Understanding the impact of environmental taxes
Unearthing the role that tax can play in reducing your organisation's environmental impact
Environmental, social, and governance (ESG) considerations are now wielding an increasing influence over corporate strategies and investment decisions. Many businesses now have a stated carbon reduction target, and most governments have committed to economy-wide targets aimed at moving towards net-zero emissions.
Organisations could benefit significantly from understanding the role tax plays in adding value to these goals. For instance, many organisations are already bearing the costs of existing environmental taxes. By understanding what these costs are, and why, can help define clearer strategies aimed at diminishing both these costs and, as a result, your organisation’s environmental impact.
“These taxes are mostly above-the-line operating costs on inputs to supply chains, including plastic, landfill, forestry-use, transportation, energy and, of course, carbon emissions. And there are more taxes coming.
The extent to which a business can absorb them or not depends on foresight and your organisation’s place and power in a supply chain.” Nicolas Alegria, Lead partner, Tax consulting, Grant Thornton Chile
This is most evident in industries such as transport or heavy manufacturing, but also applies to any entities that are actively making investments such as banks, private equity, and investment funds. For these organisations, it’s vital that any investment models and forecasts consider any future environmental tax burden on the organisations being invested into.
Through conducting this form of horizon-scanning, tax can add significant value simply by understanding what is going to affect your cost base and implementing change if that impact is significant. However, tax leaders must also be involved with ESG at a high organisational level to enact the change required, and to demonstrate the value of this tax-centric forward-facing analysis.
"There are more taxes coming. The extent to which you can absorb them or not depends on foresight and your place and power in a supply chain.” - Nicolas Alegria, Lead partner, Tax consulting, Grant Thornton Chile
Products facing new environmental taxes
Carbon is already a noteworthy focus for governments, and this is only likely to increase going forward. For example, the EU’s Carbon Border Adjustment Mechanism (CBAM) is a border levy that initially focuses on a list of products deemed to be heavily carbon intensive, including iron, steel, cement, and certain fertilisers and other chemicals.
Tax levied at the border will be based upon differences between actual carbon tax suffered, and that which would have been suffered had the product been made in the EU. Importers need to register under the CBAM from October of this year, with tax to start being paid from 2026 onwards.
The European Commission estimates that between €15 billion and €20 billion annually will be raised by the CBAM in the early years. The key for your organisation is to understand if you will directly suffer this tax, or whether costs will be passed onto you.
While CBAM is a border levy, however, certain countries have introduced direct carbon taxes locally. Singapore, for example, has set a target of achieving net zero emissions by 2050, which led to the carbon tax regime being introduced in 2019. It started at a low base, with a current rate of S$5 per ton of greenhouse gas emissions. But is set to rise and could potentially reach S$80 per ton as soon as 2030.
“The carbon tax has resulted in a higher cost of living in Singapore. In particular, an increase in electricity tariffs is expected. The Singapore Government has provided grants to certain households to fund the purchase of energy efficient equipment. As for MNCs that are directly impacted, many are aware of the additional cost of doing business in Singapore.” Eng Min Lor, Partner, Tax services, Grant Thornton Singapore
The Monetary Authority of Singapore has also been encouraging financial institutions to adopt environmentally friendly financial practices and to integrate sustainability into their operations. As a result, many Singapore-based banks have announced plans to support sustainable development and transition to a low carbon economy by eliminating exposure to non-green financing such as coal-fired power plants. Instead, the focus is on renewable energy projects, green buildings, and sustainable infrastructure development.
Another country that has implemented similar measures is Chile. Chile currently has three taxes on emissions from mobile and stationary sources, established in 2014, 2016, and 2020 respectively. The latest modification came into effect this year, expanding the entities that are subject to the tax.
“This year, a bill is expected to be introduced to gradually increase the tax on CO2 emissions and a new emission compensation scheme will be introduced to provide benefits and incentives to companies that choose to use fewer polluting fuels.” Nicolas Alegria, Lead partner, Tax consulting, Grant Thornton Chile
"The more carbon tax you have already suffered in the supply chain, the less CBAM you should suffer at the border." - Dan Dickinson, Partner, Tax, and ESG and Tax lead, Grant Thornton UK
How will the CBAM influence the global economy?
In isolation, the EU’s CBAM may help certain economies that already have existing carbon taxes in place when considered in isolation. The more carbon tax that has been incurred before a product reaches the EU border, the lower the CBAM you will have to pay.
“From a UK steel industry perspective for example, it may be the case that exports to the EU start to look slightly more competitive given that the UK already has a relatively high carbon tax burden. But the carbon tax has been suffered and potentially will be passed through the supply chain, it’s just been incurred elsewhere rather than at the EU border.”
Dan Dickinson, Partner, Tax, and ESG and Tax lead, Grant Thornton UK
Over time, certain organisations may look to push for global coordination on this, with recent OECD work already in this area. This raises the question of whether there will be a longer term move towards harmonisation, given both the importance placed on this issue by global governments and the potential for tax competition and inflationary impacts.
Scanning the horizon for further value
When considering the impact of tax on ESG and the value it can add, there’s a clear need for organisations to conduct thorough horizon-scanning. Outlining what countries’ policies will impact your organisation’s direct cost-base, what costs are being passed on by suppliers, or even the cost-base of the entities you invest in, will allow you to develop a much more informed strategy around tax and ESG. You need to understand supply chains and keep a close eye on where policy appears to be heading in the key countries related to those supply chains.
According to Dan Dickinson, Partner, Tax, and ESG and Tax lead at Grant Thornton UK, “this horizon-scanning must then be overlaid onto the environmental data that your organisation is already producing” He continues by stating that, “if you take carbon as an example, your organisation is likely already measuring emissions and actively looking to decrease them. You can overlay tax sensitivity onto that data to see how much tax costs might increase in the future due to carbon emissions.”
Tax has an impact on every facet of an organisation’s ESG agenda, and this type of proactive approach will enable you to add the most value possible from a tax point of view. As tax leaders, the more involved you can get with ESG at your organisation, the earlier you can make an impact.