The role of Tax in the green transition

In today’s competitive marketplace, a company’s Environmental, Social and Governance (ESG) policy may have a significant effect on its prospects. It is no surprise, therefore, that more and more investors are incorporating sustainability criteria in their investment decisions.

Sustainable development is also one of the fundamental principles of the European Union (EU) and a priority objective for its internal and external policies. The EU had an active role in shaping the global 2030 Agenda for
Sustainable Development, a landmark achievement that provides for a shared
global vision towards sustainable development for all.

The 2030 Agenda and its 17 Sustainable Development Goals (SDGs) have pushed global efforts for achieving sustainable development, and the European Commission (EC) has been focusing on concrete actions to achieve tangible results. Several transformative initiatives have been launched, such as the European Green Deal, the Climate Law, the European Pillar of Social Rights Action Plan, to name a few.

This article explores the ways in which Cyprus is heading towards responding to the key EU and global policy objectives around environmental sustainability and the importance of tax incentives in the furtherance of these objectives.

The European Green Deal and other initiatives from the EU

One of the targets of the EU is to make Europe the first climate-neutral continent by 2050. To achieve this, the EU Council and EU Commission, established the European Green Deal (EGD) back in 2019, a strategy to address climate change and reach climate neutrality. The EGD aims to balance environmental concerns, such as reducing resource usage and greenhouse gas emissions with continued economic growth. This balance can only be achieved by implementing and enforcing strong sustainability and reporting
standards for companies residing and operating in the EU.

In addition, the EC adopted the “Fit for 55”, a set of policy proposals to put in place new initiatives to ensure that EU policies are in line with the EU climate goals. In particular, Fit for 55 aims to reduce greenhouse gas emissions (GHG) by at least 55% by 2030.

Ιn the context of the Fit for 55 Package, the EC has adopted a recast Energy Taxation Directive, which should play a central role in the taxation initiatives both at EU and Member States level. The Directive aims to ensure that the taxation of energy products in the EU (motor and heating fuels, electricity) reflects their impact on the environment and on our health. The main changes to the revised Directive are the following:

• Fuels will no longer be taxed according to their volume, but rather based on their energy content and environmental performance.
• A hierarchical categorisation of fuels takes place whereby those having a higher impact on the environment are taxed the most.
• The phased abolishment of exemptions for certain uses of fossil fuels.
• Fossil fuels used for intra-EU air transport, maritime transport and fishing will no longer be fully exempt from energy taxation in the EU.

As part of the European Green Deal, the EU also published Council Directive (EU) 2022/542 (“the Reduced VAT Rates Directive”) that allows Member States the possibility of reducing VAT rates for environmentally friendly goods, such as solar panels and electric bicycles, to as low as 0%.

The EU’s intention is to also encourage an eventual shift from environmentally harmful supplies that may currently enjoy preferential treatment through reduced VAT rates. For example, reduced VAT rates for fossil fuels and other goods with a similar impact on greenhouse gas emissions, such as peat and
wood used as firewood shall cease to apply by 1 January 2030, and for chemical pesticides and chemical fertilisers by 1 January 2032.

Cyprus’ commitment to a green transition

As one would expect, creating a sustainable Europe requires significant financial resources. The Recovery and Resilience Facility finances EU Member States for such reforms after assessing each Member State’s Recovery and Resilience Plan (RRP). In particular, the RRP of Cyprus was developed around five policy axes, one of them being the “accelerated transition to a green economy”. The key measures included therein are:

• Green taxation: introducing a carbon tax for fuels, a gradual introduction of a levy on water, and a charge on landfill waste. A proposed green taxation framework has been created to this effect and was subject to public consultation in July 2022.
• Energy efficiency and renewables: financing various support schemes to implement energy efficiency measures and renewable energy investments and to combat energy poverty.
• Energy interconnector: contributing to the EuroAsia Interconnector project, which will connect Cyprus to the EU electricity network and boost renewable energy production.
• Promoting sustainable and green mobility: encouraging a shift from private cars to public transport, cycling, walking, and promoting the use of clean vehicles.

Fiscal incentives in Cyprus

Several countries have introduced sustainability-related tax incentives, that mostly take the form of super-deductions or tax credits. Cyprus has yet to implement such incentives. Studying the lessons learnt in other EU countries with respect to implemented fiscal incentives, could help Cyprus frame effective incentives in the future. These incentives could be “financed” by the taxes/levies/charges to be imposed within the green taxation framework.

Two main arguments support the existence of fiscal incentives. The first is that certain consumers/entities may have the financial capacity to not be overly concerned about avoiding taxes/levies/charges and others may not have the operational capability to meet certain regulations. Hence a system that only relies on taxes/levies/charges to instigate action in such consumers/entities will not prove to be very effective.

The second argument is to shift the culture of the green taxation framework from rather “punitive” to more encouraging and inspiring. More specifically, a purely punitive system may cause resistance, while a more encouraging system is likely to cause agreeability. Incentives could therefore instigate certain desirable and practical actions, through economic and reputational benefits.

One could argue that financial incentives could serve the purpose advocated in relation to fiscal incentives. Although this could partly hold true, it is often the case that one has to go through a process to apply for a financial incentive and meet various criteria to be eligible for it. This limits the (perceived) availability of the incentive.   

It is understood that the inclusion of tax incentives in the green taxation framework is under consideration by the State. To ensure appropriate tax incentives are designed and offered, timely public consultation should take place, in order to effectively encourage change in practices and consumer behaviour.