9 minute read 17 Jun 2021
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How businesses can best navigate the global carbon tax maze

By EY Global

Multidisciplinary professional services organization

9 minute read 17 Jun 2021
Related topics Tax

Carbon tax is a key tool in the global drive to meet climate targets. For the tax function, it presents opportunities as well as challenges.

In brief
  • Carbon taxes are increasingly being implemented in the drive towards carbon neutrality. It’s relentless shift that businesses have to contend with.
  • This presents a distinct challenge – carbon tax is an added cost, and compliance is complex and fast-moving. It may require major changes to operations.
  • Proactive tax functions support businesses by taking advantage of carbon incentives, while aligning them with society’s increased environmental awareness.

In December 2019, Ursula von der Leyen, President of the EU Commission, announced Europe’s “man on the moon” moment — the European Green Deal. Here was a trillion-euro plan1 to decouple the region’s economic growth from the use of natural resources, driving Europe towards achieving carbon neutrality by 2050.

There’s good reason for the ambition. In 2021, for the first time in the history of the annual World Economic Forum Global Risks Report2, four of the top five most likely global risks were related to the environment. Alongside extreme weather events — which are striking the world with increasing scope, intensity and regularity — are human environmental damage, biodiversity loss and the failure of climate action.

Europe won’t be exploring that frontier alone. US President Joe Biden has put ambitious climate targets at the center of the current US administration3, while China, South Korea and Japan have all recently made carbon-neutrality pledges4 — a sign of how far the climate message has come in the five years since the Paris Agreement was signed.

Ambitious targets require tools to drive behavior. And carbon taxes are among the most promising.

A drive towards cleaner solutions

Carbon tax is levied on the carbon component of goods and services, from fuel and air travel to food packaging. As the cost of the tax is carried by the producer of the goods — or more likely the end-customer — it serves as a clear incentive to find cleaner solutions. This is what’s known as a Pigouvian tax — meaning it’s designed to compensate for adverse side-effects that aren’t included as part of the product’s market price.

The first carbon taxes were introduced by Finland in 19905. As of May 2020, there were 82 carbon tax initiatives across 48 countries globally, covering 22% of greenhouse gas emissions in the world and raising the equivalent of $45bn6. National carbon taxes exist in countries as Argentina, South Africa and Singapore. Provincial carbon taxes exist in Canada and China. Even developing economies such as Colombia and Chile have introduced carbon taxes, albeit at very low rates.

On paper, it all looks promising. Carbon tax is regarded by many economists as the most effective way to reduce emissions. Not only are people deterred from buying offending products, but as the true cost of the impact of carbon-heavy technology is now incorporated in the price, cleaner forms of energy become more affordable by comparison — as well as receiving greater investment.

“Clean technology, such as solar and wind, has become so much cheaper in the last 15 years,” says Cathy Koch, EY Global Sustainability Tax Leader and EY Americas and Global Tax Policy Network Leader. “They never used to be price-competitive with fossil fuels, but they are now, and pricing carbon would accelerate those trends. People will want to shift to cleaner technologies as they become relatively cheaper — and that further drives the technology we need to fulfill the carbon commitments we have made.”

Weighing the pros and cons

While they’re clearly effective, carbon taxes aren’t universally loved. In the wake of the pandemic, many administrations will have concerns about introducing a carbon tax when the economy is still recovering.

The other criticism of carbon tax is that it’s regressive — the costs get passed along the chain to consumers. And for poorer people, essentials such as energy, heat and transportation soon eat up more of their limited disposable income. It’s for this reason that President Biden hasn’t included a carbon tax in his climate plans.7

There are, however, ways to address this. Larry Fink, CEO of BlackRock, is a supporter of carbon taxes, and has said that, rather than using the tax to plug budget gaps, “we need to make sure that all the money from a carbon tax is going to renewables and redistribution, that there’s some kind of credit back to those who can’t afford it.”8

Meanwhile, the Climate Leadership Council, a group of influential US corporations, has called for all the net revenue from the carbon tax to be put back into the pockets of the American people. It claims such measures could benefit a family of four in the US by $2,000 a year9.

Despite any nagging concerns, the climate crisis is only getting worse, and the pressure to meet international targets is only going to grow. So, measures like carbon tax are an inevitability across the board.

Managing the business implications

This may well prove to be a challenge for tax and finance functions at multinational businesses. First, this is a new cost to factor into operating costs and margins. And as well as managing compliance, tax teams need to stay close to the business to keep leaders informed about how carbon tax will impact any final prices set for consumers. Yet, carbon taxes can be hard to track. Take the European Green Deal. As an EU directive, a carbon tax leaves room for individual member states to choose how to apply and police their own measures. Figures from 2019 showed that while Norway’s carbon tax covered 60% of the country’s total greenhouse gas emissions, Spain was just taxing only 3% of its emissions10, as a consequence of  the limited scope of its tax.

Imagine the impact of such a varied and complex tax picture across an entire global supply chain and customer base. Depending on the country and region involved, and the products being delivered, organizations will have a lot of different taxes to comply with.

“I’ve had clients asking what their legislative landscape looks like, and what they can expect the impact of carbon taxes to be,” says Sofie Van Doninck, EY Belgium Indirect Tax Partner. “They’re just trying to understand what’s happening in the different countries, building a holistic overview of what it means in their specific case, and identifying their alternatives. The implications can be far-ranging. It can mean completely revisiting their business setup.”

Indeed, tax and finance functions will need to harness the latest data analysis technologies for tracking and reporting their own impact and exposure, and for calculating their tax liabilities. But the impact of carbon tax on the business will be far broader, and may call for bold decisions — potentially revisiting and adapting policies, operating models and business models.

“Carbon taxes need to be anticipated and integrated from the beginning of any business processes,” says Frank Burkert, EY EMEIA R&D and Innovation Services Leader. “We highly recommend companies get started by vertically integrating their supply chain —considering in one single step everything from resourcing and supplying; to processing and production; to sales and logistics. It involves the entire life cycle of a product. That's one of the key challenges, and key tasks, for businesses in the near future.”

Yet the fast-moving carbon tax picture needn’t be a threat. Many businesses are already seeing the value of investing in lower carbon intensity supply chains and in cleaner technologies, not least because they stand to benefit from tax credits and grants being offered by governments for things like renewables investments.

This field is expanding all the time — EY is currently tracking 3,600 different incentives being offered around the globe.

How tax and finance can step up

There’s a clear opportunity here for tax functions to serve as a strategic partner with their businesses — by steering leadership through the maze of global taxes, and helping them identify and capitalize on incentives and other emerging opportunities, all of which will also help align the business with the predominant direction of travel of consumer and investor sentiment.

“The opportunity here is huge,” says Burkert. “If companies approach carbon tax proactively, rather than simply treating it as a cost, it gives them a value — in terms of reputation, standing and demand. It shows they’re aligned with societal needs. This can help to gain new customers, and influence shareholder relationships and perception.”

Another advantage here is that this naturally brings the tax function into direct contact with other areas of the business — a collaboration that may foster greater innovation and help seed new ideas.

“When you’re talking about carbon taxes, it’s not typically a conversation only with the tax director,” says Van Doninck. “The sustainability team will have their own thoughts and their own strategy. This is a unique chance for cooperation.”

Given the scale of the opportunity as well as the challenge, the argument for working with an experienced partner on sustainability and related taxes becomes increasingly compelling. The right partner can help by providing advice, governance and impact assessment on the changing carbon tax landscape, including the potential effect on supply chains. They will have a solid understanding of the macroeconomic trends; of the upcoming regulations and standards; and how all this can be translated into business and operating models.

Meanwhile, the latest technology platforms, such as those harnessed in EY Tax and Finance Operate solution, can draw out the extra value hidden in a company’s carbon data — not just to track and communicate the company’s position, but to help drive better strategic decisions.

Carbon taxes are already here, and they’re becoming more prevalent. Companies need to meet them proactively, rather than sitting and waiting for the tax authorities to come knocking. By doing so, they may position themselves at the forefront of significant economic and societal change.

What begins with compliance soon becomes something much bigger: a chance to leap on to a raft of opportunity, not just in claiming the incentives governments are offering forward-thinking companies, but in standing on the right side of history.

“Investment firms are watching,” says Koch. “Customers are watching, and so are employees. I have interns now that come in because we work on carbon. And this is not unusual. This isn’t just a bunch of new taxes. These are globally important trends.”

  • Five key ways businesses can be proactive around carbon tax

    • Run an impact assessment on both domestic and global operations to understand exposure to taxes so that you are fully compliant.
    • Look into how you can reduce your carbon footprint. This means examining everything from supply chains to distribution networks.
    • Make sure you’re aware of the opportunities — tax credits, cash grants and other incentives are available across the world, often as a sustainability component to governments’ recovery programs.
    • Communicate. This is also an opportunity to bolster Corporate social responsibility (CSR), by acting on an issue that’s increasingly important to consumers, shareholders and investors. Make sure you share what you’re doing as regards carbon emissions, and why.
    • Look at your sourcing model. By choosing the right third-party support, you stand to benefit from someone with a strong understanding of macroeconomic trends, upcoming regulations, and how to factor this most optimally into business and operating models.

Summary

As leading nations seek to reach carbon neutrality by 2050, carbon taxes will play an increasingly important role in achieving this goal. As these taxes become more widely implemented, multinational businesses face a complex and rapidly changing tax picture, which has a direct impact on operations. By transforming operating models to reduce their carbon footprint and exposure to carbon tax – as well as taking advantage of carbon incentives – organizations will not only build sustainable businesses going forward, they will also meet the environmental expectations and demands of customers and investors.

About this article

By EY Global

Multidisciplinary professional services organization

Related topics Tax