- The economic transformation countenanced by the Scheme will come at a price - but that price will not be known until later this year when the emissions cap and interim targets will be revealed.
While the release of the Green Paper has provided some much needed clarity to business regarding the likely extent of their obligations under the Scheme, there is obviously still a great deal of uncertainty about some key matters that are deferred for further public consultation in the Green Paper.
What's the cost?
Foremost among the missing pieces of the puzzle is the cost. Without details of any cap, interim target or emissions trajectory, there are no hard numbers on the possible cost of the Scheme. At best, the projected price impacts of the Scheme are discussed in broad generalities with a predicted increase of 16% in the price for electricity and 9% for the price of gas on other household fuels based on an illustrative $20 carbon permit price. Overall, a 0.9% increase in the average price of all goods is predicted. Hard numbers will not become available until the modelling being done by Treasury is released in conjunction with the White Paper on the Scheme at the end of this year, and well and truly after the period for submissions on the Green Paper has closed.
Who is TEEII?
While considerable discussion in the Green Paper is devoted to the concept of TEEIIs (or Emission Intensive - Trade Exposed Industries, or EITEI as described in the paper), at the end of the day, the Government has not excluded any industry from this classification except those which face physical barriers to trade such as the stationary energy sector. Clearly, it is possible to identify some usual suspects but the Government is seeking submissions on any critical areas that will determine eligibility such as the data set to be relied on as well as the assessment process.
Where the Government has changed the paradigm to minimise an open ended commitment to support TEEIIs is by limiting the level of assistance; it has set a cap of 20% on the number of permits that can be allocated to eligible activities, or 30% if agriculture is included in the Scheme. Effectively, the test for TEEII status and the level of support to be provided will be adjusted to stay within this cap.
The independent regulator's decisions on TEEII status will be subject to judicial review. Given what is at stake for affected industries, there is a real likelihood of challenges before the Scheme even commences, and any successful challenges could impact on that commencement.
What is a strongly affected industry?
While the paper makes clear that coal fired electricity generation will be strongly affected by the implementation of the Scheme, it leaves open the opportunity for other rent-seekers to look for transitional assistance. Not only is it still unclear who will be entitled to support, the extent and level of that support, even if made on a "once and for all" basis, is also yet to be determined. Similarly, while the Government proposes a review after the commencement of the Scheme to effectively claw back any windfall gains, the rules for the review process would need to be made clear at the time that the assistance is provided to avoid disputes.
Taxation and accounting treatments
The preferred position is that discrete provisions will be inserted into the income tax legislation to provide as follows:
- permits will effectively be taxed as trading stock. The cost of acquiring a permit will be deductible in the year of income it is surrendered or sold. If a permit is banked, the deduction will be deferred until the time the permit is surrendered or sold. The deduction deferral will be achieved through a rolling balance method under which the value of permits held at the beginning and end of a year of income will be taken into account. Historical cost and market value are given as possible methodologies for valuing permits.
- proceeds received on the sale of permits will be assessable in the year of income of sale.
- the value of free permits will be assessable in the year of income in which they are received.
- cash grants given as assistance under the scheme will be assessable in the year of income in which they are received.
- if the charge for acquittal of insufficient permits is structured as a penalty for non-compliance it will not be deductible; but if it is structured (similarly to the former training guarantee levy) as a tax or charge payable where insufficient permits are surrendered, then on general principles it would be deductible if incurred in the course of business.
- if penalties are imposed for acquittal of insufficient permits, the penalties will not be deductible. A preferable option would be for the charge to be structured (similarly to the former training guarantee levy) as a tax or charge payable where insufficient permits are surrendered. In that case, on general principles, it would be deductible if incurred in the course of business.
- transactions relating to permits will not be input taxed or GST free. The normal GST rules will apply to all transactions relating to permits (GST to be included in price, remitted to ATO and an input tax credit allowed).
No preferred position is given in relation to the accounting treatment of Scheme transactions. The Government has requested IASB to amend IFRS to facilitate appropriate reporting of emissions-related assets and liabilities prior to the commencement of the Scheme. IASB has advised that it expects to release an exposure draft of the accounting rules during the second half of 2009.
Although these are the key planks of the taxation and accounting treatment, much will of course depend upon the final form these provisions take and the fine details that are yet to emerge, so we cannot at this stage fully assess their impact upon existing and future arrangements.
While there has been some criticism of the absence of phased auctioning during the initial years of the Scheme, there is also concern over the frequency of auctions. Facilitating carbon (permit) price discovery would suggest that auctions should be held more frequently, and this would seem possible given that the auction system is proposed to be done online.
Business will need to become accustomed very quickly to the auctioning process and, consequently, understand their own marginal cost of abatement to enable them to determine the number of permits required and the price which they are prepared to pay (or bid at auction). It would therefore be better for auctions to be held more regularly to build that capacity and to reduce the risk that business locks in uncommercial or uncompetitive prices in lengthy periods between auctions.
Carbon cost pass through
The Green Paper suggests that long term fixed price contracts for goods or services (such as energy) are not a widespread problem that requires a Government response. Nevertheless, the Government seeks feedback on this issue. We think there is a problem to be addressed.
Contracts entered prior to the announcement of the Scheme may not contain provisions allowing for the pass-through of costs related to the Scheme. And, because the selection of the liability point within the supply chain is arbitrary (and in some cases still be to determined by the Government), even if parties did contemplate the potential introduction of a Scheme the liability point that they assumed may be different than the liability point eventually imposed by the Scheme.
When the GST was introduced, the GST Act included a special provision dealing with "non-reviewable contracts" entered prior to the announcement of the GST. These were contracts where the contract did not contain a GST pass-through clause, or allow an opportunity for a price review to take account of the increased costs of the supplier having regard to the GST.
Similar measures ought to be considered for "non-reviewable" contracts entered prior to the announcement of the Scheme. Failure to do this may mean that large "scope 2" emitters escape the cost of the Scheme altogether, by having entered their long-term energy supply contracts before the announcement of the Scheme.
One method of ensuring that compliance costs of the Scheme are properly passed through to "scope 2" emitters may be to provide that, where scope 2 emissions are attributable to energy purchased under a non-reviewable contract entered prior to the announcement of the Scheme, the liable entity is the scope 2 emitter rather than the scope 1 emitter.
Parties who had turned their minds to the possibility of a scheme prior to the announcement of the Scheme, and who expressly allocated the risk by requiring the scope 1 emitter to indemnify the customer in respect of the costs of such a scheme, would not be adversely affected or have their contractual intention overturned by such a pass-through mechanism for non-reviewable contracts being incorporated in the Scheme. The indemnity from the scope 1 emitter would still operate to insulate the scope 2 emitter in this case, assuming the parties had in fact expressly agreed that the scope 1 emitter was to bear the burden.
This is a much more equitable way of allocating liability in respect of pre-existing non-reviewable contracts, than by arbitrarily selecting a liability point and leaving the burden to fall there without an opportunity for the assumed pass-through to occur.
The next steps
The Government will now embark on an extensive consultation process with the public and key stakeholders on the proposed Scheme design. Submissions on the Green Paper must be submitted by 10 September 2008.
At the end of 2008, the Government will release its White Paper on the Scheme which will indicate the Government's final decision on Scheme design elements, together with exposure draft legislation. It is likely that many key elements will, however, form part of regulations to be made under any Act, as well as other legislative instruments dealing with issues such as third party assurance.
Legislation underpinning the Scheme will be introduced into Parliament early in 2009 with the intention that it will come into force later that year. Work will immediately commence on the establishment of the Scheme regulator so early decisions can be made on permit allocations and auction rules, TEEII status and other matters for which the regulator will be responsible.
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.