This article first appeared in The Edge Malaysia Weekly on December 30, 2024 - January 5, 2025

Taxation is a key success factor and mandatory requirement for environmental, social and governance (ESG) programmes. Institutional investors use contributions to the public purse to measure businesses’ commitment to people, the planet and profits.

According to the Organisation for Economic Cooperation and Development (OECD), taxation is the amount of tax paid by a company to the governing authorities in the territories that it operates in. Taxation is tied to corporate governance, particularly regarding how much tax has been paid and any negative impacts stemming from tax issues.

For instance, the Global Reporting Initiative Topic Standard 207 addresses tax governance, control and risk management, stakeholder engagement and management concerns. It also addresses country-by-country reporting (CbCR). Similarly, the OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan covers topics such as aggressive tax planning, transfer pricing, hybrid structures, earnings stripping, transparency and substance. In fact, BEPS highlights CbCR as well.

Further, under the guidelines of the Taskforce for Climate on Climate-Related Financial Disclosures, scenario analysis is a key aspect of future-proofing businesses and disclosing the potential financial impacts of climate change. Scenario analysis also includes changes in policy trends, including tax policies and compliance.

Institutional investors seek clarity and want to ensure that their risk level is kept to a minimum. This includes screening via the three pillars of ESG: environmental, social and governance.

In the environmental pillar, taxation is often seen through the lens of measures such as carbon tax. Conversely, green tax incentives are also present in Malaysia and Asean. These taxes factor heavily in investment and capital expenditure decisions, with investors also evaluating ESG commitments through such tax regimes.

In the social pillar, taxation is seen through the lens of supporting local economies and the impact of tax contributions — which support local economies, public services and overall community well-being. There is also an additional challenge of managing income tax regulations for the various workers that a company may employ — with remote work and gig economy or contract workers also coming into play.

As for the governance pillar, tax transparency is paramount, with considerations such as tax strategy, policies and reporting at play. In the current environment, transparent tax practices are expected, with clear disclosures on contributions, strategies and risks among investor expectations.

The Chartered Financial Accountants (CFA) Research Institute highlights in its report titled ESG and Responsible Institutional Investing Around the World: A Critical Review that for many economists, the best way to address negative externalities is through policy tools such as taxes and or subsidies to manage negative impacts or promote more desirable corporate behaviour.

However, implementing and coordinating global environmental policies among national governments is a key challenge for taxation and ESG. Norges Bank Investment Management CEO Nicolai Tangen has stated that climate risk is a financial risk. Tangen states in the Responsible Investment Government Pension Fund Global 2023 report that the fund has set clearer expectations for how its investee companies should navigate the climate transition, underpinned by detailed transition plans with interim targets and progress updates. The report noted that 2,385 portfolio companies have set science-based net zero targets by the end of 2023, an increase of 790 from 2022’s number. It also mentioned that 68% of financed emissions are covered by net zero 2050 targets.

Across the causeway, Temasek Holdings has also showcased tools such as its Climate Transition Readiness Framework and ESG Value Creation Playbook to support its post-investment engagement efforts.

Closer to home, the Employees Provident Fund has announced its Sustainable Investment Stewardship Policy, which aims to promote good sustainability practices among its investee companies and external fund managers.

Khazanah Nasional Bhd states in its sustainable investment policy that it will incorporate and embed ESG factors in formulating its investment strategy, screening and selection.

As such, institutional investors have already started and are well into the process of using ESG metrics in their investment decisions. Tax considerations, including risks and potential investment-boosting tax reliefs, will factor into this decision-making process.

The CFA has noted that different regions globally are moving at different speeds about ESG regulation. In the European Union, the Corporate Reporting Sustainability Directive will come into force in 2025, requiring both large and listed companies to publish regular reports on their ESG risks, plus how their business activities impact people and the planet.

Across the Atlantic, the US Securities and Exchange Commission has mandated that listed companies have to disclose all material information to investors, including ESG risks.

Singapore has recently broadened the scope of its climate reporting efforts. By financial year 2025, all listed companies — regardless of sector— will have to report Scope 1 and Scope 2 greenhouse gas emissions, and by FY2026 their Scope 3 GHG emissions must also be reported.

Large non-listed companies (companies that report SG$1 billion in revenue and SG$500 million in assets) will be required to report Scope 1 and Scope 2 emissions in the financial year 2029.

Malaysia is certainly keeping pace with the race to ensure that regulations are kept up to par. The National Sustainability Reporting Framework has mandated that from 2025, Bursa Malaysia Main Market, ACE Market and large non-listed companies with an annual revenue of RM2 billion will have to comply with the new framework in a phased manner. The first phase will apply to large, listed companies on the Main Market with a market capitalisation of RM2 billion. This will be extended to other main market companies by 2026 and to the ACE Market and large non-listed companies by 2027.

It is also worth noting that as the physical and regulatory landscape evolves further, tax considerations will continue to be at the forefront. Governments and tax authorities will be constantly evolving their approaches to both tax and broader ESG issues, with companies and investors paying even more attention to such developments.

The correlation between institutional investors, tax and ESG is strong and well-defined and will only become stronger.

S Saravana Kumar is a tax lawyer with law firm Rosli Dahlan Saravana Partnership (RDS)

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