How transfer pricing leaders can integrate ESG into their practice

This includes studying how ESG efforts can transform a business.

Implementing environmental, social and governance (ESG) policies has been a priority for multinational companies to transform their businesses towards sustainability. As this is applied across companies’ offices, transfer pricing practitioners in their respective tax departments would need to make changes to address these policies.

Transfer pricing leaders would need to have an understanding of ESG-related changes to the business, revisit analysis on aspects that drive value and business profits, and identify changes to their policies.

“Internal and external stakeholders continue to demand that companies assess their business with respect to ESG considerations. And while the breadth and depth of how (and if) companies ESG varies significantly, many are moving towards more sustainable business practices,” the report read.

In the ESG and transfer pricing report, Jessi Coleman and Jack O’ Meara, principals in the Economic & Valuation Services group at KPMG, emphasised steps transfer pricing leaders should take for their pursuit of sustainability.

First, transfer pricing practitioners should determine who makes ESG recommendations and establish a sustainability strategy. KPMG said it is important to understand where these decision-makers reside in terms of legal entities and within the management structure. These may be the chief sustainability officer, and executive management, amongst others.

They should coordinate with functional leaders to get insights into who crafts each part of the ESG strategy, the report read.

Second, a company’s tax department should thoroughly evaluate the transformative potential of the firm’s ESG strategy by looking beyond the sustainability group and studying how the business is evolving with functional groups. 

“The information gathered as a part of the evaluation should be reviewed to confirm that it aligns with the MNC’s sustainability reporting that publicly describes the progress the company has made towards key ESG initiatives,” the report read.

Third, as ESG initiatives have an effect on businesses through multiple channels, KPMG said tax departments should assess the expected impact of these sustainability efforts on the business results.

KPMG said companies may increase brand awareness and value by investing in ESG. Brands can help mitigate potential negative publicity by actively discussing their support for sustainability. With this, they can gain customers who may pay a premium price for products of a company seen as environmentally friendly.

Also citing as an example, it said that a food manufacturer who opts to source products from sustainable farmers may experience an increase in costs but these could be partially or wholly offset by potentially increasing prices.

Fourth, tax leaders should analyse the transfer pricing policies for ESG-related changes. KPMG said they should into how tax and transfer pricing models allocate marginal income or loss linked with ESG projects in legal entities and jurisdictions. They should also evaluate if the income allocation is in line with the functions, assets, and risks of the concerned entities.

KPMG some of the potential ESG-relate changes they could do if these are increasing brand value include quantifying the impact of the increase which include additional customers or higher prices leading to greater sales, understanding the legal entity that took the risk and made the investment, and checking if the same entity is entitled to a return for its investment.

Lastly, multinational companies should update transfer pricing documentation to reflect the changes led by ESG initiatives.