On 10 March 2009, the Federal Government released the exposure draft of the legislation for the Carbon Pollution Reduction Scheme. The draft legislation follows the release of the White Paper in December 2008. The key aspects of the scheme have not changed but the draft legislation, comprising six separate Bills, provides greater detail on a number of elements of the scheme.
The draft legislation further outlines:
- The design of the Carbon Pollution Reduction Scheme (CPRS), including the establishment of the Australian Climate Change Regulatory Authority (Authority) and consequential amendments to the Corporations Act 2001 (Cth) (Corporations Act) to make Australian Emissions Units (AEUs) and eligible international emissions units financial products.
- Obligations for liable entities, including the operation of liability transfer certificates and netting out arrangements (using Obligation Transfer Numbers).
- Tax issues, including income tax and GST considerations.
- Assistance for emissions-intensive trade-exposed (EITE) and strongly affected industries (coal-fired electricity generators).
- International linkages, including restrictions on which Kyoto units can be surrendered for compliance and when.
We have discussed the above in this Update.
DRAFT LEGISLATION AND SENATE INQUIRIES
The exposure draft legislation comprises the Carbon Pollution Reduction Scheme Bill 2009, the Carbon Pollution Reduction Scheme (Consequential Amendments) Bill 2009, the Australian Climate Change Regulatory Authority Bill 2009, the Carbon Pollution Reduction Scheme (Charges - General) Bill 2009, the Carbon Pollution Reduction Scheme (Charges - Excise) Bill 2009, the Carbon Pollution Reduction Scheme (Charges - Customs) Bill 2009.
As has been reported in the media, the exposure draft legislation will be referred to the Senate Standing Committee on Economics for review. Submissions on the draft legislation for the CPRS are due by 14 April 2009. The Greens and the Coalition have agreed that a Senate inquiry into the Emissions Trading Scheme (ETS) be conducted by a new Senate Select Committee on Climate Policy. The Senate inquiry will examine whether:
- The ETS is the best choice to reduce carbon pollution at the lowest economic cost. " The ETS will provide incentives for long term investment in low emission technology.
- The CPRS is environmentally effective with regard to targets.
- The design of the proposed scheme will send appropriate investment signals for green collar jobs and research and development in the manufacturing service industries, taking into account permit allocation, leakage, compensation mechanisms and additionality issues.
- The Committee will report back on 14 May 2009, in time for the Senate's scheduled June consideration of the ETS.
As outlined in the White Paper, the CPRS will cover around 75% of emissions and involve mandatory obligations for around 1,000 entities (liable entities). The liable entities will be required to surrender AEUs and eligible international units equivalent to their greenhouse gas emissions each year. Each unit allows the emission of one tonne of carbon dioxide equivalent of greenhouse gases (CO2-e).
The CPRS will apply to the transport, stationary energy, fugitive, industrial processes, waste and forestry sectors. Agriculture will not be covered until at least 2015. All six greenhouse gases accounted for under the Kyoto Protocol will be covered from the commencement of the CPRS. Generally, all facilities within the covered sectors that emit 25 kilotonnes or more of CO2-e a year will be covered by the scheme.
EMISSIONS REDUCTION TARGET
The medium term targets set by the Government are to reduce Australia's greenhouse gas emissions by between 5% and 15% below 2000 levels by 2020.
The 5% target represents Australia's minimum emissions reduction target, to be implemented whether or not any international agreement is reached. The 15% target will be implemented if a global agreement is reached 'where all major economies commit to substantially restrain emissions and all developed countries take on comparable reductions to that of Australia'.
The CPRS will be a 'cap and trade' scheme. An overall cap will be set on emissions from the covered sectors and an equivalent amount of AEUs made available to be traded and surrendered. The aim of the cap is to achieve the environmental outcome of limiting greenhouse gas emissions. The act of capping will create a carbon price.
In addition, the ability to trade ensures that emissions are reduced at the lowest possible cost.
The scheme cap will be based on the emissions reduction target adopted. The scheme caps for the first five years of the CPRS will be published before 1 July 2010. Caps will continue to be set by the Government at least five years in advance. To provide additional certainty for business, ten year 'gateways' or ranges of future caps will also be published.
The Authority will be responsible for issuing AEUs.
At the end of each year, each liable entity will need to surrender an AEU or eligible international emissions unit for every tonne of greenhouse gas emissions for which they were responsible in that year.
Liable entities will compete to purchase the number of emissions units that they require, either at auctions arranged by the Authority or on the secondary trading market. Those that value the emissions units most highly will be prepared to pay more for them. For many liable entities, it will be cheaper to reduce emissions than to buy emissions units.
The CPRS will have a price cap in the form of access to an unlimited number of additional AEUs, issued at a fixed charge, for the first five financial years. These AEUs cannot be traded or banked for future use. The price cap will be $40 per unit in the first year of the CPRS and will increase in real terms by 5% each year over the first five years of the scheme.
In addition, AEUs will be issued for reforestation and for the destruction of synthetic greenhouse gases.
The quantity of greenhouse gas emissions for which liable entities are responsible for will be monitored, reported and audited.
The Australian Climate Change Regulatory Authority
The Authority will be established under the CPRS. The Authority will be responsible for administering the CPRS as well as the Renewable Energy Target and the National Greenhouse and Energy Reporting System. The responsibilities of the Authority will include the following:
- Maintaining a national registry to track emissions units.
- Auctioning AEUs.
- Allocating AEUs to EITE activities and coal-fired electricity generation.
- Overseeing the transfer of liability of emissions between corporate entities in some circumstances.
- Assessing the eligibility of reforestation projects and unit entitlements associated with those projects.
- Monitoring compliance with the CPRS.
Applications will be able to be made to the Administrative Appeals Tribunal to review some of the decisions of the Authority.
Australian Emissions Units
The CPRS will amend the Corporations Act by adding section 764A(1)(k) to make AEUs and eligible international emissions units 'financial products'.
By making emissions units financial products, the reforms will extend the financial services laws to activities such as advice and dealing in emissions units as well as trading in emissions units and making a market for these units. Restrictions will however be placed on the sale and transfer of AEUs to international markets during the first five years of the CPRS.
Brokers trading emissions units on exchanges, such as the Australian Climate Exchange, will need to be licensed. It is anticipated that ASIC will be the regulator for the financial products and services, although most AEUs will be issued by way of auction and the CPRS will be administered by the Authority (as outlined above).
It is proposed that AEUs be personal property and that transfers of such units will be required to take place through the registry to be maintained by the Authority. The registry will also record Kyoto units being transferred as international transactions as well as non-Kyoto international units.
OBLIGATIONS FOR LIABLE ENTITIES
Generally, a person can be liable under the CPRS if the person:
- Is the operator of a facility that has direct greenhouse gas emissions of 25 kilotonnes or more of CO2-e a year.
- Imports, produces or supplies certain upstream fuels, known as 'eligible upstream fuels'.
- Imports, manufactures or supplies synthetic greenhouse gas that lead to emissions of 25 kilotonnes or more of CO2-e a year.
Entities that have 'operational control' of a facility that directly emits 25 kilotonnes or more of CO2-e a year will be caught by the CPRS. The concept of operational control is the same as that used under the National Greenhouse and Energy Reporting Act 2007 (Cth) (NGER Act). An entity has operational control if it has the authority to introduce and implement operating, health and safety or environmental policies for the facility. Where there is uncertainty about which entity has operational control over a facility, the entity with the greatest authority to implement these policies will be deemed to have operational control. Pro-rata emissions thresholds are available in some circumstances, for example, when a facility changes hands.
Provisional emissions number
A 'provisional emissions number' will be used for CPRS compliance and is defined as the amount of greenhouse gases emitted from the facility in CO2-e. Certain emissions are not counted towards an entity's provisional emissions number, such as when CPRS obligations are transferred from the operator of a facility to another person using a liability transfer certificate. A liability transfer certificate may be applied for in two circumstances. The first is where a member of a controlling corporation's group takes on liability for a particular facility. The second is where an entity that has financial control of the facility takes on liability for emissions. All reporting obligations under the NGER Act for the facility will be transferred to the holder of the certificate. This includes the reporting of greenhouse gas emissions, energy production and energy consumption data. All scope 1 (direct) emissions will be covered for a facility, including emissions from fuel combustion, industrial processes, fugitive emissions and emissions from waste sources at non-landfill facilities.
The same threshold of 25 kilotonnes or more a year of CO2-e will apply to landfill facilities. However, if a landfill facility is within a prescribed distance of another landfill facility that accepts waste of a similar classification, then the threshold is reduced to 10 kilotonnes of CO2-e. CPRS obligations do not apply to landfill facilities that have not accepted waste since 1 July 2008. Also, 'legacy waste' emissions are excluded from the CPRS until 1 July 2018.
A person will be liable for emissions from the combustion of 'eligible upstream fuels' if the person imports or produces the fuel, supplies the fuel to another entity or applies the fuel to their own use. 'Eligible upstream fuels' include, for example, petroleum, LPG, black coal and liquefied natural gas. Liability for emissions from upstream fuels and synthetic greenhouse gases may be passed from the supplier to a customer in certain circumstances using an obligation transfer number (OTN). The quotation of an OTN to an upstream supplier relieves the supplier of liability to surrender emissions units for that supply and transfers the liability to the entity that quotes the OTN. It is intended to avoid double-counting of emissions and gaps in coverage. For example, where synthetic greenhouse gases are used as feedstock or entities transform one type of fuel into another type of fuel, such as coal to coke.
As outlined in the White Paper, the Government has developed a specific income taxation regime for dealings in emissions units. This regime uses a 'rolling balance' method similar to existing trading stock rules.
The proceeds of selling an emissions unit will be assessable income. A deduction is available for the cost of an emissions unit, but effectively the deduction is deferred through the rolling balance until the emissions unit is sold or surrendered. Any difference between the tax value of emissions units held at the beginning of an income year and the end of that year is included as assessable income (if positive) or allowed as a deduction. Taxpayers can elect to value the emissions units at either cost or market value at the end of the first income year that they hold the units. The choice can be made until lodgement of the income tax return for the year. Once made, the choice is irrevocable. For subsequent income years, the same method must be used. However, the chosen method can be changed only once before the 2015/16 year. After that year, no changes will be permissible. Emissions units of each vintage will be treated as being used on a 'first in, first out' basis for income tax purposes.
Where an entity surrenders an emissions unit for a purpose unrelated to producing assessable income (eg a private or domestic purpose), the deduction for the cost is effectively reversed by including in assessable income an amount equal to the amount deducted for its acquisition.
Where 'free' units are issued but not surrendered by the end of the income year, the value immediately after issue is included as assessable income at the end of that year. Although emissions units are usually able to be surrendered until 15 December following the year of income, those companies receiving free units may seek to surrender the units early to reduce the timing impact of taxation. A concession is available for EITE units which can be valued at $Nil provided they are surrendered by 15 December following the year of issue.
Goods and Services Tax
While the CPRS does contain amendments to the GST law, these are relatively minor and are limited to ensuring that GST will not apply to an emissions unit or a Kyoto unit that is sold overseas. Otherwise, the Government intends that the ordinary GST rules will apply to transactions involving emissions units and Kyoto units. Generally, GST will apply to the sale of emissions units and Kyoto units.
However, there will be different GST treatments depending on whether emissions units are sold, given away, imported, exported, traded on the secondary market or surrendered. This is likely to give rise to complex GST issues and increase the risk of GST non-compliance. In addition, a number of other GST concerns have been raised, including the increase in working capital requirements and compliance costs for businesses, the potential inability of sellers of emissions units to increase the price to take account of GST, the unrecoverable GST cost incurred by businesses involved in the secondary market for emissions units, and the risk that overseas businesses will need to register for GST solely in order to sell their emissions units in Australia.
Interestingly, the GST treatment of emissions units is not consistent within other emissions trading systems around the world. For example, the European model adopts the same approach to VAT (the equivalent of GST) as that proposed in the Australian model, whereas the proposed New Zealand model excludes GST from transactions in units.
GOVERNMENT ASSISTANCE FOR EITE AND STRONGLY AFFECTED INDUSTRIES
The draft legislation does not provide any new information regarding the treatment of EITE industries. Instead, it provides that the regulations (which we expect to be released in draft form in mid-2009) may formulate a program for the issue of free emissions for EITE activities.
The White Paper provided that EITE industries will be entitled to receive assistance from the Government aimed at easing their transition to the CPRS, while avoiding adverse economic effects and potential 'carbon leakage' (industry participants relocating to countries without a comparable scheme).
Assistance will be given in the form of an allocation of AEUs at the beginning of each compliance period. The AEUs will be allocated at the rate of 90% of projected requirements based on historical industry emissions levels per unit of production for the most emission-intensive activities, and 60% for the lesser emission-intensive activities.
The activities that will be entitled to receive EITE assistance are yet to be determined – the Government is intending to assess eligibility in early 2009 following a formal data collection and assessment process. It is anticipated, however, that activities including aluminium smelting, integrated iron and steel production, and cement, lime and silicon production will be eligible for the 90% assistance rate. Alumina refining, petroleum refining and LNG production are likely to receive the 60% assistance rate.
The 90% and 60% assistance rates will reduce by 1.3% each year to provide further incentives to those receiving assistance to reduce their emissions. It is expected that 25% of all AEUs will be provided free to participants in EITE industries, and that this proportion will rise to 45% by 2020. However, it must be noted that the EITE assistance is intended to be withdrawn once comparable carbon constraints are applied internationally.
The White Paper also contemplated that the Government would provide assistance to non trade-exposed industries likely to be strongly affected by the CPRS. It was determined that only coal-fired electricity generators meet the criteria to be classified as 'strongly affected' and are eligible to receive assistance under the Electricity Sector Adjustment Scheme. The assistance will be directed to supporting the development and deployment of carbon capture and storage technologies, structural adjustment assistance measures for affected workers, communities and regions, and direct assistance to coal-fired electricity generators through the free allocation of AEUs valued at around $3.9 billion. This is reflected in Part 9 of the draft legislation.
Other industries that did not meet the EITE or 'strongly affected' criteria, including other electricity generators, aviation, tourism, community services and public transport industries, may still be eligible for some other form of assistance.
The CPRS allows for liable entities to meet their compliance obligations by surrendering eligible international emissions units, being:
- Certified emission reductions (CERs) created under the Kyoto clean development mechanism for offset projects in developing countries.
- Emission reduction units (ERUs) created under the Kyoto joint implementation mechanism for offset projects in developed countries. Australia will not host joint implementation projects in the first Kyoto commitment period (2008-12), so it is not expected that any ERUs will be issued in Australia during this period.
- Removal units (RMUs) issued on the basis of land use, land-use change and forestry activities by a Kyotosignatory country.
In addition, the draft legislation allows for regulations to prescribe other types of units able to be surrendered for compliance purposes, this includes:
- Any additional type of unit issued under the Kyoto rules.
- A non-Kyoto international emissions unit being a unit issued under an international agreement other than the Kyoto Protocol or issued outside Australia under a law of a foreign country.
There are, however, restrictions on which Kyoto units can be surrendered for compliance and when:
- Temporary CERs and long-term CERs from forestrybased projects will not be accepted for compliance due to their high administrative costs and contingent obligations.
- ERUs issued during the first Kyoto commitment period and which have been converted from RMUs will not be able to be surrendered for compliance from 1 July 2013.
- Similarly, RMUs issued during the first Kyoto commitment period will not be able to be surrendered for compliance from 1 July 2013.
- In keeping with the Government's policy position outlined in the White Paper, it is expected that regulations will also specify that ERUs generated after the first Kyoto commitment period, regardless of when the project was established, will not be able to be used for compliance from 2012-13 onwards. However CERs issued for abatement that occurs from 2013 onwards, by projects established in the first Kyoto commitment period, will continue to be able to be used for compliance.
Provisions that allow for the future sale and transfer of AEUs to foreign registries (export) will be included in the final Bill for the CPRS. The Government's policy is that export would not be allowed in the initial years of the scheme and that it would give the market five years' notice of a decision to allow the export of AEUs. An exception to this general policy is to be made for bilateral links (for example, with New Zealand) where an independent review finds that establishing the bilateral link will not have a significant impact on the unit charge. The Minister may then decide to waive or shorten the notice period.
HOW CAN DLA PHILLIPS FOX ASSIST?
DLA Phillips Fox can help you navigate your way through the complex issues and to develop a measured and commercially astute response. We can:
- Assist with submissions on the draft legislation for the CPRS (due by 14 April 2009).
- Assist with managing NGER compliance including understanding point of obligation provisions. (NGER Act registration is required by 31 August 2009 and the first report for the period from 1 July 2008 to 30 June 2009 is required by 31 October 2009.) " Assist liable entities to understand the operation of, and their obligations under, the proposed CPRS.
- Assist liable entities in reducing their abatement costs by providing advice and assistance on linking with the international carbon market under the Kyoto Protocol and other countries' domestic and regional emissions trading schemes.
- Assist EITE industries with assistance applications.
- Assist coal-fired generation industry participants with assistance applications.
- Assist forestry-industry participants understand the impact of, and opportunities arising from, the CPRS.
- Advise on the impact of climate change issues on planning applications and development proposals.
- Advise on contractual issues, including cost passthrough, contract review clauses and the impact of the CPRS on financing arrangements.
- Assist renewable and sustainable energy participants to commercialise opportunities presented from the expanded Renewable Energy Target (RET) and the introduction of the CPRS including through project development and the linking of Kyoto units.
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This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.