Investors urged to look for ‘tax washing’ within corporate portfolios

Investors are being urged to consider conduct practices as part of their investment due diligence in order to avoid the risks of ‘tax washing’ and ‘tax cloaking’, the Fair Tax Foundation has said.

In the report Key Performance Indicators of Responsible Corporate Tax Conduct – and their Green and Red Flags an increasing number of institutional investors and asset managers are urging multinationals to embrace responsible tax conduct and tax transparency as a core element of their ESG credentials. This includes the world’s largest sovereign wealth fund, seven of Denmark’s biggest pension funds, the UK’s default auto-enrolment pension scheme and the US’s largest public pension fund among many others.

Responding to the growing realisation that poor tax conduct is a red flag for an overly negative attitude to compliance in general, the Fair Tax Foundation has developed five key performance indicators (KPIs) which institutional investors and asset managers should use to help de-risk their portfolios. Each KPI has an associated set of green flags and red flags, with businesses exhibiting five green or five red flags generally considered, respectively, to be a substantially de-risked investment or a high-risk investment from a tax conduct perspective.

The five KPIs include:

Freely available annual financial statements

Responsible tax commitments that are confirmed annually

Public Country-by-Country financial reporting

Disclosures of uncertain tax positions

Corporate cash taxes paid over a five-year period

“The world is on the verge of an explosion of corporate tax transparency. The voluntary disclosures of progressive businesses (such as Fair Tax Mark accredited companies) will soon be augmented by newly mandated disclosures from large multinational enterprises operating in the European Union, the United States and Australia. This presents both an opportunity and a challenge to investors – how to sieve the enormous pending data release and separate the wheat from the chaff,” said Paul Monaghan, CEO of the Fair Tax Foundation.

“At the behest of a number of investors, we have developed five tax conduct KPIs for institutional investors and asset managers and suggest that businesses exhibiting five red flags could generally be considered to be high-risk and any investments should be reviewed.”

Tax cloaking and tax washing

For many of the KPIs, ‘tax cloaking’ and ‘tax washing’ are considered major red flags.

The report defines tax cloaking as when income, profits and tax paid (or not) are obscured. This could occur when a consolidated set of financial statements are not freely available in the public domain, or only an abbreviated version is available. Investors should be concerned that a business seems averse to public scrutiny and engagement.

Meanwhile, tax washing could occur, for example, when businesses seek to hide behind selective ‘total tax contribution’ reporting, seek to obscure corporation tax payments, misrepresent total tax accruals or take advantage of the ‘safeguard clause’ within the EU Public Country-by-Country Reporting Directive (which allows deferred disclosure for up to five years on the basis of ‘commercial sensitivity’).

The Fair Tax Foundation is seeking feedback on the suggested KPIs and associated flags, be that refinement of what is proposed, or entirely new areas of consideration. Feedback and suggestions can be sent to [email protected].