Tax and the energy transition

Tax to stimulate green investments

Tax can be a powerful tool to incentivise investment and has been used to help stimulate the energy transition across the globe. This has taken the form of both tax reliefs to encourage investment and additional tax burdens to discourage undesirable behaviour (e.g., by increasing the cost of using fossil fuels). For example, in Italy, there are no less than 33 measures at national and regional level and Spain has introduced a right for City Councils to approve a real estate tax relief of up to 90% for solar plants.

 

Tax and differences in regulations across countries

The framework of incentives is very fragmented and, even at the national level, lacks a structural reference measure capable of driving investments that support the energy transition of corporate entities. Such measures may therefore be inadequate, on their own, to achieve a significant acceleration in the energy transition. Within the EU context, a key contributing factor to the multitude of different tax rules is that Member States in principle decide autonomously on corporate income tax incentives. Green investments might be stimulated if EU-wide tax rules for green investments were to be more closely aligned, or on an even larger scale through international cooperation (consider, for example, the OECD). International cooperation may also curb the competition on stimulating domestic green investments, which is already visible between the US, EU, and China.

 

Tax to utilise 'exceptional' gains from conventional energy production

Governments have also been turning to taxation of conventional, polluting energy production (but also taxation of green energy – see below) to help fund energy support packages that have arisen in the wake of the energy crisis. “Windfall taxes” aimed at taxing the so-called exceptional revenues or profits of - mainly - producers of conventional energy caused by high gas and electricity prices are increasingly a feature of the energy tax landscape. These types of taxes create uncertainty for businesses in the energy sector as they often apply retrospectively and are typically temporary in nature - the UK’s green energy windfall tax will be legislated to last for five years until 2028. There are calls for a permanent instrument to be set up for windfall taxes that can be switched on and off in the future whenever deemed appropriate.

 

Tax and capacity of companies to undertake green investments

The imposition of green windfall taxes seems at odds with the net zero goals of Europe and the UK and risks stifling investment in an already difficult economy, especially in light of attractive tax incentives elsewhere such as the US. In the UK, the equivalent windfall tax for oil and gas companies only applies to profits (as opposed to revenue) and is accompanied by a generous investment allowance that was not a feature of the UK’s green energy windfall tax. Declining to provide similar tax relief for investment as is available to the oil and gas companies risks disincentivising the reinvestment of funds from renewables projects in green energy.

 

Tax and M&A

In an M&A context, we are seeing parties structuring deals to account for the unexpected cost of windfall taxes. One such mitigatory measure is the inclusion of a purchase price adjustment mechanism that applies if and when the cost of the windfall tax on future revenue streams is known. Another consideration is whether there is any expenditure relief that the underlying energy project can benefit from to mitigate the overall tax cost, for example in the form of a deduction against taxable revenue (although, at least in the UK, the green energy windfall tax is revenue-based so the opportunities to deduct costs are minimal). Where available, such incentives are usually subject to conditions whereby the incentives received by the seller may be recaptured if the buyer does not continue complying with the applicable conditions. In such cases, it is advisable to contractually commit the buyer to abide by the terms of those incentives.