More tax-driven moves to boost environmentally friendly business are on the way, writes David Kennedy

Minister for Finance Brian Cowen's Budget on Wednesday marked a milestone in terms of how we might expect Ireland's tax code to be used in the future to encourage environmentally friendly behaviours and incentivise business to focus on energy efficiency.

Mr Cowen's confirmation that vehicle registration tax and motor taxation are to be fundamentally changed so as to correlate directly with the CO2 emission rating of cars had been well flagged and has been widely applauded.

Notably, the Budget also contained proposals to base the level of tax (capital) allowances available for business use of motor cars on CO2 emission levels. In particular, business tax relief will no longer be available for the use of cars emitting CO2 levels above 190g/km. While not as well flagged to business, this measure can be taken as a sign of things to come.

The tax code currently provides for a number of tax incentives to encourage more environmentally friendly and efficient fuel use. These include:

n Tax reliefs to companies for investing in renewable energy projects (solar, wind, hydro and bio), allowing businesses to write off up to 50 per cent, or €9.525 million, of the cost of investing in renewable energy projects.

n The Business Expansion Scheme (BES) allows generous tax reliefs for individuals to invest in renewable energy production, as well as waste material recycling activities. Individuals can claim tax relief against their entire income for investment in such projects, up to €150,000 per year. While not without its constraints, last year's relaxation of the BES limits has added some stimulus to this incentive.

Looking to the future we can expect that the tax code will be increasingly used to deliver targeted incentives to boost energy efficiency and a better environment. Some changes have already been flagged. In his Budget speech on Wednesday, Mr Cowen indicated that his department was examining the feasibility "of providing businesses with targeted incentives to support the installation of certain energy-efficient equipment". Specific measures in this regard will be incorporated into the 2008 Finance Bill.

Reform in this area will most likely take the form of an accelerated capital allowance for the cost of investing in energy-efficient plant and equipment. The UK has grasped this nettle and extends 100 per cent upfront tax relief to businesses for their capital spend on designated energy-saving plant and machinery.

While requiring EU approval, the UK precedent serves to suggest that a 100 per cent first-year write-off for qualifying energy-efficient plant and machinery might be a runner in Ireland also.

However, given that corporate tax rates in the UK, at 29 per cent, are considerably greater than our 12.5 per cent tax rate, the Minister might consider extending an R&D-type tax credit for energy-saving projects, as a means of creating a meaningful cost differential and incentive for business.

The introduction of a carbon tax during the lifetime of the Government is also expected. In his Budget speech, the Minister kicked this one out to the proposed Commission on Taxation. While earmarked as revenue-neutral, the introduction of a carbon tax will serve to create greater cost differentials between fossil fuels and alternative, environmentally friendly fuel sources.

Business can expect that the indirect tax codes will also be further altered to support the green agenda. From a VAT perspective, the Programme for Government contained a commitment to examine the scope for cutting the VAT rate on environmental goods and services from the standard rate of 21 per cent to 13.5 per cent. During subsequent Dáil debate, Mr Cowen has indicated that scope to cut the VAT rate on energy-efficient insulation materials and renewable energy systems (including wind, solar and geothermal systems) are under examination.

The Budget saw the VAT rate on supplies used for the agricultural production of biofuels reduced to 13.5 per cent, as part of this agenda.

Interestingly, from a Green perspective, the changes announced in the Budget centred firstly around residential stamp duty rates and secondly on the green agenda. However, the Minister refrained from interlinking the two. Notably, since October 1st, 2007, the UK has introduced an exemption from stamp duty on the purchase of new zero-carbon homes. This provides for the removal of stamp duty liabilities for new zero-carbon homes up to a purchase price of £500,000. (€692,000). In Ireland, such a scheme, coupled perhaps with some level of further increased mortgage interest relief for the purchase of carbon-friendly homes, could usefully serve the dual purposes of promoting the economic and green agendas, simultaneously.

Either way, Irish businesses can expect that the tax code will increasingly be used to drive the green agenda and that, inevitably, will further complicate tax legislation.

David Kennedy is a tax partner in KPMG