There is currently rather a lot of money being splashed around by governments around the world on the industrial transition to Net Zero. But it’s not coming from the UK.
The Inflation Reduction Act (IRA) in the US offers a whopping $369bn of tax credits and federal support for green technologies. It’s not alone. Over the last decade China has introduced significant green subsidies and financing together with support for SMEs who drive green development.
Seeing decisive action by two major powerhouses, and rightly concerned that investment will be diverted from Europe, the EU has also taken action and recently published its Green Deal Industrial Plan (Green Deal). The Green Deal will repurpose existing EU funds, allow faster approvals, improve skills, and seal trade agreements to secure supplies of critical materials.
The proposals notably loosen State Aid rules, hitherto a cornerstone of EU philosophy, for certain green investments until the end of 2025. State Aid rules are designed to prevent government assistance creating competitive advantages, an imperative in ensuring fair competition within the bloc.
The EU’s willingness to sacrifice State Aid in response to the IRA shows the seriousness with which it views the threat of green investment moving elsewhere. According to EC President von der Leyen, the Green Deal will level the global playing field for green investment. And whilst the Green Deal has triggered strong responses within the bloc, the EU is at least trying to stitch together a strategy on Net Zero.
China, the US and the EU understand that the stakes are high. The global green technology and sustainability market size was valued at $10.32 billion in 2020, and is projected to reach $74.64 billion by 2030, growing at a compound annual growth rate of 21.9% from 2021 to 2030.
Like it or not, the world economy has entered a new era of protectionism and interventionist industrial policy.
All of this begs the question of how the UK will respond, for respond it must if it is not to find itself squeezed out by the powerful blocs surrounding it.
The recent Skidmore report recognised that the tax system, whilst not representing the whole solution, has an important part to play. There are other areas where a lack of certainty impacts on UK investment, such as clarity on the carbon price or whether the UK introduces some form of Carbon Border Adjustment Mechanism, which is due to be phased in by the EU later this year.
But from a tax perspective, the UK is losing its shine as an investment location; as the US is handing out billions in tax credits, the UK is handing out windfall taxes, the headline corporation tax rate is about to increase to 25% and the super deduction is about to end with (currently) no replacement.
The UK needs to take bold action. At the moment we have a hodge-podge of grants, tax allowances and incentives that don’t quite add up to a strategy. The answer isn’t to increase all incentives and allowances; anything the government does must represent value for money.
We would like to see a strategy built on certain principles:
- Coherency. The UK needs to adopt an approach that spans the life cycle of investment and the body of grants and incentives, and that investors can understand. The way in which the tax allowances and incentives intersect needs to be addressed. The thinking needs to be joined up.
- Focussed incentives. Currently our environmental taxes, such as they are, use a stick approach penalising bad behaviours. Some carrots are needed as well, but they need to be well constructed and generous. Faffing around at the edges won’t do, as the US administration have recognised. Real barriers to investment need to be understood so that the incentives can properly change behaviour.
- Certainty. Without upfront certainty of treatment, any incentive will only play a marginal part in an investment decision. The recent Skidmore report highlighted the need for an R&D and tech roadmap to 2050, this is especially true in tax. But another certainty pillar is clarity around definitions and qualification criteria so that taxpayers know how income will be taxed and expenditure relieved.
- Expediency. One key attraction of the IRA is the ease with which funding is unlocked. The EU has set this as an objective in the Green Deal and we must too.
- Collaborative compliance. Disputes are inevitable, but early resolution is needed by more collaborative working between taxpayers and tax authorities.
Below we set out a number of suggestions that should be considered in developing a more coherent approach
- Post Brexit we are no longer tied to EU rules, particularly State Aid rules (which are loosening anyway). This gives an opportunity to take a favoured sector approach
- The government should decide which green technologies to focus on and define them well to ensure clarity for investors and to reduce the risk of abuse
- Review the grants system which has been in place for over 20 years and is seen as uncertain, slow and administratively cumbersome.
- Green capex, particularly infrastructure, needs to be incentivised. There are areas where the technology exists but the infrastructure doesn’t. A super-deduction targeted at green spend, ideally with an above the line payable credit, would help encourage businesses to invest.
- R&D incentives could offer higher rates for green technologies and could be enhanced by offering greater certainty, in line with the House of Lords Economic Affairs Committee recommendations.
- The Patent Box regime is an example of an incentive that changed behaviours. The government should continue to support it and consider introducing a lower rate for green tech.
- It is not clear whether Freeports (and the planned Investment Zones) are targeted at levelling up or at promoting certain types of investment. Trying to deliver net zero and levelling up through one mechanism risks failing at both. The two ambitions should be decoupled. They are different problems and need different solutions.
With the Spring Budget just around the corner there is a prime opportunity for the Chancellor to set out a tax and investment strategy that explains how the UK will seize its share of the green tech and how it will bring back the UK’s shine as an investment location. If he doesn’t, then the country that kicked off the first industrial revolution risks being a bystander for the next one.
