The topic of taxes—corporate, presidential and otherwise—seems to be trending these days, with calls for greater transparency coming from investors, analysts and others, including speakers at the SEC's Investor Advisory Committee. They contend that some corporate tax practices may give rise to financial, legal and reputational risks that would be material for investors to understand. Currently, however, financial statements are required to include disclosure of the total taxes paid, but are not required to break out the amounts by country or state. Consequently, investors and analysts say that they do not have sufficient visibility to understand the impact on companies of changes in tax laws or the tax environment in different jurisdictions or to otherwise evaluate companies' exposure to tax risks.
SideBar
In its 2023 benchmark policy updates, ISS noted that, although there was no specific effort to elicit information about corporate tax disclosure, two unsolicited comments indicated that tax disclosure "was becoming an issue of higher priority to investors. These commenters stated that current company disclosures are insufficient, and that tax shifting can lead to insufficient funding for safety net programs. They pointed out that the Global Reporting Initiative (GRI) had developed a voluntary tax reporting standard that companies could use to more comprehensively report on tax risks and opportunities."
[Based on my notes, so standard caveats apply.]
In December last year, the SEC's Investor Advisory Committee held a meeting that addressed the potential benefits to investors of greater tax transparency, including country-by-country tax reporting. To open the meeting, SEC Chair Gary Gensler observed that
"[i]nvestors have expressed an interest in greater details, sometimes called disaggregation, with regard to income tax information. In an effort to make more informed investment decisions, investors have raised an interest in understanding more about tax information related to the specific jurisdictions in which companies operate, including how different tax strategies might impact companies' tax rates. I understand the Financial Accounting Standards Board (FASB) recently proposed to enhance income tax disclosures in financial statements. When the proposal is publicly released, I think it is important to consider such enhanced tax disclosures. Disaggregated tax reporting from international companies—in the specific jurisdictions in which those companies operate—could benefit investors."
One speaker at the meeting observed that there are many large and highly profitable companies that pay little tax, but it's hard to figure out from public data why that's the case. It's important for shareholders, she said, because of the risk that companies could be surprised with a sudden huge tax bill, suffer reputational risk, legal risk and other financial risk. In 2020, she reported, corporate taxes fell to 5% of tax revenues, the lowest in 70 years; the percentage used to be 30%. Now, individual taxpayers must make up the difference, even as corporations benefit from the application of tax revenue to infrastructure, educated workforces and other uses. Some companies, she said, are able to structure their business, often through deals with some foreign countries or quirks of foreign tax laws, so that they avoid US tax.
Several speakers mentioned, however, that a number of large multinationals have been hit recently with multi-billion dollar tax assessments and penalties in different countries, perhaps reflecting a dramatic shift in the risk equation, especially in light of recent and impending tax increases and tax law changes in different countries (e.g., the new corporate alt min 15% tax in the US). And some companies have not been able to maintain the special tax arrangements that they had established with some countries, which has made a significant difference in their financial results, leading to declines or volatility in stock prices.
However, because of information asymmetries, investors cannot assess these risks. To address these issues, there has been a move internationally for greater tax transparency, with organizations such as GRI developing new tax reporting standards calling for country-by-country reporting of tax data. In addition, shareholder proposals to disclose tax information under the GRI standard have been introduced at an increasing number of large companies. Moreover, the FASB, which has been considering the issue for several years, is on the verge of issuing a new proposal for more detailed tax disclosure.
SideBar
According to the minutes of the November FASB meeting, the Board discussed the development of a proposed new Accounting Standards Update "to improve the transparency and decision usefulness of income tax disclosures, primarily focusing on income taxes paid and the rate reconciliation." Based on the tentative Board decisions reflected in the minutes, with regard to income taxes paid, the new proposal would require entities to disclose the year-to-date amount of income taxes paid, on both an interim and annual basis, disaggregated by federal, state and foreign taxes. Annually, the proposal would also require all entities to disclose income taxes paid, disaggregated by individual jurisdiction on the basis of a quantitative threshold of 5% percent of total income taxes paid. The disclosure of income taxes paid would be the amount, net of refunds received.
With regard to the rate reconciliation table—the table that appears in financial statements reconciling the statutory income tax rate to the effective tax rate—the proposal would require public business entities to disclose annually:
- Rate reconciliation information by a number of specific categories, with accompanying qualitative disclosures, including state and local income tax, net of federal income tax effect; foreign tax effects; enactment of new tax laws; effect of cross-border tax laws; tax credits; valuation allowances; nontaxable or nondeductible items; and changes in reserves for tax positions.
- Qualitative information about "the states that contribute to the majority of the effect of the state and local income tax, net of federal income tax effect category."
- Separately, "reconciling items by nature, on the basis of a quantitative threshold of 5 percent, within the effect of cross-border tax laws, tax credits, and nontaxable or nondeductible items categories."
- Separately, "reconciling items by nature and by jurisdiction, on the basis of a quantitative threshold of 5 percent, within the foreign tax effect category."
- Separately, "reconciling items by nature, on the basis of a quantitative threshold of 5 percent, for other items that do not fall within any specific category."
The rate reconciliation information would be disclosed using both percentages and dollar amounts. Public business entities would be required to provide, on an interim basis, qualitative disclosure about the reconciling items that cause significant year-to-date changes of the effective tax rate from the prior annual reporting period. Nonpublic entities would be required to provide "qualitative disclosure about specific categories and individual jurisdictions that result in a significant difference between the statutory tax rate and the effective tax rate."
Entities would be required to apply the amendments retrospectively as of the beginning of the earliest period presented in the financial statements. The FASB staff was directed to draft a proposed ASU for vote by written ballot, with a comment period of 75 days.
One of the speakers at the meeting, while pleased that the FASB was listening to investors, seemed to view the FASB proposal as too cautious; it avoided requiring disclosure of information that might illuminate the thornier issues of tax risk. More specifically, he said, the requirements proposed for country-by-country disclosure covered only tax data, but would not provide the underlying data, such as country-by-country disclosure of revenue and income, that would enable an effective analysis of the sources of tax risks. In addition, he argued that more tax disaggregation was needed in the tax rate reconciliation table. In his view, the SEC should be the entity issuing the tax disclosure requirements: it has the explicit authority to adopt rules for the protection of investors, and the disclosure would facilitate the analysis of potentially material tax risk. In addition, the SEC could require a uniform standard for better comparability. The necessary information has already been calculated, and, in most cases, has been reported to regulatory authorities on a confidential basis. Others expressed a different view, contending that the job belonged more appropriately to Congress and the FASB, with appropriate influence from the SEC.
One of the more interesting debates was over the underlying purpose of this tax disclosure. One committee member suggested that transparency worked against investors because it potentially increased corporate taxes. Don't shareholders benefit when companies reduce their tax liability to the lowest level possible? In addition, she argued, tax transparency is predominantly a social issue, not an investor issue. Are companies engaged in illegal practices, or just practices of tax avoidance that countries don't like? The purpose, the member suggested, is really to require companies to pay more taxes. But doesn't that hurt investors?
Some speakers, however, seemed to disagree. One speaker noted that, while some do take the view that companies should always minimize their tax obligations and aggressively employ tax avoidance strategies, she believed that view reflected short-term thinking, depriving society of the funds for infrastructure and education (from which businesses benefit), not to mention funds to address the costs that companies impose on society, such as financial crises and oil spills. Others noted that investors need to understand the potential for each company's financial, legal and reputational risk. In that regard, one of the speakers observed, the tax avoidance environment is becoming increasingly difficult to navigate—going forward, investor focus is on risk and opportunity. In addition, many stakeholders want companies to pay their fair share of taxes. Another speaker argued that what investors want is that companies pay the lowest sustainable tax rate over the long term, with stability based on competitive products and services—not volatility arising out of overly aggressive tax practices. In addition, he remarked, understanding management's tax approach—especially an aggressive approach—helps investors to understand the company's overall risk tolerance.
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