Boards should prepare external tax policy in 2021

By Kirsten Aaskov Mikkelsen, Niels Josephsen and Martin Faarborg

On 2 December 2020, the Danish Committee on Corporate Governance ("the Committee") published updated Corporate Governance Recommendations. The update focuses on current trends such as social responsibility, sustainability and a company's purpose, but also a new recommendation on the publication of a tax policy. The recommendations come into force for financial years beginning 1 January 2021 or later. The first time these areas must be reported on is when the annual report is published in 2022.

In this article, we highlight the role of the board of directors in relation to the fact that the Committee recommends, as something new, that the board of directors adopts a tax policy to be made available on the company's website. The current recommendations do not include an explicit recommendation to have a tax policy, but merely to adopt policies for the company's relationship with its stakeholders, which, according to the comment, could be a tax policy.

The Committee writes in the comment that the purpose of the new recommendation to adopt a tax policy is to increase transparency about the company's tax matters for shareholders, investors and other stakeholders. To do so, the board of directors may choose in the tax policy to provide greater insight into the company's tax matters than required under law. The recommendation does not contain actual substantive requirements, and the detailed content of the tax policy must therefore be determined by the board of directors. The comment mentions as examples that the company can describe how it addresses tax incentives, the use of tax planning, activities in tax haven countries, information on tax paid in the countries in which it operates, etc. In addition, the company may choose to describe which tax matters the company will report on in future.

The increased focus on tax policy in society – not least driven by a number of unfortunate tax cases in recent years as well as a focus on responsible tax behaviour in connection with the disbursement of the COVID-19 aid packages – is also seen in institutional investors, such as ATP. ATP would like to see more specific tax policies that answer relevant questions about each company's specific tax challenges. Several companies currently have a publicly available tax policy, although in many cases they are short and superficial. According to ATP, transparency about tax matters is important for investors' risk assessment – if too much tax is paid, ATP sees this as a commercial risk, whereas aggressive tax planning poses a reputational risk.

The reputational risk also relates to the long-term sustainability of the company's tax policy and current effective tax rate as well as whether uncertainties in relation to tax assets and liabilities are adequately disclosed and communicated to stakeholders.

The Committee's recommendation to develop a tax policy thus encapsulates a relevant societal debate that companies now must deal with publicly. Although the recommendations are soft-law and there are no direct substantive requirements, the recommendations have previously proven to create a market practice – for example, for transparency about executive remuneration. The recommendations do not require the board of directors to ensure that the tax policy is complied with, but this might be considered in future. The board may also consider discussing concrete dilemmas as part of the process.

Several listed companies are likely to address their tax policies in a publicly available policy. It will be interesting to see whether the companies will include some of the substantive proposals contained in the comment. Half of Denmark's 100 largest companies disclose tax incentives (including 80% of C25 companies), while just 22% disclose activities in official tax haven countries. Only six of these companies provide country-by-country reports.

The share of companies preparing a tax policy is likely to increase, with the development of a tax policy now formally recognised as part of corporate governance. In addition, the substantive proposals will, in the circumstances, lead some companies to report more openly on their tax behaviour in the long term, thus creating a normative market practice in this area.

Typical questions that the board of directors should consider and discuss would be:

1. How is the tax strategy aligned with the business strategy (and the sustainability strategy), including planned changes to it (e.g. acquisitions, introduction of new products and services and establishment of new business lines)? How can the tax strategy be better integrated with the business strategy in order to ensure a long-term and sustainable tax strategy, including ensuring the correct settlement of intra-group cross-border transactions?

2. How is the company's tax planning executed? Can the business justifications for the tax strategy be explained and thus defended? Are activities allowed in so-called tax haven countries if it would be optimal for tax purposes to place activities in such countries? How should the company interact with the tax authorities?

3. What commercial and reputational risks are related to the tax strategy, and how are these evaluated? What initiatives and controls have been put in place to address these risks, and do they involve compromises – in the short term and in the long term?

4. What is tax governance like? When and how should the board (and the audit committee) be involved (see also items 6 to 9 below)?

5. How transparent do we want to be about tax matters? Are we prepared to disclose tax payments in the respective countries in which the company operates, and thus also indirectly disclose the distribution of financial performance per country? If so, what impact can this have on our competitive position in the respective countries?

If the board of directors wishes to ensure that the tax policy is also complied with, typical questions would be:

6. Do we have access to the necessary information from the company to discuss and assess tax risks? Is our ongoing management reporting on tax matters to the audit committee (and the board of directors) sufficient?

7. What competences do we have in the audit committee as well as in the company in relation to tax matters? Does the audit committee need to be regularly updated on tax matters? Do the company’s competences and resources in the tax field need to be strengthened?

8. How does the company communicate and report externally on tax matters, and do we trust that these communications and reports are of high quality and contain reliable information? For example, because clear processes have been implemented for calculations, internal controls and external validation. In other words, is our external reporting on tax matters adequate and reliable?

9. Moreover, have we established internal controls to ensure compliance with the tax policy?

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