How tax can support supply chain resiliency and transformation

The increasing complexity of the global regulatory landscape, which includes green taxation and related regulations, has become a major new consideration that supply chain leaders should account for when planning for future shape and increased resilience of the supply chains. Green taxes and related regulations have the potential to adversely impact multinationals’ cost base, ability to trade and revenues. They are simultaneously giving rise to new trade-related compliance burdens. Hence, horizon scanning and planning for green taxes and related regulations is key for maintaining competitiveness, profitability, and growth.

The relative novelty of sustainability regulations brings uncertainty and ambiguity, with multinationals often struggling to identify and appraise current and upcoming regulatory requirements on their business. The interconnected nature of the global regulatory environment can often exacerbate this challenge with jurisdiction-specific rules potentially impacting operations in multiple countries, especially international trade-related regulations. Other cases include individual jurisdictions choosing to implement global or regional rules in different ways, for example when transposing an EU Directive into member states’ legislation.

Addressing regulatory, green taxation, and other complexities when managing risks and building supply chain resilience requires collaboration internally across business functions and externally across the full value chain.

Increased disclosure

Until recently, sustainable supply chains were a voluntary endeavor with multinationals greening their supplier networks to appeal to environmentally aware consumers and investors. Now, however, an uptick in regulation, green taxation, and transparency requirements means that polluting aspects and activities of supply chains either trigger potentially material taxes, levies and charges, require investment or need to be disclosed. In fact, if one focuses only on greenhouse gas (GHG) emissions pricing related regulations, there are over 70 carbon pricing initiatives in place globally², such as domestic carbon taxes and the EU’s Carbon Border Adjustment Mechanism (CBAM), and more than 3,000 green taxes, levies and fees.

Meanwhile, jurisdictions are encouraging investments into more sustainable supply chains and materials through tax incentives, grants and financing opportunities, with more than 1,850 ESG tax incentives available globally, according to the latest quarterly EY Green Tax Tracker.

The European Parliament, for example, has recently adopted a wide range of sustainability regulations that will significantly impact organizations within the EU and outside the trading bloc. These include the CBAM, the EU Deforestation Regulation (EUDR), the EU Ecodesign for Sustainable Products Regulation (ESPR) and the EU Corporate Sustainability Due Diligence Directive (CS3D).

CBAM, which took effect in October 2023, effectively places a levy on imports of selective materials and products from the most carbon-intensive sectors such as cement, fertilizer, iron and steel, aluminum, electricity and hydrogen. CBAM’s impact is driven by several factors, including whether the exporting country has a carbon pricing regime with certain qualifying features, as well as the ability to contract directly for clean energy. CBAM is designed to address the risk of carbon leakage, which occurs when companies move production to countries with less stringent carbon policies or when locally made products are replaced with more carbon-intensive imports. It also is meant to encourage the setup of domestic carbon pricing regimes.

Meanwhile, EUDR covers specific cattle, cocoa, coffee, oil palm, rubber, soy, and wood products imported into, traded within, or exported from the EU. It aims to be sure that the production of these commodities hasn’t led to deforestation or forest degradation. It also checks that they were produced in compliance with local laws, including human rights, anti-corruption and tax, trade, and customs legislation. The regulation is effective from December 2024 and looks at land use change from December 2020.

The EU Ecodesign for Sustainable Products Regulation (ESPR) is a part of the Circular Economy Action Plan and is considered one of the most transformational and disruptive pieces of the EU Green Deal package. It promotes product sustainability by imposing eco-design requirements on a wide range of products and sectors such as iron, steel, aluminum, textiles, chemicals, electronics products and similar goods. A key element of the ESPR is the Digital Product Passport (DPP), which requires digital reporting of comprehensive product information to stakeholders, facilitating environmental compliance management.

Human rights and environmental violations

Lastly, beginning in 2027, CS3D will aim to prevent and reduce human rights and environmental violations within an organization’s own operations, by subsidiaries, by upstream suppliers and by downstream suppliers in connection with the storage, distribution and transportation of goods.

Organizations must address social aspects, such as forced labor, exploitation of workers, child labor, just and favorable conditions of work, fair and adequate living wages, unequal treatment in employment, the right of freedom of association, and environmental aspects such as GHG emissions, deforestation, pollution, handing of hazardous wastes and chemicals, protection of the ozone layer, use of mercury, and water use.

Seventy percent of attendees at a recent EY roundtable said they were not confident or did not know how their organizations were responding to this complex and often overlapping patchwork of new ESG regulations.

Collaboration, internal and external, is key to making sense of this fast-evolving landscape and achieving sustainable supply chains. Internal collaboration includes key functions such as sustainability, procurement, legal and risk. The tax department also has a critical role to play in ensuring compliance with the current regulations and protecting the supply chain’s cost base. Tax can also, together with the regulatory team, highlight upcoming green taxes through horizon scanning, allowing executive management to plan and to identify links in the supply chain that may put value creation and the cost base at risk without appropriate planning and intervention.

For example, CBAM and EUDR compliance will require deep data-mining capabilities that will allow companies to trace the goods moving through their internal and external global value chain. The trade function needs to be able to identify raw materials, work in process, and finished inventories at a highly detailed level (by harmonized tariff schedule coding) to determine which regulatory frameworks they may fall under. Thereafter, a range of stakeholders, including tax, law, regulatory, the sustainability office and procurement, will address additional legislative and regulatory requirements and their application by individual countries.

As a result of macro factors and new business models, there has been a gradual shift of activities from some well-established manufacturing centers to countries closer to suppliers or customers. The share of Chinese goods and services exported to the West, for example, has fallen in recent years, with the proportion of US imports originating from China dropping to 16.5% in 2022, down from a peak of 21.6% in 2017. This was not due to a downturn in global trade, as US imports reached an all-time high of US$3.2 trillion (about US$9,800 per person in the US) in 2022. Instead, the US replaced Chinese goods and services with imports from neighboring Mexico, among other locations.³

The central role of tax functions

Tax functions, with their oversight of tax environments across jurisdictions, have a central role to play in helping C-suites identify, model and choose the most suitable location(s) for purposes of diversifying and de-risking supply chains. Tax functions understand, and can model, tax regimes in different countries, from traditional direct and indirect taxes, sometimes even the international trade measures, to the newly emerging green taxation and continuously growing incentives and funding. Transfer pricing policies and pro-active controversy management strategies are contributing to the return of investment of often centrally developed and locally deployed innovations, including innovations related to improving the sustainability of supply chain operations.

According to Jay Camillo, EY Global Operating Model Effectiveness Leader, the role of a company’s tax function should include tracking taxes and tax incentives in target jurisdictions and understanding how they can help the wider organization design its optimal supply chain diversification strategy.

“If a multinational wants to relocate its plant or de-risk its supply chain by moving it to a new location, most countries are likely to welcome the investment with open arms,” Camillo says. “You can expect this to take the form of attractive tax incentives, investment credits and subsidies.” The UK, for example, offers R&D tax relief up to 186% while the US Inflation Reduction Act offers various tax incentives for firms investing in sustainable technology, with the EU Green Deal offering a blend of incentives, taxes and levies.

This is one area where tax professionals shouldn’t wait to be consulted but rather should work proactively with the C-suite to match operationally attractive jurisdictions with new strategically important tax incentives.

Stals says that when organizations have detailed knowledge of how their supply chains are configured, they are better placed to identify risks, weaknesses, develop potential resilience strategies, establish redundancy and flexibility, and respond to and recover from unanticipated risks or disruptions. Furthermore, it enables them to be compliant.

Tax authorities are also gaining increasing visibility over supply chain transactions to ensure appropriate amounts of VAT and customs duties are being remitted.

“While tax authorities are using big data analytics to search for compliance, companies are using the same technology to predict supply chain disturbance and calculate the downstream impact on sales and operational planning,” Camillo says. “Tax teams also want transparency so they can track trade, ESG aspects and taxes, and other elements of their compliance role, while at the same time looking for opportunities to layer on emerging ESG tax and incentives benefits resulting from rapidly changing supply chains.”

Supply chain transparency can help tax functions achieve two major objectives. The first is improved governance of the existing business structure, monitoring exposure to existing and upcoming (green) tax positions and maintaining compliance. The second benefit is identification and utilization of opportunities such as tax incentives. This is only possible, however, if tax functions are actively involved in operational decisions.

"The majority of companies are in the process of comprehensively assessing the impact of their activities on the environment and society and also the impact of current and upcoming green taxes, regulations and incentives on their business,” says Alenka Turnsek, EY Global Sustainability Tax Policy Leader. “Multinationals will increasingly need to know where their value chains are exposed to environmental levies and taxes and other impacts. That’s where the tax function comes in.”

Turnsek says that more companies are starting to analyze the different layers of their supply chains, both upstream and downstream. This includes building data repositories for value chain-wide data with their customers and suppliers and applying technology such as data analytics and AI to generate insights. These efforts are intended to support redesigning their strategy and governance around managing green taxes, incentives in the context of achieving wider sustainability goals. By aligning (green) tax considerations with sustainability goals, companies can redefine engagements within the existing supply ecosystems and collaborate with new partners. Newly forged alliances and redefined engagements with existing stakeholders will put companies in a better position to improve resilience, adapt to regulatory change and the VUCA environment to drive sustainable growth.