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Three tax challenges that will determine success on the road to ‘net zero’

The fiscal environment is swiftly moving into a period of immense change.

Tax and regulatory reforms designed to cut emissions and decarbonise the world's economies will affect every sector, challenging the usual framework business leaders operate in. This is creating risks and opportunities for them to manage.

Amid a groundswell of support for climate action, over 40 countries already use carbon pricing mechanisms either through carbon taxes or through cap-and-trade programmes. Together the current carbon pricing schemes cover about half their emissions, which translates to ~13 per cent of annual global greenhouse gas emissions.

At the same time, for many organisations in the energy and extractives sector, climate change will have a profound impact on the entire value chain and business operations. Tax needs to be at the heart of boardroom decisions, with tax leaders contributing to the strategy as their organisations and the world journey to a low-carbon future.

This is the first in our series "Tax and the road to net zero", which explores why heads of tax need to be involved in their organisation’s journey to ‘net zero’. This article considers three core challenges that tax leaders working in the energy and extractive sectors need to overcome to be an effective business partner and play a central role in strategic decision-making.

Subsequent posts in the series will explore:

  1. Three reasons why tax should frame big business decisions on the road to net zero
  2. Why tax managers should prepare for hydrogen and carbon capture, usage and storage (CCUS)
  3. How tax can support the business case for investments in technology
  4. Impact on Mergers and Acquisitions
Three core tax challenges

Everyone knows climate change is on the agenda. But far fewer tax leaders have had time to really understand what decarbonisation means for their role, company and industry.

Tax functions in energy and extractive companies can be tempted to focus on a selection of key jurisdictions that they need to monitor to stay current with tax and regulatory changes that affect their business.

However, as the world strives towards net zero, tax teams face three challenges:

  • Identifying and understanding new fiscal carbon related developments and how they affect their business;
  • Understanding the tax implications of business model changes; and
  • Keeping the tax function relevant as a business partner for changing times.
1. Identify and understand new fiscal environments and how they could affect your business

By monitoring and assessing developments across many jurisdictions and sectors, organisations can gain an advantage by spotting new trends early, quickly responding to new risks and capitalising on emerging opportunities as they transition to a low-carbon business model.

To enable their organisations to make the most informed strategic decisions and be a true business partner, tax leaders need to scan the horizon effectively for potential tax changes which could arise from global, regional, country, state and even municipal initiatives.

With much talk of green recovery as part of an overall COVID-19 recovery package, governments are on one hand looking at ways of stimulating their economies by providing incentives to invest in low carbon technology and infrastructure, whilst at the same time thinking about replacing lost tax revenues as tax take from ring fenced upstream oil and gas regimes and fuel duties decline.

Fourteen of the fifteen Taxing Energy Use for Sustainable Development (TEU-SD) countries collect energy taxes, which raise government revenues and affect incentives for more environmentally-friendly energy use. South Africa, the fourteenth largest greenhouse gas emitter in the world, implemented a carbon tax in 2019 to encourage cleaner practices and mitigate climate change.

The EU is considering introducing a carbon border tax on carbon-intensive imports by 2023 in order to address ‘carbon leakage’ (where manufacturing and other polluting activities move to countries with fewer constraints on emissions). This could potentially increase costs for EU importers and cause companies to re-consider their value chains.

Alongside the ‘stick’ of carbon pricing mechanisms and carbon taxes, governments will look to devise more incentives such as credits and grants to promote research and development, intellectual property ownership, development of green buildings and the use of renewable energy. Multinational businesses face the challenge of monitoring the vast array of such opportunities whilst assessing the diplomacy of accessing such schemes where corporate reputation may be at stake.

With the energy transition tilting many organisations to become more customer centric, even if carve-outs for extractive industries and commodities are sustained in the final outcomes of BEPS Pillar 1, energy and extractive companies will need to consider the potential impact of these policies.

2. Understand the tax implications of business model changes

Now is the opportunity for the tax function to be a strategic partner to the business. Many tax leaders are already trying to manage changes in their business models because of digitalisation and technology use. The acceleration of business model transition strategies towards low carbon, can give rise to tax risks and opportunities that are very different from conventional energy and resource assets. Some interesting examples that we have seen in practice include:

  • The energy transition presents energy and extractive companies with an opportunity to update their core purpose to reflect stakeholders' concerns over climate change. Communications to stakeholders in relation to Environmental, Social and Governance (ESG) matters should be carefully aligned with tax strategy, cooperative compliance efforts and external reporting of tax information.
  • Companies revisiting their portfolios to see whether existing assets serve their future ambitions – divesting assets with a higher carbon footprint and gaining assets or technology that will increase carbon efficiency or investing in renewable energy.
  • The tax risk and cash flow profiles of assets being gained are typically different from conventional energy and resource assets. On the vendor side, there’s increased consideration of the tax implications of future decommissioning costs; and, as for any large acquisition, purchasers are considering funding and investment holding structures.
  • Companies are also considering how they can decarbonise their core businesses by looking at how they source their own power needs and carbon usage within their supply chains. This could cause the physical relocation of part of the supply chain or in use of technology to adapt an extractive process. The increased use of technology can affect where value is created for the business. Tax leaders will want to look at how these drivers of value, such as a low carbon value chain and technology may change during this transition and, in particular, the ensuing implications for tax transfer pricing.
  • Where the cost of external borrowings has been tied to lowering an organisation’s carbon footprint, should this be included as a comparable uncontrolled price for internal lending?

We will explore some of these topics in greater detail in future blogs.

3. Keep the tax function relevant for changing times

The role of the tax team needs to change. In response to increased economic uncertainty, changing business models and sweeping fiscal changes, tax teams need to be equipped with the right technology, skills and resource model to allow them to deliver the tax strategy for the road to net zero.

Given these changes, tax leaders will need to strike the right balance between being a strategic business partner supporting business change, and at the same time dealing with all of the tax policy and technical changes whilst managing inevitable increased tax disputes due to the way COVID-19 has affected some business models and the wider economies.

Next steps

Tax leaders are approaching a period of immense global fiscal change amid ongoing economic uncertainty in the shadow of COVID-19. As organisations transition their business models towards net zero, tax departments have a vital role to play in decision making and strategy. Ensuring the tax function's skills and resources are relevant for these changing times will enable tax leaders to anticipate emerging risk events, help the business seize the opportunities within and be a trusted business partner within the organisation.

That journey begins by understanding what decarbonisation means for their role, company, and industry.

To discuss this topic further, please contact me or one of our dedicated energy transition tax team leaders.

A tax strategy for the road to net zero

What are the six questions tax leaders need to consider on the road to net zero?

Please download our report here

To learn more about our analysis of the cost of hydrogen in different demand scenarios and the implications for businesses, investors and policymakers, please get in touch.