Carbon emissions tax if the UK doesn’t get a Brexit deal?
With Covid-19 issues mopping up government resources it isn’t surprising that our Brexit negotiations appear to have taken a bit of a back seat of late. But a lot of work is being done in the corridors and basements of the Treasury and HMRC to prepare for inevitable changes in tax arrangements.
Understandably most attention is on import and export matters, but there are some pretty significant developments in other areas too. Just last week HM Treasury and HMRC published their Carbon Emissions Tax Consultation which considers the introduction of a Carbon Emissions Tax to take effect from 1 January 2021 in the event that the UK doesn’t get an agreement with the EU to remain associated with the EU’s Emissions Trading Scheme (the ‘EUETS’). The principle legislation for this new tax was laid down over a year ago as a ‘just in case’ measure, but with the sands of time now pouring through our negotiators’ fingers the chances of the tax actually being implemented are growing each week.
Would a new Carbon Emissions Tax be a major change in the UK’s tax policy or a significant step up in our steps to combat climate change? Probably not – but not because the tax would be small or insignificant.
Let me just put this into context. Firstly, the Climate Change Act 2008 obliges the UK to meet stringent reductions in emissions by 2020 and the main approach taken to achieve this has been the introduction of a ‘carbon pricing’ policy – essentially the use of various fiscal levers to ensure a minimum cost of carbon in energy production and commercial use (minimum £18 per tonne of CO2e emitted from generating stations and industrial sites). There are broadly two approaches available to countries seeking to establish and maintain a carbon price: impose a carbon tax (a tax on the carbon content of energy products), or operate a cap and trade scheme (like the EUETS) in which carbon emitters acquire and trade in emission allowances in order to meet their (decreasing) emission targets. A carbon tax allows the Treasury to set the price of carbon while a trading scheme allows the markets do so (the fewer emissions allowance permits available – the higher the cost of each traded permit).
In the UK the main (though not the only) support underpinning the carbon price has been provided by the EUETS where a regime of measurement and reporting has operated for some time to manage the scheme in the UK and throughout the EU, and while its not a perfect system, it has performed adequately an important task on the way to meeting emission reduction targets.
But, as the name indicates, the EUETS is an EU scheme, so what will happen on 1 January 2021 if the UK crashes out of the EU?
We may not know until midnight on New Year’s Eve of course, but the two alternatives on the table now are:
1. the UK negotiates a link with the EUETS in future and sets up our own ‘UKETS’, and;
2. the UK introduces this Carbon Emissions Tax.
The former would, arguably, continue to operate without much in the way of structural changes to the regime – it would obviously be important that a linked market would have the effect of maintaining a similar (or the same) price of allowances, but many other operational aspects might remain relatively unchanged. However, the introduction of a new Carbon Emissions Tax would herald a switch from the ‘cap and trade’ approach to a ‘tax and enforce’ one. It would also give HM Government more direct control over the price of carbon because the price would effectively be established by the tax rate – which is set by Treasury - rather than by market forces.
Some commentators have suggested that a switch to a carbon tax could see a significant fall in the price of carbon in the UK given that the current emissions permit price is nearer £30 per tonne and a drop to a rate in support of only £18 per tonne would make carbon too low. Having looked at the plans set out in the consultation, I don’t entirely share that view because it indicates that the rate of tax would be set initially on the average price of emission permits in the EUETS over the previous year of trading and would probably continue to recognise the EUETS price in future periods too.
However, I am a little more concerned about the effect that bringing emissions under a tax regime (and under HMRC) may have. So far the EUETS has operated under the auspices of the various regulators who oversee measurement of emissions to establish which installations have met, exceeded, (or exceptionally failed to meet) their targets. If the tax is introduced, that whole measurement and reporting regime will still need to operate in order to continue to measure and evaluate emission reductions, and the taxpayers will continue to be subject to penalties for failing to comply, but they will also be subject to all the usual tax compliance requirements and, from 1 January 2021, to HMRC, penalties, interest and possibly inspections? As a tax specialist you wont be surprised that I have these concerns.
So what to do? Unfortunately, as with so many aspects of Brexit, I suggest that those involved in the EUETS regime currently cannot really afford to wait and see whether the UK will successfully negotiate a link between a new UKETS and the continuing EUETS. If a Carbon Emissions Tax is introduced post Brexit, it will result in tax ‘bills’ being issued only after the first year so, thankfully, the tax wont be collected quarterly like other environmental and indirect taxes. But given the tax bill for the year will depend on activities and emissions arising from the start of 2021, it would be an ideal time to examine the mechanisms used to report emissions and to properly understand the additional tax obligations that will come into play. After all, making ‘errors’ in tax can attract some pretty painful penalties so getting all of those newly migrated ducks in a row early is probably a good idea.