Feasible Businesses tend to focus on the long-term value of an organization
By Robert Maina
Sustainability which in many instances is used interchangeably with Environmental, Social and
Governance (ESG) has emerged as a key theme across the world. This is to a large extent driven by climate change which has been termed by some scientists as a potential existential threat to the human population. The United Nations through the United Nations Framework Convention on Climate Change has been spearheading global efforts to combat climate change.The most recent Conference of Parties (COP), that is, COP 27 was held in Egyptian coastal city of Sharm el-Sheikh.
The annual event brings together Heads of State, ministers, negotiators, climate activists, civil society representatives and private sector players. According to the UN, COP27 sought to build on the outcomes of COP26 to deliver action on an array of issues that are critical in tackling climate change. These issues include reducing greenhouse gas emissions, building resilience, adaptation and delivery of commitments to finance climate action in developing countries.
Sustainability is broadly understood as the society’s ability to meet the needs of the current generation without compromising the ability of future generations to meet their needs. It has been observed that sustainable businesses have very minimal negative impact and in some instances their operations generally have a positive impact on the environment, the society, and the broader economy.
On the other hand, ESG has a bespoke focus on specific areas which have associated metrics that can be used by shareholders, investors, regulators and other stakeholders to measure the performance of an organization against these metrics. The metrics focus on the environmental, social and governance
aspects of organizations. Sustainable businesses tend to focus on the long-term value of an organization.
This is a holistic analysis of the worth of an organization that encompasses the financial, customer, people and societal value that is created by an organization. It thus covers a broad range of stakeholders including shareholders, customers, employees, regulators and society. The long-term strategy is mostly anchored on an organization’s purpose to create long-term value.
How does tax interplay into sustainability?
Governments across the world are using a wide range of policy instruments to nudge organizations to incorporate sustainability in their business models. In most countries, governments are using a two-pronged approach that is operating as a carrot and stick approach to achieve the end-goal. On one hand, governments are extending incentives which could take the form of funding, grants, tax credits, subsidies, tax exemptions and tax rebates.
On the other hand, governments are using punitive measures to discourage activities that are creating negative environmental externalities. This could take the form of taxes, levies and fees. Tax policy is being widely used as a lever to drive carbon mitigation strategies. This includes carbon pricing, green energy incentives, taxation of emissions and taxation of plastics. This is meant to encourage organizations to transition to environmentally friendly inputs, products and processes.
As part of the Paris Agreement, countries made emissions reduction targets. These are known as Nationally Determined Contributions (NDCs) and are meant to mitigate the effects of global warming.
Environmental taxes have emerged as a core policy tool to drive organizations to align their operations to reach the set targets. Tax policies take various forms. For instance, tax incentives have been introduced for reduced emissions and the adoption of clean technologies.
Additionally, tax incentives for carbon markets to facilitate carbon pricing ar being introduced in some countries. Across the world, other environmental taxes that have been introduced include fuel taxes, pollution charges, recycling fees, congestion fees and plastic taxes. Consumer taxes are also being
deployed to act as a disincentive for certain activities and products. This encompasses among other measures, the introduction of excise taxes that are meant to change the behaviours of consumers and producers.
These are targeted at specific products that, for instance, have high concentration of sugar, fat and meat among others. Plastic bags and other packaging have been blamed for land and water pollution. This is because most of the plastic products find their way in landfills and oceans after their disposal. To curb
this menace, different governments have taken various measures. Some countries have completely banned certain categories of plastic packaging.
For instance, in 2017 Kenya banned the use of single-use plastic carrier bags. Some governments have imposed plastic packaging taxes to discourage the use of plastic packaging by organizations. Other measures that have been introduced include the EU Carbon Border Adjustment Mechanism (CBAM). This is poised to kick off in 2023 and it will introduce a carbon price on certain products imported into the EU to prevent ‘carbon leakage’ by subjecting the import of certain groups of products from non-EU countries to a carbon levy.
The levy will be linked to the carbon price that is payable under the EU Emissions Trading System (ETS)
when the same goods are produced within the EU. Regulatory interventions such as the introduction of an enabling legal and regulatory mechanism to operate emission trading systems and voluntary carbon markets are being introduced in different countries.
For instance, through the Finance Act, 2022 Kenya introduced a lower corporate income tax rate of fifteen per cent for the first ten years of commencement of the operations of a company that operates a carbon market exchange or emission trading system that has been certified by the Nairobi International Financial
Centre Authority.Also notable is that as part of transparency and ESG reporting critical tax metrics will need to be reported in the integrated financial statements and reports.
This will include important tax considerations such as total tax contribution and the effective tax rate. An analysis of each of key areas of focus under ESG demonstrate how tax policies are being used to drive the overarching goal.
Economic
The cost of producing goods is being greatly affected by the various levies and taxes that are being introduced across the world. For instance, green taxes and environmental regulatory measures are
likely to increase the cost of production. It is thus imperative for businesses to review their operations and re-align their value drivers and potentially move towards a circular economy. This will be critical in managing the usage of raw materials.
On the other hand, businesses are using the available incentives and funding opportunities to reduce the cost of transition to a greener economy. This includes research and development credits and the seeking grants from potential development partners.
Environmental
The current drive towards sustainability is largely driven by environmental concerns. To mitigate the negative impacts on the environment, governments are employing measures such as taxes, charges and levies. These are meant to internalize pollution costs for the polluting parties which should effectively reduce the production of harmful products. Indirectly, the same measures are likely to encourage more environmentally friendly actions as well as sustainable activities which will lead to a more sustainable use of resources.The push towards Green House Gases (GHG) emission reduction is being driven by measures such as carbon taxes, energy taxes and plastic taxes.
Social
There are numerous areas of focus under the social arm which include human rights, inclusion, equity, diversity and consumer protection. The overall contribution of an organization in the local society is being
considered under this arm. This is in the form of the total tax contributions hence making transparency a key theme in the
ESG agenda.
Due to the adverse effect of certain products on the long-term health of individuals there is increased focus on driving behavioural changes. This is through the introduction of excise taxes among others form of levies on certain ingredients or products such as sugar, high fat and salt content in foods.
Governance
Governance is key in the strategy of every business as the regulatory and taxation landscape evolves to
accommodate ongoing changes related to sustainability. The introduction of new taxes and regulations require a review of the tax risk control framework and processes. There is also increased disclosure
requirements whether under mandatory or voluntary reporting frameworks.
Conclusion
It is not in doubt that recent changes in weather patterns which have been attributed to climate change require concerted and urgent actions by governments and the private sector. The tax function will be critical in the implementation of organization’s sustainability strategy.
Robert Maina is an Associate Director at Ernst & Young LLP (EY). The views expressed herein are not necessarily those of EY.
