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EXPENSES & DEDUCTIONS

2050. McKinsey describes the typical Responsibility Report (CSRR)5 identi- guidance for disclosure and appropriate
role of carbon credits in a company’s fied an overall goal of reaching net-zero risk assessment is under ongoing discus-
ESG strategy:4 GHG emissions for its direct operations sion and development.
by 2030. The company stated that as
Under such principles, a company part of this goal it supports projects Climate-risk financial
would first establish its need for by others: disclosures
carbon credits by disclosing its Given concerns that climate-related
greenhouse-gas emissions from all We invest in high-quality, veri- risks are systemic and therefore un-
operations, along with its targets fied and rigorously vetted natural avoidable, the G20 Finance Ministers
and plans for reducing emissions climate solutions that generate and Central Bank Governors asked the
over time. To compensate for emis- meaningful carbon reductions as Financial Stability Board6 to review
sions from sources that it can even- well as deliver positive social and how the financial sector can take ac-
tually eliminate, the company might economic impacts. count of climate-related issues. The
purchase and “retire” carbon credits Financial Stability Board responded by
(claiming the reductions as their To the extent the company consid- establishing an industry-led Task Force
own and taking the credits off the ers these investments as a component on Climate-Related Financial Disclo-
market, so that another organization of its overall emissions goal, they could sures (TCFD).7 The TCFD was asked
can’t claim the same reductions). be said to represent VCOs. The actions to develop voluntary, consistent climate-
It could also use carbon credits to taken and overall reporting framework related financial disclosures that would
neutralize the so-called residual are voluntary. be useful to investors, lenders, and in-
emissions that it wouldn’t be able to Disney’s CSRR is a separate dis- surance underwriters in understanding
eliminate in the future. closure from its financial statements material risks.
encompassing its entire ESG strategy. The TCFD issued a report of the
As an example, the Walt Disney There is not currently any mandated task force’s recommendations that
Co. in its 2020 Corporate Social format. As discussed further below, the included an analysis of the linkage

4. Id. These carbon credits come from four categories: avoided nature loss and international standard-setting bodies as they work toward developing
(including deforestation); nature-based sequestration, such as reforestation; strong regulatory, supervisory, and other financial sector policies” (“Mandate
avoidance or reduction of emissions such as methane from landfills; and of the FSB,” available at tinyurl.com/3a3yyvpc).
technology-based removal of carbon dioxide from the atmosphere. 7. Other organizations and groups working to identify material ESG reporting
5. Available at tinyurl.com/yv7wvj8m. issues and develop consistent reporting frameworks include the Sustainabil-
6. The Financial Stability Board was established in 2009 under the auspices of ity Accounting Standards Board (SASB) and Climate Disclosure Standards
the heads of state and government of the G20. Its mandate is to promote Board (CDSB).
international financial stability “by coordinating national financial authorities

EXECUTIVE SUMMARY including the SEC are developing and the regulations, the cost may
frameworks for more consistent be capitalizable.
• Voluntary carbon offsets (VCOs) and reliable disclosure of ESG
allow a business to create a net efforts by companies. • Some companies obtain VCOs by
reduction in greenhouse gas funding projects undertaken by
emissions by funding atmo- • The tax treatment of VCOs is not a not-for-profit entity. Payments
spheric carbon reduction actions well defined and varies based on made to entities related to such
of another party. They are becom- the taxpayer’s facts and circum- projects can generally be treated
ing more important as companies stances. VCOs may be currently as a charitable contribution to
assess and report their environ- deductible under Sec. 162 if it can the not-for-profit. However, an
mental, social, and governance be shown that the cost of VCOs argument may be made that the
(ESG) goals and activities. is a current ordinary and neces- nature of VCOs may make these
sary expense of the taxpayer. payments ordinary and necessary
• U.S. and international financial However, if the VCO provides a expenses that are deductible
reporting boards and agencies long-term benefit, under Sec. 263 under Sec. 162.

20 January 2022 The Tax Adviser