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It’s not every day you hear tax and sustainability in the same sentence. But the truth is, familiarity with Environmental, Social and Governance (ESG) requirements is quickly gaining traction among Australian businesses. Tax, like many business activities, can have a major influence on the quality of a business’ ESG credentials. Before ESG became mainstream, companies may have only implemented ESG policies to meet regulatory requirements. Now that companies have a deeper understanding of sustainable development goals, ESG is a recognised core component of any business plan. With ESG issues at the forefront of increased regulatory and investor pressures, it is of utmost importance for an organisation to effectively navigate the complex regulatory tax terrain with a view to incorporate sustainable initiatives into its structure.

What is ESG?

There is no universal categorisation for what comprises ESG. The term refers to businesses taking a more holistic approach to business sustainability and socially accepted behaviour, resulting in organisational longevity. The ESG framework emphasises a company’s non-financial risk management strategy and accounting for any ESG related issues in a business model. It can be the make or break deciding factor for some stakeholders.

Profitability is no longer enough. Investors and the community now want to see businesses having policies and strategies in place that will ensure a business’s permanency and its ability to adapt to a changing environment. Stakeholders are also scrutinizing whether a company’s ESG principles align with their own. Investors, in particular, use ESG factors to assess non-financial risks and evaluate a company’s potential for sustained performance.

So how does tax fit into ESG?

Tax plays a role in every transaction, activity and strategy. So, it should come as no surprise that tax plays a fundamental role in an organisation’s ESG mandate. If there are no direct tax links, there are likely indirect tax factors that can easily be overlooked. When left unresolved, these oversights can have major consequences for a business down the line.

There is an element of tax present in each of the ESG principles:

• For example, there are likely to be tax incentives associated with “Environmental” policies implemented for the avoidance of greenhouse gas emissions.
• In relation to the “Social” principle, stakeholders are likely to look at tax as a measure to analyse a company’s contribution as a socially responsible taxpayer.
• Lastly, “Governance” demands appropriate transparency, compliance, and oversight of a business’s strategy, including its tax strategy, ensuring it aligns with the overarching company objectives as well as stakeholder expectations.

Specific examples of ESG through a ‘tax’ lens:

Environmental and governance transparency

Improving tax transparency should always be on an organisation’s agenda, as governance places a major burden on regulatory compliance. To adapt in a changing environment, businesses need to be aware of the tax incentives that follow meeting sustainable goals. Implementing such goals will lead to fundamental changes in business operations, which, in turn, is likely to change its tax structure. If ESG initiatives are navigated and incorporated effectively through a company’s tax structure, tax opportunities are created, delivering more value back to the business. For example, the Australian Government introduced the Australian Carbon Credit Unit Scheme (ACCU) which looks to support projects that minimise or mitigate the release of greenhouse gas emissions. Entities who choose to participate in this initiative will earn ACCU units for every tonne of carbon dioxide emissions avoided through prescribed projects. The Australian Government will purchase ACCU’s through carbon abatement contracts, ultimately delivering more value back to the business. ACCU receives a modified tax treatment, that is the costs of acquiring an ACCU is also tax deductible.

Australian Government’s push for tax transparency

On 6 June 2024, the Australian Government introduced new Country-By-Country (CBC) reporting measures. Demonstrating a greater commitment to transparency, the CBC rules target Australian multinational companies as well as some large domestic businesses. The new reporting obligations run parallel to the existing CBC obligations (subdivision 815-E of the Income Tax Assessment Act 1997); however, this information will no longer be confidential and is presented to the Australian Public, promoting transparency and scrutiny. The introduction of public CBC reporting is a significant step towards tax transparency and the Australian Government’s push to drive corporate behavioural changes and implement ESG and Corporate social responsibility practices externally. Reputational damage may be the product from public reporting, so it is important for companies to employ internal ESG initiatives to demonstrate their commitment.

Where from here?

Macpherson Kelley can assist when it comes reviewing an organisation’s structure via its ESG initiatives. Please feel free to reach out to anyone on the Taxation Team to discuss further

The information contained in this article is general in nature and cannot be relied on as legal advice nor does it create an engagement. Please contact one of our lawyers listed above for advice about your specific situation.