While the “carrot” of tax incentives may be useful to drive, or even kick start investment into new technology or regions, the recent roundtable discussion confirmed they are not the key issue in unlocking green investment. Similarly, while environmental taxes and reducing fossil fuel subsidies can help redirect investment into green projects, there are already many investors willing to fund such investments irrespective of the “stick” approach. There was, however, a clear message to remove counter-productive tax barriers to investment particularly in developing countries and/or territories. A common theme which emerged is the need for the international acceptance of simple, tax neutral structures to enable funds to be pooled. Such structures enable risk to be diversified and facilitate innovative funding tools such as blended finance.

On Friday 11 September 2020, the ninth roundtable in a series on potential tax policy responses coming out of COVID-19 was held. Sponsored by KPMG International and Jericho Chambers, a more detailed explanation of the program can be found here. This was the third event looking at facilitating investment in the Green Recovery. The first two roundtables consisted of discussions with sovereign wealth and pension funds and with the asset management industry. The third roundtable involved the participants from the first two roundtables providing feedback and discussing the conclusions with representatives from a number of multi-lateral organizations, including the IMF, OECD, World Bank, IFC and UN1.

The event was held under Chatham House rule and this note is a summary of the views expressed. All opinions are anonymized and do not represent official views of any organization or any KPMG member firm. Where names are mentioned, it is with expressed permission.

Mike Hayes, Global Renewables Leader, KPMG International and National Sector Leader, Renewables & Sustainability, KPMG in Ireland, began by outlining three key issues to be addressed in driving the Green recovery. First, the need for the right regulatory and legal environment. Secondly, the need to increase the flow of capital to green projects - especially in relation to the newest technologies or in certain developing markets. Thirdly, the need for more innovation not just in technology but in developing new energy sources. He posed the question whether or not tax policy could help to address these issues in terms of providing incentives to facilitate investment, removing impediments to cross-border flows or providing disincentives - for example through carbon taxes.

Participants considered that environmental taxes could play a part in shifting investment towards the green economy; nevertheless, for many investors the issue was more about unblocking obstacles to cross-border investment rather than penalizing carbon intensive investments

Some participants noted that reducing fossil fuel subsidies and increasing carbon taxes would likely encourage more investment into green technology. It was noted that the IMF, for example, has stated that a global average carbon price of $75 tons would be needed to reduce emissions to a level consistent with a 2 C target2. It was thought that it was important to ensure there is predictability about the price of carbon and it was suggested that investors needed to know that governments were committed to the decarbonization agenda and would not, for example reduce or abolish carbon taxes. A question was raised about the potential impact of a carbon border tax which was designed to protect domestic industry by imposing a charge on products with a high carbon footprint imported from jurisdictions which had more lax regulation than the importing jurisdiction. While it was acknowledged that such proposals exist – for example a carbon border has been proposed by the EU Commission – none of the participants expressed views on the likely impact.

It was also pointed out that governments have and are providing significant financial support for business due to the COVID-19 crisis and it was suggested that funds could be targeted at green developments or contain conditions requiring environmental disclosures and recipients to commit to steps towards reducing their carbon footprint.

Nevertheless, other participants noted that many investors are keen to invest in the green economy and the key issue is not so much penalizing carbon intensive investments but in removing barriers to cross border investment.

There is a need to expand green infrastructure and there are various examples of tax incentive being effective in enabling the growth of new technologies; nevertheless the tax rate is usually not the key factor in an investment and any incentives need to be carefully designed – ideally with cooperation between government and industry

It was also recognized that there is a clear need to expand infrastructure, for example by investing in grids for transportation of hydrogen if this was to become a significant source of energy or for allowing carbon capture and storage. Tax incentivization was one way to encourage investment in such projects and one participant gave the example of incentives in Germany which kick started the solar panel industry and helped make it scalable. There is a lot of green technology in existence, but one issue is how to scale up green technology, so it is economically viable.

However, it was noted that some developing countries have given incentives that benefit investors and not the local country. Furthermore, incentives can be time-consuming and complex to administer and monitor. Therefore, it was generally agreed that investors needed to work with governments in order to ensure that any incentives were effective and efficient. Well-designed incentives should produce greater certainty for investors and stimulate economic growth. Nevertheless, the loss of revenue needed to be balanced with increased investment.

Another participant pointed out that pension funds are long-term investors and that infrastructure projects have a long-time horizon. Predictability about the tax regime is therefore usually more important than obtaining incentives. Pension funds tend to be conservative investors and more concerned about their reputation. It was suggested that while short-term incentives to invest in a project at the start may help boost investment, there could be reputational risk with being associated with tax holidays or incentives that meant tax was not being paid for say 20 years. Another participant noted that political stability was more important than the tax rate, which would be just one factor in the required rate of return on an investment.

Participants thought that an internationally agreed taxonomy of green investments could aid decision making and transparency. Investors are already starting to use the EU taxonomy and it was queried if this may become a global standard

There was general agreement that some kind of internationally accepted taxonomy on what constituted green investment would be helpful. While there would inevitably be grey areas it would provide guidance and could be particularly helpful for developing countries where there was a lack of knowledge or capacity to review every investment. It was queried what body should be responsible for such a taxonomy – e.g. the UN or the OECD. One participant noted that the EU taxonomy, although it is still a work in progress, is already impacting investors’ behavior and they are using it as a tool in evaluating investment decisions. The taxonomy is designed to re-orientate investment away from unsustainable projects to sustainable ones. The fact that it is being drawn up by DG FISMA3  demonstrates that it is a capital markets issue. So many investors are interested in the implications that the UN has developed a course to help them align with the taxonomy. It was noted that questions are being asked about whether the EU regime will become a standard one and be transposed into different jurisdictions. European regulations on environmental disclosures are also scheduled for March 2021. Another participant pointed out that there are many types of green technology which could be included in any taxonomy – for example relating to waste management or water conservation.  **

Blended finance is an innovative and growing tool which can reduce risk. However, it can be overly complex and there needs to be more education and knowledge sharing about the benefits and types of arrangements available

There was a discussion about ways to reduce the risk of investment in new technology or markets and it was noted that OECD countries are using blended finance structures to facilitate investment in developing countries. This can take various forms such as guarantees, taking the first losses on debt financing or contributing equity. It was noted that the size and complexity of such blended finance funds and investment products was increasing. Often there are onerous reporting requirements. One participant thought that donors did not fully understand the complexity in the structures while some project owners felt the reporting requirements were too onerous and this was hampering their effectiveness. Another pointed out that often private developers did not understand the full range or type of finance they could access so there was a need for greater education and cooperation. **

Investor participants strongly argued for a better informed and more open discussion about the need for tax neutral investment structures to enable funds to be pooled (and risk to be diversified) without creating an extra tax cost. It was also noted that some offshore financial centers needed to modernize their rules to take account of changing international norms, but given these are still developing the task may not be straightforward

A number of the investor participants emphasized the need for tax neutral structures in order to be able to pool funds, including for blended finance structures. While there was support for the OECD’s work on Base Erosion and Profit Shifting (BEPS) and the work carried out by the UN to enable developing countries to implement such rules, it was noted that there is a distinction between structures used for tax avoidance and structures used for commercial reasons to facilitate cross-border investment. There was general agreement that there needs to be more public discussion and clarity on this matter.

The issue is not just about adverse publicity, but also about tax certainty. One participant noted that the OECD has done work on regulated investment structures to help ensure they can access treaty benefits but pension funds and sovereign wealth funds wishing to pool investments will often be using unregulated structures to provide flexibility. Such structures may be impacted by some of the BEPS rules. For example, a 20-year investment may be structured through a tax neutral (zero tax) jurisdiction but it may give rise to concern that at a later period one of the underlying investee countries will raise a principal purpose test argument to deny treaty benefits.

One participant pointed out that it was up to countries which needed inward investment to resolve these issues. For example, if a country wanted inward investment it could reduce or eliminate withholding taxes on repatriation so that concerns about treaty benefits would not arise. While there would be a reduction in tax take by eliminating withholding taxes, the argument would be that this would be more than compensated for by other taxes (corporation tax, payroll tax, indirect taxes) generated through increased investment.

Another participant noted that there are some historic issues with a number of offshore financial centers. An example was given of Mauritius, which has a number of treaties with African countries and are now perceived to be disadvantageous for the latter. Mauritius also had a system which was considered unfair tax competition as it ring-fenced foreign investment. The country has now changed its rules to remove these harmful elements, but this does create problems for investors in that the old rules were easy to apply, and the new ones are more complex. Furthermore, given that public opinion and international rules are changing it can be difficult for governments in such offshore financial centers, which wish to provide tax neutral regimes to decide what changes need to be made to their existing rules.

Some concerns were expressed about the complexity and compliance burden which can arise if countries try to tax gains from offshore indirect transfers of assets; but it was noted that some countries do consider such gains to fall within their taxing jurisdiction

There was some disagreement about the issue of the taxation of gains on overseas indirect transfers of assets. Some of the investor participants noted that there may be many investors in a multitiered structure in order to diversify risk and increase investment flows. If the transfer of an interest – which could be relatively small - by one of these investors triggers a taxable gain at the bottom of the structure it can create significant reporting and compliance complications. It was noted that the Platform for Collaboration on tax - a joint program between the OECD, UN, World Bank and IMF - has produced a toolkit to enable developing countries to implement rules to tax indirect offshore transfers. This does not mean the developing countries should implement such rules, nor do the practical issues noted above mean that taxing capital gains is always distortionary and inefficient. The point was made that some developing countries believe they should have the right to tax such gains which are attributable to assets in their country and the toolkit is there to enable them to do so.