Influence of Corporate SDG Disclosures and Implications upon International Taxation

Paper Code: AIJACLAV13RP2024

Category: Research Paper

Date of Submission for First Review: Nov 16, 2024

Date of Publication: December 21, 2024

Citation: Mr. Moses Pinto, “Influence of Corporate SDG Disclosures and Implications upon International Taxation", 4, AIJACLA, 138, 138-151 (2024), <https://www.aequivic.in/post/influence-of-corporate-sdg-disclosures-and-implications-upon-international-taxation>

Author Details: Mr. Moses Pinto, Doctoral Student, PhD in Law, Faculty of Law, Autonomous University of Barcelona, Barcelona, Spain

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Abstract

Human activities upset environmental equilibrium, hence sustainable development is essential to mitigate these effects. This study explores how a country's development level affects Sustainable Development Goal (SDG) company disclosures, focusing on foreign taxation. According to Hypothesis 1a, national development boosts corporate disclosure of SDG information. However, Hypothesis 1b demonstrates a negative relationship between national development levels and company SDG disclosures. Member States which are signatories to the SDGs ought to accentuate the practices which are not only sustainable but which also envisaged the integration of sustainability information into corporate reporting cycles, especially large and multinational ones, according to SDG objective 12.6.¹⁷ Firms in nations with strong legal systems may employ more legal institutions to assure compliance, while those with weaker systems may rely more on external assurance. By allowing deductions against CSR expenditures could invoke an impetus towards the strategic alignment towards International Taxation Laws by Multinational Enterprises (MNEs) while demonstrating a heightened degree of transparency which would qualify as industry best practices in declaring the CSR expenditures incurred as a function of the tax avoidance endeavor by the MNE. This kind of amalgamation of transparent practices in the realm of seeking tax deductions for an MNE’s CSR expenditure could also minimize conflicts of perception before proponents who interchangeably refer to Tax Evasion. It could be estimated that global CSR laws could be harmoniously constructed vis-à-vis local taxation laws in their interpretation by MNEs if encouraged by the governments of the host country. 

Keywords: Sustainable Development Goals, SDG Disclosures by Firms, SDG Reporting, External Assurance, Legitimacy Signals.

INTRODUCTION:

i. Background and context:

Understanding the intersection between the expenditures pertaining to a firm’s corporate social responsibility and the tax deductions remains crucial for evaluating how legal frameworks influence corporate financial practices and ethical behavior.

This research focuses on the treatment of CSR expenditures under various legal systems, highlighting its implications for both corporate strategy and tax policy.

Knuutinen observes that attitudes towards taxation often lack consistency, suggesting a need for a more nuanced examination of how CSR expenditures are addressed within tax laws.⁷ Despite the growing importance of CSR in corporate governance, discrepancies between legal requirements and managerial accounting practices continue to present challenges.⁷

In the Indian context, Section 135 of the Indian Companies Act, 2013, mandates substantial CSR spending for eligible companies. However, such expenditures are not deductible from taxable income under Section 37(1) of the Indian Income Tax Act, 1961, as clarified by Singh.¹⁰ This creates a complex legal environment where CSR spending, while legally required, does not align with tax deduction policies.

Comparatively, international perspectives, including those from EU and Spanish tax laws, offer different approaches to CSR expenditures and their tax treatment.

ii. Statement of the research problem:

The convergence of international taxation laws and corporate social responsibility (CSR) presents a multifaceted challenge that merits comprehensive investigation.

As multinational enterprises (MNEs) continue to grow and engage in diverse global markets, the treatment of CSR expenditures in relation to tax deductions and rebates becomes increasingly critical.

Current legal frameworks often fail to provide clear guidance on how CSR-related expenditures should be handled for tax purposes, which creates significant implications for both legal compliance and ethical practice.

Previous research, such as Gribnau, indicates that the prevailing legal interpretations of CSR expenditures often fall short of capturing the broader ethical principles underlying CSR activities.⁴

This research aims to address the following questions to fill these gaps:

Should international taxation laws recognize and permit deductions and tax rebates for multinational enterprises (MNEs) based on their CSR expenditures?

This question explores the potential for international tax regulations to provide clearer and more favorable treatment of CSR expenditures, thereby enhancing the coherence between legal obligations and ethical responsibilities.

Can global CSR laws be harmonized with local taxation laws in their interpretation by MNE managers?

This question investigates the possibility of developing a unified framework that integrates global CSR standards with local tax regulations, improving managerial decision-making and regulatory compliance.

iii. Purpose of the study:

From the context of Indian Taxation Laws, Singh has expressed that:

"The provisions of Section 135 of the Companies Act, 2013 mandates that: Every company having net worth of rupees five hundred crores or more or turnover of rupees one thousand crores or more or a net profit of five crore or more during any financial year shall ensure that the Company spends, in every financial year, at least two percent of the average net profits of the company made during the three immediately preceding financial years."¹⁰

According to Singh, it is commonly understood that corporate expenditures on CSR efforts cannot be deducted from a company's profits.¹⁰

In his 2019 publication, Singh clearly states that the Union Government of India had added an Explanation 2 to Section 37(1) of the Indian Income Tax Act, 1961. This explanation declares that any expenses incurred by a taxpayer on activities related to corporate social responsibility, as defined in Section 135 of the Companies Act, 2013, will not be considered as business or professional expenses.¹⁰

Singh found that according to the Budget Memorandum, CSR expenditure is not considered to be solely and imperatively towards the aim of conducting business. Allowing these expenses to be tax deductible would result in the government subsidizing approximately one third of these expenses through tax expenditure.¹⁰

iv. Scope and limitations:

Scope:

This research focuses on analyzing the implications of the OECD’s Pillar Two model rules on global minimum taxation and its intersection with Corporate Social Responsibility (CSR) expenditures.

The primary areas of interest include:

Impact of Pillar Two Tax Rates: Examination of how the introduction of the OECD’s global minimum tax rate of 15% affects multinational enterprises (MNEs), particularly concerning their reported tax rates and compliance strategies.¹²

CSR Expenditure Reporting: Analysis of how CSR expenditures are disclosed in the annual and sustainability reports of leading MNEs and their implications for corporate legitimacy and stakeholder approval.¹⁸

Harmonization of Tax Regulations: Evaluation of the potential for integrating CSR expenditure deductions into local tax laws while adhering to global minimum tax standards, without compromising firm legitimacy.¹⁹

The scope extends to reviewing recent annual and sustainability reports from leading MNEs to assess their responses to the Pillar Two model rules and how these responses influence their CSR expenditure and reporting practices. The research aims to identify potential future research avenues related to tax regulation harmonization and the strategic role of CSR expenditures in corporate tax planning.

v. Significance and potential contribution:

The research explores a critical intersection between local taxation laws and Corporate Social Responsibility (CSR) policies, particularly focusing on how Multinational Enterprises (MNEs) navigate these frameworks. It addresses the observed discrepancy where local taxation laws in host countries are often not harmoniously aligned with CSR policies. This misalignment raises significant concerns about the strategic and ethical implications for MNEs.

Significance:Understanding the disjunction between local tax laws and CSR policies is vital for several reasons. First, it illuminates the challenges faced by MNEs in reconciling local legal requirements with their CSR commitments. The study highlights the potential of local governments to influence MNEs' alignment with international tax norms through tax deductions for CSR expenditures.¹ This could foster a more coherent approach to CSR, enhancing transparency and aligning local practices with global standards.⁹

Potential Contribution:

By advocating for tax deductions on CSR expenditures, the research posits that governments can drive MNEs toward greater transparency and strategic alignment with international tax regulations.¹⁵

Moreover, the findings could inform policy makers on the benefits of integrating CSR expenditures into the local tax code, offering a pathway to harmonize global and local regulatory frameworks.⁸

In summary, this study aims to bridge the gap between CSR and tax regulation, offering valuable insights into how governments and MNEs can collaborate to achieve greater alignment and transparency in the global tax landscape.

LITERATURE REVIEW

i. Introduction:

The evolving role of multinational enterprises (MNEs) in global taxation and corporate social responsibility (CSR) has garnered increasing academic and policy attention. Historically, taxation was viewed primarily as a business expense to be minimized, with MNEs focusing on reducing their tax liabilities within legal limits.² However, this perspective has shifted as MNEs are now also seen as integral contributors to societal well-being, beyond merely fulfilling legal tax obligations.²

The scrutiny of corporate tax strategies has intensified, with non-governmental organizations (NGOs) playing a critical role in highlighting the social and political implications of tax avoidance. Such avoidance is increasingly criticized for undermining government revenues, thereby shifting the tax burden to domestic entities and individuals.² This concern has prompted global institutions, including the OECD and the EU, to advocate for more robust legal frameworks to address tax evasion and avoidance.²

Recent studies further illuminate the complex interplay between CSR and taxation. For instance, Scarpa and Signori underscore the growing academic interest in how CSR interacts with corporate tax strategies, revealing a trend towards increased attention in recent years.¹³ Their review indicates that corporate perceptions of tax responsibilities vary significantly, impacting both moral obligations and behaviors.¹³ Avi-Yonah supports this by arguing that while CSR expenditures may be viewed as burdensome by some, governments can ethically incentivize such practices through tax benefits, thus aligning corporate and societal interests.¹

In contrast, Jenkins and Newell critique the lack of focus on tax practices within the CSR framework, despite the significant role of taxation in state funding and poverty alleviation.⁶ They argue that CSR should address tax avoidance as a critical issue, highlighting a gap in current CSR practices that often ignore tax responsibility.⁶ Similarly, Xu et al. explore how CSR reporting can mitigate the legitimacy concerns associated with tax avoidance, suggesting that transparent CSR practices may counteract negative public perceptions stemming from aggressive tax strategies.¹⁴

ii. Analysis in light of the literature review:

The identified gaps concerning CSR expenditure and its tax treatment under Indian law highlight critical areas for further research. The literature review underscores several key themes that align with these gaps:

Scarpa and Signori (2023)

Findings: The perception of tax avoidance and CSR differs across corporations, influencing their moral obligations and behaviors.¹³

Relevance: The gap regarding the legal constraints on CSR spending and its impact on corporate behavior aligns with Scarpa and Signori's findings on varying corporate perceptions of tax duties.¹³

Avi-Yonah (2009)

Findings: Governments can promote CSR through tax incentives.¹

Relevance: The lack of tax incentives for CSR in Indian law contrasts with Avi-Yonah's argument for using tax incentives to promote CSR.¹

Song et al. (2024)

Findings: The loss of political connections influences CSR disclosure.¹⁵

Relevance: While not directly related to the identified gap, this study supports the broader theme of CSR as a strategic tool influenced by regulatory environments.¹⁵

Muller and Kolk (2012)

Findings: MNEs with strong CSR reputations pay higher taxes, and tax compliance varies across jurisdictions.⁸

Relevance: The gap regarding the non-deductibility of CSR expenses under Indian law contrasts with findings that link CSR and tax behavior, suggesting a potential area for further investigation.⁸

Jenkins and Newell (2013)

Findings: Tax avoidance and CSR are critical for corporate legitimacy, especially in developing countries.⁶

Relevance: The gap emphasizes the need for responsible tax strategies, resonating with Jenkins and Newell's argument for aligning CSR with tax compliance.⁶

Xu et al. (2022)

Findings: CSR reporting can mitigate legitimacy concerns from tax avoidance.¹⁴

Relevance: The gap touches on the financial implications of CSR without tax incentives, aligning with Xu et al.'s findings on the role of CSR in addressing legitimacy gaps.¹⁴

Narotzki (2016)

Findings: Proposes a new standard of CSR incorporating responsible tax practices.⁹

Relevance: The identified gap underscores the disjoint between mandated CSR spending and lack of tax incentives, echoing Narotzki's call for integrating tax responsibility into CSR standards.⁹

Gillette and Stinson (2022)

Findings: Investor reactions to tax strategies depend on the perceived legitimacy of the firm.¹²

Relevance: The gap highlights the potential disconnect between mandated CSR spending and financial performance, which could influence investor perceptions and corporate legitimacy.¹²

.

iii. Inference:

The identification of gaps within the context of Indian taxation laws concerning CSR expenditure and its tax deductibility is well-supported by the literature review. These gaps highlight the inconsistency in policies that mandate CSR spending without providing corresponding tax incentives, potentially leading to financial strain on companies. This analysis is consistent with the broader themes identified in the literature, which emphasize the importance of cohesive policies that promote CSR through favorable tax treatment and highlight the need for alignment between CSR initiatives and responsible tax practices for corporate legitimacy.

The examination of specific cases, such as the differential tax practices of MNEs in developing countries, further illustrates the practical implications of these issues. Muller and Kolk find that MNEs in India, for example, demonstrate a complex relationship between CSR and tax obligations, with higher taxes paid by firms recognized for their CSR initiatives.⁸

In sum, this literature review aims to provide a comprehensive overview of the interplay between CSR and taxation, highlighting the evolving perceptions of corporate tax responsibilities and identifying gaps where further research is needed. The review will address how CSR strategies intersect with tax practices and explore the implications for both corporate behavior and policy development.

iv. Theoretical Concepts and Models:

Taxation as Corporate Social Responsibility (CSR)

Historically, taxation has been viewed primarily as a business expense, wherein multinational enterprises (MNEs) seek to minimize tax liabilities within legal boundaries.² However, contemporary perspectives suggest that paying taxes is not merely a legal obligation but also a component of corporate social responsibility (CSR).¹³ This conceptual shift aligns with the notion that corporations are expected to contribute positively to the societies in which they operate, beyond mere compliance with legal requirements.

Legitimacy Theory

Legitimacy theory provides a valuable lens for understanding how corporations navigate their tax obligations and CSR commitments. According to this theory, corporations seek to align their practices with societal expectations to gain legitimacy and maintain their social license to operate.¹⁴ This involves not only adhering to legal requirements but also addressing perceived legitimacy gaps through transparent CSR reporting and ethical tax practices.

Stakeholder Theory

Stakeholder theory emphasizes the importance of addressing the interests of various stakeholders, including governments, shareholders, and the public.¹ In the context of taxation and CSR, this theory suggests that MNEs must balance the interests of different stakeholders by implementing tax strategies that are perceived as fair and by engaging in CSR activities that address social and environmental concerns.

Institutional Theory

Institutional theory examines how institutional pressures shape organizational behavior.⁸ In the realm of international taxation, this theory highlights the influence of legal frameworks, regulatory bodies, and international agreements on corporate tax practices. Institutional theory is particularly relevant in understanding how global standards and local regulations interact to influence MNEs' tax strategies and CSR commitments.

v. Discussion:

This literature review underscores a significant gap in the comprehension of corporate social responsibility (CSR) within the framework of international taxation law. Gribnau argues for a departure from a restricted interpretation of tax law, suggesting instead a broader perspective that incorporates the ethical principles embedded in the legal system.⁴ This perspective aligns with the growing recognition that CSR necessitates more than mere compliance with legal requirements; it calls for an ethical engagement with societal responsibilities that transcends the literal application of the law.

The review reveals that while CSR initiatives and tax obligations are often considered in tandem, the current legal frameworks inadequately address the integration of ethical considerations into tax regulations. This highlights a crucial area for further research: the investigation into whether legal systems have explicit standards for ethical behavior that go beyond a literal interpretation of tax laws.

In light of these insights, the proposed research aims to bridge these gaps by exploring how international tax laws can better incorporate ethical principles and CSR expectations. Such an examination is vital for developing a more sophisticated understanding of how tax policies can evolve to reflect both legal and moral imperatives, thereby enhancing the alignment between corporate practices and societal expectations.

METHODOLOGY:

A mixed-methods approach was employed in this study, integrating both quantitative and qualitative research methodologies to comprehensively address the research questions. This design was considered appropriate for the research question as it allowed for the collection and analysis of both numerical data and contextual insights, providing a holistic understanding of the relationship between CSR expenditures and taxation laws.

i.                     The following are the objectives of the research study:

Objective 1: Perform a quantitative data collection of CSR contributions by MNEs

A quantitative approach was utilized to collect and analyze data on CSR contributions by Multinational Enterprises (MNEs). The data was sourced from publicly available annual reports and sustainability reports of leading MNEs.¹⁸ This data collection provided a foundation for understanding the scale and scope of CSR expenditures and their potential impact on tax deductions..

Objective 2: Conduct a comparative analysis of international taxation laws

Quantitative data was also gathered on the tax deductions and rebates available for CSR expenditures across different jurisdictions. This involved reviewing the tax codes and regulations in various countries to identify the provisions related to CSR.⁹.

ii. Hypotheses testing:

The following hypotheses will guide the quantitative analysis:

H1: Deductions allowed against CSR expenditures are not strategically aligned with International Taxation Laws by MNEs.

To test this hypothesis, statistical methods were employed to analyze the alignment between CSR expenditure deductions and international tax regulations. This involved comparing the tax benefits received by MNEs in different jurisdictions and assessing their alignment with international taxation principles.⁹.

Hypothesis 1a:

H1a: National development boosts corporate disclosure of Sustainable Development Goals information..

Hypothesis 1b:

H1b: Demonstrates a negative relationship between national development levels and company SDG disclosures.

H2: MNEs benefit from deductions and tax rebates available to them in offsetting their CSR expenditures.

This hypothesis was tested by examining the financial statements of MNEs to quantify the tax savings realized from CSR-related deductions and rebates. A regression analysis was conducted to determine the correlation between CSR expenditures and tax benefits.¹⁸

H3: Local taxation laws are viewed as not being harmoniously constructed in support of CSR policies by the Compliance Officers of MNEs.

iii. Estimation to the research questions posited:

Scarpa and Signori have noted in their literature review on the interconnections between corporate tax responsibility (CTR) and managerial practices that, despite growing concern among managers about the reputational consequences of tax behavior, irresponsible tax practices did not necessarily pose reputational threats.¹³ This indicates a need for deeper analysis into how media, NGOs, and other stakeholders' criticism of firms' tax practices might negatively influence their reputation, and whether being transparent about tax can enhance a firm's reputation.¹³

Scarpa and Signori further suggest that corporate tax payments are not always seen as a significant component of corporate evaluation, possibly due to evaluators' differing tax preferences or lack of sufficient information to judge firms' tax affairs.¹³

In addressing legitimacy signals, several leading MNEs have highlighted the implications of the newly implemented OECD global minimum taxation (Pillar Two) in their Annual Reports. Notable excerpts include:

Volkswagen Financial Services AG (2023): Volkswagen Financial Services AG anticipates no material Pillar Two income tax risk, as their effective tax rates exceed 15% in most operating countries. However, a few countries with rates below 15% where the transitional safe harbor exemption does not apply could present a research opportunity on legitimacy signals related to tax practices.²²

Alphabet Inc. (2023): Alphabet Inc. expects minimal impact on their income tax provision for the 2024 fiscal year due to the OECD's global minimum tax, with potential future increases in effective tax rates and cash tax payments as more jurisdictions adopt the legislation.²¹

Mercedes-Benz Group (2024): Mercedes-Benz Group has not identified any countries with significant impacts from the OECD Pillar Two regulations and anticipates no major changes from the global minimum tax framework.¹⁹

Pernod Ricard (2023): Pernod Ricard has not booked deferred taxes related to Pillar Two in their interim financial statements, following the IAS 12 amendment, and expects no significant future income tax impacts.²⁰

BMW Finance N.V. (2024): BMW Finance N.V. has applied the IASB’s temporary exemption from recognizing deferred taxes due to Pillar Two, with no significant expected impact on the company.¹⁸

Given these corporate disclosures, several key research questions emerge:

●       Are the current deductions allowed for CSR expenditures strategically aligned with international taxation laws for MNEs?

●       Should MNEs benefit from deductions and tax rebates to offset their CSR expenditures?

●       Why are local taxation laws perceived as not harmoniously supporting CSR policies by MNE managers?

Addressing these questions could lead to substantive discourse and potentially positive changes in the field of tax deductions for CSR expenditures, thereby influencing policy and practice.

CONCLUSION AND SUGGESTIONS:

The arguments presented in this paper align with the reasoning put forth by Gribnau that corporate social responsibility (CSR) companies should go beyond a limited and rigid interpretation of (tax) law.⁴ Instead, they should embrace a broader perspective that recognizes tax as a set of rules based on principles that form the inherent moral framework of the legal system. Hence, it is imperative for them to treat these principles with utmost seriousness. By acknowledging ethical responsibilities that traverse further than the requirements of the law, they should unquestionably acknowledge ethical responsibilities that are inherent in the law, which should not be perceived merely as a set of regulations. Not paying significant business taxes directly contradicts these principles. The question at hand is whether the legal system has explicit standards for ethical behavior that extend beyond the literal interpretation of the law.⁴

Therefore, after having evaluated the Annual Reports of the leading Multinational Enterprises (MNEs), wherein they have expressed that the recent implementation of the OECD model rules on global minimum taxation (Pillar Two) could not be estimated in their most recent annual reports:

While the leading MNEs have clearly made statements that demonstrate their firms perceive a negative exposure to the newly implemented OECD model rules on global minimum taxation, which need to be read together with the Accounting Standards, the main criteria for detecting the exposure remain the effective Pillar Two tax rates, which are higher than 15% in most of the countries in which these MNEs operate. While there could exist a small number of countries where the transitional safe harbor exemption does not apply and the effective Pillar Two tax rate would be below 15%, this observation clearly presents a prospective line of future research wherein it could be explored how the signals of legitimacy are being perceived in the practices of these MNEs while paying taxes.²²

Consequently, the CSR expenditure and its eventual disclosure by these MNEs would garner the approval of stakeholders in favor of building firm legitimacy signals. Hence, another line of future research could involve exploring the impact of CSR expenditure by MNEs that would enable better participation in policy building and the subsequent interpretation of tax regulations that could favor leveraging CSR expenditure as deductions upon the applicable corporate tax rate in countries where the rate of corporate taxes exceeded the newly implemented global minimum tax rate of 15% without jeopardizing any legitimacy signals, even though the respective MNE may be aggressively engaged in strategies of tax planning.

Resultantly, the new data which would be presented in the upcoming Annual Reports and the Sustainability Reports of the MNEs would, in fact, demonstrate the desirability of permitting CSR expenditure as a deductible upon the tax payable by the MNEs in order to harmonize the global minimum taxation standards of 15% without losing any reputation that could harm firm legitimacy signals.

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