Recent Developments in the South African Carbon Tax Legal Regime
28 September 2016
Posted by: Authors: Andrew Gilder and others
Authors: Andrew Gilder, Mansoor Parker and Olivia Rumble (ENSafrica)
ENSafrica’s carbon markets and tax specialists unpack the looming Carbon Tax Bill, including determining the volume of greenhouse gas emissions as stipulated in the Draft Bill.
The Draft Carbon Tax Bill (“the Draft Bill”) anticipates that carbon tax will be implemented on 1 January 2017. Since the Draft Bill’s publication in November 2015, National Treasury has reported back on comments received on the Bill and the Draft Offsets Regulations. This represents another piece in the slowly clarifying carbon tax puzzle.
The Draft Bill proposes a design that requires a calculation of carbon tax liability based on the volume of greenhouse gas (“GHG”)emissions from certain, specifically listed activities. The rate is stipulated at R120 per tonne of carbon dioxide equivalent (“tCO2e”) emissions. Taxpayers will determine the quantum of their GHG emissions by multiplying their source category activities (volume of fossil fuel input, raw material used or product produced) by a legislatively stipulated emission factor. This approach means that taxpayers are not required to measure and verify their actual emissions.
The Draft Bill introduces a number of allowances intended to permit a liable entity to reduce its exposure by reducing the GHG emissions, which will eventually be taxed at R120 tCO2e. Such allowances are:
- A basic 60 per cent tax-free threshold during phase one, up to 2020.
- An additional 10 per cent tax-free allowance for process emissions.
- An additional tax-free allowance for trade exposed sectors of up to 10 per cent.
- An additional tax-free allowance of up to 5 per cent as recognition for early actions and/or efforts to reduce emissions above the industry average.
- A carbon offsets tax-free allowance of between 5 per cent and 10 per cent.
- A phase one-specific additional 5 per cent tax-free allowance for companies participating in the Department of Environmental Affairs’ carbon budgeting system.
- Phase one tax-free exemptions will range between 60 per cent and 9 per cent of total emissions, implying that the carbon tax will be imposed on 5 per cent to 40 per cent of emissions during the period.
In the feedback sessions on comments received on the Draft Bill, Treasury also clarified that:
- There is an intention to provide for a threshold of 10 mega-watts thermal capacity (estimated in volume of emissions at around 30 000 tonnes of carbon dioxide equivalent) below which threshold entities will not be tax liable. The threshold is high enough to exclude households and other non-industrial activities from the carbon tax, but low enough to make the tax applicable to the majority of emitting industries in the country.
The anticipated impact of the carbon tax on the electricity price will be neutralised for the first period. This will be achieved by a combination of the phasing out the renewable energy levy (currently imposed on fossil fuel generated electricity) and replacing (in the fiscus) the revenue raised by this levy with that raised from the carbon tax and the advantage accorded to Eskom in the calculation of carbon tax payable in respect of fossil fuel generated electricity.
The intention is that the first round of carbon tax reporting will be in March 2018. The GHG reporting legal regime, currently in development under the auspices of the Department of Environmental Affairs, will inform carbon tax reporting and the submission of returns to SARS. Treasury confirmed that the Draft Bill’s reference to a calendar year for carbon tax reporting, as opposed to a financial year, will remain to align the timing of carbon tax reporting with that for GHG reporting.
There are two important issues to highlight:
the shift, included in the Draft Bill, from an entity-based to an activity-based designation of carbon tax liability; and,
the potential benefit the utilisation of allowances will may give to carbon tax liable entities.
Shift from entity-based to activity-based liability
Until the publication of the Draft Bill, it was generally understood that the entity emitting GHG emissions would be subject to carbon tax. The consequence is that a number of emitting entities, particularly those that have estimated their potential liability by using their conglomerate GHG emissions, have likely significantly over-estimated the level of this liability. By contrast, the Draft Bill introduces an important shift by providing that carbon tax liability applies if:
”A person is –
(a) a taxpayer for the purposes of this Act; and
(b) liable to pay an amount of carbon tax calculated as contemplated in section 6 in respect of a tax period as specified in section 16, if that person conducts an activity as set out in Annexure 1 to the Notice issued by the Minister responsible for environmental affairs in respect of the declaration of greenhouse gases as priority air pollutants under section 29(1) read with section 57(1) of the National Environmental Management: Air Quality Act, 2004” (our emphasis).
This means that the investigation to determine carbon tax liability does not take into account an entity’s entire value chain but only those aspects that constitute an activity as listed in this notice. The relevant question, is not whether an entity emits GHGs in its general operations, but whether there are activities in the value chain that fall within the list of carbon taxable activities.
Some of the listed activities require that something be produced for that activity to be subject to carbon tax. An example is iron and steel production: The meaning given to the word “production” is important because it is feasible that not all elements of an iron and steel company’s value chain are devoted to iron and steel production. If holding company ABC produces steel (which falls on the carbon taxable activity list), this activity will be subject to carbon tax. However, if a division of ABC manufactures goods from the steel that has already been produced by ABC, it is arguable, based on a legal interpretation of the words used in the Draft Bill, that GHG emissions resulting from the process of manufacturing the goods will not be taxable because the manufacturing activity is not on the taxable list.
Utilisation of allowances
Treasury has demonstrated a willingness to introduce flexibility into the system and accommodate industry’s concerns that mechanisms need to be introduced that permit a reduction of liability. The starting point was Treasury’s simple position that the carbon tax revenue would not be ring-fenced but would go into the general revenue pool. Now, while carbon tax revenue will still go into the pool, a combination of the allowances and Treasury’s intention to recycle the revenue through the economy could result in a more manageable impact of the tax for both individual entities and the economy.
In order to be able to respond to the tax in the most beneficial manner, it is important for each carbon tax liable entity to know how the allowances work.
In the example below, the carbon tax liability of a company is calculated using two sets of assumptions:
- The company makes use of all the allowances.
- The company makes use of only the 60 per cent basic tax-free allowance and the carbon budget allowance.
These calculations illustrate that the allowances will result in significant reductions of carbon tax liability. Taxpayers that make use of the allowances (such as the performance allowance and the carbon-offsets allowance) will have to incur capital and/or operating expenditure to benefit from them. Taxpayers who purchase carbon credits to offset their carbon tax liability will incur expenditure to acquire that carbon credit. A taxpayer who purchases a carbon credit for R80 to offset an emission that would have been taxed at R120 achieves a saving of R40, not R120. Taxpayers must compare the expenditure they are likely to incur against the tax benefits they will receive from using these allowances.
The calculations assume that GHG emissions increase during the first phase of the carbon tax. This illustrates the financial impact the carbon tax will have on companies that fail to reduce their GHG emissions or keep them constant.
The Explanatory Note on the Offset Regulations, which were published for comment on 20 June 2016, sets out the rationale for including offsets in the carbon tax scheme. This creates the potential for hybrid carbon tax/emissions-trading activities, as opposed to a pure carbon tax, and sets out some international context.
Further regulations on the emissions intensity benchmarks and the second draft of the carbon tax Bill are expected in August or September 2016. Following this public participation in respect of the second Bill will conclude, with final submission to Parliament.
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This article first appeared on the September/October 2016 edition on Tax Talk.