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the past 20 years.1 The approach is The focus of this discussion is on the
rooted in the idea of net reductions tax deductibility of the purchase of vol-
of greenhouse gas (GHG) emissions untary carbon offsets (VCOs) as trade
or business expenses. Given that these
across the entire climate system.
offsets are nonmandatory, can they be
The offset approach has the ad- treated as “ordinary and necessary”? This
vantage of providing a mechanism question raises principles that can be ap-
for transferring resources to achieve plied to other expenses that emerge with
reductions. Carbon offsets provide a the changing business environment.
market where one party can purchase A discussion of this issue first re-
the offsets, thereby funding projects quires understanding the background on
reducing the emissions of another party. the business context of carbon offsets.
For example, a business emits carbon The motivation and business purpose of
dioxide or other carbon compounds into the expenditures is key to determining
the atmosphere but wishes to establish their tax deductibility.
itself as a net-zero emitter (i.e., emitting
none or no more than it removes). The ESG reporting and voluntary
business decides that it cannot feasibly carbon offsets
reduce its carbon emissions or remove A growing number of companies are
them enough to achieve that goal. It focusing on the climate impact of their
therefore offsets its excess emissions by activities as part of broader ESG ob-
paying another entity, either directly jectives.2 The strategy is often geared
or indirectly, to reduce its emissions toward measurement and reduction
(or remove them) by that amount. The of emissions through both direct and
transfer is mutually beneficial, as the indirect means. McKinsey & Co. reports
purchaser may have emissions that are that the number of companies with
very difficult and expensive to reduce, a pledge to reach net-zero emissions
while other parties may have easier- doubled from 500 in 2019 to more than
to-achieve reductions but may lack the 1,000 in 2020.3 Companies are adapt-
resources to do so. Given that emissions ing this emphasis to address a variety
have a global impact, the net reduction is of emerging challenges in the overall
an overall benefit. operating environment.
Carbon offsets are employed in both
compliance and voluntary markets. In Purpose of voluntary carbon
a compliance market, participants are offsets
allowed to use a certain amount of net The Taskforce on Scaling Voluntary
reduction to meet the requirements of Carbon Markets (TSVCM), an initiative
an applicable law or regulation. In a of the Institute of International Finance
voluntary market, participants are under working to establish a VCO market, es-
no formal obligation to reduce net emis- timates that demand for carbon credits,
sions. These participants may do so and which certify an amount of atmospheric
he concept and implementation
purchase voluntary carbon offsets as a carbon reduction (including by VCOs),
Tof carbon offsets has seen a large means to satisfy environmental, social, could increase by a factor of 15 or more
degree of growth and acceptance over and governance (ESG) objectives. by 2030 and by a factor of up to 100 by

1. Blaufelder, Levy, Mannion, and Pinner, “A Blueprint for Scaling Voluntary especially Background Materials, “Recommendations of the ESG Subcom-
Carbon Markets to Meet the Climate Challenge,” report, McKinsey & Co. mittee of AMAC.”
(Jan. 29, 2021), available at tinyurl.com/u6ntksvm. 3. Blaufelder et al., “A Blueprint for Scaling Voluntary Carbon Markets to Meet
2. SEC Asset Management Advisory Committee, webcast and written materi- the Climate Challenge,” citing Hsu et al., “Accelerating Net Zero: Exploring
als of public meeting (July 7, 2021), available at tinyurl.com/3nz9svjn. See Cities, Regions, and Companies’ Pledges to Decarbonize,” Data-Driven
EnviroLab & NewClimate Institute (September 2020).

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