Recent public discussions emphasise the importance of tax as a criterion when considering environmental, social and governance (ESG) factors in investment and management decisions. Policymakers in and outside Europe already use tax policy and tax transparency regulations to achieve environmental policy and sustainability goals.


In the context of Private Equity, a company’s approach to tax as a social and governance component increasingly plays a key role for the investors’ ESG strategy, tax due diligence process, and finally the value creation post-transaction.

Investor-driven demand for tax as an ESG component

As a response to the social expectations and the public interest in the way businesses contribute to society, institutional investors such as e.g. pension funds and insurance companies are more and more encouraged to demonstrate that their capital is sustainably invested and that investments meet certain ESG criteria.


To gain that trust, Limited Partners (LPs) display a strong interest in targets with a robust reputation when it comes to tax compliance and transparency (no ties to non-cooperative jurisdictions, emphasising a low tax risk appetite, disclosure compliance, etc.).  Since the release of Global Reporting Initiative (GRI)‘s tax standard in 2019 (GRI 207: Tax 2019), larger investment firms as well as pension funds and insurance companies like Partners Group, Allianz, and Munich RE voluntarily publish annual tax transparency reports where they outline their approach to tax, tax governance and risk management, the stakeholder engagement relating to tax as well as their compliance with the Principles for Responsible investment (PRI) and other guidelines.


Besides, mandatory ESG disclosure obligations, such as the EU’s Sustainable Finance Disclosure Regulation (SFDR) applicable from 1 July 2022 onwards, require certain financial market participants including private equity funds to disclose their governance practices with respect to tax compliance.


Given institutional investors further prioritize ESG factors in their investment policies, investment managers and portfolio companies consider ESG tax aspects in different phases of a transaction. Besides the LP’s interests in tax practises and the attitude to tax planning, General Partners (GPs), their investment managers, and even the portfolio companies pay attention to ESG tax factors as they increasingly become subject to regulations themselves (e.g. transparency regulations such as EU DAC 6 disclosures – see blog post).

Tax due diligence to identify ESG tax gaps and areas of improvement (good, better, how?)

While a tax due diligence process traditionally focussed on the quantification of a potential tax exposure, tax professionals increasingly need to consider tax aspects as part of the company’s sustainability performance including the risk of a reputational damage.


Besides the identification of historical tax risks from a non-compliance or tax planning activities, weaknesses in tax management could be pointed out to allow for a reduction of ESG tax gaps post-transaction with an eye to a future exit. Similarly, a strong tax function and an appropriate transfer pricing approach applied might indicate, in essence, a low tax risk profile.


For an ESG-focused tax review, the following aspects are typically considered when examining target entities, especially groups with a strong international presence:

  • Review of the group’s tax risk policy (e.g. regarding foreign taxable presences, external personnel engaged, VAT, (tax) provisioning, etc.)
  • Transfer pricing and financing approach applied
  • Assumptions and factors driving the group’s Effective Tax Rate (ETR)
  • Quality of the internal tax function and staffing; incl. management awareness of the group’s tax risk policy and processes
  • Assessment of the business’ appetite for tax planning and tax risk
  • Disclosure and handling of identified tax risks with the tax authorities

The outcome of a tax due diligence forms the basis for further optimization and ESG incorporation as part of the fund’s influence and stewardship to maximise the group’s overall long-term value on which returns, and beneficiaries’ interests depend.

Value creation post-transaction

During the ownership period, a steady consideration and monitoring of ESG tax aspects can contribute to the portfolio company’s value increase. Tax expenses and other costs arising from potential tax planning activities are linked to a business’ profitability and affect future cash flows. A profound tax risk management as part of the ESG strategy prevents extraordinary tax costs (e.g. in the course of a tax audit) thereby allowing a steady tax cost modelling as part of the business plan. As, especially in secondary buyouts, potential risks (incl. tax risks) are typically factored into the purchase price, a business plan that properly tax costs generally has a positive impact on a buyer’s evaluation of the business.


Likewise, companies that seek aggressive tax minimisation might be associated with a high-risk tolerance affecting the business’ reputation and value thereby risking being excluded from other investor’s watchlists.

Key take-away and outlook

With a continuing trend to sustainable investing and a stronger social demand for more transparency and disclosure, tax has become an inevitable component of ESG considerations when assessing targets and managing portfolio companies. Considering the active ownership role of Private Equity firms, ESG factors can be used to enhance tax risk management and facilitate predictable tax modelling as part of the business plan. Finally, a fund’s tax strategy considering ESG criteria indicates its overall values and approach to other ESG sectors as differentiator to competitors.




GRI 207: TAX 2019


Principles for Responsible investment (PRI) – Investor Guide


Sustainable Finance Disclosure Regulation (SFDR)


Draft regulatory technical standards (Draft RTS) published by the European Supervisory Authorities


European Commission / Platform for Tax Good Governance: Discussion paper on Sustainable Finance and Tax


PartnersGroup Tax Transparency Report 2020


Allianz Tax Transparency Report 2020


Munich RE Tax Transparency Report 2020


Norwegian ethical framework for the Government Pension Fund Global (GPFG)


Australian Corporate tax transparency reports


Unser nächster Beitrag aus der M&A Reihe zum Thema "Kartellrecht in der Due Diligence" erscheint nächste Woche.