The elephant in the responsible investment room

Tax is not on the ESG agenda; maybe it should be.

When British politicians called on citizens to boycott retailer Amazon in 2014, it wasn’t because of environmental concerns or the way it treats its workers; it was because of tax.

Amazon is one of many global businesses to face political ire over low effective tax rates on profits. The global tax system has not yet caught up with the global nature of today’s largest companies; something that the OECD’s base erosion and profit shifting initiative is designed to remedy.

The tech giant and its peers have successfully weathered any tax-related storm thrown their way so far. However, clearly the amount of tax that companies pay where they operate matters from a reputational point of view.

And it is on investors’ agenda. The PRI, the group established by the United Nations to act as a proponent of responsible investing, has been promoting the topic for a number of years and in May issued guidance for investors on how to engage with companies on tax transparency. This is because, among other things, an aggressive tax policy “sends a signal regarding risk tolerance” and investors want to know that investees “can withstand stakeholder scrutiny”.

So why is tax rarely, if ever, raised in the context of private equity and responsible investing? Sister publication Private Equity International hosted the European leg of its Responsible Investment Forum for the ninth year in a row recently. The event continues to gather momentum, attracting sponsors and delegates from across the general partner, investor and advisory community. Clearly the appetite among asset owners and fund managers to learn more about best practice in this part of the private markets universe is growing.

The umbrella term ‘ESG’ captures a broad range of concerns, from straightforward matters like energy usage or employee welfare to more tangential areas, like cybersecurity (are you being a responsible steward of other people’s data?). But not tax.

When we ask industry insiders about this topic, responses vary from “I don’t know, but it’s an interesting question”, to full on bafflement: “It is not an ESG issue, full stop”. Most investors are still trying to work out how responsible investing can be incorporated into their investment strategies – tax-as-an-ESG issue is a long way down their list of priorities.

It is important to distinguish here between fund structuring – and the imperative to make private equity investing tax neutral for LPs – and tax issues at portfolio company level. It is the latter that should give investors pause, according to the PRI.

Let’s not beat around the bush: private equity-owned businesses are, due to the way in which debt is deployed (both as leverage and as proxy for equity), very tax-efficient in terms of taxable profit. Deal people only think in terms of gross profit, as net profit is almost irrelevant. But this is part of what enables the asset class to deliver high levels of return to investors and build market-leading businesses. These businesses create jobs and contribute to the public purse as employers and consumers of services.

Would anyone want to jeopardise this? Absolutely not. But should the industry be ready to answer questions at some point? Absolutely.

Toby Mitchenall is senior editor of Private Equity International. Write to him at toby.m@peimedia.com