Institutional investors agreed that generally, certainty over the tax cost or duration of any incentives was more important in the investment decision than the actual tax cost. Nevertheless, reducing the tax cost on inward investment and providing transferable research and development credits would encourage investment into green projects – as would reducing current subsidies for fossil fuels. Overall tax risk is significantly less of an issue than political and regulatory risk in long term investments.

On Wednesday 22nd July the third roundtable in a series on potential tax policy responses coming out of the COVID-19 environment was held. Sponsored by KPMG International and Jericho Chambers, a more detailed explanation of the program can be found here. This event was attended by 12 globally active pension fund and sovereign wealth funds and focused on what tax barriers exist to cross-border investment in renewables and decarbonization technology and what solutions could be envisaged.

The event was held under the Chatham House rule and this note is a summary of the views expressed. All opinions were anonymized and do not represent official views of any organization or any KPMG member firm. Where individuals are quoted, expressed permission has been obtained.

Tax is only part of the framework which will be needed to encourage greater investment in a green recovery. Nevertheless, it has an important role to play.

Mike Hayes KPMG’s Global Renewables Leader began by outlining three key global barriers to investment into the climate and decarbonization sector:

  1. Government policy: this is not just about subsidies but covers much wider issues such as landownership and the legal and regulatory framework covering energy and the green sector. Long term certainty on policy is also critical.
  2. Mobilization of capital: while there is investment going into renewables in developed countries there is insufficient capital getting into many developing countries. Furthermore, it is not getting to the innovators who are going to be critical in helping to find solutions to achieve a net zero future.
  3. Technology and innovation: today's technology is not sufficient to create a carbon neutral world by 2050. Innovation does not just mean technology but also business innovation. While there is a lot of innovation taking place - particularly in improving existing technology - it is likely to be necessary to find new forms of energy that have either not been invented or are only just in inception.

Tax is therefore only part of the framework which will be needed to encourage greater investment in a green recovery. Nevertheless, it has an important role to play particularly in addressing points 2 and 3 above.

mThere were slightly differing views on whether it was necessary to have some kind of global consensus on delivering a green future as opposed to allowing carbon intensive practices to remain the norm before a productive discussion could be held on how to ensure financing reached innovators.

One participant questioned whether it was necessary to get a coherent global vision for the future before looking at particular solutions. Rather than focusing on a bottom up approach - how could tax systems provide incentives to invest - it would be better to start with a top down approach – which started by asking whether or not there was a global consensus on a green future rather than continuing with carbon intensive practices. Once this was clearer it would be easier to look at responses by countries and then by companies. However, another participant pointed out it is necessary to start somewhere. There is insufficient funding getting to the innovators and ultimately someone needs to take new technology risk rather just individual project risk. This indicates the need for partnerships, coalitions and some form of blended finance to encourage investors to take on global risks irrespective of where a project is based.

Participants thought reducing subsidies for carbon intensive or polluting investments would encourage investment in green projects. Reporting requirements can also help.

It was pointed out by some of the participants that one reason why there was not sufficient investment in green technology was the extent to which various governments still subsidize fossil fuels as opposed to the green economy. Reference was made to various data points which show that there are significantly greater subsidies globally for fossil fuels than for green energy . It was therefore suggested that one way to incentivize green investment was to reduce the subsidies in investments which ultimately damage the natural world.

Another attendee mentioned the EU Action Plan on Sustainable Finance which is designed to re-orientate capital towards sustainable finance through increased disclosure and transparency. While an important initiative, it was thought this approach was not sufficient on its own.

It was agreed that political and regulatory risk was far more critical in evaluating a project than tax risk

One participant pointed out that tax is a cost and for some – although not all taxes – it is charged on profits. If the tax cost increases, it will reduce the after tax return on an investment. However, tax usually “pales into insignificance” in comparison with political and regulatory risk. These can put an entire project at risk and it is difficult to encourage investment – especially in long term projects - where these risks are significant.

It was generally thought that providing a low tax charge – especially for inward investment - does encourage cross-border investment; although it was also recognized governments need to balance this with the need to collect revenue

It was generally agreed that there is a place for incentivizing cross-border investment - whether that is encouraging inward investment or countries and jurisdictions providing incentives for outbound investment by funds located there. However, in terms of sovereign wealth funds, or pension schemes which are (effectively) exempt from tax, this is more relevant for the investee jurisdiction than the home jurisdiction. One participant noted that countries which have a favourable inward investment climate, like the UK and Australia, have attracted a large share of global green investment and this shows in the quality of their infrastructure. Given that Australia has recently increased the tax on some inward investors it would be interesting to see if that had an adverse impact on investment. Another participant confirmed that changes in how Australia treats sovereign wealth funds under the doctrine of sovereign immunity was part of the reason for their recent disposal of an asset in that country.

It was also noted that this raises a difficult judgement for many governments. On the one hand there is the need to provide tax efficiency to encourage inward investment; on the other there is a need to raise revenue. Striking the balance is complex.

To a large extent tax is just one factor affecting the cost of capital and it is the degree of certainty over the future tax cost and changes to any incentives which is more important than the actual cost

Tax costs which impact an investment decision for a sovereign wealth fund or pension fund include withholding taxes on outbound payments, any tax charged on intermediate investment vehicles and tax charges on the ultimate disposal – including charges on indirect offshore transfers. However, these are just one part of the economic deal and will be factored into the investment model. The lower the tax cost, the lower the cost of capital.

An investment will be made on the basis of tax regimes at a particular date; if there are changes, these alter the project profile. Therefore, it was generally agreed that, regarding tax, the most important criterion is to what extent there is certainty over the life of the project, particularly as many investments involve large infrastructure projects and take a long time to be profitable. If there is significant uncertainty over how tax rates or incentives will change it would increase the risk profile and likely lead to reduced investment. But it was recognized it is very difficult for governments to provide certainty over tax regimes which remove any future risk, especially for projects which have a long-term profile which sovereign wealth funds and pension providers seek. One participant noted that assessing long term risk is the bread and butter of investment managers.

The question was raised whether this suggested that companies should be looking for stability agreements, particularly in developed countries. It was noted that such arrangements have been strongly criticized by, in particular, civil society on the basis that they restrict a governments ability to increase taxes in response to changed circumstances and can lead to situations of conflict with investors. No answer was provided to this dilemma, but it was pointed out that investors will make comparisons between different investment locations and may need to (RC) make trade-offs. If an investor knows a particular jurisdiction has a stable environment and the returns are appropriate in relation to the risk, it is more likely an investment will be made there than in a location where is greater uncertainty.

Participants thought that taxing the disposal of infrastructure projects as if they were real estate was not necessarily the right approach

The taxation of gains on the disposal of an investment was noted by one participant as potentially a bigger issue than tax on income flows. For example, in a green field renewables project, there may be a long-term horizon and the return would come at the end of the project when the asset was disposed of. A capital gains tax could be problematic. The point was made that while the investment would be in infrastructure (e.g. to create renewable energy) the tax regime applicable on an eventual disposal was often one relating to real estate. It was questioned whether this was appropriate if the intention is to incentivize investment in such projects.

Mechanisms to share risk may encourage investment

One participant noted that there are arguments for governments sharing in the risk of certain projects. This can make the difference between an investor deciding to invest or not, especially in a new environment. However, that does mean that the risk shifts to a certain extent from being about technology, research and development to a political risk on the government.

Tax incentives can encourage research and development but there needs to be mechanisms to allow investors to effectively access the benefits when they cannot be used by the project or technology developer

It was noted that tax credits in green projects – whether in infrastructure or research and development – could be beneficial as it would reduce the tax paid by the project, therefore, increasing return to the investor. However, a key issue is that developers may not be able to use tax credits due to loss in the early years. It is therefore important to find mechanisms for the benefits of incentives or credits to be passed on to investors which can then use them in other taxable transaction in the relevant jurisdiction. This would, in those early years, increase the investors return on investment, making it more palatable to invest in green field projects which are loss making in the early years. The ability to monetise renewable tax credits in the US was cited as an excellent example of how effective this strategy can be.

There was general agreement that there are sound policy reasons for sovereign wealth funds and pensions being tax exempt and therefore the OECD Inclusive Framework, Pillar 2 needed to contain a carve out from the global minimum tax rules

It was noted that the OECD Inclusive Framework, Pillar 2 proposal on a global minimum tax could have an adverse impact on tax exempt entities such a sovereign wealth funds and pension funds. The risk is that countries could apply the secondary rule on non-taxed payments where the ultimate recipient is tax exempt. A discussion in going on at the OECD level about how sovereign wealth funds and pension funds could be carved out of any new rules – given the policy reasons for their tax exemption status. One participant noted that a greater risk could be that there is no Pillar 2 agreement at the OECD Inclusive Framework and many countries press ahead with uncoordinated minimum tax measures which may not have appropriated safeguards for institutional investors.

It was agreed that the EU non-cooperative jurisdiction list had led to change in some of the affected jurisdictions. Nevertheless; while funds were conscious of reputational issues, there was not a general ban on using structures in listed countries where the reasons were clear and defensible

One participant noted that the EU Non-Cooperative Jurisdiction List had driven change in a number of jurisdictions which had taken or were taking measure to ensure they were not on or were removed from the list. Some concern was expressed that EU Commission (EC) proposals were not always fully or widely enough consulted on at an early stage. Furthermore, one participant noted the EC had been over dogmatic in negotiations with some countries – for example considering that purely domestic situations which did not give rise to a tax charge fell within the non-cooperative jurisdiction list criteria.

From the point of view of the investor it was agreed that reputational risk is an issue. One participant noted that while they would carefully consider whether or not to invest in structures which involved a listed jurisdiction, there was not a prohibition on doing so. For example, the reasons which led to Cayman being on the EU Non-Cooperative Jurisdiction List were well known and this would not stop them investing via a Cayman entity to achieve tax neutrality. Nevertheless, the situation was kept under constant review.

There were mixed views on the extent to which investors proactively price carbon into their investment decision where an actual carbon tax is not in force

There were different views about how investors price carbon into investment decisions. One respondent said they would only look at the impact of existing carbon taxes but would not model the impact of future hypothetical taxes. Another respondent said they did try and model future taxes. Also, an investment would not be made in a company where the carbon footprint was too large.

It was also pointed out that carbon taxes are not the only drivers of change. Some companies calculate an internal carbon price – even where no actual tax is payable. Some are putting pressure on suppliers to meet targets. Employees are asking questions of their employees and various reporting regimes are requiring companies to provide data on their carbon footprint.