Businesses will be eager to ensure that the costs of the carbon
pricing mechanism can be passed on to consumers.
This analysis looks specifically at the taxation aspects of the carbon pricing mechanism (the Mechanism), and will in particular cover:
- The income tax treatment that will apply to carbon permits.
- The GST treatment of carbon permits.
- The tax concessions to be introduced with the carbon pricing mechanism.
- Whether the costs of the Mechanism can be passed on.
Carbon: price or a tax?
In the first three years of the scheme, it will operate like a tax, because businesses will be able to purchase as many carbon permits as required to cover the amount of carbon pollution they produce.The price will be fixed, commencing at AUD$23 per tonne of carbon produced and rising annually in set increments.However, from 1 July 2015, there will be a limited number of permits available for purchase and the price will then be market driven, although subject to a floor and ceiling for the first three years. It will also be possible to purchase international permits (subject to certain restrictions) as there will be links to international schemes.
Income tax treatment of carbon permits
A specific tax regime is to be introduced for carbon permits, rather than relying on existing taxation law principles. Under the new regime permits will be taxed in a manner similar to that which currently applies to trading stock. That is, the proceeds from selling a permit will be assessable in the year of sale. A taxpayer will be deemed to have received market value for a permit in certain circumstances, such as a non-arm's length transfer between related parties.
A deduction will be allowed for the cost of acquiring a permit, but the benefit of the deduction will be deferred until the year in which the permit is surrendered or sold.
Taxpayers will need to elect whether to value permits on hand at the end of an income year at cost or market value for taxation purposes. The default methodology will be cost and the ability to change methodology from year to year will be limited. Where the value of permits is expected to rise, taxpayers may prefer to use the cost method rather than pay tax on the increased value of a permit at year end before it is sold or surrendered. Conversely, if the value of permits is expected to fall, taxpayers may prefer the market value method, effectively bringing forward a deduction for the drop in the permit's value at year end.
Taxpayers will be limited to one change in the valuation methodology during the fixed price period (1 July 2012 to 30 June 2015) and from 1 July 2015 will only be permitted to change the valuation methodology after a methodology has been in use for four years. The limited ability to change the valuation methodology from year to year is likely to see many taxpayers take a conservative approach and use cost as the preferred methodology.
GST treatment of carbon permits
Subject to the agreement of the state governments, the supply of carbon permits will be GST free. However, normal GST rules will apply to transactions involving financial derivatives of permits and payments of grants. Transactions involving financial derivatives of permits will generally be input taxed supplies, as they will be "financial supplies" for GST purposes. Payments of grants can give rise to a GST liability on the part of the recipient of the grant under the principles set out in GSTR 2000/11 where the grant places the grantee under an obligation. The grant can in such circumstances represent consideration for a taxable supply made by the grantee.
Accounting treatment of carbon permits
The accounting treatment for permit transactions will be determined in accordance with international accounting standards.
Tax cuts to ease the burden
The Government has linked the carbon pricing mechanism to a range of taxation measures primarily aimed at reducing the taxation burden for lower to middle income earners.
Individuals and small businesses will generally not be subject to the price on carbon, or the need to acquire carbon permits, as this requirement only applies once businesses generate more than 25,000 tonnes of carbon pollution per year. However, because some business inputs will be more expensive due to the carbon pricing mechanism, the small business instant asset write-off threshold will be increased from the AUD$5,000 promised by the Government (but not yet legislated) to AUD$6,500 for depreciable assets from the 2012-13 year.
From 1 July 2012 the tax free threshold will increase from AUD$6,000 to AUD$18,200 in conjunction with a reduction in the low income tax offset. The Treasurer estimates that 1 million taxpayers will be removed from the tax system and will no longer need to lodge an income tax return.
Taxpayers earning up to AUD$80,000 will receive a tax cut of at least AUD$300 per year. Family tax benefits and pension payments will also increase. The tax cuts are phased out for taxpayers earning over AUD$80,000.
Can carbon costs be passed on?
The tax cuts are designed to offset the expected higher costs to be faced by consumers. With the introduction of the GST on 1 July 2000, consumers were concerned that business may take advantage of the tax changes in order to charge unreasonably high prices. To counter this concern, a "price oversight regime" was established under the Trade Practices Act and administered by the Australian Competition and Consumer Commission (ACCC), which prohibited price exploitation during the transition to the "New Tax System".
No specific additional powers will be given to the ACCC during the transition to a carbon emissions trading scheme, However, to address its concerns regarding the exploitation of consumers during the lead up to and introduction of the carbon pricing mechanism and the trading scheme, the Government has announced that the ACCC will receive funding of AUD$12.8 million over four years. This will allow the ACCC to employ additional staff to facilitate the investigation and prosecution of businesses that falsely attribute price increases to the new carbon tax. It will also assist in the education of businesses on this issue. Our legal briefing on this issue was released on 21 July.
Provided businesses do not attempt to exploit the introduction of the Mechanism as a means to increase prices, there is no prohibition on businesses passing on the costs of the carbon pricing mechanism to consumers. However, on the other hand, businesses will also have no statutory right to do so. Accordingly, the wording of contracts will be very important. Contracts entered into going forward can be drafted to take account of the carbon pricing mechanism, with the benefit of knowledge of the scheme. However, long term contracts already in existence may contain no specific provisions regarding the costs of a carbon pricing mechanism, or an emissions trading scheme.
Businesses will not only need to assess their liability for direct costs under the scheme, in terms of their obligation to acquire permits, but also their indirect costs as consumers of goods and services that will suffer price increases as a result of the carbon pricing mechanism. For example, businesses that lease their business premises need to consider whether they will be liable for increases in the cost of electricity and other outgoings under their leases either directly, or because the landlord will have the right to increase rents due to the changes in the law.
Going forward, contracts will need to be drafted to ensure that parties clearly specify who is liable for the direct and indirect costs of the carbon pricing mechanism. Existing contracts need to be reviewed to determine which party will be liable for these costs. Existing contracts may include "pass-through clauses" allowing the costs of a carbon "tax" or a carbon emissions trading scheme to be passed on. It is important to ensure that these clauses are sufficiently broad to capture the proposed mechanism.
What is a tax?
A tax has been defined by the courts as being an exaction of money with three positive features, being:
it is compulsory
it is for public purposes
it is enforceable by law, and
- one negative feature, being that it is not a fee for services rendered.
During the first three years, the carbon pricing mechanism will operate like a tax because it will be compulsory, for public purposes and it will be enforceable by law. However, the carbon pricing mechanism may not technically be a tax because businesses will receive property in the form of carbon permits in return for payment of the price per tonne of carbon emissions. Therefore there is no "exaction of money", notwithstanding that businesses have no choice as to whether to acquire the carbon permits or not. Accordingly, and while in each case the result will depend on the exact wording used, contractual clauses allowing the pass through of a "carbon tax" may not be effective during this period.
From 1 July 2015, the Mechanism will be an emissions trading scheme, and will lose some attributes of a tax because the market will establish the price payable for a carbon permit. Accordingly, clauses which only allow a tax to be passed through may fail to have the desired effect of passing on the cost from 1 July 2015.
We have developed a range of carbon cost pass through clauses, which have been refined in light of the latest announcements. We can provide detailed advice regarding clauses in existing contracts, and recommend the best clauses for contracts under negotiation.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.