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HMRC Decision: VAT on Voluntary Carbon Credits is One More Reason for Companies Not to Invest in Climate Action

HMRC Decision: VAT on Voluntary Carbon Credits is One More Reason for Companies Not to Invest in Climate Action

London, 23th May 2024

 

HMRC Decision: VAT on Voluntary Carbon Credits is One More Reason for Companies Not to Invest in Climate Action

  • The voluntary carbon market is already small and is at risk of remaining so
  • The UK is at a disadvantage compared to territories where no such tax exists
  • Applying VAT to voluntary carbon credits increases the risk of driving the market offshore

The recent decision by Her Majesty’s Revenue and Customs (HMRC) to impose Value Added Tax (VAT) on voluntary carbon credits shows recognition that the voluntary carbon market has matured in recent years into an actively traded market and legitimizes this as an asset class worth caring about.

But HMRC is guilty of a significant misstep. This policy unnecessarily burdens businesses with increased administrative complexity and comes at a time when global competition for green investments is intensifying.

Companies favor markets where they can maximize their sustainability efforts without incurring extra costs and administrative burdens. This decision puts the UK at a competitive disadvantage compared to other financial powerhouses like the United States and Singapore, for reasons expanded on below.

Any deterrent to increasing corporate climate finance runs counter to the UK’s broader environmental objectives and commitments to combat climate change.

The voluntary carbon market is already small and is at risk of remaining so, with approximately $1.75 – 2.0 billion of traded volume globally each of the last three years. This means the presumed fiscal benefit of applying VAT is very small relative to the potential damage done to the market itself.

This policy therefore risks giving businesses one more reason to not engage with financing climate action and punishes those already investing and making strides. Putting up administrative hurdles – no matter how big or small – sends another signal to UK businesses that investing in climate action is not essential or urgent.

 

Here’s why in more detail:

Administrative burden on businesses

Business-to-business VAT is redeemable, but it adds another complication to the compliance landscape for UK businesses. Companies must now handle additional paperwork, track VAT payments, and ensure adherence to the new tax regulations. This administrative burden diverts resources from core business operations and sustainability initiatives, making it more challenging for businesses, especially small and medium enterprises, to focus on reducing their carbon footprint.

What’s worse, the added complexity and costs associated with VAT compliance can deter companies from participating in the voluntary carbon market altogether. This deterrent effect is a small but symbolic undermining of the ongoing efforts to promote widespread corporate engagement in the purchase of carbon credits, which is crucial for achieving national and international climate targets.

 

Competitive disadvantage compared with other financial powerhouses

This decision also puts the UK at a disadvantage compared with territories where no such tax exists. The United States does not apply VAT to voluntary carbon credits, and Singapore actually removed voluntary carbon credits from the equivalent of their VAT regime in November 2022.

This shows both the US and Singapore recognize that putting additional hurdles in front of the market for the adoption of the use of voluntary carbon credits is counterproductive to overall climate goals. Both economies make it easier to attract both project flows and secondary market trading flows, which also puts them in the driver’s seat for policy decision-making.

This dilemma, coupled with the incentives provided by the US Inflation Reduction Act (IRA), risks driving valuable investments in climate action away from the UK.  In a short space of time, the IRA’s combination of tax exemptions and proactive incentives positioned the U.S. as one of the most favorable environments for businesses committed to sustainability (KPMG) (Columbia Law Blogs). This decision further risks undermining the UK’s leadership as a green finance hub.

 

Risk of market offshoring

Building on the theme of international competitiveness, the application of VAT to voluntary carbon credits also increases the risk of driving the market offshore. Businesses seeking to avoid the additional tax burden and administrative complexities may turn to jurisdictions with more favorable tax treatments for carbon credits.

This migration would weaken the UK’s domestic carbon market, reduce its influence in setting global standards, and potentially lead to lower environmental integrity due to varying regulatory standards in other countries (Columbia Law Blogs).

 

Alternative solutions

HMRC should reconsider this decision and instead explore measures that foster competitiveness and encourage, rather than penalize, UK companies wishing to invest in climate action.

These could include providing tax incentives for the purchase of carbon credits, offering companies who fall under the UK Emissions Trading Scheme (ETS) to offset a portion of their taxable emissions akin to Singapore, or just simplifying the administrative process for reporting these credits.

These measures would foster a supportive environment for corporate sustainability efforts and help maintain the UK’s competitive edge as a leader in green finance and wider corporate climate action.

 

References

 

Media Contact 

Gavin Youll, CFO at Carbonplace

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