Climate change has moved from the fringe of business to the mainstream. Far from a monolithic issue, it is a set of complex challenges that companies face on a strategic level and in day-to-day activities. Climate change has spawned new regulations and taxes, with more than 300 introduced worldwide last year. However, “green business” has also created opportunities for enterprising firms to serve new markets, develop innovative products and services and enhance their reputations in the process. Conversely, companies that are not responding to these opportunities may risk damage to their brand, a loss of market share, rising energy costs, and decreased interest on the part of investors and potential employees. In addressing these risks and opportunities, leading companies are undertaking a broad range of activities, many of which have tax implications.
“Greening the enterprise” can begin when companies switch to alternative energy sources and invest in carbon offsets. Or it can start smaller, with a decision to recycle, use energy-efficient lighting and take other steps to cut energy consumption and limit greenhouse gas emissions. Either way, it’s serious business: respondents at 150 multinational corporations surveyed by Ernst & Young LLP in 2009 indicated that over the next decade, their companies plan to invest $276 billion to manage the effects of climate change.
As green issues move higher on the corporate agenda, board members must ensure that management considers the tax implications, both positive and negative, of investments and activities related to climate change. Ideally, this will be done while such initiatives are still in the planning stage. Directors can maintain proper focus on green tax issues by keeping in mind the following principles:
1. Going green can improve corporate performance.
Companies are greening in response to real business imperatives, such as the need to protect and grow the revenue base. Organizations that design and manufacture climate-friendly products and services can take market share from competitors. Energy-efficient organizations that sell their credits on the carbon market can also profit in the new environment. Cost reduction is another imperative. By integrating clean tech into the value chain, companies can realize energy efficiencies that encompass operations, real estate, facilities management and IT. A recent McKinsey report suggests that in the U.S. alone, energy efficiency could save more than $1.2 trillion through 2020.
A third business imperative involves responding to government regulations in the form of mandated compliance and incentives to promote green behavior. Such regulations include the Environmental Protection Agency’s rule requiring companies to disclose their greenhouse gas (GHG) emissions starting in 2010, or the mandate by California Assembly Bill 32 to reduce GHG emissions. Finally, companies must manage the expectations of shareholders, employees, customers and the news media. All of these stakeholders increasingly hold businesses accountable for their environmental actions (or lack thereof). As companies move to address sustainability issues, they will likely make significant capital investments, and perhaps even develop new intellectual property. As firms respond to these four business imperatives, they will confront tax issues at the global, federal and state levels.
2. Climate change offers a window on the future.
Given the tumult of the last two years, trying to predict what will happen tomorrow may seem futile. Nevertheless, companies (and boards) must try. Although there is no crystal ball, involvement in sustainability initiatives can help directors sharpen their future vision of the enterprise. Mainly that is because the need to reduce carbon footprints, and to assess the risks related to climate change, are concerns that most companies have only recently begun thinking about seriously. Sustainability also creates new market opportunities, alters consumer preferences and buying patterns, reshapes procurement criteria to ensure green purchasing and offers the chance to transform business processes. Directors will take on additional responsibilities in light of new rules and regulations, and will need to manage the risks that emerge as those responsibilities evolve. Many of these risks and opportunities have tax implications. Giving the tax department a seat at the table during future sustainability planning can help the organization anticipate, measure and evaluate tax implications for each green business plan. In advising companies on a strategic course of action, directors inevitably peer into the future to discern what lies ahead. Keeping abreast of tax-oriented climate change influences can help them do it more effectively.
3. Numerous tax incentives exist to offset investments in energy efficiency.
Many of the investments needed to reduce a company’s carbon footprint can be offset substantially by government incentives. About $430 billion in climate change stimulus funding was made available globally in the last year, much of it in the form of incentives such as tax credits and grants. In the United States alone, the American Recovery and Reinvestment Act of 2009 (ARRA) provides more than $90 billion in tax incentives, grants and loan guarantees. Economic payback models that do not include the full suite of tax incentives could be misleading and result in decisions to scrap projects that otherwise would meet payback criteria. In fact, companies may be able to shave years off the payback period of their investments in energy-efficient technologies and renewable energy programs. Organizations that build or retrofit structures with new lighting or temperature-control systems may discover ways to deduct the associated costs, either on a current basis or over an accelerated period. Even conducting a retrospective review of capital investment from prior years may help identify refunds or additional tax savings. Effective planning is the key to accomplishing any of these objectives successfully. Tax directors can advise on which incentive programs are applicable, and whether incentives can be combined so that the company receives all allowable benefits.
4. Carbon management requires compliance.
Apart from the many sustainability activities that companies are undertaking voluntarily, there are mandated programs in the U.S. and abroad. Potential U.S. legislation mandates a cap and trade system, which could result in increased costs throughout a company’s supply chain. Multinational companies may already be dealing with GHG regulation such as the European Union’s Emission Trading Scheme. This legislative and regulatory activity is driving a rapidly expanding carbon market, and companies that intend to capitalize on the acquisition of carbon credits and offsets should involve their tax departments early in the process. Tax can provide valuable input on such issues as the appropriate accounting model for the company’s particular carbon management strategy. It can also identify the character and timing of potential gains or losses — a crucial consideration in the absence of GAAP or IFRS directives.
In addition, companies may find themselves exposed to new consumption taxes linked to energy. Just as many countries have for years taxed fuel used for transportation, so are the European Union, Canada, Australia and others now applying similar excise taxes to various forms of fuel consumption. Companies may also face less obvious tax consequences related to climate change. Existing and potential future trading schemes allow organizations to meet their carbon emission obligations through offsets: planting trees in non-forested areas in exchange for an offset credit, for example. What are the tax implications for international offset projects? Will the company realize taxable income from the sale of the credit? Will intercompany transfers of the credits create transfer-pricing issues? Are there ways to structure offset projects to minimize the tax impact? These questions must be considered carefully, and well in advance.
5. Cooperation between boards and tax can help the company respond more effectively to climate change.
Directors and corporate tax departments should monitor the results of global conferences on climate change—not because any single meeting will determine the exact direction of government initiatives, but because tax incentives and penalties developed by different countries will probably be designed around commitments made at those sessions. Tax departments can help companies prepare for the new compliance burden of any such initiatives, while monitoring international and domestic developments at various levels of government. Working more closely with boards, tax can help align corporate behavior and policies with the dynamics of climate change and sustainability. This kind of cooperation can enable the company to achieve both compliance and competitive advantage.
There is uncertainty about which companies will thrive in the new world of green business. What is clear, however, is that climate change and sustainability are about more than corporate social responsibility or concerns about global warming. While climate change certainly has a political dimension, it also affects the bottom line, which includes significant tax implications.
To advise company management, boards must focus on costs, potential benefits and risks to the organization. Board members should attempt to derive maximum value from their tax departments by including tax professionals early in the design and implementation of any corporate initiatives related to climate change.
Here are some examples of U.S. tax incentives to invest in energy-efficient technologies:
Federal
- Incentives for on-site renewable energy production
- Tax credits for manufacturing advanced energy components
- Credits and incentives to help offset the cost of increasing a building’s energy efficiency
- Deduction for cost of eligible energy-efficiency equipment in construction
- Loans for manufacturers to re-equip, expand and establish manufacturing facilities to produce advanced technology vehicles and their components
- Investment tax credits for qualifying energy facilitie
- R&D tax credit
State
- Credits and incentives to help offset costs of making a building more energy efficient
- Credits for renewable energy production
- Recycling incentives
- Credits for programs to train workers on sustainability
- Funding for “shovel-ready” projects
Kate Barton is Americas vice chair of tax services at Ernst & Young.
Steve Starbuck is Ernst & Young global organization’s Americas leader, climate change and sustainability services.
The views expressed herein are those of the authors and do not necessarily reflect the views of Ernst & Young LLP.