Definitions & Terminology
EU Taxonomy explained: environmental objectives, eligible vs. non-eligible activities, alignment criteria, and KPIs.
Introduction to EU Taxonomy
What is the EU Taxonomy?
The EU Taxonomy is the European Union’s official classification system for economic activities. Think of it as a dictionary that defines what counts as environmentally sustainable economic activity.
Its purpose is simple: to create a common language that allows companies, investors, and policymakers to assess environmental performance in the same way.
Why does this matter?
Without such a framework, each company could define “green” in its own way, making it impossible to compare results. The EU Taxonomy closes this gap by setting clear rules for:
Which activities can be considered sustainable.
What criteria they must meet.
How results must be disclosed.
From 2022 onward, large EU companies and financial institutions are legally required to check their activities against the Taxonomy and publish the results. This improves transparency and helps channel investments toward activities that truly support Europe’s climate and environmental goals.
The Environmental Objectives
The EU Taxonomy is built around six environmental objectives:
Climate change mitigation (CCM)
Climate change adaptation (CCA)
Sustainable use and protection of water and marine resources (WTR)
Transition to a circular economy (CE)
Pollution prevention and control (PPC)
Protection and restoration of biodiversity and ecosystems (BIO)
For each objective, the European Commission has published a list of economic activities that may contribute substantially to it. Each listed activity comes with defined technical screening criteria (TSC) that set the conditions it must meet for contribution.
When reporting under the EU Taxonomy, companies must first check whether their activities appear in one of these official lists.
How Activities Are Classified
To understand the classification system better, let us look at the schematic diagram depicted below:
As illustrated above, the EU Taxonomy classifies economic activities into two broad categories:
Taxonomy-eligible activities
Activities that are explicitly listed in the EU Taxonomy Regulation as potentially contributing to at least one environmental objective.
Eligibility means the activity is in scope and has defined technical screening criteria (TSC), but it may or may not meet those criteria.
Eligible activities can therefore be classified as either aligned (meeting all criteria) or not aligned (failing one or more criteria).
Taxonomy-eligible and aligned activities
Activities that are listed in the Taxonomy and meet all the conditions:
Technical screening criteria (TSC)
Do No Significant Harm (DNSH)
Minimum social safeguards (MSS)
These activities are considered “sustainable".
Taxonomy-eligible but not aligned activities
Activities that are listed in the Taxonomy but fail one or more conditions.
For example, a renewable energy project that harms biodiversity may be eligible but not aligned.
From 2026 onwards, taxonomy-eligible but not aligned activities are no longer required to be explicitly reported.
Taxonomy non-eligible activities
These are activities not yet listed in the Taxonomy.
Non-eligible does not mean unsustainable. It only means the activity is not currently defined under the regulation.
From 2026 onwards, non-eligible activities are no longer required to be explicitly reported.
A note on Materiality
Before assessing eligibility and alignment, companies must first determine which activities are financially material. An activity is generally considered non-material where its cumulative Turnover, CAPEX, or OPEX represents less than 10% of the respective KPI denominator.
Non-material activities are not required to undergo a full eligibility and alignment assessment. However, they are not omitted from reporting entirely; companies must still disclose their combined share as a single percentage of the relevant KPI denominator. Only material activities proceed to the full eligibility and alignment assessment described above.
In short:
Eligible = on the list
Aligned = on the list and meets all criteria
Non-Eligible = not on the list
Non-material = not assessed for eligibility or alignment.
Key Performance Indicators (KPIs)
Once activities are classified, companies must report how much of their business falls into each bucket using three mandatory Key Performance Indicators (KPIs):
Revenue/Turnover – Proportion of revenue from eligible, aligned, or non-eligible activities (in other words, what share of sales comes from eligible or aligned activities).
Capital Expenditure (CAPEX) – proportion of CAPEX related to eligible, aligned, or non-eligible activities (how much investment goes into eligible or aligned activities).
Operational Expenditure (OPEX) – proportion of OPEX related to eligible, aligned, or non-eligible activities (how much day-to-day spending supports eligible or aligned activities).
These KPIs convert the classification into measurable, comparable numbers making disclosures easier to compare across firms and over time.
How the EU Taxonomy Works
The Taxonomy uses a step-by-step approach to classify economic activities:
Identify Eligible Activities within KPIs
Companies begin by reviewing their turnover, capital expenditure (CAPEX), and operating expenditure (OPEX) to see which activities appear on the official EU Taxonomy lists linked to the six environmental objectives.
If an activity is listed, it is taxonomy-eligible.
If not listed, it is taxonomy non-eligible.
Example: A power utility earns $100 million in revenue. $30 million comes from renewable wind farms (an activity listed in the Taxonomy), while $70 million comes from coal power plants (not listed). In this case:
$30 million of turnover is classified as eligible.
$70 million of turnover is classified as non-eligible.
Assess Alignment
Eligible activities are then tested against three conditions:
Meet the technical screening criteria (TSC),
Do no significant harm (DNSH) to other objectives, and
Comply with minimum social safeguards (MSS).
Activities that satisfy all three are considered taxonomy-aligned, while those that fail one or more are considered taxonomy-eligible but not aligned.
Determine Substantial Contribution to Environmental Objectives
Once aligned activities are identified, companies must indicate which environmental objective(s) these aligned activities contribute to.
The contribution is expressed as a percentage of the relevant KPI denominator (turnover, CAPEX, or OPEX), showing not just whether an activity is aligned, but also how much of the company's business supports each environmental goal.
Example: Suppose a wind power generation project is taxonomy-aligned under Climate Change Mitigation (CCM). If the project generates $30 million out of a total $100 million in turnover, the substantial contribution is reported as:
CCM: 30% of total turnover aligned
CCA, WTR, CE, PPC, BIO: 0%