Tax policy plays a vital role in a company's ESG strategy, and it will become increasingly important as companies try to mitigate their environmental impact through the use of tax credits and incentives
Tax policy plays a vital and often overlooked function in the environmental, social & governance (ESG) space. Tax reporting is a pillar of a corporation’s social contract as well as an act of financial transparency. Mitigating climate change in line with the Paris Agreement’s 1.5°C global warming limit requires an estimated $5.2 trillion per year of investment and lending to meet the limit by 2030.
Through taxes, governments can finance public initiatives and subsidize private investment in green industries and other initiatives, incentivizing a shift in private capital towards activities that will further the transition to net zero emission goals. Such investments will help prevent us from breaching our planetary boundaries and mitigate physical risks such as extreme weather, droughts, floods, and wildfires.
Tax credit investments
Investment tax credits at the federal level incentivize business investment. They let businesses deduct a certain percentage of investment costs from their taxes. In the context of green energy, tax credit investments return financial capital to companies to deploy directly into investments such as renewable energy, which boosts the investor’s ESG credentials and helps align the business with a low-carbon economy. Tax credit investments, which is a method used by corporations to provide funding for a project in exchange for the right to claim the available tax credit, enable corporations to use their access to capital to pursue their own path towards a sustainable economy in accordance with their risk/return assessments.
An increasingly popular option as part of an organization’s ESG strategy, tax credit investment has been and is set to become even more popular with the ambitious climate and energy policies of the Inflation Reduction Act (IRA), most of which relate to its more than 24 available tax credits. The IRA, which imposes a 15% corporate minimum tax, will drive $380 billion of investment into renewable energy and sustainable technologies, opening up new areas for tax credit investments such as electric vehicle charging infrastructure, bio-gas, green hydrogen, battery storage, and nuclear energy.
One significant change the IRA made to the clean energy tax credits is to make them refundable and transferable. Transferable tax credits allow companies to sell their tax credits to other entities for cash Refundable credits allow cash payment for tax credits if the amount owed is below zero.
Many U.S. companies need RECs in order to make progress towards their publicly stated goals, such as the country’s commitment to be net zero by 2050.
The Financial Accounting Standards Board, however, is now developing new guidance to clarify and smooth the process, and the Internal Revenue Service will be publishing guidance on the transferability of investment tax credits by mid-2023. Under the new rules, corporations can offset up to 75% of their federal income tax liability and roll this back three years, effectively gaining a rebate of taxes already paid to reinvest in ESG-positive opportunities.
Finally, renewable energy credits (RECs) are “tradeable, market-based instruments that represent the legal property rights to the ‘renewableness’ — or all non-power attributes — of renewable electricity generation,” according to the US Environmental Protection Agency (EPA). In effect, RECs assign ownership for the renewable aspects of the energy creation to the owner, allowing consumers to offset some of their carbon footprint.
Many U.S. companies need RECs in order to make progress towards their publicly stated goals, such as the country’s commitment to be net zero by 2050. Such credits provide a market and revenue stream for renewable energy-producing organizations. These opportunities enable companies to align themselves with a sustainable, green, low-carbon economy, which in turn, will likely lower companies’ transition and liability risks and their cost of capital.
There are also upsides as investors, lenders, and consumers recognize companies’ ESG-credentials. These opportunities for ESG-aligned investment will have notable social impacts around investments in infrastructure, human capital, and research & development. Job creation is a key outcome of investment in renewable energy, contributing to a just transition away from fossil fuels.
Under the IRA, a two-tiered system for renewable energy investment tax credits provides a base credit equal to 20% of the maximum credit and a bonus credit equal to an additional 80% of the maximum credit, but only if certain prevailing wage and apprenticeship requirements are satisfied in connection with the relevant project.
In addition, there are three adder credits that can be stacked on top of underlying credits for: i) meeting specific, domestic content requirements; ii) placing projects in the IRA’s defined energy communities; or iii) undertaking certain low-income solar activities.
While bringing more manufacturing jobs to the U.S. will strengthen employment overall, specifically selecting rural communities for large solar investments, for example, will provide an economic boom to those areas and enrich them through tax equity. There are further social benefits to community solar investments, which will have the ability to sell more than 50% of electricity generated to low-income families at discounted rates.
On the horizon
ESG alignment is the future of corporate investment, and companies should take advantage of the numerous investment opportunities that are emerging in the green transition.
In order to understand how companies can improve their status as social and environmental citizens and mitigate ESG-related risks, accurate measuring and reporting is needed as the first step. And tax credit investments are a direct, straight-forward way to turn this knowledge into a business upside.
In a time of economic and stock market uncertainty, tax credit investments offer a clear opportunity to grow and strengthen a company’s business strategy, while aligning it with the green transition.
This article was written for the Thomson Reuters Institute blog site by Foss & Co. For more information, contact ir@fossandco.com.
