INTRODUCTION
ESG principles can be incorporated into an investment strategy or business operations in many, many ways. ESG factors can also be leveraged to access unique financing tools. Some are industry specific, such as the array of certifications and tax credits currently available in the renewable energy and fuels industries. Others are not, such as sustainability-linked bonds and local government incentives.
These tools can improve the financial performance of a business, thus making it more appealing to investors considering ESG factors strictly in terms of risk mitigation at the company level. For example, whether an investment in a sustainable agriculture operation makes good financial sense could be significantly impacted by whether mitigation credits are available in respect of wetlands that are not farmed, or whether a biomass digester that qualifies for U.S. federal income tax credits is used to process farm waste into renewable natural gas (and perhaps also capture carbon oxides that would otherwise be released into the atmosphere). They can also improve the financial performance of an entire industry, which may be important to an investor utilizing ESG factors to balance risk across an investment portfolio. For instance, federal tax credits for renewable energy have helped to make renewable energy technologies viable in the United States.
ESG also may impact insurance markets. In recent years, we have seen increased underwriter interest in evaluating ESG factors to gauge whether coverage should be extended and at what cost. This is an important trend that warrants attention at many levels of any operating business, including the boardroom.
GOVERNMENT INCENTIVES FOR ESG ACTIVITIES
As aspects of ESG become more important from a policy perspective, governments and industry organizations with standardssetting roles have a choice between wielding a carrot and a stick. The stick is, of course, the various types of regulations and limitations discussed in other sections of this handbook. However, in some countries, government organizations have also created a number of carrots. The following is a high-level discussion of several carrots used in the United States and other select jurisdictions.
TAX INCENTIVES
Tax incentives are used in a variety of jurisdictions, but in most they tend to be limited to specific types of activity, rather than focused on particular industries. Thus, while some generally applicable tax incentives may be useful in some industries that are attractive for ESG investment, they are generally not intended to specifically incentivize the activities that are most valued in ESG investment circles. For example, patent or intellectual property boxes popular in Europe and the United Kingdom may be helpful for the development of newer technologies, such as carbon capture and removal or renewable hydrogen production. As an example, incentives oriented toward ESG's social and governance prongs, like those that encourage hiring individuals in socioeconomically disadvantaged groups, may also be available in some jurisdictions.
On the other hand, some jurisdictions liberally use tax incentives to incent certain types of activities and behaviors, including those consistent with ESG investment principles. The federal and state governments in the United States are particularly prolific in this respect.
There is currently a U.S. federal income tax credit in respect of certain carbon oxides (primarily carbon dioxide) that are captured from an industrial process or removed from the atmosphere using direct air capture and then either sequestered in a secure geologic formation, used as a tertiary injectant in a qualified enhanced oil or natural gas recovery project, or utilized in certain photosynthetic, chemical, or biologic processes. The credit is not available with respect to the capture of naturally released carbon oxides or natural processes that capture carbon oxides, e.g., growing trees. The tax credit rate varies based on the technology used, date it was placed in service, and how the captured or removed carbon oxides are disposed of. Although infrequently claimed during most of its history, a change in legislation and the recent release of regulations may result in more taxpayers claiming this credit.
U.S. federal income tax incentives for renewable energy and fuels include a variety of programs:
- The Investment Tax Credit (ITC) offsets tax otherwise payable by a U.S. taxpayer by an amount equal to up to 30% of the basis of "energy property" that is placed in service (i.e., becomes available for use) in the United States in a particular year. The taxpayer must directly or indirectly (through one or more partnerships) either own or lease the facility to claim the credit. The ITC tends be used for solar facilities, but is currently available for a variety of other renewable energy facilities, including open- and closed-biomass, small hydroelectric, waste-heat-to-energy, and hydrokinetic. The ITC is also available for amounts spent on energy storage that is more than 75% charged by energy produced by renewable energy facilities that qualify for the ITC. There is also a version of the ITC available to homeowners who install certain energy property, e.g., rooftop solar panels.
- The Production Tax Credit (PTC) offsets tax otherwise payable by a U.S. taxpayer by an amount equal to an annual adjusted amount per kilowatt hour of energy produced by certain renewable generation facilities and sold to a person that is not related to the owner of the facility. The PTC is available for 10 years after the date on which a qualified facility is placed in service. Taxpayers typically seek to qualify large wind facilities for the PTC, but it is currently available for several other types of technologies.
- There is a credit for hydrogen fuel cell vehicles. The amount of the credit varies depending on the technology used in the vehicle. There is also a separate credit for plug-in electric vehicles, but the availability of the credit varies based on manufacturer.
- There is a 30% income tax credit (subject to caps) for the cost of infrastructure used to support alternative fuel vehicles, including hydrogen and electric vehicles.
- There is an excise tax credit for certain alternative fuels, including hydrogen.
- U.S. state tax incentives for renewable energy tend to fall
into three categories: income tax credits or deductions, property
tax abatement, and excise tax abatement.
- In prior years, income tax credits were very popular in a few states. Examples include Oklahoma's income tax credit for wind and North Carolina's income tax credit for solar. However, political tides for income tax incentives largely shifted in the last several years and most income tax credits for renewable energy have now expired. A notable exception is the Green Jobs income tax credit in Virginia.
- There are still significant state property and excise tax incentives, however. For example, California has a very successful property tax incentive for energy storage facilities, and Texas has a sales and use tax exemption for certain property incorporated into a solar facility. In some local jurisdictions, property tax reductions are available through structural means– such as transferring title, but not beneficial ownership, of a solar facility to a local government to achieve tax exemption. In addition, local tax abatements or reductions are sometimes available through negotiation with government authorities, often in the context of a broader discussion on government incentives.
Several U.S. federal income tax incentives are available for certain pollution control, conservation, and environmental remediation efforts. Some states also have incentives for these types of activities.
- Taxpayers may elect to amortize certain certified pollution control facilities over five or seven years.
- Farmers are allowed to elect to deduct soil and water conservation expenditures and land erosion prevention expenditures that do not give rise to a deduction for depreciation.
- Endangered species recovery expenditures paid or incurred by a farmer are treated in a manner similar to soil and water conservation expenditures and are also deductible if the election is made.
- Up to $10,000 of reforestation expenditures per property may be currently deducted and the excess amortized over 84 months. Reforestation expenditures are defined to include forestation expenditures.
Several U.S. federal income tax incentives are also available in respect to activities in designated low‑income areas:
- The low-income housing tax credit may be claimed by the owner of a newly constructed or substantially rehabilitated qualified low-income housing.
- The new markets tax credit may be claimed by investors in businesses that qualify as qualified community development entities, i.e., that have a primary mission of serving or providing investment capital for low-income communities or low-income persons and that maintain accountability to residents of those communities through board members.
- The empowerment zone income tax credit may be claimed in respect of wages paid to persons working for a business located in a federally designated empowerment zone, which are generally low-income areas.
- The qualified opportunity zone program incentivizes investment into businesses and facilities located in federally designated opportunity zones (which are generally low-income areas or areas adjacent to them) by permitting investors to defer taxation on capital gains invested into an opportunity zone fund. In some cases, investors may reduce that gain when it becomes subject to tax, and eliminate taxation on any gain recognized on an exit after investors have held their interest in the opportunity zone fund for at least 10 years.
Tax credits are also available for low‑income housing and investment in businesses and facilities in low‑income or economically disadvantaged areas. These may be complemented by many of the state and local incentives discussed below.
Another group of U.S. federal income tax incentives are intended to primarily assist certain groups of people:
- An employer-provided child care credit and a credit for wages paid to employees using family and medical leave largely benefit women.
- The work opportunity credit provides employers with an incentive to hire persons from targeted groups having a particularly high unemployment rate or other special employment needs. The credit is a percentage of the qualified wages paid during an employee's first year of employment, based on the number of hours worked. Targeted groups of employees include qualified recipients under the Temporary Assistance for Needy Families program, supplemental nutrition assistance program benefits recipients, Supplemental Security Income recipients, veterans, ex-felons, designated community residents, vocational rehabilitation referrals, summer youth employees, unemployed veterans, and disconnected youth.
- An income tax credit is also available to employers for certain wages and health insurance costs paid or incurred by the employer for certain employees who are either an enrolled member of a federally recognized Indian community (or spouse of an enrolled member) who performs substantially all of the relevant services within an Indian reservation and has a principal residence while performing such services on or near the reservation where the services are performed.
- A taxpayer may elect to currently deduct up to $15,000 of the cost of making a facility or public transportation vehicle more accessible to handicapped or elderly individuals (age 65 or older). The facility or vehicle must be owned or leased by the taxpayer for use in the taxpayer's trade or business.
OTHER GOVERNMENT INCENTIVES
Many companies are consciously pursuing ways to reduce their emissions and address their social impact, and government incentives can help make these goals more financially viable. Cost savings to companies also often mean cost savings to customers who purchase products, resulting in lower overall social costs. As the goals of business and government become more aligned, economic incentives have increased in popularity in many states as tools to address rapidly changing environmental challenges ranging from water pollution to global warming. These eco-friendly incentives are supported by local communities that encourage companies to adhere to environmental and health protection initiatives. These projects may also qualify for U.S. Department of Agriculture and/or U.S. Department of Energy loans and loan guarantee programs that can support the financial stack and help the project become feasible.
Some of the ESG-related economic incentives and programs available to projects and businesses include:
- Cash grants
- Infrastructure improvements
- Low-cost financing
- Job training
- Expedited permitting
- Reduced cost land and buildings
- Green energy incentives
- Green bonds (tax exempt)
- Solid waste bonds
- Energy storage incentive programs
Employment in industries relating to the field of renewable, alternative energies includes the manufacture and operation of products used to generate electricity and other forms of energy from alternative sources that include hydrogen and fuel cell technology, landfill gas, geothermal heating systems, solar heating systems, hydropower systems, wind systems, and biomass and biofuel systems.
Some incentives are focused on job creation, particularly in targeted industries such as alternative energy generation, manufacturing of equipment used in alternative energy generation and energy storage, landfill gas, geothermal heating systems, solar heating systems, hydropower systems, wind systems, and biomass and biofuel systems. These incentives are typically focused on the creation of jobs with good benefits and wages, the attraction of a more diverse workforce, and often apprenticeship programs that allow entry-level, unskilled workers to obtain free training, a job, and a defined path toward career advancement.
Negotiating for government incentives can be a long-term effort and should be approached holistically by highlighting the community benefits of a project and the impact of a project on public economic development, as well as the fulfillment of business objectives. In addition, relationships with local government officials and a comprehensive knowledge of the potential incentives and how they interconnect is crucial. Selecting a strategic location in a community that supports a company's vision for growth and expansion–and is willing to incentivize that effort–is critical to the success of a project.
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