Environmental tax policy is important in achieving Earth Day’s objectives

Corporate tax continues to be a powerful lever for environmental policy as more carbon pricing mechanisms, such as carbon taxes, are enacted following the UN Climate Change Conference (COP26) in October 2021. Additionally, the EU has a contentious proposal for a carbon border adjustment mechanism (CBAM), while more governments are turning to plastic taxes for extra revenues.

“As countries hold lofty sustainability targets, we need to be conscious of the distributional effects of any environmental measures taken including carbon taxes,” said Muhammad Ashfaq Ahmed, chairman of the Federal Board of Revenue in Pakistan and member of the UN Tax Committee.

Environmental, social, and governance (ESG) policies are also big tax items for multinational enterprises (MNEs) to mitigate climate change alongside government investment in carbon pricing. ESG items influence investor portfolio management, MNE strategic decision making, and intergovernmental policymaking.

The ITR team compiled a list of the top business-focused environmental tax developments in 2022.

Tax teams are collaborating with other departments in their companies more often to manage ESG responsibilities as global legislative changes in environmental tax policy ramp up following COP26.

“Environmental tax plays an increasingly important role in ESG transformations at companies,” said Evi Geerts, director at PwC Netherlands.

Environmental tax and ESG legislation often straddle more than one discipline as carbon pricing could take the form of an emissions trading scheme (ETS) or a carbon tax. This means that colleagues from different teams within MNEs will need to work together to comply with several incoming rules. 

“MNEs are less siloed and work more holistically with other teams as ESG legislation is getting more ambitious,” said Karl Berlin vice president of tax at Ørsted.

ESG initiatives coming from either shareholder pressure or government pressure are helping C-suite leaders pivot away from aggressive tax planning and identify more sustainable in-house tax policy and cross-border tax structures. More companies including Ørsted are publishing their tax policies and preparing public annual tax reports that outline their contributions to direct and indirect taxes.

“As a result, we and our stakeholders have proof that we strive to pay tax on profits according to where value is created in the normal course of commercial activity,” explained Berlin.

Tax directors are expecting a series of environmental tax and ESG legislation to follow in the next five years following discussions at climate change conferences in 2021. This will continue to have an impact on how MNEs structure their in-house tax teams.

Carbon pricing is among the most important policy levers that governments can use to combat global warming. Many countries already have carbon pricing, but momentum is growing as more countries face pressures to tackle carbon emissions and meet targets under the Paris Agreement.

Indian Finance Minister Nirmala Sitharaman, alongside other finance ministers, again called for a coordinated approach to carbon pricing at the meeting of the G20 Emerging Market Economies in April 2022. 

The World Bank reported that 45 countries have carbon pricing initiatives in one form or another, whether an emissions trading scheme (ETS) or carbon tax. That list is growing as Indonesia is among the latest countries to adopt a carbon tax in January 2022.

Additionally, plastic taxes are increasingly common around the world, driven by a combination of public pressure and political will. The EU introduced a tax on its member states of €0.80 ($0.86) per kilogramme on non-recycled plastic packaging waste, which produced reactionary local legislation in other countries including the UK. The plastic tax at £200 ($272) per tonne came into effect from April 2022.

Similar environmental measures are part of the 100-item-list of proposals in the European Green Deal.  

A growing awareness of global climate change among EU policymakers led to the Green Deal, the proposal to revise EU climate legislation. All business departments from tax operations, supply chains, and marketing are impacted. 

The EU intends to reach its net-zero energy target by 2050 with the Green Deal. The package seeks to reduce EU greenhouse gas emissions by 55% by 2030 and it is the first step to carbon neutrality by 2050. The package is composed of more than 100 initiatives, including a CBAM.

“State aid may be necessary to achieve our targets,” said Benjamin Angel, tax director at the Taxation and Customs Union at the EU Commission.

Steelmaker ArcelorMittal and some other MNEs have advocated for the CBAM over the EU’s emissions trading system (ETS) as the ETS leaves EU MNEs at a disadvantage compared to non-EU competitors.

“Proper monitoring of these taxes is key as they directly hit the profitability of companies,” added Geerts.

However, less than half of the businesses in EU countries are prepared for the Green Deal, according to a PwC survey on environmental taxation. Many in-house teams have not yet quantified the cost of taxes in the Green Deal after legislation was revised in July 2021 to widen the legal framework.

Russia’s war in Ukraine shows countries are still dependent on fossil fuels as many introduced subsidies amid the struggle to shore up energy supplies when the world must slash the use of gas and coal. 

For example, the Ukraine State Tax Service issued a zero-excise tax rate on April 11 on the production of liquefied gas and certain other greenhouse gas activities while under temporary martial law. Also, the US released more oil from national reserves in March and encouraged drilling to lower gas prices.

Meanwhile, the EU still intends to reach its net-zero energy target by 2050 under the European Green Deal. However, energy sanctions in Russia are slowing progressing as Germany and other EU countries add temporary subsidies including tax breaks on the local production of coal and gas to limit exposure to Russian energy, which provides 40% of the European energy supply.

Advisors suggest the war is only the most recent complication for carbon pricing alongside other international setbacks such as rapid inflation that governments must also manage to meet their climate targets. 

While recent subsidies on fossil fuels amid the global energy transition is undermining climate change targets, some countries such as India have kept fossil fuel subsidies in place for years. 

Earth Day is an event to raise awareness of the various environmental challenges facing our planet. While 2022 highlights certain setbacks to climate change targets amid Russia’s war, it also marks the fastest pace of change in environmental tax policymaking at the corporate and government-levels. Carbon pricing is also likely to be the next global cooperative tax effort via the OECD/G20 Inclusive Framework on BEPS.