Tax Articles

Understanding ESG (2nd of 2 Parts)

By: Atty. Jomel N. Manaig

In last week’s article, our elementary stroll opened our eyes to what Environmental, Social, and Governance (ESG) is. But, as we already figured out last week, knowing the “what” of it all is just half the battle. Equally imperative for us is to also know the “why.” Why is ESG important?

Before we go any further, let me first say that ESG compliance is not a simple matter. It is not something that may be fully threshed out in a meeting over a pile of notes and a powerpoint presentation. So to prevent going down aimlessly at the rabbit hole of understanding ESG importance, we will wear a more focused lens and take aim at two crucial concerns: investments and taxes.

Ever since movements began to highlight corporate sustainability and responsibility, there has been a steady rise in ESG investing. Basically, ESG investing is an investment strategy used by institutional investors and fund managers that let ESG factors affect, if not determine, investment decisions. If a company has a good ESG rating, investors are more likely to invest in that company. On the other hand, if the ESG rating is poor, investors may shy away or even distance themselves from such company.

In a 2021 survey by Deustche Bank Research, 75% of their investor-respondents said that ESG has some impact on their investment process. Among the three pillars, environmental factors are more important for European entities while US firms are relatively more focused on social factors. Nonetheless, the respondents still perceive increased importance of ESG, as a whole, in the future.

In evaluating the ESG compliance of a potential investee-company, investors would rely on ESG disclosures in the financial statements. Some Asia-Pacific economies like Hong Kong, Japan, and Singapore have adopted various regulatory guidelines for mandatory ESG disclosure requirements. Similar requirements are also under various stages of discussion and adoption in the United States and the European Union.

Also, independent agencies are now providing ESG rating services to quantify the otherwise mainly qualitative ESG aspects of each corporation. Compliance then, at least in this aspect, is certainly not beyond reach. It should be noted though that in the absence of a global standard, these ESG rating agencies have largely adopted their own ratings framework.

In the Philippines, ESG is still a matter that takes up space largely as an unofficial concept. Discussions are there, even if barely, but application is close to non-existent. However, this does not mean that we should just shrug it away. Non-compliance with ESG requirements may remove Philippine companies from any preferential investment list. Worse, they may be considered as undesirable investment destinations.

Lack of ESG regulation initiatives may likewise cause multinationals to forego investing in the Philippines as operating here may cause them compliance issues.

Aside from loss of investment opportunities, taxes are also a concern when it comes to ESG compliance due to the application of what is coined as “green taxes.” Green taxes are tax impositions computed on the basis of pollution, emissions, consumption of fuel and other natural resources, and carbon footprint, among others. Incentives may likewise be granted to corporations to encourage them to reduce environmental harm.

In Asia-Pacific jurisdictions like Cambodia, China, India, Japan, Singapore, and South Korea, among others, various green taxes are imposed against corporations. Examples of these taxes are the Carbon Tax, Single Use Plastic Tax, Excise Taxes on Automobiles and Fuels, Pollution Tax, and Energy Tax, to name a few.

Considering that the environment is one of the pillars of ESG, corporations would have more motivation to clean up their acts, pun intended. Should ESG disclosures become mandatory, tax authorities would easily be able to impose the appropriate green taxes commensurate to the environmental harm that a corporation causes. In order to escape this liability, corporations must do everything in its power to have an environmentally sound business practice.

It should be noted that green taxes like carbon and pollution taxes, are not limited to the pollution that a corporation directly creates. It may include the pollution caused by those within the supply chain of the corporation. What corporation likes to pay additional taxes?

Despite its complexity, one reassuring thing is that everyone is still new at ESG. Everyone still has time and room to grow into it. The question for Philippine companies and regulatory agencies alike is that do we want to grow and mature together with other economies? Or will we join the party only when everyone else is starting to move on to the next big thing?

We have been enacting various amendments to our investment and tax laws for the better part of the past decade with the aim of shedding the title of the “Sick Man of Asia.” But perhaps, we should be more proactive to emerging trends. While we may no longer be Asia’s sick man, but we are still always late to the party. Let us be early for once.