Why life sciences tax departments need to act now on sustainability

Life sciences organizations should consider tax liabilities and compliance obligations resulting from myriad new sustainability taxes.

In brief

• Governments and international institutions increasingly focus on sustainability taxes. Sixty-five carbon pricing initiatives have been implemented globally.
• It is prudent for life sciences to engage with stakeholder groups to assess and to quantify the impact of sustainability taxes on their business.
• Tax and finance functions need to have a seat at the ESG strategy planning table. They are often overlooked while organizations develop their ESG strategies.

As governments strive to take the lead on sustainability, we are witnessing a global proliferation of new taxes, incentives and funding programs as part of a “carrot and stick” approach to driving greener activities and behaviors.

There are several areas affecting life sciences companies from a tax perspective that we often refer to collectively as “Sustainability Tax.” These include pertinent tax policy, tax compliance and reporting, tax impacts of supply chain decarbonization, government reporting and tax disclosure, and new sustainability-related taxes and incentives.

In the EU, a climate law and plastics levy has already been introduced, and the first plastic packaging tax (PPT) was enacted on 1 April 2022 in the UK. 

Additionally, there is the potential for companies to leverage available “green” incentives and funding programs to generate a greater return on investment on related capital investments. These incentives aim to encourage organizations to reduce global emissions and natural resource consumption by switching to alternative energy sources and focusing on low-carbon and product innovation. In August 2022, the US Congress passed the Inflation Reduction Act.¹ The Act offers incentives to accelerate renewable energy, improve the energy efficiency of buildings and advance the adoption of electric vehicle (EV) technologies.

To prepare for the coming wave of sustainability tax developments, life sciences organizations should do the following:

1.    Focus on optimizing internal functions

• Create end-to-end governance. Corporate governance focuses on an organization’s ability to act in a compliant and ethical way towards employees and stakeholders, which is paramount in the highly regulated life sciences industry.² It is imperative to ensure that the tax policies and corporate governance structures are aligned and have clear control. The processes within the corporate governance and communications framework should support proactive tax decision-making and its management on sustainability linked issues.
• Prioritize long-term value and value-led sustainability. According to a 2021 GlobalData survey, 70% of respondents believe that the pharmaceutical industry is not doing enough to become more environmentally sustainable.³,⁴ Organizations need to put long-term value and value-led sustainability at the heart of their business strategy and be better prepared to respond to the volatility triggered by unpredictable future challenges. It will help them to measure value to shareholders and stakeholders alike. Pharmaceutical organizations are formalizing sustainability metrics and benchmarks to measure their progress. The regulatory environment, evolving urgency from climate science, customer and shareholder expectations and technology moving from a cost to a saving position are the driving factors for evolving corporate commitments to sustainability.⁵
• Model the organization’s current and potential global ESG tax challenge. With continuously evolving tax rules worldwide, life sciences organizations need to update their tax strategy to model increasingly complex tax scenarios and model the impact of changing tax rules around the world. Many sustainability taxes will include exemptions that could be particularly relevant for life sciences companies. They could vary by jurisdiction, including medical exemptions for pharmaceutical or medical device packaging PPTs, like extension and modification of Internal Revenue Code (IRC) section 48 investment tax credit (ITC), provision of electric vehicles (EVs) and other energy-efficient technologies and clean fuels as proposed by IRA 2022 in the US.
• Model the organization’s carbon footprint. Every stage of the pharmaceutical supply chain has a carbon footprint, starting from sourcing raw materials for active pharmaceutical ingredients.⁶ Knowing the size of an organization’s carbon footprint and its composition helps quantify the exposure from ESG reporting and carbon-related policy changes and identify potential focus areas for mitigation strategies. Organization-specific financial modeling and scenario planning can be helpful tools as organizations work through these issues.⁷ The life sciences industry is at an innovation pivot point, with new technologies being deployed through the supply chain and to produce new technologies and medicines. Modeling enables measurement of indirect tax effects of changes to pharmaceuticals or the supply chain.

2. Capitalize on incentives, exemptions and fundings

The life sciences industry consumes large amounts of energy due to the unavoidable need for cleanrooms.8 Approximately US$1 billion worth of energy is utilized by pharmaceutical organizations in the US every year.9 As tax regimes are evolving and energy costs are rising, global environmental and energy tax incentives are becoming increasingly relevant for life sciences organizations. These changing regimes have motivated life sciences organizations to establish sophisticated energy management and sustainability strategies. Ten leading pharmaceutical organizations are collaborating with Schneider Electric to increase access to renewable energy.10 Organizations can also target exemptions offered by governments from environmental taxes for certain qualifying products, uses or taxpayers to promote “green” behavior. More than 40 countries are offering sustainability incentives to drive green initiatives and economic growth by lowering costs.11

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The table lists the different types of sustainability incentives prevalent globally. The first column mentions the count of global sustainability incentives categorized by focus of the incentive in column 2. The classification is based on the aim of the incentive i.e. whether it aims to encourage a reduction in natural resource consumption or a switch to renewable or alternative enegry sources or innovation in research and development including new low-carbon products and manufacturing processes. The third column provides examples of incentives that include tax credits, exemptions, grants, and loans.

Life sciences organizations can utilize power purchase agreements (PPAs) to achieve carbon-neutrality goals. These can move businesses closer to achieving carbon-neutrality by lowering scope 2 emissions (emissions from the purchase of energy) and can help with scope 3 (value chain) emissions.¹² In 2019, a large multinational organization seeking to accelerate its move toward sourcing 100% electricity needs from renewable sources by 2025, signed four new power purchase agreements totaling over 370,000 megawatt-hours (MWh) per year.¹³ A multinational organization with revenue greater than US$50 billion signed five virtual PPAs (VPPAs), where no physical exchange of energy takes place, in 2020, collectively adding more than 275 megawatts of clean power. This move makes it the first pharmaceutical organization set to achieve 100% renewable electricity in its domestic operations through VPPAs.₁₄

3. Make use of third-party policy tracking

Third-party policy tools can provide a snapshot of carbon, environmental and sustainability taxes, and incentives and exemptions around the world, including government actions to meet commitments to carbon-neutrality and emissions reduction. Take, for example, the EY Green Tax Tracker, which identifies more than 3,700 sustainability incentives globally, including tax credits, exemptions, grants and loans. These incentives are generally divided into three categories, with many programs a mix of the three:

• Encouraging a reduction in natural resource consumption
• Encouraging a switch to renewable or alternative energy sources
• Encouraging the development of new low-carbon products and manufacturing processes

4. Take an active role in the planning of tax legislation around sustainability

Tax policy and regulation are tools that support the wider sustainability transition and transformation. So it could benefit organizations to play an active role in engaging with wider business and policy context for sustainability goals.

Life sciences organizations are engaging with policymakers at the country, state and local levels to further policy frameworks. A large multinational organization supported the position of various advocacy organizations on the idea of allocating true price to carbon as an effective measure in mitigating climate change. The organization has set and implemented shadow price on carbon of US$100 per ton CO2e, in order to represent the true cost of climate change and to have a relevant influence on energy costs. Recently, a policy institute has been created to promote carbon dividends framework in the US and includes among its founding members many of the country’s largest life sciences organizations.

5. Monitor changes to ESG and sustainability tax policy and their potential impact

Globally, 36 jurisdictions have implemented a carbon tax, including several key markets for life sciences companies, such as Mainland China, Japan, Singapore, portions of the EU (18 jurisdictions have implemented carbon taxes at the national level) and the UK.15 Twenty-nine other jurisdictions are discussing carbon pricing schemes. Governments have also started to levy taxes on plastics used in packaging besides already implemented regulations for single-use plastic (SUP) items or extended producer responsibility-related measures.

For the reasons discussed above, life sciences companies must prepare now for the current and anticipated sustainability impacts facing the entire business, including their tax departments. Organizations must be aware of the environmental or green taxes levied to discourage them from engaging in anti-ecological business practices. The new generation of plastic packaging taxes challenges businesses concerning data and document availability. Alignment among several stakeholders within the business is critical. Additionally, lacking harmonization of sustainability rules, for example, plastic packaging taxes across Europe, leads to even more complexity and a need for analysis.

The authors would like to thank the following individuals for their contributions to this article:

Dheeraj Gour, Senior Analyst, Health Sciences and Wellness, EY Knowledge

Kaveri Mahajan, Assistant Manager, Health Sciences and Wellness, EY Knowledge