The Impact of the IRA on ESG: Preparing for Opportunity

March 18, 2024
Publications

By Elizabeth Smith and Martha “Frannie” Reilly

What Is ESG?

The term “ESG” stands for environmental, social, and governance principles. While individuals may understand what these letters represent, many people are looking to understand why ESG is relevant, what ESG means in practice, and how it can be incorporated into business practices to the advantage of the business. In the last several years, ESG has become a hot topic and, for many, is the new standard of excellence for businesses moving forward. These principles, at their core, provide a framework for businesses to measure the tangible impacts of these issues on their operations and bottom line, as well as the community at large. This framework expands this analysis to account for a broader group of stakeholders.

Sustainability of a business now depends on more factors than ever before. Environmental sustainability focuses on a reduction of energy and water consumption—in particular a reduction of carbon and greenhouse gas emissions—as well as an improvement in recycling and waste reduction efforts.

Social sustainability focuses on how a business treats people both inside and outside of the organization. This includes not only compliance with safety and labor regulations, but also includes a business’ approach to diversity, equity, and inclusion (DEI) as well as overall impact of the business on its community. The current focus has even expanded to where consumers will take into account a business’ global social impact, including use of overseas labor in countries with exploitative practices or the sourcing of materials from countries rife with social and political oppression. This factor also includes fair compensation plans, including addressing the gap between executive and other employee compensation, as well as transparency within an organization.

Sustainability from a governance perspective depends on the consistent and ethical management of a business at all levels. Starting with the board, a business must intentionally focus on the board composition to determine who is making decisions on behalf of the business. In addition, the board and senior staff need to focus on the impact of these decisions including the impact of various policies and procedures. Are they being applied fairly? Are they responsive to issues faced by the business? These are all questions business leaders face when determining whether a business is well-governed for a sustainable term.

One of the main goals of the ESG principles is to determine whether a business is sustainable. By incorporating good environmental, social, and governance practices, a business is making an intentional effort to focus on core components identified in a 2004 Report from the United Nations titled “Who Cares Wins,” which was a joint initiative of financial institutions.

Recognizing the importance of these factors, the next question is—how does a business obtain funds to pay for these sustainable practices? As discussed below, one option is the IRA.

What Is the IRA?

The Inflation Reduction Act of 2022 (IRA) was signed into law on Aug. 16, 2022. The IRA’s main purpose is to direct federal spending in a way that will reduce carbon emissions which will, in turn, lower health care costs and reinvigorate investments in domestic manufacturing and infrastructure. The IRA encourages the procurement of materials and supplies from domestic sources or from countries that are free-trade partners with the United States. The IRA also aims to incentivize the research and development and, ultimately, the commercialization of carbon capture, storage, and clean hydrogen technologies.

The IRA not only supports many of the ESG principles and goals outlines above, but also gives a fresh incentive to ESG investing. Indeed, the IRA has earmarked $369 billion for climate change and green energy investments over the next ten years and enhances many existing energy-related tax credits such as credits for renewable electricity production, sustainable aviation and biofuels, electric vehicles and infrastructure, and greenhouse gas reductions.

The IRA is also aimed at supporting social policies by tying many of these credits to an organization’s satisfaction of prevailing wage and apprenticeship requirements and investment in low-income communities. There is also an emphasis on domestic manufacturing and job creation.

What Are ESG Projects That Could be Funded by the IRA?

The primary focus of the IRA is the reduction of greenhouse gas emissions, which is squarely in line with ESG’s environmental principles. What is unique about the IRA is that many of the funds dedicated to this reduction will be allocated to projects that focus on historically marginalized and low-income communities—thereby also addressing ESG’s “S” principles. By way of illustration, the communities that are typically located closest to heavy industrial areas, waste treatment, storage, and disposal facilities, and shipping ports tend to be low-income communities.

These communities are also disproportionately impacted by the pollution from these facilities, and generally higher utility bills which further compound their financial difficulties. The funds set aside by the IRA are, in part, meant to support programs that aim to provide better access to energy efficient buildings that will lower utility costs for these communities and spur development initiatives. There are also additional funds earmarked for affordable housing projects with the aim of creating new businesses in these communities in addition to alleviating the effects of pollution in these areas.

The Greenhouse Gas Reduction Fund created by the act will also create opportunities for grants and funding to support research and development related to zero-emission technologies as well as funding advancements in waste treatment and storage. There are also new incentives available to manufacturers of renewable energy such as solar, offshore wind, geothermal, hydrogen, and nuclear aimed at invigorating domestic renewable energy production.

These incentives, primarily in the form of tax credits, are earmarked for projects in various industries including agriculture, real estate development, and shipping. These projects include funding for zero-emission port equipment and technology as well as additional funding for low emission trucks and heavy-duty vehicles used in these industries. The IRA has also provided increased tax credits and funding for companies and suppliers in hard-to-abate industries. In particular funding for building and material suppliers that work with iron, steel, concrete, glass, pulp, paper, ceramics, chemical production, and refining. These tax credits are designed to spur new private investment in clean energy, transportation, and manufacturing using “direct pay” credits—meaning organizations can claim the full amount even if their tax liability is less than the credit.

In addition to these tax credits, the US Department of Energy’s Loan Program will receive $12 billion to create a new loan program dedicated to upgrading, repurposing, or replacing energy infrastructure. The goal is that with broader incentivization of lower-carbon energy sources should, in time, also result in reduced emissions in other industries such as hospitality, retail, and office buildings.

How Do Organizations/Governmental Entities Prepare for These Projects?

Businesses should assess their current carbon footprint and emissions data. The primary focus of the IRA is to reduce emissions across all industries. In order to take advantage of these incentives, businesses will need good metrics and data to determine their baseline and to keep track of progress.

Many of the incentives and opportunities discussed above are tied to the satisfaction of prevailing wage and apprenticeship requirements. As a preliminary matter, before taking advantage of any of these opportunities, businesses should examine their own compliance with these principles. These programs also focus on incentivizing investment in low-income and energy communities. Businesses, therefore, should identify those communities in their area that qualify, and involve themselves with those community leaders and stakeholders to effectively develop projects that will capitalize on the opportunities offered by the IRA.

With respect to domestic manufacturing and job creation, businesses will need to thoroughly examine their current supply chain in order to recoup the tax benefits being offered. For example, the incentives offered may vary depending on where a manufacturer’s component materials come from, where they are assembled, as well as other variables. Businesses will likely see increased flexibility in their supply chains as different industries and investors try to capture the maximum benefits offered by the IRA.

What are some compliance issues that need to be considered to accept these IRA funds? There are several important provisions and restrictions within the IRA that may impact tax obligations and reporting requirements both for businesses and their clients. This may require adjusted profit and loss calculations. Additionally, the 15% minimum tax on corporate profits above $1 billion could have other implications.

Therefore, before taking advantage of the tax credits or grant funds available, businesses should meet with their legal and financial advisers to understand their reporting obligations and potential impacts on their business. This includes compliance with prevailing wage laws, safety and labor regulations, as well as diversity standards required by the IRA. Businesses interested in obtaining this funding must establish good governance policies and procedures to ensure compliance with the IRA requirements.

The IRA also includes requirements for more transparent, uniform standards in labeling for product declarations related to carbon impact. This will require fund recipients to ensure that they have accurate data and adequate internal processes for synthesizing and reporting that data. This will ensure compliance and allow organizations to track their success.

Elizabeth Smith is an attorney in McNees Wallace & Nurick’s litigation and environmental, social and governance (ESG) groups. She works with clients on navigating the Inflation Reduction Act (IRA) and other ESG compliance matters from the firm’s Harrisburg, office. She can be reached at esmith@mcneeslaw.com or 717-237-5404.

Martha “Frannie” Reilly is co-chair of the firm’s public finance and government services group and chair of the firm’s environmental, social and governance (ESG) group. Serving clients from Devon, she advises businesses of all sizes on the development and implementation of corporate policies, best practices and corporate governance as well as counsels clients on the use of ESG Bonds and Green Bonds to further their sustainability plans. She can be reached at freilly@mcneeslaw.com or 484-329-8036.