Adrian Zicari, Prof. of Accounting and Management Control, ESSEC Business School and Cécile Renouard, Director of the ‘Companies and Development’ (CODEV) research programme at the ESSEC IRENE institute, explore the emerging, yet elusive, concept of fiscal responsibility and explain how it could be articulated into the wider realm of CSR.
By CoBS editorialist Afifeh Fakori from the paper A Forgotten Issue: Fiscal responsibility in the CSR debate by Adrian Zicari and Cécile Renouard.
Corporate Social Responsibility, or CSR, is undoubtedly one of the most trending catchphrases of today. And what idea does this term conjure up for us? Philanthropy. Sustainability. Perhaps a greener planet. But we can bet that only a select few would associate it with corporate tax practices. Yet, the emerging concept of “Fiscal Responsibility” is one that may need to be articulated into the wider realm of CSR today in light of the current practices in the corporate world.
What brings Fiscal Responsibility into the limelight?
Simply put, globalisation pushes the notion of Fiscal Responsibility (FR) to the surface of debatable social issues today. Globalisation has enabled companies to manufacture products in one country using raw materials sourced from one or more different countries in order to serve customers all around the globe. This is all good news for consumers. But as companies start to spread their value chain across multiple countries, the ambiguities surrounding tax calculation become more pronounced. It is difficult to identify which part of the value chain, and the respective taxes, corresponds to which participating country. Information asymmetry arises as tax authorities are only aware of dealings within national boundaries, and not across. Some firms, unfortunately, take advantage of the ensuing ambiguity and engage in abusive practices. They create different legal entities in different countries and assign the largest possible part of created value to the lower tax rate jurisdictions. Companies also get the opportunity to manipulate their transfer prices within the corporation in order to reduce their tax burden. Needless to say, this translates into bleak consequences for the economy and society of many of the countries where they operate. The growing shift towards a knowledge economy is exacerbating this situation as the prices of intangible assets can be manipulated all the more easily.
Tax Mitigation vs Tax Evasion: A treacherous continuum
As surprising as it may appear, there is nothing explicitly fair or unfair in the eyes of fiscal law when it comes to corporate taxation. This gives companies the opportunity to engage in activities which range from being mere tax mitigation moves to outright violation of the law. So, while adopting accelerated depreciation methods can be classified as “tax mitigation,” contriving an imaginary transaction to minimise taxes might be a case of “tax evasion.” In the continuum between mitigation and evasion, exists the grey area of “avoidance.” The spirit of fiscal law is often violated in this space and yet fiscal authorities are powerless to act as the companies have abided by the law in its literal sense.
Who stands to lose from tax avoidance?
For a moment, let’s go back to basics and ask ourselves what the prime objective for a firm’s existence is? Some would say the objective is to “maximise shareholder value.” This view is widely known as the “legal fiction” perspective and it encourages firms to pursue aggressive tax avoidance as long as they adhere to the so-called “rules of the game.” But in doing so, some companies might also be defrauding shareholders as well. Tax avoidance practices tarnish a company’s reputation in the eyes of its investors, who begin to doubt whether profits really correspond to real value creation. In the end, such short-term focus on share value maximization comes with the risk of lower shareholder value in the long run.
Another group of people subscribe to the “real entity” perspective on companies. They contend that the firm is a legal person whose objectives correspond to the needs of several stakeholders, which includes the State. Thus the firm should consider the needs of stakeholders (including the State), instead of only focusing on shareholders. These shareholders, while necessary, are merely a source of financing, not the “owners” of the firm. Tax avoidance would then deprive the State of the fiscal revenues it legitimately needs and consequently, citizens can end being deprived of social services, such as healthcare. But it is not only the State and citizens who lose. The company stands to lose government contract and it might have to bear the brunt of stricter regulations enforced by the negatively impacted State.
How does Fiscal Responsibility fit into the domain of CSR?
Most companies behave in socially responsible ways because they want to and not because they have to – it is a voluntary choice they make. Similarly, they also have the freedom to adopt or forego tax avoidance practices, while still adhering to legal boundaries. In this sense, a parallel can be drawn between CSR and FR (Fiscal Responsibility).
There are also a number of other ways to articulate FR into CSR:
- CSR and FR both work towards maximisation of long-term shareholder value and goodwill, and reduction of business risk.
- Large corporations have a great deal of responsibility towards their communities. Both CSR and FR help these corporations meet this responsibility, be it directly or indirectly.
- A company depends on its stakeholders for survival. As a result, it should have a high level of responsiveness towards stakeholder demands. CSR initiatives attain this responsiveness by contributing to the greater good of society while FR does so through transparent tax practices which facilitate informed dialogues between the company and its stakeholders
Some people argue that corporate philanthropy can replace tax contribution. This is a flawed argument since philanthropy allows managers to spend money at their own discretion – and possibly in ways that are not optimal for society. In many countries, governments have a system of checks and balances that allow them to address social issues that are in greater need of immediate attention.
Grey areas in fiscal laws provide companies with loopholes to avoid taxes. International cooperation and disambiguation of fiscal laws may be the need of the hour under such circumstances. But, while we wait for that to happen, it is important to revamp the existing CSR reporting practice to incorporate details on how companies address their tax obligations. It’s time we question our collective consciousness whether or not we can call a company ‘socially responsible’ if it is involved in ambiguous tax avoidance practices.
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