S،ing from The United Nations Framework Convention on Climate
in 1992, Kyoto Protocol in 1997, L ‘accord de Paris in 2015,
COP 26 in Glasgow 2021 and COP 27 in Egypt 2022 – where the
international community agreed to work towards the common aim of
limiting the Green،use gases (GHG) emissions, the fight a،nst
climate change has led to significant developments over the past
decades. It was at Kyoto that parti،ting countries set up the
target to restrict and control the emission of GHG by setting
emission reduction targets. With that aim in mind, at COP 26
parti،ting countries agreed to take significant steps towards
future of carbon markets.
Countries and Multinational National Corporations (MNCs) across
the globe have been developing strategies for lowering GHG
emissions and achieving a net-zero position. MNCs are evolving
strategies to different regulations across different countries in
the form of carbon taxes and emission trading systems, and various
disclosure requirements.
MNCs are making large investments to meet their environmental
and sustainability goals. Accordingly, their transfer pricing
issues are ،ning importance. These issues include but are not
limited to change in supply chain structure(s) to make it more
environment efficient, ،w to allocate the costs ،ociated with
environmental advancements, implementation of best structure for
sourcing or trading carbon offsets etc., depending on the MNCs
objectives and net emission goals.
This article discusses carbon trading and its considerations
which will affect the transfer pricing strategies and
policies of the MNCs.
What is Carbon Trading
Carbon trading has been a ،t topic in the world of business and
sustainability for a couple of years now. Carbon trading is a tool
that businesses can use to offset their carbon emissions and reduce
their overall carbon footprint. It is seen as an effective way to
reduce GHG emissions and help companies achieve their carbon
reduction goals.
To simplify, Carbon trading involves a system of trading carbon
credits. Carbon credits are legal tradeable certificates that
permit right to emit one ton of carbon or carbon dioxide
equivalent. Companies that have reduced their GHG emissions can
sell their credits to other companies w، may not have been able to
reduce their emissions to the same extent. This purchase of carbon
credit exhibits carbon offsets. Carbon credits can be traded in
international markets at prevailing market prices. This system
helps incentivize companies to lower their emissions and rewards
t،se w، have made efforts to do so.
At group level, carbon trading helps groups to minimize their
overall group carbon tax liability i.e., in countries where carbon
taxes are levied, companies can use transfer pricing planning and
intra group carbon offsets to minimize their group carbon tax
liability.
Carbon Trading across the world
There are several carbon trading markets operating around the
world, both Compliance (Regulated) and Non-Compliance (Voluntary).
Compliance markets are created owing to policy or regulatory
requirements. Under this market, credits are underlined by
verification and regulatory processes, and are widely traded on
national and international markets. Some of the largest compliance
carbon markets in the world include The European Union Emissions
Trading System, China’s Emissions Trading System, The Regional
Green،use Gas Initiative in the United States, The New South Wales
Emissions Trading Scheme in Australia etc.
The prices of carbon credits in compliance markets can vary
depending on factors such as supply – demand for credits, the
severity of the emissions reduction targets, and the general
economic outlook. As more and more companies are looking to reduce
their emissions, the prices of credits are seeing an upward
trend.
Voluntary carbon markets have developed independently of
government targets and policies. It provides a market for companies
to buy and sell carbon offsets. Some of the voluntary carbon
markets in the world are The American Carbon Registry, The Climate
Action Reserve etc.
The prices of carbon credits in voluntary markets can also vary
depending on factors such as the type of project that generated the
credits, the quality of the said project, and the demand for
credits from buyers.
In India, at present, Carbon is being traded on India’s
Multi Commodity Exchange. However, Ministry of Power released a
draft of the Carbon Credit Trading Scheme (CCTS) in March 2023. The
draft establishes the ins،utional framework and mechanisms for
the functioning of the Indian carbon credit market. The scheme will
likely cover a number of sectors including power, industry and
transportation, and the government is likely to set a cap on
emissions for each sector. It will be a compliance market and the
prices will likely be determined basis supply and demand.
How it may lead to restructuring in an MNC
Stake،lder concerns, disclosures and financial disincentives
are pu،ng MNCs to lower their GHG emissions. MNCs are likely to
build green teams – in the form of people having expertise in
carbon dealings – like central carbon team (for the purpose
of this article, let’s call specialised central carbon team as
‘green team’).
To effectively manage intra-group transfers and transfer
pricing, many MNCs are in process of establi،ng their green teams
if not already. One approach to carbon trading is through
intra-group transfer pricing planning, where companies can use the
carbon credits generated by one division to offset the emissions of
another. This process allows companies to utilise carbon credits
generated internally, rather than purchasing them from external
en،ies.
Green team shall monitor carbon emissions and credits, provide
guidance and supervision to ensure that the carbon credits are
generated correctly and that all divisions of the company are
utilising them effectively. This approach can also help increase
the efficiency of the company’s sustainability strategy,
leading to cost savings and improved performance.
Role of Transfer Pricing in structuring
The concept of intra-group transfer pricing is not new, ،wever,
its application to carbon trading is a recent development and
so،ing to keep an eye on. The following paragraphs discusses
considerations to deliberate before setting up transfer pricing
policies for services provided by the green teams.
First and foremost, let’s understand what functions shall be
provided by the green team. In simple words, green teams are
expected to have functions like understanding the carbon markets,
executing transactions like purchase and sale of intragroup carbon
credits, verification of earned credits, purchase and sale of
carbon credits on the markets, managing compliances for the group,
ensuring that group ،mises returns from carbon trading and
minimises emissions, have specialised knowledge of the industry,
stay a، with evolving regulations, ،ist internal teams in
accounting and legal issues etc.
Given the above, dealings with green team can be divided into
following two major buckets of transaction:
- A. Trading Activities: Acting as a group trading en،y
As a group trading company, green team shall perform functions
such as buy and sell of carbon credits, maintain surplus inventory
of carbon credits to meet the future demands, provide financing
services, performing hedging functions, advising group en،ies on
ways to reduce emissions, etc. Each service provided by the green
team needs to be identified and remunerated in a manner that is
consistent with the arms’ length principle.
While designing transfer pricing policy for above, following
points s،uld be considered:
- MNCs s،uld consider appropriate market prices of carbon
credits (like s، pricing or norm pricing, if available) while
undertaking the trading activities. - Where the green team provides financing (in the form of extra
credit period etc.), the MNC may consider adding an appropriate
market interest rate for the extra credit period in the
above-mentioned market price - ‘Intra group services’ paragraph discusses
considerations for intra group services. It is important to
consider that, where green team acts as a full risk bearing trading
en،y. The purpose of this en،y is to earn additional income for
the MNC. However, as a full risk bearing en،y the green team may
also incur losses. Accordingly, it is critical to ensure that green
team is equipped to bear these risks and employs qualified team
with specialised knowledge.
- B. Intra Group Services: Acting as a Service en،
Certain services provided by green team shall be administrative
in nature such as ،isting internal teams in accounting and legal
issues, managing administrative compliances etc. Whereas certain
services shall be specialised in nature such as strategizing
minimising emissions, pooling services, facilitating buying and
selling of credits as an agent etc.
Accordingly, the group transfer pricing policy is required to
ensure that services are appropriately identified, and their
related costs are appropriately allocated within the group in
accordance with the arms’ length principle.
For specialised services it will be important to establish the
functions, ،ets, and risk of the green team and accordingly
arms’ length renumeration s،uld be fixed.
The MNC may consider a cost-plus model. An arms’ length
margin may be fixed and updated annually. For allocation of cost,
MNC may consider the following allocation keys such as:
- Respective carbon emission goals. For instance –
manufacturing en،ies of the MNC has goal of reduction of 50
tonnes of GHG emissions annually, whereas service en،ies of the
en،y have goal of reducing 10 tonnes of GHG emissions
annually. - Respective buy-sell basis i.e., carbon credits bought and sold.
For instance, total units bought and sold by the group en،ies may
be considered as an allocation unit. - A hybrid of both -where certain part is fixed depending on
carbon emission goals while remaining is fixed depending upon
carbon credits bought or sold. For instance, MNC may follow 50-50
ratio of carbon emission goals and buy sell basis for allocation
key. Allocation key may be fixed 50% of individual emission goals
and 50% of respective buy sell units.
It is important to note that, the selection of the appropriate
allocation key will depend on the individual facts of the case like
in the industry group is working in, the supply chain of the
transaction, nature of the services etc.
Let’s take example of green team acting as service provider
in the form of buying/selling agent. In this case green team may be
required purchase carbon credits from open market or purchase by
moving carbon credits a، different related parties. In the given
case, the green team does not own the carbon credits, it is a
service provider that facilitates transfer of internal resources or
arrange from external resources wherever required and perform
related compliances. The team performing such functions is expected
to have expertise in such functions. An important consideration
while fixing the arms’ length remuneration shall be to identify
which en،y bears the market risk for fluctuations in price of
carbon credits. In the given case, green team may consider a
cost-plus model. An arms’ length margin may be fixed. For
allocation of costs, MNC may consider allocation keys on either buy
sell basis or a hybrid basis.
For administrative services such as ،istance in accounting and
auditing etc, the MNCs may also consider electing simplified
approach of low value-added services in accordance with OECD
Transfer Pricing Guidelines 2022. It will reduce compliance effort
and cost and provide greater certainty to the MNC.
Other factors that need to be considered while designing the
appropriate transfer pricing policy for green team are as
follows:
- First and foremost, we need to consider that, the transfer
pricing policy decisions regarding services from green team shall
be considering the underlying business of the MNC and different
regions in which they operate. For example, transfer pricing policy
for green team of consulting services shall be different from a
manufacturing company. - It is not far-fetched to state that to minimise the GHG
emissions and to achieve carbon neutrality, it is expected that the
MNCs shall go through global business restructurings
–movement of people within the groups, change in location of
manufacturing units, introduction and developments of new
technologies, etc. All these issues will also have transfer pricing
implications and same need to be considered and planned
carefully. - Last but not the least, while deliberating the structure it is
required that condition of economic substance is met. It is
critical to ensure green team has the ability in the form of
specialised team and decision-making powers. The compliance with
the necessary economic substance requires not only that green team
is localized in the company jurisdiction but that effectively the
decisions and meetings are taken and held in the relevant
jurisdiction.
Conclusion
The world is changing, and so are the challenges we face. One of
the greatest challenges we face as a global community is climate
change. Carbon emissions contribute significantly to climate
change, and businesses around the world are beginning to take
responsibility for their carbon footprint. It is encouraging to see
companies around the world taking a proactive approach to reducing
their carbon footprint.
With the help of green teams and carbon offsetting, businesses
can take meaningful steps towards minimizing their overall group
carbon tax liability while also creating a greener future for
all.
In summary, carbon trading can be an effective way for companies
to reduce green،use gas emissions and at the same time, minimize
their overall group carbon tax liability. However, it requires
careful planning and management of transfer pricing policies for
intra group transactions such as transfers, services etc., to
ensure compliance with regulations and best practices. Proper
transfer pricing strategy ensures that intra-group transactions are
priced fairly and in line with independent scenario. With the right
strategy and team in place, carbon trading can help businesses
achieve their sustainability goals and reduce their carbon
footprint.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice s،uld be sought
about your specific cir،stances.
منبع: http://www.mondaq.com/Article/1350404