Why tax functions should play a central role in reshaping supply chains

The switch to more sustainable business models and supply chains will provide for products and services which will have new value but also, potentially, different tax implications.

In brief

• Tax functions will need to be involved in the development and implementation of organisations’ sustainability strategies.
• Organisations need to be aware not only of their carbon footprint but also the environmental tax footprint of their supply chains.
• Tax functions need to work in close collaboration with the chief supply chain officer, chief procurement officer and chief operating officer (COO) from as early in the process as possible.

Supply chain disruptions over the past two years and more have caused many organisations to fundamentally reassess their operating models. In an effort to improve supply chain resilience they are looking at near-shoring, re-shoring, and other strategies to reduce complexity and fragility.

Those efforts have been accelerated by the climate crisis which is seeing consumers become more conscious of the environmental provenance of the products they buy. It is also seeing investors becoming more aware of climate and reputational risk, and governments introducing policies aimed at achieving a change in behaviour on the part of both citizens and corporations.

Those government policies tend to boil down to a carrot and stick approach - a mix of incentives and penalties. On one side there are grants and tax credits, while on the other there are tax penalties for activities with negative environmental consequences.

This is bringing about a new situation where organisations need to be aware not only of their carbon footprint but also the environmental tax footprint of their supply chains. Organisations that fail to understand their environmental tax footprint and how it is likely to change in future will expose themselves to higher tax costs at the same time as under-utilising the incentives available to them as they move along their decarbonisation journeys.

The tax layers

When it comes to penalties and taxes, governments across the world have introduced or are considering the introduction of carbon taxes and other pricing instruments to penalise carbon emitting activities and other negative environmental outcomes such as waste in the supply chain.

One such instrument is the EU’s Carbon Border Adjustment Mechanism (CBAM) which is due to come into force in 2026, with reporting requirements commencing in 2023 for specific groups of products. In effect, this will be a balancing tax on goods paid at the point of import into the EU. It will ensure that goods do not enjoy a competitive price advantage due to less onerous carbon tax regimes in their countries of origin.

This will add another layer of tax complexity to supply chains. And it’s set to get even more complex with the introduction of new plastic packaging taxes from this year, the expansion of extended producer responsibility schemes, and other waste-reduction related pricing tools ‑ all of which target waste reduction and increased reuse and recycling of plastic packaging and other materials. Water preservation and biodiversity pricing and preservation measures are expected to move up the international agenda as well.

Tax function to take the lead

While this all puts pressure on COOs and chief supply chain officers, the tax function has a key role to play too. The shift towards more sustainable supply chains and business models will bring with it new products and services which will add new value. It will also mean new value being placed on existing processes and products because of their positive economic, environmental, and societal impact. This new value will naturally have tax implications.

This will also have major implications for transfer pricing. In the latest EY Transfer Pricing Survey, published in October 2021, 68% of respondents said that ESG and sustainability policies in their organisation would have a medium or high impact on their approach to transfer pricing. And 74% said supply chain change would have a similar medium or high impact.

This is to be expected. For example, activities may cease in certain jurisdictions fundamentally, shifting the weighting of value across the organisation. The R&D department in another will have to be compensated for the development of the new processes or innovations which enable more sustainable and circular products and services.

Organisations also have the opportunity to avail of incentives from governments to fund the reshaping of supply chains in pursuit of greater sustainability. This can help mitigate the impact of new environmental taxes.

To achieve these positive outcomes, organisations will need to involve their tax functions in the development and implementation of their sustainability strategies. This will enable a deeper understanding of emerging green legislation and taxes, as well as the changing incentives landscape and the forms they are likely to take. It will also enable the conversion of that understanding into financial gains for the business.

In addition, the tax function must work in close collaboration with the chief supply chain officer, chief procurement officer and COO, from as early in the process as possible. Many sustainability measures in the supply chain may take three to five years to have any effect and it is the job of the tax function to feed the latest information around incentives, tax, and other pricing measures into high-level planning. Failure to do so will invite extra costs.