On 15 June, HMRC published their views on theVAT treatment of non-compliance carbon credits and services supplied by carbon offset providers.
Carbon credits fall into two categories:
- compliance market credits, which derive from the Kyoto Protocol and the EU Emissions Trading System (‘EUETS’); and
- non-compliance credits, which do not.
Examples of compliance market credits include Emission Reduction Units (ERUs), Certified Emission Reductions (CERs) and EU Allowances (EUAs).
The most common example of a non-compliance credit is the Verified Emission Reduction (VER).
The important distinction, for VAT purposes, between compliance market credits and VERs is that the former are capable of consumption of the type envisaged by the VAT system, and the latter are not. As VAT is a tax on consumption, this means that compliance market credits are potentially subject to VAT, whilst VERs are outside the scope.
Compliance market credits
Compliance market credits are recognised under statutory ‘cap and trade’ regimes. Polluting businesses which are subject to these regimes must hold, or obtain on the open market (and then ‘retire’) sufficient credits to cover their emissions. If they do not, they will suffer financial penalties. The credits are consumed to enable businesses to engage in economic activity without penalty, and to meet their Kyoto commitments.
Kyoto and the EUETS provide for exacting verification and regulatory processes, which mean that both parties to a compliance market transaction are able to attribute a subjective value to the credit units. The credits are widely traded on national and international markets.
The motive of someone paying for a credit doesn’t matter; nor does it matter what is done with it. Thus, if a private individual buys a compliance market credit, the supply to the individual is still taxable – even though the individual is not subject to any regime (because the credit is capable of consumption).
Verified Emission Reductions
A Verified Emission Reduction, on the other hand, is essentially just a promise that carbon has been, or may be, reduced somewhere in the world. There may be a general benefit to the reputation of a business (good PR/marketing/corporate responsibility) in paying for a VER, but no particular service is rendered, which can be identified as a cost component of the business. There is thus no consumption. No service is being provided to an identifiable consumer and no benefit is being provided, which is capable of forming a cost component of the activity of another person in the commercial chain.
Payment for a VER might produce a general social benefit, it might produce a specified result, or it might give rise to a legal relationship with reciprocal obligations. However, a taxable person’s income is relevant for VAT purposes only if it constitutes the consideration for a supply of goods or services to a consumer. The mere fact that something is, or may be, done in exchange for a payment is insufficient to bring such a transaction within the VAT system. The public at large cannot constitute a specific recipient of the kind which must exist in order to give rise to a transaction chargeable to VAT.
HMRC have, as yet, seen no evidence of the existence of a genuine secondary trading market in VERs.
Carbon offset services
A growing number of businesses are providing carbon offsetting services. The range of services offered varies widely, but the VAT treatment of any individual transaction will depend on the particular arrangements.
In many situations, when a member of the public makes a payment to a carbon offset provider, there is no supply for VAT purposes. This is because there is no identifiable, direct benefit being received by the member of the public in return for their money.
Examples of where VERs might be used would be where a carbon offset provider makes a commitment that funds paid across by members of the public will be used to fund overseas projects, wind farms, development of environmentally friendly energy generation projects etc. without making any supply of direct benefit to the person making the payment. The payment by the member of the public is, on this basis, outside the scope.
An illustration given by HMRC is of an airline offering its passengers the facility to offset the carbon emissions generated by their flights (perhaps via a third party carbon offset provider). Generally the passenger pays across an amount, calculated to be the cost of offsetting the resulting emissions, but receives no identifiable, direct benefit in return. There are a number of possible variants, including:
where the passenger has no choice, being obliged to pay the offsetting charge – the airline is making a single zero-rated supply of transport;
where the offsetting facility is optional, but a separate administration charge is made to the customer for providing the service , the administration charge is standard-rated, but the amount paid to offset is outside the scope; or
where the offsetting service is optional, there is no administrative charge, and the entire payment goes to offset. In this case, the whole of the payment is outside the scope.
In other situations, a carbon offset provider might make taxable supplies of carbon credits. Supplies of compliance market credits are currently zero-rated (see our earlier e-mail of August 2009, which is reproduced in the News section of our website), or of the purchase and ‘retirement’ of compliance market credits (standard-rated), or of general advice on how an individual or a business can improve its energy efficiency (standard-rated). The zero-rating was introduced from 31 July 2009 as an attempt to combat MTIC fraud.
Businesses incurring VAT in order to offset their own carbon emissions must follow the usual rules to determine whether, and to what extent, any VAT incurred is recoverable as Input Tax.
Anyone wishing to discuss this should contact Peter Landon (email@example.com) 020 7936 8306 or their usual CWE contact.