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EXPENSES & DEDUCTIONS

consider such areas as customer prefer- It is reasonable to conclude that continue to be important in addressing
ences, supply chain issues, and even other costs that companies incur to issues with the IRS.
physical location risks. satisfy ESG objectives would also be
Much of this impact is taking deductible. The clear expectation and Evolving expectations
the form of building and protecting movement in policy from stakeholder Arguably, the motivation for incur-
reputational “goodwill.” This aspect groups is that these amounts are now ring ESG expenditures is becoming
is particularly relevant in the case of both “ordinary and necessary.” The more “ordinary and necessary” over
VCOs. The purchase of the offsets is costs would still need to be assessed in time. External stakeholders are hold-
made to benefit another party; how- terms of the period of benefit. ing companies to higher standards,
ever, it has reputational implications to with tangible effects on many aspects
the protection and furtherance of the Potential movement away from of business operations. VCOs are
company’s existing trade or business. charitable contributions one tool in meeting the evolving net-
This relationship is similar to that The evolving VCO market is mov- zero expectations of regulators and
found in the Jenkins case discussed ing toward a greater reliance on an other stakeholders.
above. Likely, this tie will continue exchange type of approach. VCOs can What once might not have been
to grow stronger as policymakers and be purchased on the market rather deductible or, at best, was treated as
other stakeholders further ingrain than directly funding a specific project. a charitable contribution is now be-
ESG considerations into regular busi- Alternatively, companies can directly coming expected as an ordinary and
ness operations. fund projects developed within not- necessary cost of doing business. The
The current deductibility of VCO for-profit organizations.22 analysis of VCOs raises a question
payments is also contingent on the In the case of a not-for-profit orga- regarding the evolution of a newer
nature of the asset purchased and the nization developer, an issue may again business expenditure into a deduct-
time frame of the benefit. As in the arise as to the substance of the intent of ible expense. The wisdom provided
example in Regs. Sec. 1.263(a)-4, gen- the payments. Is the company making in Welch is still true: “Life in all its
eral ESG allocations are not creating a the payment for altruistic charitable fullness must supply the answer to the
“separate and distinct” intangible asset purposes, or is there an exchange type riddle.” ■
from the business itself. The costs are of motivation similar to the “ordinary
enhancing the operating viability of and necessary requirement”? The rel-
the business, so they are not required evance of this question would be par-
to be capitalized under the approach in ticularly important at the beginning of
the regulations. ESG considerations or any form of ex- Contributor
A VCO, however, is somewhat dif- ternality benefit type of expense. Is an
ferent from the example in the regula- amount voluntarily remitted to another Craig White, Ph.D., is a professor of
tions. The payments in the example party a trade or business expense or an accounting at the University of New
are made directly to or on behalf of the amount designed to provide a general Mexico in Albuquerque, N.M. For more
third party. A VCO can be purchased societal benefit? An examination of information about this article, contact
on an exchange as a tradeable property websites of organizations developing thetaxadviser@aicpa.org.
right. In this case, as a property right, carbon offset credits shows that many
the VCO would be capitalized on of these organizations address this issue
purchase as a separate and distinct as a “charitable contribution.” The view
intangible asset. However, the overall to this question may shift as expecta-
net-zero intent of employing offsets tions further change and mandatory AICPA RESOURCES
results in their “retirement” once requirements evolve.
counted against the emissions of the Charitable contribution deductibil- Report
company holding the VCO. In effect, ity comes with a number of restrictions ESG Reporting and Attestation:
the VCO cannot be double-counted in relative to normal trade or business A Roadmap for Audit Practitioners,
reporting the net reduction in GHG expenses. A company’s rationale and tinyurl.com/4npy9fy3
emissions.21 documentation for incurring costs will

21. Robust accounting procedures and controls are necessary to avoid fraudu- 22. For instance, the Walt Disney Co. funds projects developed by not-for-
lent implementation. profit organizations.

24 January 2022 The Tax Adviser