ENGAGING ON… RESPONSIBLE TAXATIONToby Ross, Investment Manager. Third Quarter 2019
At the start of each year the Global Income investment team sets out the engagement plan for the year ahead, based on what we think the greatest governance and sustainability priorities are. This note aims to illustrate what our 2019 engagement plan means in practice.
“So, what do you think tax is?”
This was how we started a recent conversation with the finance director of a FTSE 100 company we invest in. For some executives (and perhaps some fund managers), this might seem a strange question to ask. It is generally taken for granted that tax is a cost, similar to rent or the wage bill; and part of the job of any self-respecting finance director is to make the tax bill as low as possible, so as to maximise after-tax profits for shareholders. In which case, a finance director must feel justified in joining The Kinks in pleading, “save me, save me, save me from this squeeze”.
We think there is a better way for businesses and shareholders to think about tax. Rather than a cost, our view is that it should be seen as one of the mechanisms by which the benefits of conducting a business are distributed. Just as workers and shareholders are eligible to a share of the gains, so is the society that created the conditions for that activity in the first place – tax gives a company a ‘licence to operate’. Sustainably-managed businesses recognise the need to ensure the benefits of their businesses are distributed fairly to all three groups.
It is more than just a philosophical question, though. As the FTSE 100 finance director we spoke to explained, politicians and voters are increasingly concerned by their perception that multi-national businesses are going to extraordinary lengths to avoid paying “their fair share” in the communities where they operate. Because of our long-term time horizon, we think we are well placed to encourage companies to move in the right direction – and that over the long run our clients will benefit from this.
That is why tax responsibility is one of the three priorities we set for our 2019 Engagement Plan. We began by looking at where tax risks might be highest. For example, we compared the actual amount the businesses we invest in had paid to the tax authorities (“tax cash”) with the statutory rates in the countries where they operated. This highlighted some anomalies, which we investigated and used as a starting point for engagement.
As part of our investigations we found, for example, that insurance broker Arthur J. Gallagher has for some time invested in refined coal facilities that chemically treat coal to make it burn cleaner and release fewer pollutants and emissions. A noble cause, perhaps - but one which has nothing to do with broking insurance. The only reason the company was investing in these projects was to earn the US refined coal tax credits which Congress had temporarily made available for such investments. In other words, the company was doing it to reduce its tax bill, which in turn means that less money would be available to fund roads, teachers or tax inspectors for their community.
So far, we have had two useful conversations at a senior level with the company, challenging them over these structures. They told us that this was the first time an investor had questioned them as to whether these arrangements were responsible – normally, investors just want to understand how they impact post-tax earnings. We recommended that when these arrangements expire in the next few years, they should not look to replace them, even if that means the company’s tax bill goes up and its post-tax profits go down a little.
Sometimes encouragement can be just as powerful as challenge. The FTSE 100 finance director we spoke to said he had asked his team to review some of the tax arrangements he had inherited with “a critical eye”, to ensure that they were not just legal but fair. He gave us detailed examples of what this meant in practice – real decisions that had short-term financial consequences, but which were the responsible thing for the company to do. We believe our role as long-term shareholders is to strongly encourage him and the board on this initiative, both verbally and in writing, so that the importance that some of the company’s long-term shareholders place on these efforts is clear.
We also suggested that they could do a better job of explaining to the outside world what they are doing, and how they consider the “fairness” of their tax practices. Our holding Prudential produces an excellent report called Managing our tax affairs responsibly and sustainably, which we have used as an example of best practice: in our view many companies can learn from the way Prudential is approaching these issues.
These examples show some of the ingredients that can make for a successful engagement. We approached the companies as a supportive, long-term shareholder, who expect to be on their register in five years’ time, and so will be beneficiaries of any changes they make. We encouraged management teams to keep doing the things they were doing well. Where we felt that change was necessary, we tried to ensure our challenges were constructive, with a clear sense of what we were asking the companies to change. The engagements were jointly led by both investors and our governance and sustainability specialists. This ensured the companies knew that we consider these questions holistically.
But perhaps most importantly, we have not viewed these engagements as a one-off. Meaningful change doesn’t happen overnight. Indeed, it’s far too early to know if our conversations with Arthur J. Gallagher have ‘worked’. We will continue to explain our views to the company over the coming years, to persuade management of the importance of taking a more rounded view of what a ‘responsible’ tax policy is. But for us, it is worth the wait.
IMPORTANT INFORMATION AND RISK FACTORS
The views expressed in this article are those of the author and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.
This communication was produced and approved on the stated date and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.
This article contains information on investments which does not constitute independent research. Accordingly, it is not subject to the protections afforded to independent research and Baillie Gifford and its staff may have dealt in the investments concerned.
All information is sourced from Baillie Gifford & Co and is current unless otherwise stated.
The images used in this article are for illustrative purposes only.
Baillie Gifford & Co and Baillie Gifford & Co Limited are authorised and regulated by the Financial Conduct Authority (FCA). Baillie Gifford & Co Limited is an Authorised Corporate Director of OEICs.
Baillie Gifford Overseas Limited provides investment management and advisory services to non-UK Professional/Institutional clients only. Baillie Gifford Overseas Limited is wholly owned by Baillie Gifford & Co. Baillie Gifford & Co and Baillie Gifford Overseas Limited are authorised and regulated by the FCA in the UK.
Baillie Gifford Investment Management (Europe) Limited provides investment management and advisory services to European (excluding UK) clients. It was incorporated in Ireland in May 2018 and is authorised by the Central Bank of Ireland. Through its MiFID passport, it has established Baillie Gifford Investment Management (Europe) Limited (Frankfurt Branch) to market its investment management and advisory services and distribute Baillie Gifford Worldwide Funds plc in Germany. Baillie Gifford Investment Management (Europe) Limited is a wholly owned subsidiary of Baillie Gifford Overseas Limited, which is wholly owned by Baillie Gifford & Co.
Persons resident or domiciled outside the UK should consult with their professional advisers as to whether they require any governmental or other consents in order to enable them to invest, and with their tax advisers for advice relevant to their own particular circumstances.
Potential for Profit and Loss
All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.
Any stock examples and images used in this article are not intended to represent recommendations to buy or sell, neither is it implied that they will prove profitable in the future. It is not known whether they will feature in any future portfolio produced by us. Any individual examples will represent only a small part of the overall portfolio and are inserted purely to help illustrate our investment style.
Important Information Hong Kong
Baillie Gifford Asia (Hong Kong) Limited 百利亞洲(香港)有限公司 is wholly owned by Baillie Gifford Overseas Limited and holds a Type 1 licence from the Securities & Futures Commission of Hong Kong to market and distribute Baillie Gifford’s range of collective investment schemes to professional investors in Hong Kong. Baillie Gifford Asia (Hong Kong) Limited 百利亞洲(香港)有限公司 can be contacted at 30/F, One International Finance Centre, 1 Harbour View Street, Central, Hong Kong. Telephone +852 3756 5700.
Important Information South Korea
Baillie Gifford Overseas Limited is licensed with the Financial Services Commission in South Korea as a cross border Discretionary Investment Manager and Non-discretionary Investment Adviser.
Important Information Japan
Mitsubishi UFJ Baillie Gifford Asset Management Limited (‘MUBGAM’) is a joint venture company between Mitsubishi UFJ Trust & Banking Corporation and Baillie Gifford Overseas Limited. MUBGAM is authorised and regulated by the Financial Conduct Authority.
Important Information Australia
This material is provided on the basis that you are a wholesale client as defined within s761G of the Corporations Act 2001 (Cth). Baillie Gifford Overseas Limited (ARBN 118 567 178) is registered as a foreign company under the Corporations Act 2001 (Cth). It is exempt from the requirement to hold an Australian Financial Services License under the Corporations Act 2001 (Cth) in respect of these financial services provided to Australian wholesale clients. Baillie Gifford Overseas Limited is authorised and regulated by the Financial Conduct Authority under UK laws which differ from those applicable in Australia.
Important Information South Africa
Baillie Gifford Overseas Limited is registered as a Foreign Financial Services Provider with the Financial Sector Conduct Authority in South Africa.
Important Information North America
Baillie Gifford International LLC is wholly owned by Baillie Gifford Overseas Limited; it was formed in Delaware in 2005. It is the legal entity through which Baillie Gifford Overseas Limited provides client service and marketing functions in America as well as some marketing functions in Canada. Baillie Gifford Overseas Limited is registered as an Investment Adviser with the Securities & Exchange Commission in the United States of America.
43324 PRO WE 0078
Toby Ross Co-Head of Global Income
Toby joined Baillie Gifford in 2006 and is an Investment Manager in the Global Income Growth Team and Joint Manager of The Scottish American Investment Company PLC (SAINTS). He has also been a member of the International Alpha Portfolio Construction Group since 2018. Since joining Baillie Gifford, Toby has also spent time as an Investment Analyst in the UK Equity Team and as a Global Sector Specialist. He graduated MA in English Literature from the University of Cambridge in 2006 and is a CFA Charterholder.
YOU MAY ALSO LIKEInsights.Visit Baillie Gifford's Insights page.Asia ex Japan manager updateRoderick Snell and Qian Zhang discuss current views and portfolio positioning for the Asia ex Japan Strategy.Navigating Change in US Equities.In this webinar recording, US Equity strategy specialist Ben James talks to all four of the key decision makers in the US Equities Team, Tom Slater, Kirsty Gibson, Gary Robinson and Dave Bujnowski. The team explore the thought processes that have helped them navigate the challenge of maintaining a 5-10 year investment horizon during what has been a year of rapid change, followed by questions from attendees.A shot in the arm for infectious diseases.Moderna’s mRNA vaccines are all set to become the cornerstone of an efficient health system.