In recent years, various international frameworks, treaties, and agreements have been formulated to reduce carbon emissions and the adverse effects of carbon dioxide and other harmful greenhouse gases. More pertinently, the 2021 COP26 held in Glasgow further witnessed the international community take significant steps towards the escalation of reducing carbon emissions.
Consequent to such international agreements, Countries and Multinational Corporations (MNEs) are formulating long term strategies towards reducing their carbon emissions. One such strategy is to indulge in carbon trading and create a carbon neutral and/or carbon compliant prospectus. Resultantly, MNEs are now actively forming carbon trading teams within their organizations that could buy, sell and subsequently, allocate carbon charges to a service line that maintains a carbon neutral position of the organization.
As MNEs move their carbon credits between group entities, it has led to an increase in the need for transfer pricing professionals to consider certain unique aspects of the carbon market, such as:
- The credibility of the international carbon credit market – There are worries about whether externally bought carbon credits are authentic. Efforts are ongoing to ensure proper verification of credits. An example is the World Bank Group’s collaboration with the Singaporean government in aiming to provide transparency in sharing and reporting carbon credit information;
- Market volatility – The carbon market is currently quite unstable, increasing market risks for companies that engage in carbon trading. Geopolitical issues have exacerbated this volatility. For instance, concerns have been raised about how the war in Ukraine might impact Europe’s climate priorities.
- Regulatory increases – Those entering carbon trading need to keep up with these rules, which may influence buying, selling, accounting, and other tax issues. MNEs will need to consider accounting and legal issues, such as those related to accounting recognition of costs.
MNEs are increasingly considering certain key issues in emissions and transfer pricing. They need to consider their long-term strategy for emission reduction and how to achieve these objectives based on their industry and geographic presence. MNEs might also investigate their reduction of emissions by the most appropriate way, such as planting trees or cutting down on operations that produce significant emissions or choosing to buy carbon credits.
All the above would have long term transfer pricing ramifications. Decisions taken in view of the carbon market will drive changes within an organization. These changes include reanalysis of manufacturing functions, restructuring of supply chains, changes in functional, risk, or asset profiles, to name a few. Another aspect of this movement would be companies examining exactly where to set up their green technology innovation centers. It would be beneficial to choose countries that offer incentives on R&D and investment in green technology. These considerations need to be taken along to potentially minimize the impact of tax.
Furthermore, these considerations should be made alongside how credits and incentives will be treated under any potential minimum tax regime. Carbon trading, environmental taxation, and the incorporation of carbon into the value chain has already become extremely important for MNEs. The Organization for Economic Cooperation and Development (OECD) is devoting considerable resources in the study of environmental taxes. An OECD report from 2021 suggests that approximately 60% of carbon emissions from energy use in OECD and G-20 countries remained unpriced in 2018. Thus, it can be easily understood that governments would aim to change this.
Carbon trading and related transfer pricing issues will continue to be significant for MNEs in the future. Therefore, it would be advisable for corporations to begin the development of strategies and initiate planning in that regard at the earliest!
Author: Ameya Dadhich, Trainee, TPA Global