By: Jessie Coleman, Sayantani Ghose, Richard Murray and Lorie Srivastava, KPMG
With an increasing focus on environmental, social and governance issues, many multinational corporations (MNCs) across the globe have made public commitments to net zero and have started developing long-term strategies for lowering greenhouse gas emissions. As MNCs make large investments to meet their environmental and sustainability goals, transfer pricing issues are gaining prominence. Transfer pricing represents the price that one related party in a company charges another related party for goods and services provided. These prices/charges need to follow the “arm’s-length principle” – meaning that the amount charged by one related party to another for a given product must be the same as if the parties were not related.
The benefits of intragroup transfers of carbon credits
MNCs may seek to minimize overall group carbon tax liability – or the need to purchase credits under an emissions trading system – by moving carbon credits among different related party entities. A key transfer pricing consideration would be how to price the carbon credits. The MNC would need to consider the price of the credit of a willing buyer and seller, which may be different in compliance and voluntary markets. In terms of pricing, the appropriate market price – such as spot prices at different dates and potentially forward price curves – would need to be evaluated to understand alternatives. It would also be important to consider whether aligning emissions and credits would benefit the MNC. For example, a benefit to its reputation that allows it to charge a premium price or boost sales.
Below are just some of the transfer pricing implications companies should consider for carbon trading and the different roles a centralized carbon trading team (CT) could play.
CT as a service
In the most basic intercompany arrangement, each operating entity/carbon producer settles its obligations related to emissions with its local exchange or regulatory body directly. The CT, in this case, provides administrative services, and the transfer pricing issue at hand will only involve compensating the CT for its activities. These services and associated rewards may vary, depending on the role the CT has in structuring the arrangements on behalf of its affiliate company and whether the activity is purely execution services or something more strategic.
Buying and selling credits
In order to meet an overall carbon emissions reduction target, many MNCs will need to purchase carbon credits from the open market and have a CT lead this effort. A key transfer pricing consideration is how to remunerate the CT for its administrative and agency activities. Should it be remunerated based strictly on its total costs or should it be remunerated based on a discount/premium on the price of the carbon credits (with the service fee included in that discount/premium)? To the extent operating entities transfer carbon credits among related parties, there are transfer pricing questions regarding appropriate pricing. It is important to understand which entity bears the market risk for fluctuations in carbon price to ensure that the entity is appropriately remunerated. This can be particularly relevant when there is a multiyear lag between the acquisition of offset certificates and settlement date.
Determining the market risk
A CT could execute transactions with the market itself. Depending on whether the group is operating in a compliance or voluntary market, the rules for market access and carbon credit retirement or settlement vary. The transfer pricing analysis will have to consider the arm’s length markup the CT should earn as remuneration for its services, the market risk faced by the CT while selling excess carbon credits in the external carbon market, how well the CT should be capitalized to bear such risks, and whether there is a cost of carry related to holding inventory.
A fit-for-purpose structure
A company could consider a structure where a CT has more functions and greater responsibilities and works as a profit center by buying and selling carbon credits in the open market and earning related profits. In order to have robust transfer pricing support for this arrangement, the company should maintain transparent records so that there is a clear demarcation between income/loss generated from proprietary trading activity and income generated selling/sourcing surplus carbon credits for the operating entities. Each service that the CT provides to the operating entities needs to be identified and compensated in a manner consistent with the arm’s length standard.
Environmental taxation and the treatment of carbon as part of the value chain are very likely going to be the next frontier influencing MNCs as governments make more impactful climate commitments moving forward and as MNC stakeholders continue to expect increasing emission reductions. It’s clear that carbon trading – and the related transfer pricing issues – will be important for MNCs to consider in the months and years ahead.
About the authors:
- Sayantani Ghose is a principal in the Economic Valuation Services (EVS) group within KPMG’s Washington National Tax (WNT) practice
- Jessie Coleman is also a principal in the EVS group within KPMG’s WNT
- Lori Srivastava is a senior manager in the EVS group within KPMG’s WNT
- Richard Murray is a Partner with KPMG in the UK.