P ERS P ECTIVES ON TAX LAW & P OLICY Editor: Jeffrey Trossman Volume 2, Number 2, June 2021 Perspectives on Tax Law & Policy aims to provide a variety of perspectives on important policy-related issues in the tax system, with the goal of fostering informed, accessible commentary that bridges the gap between tax professionals, policy makers, and the general public. The views expressed in the articles in this newsletter by any particular author are solely the personal views of that author. They should not under any circumstances be construed as reflecting in any way the views of the organization with which such author is affiliated or of any other person or entity. interests of a wide array of stakeholders—not only sharehold- The Intersection of Tax and ESG ers but also employees, retirees and pensioners, creditors, Nadine de Gannes, Ivey Business School, Western University consumers, governments, and the environment. Indeed, this concept is now embedded in section 122 of This issue of Perspectives focuses on the intersection of tax law the Canada Business Corporations Act, which authorizes the and policy in the emerging phenomenon of “environmental, directors and officers of a corporation to consider these vari- social, and governance” (ESG). ous interests in the course of acting in the best interests of The past year witnessed the once-in-a-century COVID-19 the corporation. pandemic—a threat to lives and livelihoods—along with dev- The ESG phenomenon is by no means confined to Canada. astating floods, wildfires, droughts, and civil unrest. As these In 2019, the Business Roundtable, an association of chief exec- events dominated the landscape, investors and policy makers utive officers of leading US companies, revised its statement sharpened their focus on the planet’s urgent environmental on “the purpose of a corporation” to include the interests of all and social crises. The interest in ESG is not new, but its prom- stakeholders: a corporation should serve not only shareholders inence on investors’ and regulators’ agendas in many OECD but also customers, employees, suppliers, and communities. countries is evidence of a paradigm shift. Previous versions of this purpose statement “[had] endorsed In what follows, I provide some background to the ESG principles of shareholder primacy—that corporations exist prin- movement and discuss the role that tax policy has played, and cipally to serve shareholders.” could play, in the movement. These shifts from shareholder capitalism to stakeholder Background: The Rise of “Stakeholder capitalism represent a sea change in corporate thinking. ESG, which has long been an element in stakeholder capitalism, is Capitalism” now finding broad appeal. Although the term “ESG” was pop- Very broadly speaking, the concept underlying ESG is the idea ularized only in 2004, the notions of ethical, social, or value- of “stakeholder capitalism.” There is a growing consensus that based investing have existed for centuries. The authors of a businesses, rather than narrowly pursuing maximum profits 2008 article observed that ethical investing has origins in to the exclusion of all other objectives, should consider the Jewish, Christian, and Islamic traditions. In these different traditions, investments have been appraised on the basis of In This Issue religious laws and beliefs, giving rise to exclusionary screen- ing and the divesting of “sin stocks.” In the 1970s, as I have The Intersection of Tax and ESG 1 described elsewhere, socially responsible investing (SRI) arose ESG and Executive Compensation in Canada 4 in opposition to the Vietnam War and to apartheid in South Behavioural Responses to Sin Taxes: The UK Experience Africa. In the 1980s, several disasters—the Bhopal gas tragedy, of Environmental Levies 7 the Chernobyl nuclear disaster, and the Exxon Valdez spill— The Importance of Integrating ESG Factors in Tax brought environmental concerns to the forefront of investors’ Strategy: An Institutional Investor’s Perspective 9 minds. By the beginning of the 21st century, climate change We Are Already Taxing the Environment—Just Not in was widely identified as responsible for the dramatic increase the Right Direction 11 in the frequency and severity of floods, droughts, heat waves, Convergence of Tax and ESG 14 and windstorms. The global financial crisis of 2008-9 was also Canada and ESG: A High-Level Overview of What Is significant in shaping ESG discourse, especially as it related to in Store for 2021 and Beyond 16 board oversight, internal controls, and enterprise risk manage- ment—all of which are systems that support corporate gov- ernance. Most recently, the COVID-19 pandemic and the social justice movements triggered by the killing of George Floyd have shifted the discourse on “the social.” Corporations and 1 ©2021, Canadian Tax Foundation Pages 1 – 18 P ERS P ECTIVES ON TA X LAW & P OLICY society are now grappling with the racial, social, and health linked loans (SLLs) totalled US $143 billion, up from just inequities that have been exposed over the past year. It is US $5 billion in 2017, and the number of ESG-linked loan against this backdrop that the ESG movement has rapidly as- lenders grew significantly, from 8 lenders in 2017 to 265 lend- sumed a prominent role in capital markets, government pol- ers in 2020. icies, and business school curricula. Green Bonds What Is ESG? By October 2020, “green bonds”—that is, debt obligations There is no single, universally accepted definition of ESG. whose proceeds must be invested in projects aimed at en- The basic concept is that individuals, businesses, and govern- vironmental protection or positive environmental impact— ments should pursue objectives that improve the environment achieved a milestone: US $1 trillion in issuance. In both the (by addressing climate change, for example), promote social United States and Canada, green bond deals are growing ever justice (by reducing economic inequality, for example), and more popular, with most major banks providing structuring better the governance of businesses (including through the services. In the 2021 federal budget, the Canadian government pursuit of broader stakeholder objectives, as outlined above). said that it intends to publish a “green bond framework” in This third objective may affect the way a business pursues its the coming months in advance of issuing its inaugural federal tax planning. In addition, investors’ intensifying search for green bond in 2021-22, with an issuance target of Cdn $5 bil- opportunities to pursue these objectives may motivate busi- lion, subject to market conditions. This is intended to be nesses to appear at least to be trying to achieve these goals so the “first of many” green bond issuances. Interestingly, no as to minimize their own cost of capital. corresponding tax measures—such as favourable treatment It is common for media articles, reports, and corporate for investors holding such bonds or other measures to nudge briefings to describe ESG in relation to “responsible,” “sus- private issuers into issuing these kinds of obligations—were tainable,” or “social” investing. BlackRock, for example, in its announced. Such measures could increase demand for green account of ESG, considers sustainable investing to be the um- bonds and might be worth pursuing in the future. Other brella term and ESG to be a data toolkit for identifying sus- countries are experimenting with, or considering, such tax tainable investing solutions. ESG Global Advisors, a Canadian incentives. consulting firm, describes ESG as a “subset of financially ma- In 2020, Brazil’s federal government introduced regula- terial CSR [corporate social responsibility] factors that are of tions intended to encourage the issuance of “climate bond interest to capital market participants, including shareholders, certified” green bonds through capital market tax incentives. bondholders, lenders, insurers, proxy advisors, rating agen- (See the commentary from Englobally and Fatin.) The program cies and financial regulators.” Although ESG usually appears is focused on funding green infrastructure bonds and is set as a subset of sustainability, the US Secur ities and Exchange to include income tax exemptions for individual and non- Commission (SEC) recently announced the appointment of resident investors. China is also considering tax incentives. a “Senior Policy Advisor for Climate and ESG”—language Since its first issuance of green bonds in 2015, China has that likely reflects the trend in the discourse. As John Coates, grown to be the second-largest green bond market globally. At acting director of the SEC’s Division of Corporation Finance, the same time, green bonds constitute less than 1 percent noted in a March 2021 speech, the fact “[t]hat ESG no longer of the Chinese debt market. With a view to meeting its carbon- needs to be explained illustrates how important these issues neutrality pledge (net zero emissions by 2060), the Chinese have become to today’s investors, public companies and cap- government is particularly keen to grow this market; however, ital markets.” investors currently lack incentives. Obstacles to development In 2020, so-called responsible investment assets in the include investors’ relative unfamiliarity with green bonds and largest global markets climbed to US $40.5 trillion, up from a lack of awareness of what makes green bonds unique—a US $30.7 trillion in 2018. In Canada, as was noted in a report result of the fact that the reporting and verification infrastruc- from the Responsible Investment Association, “responsible” ture for these bonds is not adequately developed. investments grew from Cdn $459.5 billion in 2006 to Cdn $3.2 trillion by the end of 2019, and they now represent 61.8 per- Carbon Tax cent of Canada’s investment industry. ESG indices and data Another instrument of interest to tax policy makers is the services are also on the rise. For MSCI, a leading provider of carbon-pricing regime. In Canada, British Columbians have financial market indices and data, approximately $200 million had such a regime for over a decade.