Tax Relief For Reducing Carbon Emissions
10 September 2009
Posted by: Author: Prof. Jackie Arendse
Tax Relief For Reducing Carbon Emissions
A recent tax amendment provides an exemption for proceeds from the disposal of certified emission reductions (CERs) derived in the furtherance of a qualifying clean development mechanism (CDM) project.The provision concerns a novel type of transaction that is intrinsically linked to the global quest to reduce greenhouse gas emissions (GHGs).This article explores the background to CERs and takes readers through the developments that have given rise to the recent tax amendment. It also explains how companies can possibly benefit from the exemption.
The butterfly effect is the theory whereby one seemingly insignificant event has far-reaching consequences on subsequent events. When the idea was first mooted, one meteorologist remarked that if the theory was correct, "one flap of a seagull’s wings could change the course of the weather forever”.While the meteorologist’s statement was idealistic, this idea does come very close to explaining the changes observed in the today’s weather patterns, where seemingly insignificant events, like the release of GHGs from anywhere on earth contribute to major climate changes experienced on every part of the world.
GHGs are necessary as they play an important role in keeping the earth warm so that life can flourish. GHGs do this by trapping solar radiation in the atmosphere so that heat does not escape into space. However, in the past few years, the levels of GHGs have increased to such an extent – mainly due to human activities – that the earth is getting too hot. In a 2007 study conducted by the National Data Climate Centre, the ten years from 1997 till 2007 were the hottest that the earth has experienced since 1880.
This increase in global temperatures, which is causing our climates to change, is called global warming.World leaders have recognised the effects that global warming have on our climates and are working together to lessen its effects. One hundred and eighty nine countries have, so far, ratified the Kyoto Protocol, the main environmental instrument of the United Nations Framework Convention on Climate Change (UNFCCC), and have committed themselves to reduce GHG emissions by 5.2 percent by 2012.
One emission reduction mechanism used in the Kyoto Protocol is the CDM. Since GHGs mix uniformly in the earth’s atmosphere, one ton of GHGs released anywhere in the world has the same effect on global climates and temperatures.Therefore, it does not matter where, in geographical terms, one begins to reduce emissions.As it generally costs less to reduce emissions in developing countries than in industrialised countries, the CDM has created a scheme whereby industrialised countries with emission reduction commitments can make investments in emission reduction projects to meet some of their emission reduction obligations.In effect, industrialised countries can buy in carbon emission savings from developing countries to meet their emission reduction targets.Businesses and municipalities in South Africa that are involved in processes that achieve reductions in carbon emissions are therefore well-placed to take advantage of this opportunity to realise a return on their CERs.
In terms of the Kyoto Protocol, only developing countries can operate CDM projects.These CDM projects must embrace renewable energy, energy efficiency and other fields related to achieving reductions in emissions.Furthermore, they must demonstrate five concepts of ‘additionality’ as listed below:
• Emission (Environmental) additionality: Any amount reduction of emissions is in addition to what would occur without the CDM project.
• Financial additionality: Any public funding of the projects is in addition to and not part of the existing
• Investment additionality: The investment project would not occur without a CDM project.
• Legal additionality: The project is in addition to the projects required by law.
• Technical additionality: The technology used in the project is superior and would not otherwise be used if it was not for the CDM project.
If all five elements are satisfied, the CDM project is entitled to receive carbon emission reduction(CERs) credits.For each ton of carbon dioxide or any equivalent GHG reduced, the CDM project is awarded one CER credit.The CER can then be sold to developed countries to be used against Kyoto Protocol emission reduction obligations or mandatory compliance programmes such as the European Union Emission Trading Scheme (EUETS).
CDM Projects in South Africa
There are currently very few CDM projects in South Africa, even though South Africa’s greenhouse gas emissions rank in the top twenty in the world, contributing 1.8 percent of global emissions and 42 per cent of Africa’s emissions.The Department of Minerals and Energy website indicates that out of the 125 CDM projects submitted to date, 96 are project idea notes (PINs) and 29 are project design documents (PDDs). Out of the 29 PDD, only fifteen are registered CDM projects and four have been issued with CERs.This is minuscule when compared to China, which has 501 registered CDM projects.
One of the reasons identified for the slow uptake of CDM projects was the uncertainty of the tax treatment of the proceeds from disposals of the CERs.Until the announcement in the 2009 Budget Speech of the proposed tax amendment, it was not clear whether the proceeds would be subject to full tax, capital gains tax or a tax exemption.
2009 Tax Amendment
In order to increase the uptake of CDM projects in South Africa, section 12K was inserted into the Income Tax Act by the Taxation Laws Amendment Act No. 17 of 2009.Section 12K(2) provides that "there must be exempt from normal tax any amount received by or accrued to or in favour of any person in respect of the disposal by that person of any certified emission reduction derived by that person in the furtherance of a qualifying CDM project carried on by that person.”
A qualifying CDM project is one approved by the Department of Minerals and Energy and registered with the CDM Executive Board of the UNFCCC by no later than 31 December 2012.The 2012 sunset clause coincides with the expiry of the Kyoto Protocol.The exemption applies to CERs disposed of on or after 11 February 2009 (the date on which the 2009 Budget Speech was presented in Parliament).It is important to note that the section 12K exemption will apply only to the initial sale of CERs by the project owner; any subsequent trading of the CERs will be taxed.This ensures the incentive remains for the generation of the CER and not for speculation in the CER trade.
VAT on disposals of cers
The Explanatory Memorandum to the Taxation Laws Amendment Bill, 2009 notes that the disposal of CERs is regarded as a supply of services rather than a supply of goods for VAT purposes.This treatment is in line with the international treatment of such disposals as countries such as the United Kingdom and Sweden and international bodies like the Organisation for Economic Co-operation and Development (OECD) have also adopted this view.
As all CERs will be exported, a disposal of CERs is a supply of an exported service, on which VAT will be levied at the zero rate.The documentation requirements for exported services will have to be met but these requirements are not as onerous as those for the export of goods.
Source: By Prof. Jackie Arendse (TaxTALK)