The first legally binding, universal agreement to address climate change was signed by representatives from 196 countries at the 21st session of the Conference of the Parties (“COP21”) of the UN Framework Convention on Climate Change (“UNFCC”) in Paris on 12 December 2015.
The Agreement specifically defines the long-term goal to hold the increase in global average temperature to well below 2°C above pre-industrial levels and pursue efforts to limit the temperature increase to 1.5°C.
Carbon regimes such as carbon taxes and cap-and-trade systems are on the rise as a regulatory instrument to reduce greenhouse gas (GHG) emissions. Most companies have incorporated sustainability strategies into their business planning for several years now due to drivers such as energy risks and resiliency, cost reduction, government regulations and stakeholder expectations.
This changing business climate will also impact the day-to-day responsibilities and corporate profile of the tax department. Tax departments should adapt to this evolving climate by understanding the risks and opportunities presented by environmental tax policies, carbon regimes and sustainability incentives on a global basis, planning accordingly to reduce costs and risks and making sure compliance is completed accurately and effectively.
These three integrated areas of tax policy can help CFOs, tax directors and facilities and energy managers navigate through the sea of change surrounding environmental and sustainability issues:
- Sustainability-related tax and business incentives: countries and local jurisdictions are increasingly offering incentives to encourage organizations to invest in projects and technologies that will help reduce the carbon intensity of their operations. Identifying and securing tax and other business incentives can often help companies meet or improve the return on investment (ROI) thresholds that are required for these projects.
- Environmental and energy taxes: governments across the globe are continuing to develop their environmental policies and are concurrently looking for new sources of revenue. This has led to an increase in environmental and energy taxes in recent years, including new legislation and the development of regulations for existing taxes. These taxes cover activities including emissions, manufacturing of certain products, transportation, energy generation, resource use and other negative environmental externalities.
- Emission trading schemes and carbon taxes: as the global economy continues to rely on fossil fuels, concern over limiting the release of carbon dioxide emissions associated with the combustion of these fuels has intensified. Governments are increasingly turning to carbon regimes such as carbon taxes and cap-and-trade systems as an effective way to limit these emissions. Such carbon regimes are not only growing geographically, but are beginning to cover more industries as they progress.
Why should the tax department be involved?
Global environmental and energy taxes (EETs) are becoming increasingly relevant as more businesses establish sophisticated energy management and sustainability strategies and as respective tax regimes are continuously developed by governments.
Companies will need to factor the growing role of environmental taxes, resource efficiency and low-carbon activity incentives into their thinking and modeling when making investment decisions.
While business strategy is adapting rapidly to the continuing development of environmental taxes, sustainability incentives and carbon regimes, the tax department is often not at the table during these discussions. In addition, carbon regimes are relatively new and may not be seen as a tax function. So why should the tax department be involved and how can the tax department help to drive corporate value?
Cost reduction: businesses in all sectors are focusing on cost reduction more than ever before. Incentives can have a direct impact on the up-front capital cost of sustainability-related projects and help improve the overall ROI. In addition, EETs have a substantial impact on production and energy procurement costs.
These taxes add cost to a wide range of operational activities, from energy and resource consumption to manufacturing and transportation. The available incentives and specific impact of these taxes depend on the operations of the business and its footprint.
Revenue generation: in addition to reducing the cost of environmental taxes, the tax department can also help drive revenue through the identification and implementation of tax and other business incentives related to investments and processes around environmental and sustainability strategies. Tax can be a driver to reduce the up-front cost of projects and improve the ROI by making sure that all available incentives are realized and complied with in a timely manner.
Coordination: as companies evolve their energy sourcing strategies for energy security and economic reasons, many companies are turning to self-generation solutions. Tax reliefs and tax incentives are the most obvious and economically beneficial aspect for businesses from investments in self-generation.
However, a change in energy sourcing may also result in further EET consequences as it may technically turn companies into energy suppliers subject to energy tax obligations.
Administration and compliance: even though EETs have a substantial and growing impact on production and energy procurement costs, the administration of these taxes is often left to the facility level while the role of the indirect tax function remains unclear. The tax department can help identify EET relief opportunities, leading to substantial cost reductions, as well as manage compliance processes in the context of changes to the business operating model.
Planning and management: the increased focus on sustainability and energy strategy requires businesses to also assess and manage EET consequences. Based on their energy strategies, businesses implement centralized energy procurement approaches and revert to self-generation solutions, in particular those based on efficient cogeneration solutions or renewable energy technologies.
As part of their sustainability strategy, businesses should develop strategic approaches to reduce GHG emissions and/or increase energy efficiency and any respective tax reliefs that might be available for each facility.
Multidisciplinary management approach: the management of all of these energy tax impacts is challenging for an indirect tax function, especially for multinational companies. This is not only due to the very specific tax regulations but also to the required level of interaction with related technical and environmental aspects.
To effectively manage this, a joint multidisciplinary management approach (MDMA) with the related business functions is advisable. This MDMA not only helps the tax function understand relevant technical and regulatory backgrounds, but can also help other functions understand energy tax impacts and help optimize the energy tax position of the business moving forward.
Overlap with existing tax functions: management of EETs creates considerable challenges and opportunities for businesses. The indirect tax function can be a feasible stakeholder for this as both systematic issues and underlying transactions are often closely connected to value-added tax (VAT)/goods and services tax (GST) challenges.
It is imperative for corporate management and boards to make sure that the tax department is fully engaged in the organization’s agenda of operational efficiency and low-carbon activity. How well a company navigates in this evolving tax landscape can make a big difference in relative competitive performance.
As the tax department becomes more involved with energy and environmental taxes, sustainability incentives and carbon regimes, they should be aware of the role they play throughout the life cycle of these taxes. The diagram below demonstrates the issues that the tax function should be considering through the planning, accounting, compliance and controversy stages of the tax life cycle.