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Abidance by ESG principles key for companies’ survival

by Mohammad Ghazal

Whilst in the past, companies were mainly concerned with profit and appeasing their shareholders, the global focus for companies is changing. The concept of ESG does not merely consider how compliant a company is with the law but rather how it chooses to operate, which includes the effects on the environment, a company’s social obligations and the manner in which it is run.

Whilst tax itself is not part of the acronym, it is becoming closely related to the principles of ESG. A company may be able to legally get away with paying minimal tax, due to tax loopholes but the perception of these companies becomes increasingly negative when viewed by the public. The public issue of companies paying their fair share of tax has become far more prominent since the 2008 financial crisis and further kept alive by leaks such as the Panama Papers, Paradise Papers and Lux Leaks.

Companies are beginning to realise that for long term survival they need to consider the principles of ESG with respect to taxation and paying their dues. There are global calls by ESG supporters that companies be subject to Country-by-Country Reporting (CbCR) and that it be made public. The USA and Europe are taking measures to apply public CbCR and its not a matter of if, but when, and sooner rather than later.

Although the primary global focus in linking ESG to taxation appears to be public CbCR, there are no indications so far this will be followed within the UAE. However, there are other ways in which taxation can guide and promote acceptable ESG policies. Further, nothing will stop companies voluntarily disclosing the amounts they have paid towards tax.

The UAE, as a whole, is fairly new to the concept of taxation. Excise Tax began in late 2017 and VAT was first established in January 2018 at a rate of 5%. Further Corporate Tax is due to be implemented from 1 June 2023 at a rate of 9%. This being said, taxation has existed within the UAE for some time on the Emirate level. Foreign branches of banks are subject to taxation at a flat rate of 20% as per separate Emirate decrees and companies engaged in UAE oil and gas petrochemical activities are subject to income tax at 55%+ rates under their individual UAE concession agreements or fiscal letters.

There are numerous reasons for the relatively high tax placed upon companies involved in oil and gas petrochemical activities and on foreign banking institutions. One of those reasons is indeed a substantial effort by the relative emirate level governments to get those companies to comply with ESG. Petrochemical companies will be making an excessive impact on the environment (whether directly or indirectly) and make a substantial income in doing so. The high taxation is at least partly motivated to ensure that part of it can pay for further environmentally friendly technologies and social programs in the future. Further, the higher tax placed on banking institutions is also relative with the amount of profit they earn and “paying their fair share” to do so. The UAE has also recently taken to taxing the use of single use plastics and are banning them by the year 2024. This tax is minor and generally felt by the consumer, but is yet another step towards meeting ESG ideals.

ESG principles further play a role in the introduction of corporate tax and VAT. A substantial reason these taxes have been introduced is to permit the UAE to modernise its economy and move away from reliance on oil. This in itself is because the UAE recognises that there is a global initiative to move away from fossil fuels to more environmentally friendly options and were it to continue to rely on an oil-based economy, it would suffer in the future.

Although taxation alone is not going to achieve the objectives of ESG, the two are clearly closely linked. It has been argued by ESG supporters that public CbCR is required to truly assist with the realisation of the objectives of ESG and whilst there are currently no indications the UAE will implement public CbCR, it is certainly moving in the right direction with the objectives of ESG in mind.

By Tyne Hugo – Senior Associate – BSA

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