Carbon Tax’ Effect on the Iron and Steel Industry
28 September 2016
Posted by: Author: Thinus Cronje
Author: Thinus Cronje (ArcelorMittal South Africa)
A look at the effect that the looming Carbon Tax would have on the already struggling iron and steel industry.
Society is negatively affected by pollution, yet the polluter is often not held accountable. In such instances, it is the duty of government to intervene by way of regulations. Carbon Tax, which is set to come into effect on 1 January 2017, is such a manner of intervention.
According to the Carbon Tax Policy Paper of May 2013, the draft bill and related documents dated 2 November 2015, the proposed Carbon Tax forms part of a broad framework of policies aimed at addressing the key challenge of climate change. This was also reinforced by the commitment shown by South Africa when it signed the Paris Nations Climate Agreement dated 22 April 2016.
Government’s aim is to assist South Africa in transitioning to a low-carbon economy in order to ensure environmental sustainability. Intended targets are a reduction of 34 per cent by 2020, and a further reduction to 42 per cent by 2025 when compared to the status quo. However, achieving such ambitious targets is not without potential pitfalls. This has also been recognised by government.
Government proposes a gradual implementation intended to drive changes in producer and consumer behaviour. They want to contribute to significant emission reductions, but at the same time have a largely neutral impact on economic growth, employment and income inequality.
A major tool to accomplish lower pollution would be “revenue recycling”, which could include tax shifting by decreasing some taxes or tax incentives.
It can therefore be seen that, unlike most other taxes, theoretically the main purpose of Carbon Tax is not revenue generation, but rather government intervention to create a mechanism to facilitate positive change.
Challenges facing the Iron and Steel Industry
Having looked at the rationale from government for implementing Carbon Tax, the rest of this article will look at the effects that such an implementation would have on changing industry behaviour as well as unintended consequences on economic growth and employment.
The main issues facing the Iron and Steel Industry, are:
- The timing of the taxation
The relevant technology available, and therefore the possibility of changed behaviour;
Efficiency of current tax incentives;
Insufficient guidance on the definition of the “taxpayer”.
The Timing of Carbon Tax
The iron and steel industry is a major employer in South Africa, employing more than 10 000 full time employees. It also affects at least 100 000 contractors and employees in downstream operations. ArcelorMittal South Africa Limited (AMSA), a major player in the iron and steel industry, has incurred net losses of almost R12 billion since 2012, and has not yet recovered. The Highveld Steel plant was closed in 2015, and more plant closures could follow if an additional cost for Carbon Tax becomes part of the equation. The latest estimated impact on AMSA is more than R250 million per annum for the first phase, but will later increase as Carbon Tax is phased in. This cost could be passed on through to the consumer, but it would not be ideal as it will encourage the use of imported steel, much of which is not yet affected by similar taxes. For the current year, AMSA made a net loss for the six months up to 30 June 2016 of R450 million, and is still not in a position to afford possible Carbon Taxes. Due to flat international commodity prices, other companies in the industry are in similar financial distress.
Should Carbon Tax be implemented at an expected rate of R54 per ton of liquid steel production, the effect on the most recent historical EBITDA (earnings before interest, taxes, depreciation and amortization) would be as per the table below. To illustrate the potential impact, the table assumes AMSA will absorb the cost of Carbon Tax. It is clear that this impact will be significant.
In assisting AMSA with job preservation, government has implemented import tariffs at a bound rate of 10 per cent on ten locally produced steel products since the end of 2015. However, the iron and steel industry remains vulnerable, and implementing Carbon Tax at this stage will greatly mitigate the positive effect of these tariffs.
Based on the current vulnerable status of the industry and Carbon Tax not being affordable in the short term, it is proposed that Carbon Tax could be limited to taxable income. This will ensure that companies are only liable for an additional cost at a time when they have sufficiently recovered and can therefore afford it without sacrificing jobs and negatively contributing to South Africa’s economic growth.
Lack of alternative technology
The main purpose of Carbon Tax is to change behaviour and force producers to use more environmentally friendly technologies. The iron and steel industry needs to use carbon as a reductant to convert iron ore to steel, which makes carbon emissions and the resultant taxation thereof unavoidable should production take place.
Globally, there are only two environmentally friendly processes available to produce steel. Electric Arc Furnace (EAF) technology is already implemented by the South African iron and steel industry at many facilities. However, EAF technology is electricity intensive, which is not supported by current infrastructure. The only remaining alternative is to use a natural gas based technology, which is again dependent on the availability of natural gas. This is not seen to be a viable option unless “fracking” becomes a reality. It also needs to be kept in mind that neither of these alternatives is currently able to reduce carbon emissions to “acceptable” levels, even if current infrastructure challenges could be overcome.
Based on current technological advancement, Carbon Tax will unfortunately not result in any behaviour changes for the iron and steel industry, and will have the effect of being a penalty or stick, rather than the carrot it is intended to be.
Efficiency of current tax incentives
Government intends to use “revenue recycling” in the form of tax shifting by decreasing some taxes and/or granting tax incentives.
The Draft Carbon Tax Bill suggests that Carbon Tax must be treated as an environmental levy as contemplated in section 54A of the Customs and Excise Act, 1964 (Act No. 91 of 1964). Normally, a levy is deemed as a cost of production. However, in this instance National Treasury is of the view that it should be regarded as a tax, and will therefore not be allowed as an Income Tax deduction.
Section 12L incentives were given as recognition for energy efficiencies, leading to sustainable savings. Unfortunately, these Income Tax allowances are not of immediate benefit to a loss making company, some of which fall in the Iron and Steel Industry. As these companies are not in a tax paying position, they might not be able to offset these Section 12L incentives for a considerable time into the future. Furthermore, energy efficiency improvements are most often achieved by once-off projects and hence the rebates are also once-off in nature, whereas the tax will be collected on a continuous basis. Within the Iron and Steel Industry, the tax rebates may be small compared to the Carbon Taxes that will be imposed and which it is meant to help neutralise. The South African Iron and Steel Institute (SAISI) is of the view that emission reductions that relate to 12L rebates should rather be considered as an offset towards Carbon Tax.
Who is the “taxpayer” for Carbon Tax?
As part of the easing in of Carbon Tax, tax-free allowances are given based on various criteria. The issue relevant to the iron and steel Industry is a variable tax-free allowance for trade-exposed sectors, up to a maximum of 10 per cent. Should AMSA be evaluated based on individual legal entities, only a small portion of its operations namely the Saldanha plant, would obtain this exemption. However, should AMSA be regarded as a Group, then steel exports would reduce the potential burden of Carbon Tax. Treasury has indicated that they will probably regard Group structures for Carbon Tax purposes, but a firm commitment to provide certainty is needed in this regard.
The general commitment and thought processes of National Treasury with regards to Carbon Tax are commendable. However, careful consideration should be given to ensure that their stated objectives, specifically the nudging towards behaviour changes while limiting adverse effects such as job losses, is achieved.
With specific reference to the iron and steel Industry, but also applicable to other companies and/or Industries in distress, National Treasury could consider a tax holiday for Carbon Tax implementation. Alternatively, National Treasury could limit Carbon Tax to taxable income, which would afford struggling companies a similar grace period.
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This article first appeared on the September/October 2016 edition on Tax Talk.