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What’s the SFDR and what does it must do with tax?
A protracted-standing problem for funds advertising themselves as selling or exhibiting ESG standards is that there’s little widespread consensus on what ESG truly means. The SFDR goals to alleviate a few of these considerations and set up clearer parameters round what sustainable funding seems like in observe. Nonetheless, whereas the SFDR supplies some welcome commonality within the type of comparable disclosure necessities, it’s removed from complete on different elements – together with tax. This leaves fund managers within the unenviable place of figuring out that tax is one thing they should get proper in the case of positioning a fund as Article 8 or Article 9 for SFDR functions however with no clear path as to how to take action.
The SFDR requires that Article 8 fund investments should comply with good governance practices, whereas Article 9 funds are required to make “sustainable investments”, which by definition should comply with good governance practices. The SFDR idea of “good governance” is derived from the SFDR definition of “sustainable funding”, and consists of, amongst different issues, reference to “tax compliance”. What does that imply within the context of “good governance”?
What “good tax governance” means shouldn’t be elaborated on. Nonetheless, whereas there is no such thing as a concrete steerage or algorithm as to how one can strategy this query within the particular context of SFDR, there may be an growing quantity of steerage and precedent to attract on to point out {that a} accountable overview of tax governance has been taken critically. This may increasingly not present a panacea for fund managers on this context, however it’s at the very least a place to begin.
So, what’s “good” tax governance?
As so typically in tax, the reply is to some extent “it relies upon”. We have now been seeing the emergence of varied sources of steerage and requirements for good tax governance, from voluntary requirements just like the International Reporting Initiative, to an enhanced concentrate on “programs and supply” in HMRC’s massive enterprise danger critiques. Whereas there are widespread themes between these, there’s a clear sense that the metric shifts relying on who it’s measuring.
This isn’t tax relativism, however a realistic acknowledgement that not all companies face the identical tax dangers, and an organisation’s measurement and enterprise mannequin might render sure tax governance KPIs defunct. Proportionality stays an necessary consideration in what “good” seems like. For example, there may be not a lot level asking nuanced questions on an organisation’s tax division whether it is too small to justify having one, or if that operate is outsourced. The crux is knowing what is acceptable for the taxpayer in query.
That isn’t very useful for these tasked with diligencing whether or not a given customary is met. Within the absence of clearer EU steerage for SFDR functions, a realistic response appears to be to concentrate on the rising widespread strands of excellent tax governance, which embody:
- dedication to appearing in accordance with relevant tax legal guidelines and sustaining a constructive dialogue with the tax authorities;
- documenting and commonly reviewing tax coverage and technique;
- top-down dedication to together with tax as a board and strategic matter;
- the power to establish and talk the primary tax dangers dealing with the enterprise;
- a tax management framework, together with a tax danger register and good information administration; and
- recognized duties and clear escalation procedures.
Subsequent: how one can diligence this?
Understanding the tax practices and governance preparations of any organisation is never a checkbox train and – as consensus will increase on what good tax governance means in observe – might require extra of a dialogue (maybe with a wider vary of individuals) than typical due diligence processes have beforehand concerned.
It’s wise to begin by approaching the duty with a structured listing of tax governance questions as prompts for dialogue and to speak clearly to a possible investee firm what it is advisable perceive. Fund managers might want to overview their present diligence and engagement practices and work out the place tax governance would most naturally match (to the extent it’s not already an express diligence focus). Managers typically take an initially standardised strategy and require portfolio entities to finish due diligence questionnaires in respect of their tax compliance and danger administration preparations.
There may be worth to this diligence past ESG compliance and supporting a specific SFDR fund categorisation: the method can unearth unattractive tax “skeletons within the closet” that will not be picked up by conventional tax diligence, and might also due to this fact present a possibility to cost chip.
To facilitate this course of, we now have been creating a spread of options for our shoppers to navigate the nebulous and sophisticated world of diligencing tax as an ESG matter within the funding area, and we now have a spread of instruments and merchandise obtainable to fast-track what is usually a daunting and time-consuming process right into a manageable train. This features a self-assessment software for investee corporations to use to their tax governance preparations.
Conclusion
The dearth of granularity on what good tax governance means within the SFDR is maybe not shocking. It’s honest to say that taxpayer behaviour shouldn’t be a central focus of the SFDR, with the phrase “tax” showing solely as soon as in your complete regulation. Nonetheless, the truth that it seems in any respect – and as a crucial a part of the central idea of “good governance”, itself a core requirement of “sustainable funding” – underscores the truth that tax is an embedded a part of the ESG panorama and fund managers should due to this fact become familiar with how one can reveal that their investee corporations practise good tax governance.
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