The quest for net zero and the role of the UK tax system
Amanda Tickel and Claire Galineau of Deloitte track existing environmental policies and how the tax system could be used to help achieve the UK’s net zero goals.
In November 2021, at the UN Climate Change Conference (COP26), there was a sense of urgency in actions and commitments in the quest for net zero. Amongst the main achievements were: 100 countries agreeing to end deforestation by 2030, a pledge to cut global methane emissions by 30% by 2030, and large amounts of private capital committed to transform the economy for net zero. Many countries agreed fresh new pledges on carbon neutrality which included the highest-emitting countries such as China and the US. Cities, regions, universities, business and investors also committed to specific and personalised net zero targets during COP26.
The journey to decarbonisation will by no means be an easy one, but the UK has already achieved the fastest per-capita reduction in the G7 and was one of the first countries to set a legally binding net zero target for 2050, in 2019. Such a result came predominantly from regulation and switching early from coal to gas and renewables to generate electricity.
That said, the UK does also have the highest carbon rate in the G20 (the emissions trading rate plus fuel excise duty) – so the use of carbon pricing and taxation is likely to be making a difference in production and consumption choices already.
The starting point: A jigsaw with no defined frame
In the UK, HM Revenue and Customs (HMRC) and HM Treasury (HMT) administer four environmental taxes with explicit environmental objectives, which are: the climate change levy, the carbon price support, landfill taxes and the aggregates levy – with the addition of a fifth, the new plastic packaging tax to be introduced in April 2022. However, the tax and incentive system is also being used much more broadly towards achieving net zero and the Office for National Statistics cites a large inventory of taxes, levies or obligations that increase directly or indirectly the price of goods or services linked to a climate objective, such as air passenger duty or the UK emission trading system.
This breadth is best illustrated by considering vehicle taxation. Tax policy levers have been pulled extensively to encourage the manufacture and consumption of electric and hybrid cars in line with the government’s plan to ban the sale of all new petrol and diesel cars by 2030. There are lower first year and standard rates for vehicle excise duty (£0 first year for zero-emission vehicles compared to higher rates based on CO2 emissions) and fuel duty of currently 57.95 pence per litre applying to petrol and diesel.
On top of those, in London, vehicles pay a daily congestion charge of £15 but there is a full exemption for zero-emission vehicles. There is also an Ultra Low Emission Zone daily charge of £12.50 for more polluting petrol and diesel car models. A range of manufacturer grants are in place including for plug-in cars and vans (recently lowered from a maximum of £2,500 to £1,500), a grant of up to £350 for homeowners to instal a charging point (until 31 March 2022) and scrappage schemes (e.g. low-income and disabled Londoners can receive £2,000 to scrap a car).
Further, businesses can deduct upfront the full cost of capital expenditure on some cars with zero CO2 emissions and electric vans to provide a cash flow advantage. Finally, employment tax provisions incentivise zero-emissions vehicles as company cars through a reduction of up to 90% of income tax costs compared to a petrol or diesel car.
When turned into a list like this, incentives for electric vehicles seem numerous (and generous). Whilst it is difficult to pinpoint a single policy, regulatory or consumer sentiment reason why, the fact is the UK has achieved a significant consumption switch in this sector and the trends are positive – according to the Society for Motor Manufacturers and Traders, in December 2021, one in four cars sold was an electric or hybrid vehicle.
However, the range of taxes and incentives in operation are not always easily identifiable and can take time to apply for, with businesses and individuals perhaps not realising their full potential as a result. Effective tax policies are generally transparent, simple, certain and long-lasting.
Outside of the breadth evident in the car industry, it starts to get patchier. Homeowner incentives such as solar panels, heating system and insulation have been poorly understood and have come and gone. By contrast, in France and Germany, successful retrofit schemes covering both energy efficiency and heating in the last five years relied on leveraging private sector finance and a fast application process.
For business investment and innovation, there is in fact very little use of the tax and incentive system specifically to help achieve net zero. Various general research and development (R&D) incentives exist for businesses in the UK, together with the patent box regime; however, they are not specifically targeting or increasing reliefs or incentives for eco-friendly investment. Similarly, the super-deduction of 130% available for capital expenditure by companies on certain plant and machinery, in place until March 31 2023, does not incentivise investment in energy-efficient equipment over other expenditure.
At the autumn budget in October 2021, many expected a ‘green budget’ – but the Chancellor Rishi Sunak only announced limited changes to the Business Rates system (tax payable annually to local councils and charged on most non-domestic properties), introducing a new investment relief for companies adopting green technology (such as solar panels and heat pumps) and a further relief on any expenditure on improving properties. Such improvements will be exempt from Business Rates for 12 months starting from April 1 2023.
Also in October, the UK government published its long awaited Net Zero Strategy to ‘build back greener’ in the aftermath of a global pandemic whilst HMT published its final Net Zero Review. In these documents, taxation as a policy lever was surprisingly largely absent. Calls for the government to publish a tax roadmap to signal a clear trajectory to taxpayers for how tax measures will be deployed to contribute to net zero, made by Member of Parliaments and the Chartered Institute Of Taxation were recently dismissed by HM Treasury.
The reason being the “great deal of uncertainty inherent in any modelling as far into the future as 2050, which is highly sensitive to economic, societal, and technological developments” which would mean that “a tax roadmap could ultimately give a false sense of certainty.” It is understandable that a tax roadmap was not possible given the number of taxes, incentives, and reporting requirements already in existence and the timeline of nearly 30 years. However, perhaps a shorter five-year plan presenting existing and future taxes, reliefs and incentives would be valuable to provide the certainty individuals and businesses need to action new green investments.
Fixing the bugs: Troubleshooting imbalances
The largest imbalance that will certainly take governments around the world a while to troubleshoot in the coming years is the loss of revenue from fuel duty as electric vehicles become the norm. For the UK, fuel duty raised £21 billion in 2021 compared to total public sector receipts for 2020/21 of £793 billion. This gap may in future be filled partly through general taxation and possibly through gradually removing reliefs for electric vehicles. A road tax does not seem likely as it would be earmarked to road maintenance rather than going to the treasury’s budget. This was discussed at length by the Institute for Government in 2021.
Chancellor Sunak’s October budget announcements regarding investments in solar panels comes as a welcome rectification now allowing exemption of Business Rates for investments both where electricity is ‘for sale to consumer’ and for ‘self-consumption’ (previously only the former was exempt) although this will only take effect from April 1 2023, which may delay investments.
Another example of an imbalance is the one between electricity and household gas, with the latter being effectively subsidised. This was demonstrated at length in the 2021 Green Budget published by the Institute for Fiscal Studies. The rebalancing of the taxation of electricity compared to gas is something governments in Europe are particularly interested in, at a time of high price volatility in energy over the winter months and the shadow of social unrest that arose in France three years ago. The UK announced in the autumn several consultations to address this.
Finally, looking at electric vehicles, there is also a discrepancy in VAT rates for electric vehicle charging: home charging is subject to a 5% VAT rate compared to a 20% rate for public charging. As people living in flats cannot access the lower VAT rate, they therefore face a higher charging bill compared to home occupants. On several occasions, HMRC has confirmed there are no plans to address this inequity.
Carbon pricing at the border
In a globalised economy, international tax systems will need to evolve to help achieve net zero. In the last few decades, explicit carbon pricing policies have been enacted by governments around the world to impose a price based on territorial carbon emissions either through a carbon tax or an emission trading system (ETS). Currently, 65 jurisdictions have implemented carbon pricing initiatives according to the World Bank, and these are widely recognised to be effective in shifting production and consumption choices towards low and zero carbon options.
The thing is, carbon pricing needs to be on a global scale with similar rules across the board to discourage businesses from shifting their production or sourcing away from a jurisdiction, to lower carbon cost locations or countries with less ambitious climate change policies. Actually, the only reference to taxation at COP26 was in relation to carbon pricing, following the OECD report released in October 2021. As seen with the G20/OECD Base Erosion and Profit Shifting (BEPS) Project, international tax reforms are possible and can be achieved on a large scale – the ground-breaking political agreement on pillar two, to implement a global minimum tax rate, managed to align 137 jurisdictions. However, the journey has been a long one and in the context of climate change, time is of the essence.
In its Net Zero Strategy the government “recognises the importance of addressing the risk of carbon leakage so policy interventions do not lead to increase emissions elsewhere” with an “emphasis on an international, multilateral effort”. While a plurilateral approach might take a long time to come through, the EU is pursuing unilaterally a new Carbon Border Adjustment Mechanism (CBAM) to put a price on imports, reducing the risk of carbon leakage and protecting the competitiveness of EU businesses.
It expects the CBAM to be fully operational by 2026, initially applying to highly polluting products: iron, steel, cement, fertilisers, aluminium, and electricity. Introducing something that looks and feels like a tariff would fall foul of international rules on trade, so the EU Commission explicitly notes that its CBAM is an environmental measure, not a tax or a tariff – its compliance with World Trade Organisation (WTO) will need to be further assessed. The reaction of other jurisdictions around the world has ranged from initially cautious like the US to more loudly against the proposal in countries like Brazil and China.
Currently, the UK government is watching how this CBAM measure develops and the House of Commons, Environmental Audit Committee’s launched a call for evidence on it during October 2021.
Levers the UK government could use in the coming years
According to the think tank Green Alliance, in a recent report, a new green VAT rate would be the best way to accelerate a just transition towards net zero, as the system already exists, works well for businesses and the tax administration, and is well understood by people. Indeed, the UK VAT system is capable of fast adaptation as we saw during the global pandemic. VAT rates for hospitality, accommodation and attractions were reduced initially to 5% then to 12.5% before reverting back to 20% by March 31 2022. These rate reductions combined to support businesses and aid consumers by lowering prices and was quickly and ably managed by HMRC and businesses alike. It is a simple lever to drive consumer behaviour. The European Commission is currently looking into the possibility of allowing member states such a green VAT rate.
Innovation will be critical in the transition to carbon neutrality, as a Scottish report highlighted recently: “up to 75% of the emissions reductions we need to achieve net zero are dependent on technologies which are immature, have not been deployed at scale or have not even been invented yet.” In Deloitte’s CFO survey in October 2021, some 87% of chief financial officers declared the climate transition as an opportunity, with 40% rating it as a ‘significant’ or ‘very significant’ opportunity. In addition, the key theme of Deloitte’s most recent CFO survey is that 2022 will be a year of rising business investment, which would have significant impact if a large portion of this was towards eco-friendly or net-zero measures.
Using the capital allowances system could incentivise investment in green assets. Keeping the 130% super-deduction for capital expenditure but limited to specific eco-friendly assets beyond 2023 could provide the certainty needed for businesses to build this measure into their budgets for the coming years. Such an incentive, anchored in certainty, would create a circular effect encouraging carbon reduction across the wider economy.
Similarly, an enhanced R&D expenditure credit based on defined green criteria (e.g. carbon footprint reduction) could incentivise and reward innovative companies investing in green projects. Together with a 130% super-deduction, those incentives would significantly enhance the UK’s role as a manufacturer and exporter of carbon-reducing equipment and technology which would be a win-win situation for the UK government.
The corporation tax film tax relief regime in the UK provides a case study which could be replicated to help drive a bigger industry around net zero. This encourages productions into the UK by providing an additional tax deduction of up to 100% of UK production expenditure, with the additional deduction able to reduce a company’s profit or increase its losses. The relief is easy to administer, certain and reliable so the benefits can be built into businesses’ production budgets as a matter of course. The scheme has been regarded as a success supporting over £5 billion of investment into British films with a 70% increase in the film production workforce since its introduction in 2007. It is a clear example of a fiscal measure that is achieving a policy objective; imagine what this approach could do to transform investments in net zero advances.
The steps ahead
The next three years will be critical to ensure carbon neutrality targets are on track to be met by 2050. The UK government is determined to follow through with its ambitious targets to address the climate crises but concrete changes to what is already a very comprehensive and resilient tax framework could unlock immediate ripple effects. The coming spring statement in March 2022 could be an opportunity to proceed with a green VAT rate, an enhanced R&D expenditure credit based on green criteria, targeted enhanced capital allowances, and a new tax relief based on the film tax relief, which would all encourage consumer choice and investment in net zero.
Unilateral environmental measures can and do have positive impacts, but it is important these do not disadvantage a country from a competition perspective, nor result in emissions being pushed elsewhere. Given the importance of this, a multilateral approach, potentially through a new fast tracked joint WTO/OECD inclusive framework, agreeing both carbon pricing and a carbon leakage mechanism such as a CBAM-style measure, could provide an effective global approach to tackling the climate crisis.
Deloitte UKT: +44 20 7303 3812
Amanda Tickel is head of tax and trade policy group at Deloitte UK. She is an international tax partner and also leads on Deloitte’s Brexit and trade insights, advising businesses on the spectrum of issues related to international trade in goods and services.
Amanda has held a wide number of roles during her career, including leading client relationships, global representative to the OECD, mentoring, non-executive board role and trusteeships. As well as previously being a partner at another Big 4 firm, she was global head of indirect taxes and responsible for managing tax value chain and centralisation initiatives at Vodafone.
Deloitte UKT: +44 20 7007 3017
Claire Galineau recently re-joined Deloitte as an associate director in the tax and trade policy group specialising in international taxation and climate change taxes. She trained with Deloitte in Luxembourg and in the UK for five years before spending three years in-house at a large UK company. She also has experience with competition law and state aid issues having worked on the Luxembourg and UK controlled foreign companies investigation throughout her career.
Claire has a master of tax law degree from Queen Mary, University of London, is a chartered tax advisor, and has completed her advanced diploma in international taxation.