The sustainability of economies and in turn, society, largely hinges on how well we adopt Environmental, Social, and Governance (ESG). Given that naturally this comes at some cost, the tax deductibility of related expenses comes into focus.
Cor Kraamwinkel, partner Webber Wentzel Tax, Candice Meyer, partner Webber Wentzel Corporate, and Margaret Vermaak, senior associate Webber Wentzel Tax, consider ESG-related expenditure from a tax perspective.
The impact of ESG goals in South Africa
According to Meyer, the United Nations Sustainable Development Goals (SDGs), were adopted by UN member states in 2015 as part of the 2030 Agenda for sustainable development. The SDGs aim to address global challenges and guide countries and organisations towards a more sustainable, equitable world by 2030. The SDGs address a range of social, environmental, and economic issues, with the objective of promoting prosperity, while at the same time protecting the planet. In SA, ESG considerations permeate our regulatory law, most obviously in our environmental, employment, corporate and B-BBEE legislation.
Three areas where ESG considerations influence taxation
Kraamwinkel highlights the practical considerations of taxation in the ESG context, by expanding on three main areas:
1. Tax transparency and disclosure
“This is a theme that is more advanced in certain of the first world countries where there is particular legislative guidance on how and what you need to disclose in your financials from a tax perspective. South Africa is not there yet, but we are seeing corporate groups moving forward and starting to be early adopters." This results in ESG impacting on how and what is reported from a tax perspective, throughout the financials.
2. Ethical tax contributions
The discussion around fair share of tax and whether there is a duty beyond legislation is ongoing, but ESG now also informs it. For example, in South Africa, some groups chose not to exercise certain COVID-19-related relief measures because they could financially afford not to, and they regarded it as their duty, speaking to the “S” in ESG.
3. Tax treatment of ESG expenditure
The tax treatment of this area is the most technical, and it includes some of the following examples of ESG expenditure by a company or group: costs incurred for receiving environmental sustainability advice, calculations of carbon tax credits, or the newly introduced incentives around renewable energy. Furthermore, depending on the industry, for example, the mining industry, certain mandatory costs need to be incurred, yet there is not necessarily a particular tax rule that deals exactly with how to treat the expenditure.
General principles and case-specific analysis apply
Kraamwinkel advises that to determine the deductibility of ESG-related expenses, the first point to remember is that there is no dedicated section in the Income Tax Act that deals with specifically with ESG. Instead, general principles apply for business entities: i) expenses must be incurred for purposes of trade in the production of income and ii) expenditure must not be of a capital nature. This also means that the tax deductibility of ESG-related expenditure will require a case-by-case analysis with case-specific rules that may allow for a deduction or allowance in a specific context. “In general terms, you cannot say expenditure, A, B, and C will always be deductible and D, E, and F will never be deductible. It's going to be influenced by the specific case.”
Vermaak shares practical examples of where ESG expenditure was incurred and how the tax was treated:
- To proceed with certain projects, often energy projects, taxpayers are required under the National Environmental Management Act (NEMA), to incur expenditure for the conservation of biodiversity or to mitigate disturbances of ecosystems to ultimately obtain environmental authorisation to proceed with the relevant project. A taxpayer acquired a piece of land, and to consider the deductibility of this expenditure, which was mandatory in terms of legislation, “we had to take a step back and analyse the expenditure against the general criteria…so we concluded that it would probably not be deductible based on the expenditure being capital in nature.”
- A court case earlier this year involved the expansion of a mining pit, but the area to which they planned to expand was occupied by a community. The taxpayer then decided to relocate the whole community, which included existing roads, railways, water, electricity, infrastructure, and housing. The taxpayer also reconstructed electricity lines for ESKOM and railways for Transnet before they could continue with the expansion projects. “The question then arose, are these expenditures deductible? Apart from the general rules, our tax legislation does contain special mining provisions, which allows for broader criteria for deductibility, meaning expenditure that will normally not be deductible due to it being capital in nature may be deductible if you conduct mining operations.” The court held that the expenditure was not incurred as part of the taxpayer's mining operations (or rather its mining right). In addition, the court also held that the taxpayer was attempting to claim deductions for infrastructure that neither belongs to them nor will be used by them in their mining operations, such as the electricity lines and the housing. “The taxpayer is now taking this matter to the Supreme Court of Appeal, and one of the grounds of appeal specifically is to obtain clarity on the deductibility of ESG expenditure.”
- The installation of solar panels, for example, is a typical expenditure that should be deductible. “While the panels itself may be capital in nature, taxpayers are allowed to sometimes claim capital allowances against the expenditure, essentially resulting in a claim of the cost over a period of time.”If a company engages in a community cleanup project, the expenditure incurred to buy refuse bags, and the transport to have the bags collected and removed, for example, should be deductible.
From a tax treatment perspective:
- there is no particular ESG-related tax rule,
- analyse tax deductibility on a case-by-case basis, and
- apply ordinary principles.
Listen to Kraamwinkel, Meyer and Vermaak as they unpack the tax deductibility of ESG-related expenses.