Decarbonisation and tax

The Irish Government recently published the Annex of Actions to the Climate Action Plan 2023. It lists the greening of business and enterprise as one of six vital high-impact sectors. If this is to be achieved, significant investment is needed along with changes to existing business models.

Governments around the world are using tax policy to drive investment in decarbonisation and influence behavioural change. This has resulted in an evolving, complex and challenging tax environment. In this insight, we highlight the importance of quantifying and managing environmental taxes (including carbon taxes) in your business and the opportunity presented by the increasing number of green tax incentives and subsidies that can accelerate and reduce the cost of decarbonisation projects.

Decarbonisation projects include investments in renewable energy sources, green infrastructure and technology, energy efficiency, green research and development, and supply chain reviews. These projects tend to be driven by teams outside the tax function. In practice, tax can often be forgotten during the planning process. Like any business decision, there can be a significant tax cost for companies where tax is ignored at the outset and they ultimately get it wrong. This may have a material financial impact on the company and become a reputational issue. It is also important to be aware of the tax incentives and subsidies that are available for decarbonisation projects.

The tax considerations will vary depending on the project, but here are some key tax themes:

Carbon footprint and carbon pricing

Companies should measure and understand their existing carbon footprint. This includes direct and indirect emissions (i.e. scope 1, 2 and 3). This is the starting point for any decarbonisation plans.

Over 60 jurisdictions now impose some form of carbon pricing regime. This includes carbon taxes and/or cap and trade regimes, such as the EU Emissions Trading System (ETS). Companies should quantify their current exposure to carbon pricing and factor in any known future changes. For example, assess whether the EU’s new carbon border adjustment mechanism (CBAM) will impact the business directly as an importer or indirectly through the supply chain. For context, CBAM is a tax on importing certain carbon-intensive products from outside the EU into the EU. Another example is the inclusion of maritime transport in the EU ETS from 2024. 

Carbon pricing, which includes carbon taxes, is on an upward trajectory. This should be factored into future cash flow projections and considered as part of supply chain and decarbonisation reviews to ensure tax costs are included and to determine if savings can be made. Companies should also consider appointing someone within their business to upskill and take charge of carbon pricing and the associated carbon reporting requirements.

Other environmental taxes

There are an increasing number of environmental taxes, such as plastic, waste, water and fuel taxes. Like carbon pricing, companies should conduct impact assessments to understand and quantify their existing and future exposure to these taxes and identify areas where savings can be made as part of their decarbonisation projects.

Tax incentives and subsidies

Companies should also identify tax incentives and subsidies available to support decarbonisation initiatives. Different jurisdictions have taken different approaches and it is important for companies to keep track of these developments. For example, changes around subsidies and tax incentives for investment in green technologies are expected in Europe following the presentation of the Green Deal Industrial Plan by the EU Commission. In the US, the Inflation Reduction Act introduced many tax credits, subsidies and other provisions to help companies deliver on sustainability and carbon reduction projects.

In an Irish context, this might include the following:

• Accelerated tax depreciation for investment in certain energy-efficient equipment.

• Research and development tax credits. For example, a tax credit of 25% applies to the full amount of qualifying research and development (R&D) expenditure incurred by a company on qualifying R&D activities. This credit is in addition to the normal 12.5% revenue deduction available for the R&D expenditure, resulting in an effective benefit of 37.5%.

• The availability of grants and subsidies in Ireland and the EU, including low-cost funding options.

A decision to apply for a tax incentive or subsidy should also take into account some or all of the following:

• Understand the conditions that must be met to avail of the tax incentive or subsidy and whether it leads to additional tax compliance or reporting requirements (for example, more detailed disclosures in tax returns or reporting to tax or regulatory authorities).
• Consider whether the tax incentive creates or augments a tax loss and if there are restrictions on the utilisation of those tax losses that could reduce the financial benefit of the tax incentive.
• Think about the potential impact of Pillar Two rules, which aim to ensure that large multinational companies pay a minimum effective tax rate of 15%. If tax incentives result in the company falling below the minimum effective tax rate of 15%, a top-up tax could apply. This could also potentially dilute the financial benefit of the tax incentive. These rules are evolving, but this should be factored into the decision-making process.
• Consider the potential impact of the Foreign Subsidies Regulation (FSR), which is effective from 12 July 2023 for all companies (EU and non-EU) active in an EU market and which receive or have received governmental support from non-EU governments, in whatever form (for example grants, guarantees, fiscal advantages). The FSR may increase the regulatory burden to enter or grow EU markets for all these entities.

Value Added Tax (VAT)

VAT can have a significant cash flow impact on decarbonisation projects. It is important to ensure that the correct VAT treatment is applied.

VAT rules are also changing to encourage net zero investments. For example, a 0% VAT rate applies in Ireland to the supply and installation of solar panels for private dwellings from 1 May 2023.

VAT should be considered as part of the overall tax structure for decarbonisation projects and again at the implementation stage (including a review of the relevant transaction documents from a VAT perspective).

Tax structuring for decarbonisation projects

The tax implications for all aspects of decarbonisation projects must be considered before implementation. Some were referenced earlier in this insight. Another key consideration is a review of the funding structure (the issue of green bonds, for example) to understand if there are any potential restrictions to tax deductions for funding costs (including a review of interest limitation rules). Also, consider the application of withholding taxes and anti-hybrid rules. Transfer pricing may also be relevant when the project involves transactions with group or related parties, including the provision of loans.

Five key actions to take now

Decarbonisation should be a priority area for all businesses. Companies should consider the following actions today:

1. Measure your carbon footprint and exposure to environmental taxes

Carry out carbon pricing and environmental tax impact assessments. Measure where you are today and use this information to set meaningful short-, medium- and long-term decarbonisation targets.

2. Put processes in place to enable ongoing collaboration between decarbonisation teams and tax and finance teams

It is important to include tax at all stages of decarbonisation projects, from planning to implementation. Understand the tax costs, the tax opportunities and any conditions that must be met for all options under consideration. This includes direct taxes (including the potential application of Pillar Two rules and securing tax deductions for funding costs), indirect taxes, carbon and environmental taxes, tax incentives, subsidies and transfer pricing.

3. Keep up-to-date on tax costs, incentives and subsidies

The global tax landscape is constantly changing and becoming increasingly complex. It is important to keep up-to-date with tax policy developments and understand how taxes and incentives can significantly impact investment decisions in all jurisdictions where your company operates.

4. Technology

The ability to extract and report relevant tax data is becoming increasingly important. Tax authorities and other regulatory bodies increasingly demand more disclosures and information. For example, CBAM will require in-scope companies to share and rely on sustainability-related data. Technology solutions should be considered to monitor and track all taxes and incentives, including carbon taxes, environmental taxes and green tax incentives and subsidies.

5. Sustainability reporting

Consider including tax in sustainability reports. The management and reduction of carbon and environmental taxes as part of decarbonisation projects can be an important indicator of the success of decarbonisation strategies. Equally, total tax contributions may fall where green tax incentives apply, and it is important to explain this in a meaningful way to key stakeholders.

We are here to help you

At PwC, we help our clients understand the tax impact of decarbonisation and net zero strategies. Through our global network, we can work with you to quantify the relevant environmental and energy taxes that impact your business in Ireland and elsewhere. We can also help you identify, apply and comply with various environmental and energy incentives made available through decarbonisation activities. Our technology solutions will help you track environmental taxes and incentives and model key tax developments, including Pillar Two rules. If this is of interest, contact us today.