How sustainability is shaping global indirect tax

They must also consider the bigger picture and how the overarching global trends of global trade, transformation and sustainability shape the indirect tax function. This is the fourth of a four part series of articles that dive deep into each trend to help leaders frame the indirect tax discussion within their business, navigate the challenges and grasp the opportunities.

Tax authorities have an increasingly important role in encouraging citizens and businesses to make the necessary changes in lifestyle, manufacturing, packaging and purchasing decisions that help meet sustainability targets. For years governments have been leveraging indirect tax policies to achieve sustainability targets, and that trend is likely to continue in 2023 and beyond.

Governments use both the policy stick – for example, carbon levies, plastic packaging and excise taxes, waste management fees – and the carrot – for example, incentives for sustainable development. Indirect tax and trade functions are often at the heart of these policy decisions.

As the sustainability imperative grows, an increasing number of countries are vying to present themselves as the most attractive places to grow renewable industries. The European Commission recently unveiled its “Green Deal Industrial Plan” in part to match the United States (US) and China's clean subsidy push. The European Union (EU) bloc is set to loosen state aid rules on tax credits for green investment. The new measures give flexibility in providing aid to companies in the green and renewable energy sector and those involved in the decarbonization of industry. There will also be tax breaks for companies in strategic net-zero sectors.

The EU package is a response to a landmark US spending bill last year that funnels US$370b into subsidies for the US's energy transition. The Inflation Reduction Act (IRA) offers huge subsidies and tax credits to companies investing in electric vehicles and renewable energy technologies, such as batteries, solar panels and wind turbines, as long as the products and parts they manufacture are made in the US. Previously, there was a difference in green strategy, with the US policy of incentives compared to the EU policy of penalties and taxes. Now the EU is offering wealth of opportunities for grants, incentives, tax benefits and so on. And this is the time for businesses to explore them. But at the same time, new legislation is being introduced that requires businesses to prepare for upcoming compliance obligations and potential cost burdens.

This large and ever-evolving group of taxes and incentives creates pressure on businesses and their tax departments as the environmental tax landscape is evolving rapidly. One challenge for companies is keeping abreast of all the developments in every region in real-time. On top of that, they must understand how to comply and avoid falling foul of the new regulations as they evolve. They must understand and respond to the associated costs, which significantly add to the workload and spending on compliance activities while identifying the crucial opportunities to use tax credits and grants to fund their organizations' green ambitions.

Whose job is it?

The key for businesses is to assign responsibility and accountability effectively in response to these new measures. The risk is that they need to fit neatly into historic indirect tax capability, says Alwyn Hopkins, EY UK&I Advanced Manufacturing and Mobility (AM&M) Sustainability Leader, Ernst & Young LLP. "Take someone responsible for monitoring the new regimes and identifying ones that will potentially impact you. That's where we see businesses often falling down."

"We’ve seen examples previously where businesses have found themselves non-compliant with new environmental taxes they didn’t know existed because no one was monitoring developments in a specific territory – with new developments springing up ranging from a packaging tax in the Republic of Korea to chemicals taxes in Sweden and the US,” says Hopkins. “And in the last few years, the diversity and speed of implementation of these new regimes has significantly increased. As such, businesses need to have the right resources in place to identify them and to respond.”

Taxing carbon and CBAM

As governments work towards ambitious net-zero targets, they are introducing policies aimed at reducing emissions throughout the supply chain. One of the significant challenges facing indirect tax teams on sustainability is new regimes that the indirect tax team or the trade compliance team should be managing and responding to but are more akin to market-based mechanisms. They need to monitor evolving sustainability tax policies across the globe. The EU's Carbon Border Adjustment Mechanism (CBAM), for example, is due to enter into force in October 2023. The CBAM will initially cover specific products in some of the most carbon-intensive sectors – iron and steel, cement, fertilizers, aluminum, electricity and hydrogen, precursors, and a limited number of downstream products.

"CBAM is not technically an indirect tax; it's going to be paid via purchasing certificates worth a tonne of carbon each. But it's very close to an indirect tax, to the extent that most businesses we're talking to see the responsibility falling onto either indirect tax or trade compliance," says Hopkins. "That's challenging for a couple of reasons. One is because indirect tax needs more expertise in these complex, evolving topics. Despite CBAM using some familiar data points, tax teams are not fully prepared because they are rarely sustainability experts. They need to understand carbon pricing. That's a real challenge. Secondly, compliance is going to need new systems and data. That requires investment, and they might not be willing to push for that investment because they don't think they should own it."

Despite the fact that CBAM is not a tax or customs duty, but a regulatory policy measure, it is still connected to the customs function. There will be many businesses that find themselves not fully equipped. Organizing the compliance alone for CBAM is a significant piece of work. That includes finding the right data and ensuring it is collected at the correct time. "It is not something that can be done in a week; it needs a couple of months at least. That should not be underestimated. The obligations will start by 1 October this year based on current planning. That is not much time left. The financial burden is expected to kick in from 2026 onwards," says Richard Albert, Global Trade Partner, Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft.

Plastic waste and pollution

For indirect tax teams, plastic taxes present new data, technology, knowledge and cross-functional collaboration questions. Some of the biggest challenges facing indirect tax functions on plastic taxes are awareness and clarity about the scope of the new regulations. Additional obstacles may include a need for more completeness and accuracy of data, uncertainty about the responsibilities of business functions for plastic packaging taxes projects, and a fear of running out of time.

"There is a general consensus that the tax department is responsible for plastic packaging taxes. However, there is a recognition that other departments (especially strategy, purchasing, finance, supply chain and logistics) are needed. Some companies have not yet determined responsibilities, likely owing to the high level of cross-functional collaboration needed, which may be unchartered territory," says Sofie Van Doninck, EY EMEIA Plastic Packaging Taxes Leader, Indirect Tax Partner, Ernst & Young Tax Consultants.

The landscape in Europe, a region driving the rise in plastic taxes, has changed significantly. The UK introduced a Plastic Packaging Tax (PPT) as of 1 April 2022, and Spain introduced a similar tax in January 2023. These taxes may bring significant compliance challenges, both in determining what is in scope but also in obtaining and reporting the necessary data. And it is not just pure taxation that is creating new obligations related to packaging, including paper, card and aluminum. In the EU, Extended Producer Responsibility (EPR) schemes need to be revisited by the end of 2024, driving legislative measures in countries such as Belgium, Germany, Hungary and Poland. While EPR was recently enacted in the UK at the end of February 2023. With an unharmonized landscape across Europe, businesses must stay up to date on all new developments and be cognizant of the different rules in various EU member states.

To ease the burden, however, there are opportunities for indirect tax teams to leverage the work they have done related to PPT in the UK, and other countries for similar taxes and levies. Firstly, the data sets are often similar. The UK PPT legislation, while different, is closely related to the EU Plastic Packaging Levy, and subsequently to every EU member state that will apply the plastic packaging tax. Conceptually the points of taxation and components and products that are in scope are similar. "In a sense, the base is the same," says Danny Vu, EY UK&I Green Taxes Leader, Indirect Tax Director, Ernst & Young LLP. "There are differences in some exemptions and the secondary and tertiary packaging. But the infrastructure of the data set, i.e., the key characteristics that you have to identify and build within both your business and in suppliers and customers, they stay the same for the UK, Spain and Italy. So those are the live ones that we can actually compare to."

Secondly, it creates a blueprint on how to access the right data and how to troubleshoot the solutions. "UK PPT has helped us identify the work that clients have done to identify the right stakeholders to get that information that will also apply and is being mirrored in the other business units or to different countries, and this will also apply for UK EPR and the EU EPR," says Vu.

Thirdly, it helps determine who is responsible for plastic taxes. "The most important questions are, who is accountable? Who is in charge of reporting it? Who is in charge of paying it? And who is in charge of providing and cleansing the data?"

Seizing the opportunity

Enterprises should also be able to spot the opportunities created by new sustainability regimes. That often involves finance, tax and indirect tax teams, customs, supply chain and procurement. Incentives are a crucial part of many governments' sustainability policies. They are intended to bring change and drive specific behaviors, which is increasingly important with ambitious net-zero targets. It is essential to understand the different types of sustainability incentives available; appreciate the difference between statutory incentives, such as research and development (R&D) tax credits, and discretionary incentives, such as cash grants; and know how to approach each type of incentive.

The key is for the management of multinational companies to fully understand the relevant sustainability taxes in each country and what incentives are available to leverage, says Andrea Yue, Partner, Ernst & Young (China) Advisory Limited.

Key sustainability actions for indirect tax and trade functions:

• Understand your organization's plans to achieve its climate ambitions and get involved.
• Measure the impact of sustainability taxes and levies as well as related policy measures such as CBAM on your operations.
• Identify tax credits, grants and incentives that will support your organization's green agenda.
• Assign clear responsibilities.
• Assess exposure and liaise with relevant stakeholders within the value chain.
• Plan and implement your response to the new measures impacting the business. 
• Monitor developments to respond to new measures, opportunities and changes in a coordinated and timely manner.