João Miguel Fernandes of Morais Leitão, Galvão Teles, Soares da Silva & Associados considers the societal factors and international initiatives driving the increasing adoption of ESG concepts in business strategy.
The various challenges that society is facing – triggered by factors such as digital transformation, climate change, the COVID pandemic and the war in Ukraine – are contributing to a fast paradigm shift regarding the principles and purposes that traditionally ruled society, in general, and economic activities, in particular.
This context has led to a significant growth in the importance of matters such as responsible investing, sustainability and wellbeing. The primary focus of business practices has moved from costs and short/medium-term profitability to an approach more focused on long-term value creation, through the adoption of ESG concepts in business strategy.
Although influenced by several factors – such as industry, geography or culture – the cornerstones of ESG tend to be:
- At environmental level – climate change; energy, waste and water sustainability; and carbon and green taxation;
- At social level – employees’ health and safety, talent management and workplace diversity; and
- At governance level – executive board independence and composition, executive board compensation, transparency for stakeholders and responsible tax policies.
International initiatives to promote ESG
During the past few years, a large number of international organisations have promoted initiatives to develop and spread principles and standards for ESG reporting, such as:
- The United Nations, through the Principles for Responsible Investment and their strategic plan for 2021–24;
- The OECD, by means of several reports, such as OECD (2022), ESG ratings and climate transition: An assessment of the alignment of E pillar scores and metrics, OECD Business and Finance Policy Papers, OECD Publishing, Paris;
- The IFRS Foundation, which announced in November 2021 the creation of a new standard-setting board for ESG matters, namely the International Sustainability Standards Board;
- The EU, through the 2018 European Commission action plan on sustainable finance and the associated measures; and
- The World Economic Forum, through the set of 21 ESG metrics it published in September 2020.
In turn, several institutional investors have also developed ESG investment requirements and some ratings agencies, such as S&P and Sustainalytics, have developed ESG ratings and rankings.
Moving towards a fairer system
The general ESG trend is also in line with the updates that occurred during the past decade within the scope of taxation that aimed to adapt the tax system to the challenges of today and towards a fairer allocation of tax bases and income, grounded on the proper economic substance of tax structures. Examples are the OECD BEPS and BEPS 2.0 projects and the package of EU directives to implement measures against tax avoidance practices and increase tax transparency, such as the two anti-tax avoidance directives, DAC6 and the unshell directive proposal.
Therefore, taxation is a key part of ESG, on one hand, as a useful tool to be considered by the economic actors in the structuring and setting up of ESG policies, and, on the other hand, as a relevant standard to assess if those economic actors are ESG compliant.
The Portuguese tax system
Within the scope of the first dimension referred to above, it should be highlighted that the Portuguese tax system sets out several regimes and tax benefits that should be considered when structuring ESG policies in order to implement them efficiently; namely:
- The corporate income tax regime for the granting of social benefits to employees;
- The tax benefits for investment support;
- The tax benefits for real estate allocated to the production of renewable energies; and
- The creation of car and/or bike-sharing systems.
With regard to the second dimension, ESG will put an additional pressure on economic actors to provide qualitative and quantitative information about their tax policies, strategies and risks, improving and extending reporting duties towards stakeholders and tax authorities. Nevertheless, in a scenario where this challenge is properly addressed by the economic actors, the tax policies developed for ESG purposes may represent a relevant instrument.
In fact, such tax policies may be useful to document and relate the adopted tax strategy with the company’s overall values and evidence their economic substance and alignment with its business purpose, allowing taxpayers to properly evidence the economic rationale and substance of their structures and/or transactions, if challenged by the tax authorities.
Adaptation is key
Considering the above, this is a moment at which companies should focus their attention on the development and implementation of ESG policies to adapt their structures proactively and efficiently to these new demands, taking into consideration the particular importance that this matter may have for tax purposes.