Why in-house tax departments should take a more active role in their companies’ ESG programs and what they can do to be more involved.
This article was originally published in the Jan/Feb issue of Tax Executive, the professional journal of the Tax Executives Institute.
Environmental, social, and governance (ESG) considerations are commanding a continually growing share of attention in organizations of all types as various stakeholder groups sharpen their focus on sustainability, equity, and accountability. Today, more and more investors, consumers, and employees are making decisions based on an organization’s ESG strategy, policies, and actions.
As companies develop strategies for addressing these concerns, their tax departments are often left out of the discussion. This is an unfortunate – and often costly – oversight.
Fortunately, the dozens of tax incentives in the Inflation Reduction Act of 2022 (IRA) have given fresh visibility to the tax department’s potential role in ESG, particularly in supporting the environmental component of the effort. Ultimately, however, the IRA’s provisions represent only one aspect of the tax department’s capabilities to contribute to a successful ESG program.
In fact, the tax function can add value in many other ways, including by helping to formulate the overall ESG strategy and by helping to quantify, measure, and report results. Ultimately, tax teams also can identify opportunities to bolster the ESG program that might otherwise be overlooked.
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The first steps toward greater involvement are to identify where strategic ESG decisions are being made, and then actively work for more tax team participation. Many companies either have or are working toward a team or committee approach to ESG, which typically includes board oversight and management accountability.
Regardless of the specific ESG decision-making structures in their organizations, tax departments have a timely opportunity to expand their roles as they interact with these working groups to begin implementing some of the IRA’s incentives. But rather than reacting to ESG issues after the fact or waiting to be asked about specific ESG-related tax questions, in-house tax professionals should take an active role, seeking out opportunities to get involved with the relevant working groups to offer additional ideas, suggestions, and initiatives.
Broadly speaking, there are four general areas of activity where tax professionals can add value to their companies’ ESG initiatives.
1. Defining the tax narrative
Because tax policies and strategies have a direct impact on both the social and governance components of ESG, they represent a logical place for in-house tax professionals to begin enhancing their involvement. Taking the lead in this area is also an ideal way to open the door to greater involvement in other aspects of ESG, since developing tax policy consistent with the organization’s tax risk appetite is within the tax department’s purview. Such activities are fundamental to the department’s role.
Transparency is one of the most critical considerations in addressing this responsibility. Public interest groups and activist stakeholders give a high priority to issues of tax fairness, especially as it becomes easier for them to gain access to public companies’ tax information. Unfortunately, such campaigns often address only a part of the story, leaving organizations vulnerable to false impressions regarding whether they are paying their “fair share.”
The tax team is uniquely positioned to present the whole story, with maximum accuracy and transparency, in order to provide a more complete depiction of the many ways most companies contribute to tax systems and structures in numerous jurisdictions. Maximum transparency not only demonstrates a commitment to good governance, it also helps convey a positive narrative about how an organization is engaging in and supporting socially responsible behaviors.
In addition to taking the lead in developing this narrative, the tax team also should be actively engaged in developing other sections of any sustainability publication, recognizing that tax issues have a direct – but often overlooked – impact on many other aspects of the ESG story.
2. Helping to fund sustainability
In a 2022 survey of 653 ESG executives and professionals, more than 90% of the respondents said their companies are planning to increase their investments in environmental sustainability initiatives over the coming year. In-house tax professionals have an important role to play in helping to fund those initiatives by accessing available tax incentives.
Clearly those efforts will be needed. In the same survey, 90% of respondents said they had been generally successful in meeting their energy efficiency, emissions reduction, pollution prevention, and recycling goals over the previous 12 months. But only 67% said they were optimistic about achieving their goals for the coming 12 months, and only 63% were optimistic about achieving the goals they have set for the year 2030. Because concerns over funding almost certainly contribute to such doubts, offering access to tax incentives that support sustainability initiatives is one of the most effective ways for tax departments to add value to their organizations’ ESG programs.
The dozens of clean energy-related tax credits enumerated in the IRA have an obvious affect in this area. In addition to introducing various new programs that encourage businesses to produce and use clean or renewable energy, the IRA also extends or expands many already existing energy-related tax incentives. Some of its most prominent provisions include:
- Sale and use of biodiesel, renewable, and alternative fuels credits
- Investment in clean energy facilities credits
- Construction of carbon capture and sequestration facilities credits
- Renewable energy production credits
- Accelerated cost recovery for green buildings
- Plug-in electric vehicle credits
- Alternative fuel vehicle refueling credits
Notably, many of the IRA credits also include multipliers and additional incentives based on a project’s location, employment practices, and other factors. These provisions can contribute to an organization’s social and governance objectives in addition to helping it achieve environmental and sustainability goals. Another consequential feature of the IRA is its direct pay option, which allows many types of organizations to monetize clean energy tax credits, along with transferability provisions that allow companies operating at a loss or that generate more energy-related credits than they need to turn unused credits into cash.
Although most tax departments already are actively engaged in working through the IRA’s many provisions, it is important not to overlook other available incentive opportunities. These include many of the credits enumerated on IRS Form 3800, “General Business Credit.” Many of these credits support activities that are directly related to ESG goals.
Many state and local governments also use tax policy to encourage ESG-related activities. Seeking out and quantifying such incentives can provide added financial support to an organization’s ESG efforts.
A proactive approach to identifying and accessing available incentives can help open the door for the tax department to take an even more prominent role in further ESG program development. Not coincidentally, it also can help justify tax department budget requests by demonstrating a clear added value and positive return.
This article was originally published in the March/April issue of Tax Executive, the professional journal of the Tax Executives Institute.
3. Engaging with strategy and operations
In addition to identifying and applying ESG-related credits, a proactive tax team will take its efforts to the next level, providing input about the impact various incentives could have on the organization’s overall ESG narrative. This input can help senior management make more considered strategic decisions regarding participation in certain optional programs.
ESG-related tax issues can directly affect high-level decisions related to where and how an organization operates, such as choosing new locations for facilities, managing fleet decarbonization efforts, or addressing critical supply chain issues. Well-known examples include federal opportunity zone credits and work opportunity credits. In addition to providing financial incentives, participation in such programs also contributes to a company’s positive social and governance narrative – a contribution the in-house tax team should be careful to document and report. At the state and local level, tax departments can be a part of discussions related to relocation of the business or new location investments that would help bring jobs to certain areas or contribute to a local economy. They can help determine what municipalities’ incentives might be available to do so.
For companies with international operations, the possibility of changing carbon tax penalties and incentives also can have significant implications for transfer pricing models. Here again, in-house tax professionals can contribute to the financial analyses that support such strategic and operational decisions and can provide useful insights into opportunities that might otherwise be overlooked.
Rather than reacting to strategic decisions that have ESG implications, the tax department should be actively engaged early in the decision-making process in order to provide boards and senior executives with a more complete and accurate understanding of how the related tax considerations can affect operating profits, net cash flow, and forecasting models.
4. Contributing directly to the effort
One of the most fundamental ways that tax departments can contribute to ESG initiatives might be easily overlooked. It is also a step that a tax department head can undertake directly, by leading the department in support of the company’s diversity, equity, and inclusion (DE&I) goals.
Creating a more diverse and inclusive workforce is fundamental component of many companies’ overall social and governance narrative, but it can be a major challenge in certain industries. In some instances, the physical demands of the workplace or the need for highly specialized skills that are developed over decades of experience can make it difficult to adapt longstanding hiring and personnel practices in ways that will lead to a more diverse employee population.
In many cases, the tax department can help offset some of those companywide challenges due to the nature of its work and the universality of the skills and training required. Tax also can serve as an excellent laboratory for developing new recruitment, testing, and onboarding methodologies that can help attract a diverse workforce that is representative of the communities where a company operates and the customer populations it seeks to serve.
In-house tax operations also can provide companies with opportunities to apply innovative incentive and promotion policies that can be more effective in rewarding, retaining, and reinforcing valued employees who are committed to the company’s ESG effort – and to helping shape its ESG narrative in the future.
Getting started: Steps toward greater involvement
Within the context of the four general areas of opportunity, how can tax departments get started? What steps can they take to start engaging more actively in their organizations’ ESG programs?
There is no single answer, of course. Successful approaches can vary widely, depending on a company’s industry, size, location, ownership, and corporate governance, to name only a few of the relevant factors. An equally critical variable is the underlying organizational culture – including internal department ownership issues and sensitivities, which can directly affect how the tax department can most effectively engage and fit in.
Bearing those variables in mind, however, it is possible to outline general steps that tax department heads can use as a road map to get started:
- Identify ESG processes and decision-makers. Determine where ESG strategies are being developed and considered and identify the groups and individuals who are taking the lead. If tax is not already an active participant, develop a plan for getting involved.
- Start in house. Review and confirm the organization’s overall tax strategies and risk appetite. Then develop a comprehensive tax narrative that gives visibility to the organization’s contributions in support of social concerns and good governance. At the same time, explore ways the tax department can help advance the organization’s DE&I priorities from within.
- Engage in the conversation. Actively promote the tax narrative as part of the organization’s public sustainability report or web publication. Aim for maximum transparency. Then use this engagement as an opportunity for tax to take a larger and more prominent place in other components of the ESG process.
- Seek out opportunities to contribute. Research available tax incentives as well as potential tax penalties to avoid. Rather than waiting for direction, seek out and suggest overlooked opportunities that demonstrate a potential for ROI.
- Add strategic and operational value. Engage management as early as possible in the strategic decision-making process. Offer tax-related insights into critical decisions and be prepared to research and demonstrate both their financial and ESG implications.
As ESG attracts more and more attention from investors, customers, employees, and the community at large, tax departments and the in-house professionals who lead them have significant roles to play in helping companies pursue their ESG objectives. By taking a proactive and systematic approach, tax teams can make positive contributions and add demonstrable value to their companies.
1 “Honeywell Launches Environmental Sustainability Index Showing Sustainability Leaders’ Sentiment on Past Progress and Future Expectations Towards Corporate Environmental Goals,” news release, Honeywell, Oct. 20, 2022, https://www.honeywell.com/us/en/press/2022/10/honeywell-launches-environmental-sustainability-index-showing-sustainability-leaders-sentiment-on-past-progress-and-future-expectations-towards-corporate-environmental-goals
2 Ibid.
