Paying a fair rate of corporate tax is an important contribution that companies make to society. If companies are proactively seeking to minimize their tax payments, this should be seen as a red flag.
Economists at the International Monetary Fund estimate that global corporate tax avoidance costs governments between US$500 and US$600bn every year.1 This includes $200bn in revenues being channelled away from low-income economies, which is more than these countries receive in foreign aid each year.2 These vital resources could be spent on improving education, health and social services, as well as supporting sustainable development and contributing to a fairer and more equal society.
As governments around the world continue to ratchet up higher levels of debt following the Covid-19 crisis, this loss of tax revenue becomes even more critical. Since the 2008 global financial crisis, large companies have been paying lower rates of tax on average.3 Big tech firms in the US have come under the spotlight for their tax avoidance antics. A study by the UK transparency campaign Fair Tax Mark, found that six of the largest tech firms, including Amazon, Facebook and Google, have been ‘aggressively avoiding’ the payment of taxes, totalling US$100bn over the past decade.4 Regulators are starting to pay attention, especially in Europe and the UK. Governments are beginning to roll out digital taxes.
Corporations today can legally avoid or minimise their tax bill in various ways. For example, they can set up foreign subsidiaries in tax havens, such as the Cayman Islands, or use transfer-pricing to shift profits from one division to another. These tactics may be seen by some as ‘sensible business’. Some investors even celebrate when companies pay minimal tax. On the contrary, we believe that deliberate and systematic tax avoidance strategies can contribute to inequality, weaken our social fabric and reduce the ability of governments to make societies fairer and safer for all citizens.
Paying a minimal amount of tax today may benefit companies in the short-term, but does not help build economic strength in the long-term. Studies have shown that higher taxation is associated with higher spending in health care and education, particularly in low-income countries, as well as helping to build a more responsive, accountable and capable state.5 The Austrian economist Joseph Schumpeter famously explored the link between tax and more responsible spending by governments over a century ago.6
A low tax rate is a risk
Paying low levels of tax can also be a source of significant risk to future cash flows within companies. In India, for instance, the government has been charging an additional 18% interest rate on disputed balances over years – this can quickly compound into a serious liability.7 It can also lead to reputational damage for companies. Ultimately, a dollar or rand or rupee of earnings at the legitimate company tax rate is worth more to us than the same earnings at a tax rate half the level or less.
When we come across a company proactively trying to minimise their tax payments, it is a red flag for us.
As such, tax is a key topic that we raise with companies as part of our engagement activities.
We actively engage on tax
One of our most prominent tax engagements in the past decade involved a large pharmaceutical company. This company used complex structures to reduce tax rates to mid-single digits that lasted for nearly a decade. We felt these structures violated the spirit of the law and increased the risk to future cash flows. Lengthy engagement did not lead to much progress and we were left with no choice but to sell our holdings. Today, many years later, governments are demanding half a billion dollars in back taxes from the company. The company is also fighting several antitrust cases and had failed to report a material related party transaction – a stark reminder that governance lapses do not happen in isolation.
Assessing tax rates on their own is obviously not enough to make a full assessment of the quality of the management or the financials of a business. However, it is a very useful piece in the “quality assessment jigsaw puzzle” that investors should consider during their appraisal of a company.
Lorna Logan, Senior Investment Analyst
For illustrative purposes only. Reference to the names of each company mentioned in this communication is merely for explaining investment insight and Stewart Investors does not necessarily maintain positions in such companies. Any fund or stock mentioned in this presentation does not constitute any offer or inducement to enter into any investment activity nor is it a recommendation to purchase or sell any security.
View our list of investment terms to help you understand the terminology within this document.
This document has been prepared for general information purposes only and is intended to provide a summary of the subject matter covered. It does not purport to be comprehensive or to give advice.
The views expressed are the views of the writer at the time of issue and may change over time. This is not an offer document, and does not constitute an offer, invitation, investment recommendation or inducement to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement.
No person should rely on the content and/or act on the basis of any matter contained in this document.
This document is confidential and must not be copied, reproduced, circulated or transmitted, in whole or in part, and in any form or by any means without our prior written consent. The information contained within this document has been obtained from sources that we believe to be reliable and accurate at the time of issue but no representation or warranty, express or implied, is made as to the fairness, accuracy or completeness of the information. We do not accept any liability for any loss arising whether directly or indirectly from any use of this document.
References to “we” or “us” are references to Stewart Investors. Stewart Investors is a trading name of First Sentier Investors (UK) Funds Limited, First Sentier Investors International IM Limited and First Sentier Investors (Ireland) Limited. First Sentier Investors entities referred to in this document are part of First Sentier Investors, a member of MUFG, a global financial group. First Sentier Investors includes a number of entities in different jurisdictions. MUFG and its subsidiaries do not guarantee the performance of any investment or entity referred to in this document or the repayment of capital.
Any investments referred to are not deposits or other liabilities of MUFG or its subsidiaries, and are subject to investment risk including loss of income and capital invested.
Past performance is not a reliable indicator of future results.
Reference to specific securities (if any) is included for the purpose of illustration only and should not be construed as a recommendation to buy or sell. Reference to the names of any company is merely to explain the investment strategy and should not be construed as investment advice or a recommendation to invest in any of those companies.
Hong Kong and Singapore
In Hong Kong, this document is issued by First Sentier Investors (Hong Kong) Limited and has not been reviewed by the Securities & Futures Commission in Hong Kong. In Singapore, this document is issued by First Sentier Investors (Singapore) whose company registration number is 196900420D. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore. Stewart Investors is a business name of First Sentier Investors (Hong Kong) Limited. Stewart Investors (registration number 53310114W) is a business division of First Sentier Investors (Singapore).
In Australia, this document is issued by First Sentier Investors (Australia) IM Limited AFSL 289017 ABN 89 114 194 311 (FSI AIM). Stewart Investors is a trading name of FSI AIM.
This document is not a financial promotion. In the United Kingdom, this document is issued by First Sentier Investors (UK) Funds Limited which is authorised and regulated in the UK by the Financial Conduct Authority (registration number 143359). Registered office: Finsbury Circus House, 15 Finsbury Circus, London, EC2M 7EB, number 2294743.
European Economic Area (“EEA”)
In the EEA, this document is issued by First Sentier Investors (Ireland) Limited which is authorised and regulated in Ireland by the Central Bank of Ireland (registered number C182306) in connection with the activity of receiving and transmitting orders. Registered office: 70 Sir John Rogerson’s Quay, Dublin 2, Ireland, number 629188.
In certain jurisdictions the distribution of this material may be restricted. The recipient is required to inform themselves about any such restrictions and observe them. By having requested this document and by not deleting this email and attachment, you warrant and represent that you qualify under any applicable financial promotion rules that may be applicable to you to receive and consider this document, failing which you should return and delete this e-mail and all attachments pertaining thereto.
In the Middle East, this material is communicated by First Sentier Investors (Singapore).
If in doubt, you are recommended to consult a party licensed by the Capital Markets Authority (“CMA”) pursuant to Law No. 7/2010 and the Executive Regulations to give you the appropriate advice. Neither this document nor any of the information contained herein is intended to and shall not lead to the conclusion of any contract whatsoever within Kuwait.
UAE - Dubai International Financial Centre (DIFC)
Within the DIFC this material is directed solely at Professional Clients as defined by the DFSA’s COB Rulebook.
By having requested this document and / or by not deleting this email and attachment, you warrant and represent that you qualify under the exemptions contained in Article 2 of the Emirates Securities and Commodities Authority Board Resolution No 37 of 2012, as amended by decision No 13 of 2012 (the “Mutual Fund Regulations”). By receiving this material you acknowledge and confirm that you fall within one or more of the exemptions contained in Article 2 of the Mutual Fund Regulations.
United States of America
In the United States, this document is issued by First Sentier Investors International IM Limited, as SEC registered investment adviser. Stewart Investors is the trading name of First Sentier Investors International IM Limited. This material is solely for the attention of institutional, professional, qualified or sophisticated investors and distributors who qualify as qualified purchasers under the Investment Company Act of 1940 (hereafter the “1940 Act”), as accredited investors under Rule 501 of SEC Regulation D under the US Securities Act of 1933 (“1933 Act), and as qualified eligible persons as defined under CFTC Regulation 4.7. It is not to be distributed to the general public, private customers or retail investors.
In other jurisdictions where this document may lawfully be issued, this document is issued by First Sentier Investors International IM Limited which is authorised and regulated in the UK by the Financial Conduct Authority (registration number 122512). Registered office 23 St. Andrew Square, Edinburgh, EH2 1BB number SC079063.