The topic of taxes—corporate, presidential and otherwise—seems to be trending these days, with calls for greater transparency coming from investors, analysts and others, including speakers at the SEC’s Investor Advisory Committee. They contend that some corporate tax practices may give rise to financial, legal and reputational risks that would be material for investors to understand. Currently, however, financial statements are required to include disclosure of the total taxes paid, but are not required to break out the amounts by country or state. Consequently, investors and analysts say that they do not have sufficient visibility to understand the impact on companies of changes in tax laws or the tax environment in different jurisdictions or to otherwise evaluate companies’ exposure to tax risks.
[Based on my notes, so standard caveats apply.]
In December last year, the SEC’s Investor Advisory Committee held a meeting that addressed the potential benefits to investors of greater tax transparency, including country-by-country tax reporting. To open the meeting, SEC Chair Gary Gensler observed that
“[i]nvestors have expressed an interest in greater details, sometimes called disaggregation, with regard to income tax information. In an effort to make more informed investment decisions, investors have raised an interest in understanding more about tax information related to the specific jurisdictions in which companies operate, including how different tax strategies might impact companies’ tax rates. I understand the Financial Accounting Standards Board (FASB) recently proposed to enhance income tax disclosures in financial statements. When the proposal is publicly released, I think it is important to consider such enhanced tax disclosures. Disaggregated tax reporting from international companies—in the specific jurisdictions in which those companies operate—could benefit investors.”
One speaker at the meeting observed that there are many large and highly profitable companies that pay little tax, but it’s hard to figure out from public data why that’s the case. It’s important for shareholders, she said, because of the risk that companies could be surprised with a sudden huge tax bill, suffer reputational risk, legal risk and other financial risk. In 2020, she reported, corporate taxes fell to 5% of tax revenues, the lowest in 70 years; the percentage used to be 30%. Now, individual taxpayers must make up the difference, even as corporations benefit from the application of tax revenue to infrastructure, educated workforces and other uses. Some companies, she said, are able to structure their business, often through deals with some foreign countries or quirks of foreign tax laws, so that they avoid US tax.
Several speakers mentioned, however, that a number of large multinationals have been hit recently with multi-billion dollar tax assessments and penalties in different countries, perhaps reflecting a dramatic shift in the risk equation, especially in light of recent and impending tax increases and tax law changes in different countries (e.g., the new corporate alt min 15% tax in the US). And some companies have not been able to maintain the special tax arrangements that they had established with some countries, which has made a significant difference in their financial results, leading to declines or volatility in stock prices.
However, because of information asymmetries, investors cannot assess these risks. To address these issues, there has been a move internationally for greater tax transparency, with organizations such as GRI developing new tax reporting standards calling for country-by-country reporting of tax data. In addition, shareholder proposals to disclose tax information under the GRI standard have been introduced at an increasing number of large companies. Moreover, the FASB, which has been considering the issue for several years, is on the verge of issuing a new proposal for more detailed tax disclosure.
One of the speakers at the meeting, while pleased that the FASB was listening to investors, seemed to view the FASB proposal as too cautious; it avoided requiring disclosure of information that might illuminate the thornier issues of tax risk. More specifically, he said, the requirements proposed for country-by-country disclosure covered only tax data, but would not provide the underlying data, such as country-by-country disclosure of revenue and income, that would enable an effective analysis of the sources of tax risks. In addition, he argued that more tax disaggregation was needed in the tax rate reconciliation table. In his view, the SEC should be the entity issuing the tax disclosure requirements: it has the explicit authority to adopt rules for the protection of investors, and the disclosure would facilitate the analysis of potentially material tax risk. In addition, the SEC could require a uniform standard for better comparability. The necessary information has already been calculated, and, in most cases, has been reported to regulatory authorities on a confidential basis. Others expressed a different view, contending that the job belonged more appropriately to Congress and the FASB, with appropriate influence from the SEC.
One of the more interesting debates was over the underlying purpose of this tax disclosure. One committee member suggested that transparency worked against investors because it potentially increased corporate taxes. Don’t shareholders benefit when companies reduce their tax liability to the lowest level possible? In addition, she argued, tax transparency is predominantly a social issue, not an investor issue. Are companies engaged in illegal practices, or just practices of tax avoidance that countries don’t like? The purpose, the member suggested, is really to require companies to pay more taxes. But doesn’t that hurt investors?
Some speakers, however, seemed to disagree. One speaker noted that, while some do take the view that companies should always minimize their tax obligations and aggressively employ tax avoidance strategies, she believed that view reflected short-term thinking, depriving society of the funds for infrastructure and education (from which businesses benefit), not to mention funds to address the costs that companies impose on society, such as financial crises and oil spills. Others noted that investors need to understand the potential for each company’s financial, legal and reputational risk. In that regard, one of the speakers observed, the tax avoidance environment is becoming increasingly difficult to navigate—going forward, investor focus is on risk and opportunity. In addition, many stakeholders want companies to pay their fair share of taxes. Another speaker argued that what investors want is that companies pay the lowest sustainable tax rate over the long term, with stability based on competitive products and services—not volatility arising out of overly aggressive tax practices. In addition, he remarked, understanding management’s tax approach—especially an aggressive approach—helps investors to understand the company’s overall risk tolerance.