The circular economy envisions a shift from the linear “take-make-dispose” model to a system where products and materials are reused in new cycles. While we are beginning to see a focus on increased resource utilization and waste reduction, only 8.6% of all materials extracted and used return to our economy.
The transition to the circular economy is high on the political agenda in many countries, as evidenced by the recent US Climate Bill (Cut Inflation Act of 2022) and the Green Deal of the EU. While explicit legal commitments to address climate change are crucial to promoting sustainable business practices, it is equally important to ensure that the adoption of circular business models is not unintentionally hampered by legacy legal rules that were designed when climate change was not considered. a major problem. concern.
Tax laws were written decades ago in a world of linear supply chains where raw materials were extracted, turned into products, and ultimately discarded as waste. The origin of state sales taxes in the US dates back to the Great Depression. The EU Value Added Tax (VAT) rules were first enacted in 1967. Although both EU and US states made many changes to their excise legislation, adapting it to realities e-commerce and the digital economy, there were hardly any tax reforms. was directly related to the issue of climate change. As companies are shifting to circular business models using strategies such as product-as-a-service, product-life extension, or design-for-recycling, it is worth considering whether this transition will not expose them to tax risks and additional compliance costs. .
product as a service
In a product-as-a-service approach, a company rents or leases products to its customers instead of selling them. A shift from ownership to access creates incentives for green product design and more efficient product use, which reduces the consumption of natural resources. Rental and leasing have been common in the auto industry for years, but are now taking hold in other sectors as well. For example, Stripe He saw a 550% increase in money spent on clothing, equipment and tool rentals in the first three quarters of 2022 compared to the same period in 2019. However, leases or rentals where a transfer of ownership does not occur may generate additional tax liabilities.
Under US sales tax laws, owning a property in one state can immediately create a physical nexus for the landlord and lead to sales tax registration obligations. In contrast, remote sales by an out-of-state seller create an economic nexus if certain monetary and quantitative thresholds are exceeded. In most US states, the landlord must collect and remit sales tax on the tenant’s recurring payments. However, in some states (Maine), the landlord must pay sales tax for the purchase of the property in advance, while the lease payments are not taxed. There are also states (California, Nevada, Michigan) that allow landlords to choose whether they want to pay taxes on the purchase price they paid to acquire the property or collect taxes on rental payments. Another complicating factor is that some local jurisdictions impose their own rental and lease taxes; For example, the City of Chicago imposes its own 9% personal property lease transaction tax on lease payments. This is in addition to the state tax that the landlord must pay on the purchase of the property.
In the EU, although the letting or rental of movable property is treated as a provision of services under the general sourcing rules, some countries (Ireland) have enacted use and enjoyment provisions which in certain scenarios may override the usual sourcing rules and change the place of taxation to the place where the property is actually used. The rules of use and enjoyment are known for their complexity and vary by country.
In both the US and the EU, there may be special rules for transportation rentals, short-term rentals, and for “rental purchase agreements” where the customer acquires ownership of the product at the end of the lease. If the lessor provides additional services (installation and maintenance) under a single contract, it must be determined whether such services are accessories to the lease or constitute independent services with their own tax treatment.
product life extension
Product life extension models slow the flow of raw materials through the economy, reducing the rate of resource extraction and waste generation. When it comes to extending the life or use of a given product, the two common approaches are resale and repair.
In a resale model, the supply chain becomes a loop. A business sells goods to a consumer, buys them back, and then sells them again at a discount. Every time the product is resold, the tax is collected. To avoid the accumulation of taxes on the same product, EU companies can use a margin scheme that allows them to account for VAT on the difference between the sale price and the repurchase price. If the sale price is less than the purchase price, no tax is due. However, costs associated with preparing the product for resale (for example, repair or maintenance) are not taken into account in the margin calculation.
Repair creates value for the consumer when a product can be repaired and maintain satisfactory functionality at a significantly lower cost than buying a new one. Many EU countries apply reduced VAT rates to various repair services to make them more affordable. In the US, repair services may be taxable or exempt from state sales tax, depending on many factors. For example, in Florida, labor-only repair services are exempt from tax, but transactions that require both labor and materials to repair tangible personal property are taxable. One big disadvantage for Florida-based repair companies is that they have to pay taxes on purchased materials that will be used during the repair process but will not become part of the repaired property. Taxing business inputs increases the cost of doing business and places repair service providers at a competitive disadvantage compared to those located in states without such taxes.
design to recycle
Design for recycling aims to maximize the recoverability of materials for use in new products. Despite the clear environmental benefits of reusing materials, products made from recycled materials are taxed in the same way as those made from newly mined resources. Several business Y NGO they have called on governments to introduce lower VAT rates for environmentally responsible products to stimulate their consumption.
Although it may seem like a good measure to promote the circular economy, economic studies (Institute of Environmental Studies, economy of copenhagen) have questioned the use of reduced VAT rates to increase the consumption of ‘green’ products for several reasons. First, VAT rate reductions affect consumer behavior only if they are passed on to consumers. However, empirical evidence suggests that this rarely happens and that it is not possible to require companies to transmit a fee reduction. Additionally, the reduced rates are available to anyone, which means they also benefit those who could have purchased green products without this financial incentive. For those with more limited financial resources, the rate difference must be significant to have a real effect on consumption. Finally, the preferential treatment of some products can give rise to product classification disputes, which increases the overall complexity of the tax system and makes it vulnerable to abuse.
Building sustainable supply chains at scale requires not only a new technology infrastructure, but also a new approach to managing your fiscal affairs. Companies moving to circular business models should be aware that from a tax perspective, service-based delivery models are more complex than traditional sales. Although many companies call for lower tax rates for sustainable products and see it as a key enabler of the circular economy, reduced rates may not be the most efficient policy measure to stimulate the use of sustainable products.
The opinions expressed in this article are those of the author and do not necessarily reflect the views of any organization with which he is affiliated.
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