This article analyses the impact of ESG on MNE tax management with a special focus on transfer pricing and business restructuring.
Tax Management and ESG
As stated by the UN, environmental social and corporate governance (ESG) is not only an issue that concerns individuals but also a strategic priority of multinational enterprises (MNEs), investors and governments as well. Following the UN initiative, European Commission has also introduced several directives regarding ESG. In this regard, ESG impacts MNES’ tax management in various ways.
For example, many governments provide tax incentives to encourage environmentally sustainable practices. For instance, companies utilising renewable energy sources may be eligible for tax advantages. These incentives encourage companies to adopt eco-friendly practices and alleviate their tax burdens.
Another area of impact is environmental regulations and carbon taxes. Numerous countries have implemented policies aimed at reducing greenhouse gas emissions such as the new EU Carbon Border Adjustment Mechanism (CBAM) and EU Emission Trading System revisions . Such regulations can result in higher taxation for high carbon-emitting companies or offer tax benefits to those with low carbon footprints. Carbon markets and emission trading mechanisms further integrate taxation with management of environmental impacts, requiring companies to adapt their tax strategies to take account of these measures aimed at improving their actions.
In corporate social governance, compliance with appropriate minimum wage requirements, anti-slavery policies and the communication of and compliance with published tax strategies requires MNEs to have appropriate procedures and appropriate resources to meet their corporate governance responsibilities.
As envisaged by the OECD and BEPs initiative, many countries have introduced domestic legislation designed to improve corporate governance specifically in relation to tax. The focus is ensuring that company boards are obliged to ensure that they pay the right amount of tax across their business and minimize the risk in case this is not happening. Many MNEs are leveraging tax control frameworks across their international business and reap the benefits of what good tax governance can provide as opposed to viewing it as a compliance burden.
Transfer Pricing and ESG
Transfer pricing regulations target arm’s length pricing related to the transfer of goods, services, or intellectual property rights between multinational companies in different countries. Although there may be different practices in different tax jurisdictions in terms of the application of the arm’s length principle, OECD Transfer Pricing Guidelines are the main reference source for the global transfer pricing standards.
ESG also influences transfer pricing due to the financial impact of ESG policies pursued by governments. For instance, the transfer of eco-friendly products or technologies may attract scrutiny from revenue authorities regarding the pricing structures used. In the same way, MNEs should be assessing their pricing structures against appropriate comparable to monitor compliance with transfer pricing requirements.
Business Restructuring and ESG
ESG considerations can significantly impact group business restructuring which must be consistent with the arm’s length principle (Chapter IX of the OECD transfer pricing guidelines). Companies adopting more sustainable practices may restructure their operations and supply chains to:
- reduce their carbon footprint; relocate production activities to avoid countries with low transparency on labor conditions
- develop new products more aligned with ESG targets
For example, a company might relocate manufacturing facilities closer to renewable energy sources or spend more R&D to develop its product portfolio to focus on environmentally friendly offerings.
There will be a range of tax and compliance requirements to consider such an exercise. Business restructuring, driven by ESG strategies, will certainly have transfer pricing consequences. Changes in the supply chain or location of operations may result in a shift in the financial outcomes and profit allocation in each tax jurisdiction. Companies must assess the tax consequences of their restructuring decisions to ensure compliance and optimise their tax positions. Although the OECD transfer pricing guidelines Chapter IX is an excellent starting point for assessing transfer pricing compliance, it does not currently cover ESG aspects of business restructurings . We expect additional changes that would take this into account in the near future.
The relationship between ESG and transfer pricing is both complex and a sensitive issue. MNEs must navigate the evolving tax landscape and consider ESG-related risk factors in their transfer pricing models. Managing environmental regulations, leveraging tax incentives, and ensuring fair transfer pricing practices at the same time may be difficult. Nevertheless, a proactive approach to tax management and a strong commitment to ESG standards can lead to a harmonious alignment between a company’s financial goals and its ESG responsibilities.
- DIRECTIVE 2014 95 /EU OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 22 October 2014 amending Directive 2013 34 /EU as regards disclosure of non financial and diversity information by certain large undertakings and group
- REGULATION ( EU)2020 852 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 18 June 2020 on the establishment of a framework to facilitate sustainable investment
- DIRECTIVE (EU) 2022 2464 OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL of 14 December 2022 amending Regulation ( No 537 2014 Directive 2004 109 / Directive 2006 43 /EC and Directive2013 34 / as regards corporate sustainability reporting)
- Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL on Corporate Sustainability Due Diligence and amending Directive ( 2019 1937)
- REGULATION published for new EU Carbon Border Adjustment Mechanism (CBAM) and EU Emission Trading System revisions; CBAM transition period begins 1 October 2023