VAT charge on carbon credits

As of 1 September 2024, the UK has introduced a new VAT charge on the supply of carbon credits. This significant policy shift is part of the UK government's broader strategy to enhance environmental sustainability and align financial regulations with climate goals.

The new VAT regulations are expected to have far-reaching implications for businesses and environmental initiatives alike. This shift aligns with broader EU VAT rules and reflects a move towards more standardised tax practices across member states.

Understanding carbon credits and VAT implications

A carbon credit is a tradable instrument issued by an independently verified carbon-crediting programme. It represents a reduction or removal of one metric tonne of carbon dioxide, or an equivalent amount of greenhouse gases (GHGs), from the atmosphere measured by reference to a baseline scenario.

So, in simple terms – carbon credits are a form of permit that allows companies or individuals to emit a certain amount of carbon dioxide or other greenhouse gases.

Each credit represents the right to emit one ton of carbon dioxide or its equivalent in other greenhouse gases. The carbon credit market is designed to incentivise reductions in greenhouse gas emissions by allowing entities that reduce their emissions below their allocated cap to sell their excess credits to others who need them to meet regulatory requirements.

Traditionally, financial products, including emissions allowances, have been exempt from VAT. But as announced in HMRC Brief 07/2024, following the emergence of secondary market trading in voluntary carbon credits, and businesses incorporating voluntary carbon credits in their onward supplies, the sale of these credits will become taxable from 1 September 2024 if the place of supply is the UK.

Exceptions to the change

Most transactions involving voluntary carbon credits will be within the scope of VAT. A voluntary carbon credit is any carbon credit that is not a compliance market credit. Guidance on compliance market credits already confirms that they are in scope of UK VAT and this is explained in VATSC06584.

The following activities are still outside the scope of VAT:

• the first issue of a voluntary carbon credit by a public authority
• the holding of voluntary carbon credits as an investment, where there is no economic activity
• donations made to voluntary carbon credit projects
• sales of voluntary carbon credits from self-assessed projects with no independent or third-party verification.

Some examples have been provided in VATSC06586.

HMRC guidance within VATSC06584 provides the key principles that should be used when considering the VAT treatment of ecosystem services.

Purpose of the change

The introduction of VAT on carbon credits serves several purposes:

1. Alignment with EU VAT rules: As part of its post-Brexit alignment with European standards, the UK is harmonising its VAT regulations with those of the EU. Many European countries already apply VAT to carbon credits, and this change helps to ensure consistency in the market.
2. Revenue generation: By imposing VAT on carbon credits, the UK government aims to generate additional revenue. This revenue can be reinvested into environmental initiatives, helping to fund further climate change mitigation efforts.
3. Market adjustment: The VAT charge may also impact market dynamics by influencing the cost structures for businesses and organisations involved in carbon trading. It might lead to adjustments in pricing strategies and operational approaches.

Implications for businesses and organisations

1. Increased costs: Businesses purchasing carbon credits will face a 20% increase in costs due to VAT. For companies that rely heavily on carbon credits to offset their emissions, this could represent a significant financial burden. It is crucial for businesses to factor in this additional cost when budgeting for carbon management.
2. Adjustments in pricing: Companies selling carbon credits might need to adjust their pricing strategies to reflect the added VAT. This change could affect their competitive positioning in both domestic and international markets.
3. Strategic planning: Businesses may need to reassess their carbon offset strategies. The increased cost of carbon credits could drive some companies to explore alternative ways to meet their sustainability targets, such as investing in direct emissions reductions or alternative carbon offset projects.
4. Administrative changes: Organisations involved in carbon trading will need to update their accounting and invoicing processes to accommodate the new VAT charge.

Further guidance

ACCA's technical factsheet clarifies on international VAT and place of supply rules.