designing or updating a tax policy is a good opportunity to understand the standards published by, for example, industry associations, the EU and OECD.

A tax policy can also help to gather internal support to achieve certain strategic tax goals, such as digitalisation of tax processes and more control over compliance.

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