By EY Global
As governments apply the carrot and stick to sustainability, tax functions can help companies take advantage of one while avoiding others.
- With environmental issues high on the global agenda, governments are directly targeting businesses in their drive to sustainability.
- Incentives and penalties are being introduced on a regional and domestic basis, creating a challenging landscape with which businesses must contend.
- The tax and finance function can play a major strategic role to the broader business by helping reduce risk and make the most of opportunity.
Around the world, floods, hurricanes and bushfires are becoming more common, unpredictable and intense. Along with air pollution and rising temperatures, they are evidence of the increasing urgency of the climate crisis. As a result, governments are setting ever more stringent targets to drive sustainability.
To encourage businesses to help meet these targets, governments are introducing tools that fit into two broad categories: incentives — including grants and tax credits; and penalties — such as taxes and fines. The carrot and the stick.
More progressive countries may favor incentives — they encourage new business, and can help seed a positive, innovative business culture that will help foster solutions to the problems. Yet incentives can be expensive, a potential hurdle for governments finding themselves cash-poor in the wake of the COVID-19 pandemic. Punitive measures are less progressive and may feel like a case of doing the bare minimum to arrest the problem, but they can be a source of much-needed revenue.
Businesses have to navigate a path through this complex environment, which varies from country to country. And the range of measures, their scope and their implementation are changing day by day. The tax and finance function has a key role to play here — in helping businesses seize the opportunities presented by incentives, while minimizing exposure to the risk of incurring penalties.
“There are a couple of important wide-scale factors that are now influencing governments’ actions,” explains Akshay Honnatti, EY US Sustainability Tax Leader, based in San Francisco. “The first is that countries are now waking up to the commitments they made under the Paris Agreement.”
Signed in 2016, the Agreement forms part of the United Nations Framework Convention on Climate Change (UNFCCC). As of May 2021, 197 jurisdictions had signed on to its terms, which include limiting global warming to below 2C of pre-industrial levels and preferably to 1.5C.2
The second factor is linked to COVID-19. “Some economies and governments are looking at this as an opportunity to hit a reset button on the environment,” says Honnatti, adding that some jurisdictions have added investments in climate and environment in their COVID-19 recovery packages.
Carrots and sticks
In many cases, reducing environmental impact is expensive and inconvenient. Clean technology is not produced on the same scale as fossil fuel technologies. The carrot may be the answer.
“In order to encourage meaningful steps towards sustainability, financial incentives and penalties are usually necessary,” says Paul Naumoff, EY Global Sustainability Tax Leader and EY Global and Americas Location Investment, Credits and Incentives Leader. “They are a proven way for governments to impact the behavior of both companies and individuals.” He cites a couple of examples:
- Diesel engine replacement grants (DERG) are administered by US state government agencies. They are intended to incentivize the replacement of old diesel vehicles with new, cleaner ones. Company fleets and government organizations can receive funding up to 25% of the cost of replacement diesel or alternative fuel vehicles and up to 75% of the cost of replacement zero-emission vehicles.
- A common method used to curtail emissions is a cap-and-trade system. Jurisdictions like China and South Korea have put a price on carbon and capped the total amount of greenhouse gases that can be emitted by covered entities through Emissions Trading Schemes. If a company does not pay for its excess emissions or has exceeded its emissions allowance, the company faces significant fines.
Climate change and sustainability programs differ substantially by country and region. Countries have competing priorities, such as how to drive economic growth while attempting to mitigate the use of natural resources and replace them with alternative green sources. Around 40 countries now offer sustainability incentives, most of which are intended to drive green initiatives as well as economic growth by lowering costs.
In terms of large-scale funding programs, several nations administer opportunities for innovative low-carbon technologies. National policy differences become clear when comparing those of Europe and East Asia, for instance.
The EU Innovation Fund, for example, will provide €10bn of support between 2020 and 2030 for European companies that invest over €7.5 million in sustainable technology. Business sectors eligible for these types of programs include renewable energy, energy storage and other energy-intensive industries, like transportation, manufacturing and electric power generation. Programs like the Innovation Fund can certainly attract new business while proliferating local clean technology.
Meanwhile in ASEAN, sustainability is starting to appear high on the priority list since the region is vulnerable to the impacts of climate change — from urban pollution and heat waves, to flash floods and rising sea levels.
“Various incentives are now starting to appear in the region,” explains Brian Smith, EY Global Incentives, Innovation and Location Services Leader. “Whether it’s the Philippines providing incentives for setting up green data centers or installing solar panels to buildings, or Malaysia offering tax incentives to companies who undertake renewable or biomass energy initiatives.”
New US initiatives
Some of the most significant changes appear to be happening in the US. One of the first actions taken by the Biden administration after taking office in January 2021 was rejoining the Paris Agreement. This was a major step and signaled the new government’s policy direction. Further executive orders followed.
All US government vehicle fleets, for instance, will be required to purchase zero emission vehicles. Proposed sustainability regulations include rigorous new fuel economy standards aimed at ensuring full electrification of new light- and medium-duty vehicles, and annual improvement of fuel standards for heavy-duty vehicles.
There have been several proposals in the past for carbon taxes and border adjustments. This continues to be a focus area, and most recently there have been discussions about carbon border taxes as well.
An illustrative broad-based carbon tax starting at $25 per ton in 2017 and rising at 2% more than inflation would have raised $1 trillion over its first decade, according to the Congressional Budget Office.
While review periods follow executive orders, the Biden administration has demonstrated from the start that it’s committed to sustainability and cleaning up the environment. This is a significant step for the US and the rest of the world.
Have incentives been successful?
Some major policies have set the bar very high. The European Green New Deal includes a suite of standards, targets and reduction goals supported by incentives and tax policies. Jurisdictions like China, South Korea and Japan are aiming to be entirely carbon neutral within 50 years.
Naumoff says that in general, national-level incentives have been successful in targeted areas, including improving air quality, increasing adaptation of electric vehicles, and developing innovative renewable energy technologies.
He cites how an emission mitigation grant program introduced in the US has succeeded in reducing the nitrogen oxide (NOx) emission rate to a record low of 4.9 million metric tons in 2019, with the ultimate goal of rapidly removing 100,000+ tons of NOx from the atmosphere by 2027.
As has been seen in the US, what one national government administration may put in place, another may repeal. In Australia, for example, a carbon pricing policy introduced in 2012 was repealed following a change of government in 2014.
That was then. Now in 2021, the tide of public opinion, government commitment and business practices have turned. For example, applications for the first round of the EU’s Innovation Fund were massively oversubscribed as businesses with qualifying proposals scrambled to receive subsidized funding. From this perspective, this and other initiatives have successfully sought and gained support.
What about punitive measures?
More than 100 jurisdictions have implemented environmental protection fees, tariffs, or taxes to reduce corporate pollution, Naumoff explains. This includes air pollution non-compliance fees, increased excise duties on fossil fuels and fossil fuel vehicles, and taxes on carbon dioxide. These have been mostly successful in driving corporations to be more responsible and decrease harmful pollution.
“The impact can be felt especially in air quality standards,” he says. “In Europe, at least 16 countries have implemented air pollution fees since 1980 and this has resulted in a 40 percent-plus reduction of harmful air pollutants.”
But reacting to penalties is easier for some types of business than for others. For example, financial services businesses that do not produce much pollution are unlikely to fall foul of penalties, though they may take measures to reduce emissions from their buildings.
Energy generators and suppliers have a much more difficult job and can be major buyers of carbon emissions permits. Many of these are changing their operations to generate energy from renewable resources, but these are generally very large organizations that cannot change their operational models overnight.
Business impact and action
A business that operates within one state or jurisdiction may find it relatively straightforward to keep up with new local or national environmental legislation and regulation. Even then, the game can change quite quickly.
How much more demanding is it then to remain abreast of requirements and opportunities if the business operates across a number of jurisdictions, countries or regions?
Businesses need to know how environmental incentives and penalties will affect their operations, so they can make informed strategic decisions, minimize their risk, and benefit from the changing opportunities.
“A good first step is to consider your company’s existing practices,” says Naumoff. “This can be done through global carbon footprint monitoring of a business’s full supply chain, allowing a business to accurately understand the impacts of proposals in specific business units, markets, and geographies.”
This will also allow businesses to map out cross-border standardization of sustainability policies and minimize negative externalities.
“From an external perspective, tracking and monitoring legislative developments is crucial, especially under overarching policies such as the European Green Deal,” Naumoff continues. “While businesses have been making steady progress by prioritizing corporate environmental responsibility, it’s easy to lose sight of the holistic and detailed environmental impact. This results in unpredictable costs as new penalties and incentives are put in place.”
Akshay Honnatti, “It’s imperative that a businesses understand the landscape and how fast it is changing. “They need to know if new developments are material to their business. This leads to what decisions they can make to minimize the impact of these initiatives and benefit of the available incentives because everyone needs to make investments to meet the required high-level government commitments.
If you’re making those investment decisions without balance around incentives, you’re probably not doing justice to your stakeholders.”
It is critical to government sustainability incentives and penalties that everyone shares the burden. Businesses can, however, both lessen negative impacts and gain funding and tax benefits by adopting compliant strategies and practices.
This means getting to grips with new environmental legislation, regulation and initiatives wherever they do business, and putting in place processes and procedures that enable them to keep informed as these evolve and change in the months and years ahead.
This article has been sourced from EY Global and can be accessed here