Navigating the Tax Implications of Carbon Markets: A Guide for Businesses

The Rise of Carbon Markets: How Businesses Are Adapting to the Changing Landscape

The importance of carbon markets for companies is on the rise, with the cost of carbon increasing in compliance markets such as the EU ETS. As prices continue to rise and the benefits of free allowances diminish, businesses are facing new exposures that they must manage strategically. This has led to companies adapting their operating models to work with carbon markets, including setting up carbon trading desks and navigating the complexities of handling EU allowances and voluntary carbon certificates as tradeable assets.

One of the key challenges for businesses entering the carbon market space is the lack of specific legislation or guidance on the tax treatment of carbon credits in many jurisdictions. This uncertainty requires companies to base their tax treatment on first principles, considering factors such as accounting treatment and jurisdiction-specific regulations. Some countries, however, have provided clear guidance on how carbon credits should be taxed, offering more certainty for businesses operating in those markets.

In addition to tax considerations, businesses must also navigate indirect tax implications when engaging in carbon trading. The type of credit and trading contract, as well as the location of counterparties and brokers, will impact the correct indirect tax treatment. Differences between compliance and voluntary markets further complicate the indirect tax landscape, with compliance credits typically treated as taxable supplies while voluntary credits may fall outside the scope of indirect tax in some countries.

As businesses establish centralised procurement or carbon trading desks to manage their carbon-related activities, transfer pricing implications must also be considered. Pricing intragroup transfers of carbon allowances and credits in line with transfer pricing principles can be challenging, especially for groups new to commodity trading. Businesses will need to ensure their transfer pricing model aligns with their overall organisational strategy and document their approach to pricing these assets.

As carbon markets become more important to businesses, tax functions must be closely involved in designing new operating models and addressing key tax risks. Understanding the business’s engagement with carbon markets, identifying internal stakeholders, and engaging a cross-disciplinary team are crucial steps for tax teams to prepare for the evolving landscape.

While the growth of carbon markets presents new challenges for businesses, it also offers opportunities for decarbonisation and tax relief. With the cost of carbon expected to increase, there is a real incentive for businesses to reduce emissions and collaborate with tax authorities on decarbonisation initiatives. Despite the compliance risks, the growth of carbon markets provides tax functions with a chance to demonstrate their value to the wider business.