[Tax Story] ESG Management and Taxes

Professor Ahn Chang-nam, Department of Taxation, Gangnam University

One of the forces manipulating South Korea's stock market is foreign capital. What are their investment decision criteria? Previously, financial factors focusing on how much profit was made were emphasized, but in the era of ESG management, non-financial factors regarding how profits are made are also considered.

ESG is a concept derived from the Principles for Responsible Investment (PRI) established by the United Nations, which requires financial institutions to consider a company's Environmental, Social, and Governance (ESG) issues when making investment decisions.

The PRI principles, first announced in 2006 at the New York Stock Exchange in the United States, have led institutional investors such as pension funds worldwide to incorporate ESG evaluations when deciding whether to invest. This is the right approach. Public funds investing in companies that engage in tax evasion cannot be said to have fulfilled their social responsibility.

However, creating models (questionnaires) for ESG evaluation is not as easy as it seems. Non-financial factors are difficult to quantify and measure. Although the US and Europe have proposed evaluation models by sector, there is still no globally unified evaluation model.

On the other hand, the tax field is relatively easier to quantify, and establishing international unified standards is not very difficult. Taxation is a core topic in capitalist countries, and as seen in the recent agreement on digital tax by the Organisation for Economic Co-operation and Development (OECD) and the Group of Twenty (G20) on the 11th, there is already extensive experience in international cooperation and harmonization, as well as many international tax norms.

The intersection of ESG and taxation is as follows. First, the E in ESG relates to carbon tax. In particular, the Paris Climate Agreement established in 2015 recommends all UN member states to adhere to carbon emission reduction measures. The argument that carbon tax imposes a burden on corporate management is becoming less tenable. The increase or decrease in carbon tax payments relative to corporate sales can be presented as an evaluation criterion.

The S in ESG is related to donation tax systems aimed at helping socially vulnerable groups. When companies and shareholders monopolize the profits earned, it entrenches the rich-get-richer and poor-get-poorer phenomenon in society. After all, how can companies make large profits without the purchasing actions of socially disadvantaged groups? The increase or decrease in donation expenditures relative to operating profit can be presented as an evaluation criterion.

Finally, the G in ESG can be linked to a company's fulfillment of tax obligations. Tax evasion, nominee trusts, accounting fraud, money laundering, real estate speculation, and pursuit of criminal proceeds are impossible without the decision or tacit consent of the major shareholder. The frequency of fraud or dishonest acts can be presented as an evaluation criterion.

Tax authorities should develop a Korean-style ESG tax evaluation model (K-ESG TAX Model) focusing on carbon tax, donations, and tax evasion, guide companies to manage accordingly, and prepare tax support measures as needed. This is similar to how preparing well for a mock exam (Korean-style ESG evaluation) can lead to high scores on the college entrance exam (ESG evaluation by foreign institutional investors). Our companies must diligently study the internationally common ESG textbook and compete with foreign companies. The higher the evaluation, the more the stock price will rise.

ESG management is a good prescription to cure the evils of vulgar capitalism that only cares about money. Let us prepare a refined tax evaluation model that serves as a touchstone for our companies to achieve excellent results on the global stage and strive for its adoption as an international standard. Companies with insight will base themselves on such evaluation models to continuously pursue transparent management, dedicate themselves to realizing a fair society, and as a result, enter the path of sincere tax compliance. Then, stock prices and national prestige will rise as a bonus.

Changnam Ahn, Professor, Department of Taxation, Gangnam University