How tax departments should prepare for CBAM

Tax functions need to plan for the challenges CBAM will create and identify the potential opportunities it offers.

In brief

• Key legislative elements of the "Fit for 55" package have been approved. Companies should review the new requirements and reporting obligations.
• Companies should determine the ownership and role of tax in the CBAM process.
• CBAM can act as a catalyst for restructuring initiatives, and its implications extend beyond the EU, making it crucial that tax leaders adapt their strategies.

The introduction of the Carbon Border Adjustment Mechanism (CBAM) by the European Union (EU) is further evidence of decarbonization commitments by governing bodies. But are companies prepared to take what could be seen as supply chain barriers and reshape them into building blocks for their own carbon ambitions?

CBAM is more than a regulatory policy measure, it will also be a policy that blends aspects of both tax and customs duties, so it is intrinsically connected to the customs function. Many companies may find themselves not fully equipped for the policy requirements. The data and processes for compliance could create a significant amount of work. For already overworked departments, identifying ownership of CBAM at a company could be a challenge. Should the tax department drive the effort or be a part of the larger team?

A quick recap

In April 2023, the European Parliament approved key legislative elements of the "Fit for 55" legislative package: European Union Emission Trading System (EU ETS) reform and the new EU CBAM. Affected companies will need to understand the new requirements and upcoming reporting obligations. The EU's "Fit for 55" legislative package, initially announced in July 2021, is viewed as a critical enabler for helping Europe reduce emissions by at least 55% by 2030 (from 1990 levels).

CBAM will take effect in October 2023. Until the end of 2025, importers will be subject to CBAM reporting requirements. CBAM will become fully operational in 2026. It will initially cover specific products in some of the most carbon-intensive sectors – iron and steel, cement, fertilizers, aluminum, electricity and hydrogen, including precursors and a limited number of downstream products in these product categories. The CBAM's main objective is to reduce "carbon leakage" and incentivize the EU's global trading partners to decarbonize their heavy-emitting sectors.

Leading in the gray zone

One of the primary hurdles companies face is determining who should own the CBAM process. Tax departments are often hesitant to take on this responsibility, as CBAM is a regulatory measure rather than a tax. The governance of CBAM often falls to departments such as procurement, supply chain, or environmental, social, and governance (ESG) functions. This lack of clarity creates a void where departments are slow to assume accountability, leading to potential inefficiencies.

"The challenge is that CBAM sits in a gray area, involving multiple business departments, with ownership stakes," says Richard J. Albert, Partner, Indirect Tax, Global Trade, Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft. "We hear from companies that, in most cases, tax doesn't take charge. Often, the sustainability function, procurement, or the supply chain function takes a leading role. The key for companies is to discuss the best option for them. Who should own it will depend on the company profile. There is no simple answer. It should be determined by the capabilities that a company has, respectively, their structure and exposure to CBAM."

Tax may not be the driving force behind CBAM, but it can contribute significant input and value into the process. This can include supporting the reporting and compliance functions, as well as considering potential transfer pricing implications in the future.

Engaging with companies reveals varying perspectives on CBAM and restructuring initiatives. Some companies have dozens of entities across Europe, necessitating comprehensive reporting. This prompts discussions around restructuring procurement, importation and supply chain activities, which may have long been contemplated but are now accelerated by CBAM.

Global impact of CBAM

Although CBAM is an EU policy, non-European companies are increasingly conscious of its implications. Companies outside the EU, particularly in Asia and the Middle East, have proactively addressed CBAM-related challenges. “CBAM is levied on the emission occurring upon manufacture outside the EU when those goods are going into the EU. So it implicates the competitiveness of those non-European exporters. If they want to stay relevant, they need to deal with it,” says Albert.

The impact of CBAM on non-EU countries will vary depending on their trade patterns and carbon pricing policies. Countries that export carbon-intensive goods to the EU will be the most affected. The potential for CBAM-like policies to emerge globally makes it crucial for tax leaders to stay informed and adapt their strategies accordingly. Given that the EU CBAM provides credits for home country carbon pricing, successful strategies may include the establishment of carbon pricing systems. With the rise of carbon pricing in more and more countries, by way of Emission Trading Systems, carbon taxes and Border Adjustment Mechanisms, the pressure to decarbonize increases as regulatory costs from carbon pricing will severely impact the competitive position of emission-heavy products.