According to a Climate Bonds report published on March 17, 2026, green-labelled (or environmentally-focused) debt represented the majority (64%) of aligned volume (i.e. the amount of bond proceeds that qualifies as “aligned” with the relevant sustainability standard) in 2025. Whilst the report showed that social bonds fell to their lowest level since the pandemic, sustainability-labelled debt overall continues to build momentum with annual volume marking a second consecutive high in 2025.
Given the continued importance of sustainable bonds, it is worth taking the time to understand the tax implications of these instruments. This article explores key tax themes that arise in relation to sustainable bonds, drawing insights from the UK, the U.S., Luxembourg, Italy, and Poland.
Types of sustainable bonds
- Sustainable use of proceeds bonds: sustainable use of proceeds bonds are conventional bonds where the proceeds of the issuance are used for sustainable purposes. Generally, these bonds do not present unique tax issues compared to traditional bonds. The tax treatment remains consistent across different jurisdictions, as the fact that proceeds are to be used for sustainable purposes does not alter the fundamental characteristics of the bond when viewed from a tax perspective.
- Sustainability-linked bonds: the proceeds of sustainability-linked bonds can be used for general purposes. The sustainability element comes from the fact that their terms are tied to the achievement of specific sustainability objectives. This may be linked to a KPI, such as reducing carbon emissions or meeting gender diversity targets. These bonds may feature a coupon step-up mechanism or a premium on maturity if the issuer fails to meet the predefined sustainability targets. The tax implications of these bonds can vary from jurisdiction to jurisdiction.
Key tax themes
Interest rate toggles
In many jurisdictions, the tax treatment of a debt instrument may be adversely affected if it has “equity-like” or “contingent” payment features. For instance, in the UK, if an interest rate is dependent on the results of the business, prima facie, this may result in (a) the interest payments becoming non-deductible for tax purposes and/or (b) stamp duty arising on any transfer of the debt instrument. It can even lead to companies being de-grouped for tax purposes (resulting in otherwise exempt intra-group transfers becoming taxable and/or loss of group loss relief). In the U.S., contingent payment terms including interest-rate step ups or step downs may cause a debt instrument to be classified as a so-called “contingent payment debt instrument” (or “CPDI”) which may trigger certain adverse tax and reporting consequences and impact marketability. In Luxembourg, arm's length interest payments are not subject to Luxembourg withholding tax. However, withholding tax applies to certain bonds that provide for interest that varies depending on the profits of the issuer in addition to a fixed interest component. In Poland, as in the UK, results-dependent interest can mean that interest payments are not deductible. If interest is forgiven or is reduced significantly below market level, this can trigger taxable revenue for the issuer.
Given these potential pitfalls and risks, the terms of a sustainability-linked bond must be carefully reviewed to ensure they do not adversely impact the tax position. There are some important caveats that can often assist in practice. For instance, when thinking about the UK tax treatment, many sustainability-linked bonds will not be contingent on the business (i.e. the relevant KPI would not be considered to be “business” related). Further, even where the interest rate does vary depending on the results of the business, the tax treatment will not generally be adversely affected where the interest rate decreases as the business results improve (or increases if they get worse). This is helpful in the context of many sustainability-linked notes which are generally designed to reward the business moving in the “right” direction. However, some sustainability-linked notes do not fall neatly within these exceptions. For example, the UK tax position is more complex where the interest rate “step up” occurs where, say, the debtor company’s revenues from a particular sector (e.g. oil/gas) increase. Similarly, the U.S. tax rules for CPDIs may not apply in cases where a single interest-rate schedule is significantly more likely than not to occur or the interest rate toggles can be disregarded as remote or incidental, which typically may be the case in respect of the types of interest rate toggles commonly included in sustainability linked bonds.
In Italy, if the adjustment affects only the coupon, the tax treatment remains similar to conventional bonds. However, if there is a reduction in the nominal value to be repaid, this may potentially alter the bond's tax classification to become an atypical bond. This would have an impact on the withholding tax treatment of the bond and could effectively make them unmarketable.
Contingent payment debt instruments (CPDIs)
In the United States, sustainability-linked bonds may trigger the rules governing CPDIs. These rules require the issuer to determine a comparable fixed-rate yield and construct a payment schedule that produces such yield. Holders must accrue Original Issue Discount (OID) for tax purposes. While issuers typically structure these bonds to avoid CPDI classification as this can impact marketability of the bonds, it remains a critical consideration during the issuance process.
Tax exemptions and credits
There are relatively few jurisdictions offering specific tax exemptions and credits for sustainable bonds. However, there are wider exemptions that can be utilized in this context. For instance, in the U.S., tax-exempt bonds issued by U.S. state and local governments can be used to finance sustainability-linked projects and the interest on these instruments is generally exempt from federal income tax.
In Luxembourg, while there are no specific tax exemptions for green bonds, certain investment funds may benefit from a reduced subscription tax rate for sustainable investments, provided they comply with stringent EU green taxonomy requirements. A collective investment governed by the law of December 17, 2010, relating to undertakings for collective investment, as amended, (UCI) or an individual compartment thereof, may benefit from a reduced subscription tax (the normal rate being 0.05%) on the portion of net assets invested in environmentally sustainable economic activities, according to various thresholds: ranging from 0.04% where at least 5% of total net assets are invested in such activities, to a rate of 0.01% where at least 50% of total net assets are so invested. The budget law for tax year 2023 aims to exclude investments in natural gas and nuclear energy from the reduced subscription tax rate for investment funds. Consequently, the reduced subscription tax does not apply to the portion of net assets of a UCI or of an individual compartment invested in economic activities relating to natural gas or nuclear energy.
Comparison with sustainability-linked loans
Sustainability-linked loans, similar to bonds, tie the loan terms to the achievement of sustainability targets. In Luxembourg, these loans may offer a slight advantage from a withholding tax perspective compared to bonds providing for interest varying depending on profits of the issuer in addition to a fixed interest component. However, by way of contrast, the withholding tax position in the UK and Poland is more favorable to bonds. Whilst neither country has specific sustainability-linked exemptions, the availability of more general withholding tax exemptions tend to favor bonds, for instance the exemption for notes listed on a recognized stock exchange (in the UK) or admitted to public trading (in Poland).
ESG-linked financial instruments
Beyond bonds, other ESG-linked financial instruments, such as derivatives, index-linked structured notes, commercial papers (cambiali finanziarie in Italy), also raise tax considerations. For example, ESG interest rate and toggles in swaps may affect their qualification as notional principal contracts for U.S. tax purposes. Additionally, thematic indices like the S&P 500 ESG can impact the tax treatment of structured notes linked to such indices.
Conclusion
The tax treatment of sustainable bonds can significantly impact their marketability. Issuers must diligence the tax treatment to ensure compliance and maintain the attractiveness of these instruments to investors. While the tax treatment of sustainable use of proceeds bonds generally aligns with that of conventional bonds, sustainability-linked bonds may require more attention.
As the sustainable finance market matures, tax rules may evolve to incentivize sustainable investments and accommodate new financial instruments. Issuers and investors should monitor these developments closely to manage risk and marketability in a shifting economic and geopolitical environment.
