Naz Klendjian, Partner, Head of Infrastructure Investment, KPMG LLP

Chris Morgan, Head of Global Tax Policy, KPMG LLP

“Tax is the entry fee we pay for a civilised society. Without it, there can be no roads, no schools, no hospitals, no social care.” This guiding thought behind KPMG’s 2014 Responsible Tax Projectserves as a useful way to introduce a discussion of responsible tax in infrastructure investment.

The role of tax as an ultimate source of funding is just one aspect of the complex and multi-layered relationship between tax and infrastructure. Today, as trust – and being trusted – are of growing importance to the sector, responsible tax is rising up the agenda and becoming part of the industry’s licence to operate.

High on the responsibility agenda

This is driven in part by the broader debate about tax, where OECD-led global efforts to harmonise the response to base-erosion and profit-shifting (BEPS) and transparency have elevated tax to the highest levels of discussion. These changes are already fundamentally changing structures and behaviours, and embedding tax firmly in the responsibility agenda. We’re seeing pension funds, for example, begin to draft tax policies that define what is and what isn’t ‘aggressive’ – and expecting the fund managers with whom they deal to uphold the same standards.

The growing need for trust

So given where the capital to fund infrastructure comes from – pensioners, sovereign funds, insurers and institutional investors (as well as a new generation of savers to whom ethical and sustainable investment is important) – those who deploy it feel an increasing responsibility to be trusted both by the capital they represent and the customers their assets serve. For their part, although they have fiduciary obligations to invest for a financial return, investors have begun to recognise that they are also asking for the licence to operate essential assets that are public goods, and must therefore ensure they invest responsibly and deliver societal value.

At the heart of the responsible tax issue are classic dilemmas around tax that are especially relevant to infrastructure. Is tax a cost that has to be managed or is it part of a contribution to society? Is it a legal or a moral issue? It’s certainly no longer acceptable in reputational terms to say in relation to tax: “if it’s legal, we can do it”. Heads of Tax, particularly those representing long-term institutional capital deployed into long-term infrastructure, no longer take this view – but as yet, the parameters, the diverse stakeholders and the dialogue are hard to pin down.

Of course, tax must operate within a legal framework because without it, the rule of law is undermined; but in our view it has moral dimensions because how much tax is paid depends on why and how structures are used.

International questions and uncertainty

In infrastructure, the need to access low-cost capital such as bank debt and bonds to make construction and investment cost-effective for society, together with the coming together of investors from multiple geographies, leads to ‘international tax’ questions around how to structure debt financing and joint ownership structures. There are also questions on how to manage withholding taxes within the intent and spirit of double tax treaties, which are designed to encourage the sort of global cross-border investment on which governments are so reliant for their infrastructure needs. Front-of-mind with many investors and heads of tax is the ‘principal purposes test’, an anti-abuse test to determine whether the use of a double tax treaty is inconsistent with the spirit of the law. This is creating a degree of uncertainty, particularly because investors are not clear about how a subjective set of rules might be applied to structures that are sometimes unavoidably complicated and thus not easily understood by governments.

The need for clear communication

Further, where global capital is funding domestic infrastructure that is large-scale and long-term, there is a need to communicate more clearly around natural ‘domestic tax’ outcomes such as relief for financing costs and interest, and relief for capital expenditure that comes in the form of tax depreciation or capital allowances.

These international and domestic tax aspects lead to the broader challenges around how to communicate structuring and funding decisions and outcomes clearly and transparently to users, taxpayers, governments, regulators, investors and the public at large. Some have already sought to get on the front foot by ‘onshoring’ their fund structures and removing offshore companies.

New tax rules for the digital era – unintended impacts for investors?

Tax responsibility is also made more complex for the infrastructure industry by rules that may inadvertently impact bona-fide commercial structures. There’s a question, for example, over how the OECD’s proposed minimum tax rate might apply to pension or sovereign wealth funds that are tax-exempt, without impinging on commercial arrangements. Another example is BEPS Action 5, which requires increased substance for certain mobile activities but could impact commercial structures that are ‘light’ on substance yet are nonetheless set up for tax neutrality rather than avoidance (such as offshore vehicles that are used to pool capital from multiple investors).

Steps towards best practice

Despite the complexity and many continuing questions around the topic, in our view there are some simple and fundamental steps towards best practice for those involved in infrastructure investment.

Transparency and clear communication are essential. Not just to secure the trust and foster the understanding that we discussed at the beginning of this article, but also to stay in step with regulations such as the EU’s Mandatory Disclosure requirements, which are part of a wider drive towards more real-time transparency, disclosure, administrative cooperation, exchange of information and enhanced governance.

Responsible tax is clearly linked to the licence to operate. It’s not an issue of corporate social responsibility or ‘greenwashing’ to be bolted on to business as usual: it’s a core strategic theme with the potential to drive and protect value, which needs embedding throughout the spectrum of an organisation’s teams, functions and policies. And it should be a board strategy that is effectively communicated throughout an organisation.

It’s even aligned with the need for more inclusion and diversity, as organisations need a way of listening to and engaging with a multitude of different and sometimes conflicting perspectives from an ever-more diverse pool of stakeholders.