The TP treatment of ICP: corporate law fundamentals apply
Internal carbon pricing (ICP) is not new – companies such as Microsoft are reported to have introduced internal carbon fees over 10 years ago. ICP policies are designed to factor in the estimated cost of carbon dioxide emissions into business decisions.
Such policies can take a number of forms. But one essential distinction is between ‘shadow’ (or hypothetical) carbon pricing on the one hand, and ‘actual’ internal fees on the other.
Shadow carbon pricing involves calculating the price or cost of carbon dioxide emissions, and allocating them to individual business units or entities as a management tool. There is no actual flow of funds as a result. According to a 2021 report issued by CDP (the NGO formerly known as the Carbon Disclosure Project), 50.8% of companies surveyed used a shadow ICP policy – see the chart in the slide above.
By contrast, policies using internal carbon fees result in actual payments being made between group entities. This may not only influence behaviours, but also creates a pot of funds which can be used for the group’s sustainability enterprises. In that respect, such an ICP policy is like a voluntary internal tax imposed by the group on its constituent entities. According to the CDP 2021 report, 15.0% of companies surveyed used internal carbon fees.
As far as I can see, the materials issued by CDP do not provide guidance on the tax or transfer pricing treatment of internal carbon fees.
An article entitled ‘Intercompany Fees for Internal Carbon Pricing – The Next Frontier’, written by members of Economic and Valuation Services practice of KPMG in the US and published in Tax Notes, notes that "these fees are not statutory costs that directly affect [companies’] tax filings." It also points out the need for guidance on the deductibility of carbon fees. (A large part of the article focuses instead on the contribution which transfer pricing professionals can make to the development of ICP policies generally.)
In a recent LinkedIn post, Leonard Wagenaar has pointed out complexities in the interaction between internal carbon fees, carbon taxes and carbon credits: should carbon taxes be credited against internal carbon fees?
From an intercompany legal perspective, corporate law fundamentals apply, irrespective of the tax treatment of internal carbon fees. Those fundamentals require that any fees payable by an individual legal entity must form part of an arrangement which the directors of that entity can properly approve as being in the interests of that entity. Failure to meet this standard may expose directors to personal liability for breach of duty, and may result in the payments being characterised as unlawful deemed dividends.
In general, this requires each paying entity to receive a tangible benefit which is expressed in the underlying contractual arrangements – as opposed to an arbitrary fee or ‘internal tax’. In many respects, this coincides with the benefit test for service fees from a transfer pricing perspective.
It will be fascinating to see how this area of policy and practice develops.
In the meantime, if you have come across (or written) other useful commentary on these issues, please do share them.
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