Increasingly, ‘social investment’ means more than just philanthropy, with investors seeking to promote social and environmental ends through their investment in companies.

Paying a fair amount of tax is increasingly seen as a sign of responsible corporate behaviour and the rise in global equity impact funds means multinational public businesses are increasingly under greater scrutiny, including when it comes to their tax behaviour. So how can investors check that companies are ‘playing fair’?

Tax contributions are a key part of the wider social and economic contribution made by businesses, helping the communities in which they operate deliver valuable public services and build vital infrastructure.

There is also a growing understanding that poor tax conduct is a red flag for an overly negative attitude to compliance in general, and of weak corporate governance.

So, from both an impact and financial standpoint, a progressive attitude to tax is a win-win. But how are investors identifying this?

As operators of the Fair Tax Mark,  we have put together an ever-evolving list of key indicators of responsible tax conduct, and their green and red flags. These are informed by our accreditation standards as well as 10 years of experience assessing the financial statements and tax reports of a wide variety of businesses – both in size and industry.

1. Does the business have a freely available, complete set of annual financial statements?

For large, listed companies, this seems like a low bar and yet many businesses do not publish a full set of financial statements.

Many social investors operate in private equity or with smaller organisations. In these cases, we still believe full statements including a balance sheet, income statement and cashflow, together with a full set of explanatory notes, are best practice.

Given many businesses deemed ‘small’ do not usually place their full set of accounts in the public domain, Fair Tax Mark accreditation can also be a good indicator, as we work with our smaller businesses to develop a Fair Tax Mark Statement that satisfies this need for transparency.

2. Does it have robust responsible tax conduct commitments that are subject to annual compliance confirmation?

Progressive corporations understand it is no longer enough for a business to pledge to forego tax evasion and to adhere to the ‘letter’ of the law only – which is full of unintended loopholes. Businesses should also explicitly commit to follow the spirit of the law in their tax policy, and detail their commitments on responsible tax.

A public tax policy or strategy that explicitly shuns artificial or aggressive tax practices, profit shifting and the artificial use of tax havens; and instead commits to declaring profits and paying taxes in the places of economic substance and value, and adhering to the spirit as well as the letter of the law, would be a green flag. Just pledging legislative compliance is not an indicator of responsible tax conduct.

3. Does it break down financial disclosures by country, with narrative to explain unusual positions?

Even though this does not apply to many small businesses, for multinational companies receiving impact investment not only is public Country-by-Country Reporting best practice, but in many jurisdictions, legislation mandating it is coming down the line.

Not only can reporting by country prove a company is doing what it set out in its tax policy, but it also provides a strong indication of the economic footprint within a jurisdiction and can signal emerging financial and reputational risks.

Disclosures in each country a business operates should include revenues, profit/loss, current tax provision, deferred tax provision, cash taxes paid, assets, and employees – with numbers reconciled to consolidated annual reports and accounts – and a narrative to explain any unusual or significant activity (such as having substantial income in a country where the business has very few staff and/or assets).

4. Does it disclose uncertain tax positions, with narratives to explain significant tax disputes?

When a business files its corporate income tax returns, it may sometimes apply judgements relating to the tax treatment of specific elements. An uncertain tax position (UTP) arises where there is uncertainty over the tax treatment applied. It can be an indicator of aggressiveness, or it can be a genuine uncertainty in law. Without clarity on UTPs the business has taken and why, or how they have been accounted for in the financial statements, it makes it difficult to determine the impact (both financial and reputational) of this uncertainty.

Green flag activities include a full numerical and narrative analysis of UTPs and the actions taken to minimise uncertainties. Red flag activities include no material discussion or consideration of UTPs, and/or lots of UTPs with no indication of the business taking a responsible approach.

5. Is the business’ average tax rate (in terms of cash taxes paid) over the past five years greater than 20 per cent of profits?

Over time, corporate cash taxes paid are a far more accurate means of measuring ‘contribution’ than total tax accounting accruals, not least as the latter includes deferred tax accounting adjustments that may never materialise as cash taxes paid. Therefore, where available, we recommend investors look at cash taxes paid over a five-year period.

At the moment, although this varies by sector, an average tax rate above 20 per cent would be a green flag and indicates the business is contributing taxes close to the average headline rate for corporate income tax around the world. Less that 7.5 per cent would be a red flag, although again, higher thresholds may be applicable within sectors where intangible assets are characteristically booked in low-tax jurisdictions. Businesses that invest heavily in capital equipment would have a lower cash tax rate, and this should be considered when determining whether a business is making a fair contribution.

 Jaime Boswell is Head of Accreditation, Fair Tax Foundation