Corporate Tax Incentives for ESG Compliance in India: Aligning Fiscal Policy with Sustainability Goals

Corporate Tax Incentives for ESG Compliance in India: Aligning Fiscal Policy with Sustainability Goals

I. Introduction and Research Framework

The global commitment to sustainable development and climate change mitigation such as India’s 2070 net-zero target [1] has made Environmental, Social, and Governance (ESG) performance a core corporate imperative. In India this is legally enforced by the Securities and Exchange Board of India (SEBI)’s Business Responsibility and Sustainability Report (BRSR) that mandates quantifiable disclosure of ESG metrics from the top 1000 listed companies.[2] Against this backdrop, corporate tax policy – an important lever of fiscal management – is increasingly being considered as a tool to incentivize sustainable practices.[3]

This article “Corporate Tax Incentives for ESG Compliance in India: Aligning Fiscal Policy with Sustainability Goals” answers three main research questions: 1) How well do India’s current corporate tax incentives, under the Income Tax Act, 1961, incentivize companies to adopt ESG practices? 2) To what extent the principles of tax equity and neutrality support or oppose the design of tax incentives for ESG compliant companies in India? 3) What are the legal and policy reforms that can be undertaken in India to balance the revenue generation and incentives for corporate ESG compliance, drawing from the global best practices?

The analysis is guided by the central hypothesis: “India’s existing corporate tax framework provides limited and inconsistent incentives for ESG compliance, resulting in low adoption rates among companies. The principle of tax neutrality may conflict with ESG-focused tax incentives, potentially distorting market competition while failing to ensure equitable tax burdens across industries. A targeted tax incentive regime for ESG compliance, aligned with international standards, can enhance corporate sustainability without compromising fiscal stability.” The objective is to critically evaluate existing mechanisms, assess their alignment with tax principles, and propose a reformed tax policy framework that incentivizes sustainable corporate practices while ensuring fiscal fairness and compliance.

II. Effectiveness of Current Corporate Tax Incentives and Limitations

A. The Dominance and Inefficiency of Environmental Incentives (RQ1)

Indian tax system currently is a net beneficiary of the Environmental (E) pillar by way of capital expenditure (CAPEX) deduction. The most notable example is Accelerated Depreciation (AD), mainly available under Section 32 of the Income Tax Act, 1961[4]; which permits businesses in installing solar power systems and other renewable energy assets to claim a much higher depreciation rate (currently up to 40% W/DV, with possible 20% “bonus depreciation”)[5] which helps to speed up the write-off of green assets[6], reducing the pay-back period and making it cost-effective.[7]

However, AD has a limited efficacy. Empirical analysis of the Indian renewable sector shows that AD, being an investment-based scheme, had lower generation efficiencies (PLFs) for assets such as wind power plants than the production-based schemes, which shows that while AD effectively promotes asset acquisition, it doesn’t sufficiently promote operational efficiency and sustained optimal performance.

B. Structural Discontinuity and the Trade-Off Conflict

The combination of these targeted incentives with the government’s low-rate corporation tax regimes (e.g., Sections 115BAA or 115BAB) creates a significant structural obstacle. Companies that choose the reduced corporation tax rate (as low as 15% or 22%) must forego the majority of deductions and exemptions, including the advantage of Accelerated Depreciation. This requires large, successful firms to choose between a lower statutory tax rate and separate green incentives, which frequently render the latter economically irrelevant. This trade-off supports the argument that the current framework provides inconsistent and frequently incompatible incentives, resulting in dispersed adoption.[8]

C. The Social and Governance Lag: The CSR Paradox

The Social (S) and Governance (G) pillars are still far behind in terms of incentives. India’s mandatory Corporate Social Responsibility (CSR) expenditure (minimum 2% of average net profit as per Companies Act, 2013)[9] is expressly barred from deduction as a tax deduction under Section 37(1) of the IT Act, 1969[10].

This refusal to deduct is very important: by considering mandatory social spending as an appropriation of profit and not as a legitimate business cost, the fiscal policy considers CSR as a quasi-tax or levy[11], which does not allow to tax it and consequently reduces the incentive to incorporate strategic social responsibility. Furthermore, companies that spent more than the 2% limit prior to the law’s adoption tended to decrease subsequent spending to anchor themselves at the required minimum, limiting discretionary high-impact social spending.[12] While some charitable spending may qualify for deduction under S80G[13], the blanket denial for required CSR spending shows the fundamental disconnect between the MCA’s regulatory requirement for social responsibility and the Income Tax Act’s fiscal treatment. This supports the hypothesis that the framework gives limited incentives, especially for the S and G components of ESG.

III. Analysis of Tax Principles: Equity and Neutrality

The design of tax policy for ESG compliance is a classic exercise in balancing the three foundational principles of tax law: equity, neutrality, and efficiency.[14]¹⁹

A. The Doctrinal Conflict: Neutrality vs. Efficiency

Tax neutrality implies that the tax system should not distort economic choices, guaranteeing efficient allocation of resources by treating comparable investments the same.[15] Green tax incentives, including offering AD for solar assets, are inherently non-neutral because they intentionally distort investment decisions in favor of preferred green technologies.[16]

However, this non-neutrality can be justified under economic theory if the incentive is a Pigouvian subsidy, that is, a mechanism that corrects market failure by encouraging activities that yield positive externalities (such as clean energy production) that the market otherwise fails to price correctly. The legal justification for this distortion, therefore, is purely based on the resulting efficiency.[17]

As discussed in Section II, the reliance on investment-based AD (equivalent to an Investment Tax Credit) does not pass this efficiency test. Studies comparing AD to Generation-Based Incentives (like a Production Tax Credit) showed that the latter created higher Plant Load Factors (operational efficiency) by at least 3 percentage points[18], showing that the current scheme’s distortion of market neutrality does not present the maximum public good (energy generation), and makes the efficiency rationale for its existence invalid. On the other hand, research indicates that properly structured CIT incentives can enhance ESG performance by enhancing firms’ cash flow and technological innovation capacity[19], and the lack of efficiency of existing incentives proves the hypothesis that the non-neutral design is not producing proportional environmental outcomes.

B. Tax Equity and Tax Governance

Tax equity is the equitable distribution of the tax burden. Taxpayers in comparable circumstances must pay the same amount of taxes in order to maintain horizontal equity, whereas vertical equity demands that higher income taxpayers pay a greater proportion.[20]

ESG incentives pose horizontal equity problems: they treat firms differently based on their investment behaviour (e.g. a clean firm versus a polluting firm).[21] Although differential treatment is required to deal with externalities, policy makers must be careful that the benefits are not disproportionately skewed. If the tax benefits mainly accrue to large corporations in lucrative green sectors, this may create equity issues for Small and Medium Enterprises (SMEs) or traditional industries that are doing the social cost of transition.[22] Empirical evidence suggests that CIT incentives are often more effective and impactful for non-state-owned enterprises (non-SOEs) and manufacturing firms[23], highlighting the heterogeneity of impact.

Finally, the Governance (G) pillar of ESG is intimately connected with responsible tax behaviour, which requires companies to pay their “fair share” and for tax policy to be transparent.[24] This entails the need for the government to explicitly analyse and report the fiscal cost of incentives (known as Tax Expenditures or Revenue Forgone) in comparison to the opportunity cost of financing important public policy objectives such as the Sustainable Development Goals (SDGs).[25] Transparency enables the government to balance the efficiency of the forgone revenue with direct spending on sustainability efforts.[26]

IV. Legal and Policy Reforms for Balancing Revenue and ESG

To address the limitations of the current framework and align fiscal policy with sustainability goals, India must implement a coordinated regime of incentives and disincentives, primarily informed by the inevitable repercussions of the OECD’s Pillar Two Global Minimum Tax (GMT) and the utility of the BRSR Core.

A. The Pillar Two Imperative: Transition to QRTCs (RQ3)

The most important reform is structural compliance of the OECD’s Pillar Two, which mandates 15% minimum Effective Tax Rate (ETR) on large MNE[27]. Traditional incentives in India in form of tax deduction (e.g. AD) or reduction in corporate tax rate (e.g. 115BAA) reduce ETR of MNE below 15%.[28] When this occurs, the benefit is eliminated as the incentive is clawed back in the form of top-up tax collected by a foreign jurisdiction.[29] This policy failure makes the domestic incentives in India economically ineffective to attract green FDI.

The strategic solution is the legislative adoption of Qualified Refundable Tax Credits (QRTCs).[30] QRTCs are tax credits under the aegis of the Organisation for Economic Cooperation and Development (OECD) which are payable in cash or marketable securities within a period of four years irrespective of the underlying tax liability of the taxpayer. Crucially, QRTCs are considered to be income under the Pillar Two GloBE rules, and not a reduction in covered tax.[31] This results in the ETR remaining above 15% preserving the value of the incentive for MNEs and preserving.[32]

B. Linking Incentives to Measurable BRSR Core KPIs

New QRTCs should be performance-based, clearly linked to the measurable metrics proposed under the SEBI BRSR Core framework, which requires verifiable data disclosure on parameters like greenhouse gas (GHG) emissions, water consumption, and median wages.[33]

Policy reform should ensure that QRTCs are awarded on the basis of the proven ability to deliver tangible sustainable results including:

1. Environmental Credits: QRTCs for verifiable annual absolute GHG emissions reductions or water efficiency improvements that are reported in and assured in BRSR filings.

2. Social/Governance Credits: Introducing credits for measurable social outcomes (e.g. median wage), on top of existing fiscal mechanisms, which means providing fiscal resources to the currently overlooked S and G pillars.

This linkage will take policy beyond investment-based subsidies that are not justified by better, measurable public benefits, which will eliminate the efficiency concerns and verify the last element of the hypothesis.

C. Fiscal Balance: Implementing Green Levies

Using a complementary Pigouvian carbon levy and environmental tax regime, India can fund the forgone revenue under an expanded QRTC regime[34] (policy makers are already debating a carbon tax on high emitting industries such as steel and cement or a differential GST/Green Cess on high carbon footprints) to internalize the negative externalities of pollution[35] and generate a dedicated sustainable stream of revenue to finance the QRTCs and the green transition.[36]

V. Conclusion

The analysis confirms the hypothesis that the current corporate tax framework in India offers limited and inconsistent incentives for ESG compliance, which is mainly restricted to inefficient and investment-based environmental deductions (AD) with social (CSR paradox) and governance left behind. The incentives are structurally inconsistent with the concessional tax regimes of the IT Act, 1961 as well as the looming OECD Pillar Two Global Minimum Tax, and therefore fundamentally ineffective.

To meet the goal of bringing fiscal policy and sustainability objectives closer, India needs to make a strong shift towards a GloBE-resilient and performance-driven incentive structure. The key policy suggestions are: 1) Fiscal competitiveness and integrity under Pillar Two can be ensured by legislatively converting all major green incentives into Qualified Refundable Tax Credits (QRTCs). 2) Tightly couple the issuance of these QRTCs with the attainment of verifiable, auditable performance indicators which are laid out by the SEBI BRSR Core framework. 3) Balance of revenue generation and incentivization by adding complementary Pigouvian carbon levies to pay for the tax expenditures involved. This holistic approach is needed to make sure that corporate sustainability is accomplished without sacrificing fiscal stability or tax equity and efficiency.

Notes:

[1] Net Zero Emissions Target.

[2] SEBI’s BRSR Mandate: How ESG Disclosure Became a Legal Obligation for Indian Corporates, S.S. Rana & Co.

[3] “PricewaterhouseCoopers, The New ESG Tax Landscape: What Companies Need to Know and Do, PwC (Jan. 24, 2023).”

[4] open access power, From Sunlight to Tax Savings: Accelerated Depreciation in Action, open access power,.

^[5] Accelerated Depreciation on Solar Panels: What You Must Know, Tata Power.

[6] India Briefing, Accelerated Depreciation of Solar Power Assets in India, India Briefing News (Feb. 6, 2024).

[7] ESG & Tax in India: How Carbon Taxes and Green Incentives Will Shape Your Business.

[8] Incometaxindia.Gov.in/Tutorials/74.Special-Regimes-for-Taxation.Pdf,

[9] Supra 2

[10] Supra 8

[11] “Guha, P. (2020). Why comply with an unenforced policy? The case of mandated corporate social responsibility in India. Policy Design and Practice, 3(1), 58–72.”

[12] “Jain S, Desai N, Pingali V, Tripathy A. Choosing Beyond Compliance Over Dormancy: Corporate Response to India’s Mandatory CSR Expenditure Law. Management and Organization Review. 2023;19(3):594-623.”

[13] Gaurav Sharma, Tax Benefits of CSR Fund & 80G Deductions with NGO Partnerships, Bal Raksha Bharat (Mar. 20, 2025).

[14] Fiveable. (2024, July 31). 2.3 Tax equity, efficiency, and simplicity – Federal Income Tax Accounting.

[15] The Concept of Neutrality in Tax Policy, Brookings,.

[16] Cowan, Mark J. and Cutler, Joshua (2023) “ESG and the Demand for State Tax Incentives,”Florida TaxReview: Vol. 27: No. 1, Article 3.

[17] Hiort af Ornäs Leijon, Lena. “Tax policy, economic efficiency and the principle of neutrality from a legal and economic perspective.” (2015).

[18] “Shrimali, Gireesh & Pusarla, Shreya & Trivedi, Saurabh. (2017). Did accelerated depreciation result in lower generation efficiencies for wind plants in India: An empirical analysis.”

[19] “Wang, W.; Meng, F.; Gao, S. The Interaction Effects of Income Tax Incentives and Environmental Tax Levies on Corporate ESG Performance: Evidence from China. Sustainability 2025, 17, 5354”

[20] Supra 14

[21] Tax Equity, Green Innovation and Corporate Sustainable Development.

[22] Corporate Tax Incentives for Green Growth: Where, When, and How They Are Being Used, World Bank Blogs.

[23] Supra 19

[24] Lisa Chen,More T in ESG: Tax as a Crucial Component of ESG, 75 UC LAW SF L.J. 1245 (2024)

[25] Statement of Revenue Impact of Tax Incentives under the Central Tax System

[26] “Masiya, M., Hall, S., Murray, S., Etter-Phoya, R., Hannah, E., & O’Hare, B. (2024). Tax expenditures and progress to the Sustainable Development Goals. Sustainable Development, 32(6), 6144–6162.”

[27] Global Minimum Tax and India’s Response: A Double-Edged Sword?, TaxTMI.

[28] OECD (2022), Tax Incentives and the Global Minimum Corporate Tax: Reconsidering Tax Incentives after the GloBE Rules, OECD Publishing, Paris

[29] India and the Two-Pillar Solution: The Road Ahead | International Tax Review.

[30] Supra 29

[31] Qualified Refundable Tax Credits – Oecdpillars.Com.

[32] Supra 29

[33] Supra 2

[34] Supra 7

[35] Green Tax Credits: What Accountants Need to Know.

[36] ESG & Sustainability: Green Initiatives Driving India’s Net-Zero Future.