In 2023, California passed legislation requiring large companies to file climate disclosures beginning in 2026 for FY 2025. A year later, Governor Gavin Newsom signed legislation that delayed the releasing of the implementation guidelines for climate reporting until July 1, 2025. As the deadline quickly approaches, the California Air Resources Board is still in the early stages of rulemaking, making the July 1 deadline unobtainable. A virtual workshop held on May 29 addressed concerns and floated early staff proposals for key aspects of the law.
In September 2023, California approved the Climate Accountability Package, a pair of bills aimed at creating sustainability reporting requirements. Senate Bill 253 required companies that do business in California and have an excess of $1 billion in revenue, defined as “reporting entities”, to submit an annual report for Scope 1 and Scope 2 starting in 2026. Scope 3 reporting will begin in 2027.
Senate Bill 261 required companies that do business in California and have an excess of $500 million in revenue, defined as “covered entities”, to submit a biennial climate-related financial risk report. The report is based on the work of the Task Force on Climate-Related Financial Disclosures, established by the Financial Stability Board.
The responsibility of drafting specific regulations and implementing the reporting standards was delegated to the California Air Resources Board. CARB was initially given until January 1, 2025 to draft the rules and processes. However, the process of drafting such complex regulations required more time. As a result, the Legislature gave CARB an additional six months to complete the drafting. Now, it is clear that deadline will also not be met.
On May 29, CARB held a virtual workshop to update stakeholders on the progress of the rulemaking. Over 3,000 people from five continents attended the presentation.
Senator Scott Wiener and Senator Henry Stern, the sponsors of the original Climate Accountability Package spoke on progress. Wiener made a point that, despite speculation in the media, reporting requirements will not be delayed and will go into effect in 2026. Under the current timetable, Scope 1 & Scope 2 reporting begin in 2026 for FY 2025. Scope 3 reporting will begin in 2027 for FY 2026. However, CARB used its authority to not enforce reporting requirements in 2026, as no reporting requirements exist.
Stern acknowledged ongoing litigation and headwinds on sustainability reporting. He noted that it was his intent to work collaboratively with the European Union and their Corporate Sustainability Reporting Directive. He also noted they are watching the proposed changes by the International Sustainability Standards Board, the organization that drafted the international standards for sustainability reporting and filled the void after the TCFD was dissolved.
The EU is currently engaged in a massive rewrite and simplification of the reporting requirements of the CSRD and its sister regulation, the Corporate Sustainability Due Diligence Directive. A strong green push back in the EU and internationally is causing the EU and other jurisdictions to rollback gains made in the past few years. Changes in the EU are expected by the end of the year.
CARB is still in the informal pre-rulemaking phase. Once if moves to formal rulemaking, CARB will have one year to complete the process. It will include a 45-day comment period. If amendments are adopted, a second comment period will run for 15-days.
Initial solicitation for comments opened in December 2024 and closed in March. CARB received 261 responses during that period. The themes of those responses focused on who qualifies as a “reporting entity” in SB 253 or “covered entity” in SB 261.
“Reporting entity means a partnership, corporation, limited liability company, or other business entity formed under the laws of this state, the laws of any other state of the United States or the District of Columbia, or under an act of the Congress of the
United States with total annual revenues in excess of one billion dollars ($1,000,000,000) and that does business in California. Applicability shall be determined based on the reporting entity’s revenue for the prior fiscal year.”
“Covered entity means a corporation, partnership, limited liability company, or other business entity formed under the laws of the state, the laws of any other state of the United States or the District of Columbia, or under an act of the Congress of
the United States with total annual revenues in excess of five hundred million United States dollars ($500,000,000) and that does business in California. Applicability shall be determined based on the business entity’s revenue for the prior fiscal year. ‘Covered entity’ does not include a business entity that is subject to regulation by the Department of Insurance in this state, or that is in the business of insurance in any other state.”
Themes were focused on the definition of “doing business in California”, revenue, and corporate relationships between parent and subsidiary companies.
What classifies as “doing business in California”
In the development and interpretation of law, words matter. Codes, ordinances, laws, and regulations typically begin with a list of definitions of key terms. Frequently, those definitions are prefaced with the phrase “for purposes of this section.” This allows lawmakers to define a term for limited use in that section of the law preventing new legislation from negatively impacting established law. Definitions bring clarity, allowing those subjected to the law, regulators, attorneys, and judges to know the exact intent of the lawmakers.
In the Climate Accountability Package, the phrases “covered entity” and “reporting entity” are both defined in their respective sections. The only notable distinction between the definitions is the annual revenue threshold. Both include the phrase “that does business in California.” However, that phrases is not defined and was quickly identified as an issue.
Initial proposals pointed to Article 1, Section 23101(a) of the California Revenue and Taxation Code definition of “doing business.” The California Franchise Tax Board interprets the definition to mean meeting one of five conditions. The board updates the dollar thresholds annually. A company is considered doing business in California if
- The company is “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit”;
- The company is “organized or commercially domiciled” in the state;
- The company has annual sales in California exceed the lower of or 25% of the company’s total sales;
- The company has real property or tangible personal property in California exceeds the lower of $73,502 or 25% of the company’s total; or
- The company has payroll compensation in California exceeds the lower of $73,502 or 25% of the company’s total payroll.
In the initial solicitation, stakeholders were asked “Should CARB adopt the definition of ‘doing business in California’ found in the Revenue and Tax Code section 23101?” The presentation did not give the breakdown on responses, most likely because CARB admitted they had not fully reviewed all of them.
The workshop included an initial staff concept. They propose using the tax board’s definition, but with one change. Companies would need to meet requirement 1 AND any of requirements 2 – 5. This establishes a clearer standard for companies that would fall under the reporting requirements, but is so low that most companies will qualify.
The workshop identified three questions that need to be addressed:
- What specific resources exist to identify businesses that would be subject to the RTC Section 23101 definition?
- Commenters stated that RTC Section 23101 may be overly broad for the purposes of SB 253, potentially including businesses that conduct too few transactions to merit inclusion under this regulation. Does staff’s initial concept help address this concern?
- Commenters have suggested exemptions for various businesses sectors. What would be the rationale for such exemptions? Are those sectors covered in RTC Section
23101.5?
What is included in revenue?
The distinction in reporting requirements under SB 253 ad SB 261 are based on “total annual revenue.” However, as was the issue with “doing business in California”, questioned remained as to what is used to calculate revenue. Specifically, if the thresholds are for the parent company or the subsidiary. Comments
The initial staff concept defines revenue as “For the purposes of determining whether an entity meets the annual revenue threshold in SB 253 and SB 261, ‘total annual revenue’ would be defined as gross receipts as set forth in California Revenue and Taxation Code § 25120(f)(2).”
That section defines gross receipts as “the gross amounts realized (the sum of money and the fair market value of other property or services received) on the sale or exchange of property, the performance of services, or the use of property or capital (including rents, royalties, interest, and dividends) in a transaction that produces business income, in which the income, gain, or loss is recognized (or would be recognized if the transaction were in the United States) under the Internal Revenue Code , as applicable for purposes of this part. Amounts realized on the sale or exchange of property shall not be reduced by the cost of goods sold or the basis of property sold.” The definition includes a list of exemptions.
However, that still leaves unanswered the question as to if revenues are for the parent or the subsidiary. This is an important distinction that needs to be addressed. A subsidiary may only meet the lower reporting requirement, while the parent based in another jurisdiction may trigger the higher reporting requirements.
How should CARB address corporate relationships?
In a simple world, a company is only liable for the actions of the company. However, companies are frequently established as subsidiaries, have institutional investors, and various other factors that make defining a company often times legally murky. This is posing an issue for CARB as they look at the relationship between a parent company and a subsidiary.
The workshop pointed to three main questions that need to be addressed relating to corporate relationships.
- What is the definition of a Parent and a Subsidiary?
- Is a definition of “level of control” needed?
- If a Subsidiary business is “doing business in California”, do the requirements of these regulations extend to the Parent company located outside of California?
The initial staff concept is to leverage the Cap-and-Trade approach defining corporate relationships:
- Under the California Cap-and-Trade program, a corporate association exists when one entity has a degree of ownership or control over another entity
- A level of ownership or control of 50% or greater requires establishment of a Corporate Association in the Cap-and-Trade program
Montrose Environmental Group
CARB engaged the Montrose Environmental Group to conduct a comprehensive study on existing GHG accounting and reporting programs around the world. The study was presented by Mariah Gehle and Alexa Ambroseo.
The presentation looked at the reporting requirements by Scope, if third party verification is required, and data availability. They noted that “Voluntary programs publish more emissions methodologies for Scope 2 and 3 emissions sources and allow flexibility in how they calculate and report the indirect emissions. Regulatory frameworks tend to cover Scope 1 emissions and may not provide guidance or
methodologies for Scope 2 and 3 emissions.”
The next steps
The California Air Resources Board will continue to operate in the informal stage of rulemaking, holding discussions with stakeholders to address issues before the official process begins to make climate disclosure standards. Now is the time for interested parties to weigh in. Once the formal process begins, the template will be set. Expect the formal process to begin by fall, with a target of final approval by the end of 2025.
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