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Taxation of Cross-Border Transfers of Carbon Emission Allowances under Linked Emissions Trading Schemes

Published online by Cambridge University Press:  15 March 2017

Celeste M. Black
Celeste M. Black*
Affiliation:
The University of Sydney, Faculty of Law, Sydney (Australia). Email: [email protected].
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Abstract

Economic arguments in support of linking emissions trading schemes suggest that such linking could provide access to lower cost abatement options and increase market stability. The decisions of whether and how to link emissions trading schemes often focus on the design features of the relevant schemes, but an additional factor which has the potential to undermine the efficiency of linked schemes is taxation. This article systematically tests two alternative approaches to the direct (income) taxation of cross-border transfers of emission allowances for differential tax outcomes. Four hypothetical transactions are considered under three different linking mechanisms and on the assumption that a tax treaty based on the OECD Model Tax Convention on Income and on Capital is in force. This analysis evidences that, in some cases – and especially if the relevant jurisdictions adopt different approaches to the taxation of allowance transactions under domestic law – there is the potential for timing differences or double taxation that could impact on the efficiency of the linked trading schemes. It is therefore important for tax implications to be considered as part of any linking proposal.

Keywords

Emissions trading schemesCarbon tradingLinking emissions trading schemesInternational taxCarbon emission allowances
Type
Articles
Information
Transnational Environmental Law , Volume 6 , Issue 2 , July 2017 , pp. 335 - 361
Copyright
© Cambridge University Press 2017 

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Footnotes

This article builds on research undertaken while the author was a doctoral candidate at Macquarie University (Australia). I would like to thank the anonymous reviewers of this article for their helpful comments.

References

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5 Ibid., p. 21.

6 The World Bank, ‘State and Trends of Carbon Pricing 2016’, p. 11, available at: http://www.ecofys.com/files/files/wb_report_2016_161018_screen.pdf. Thomson Reuters also confirms an increase in the coverage of carbon markets, although the overall volume declined in 2015 compared with 2014 levels. A notable future development will be the launch of the national market in China in 2017: Thomson Reuters, ‘Carbon Market Monitor: Review of Global Markets in 2015 and Outlook for 2016–2018’, 11 Jan. 2016, available at: https://climateobserver.org/wp-content/uploads/2016/01/Carbon-Market-Review-2016.pdf.

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9 Ibid.

10 Flachsland, Marschinski & Edenhofer, n. 7 above, p. 1637. A similar distinction was made in Jaffe, J., M. Ranson & R. Stavins, ‘Linking Tradable Permit Systems: A Key Element of Emerging International Climate Policy Architecture’ (2007) 36(4) Ecology Law Quarterly, pp. 789–808 Google Scholar.

11 Flachsland, Marschinski & Edenhofer, n. 7 above, p. 1641.

12 The Kyoto first commitment period expired in 2012. An amendment to the Kyoto Protocol (n. 64 below) to establish a second commitment period (to expire in 2020) was adopted in Doha (Qatar) in Dec. 2012, but requires acceptance by three-fourths of the parties (144 instruments of acceptance) before it enters into force. As of 9 Nov. 2016, only 73 countries had ratified the Doha Amendment: United Nations Framework Convention on Climate Change (UNFCCC) Secretariat, ‘Status of the Doha Amendment’, available at: http://unfccc.int/kyoto_protocol/doha_amendment/items/7362.php.

13 Paris Agreement, Paris (France), 13 Dec. 2015, in force 4 Nov. 2016, UNFCCC Secretariat, Decision 1/CP.21 ‘Adoption of the Paris Agreement’, UN Doc. FCCC/CP/2015/10/Add.1, available at: http://unfccc.int/resource/docs/2015/cop21/eng/10a01.pdf. Art. 6 recognizes the role of both market and non-market approaches to mitigation of emissions and sustainable development.

14 M. Ranson & R. Stavins, ‘Linkage of Greenhouse Gas Emissions Trading Systems: Learning from Experience’ (2016) 16(3) Climate Policy, pp. 284–300Google Scholar.

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17 Ibid., p. 610.

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20 Kane, n. 8 above.

21 S. Næss-Schmidt et al., Tax Treatment of ETS Allowances: Options for Improving Transparency and Efficiency (Copenhagen Economics, 2010), p. 62.

22 Costantini et al., n. 16 above, p. 610.

23 Kane, n. 8 above, pp. 90–1.

24 Ibid., pp. 101–2.

25 For an analysis of this issue see, e.g., H. Huizinga & L. Laeven, ‘International Profit Shifting within Multinationals: A Multi-Country Perspective’ (2008) 92(5–6) Journal of Public Economics, pp. 1164–1182Google Scholar, and the studies cited therein.

26 New Zealand created some specific rules for the treatment of carbon units but otherwise allowed the general tax treatment to operate, e.g., Income Tax Act 2007 (New Zealand), ss CB 36, DB 60, DB 60A: Black, C., ‘Tax Accounting for Transactions under an Emissions Trading Scheme: An Australasian Perspective’ (2011) 5(1) Carbon & Climate Law Review, pp. 91–99 CrossRefGoogle Scholar.

27 Clean Energy Legislation (Carbon Tax Repeal) Act 2014 (Cth), with effect from 1 July 2014.

28 Australian Government, ‘The Safeguard Mechanism: Overview’ (2016), available at: https://www.environment.gov.au/climate-change/emissions-reduction-fund/publications/factsheet-erf-safeguard-mechanism. The safeguard mechanism came into operation on 1 July 2016 and covers roughly half of Australia’s emissions: ibid.

29 The main elements of the CPM were established by the Clean Energy Act 2011 (Cth).

30 The EU ETS was established by Directive 2003/87/EC Establishing a Scheme for Greenhouse Gas Emission Allowance Trading within the Community and Amending Directive 96/61/EC [2003] OJ L 275/25 (ETS Directive); and amended by Directive 2004/101/EC Amending Directive 2003/87/EC Establishing a Scheme for Greenhouse Gas Emission Allowance Trading within the Community, in respect of the Kyoto Protocol’s Project Mechanisms [2004] OJ L 338/18 (Linking Directive).

31 OECD, Model Tax Convention on Income and on Capital 2014 (OECD Model), available at: http://www.oecd.org/tax/model-tax-convention-on-income-and-on-capital-2015-full-version-9789264239081-en.htm. The OECD Model includes the text of the articles of the model and their commentaries as well as other relevant reports and other information. The OECD Model is updated on a regular basis. For the purposes of this article, a reference to the ‘OECD Model’ refers to the most recently updated version of 2014.

32 E. Haites, ‘Lessons Learned from Linking Emissions Trading Systems: General Principles and Applications’, Partnership for Market Readiness, Technical Note 7, Feb. 2014, pp. 6–7, available at: https://www.thepmr.org/system/files/documents/PMR%20Technical%20Note%207.pdf. See also M. Mehling & E. Haites, ‘Mechanisms for Linking Emissions Trading Schemes’ (2009) 9(2) Climate Policy, pp. 169–84.

33 California Air Resources Board and Government of Quebec, ‘Agreement between the California Air Resources Board and the Gouvernement du Quebec concerning the Harmonization and Integration of Cap-and-Trade Programs for Reducing Greenhouse Gas Emissions’, Sept. 2013, available at: https://www.arb.ca.gov/cc/capandtrade/linkage/ca_quebec_linking_agreement_english.pdf. The Canadian province of Ontario has also announced its intention to establish a cap-and-trade programme and to join the Quebec and California scheme: Kathleen Wynne, Premier of Ontario, ‘Cap and Trade System to Limit Greenhouse Gas Pollution in Ontario’, News Release, 13 Apr. 2015, available at: https://news.ontario.ca/opo/en/2015/04/cap-and-trade-system-to-limit-greenhouse-gas-pollution-in-ontario.html.

34 WCI Partners, ‘Design for the WCI Regional Program’, July 2010, available at: http://www.westernclimateinitiative.org/the-wci-cap-and-trade-program/program-design.

35 The State of California made a commitment in 2006 to reduce GHG emissions and the California Air Resources Board adopted regulations to establish a cap-and-trade programme: Global Warming Solutions Act of 2006, AB 32, Nunez, ch. 488 Cal. Stat. 2006, adding Division 25.5 to the Health and Safety Code (California) and California Code of Regulations, Title 17, subch. 10, Art. 5 California Cap on Greenhouse Gas Emissions and Market-Based Compliance Mechanisms, §§ 95801–96023. The first auction of allowances took place in late 2012. Information on the cap-and-trade programme generally and the auctions specifically can be found on the California Air Resources Board website, available at: http://www.arb.ca.gov/cc/capandtrade/capandtrade.htm. The Quebec cap-and-trade programme was made possible through an amendment in 2009 to the Environmental Quality Act, RSC 2014 (Quebec), c. Q-2, and regulations issued thereunder in 2011: see An Act to Amend the Environmental Quality Act and Other Legislative Provisions in Relation to Climate Change, RSQ 2009 (Quebec) and Regulation Respecting a Cap-and-Trade System for Greenhouse Gas Emission Allowances, RR 2011, c Q-2, r 46.1 (Quebec). The first compliance period for both schemes started on 1 Jan. 2013: Gouvernement du Quebec, Regulation Respecting a Cap-and-Trade System for Greenhouse Gas Emission Allowances (C&T): Technical Overview (Gouvernement du Quebec, 2013).

36 State of California, Air Resources Board, ‘Linking Readiness Report’, 1 Nov. 2013, pp. 17–8, available at: https://www.arb.ca.gov/cc/capandtrade/linkage/arb_linkage_readiness_report.pdf.

37 Ibid., p. 3.

38 Details of the joint auction results can be found at the California Air Resources Board, ‘Auction and Reserve Sale Information’, 2016, available at: http://www.arb.ca.gov/cc/capandtrade/auction/auction.htm.

39 Ministry of the Environment and Climate Change, Ontario, ‘Reducing Greenhouse Gas Pollution Through Cap and Trade’, Press Release, 8 June 2016, available at: https://news.ontario.ca/ene/en/2016/06/reducing-greenhouse-gas-pollution-through-cap-and-trade.html.

40 The (now former) Australian Minister for Climate Change and Energy Efficiency, Hon. Greg Combet MP, and the (now former) European Commissioner for Climate Action, Ms Connie Hedegaard, ‘Australia and European Commission Agree on Pathway towards Fully Linking Emissions Trading Systems’, Joint Press Release, 28 Aug. 2012, available at: http://europa.eu/rapid/press-release_IP-12-916_en.htm.

41 European Commission and Australian Government, Department of Climate Change and Energy Efficiency, ‘Registry Options to Facilitate Linking of Emissions Trading Systems: Consultation Paper’, 2013 (Linking Design Paper), a copy of this paper is on file with the author.

42 Ibid., pp. 23–5.

43 Ibid., pp. 17–22.

44 Sterk & Schüle, n. 15 above, p. 426

45 Linking Design Paper, n. 41 above, p. 26.

46 The view was taken that the swap-back was necessary to facilitate liquidity in the market and the development of derivatives markets: ibid., p. 22.

47 Black, C., ‘Approaches to the Taxation Treatment of Carbon Emission Allowances and Liabilities: Comparing the United Kingdom and Australia’ (2013) 3 British Tax Review, pp. 287–320 Google Scholar.

48 European Commission, ‘Report on the Responses Received to the Consultation of Accounting Regulatory Committee Members on the Use of Options within the Accounting Directives’, Sept. 2011, ‘Responses to Question 8’, available at: http://ec.europa.eu/internal_market/accounting/docs/2010-options_en.pdf.

49 The International Accounting Standards Board commenced work on these issues in 2004 and was joined in these efforts by the US Financial Accounting Standards Board, but they have recently suspended work on the project: International Financial Reporting Standards (IFRS), ‘Pollutant Pricing Mechanisms’, available at http://www.ifrs.org/Current-Projects/IASB-Projects/Emission-Trading-Schemes/Pages/Emissions-Trading-Schemes.aspx.

50 Black, C., ‘Accounting for Carbon Emission Allowances in the European Union: In Search of Consistency’ (2013) 10(2) Accounting in Europe, pp. 223–239 CrossRefGoogle Scholar.

51 A total of 69.4% of the sample entities disclosed the characterization of emission allowances as intangible assets: ibid., p. 231.

52 The Acid Rain Program was created under the Clean Air Act Amendments of 1990, 42 USC, subch. IV-A (1990) (US). The Program is operated through the US Environmental Protection Agency (EPA) and information on the program can be found on the EPA website, available at: http://www.epa.gov/airmarkets/progsregs/arp/basic.html.

53 IRS, Revenue Procedure 92-91, 1992-2 CB 503 (July 1992); see also Y. Margalioth, ‘Tax Policy Analysis of Climate Change’ (2010–11) 64(4) Tax Law Review, pp. 63–98.

54 Black, n. 50 above, p. 232. A total of 62.9% of the sample entities disclosed a nil or nominal valuation for free allocations.

55 OECD Committee on Fiscal Affairs, ‘Tax Treaty Issues related to Emissions Permits/Credits’ (OECD, 2014), para. 14, available at: https://www.oecd.org/tax/treaties/report-emissions-permits.pdf. See also Næss-Schmidt et al., n. 21 above, p. 9.

56 IRS, Revenue Ruling 92-16 (1992), ‘Issuance of Emission Allowances’. See also IRS, Private Letter Ruling 201228020 (17 Apr. 2012); IRS, Private Letter Ruling 201123003 (4 Mar. 2011).

57 Lucas, G.M., ‘The Taxation of Emissions Allowances Distributed for Free as Part of a Carbon Cap-and-Trade Program’ (2010) 1 George Washington Journal of Energy & Environmental Law, pp. 16–39 Google Scholar; Yale, n. 19 above; Kane, n. 8 above.

58 International Accounting Standards Board, ‘IAS 1 – Presentation of Financial Statements’, available at: http://www.iasplus.com/en-gb/standards/ias/ias1; and ‘IAS 37 – Provisions, Contingent Liabilities and Contingent Assets’, available at: http://www.iasplus.com/en-gb/standards/ias/ias37.

59 Black, n. 50 above.

60 Ibid., p. 236.

61 IRS, Revenue Procedure 92-91, 1992-2 CB 503 (July 1992); see also Margalioth, n. 53 above.

62 Australian Government, ‘Carbon Pollution Reduction Scheme: Australia’s Low Pollution Future: White Paper’ (2008), Ch. 14 (White Paper).

63 Division 420 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) was inserted by the Clean Energy (Consequential Amendments) Act 2011 (Cth), Sch. 2.

64 Kyoto Protocol to the UNFCCC, Kyoto (Japan), 11 Dec. 1997, in force 16 Feb. 2005, available at: http://unfccc.int/kyoto_protocol/items/2830.php.

65 ITAA 1997, n. 63 above, s. 420-12.

66 Black, C., ‘Considering the Taxation Implications of Australia’s Carbon Pricing Mechanism’ (2012) 41(3) Australian Tax Review, pp. 136–153 Google Scholar.

67 ITAA 1997, n. 63 above, s. 420-45.

68 White Paper, n. 62 above, Ch. 14-5.

69 ITAA 1997, n. 63 above, s. 420-15.

70 Ibid., s. 420-25.

71 Ibid., s. 420-60.

72 This term was coined in the White Paper, n. 62 above, Ch. 14-14.

73 The Jobs and Competitiveness Program operated under Part 7 of the now repealed Clean Energy Act 2011 (Cth).

74 P. Harris & D. Oliver, International Commercial Tax (Cambridge University Press, 2010), p. 14.

75 E.g., in Australia, tax treaties are given the force of law by the International Tax Agreements Act 1953 (Cth) and, in the case of any inconsistency, the provisions of a tax treaty prevail over domestic law (except for the operation of the income tax general anti-avoidance rule).

76 E.g., ITAA 1997, n. 63 above, s. 6-5; Corporation Tax Act 2009 (UK), s. 5.

77 Harris & Oliver, n. 74 above, pp. 59–60.

78 R.J. Vann, ‘Taxing International Business Income: Hard-Boiled Wonderland and the End of the World’ (2010) 2(3) World Tax Journal, pp. 291–346, at 298.

79 Explanatory Memorandum to Clean Energy (Consequential Amendments) Bill 2011 (Cth), paras 2.119–2.120.

80 ITAA 1997, n. 63 above, ss. 420-25(3) and 420-45(4).

81 Ibid., s. 420-21(1).

82 Ibid., s. 420-35.

83 OECD, ‘Introduction to the OECD Model 2014’, in OECD Model, n. 31 above, para. 1.

84 UN Department of Economic and Social Affairs, ‘Model Double Taxation Convention between Developed and Developing Countries’, 2011, available at: http://www.un.org/esa/ffd/documents/UN_Model_2011_Update.pdf.

85 OECD Committee on Fiscal Affairs, n. 55 above.

86 The question of whether a PE exists and the allocation of enterprise profits to that PE under Article 7 OECD Model are particularly complex and have been the subject of recent debate and changes in the OECD approach: OECD, ‘2010 Report on the Attribution of Profits to Permanent Establishments’, 22 July 2010, and the associated amendments to Article 7, available at: http://www.oecd.org/ctp/transfer-pricing/45689524.pdf.

87 OECD, ‘Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations’, 16 Aug. 2010, available at: http://www.oecd-ilibrary.org/taxation/oecd-transfer-pricing-guidelines-for-multinational-enterprises-and-tax-administrations-2010_tpg-2010-en.

88 This deemed purchase of REUs gives rise to a deduction for the purchase price and a cost to include in the rolling balance. As the REUs are still held at the year end, the deduction for cost is matched by the increase in the rolling balance representing the new REUs, so there is no net tax result in year 1.

89 Although there is a disposal of the allowances on surrender, which could technically be seen as a realization event for tax purposes, the value of the consideration received for the allowances is likely to be taken to be the value of the compliance liability, which would pick up the same amount and therefore not give rise to any gain or loss from the disposal.

90 Costantini et al., n. 16 above.

91 For example, in the analytical model developed by Costantini et al. and described in their paper, firms take the permit endowment and taxation as given and then choose their level of emissions and trading activities, so this thereby limits the model to market participants that have emission obligations: Costantini et al., n. 16 above, p. 609. Similarly, two of the four key questions considered in the Copenhagen Economics report – (i) whether firms should be allowed to deduct the purchase costs for allowances when purchased or when they are used for compliance, and (ii) how free allowances should be taxed – and the accompanying analysis in the report evidence that the tax considerations are being viewed from the perspective of liable entities: Næss-Schmidt et al., n. 21 above, pp. 6–7.