Environmental taxes and CBAM: What should a Head of Tax know and do?

Environmental taxes and the EU Carbon Border Adjustment Mechanism (CBAM) are two important policy tools that aim to reduce greenhouse gas (GHG) emissions and promote a green transition. They also pose significant challenges and opportunities for companies, especially for their Heads of Tax (HoT), who need to understand the implications and act accordingly. In this article, we will explore some of the key aspects of environmental taxes and CBAM that HoT should be aware of and how they can play a strategic role in managing them.

Environmental taxes are taxes that are levied on activities or products that have a negative impact on the environment, such as carbon emissions, energy consumption, waste generation, or pollution. They are designed to discourage harmful behaviour and incentivise cleaner alternatives, as well as to generate revenue for aiding cleaner environmental processes. Environmental taxes can vary widely in terms of their scope, rate, and design across different jurisdictions, and they can affect different parts of the value chain, from production to consumption. For example, some countries have introduced carbon taxes that apply to fossil fuel producers or users, while others have energy taxes that apply to electricity or fuel consumption. Increasingly, countries also have specific taxes and levies on waste disposal, plastic bags, or air travel.

CBAM is a measure by the EU that will impose a charge on the carbon content of certain imports from countries that do not have a comparable carbon pricing system to the EU. The charge will be equivalent to the price of carbon paid by EU producers under the EU Emissions Trading System (ETS), which is a cap-and-trade scheme that covers around 40% of the EU's GHG emissions. The main objectives of CBAM are to prevent carbon leakage, which is the relocation of production or consumption to countries with lower environmental standards, and to encourage global climate action by creating a level playing field for trade. At this stage CBAM covers sectors that are exposed to international competition and have high carbon intensity, such as steel, cement, aluminium, hydrogen, fertilisers, and electricity. The full CBAM will kick in with corresponding financial obligations for companies starting January 2026. In the meantime a transitional regime is applicable as of 1 October 2023, under which companies already have certain compliance obligations. 

Environmental taxes and CBAM have significant implications for the tax function of companies, as they can affect their tax burden, cash flow, compliance, reporting, and reputation. HoT should not be passive or reactive in dealing with these issues, but rather aim to be proactive and strategic. For example, in many cases the financial burden of environmental taxes can be mitigated (at least in part) by investing in more sustainable business practices (which ultimately reduce the adverse environmental externality and therefore the ultimate environmental tax liability). These investments can also (in many cases) be supported through government issued environmental subsidies or innovation incentives, further supporting the business case.   

Steps a Head of Tax can take to manage environmental taxes and CBAM effectively

1. Develop a strategic vision for environmental taxes and CBAM

Develop a strategic vision for environmental taxes and CBAM, which aligns with the overall corporate strategy and the sustainability (ESG) goals of the group.

The strategic vision should articulate the objectives, principles, and actions of the group in relation to environmental taxes and CBAM, such as how to manage the tax burden, maximise the tax incentives to support innovation and reduced environmental impact, comply with the tax obligations, report the tax contributions, and engage with the tax authorities and policymakers. The strategic vision should also reflect the sector-specific and regional-specific characteristics and challenges of the group, as environmental taxes and CBAM can have different effects on different sectors and regions. For example, manufacturing companies may face higher exposure to environmental taxes and CBAM than service companies, and companies operating in emerging markets may face more uncertainty and complexity than those in developed markets, where clarity over information and data availability may be stronger.

2. Assess the current and future exposure to environmental taxes and CBAM across the group

Assess the current and future exposure to environmental taxes and CBAM across the group, taking into account the different types, rates, and regimes of environmental taxes in each jurisdiction and the potential impact of CBAM on the import and export activities of the group.

This can help HoT to identify the risks and opportunities, as well as to plan ahead for any changes or adjustments that may be required. As there are a multitude of possible environmental taxes that can apply, HoT’s should engage with the in-country operations teams to help determine an appropriate scope for their focus. 

3. Develop a RACI matrix for environmental taxes and CBAM

Develop a RACI matrix for environmental taxes and CBAM, which defines the roles and responsibilities of the tax function and other relevant functions, such as finance, operations, customs and trade, sustainability, and legal, in relation to these issues.

The RACI matrix should specify who is accountable, responsible, consulted, and informed for each task or decision, such as tax calculation, payment, filing, reporting, audit, or policy advocacy. HoT should either be accountable or consulted for these tasks or decisions, as they have the expertise and the oversight of the tax function. HoT should also ensure that there is effective communication and coordination among the different functions and stakeholders involved. Recent measures (such as CBAM) also have review mechanisms built into them, whereby government authorities will cross reference information from different fillings made by a company. For example, under CBAM, the customs declarations upon importation of the goods into the EU will be used to verify the CBAM declarations (which are lodged and reported on separately). Consistency in the information being reported by different elements of the same business will be critical going forward. 

4. Adopt a comprehensive and transparent reporting framework for environmental taxes and CBAM

Adopt a comprehensive and transparent reporting framework for environmental taxes and CBAM, which reports the tax contributions and the environmental performance of the group to the internal and external stakeholders, such as the board, the management, the investors, the customers, the regulators, and the public.

The reporting framework should ideally go beyond the total tax contribution (TTC) approach, which measures the total amount of taxes paid by the group, as it can be misleading or unhelpful for environmental taxes. For example, a higher TTC due to environmental taxes may indicate a higher environmental impact or a higher tax burden, rather than a higher tax contribution. Instead, the reporting framework should include indicators and narratives that show how the group is reducing its environmental impact, improving its environmental efficiency, and achieving its sustainability targets, as well as how the environmental taxes and CBAM are affecting or supporting these outcomes. The reporting framework should also benchmark the group's performance against its peers and the best practices in the industry and the market.

Environmental taxes and CBAM are not only tax issues, but also strategic issues that can have a significant impact on the business and the society. HoT should care about sustainability and play a leading role in managing environmental taxes and CBAM, as they can create value and competitive advantage for the group, as well as contribute to the global climate action.