[Tax Notes] On November 2, as part of the Government’s measures to address climate change and to reduce greenhouse gas emissions in South Africa, the National Treasury published draft carbon tax legislation for public comment.
South Africa has committed to reduce GHG emissions below their current levels by 34 percent by 2020 and by 42 percent by 2025. The Government decided last year that the carbon tax should be postponed by a year, into 2016, to allow for further consultation, which has been ongoing since 2010.
It is proposed that an initial carbon tax rate of ZAR120 (USD8.61) per ton of CO2 will be imposed. However, taking into account certain tax-free thresholds and allowances, the effective tax rate over the first phase of the carbon tax – from the eventual implementation date up to 2020 – is expected to vary between ZAR6 and ZAR48 per ton of CO2.
For example, a basic 60 percent tax-free threshold will be available during the tax’s first phase, together with additional tax-free allowances of up to 10 percent for process emissions and for trade exposed sectors. Recognition for early action and/or effort to reduce GHG emissions that beat the industry average will result in a tax-free allowance of up to five percent.
It is also intended that carbon offsets will enable firms to cost-effectively lower their carbon tax liability by between five and 10 percent of their actual emissions, and will incentivize investment in GHG emission-mitigation projects that deliver carbon emissions reduction at a cost lower than the carbon tax.
The combined effect of all of the tax-free thresholds will be capped at 95 percent. With the tax-free exemptions ranging between 60 and 95 percent of total GHG emissions, it is implied that the carbon tax will be imposed on only 5 to 40 percent of actual emissions during the tax’s first phase.
Revenue recycling measures are also proposed. These will include funding for the energy efficiency tax incentive already being implemented; a reduction in the electricity levy; additional tax relief for solar energy as already provided for in the 2015 tax legislation; a credit for the premium for renewable energy; and additional support for free basic electricity to low income households…
[Lexology] The following high-level points are important to note in relation to the Bill:
- The essential carbon tax design that has been discussed since 2010 is unchanged, although the Bill provides greater detail on particular architectural elements while providing only glimpses of others, e.g. the proposed use of carbon offsets against a carbon tax liability, the detail of which will be provided in regulation that is expected to be published for comment in early 2016.
- The Bill proposes that carbon tax be paid in respect of every “tax period” and that the first tax period will commence on 1 January 2017 and end on 31 December 2017. Note the distinction between “tax period” and the “phase” of carbon tax implementation, discussed below.
- In an evolution of Treasury’s previous stance that carbon tax revenues will simply go into the general revenue pool, the Bill proposes that revenues will be spent on a range of sustainable interventions, e.g. providing tax relief for rooftop solar power, a reduction in the fossil fuel electricity levy or providing support for free basic electricity. While this represents a welcome softening of Treasury’s position, it is unlikely that Treasury will irrevocably commit itself to these applications of carbon tax revenue due to the need to retain fiscal flexibility in the national budgeting process.
- While the Bill provides some insight into the proposed design up to 2020, including emissions thresholds and exemption, it is silent on the post-2020 period, which is unhelpful for predicting the longer-term implications of the carbon tax. It is probably safe to assume that the tax will gradually be ramped-up after 2020, including the lowering of thresholds and the removal of exemptions.
- The carbon tax will be introduced in a phased manner. The first phase of the tax will run from the commencement of the regime until 2020, during which time the tax is intended to be neutral to revenue and to electricity prices (once revenue recycling measures are taken into account), although a press statement accompanying the Bill states rather obliquely, that while “the tax and revenue recycling measures are designed to be revenue neutral from a macroeconomic perspective [they] will not necessarily be neutral for companies with significant emissions”. This is a warning to large emitters of scope one emissions that the carbon tax will have financial consequences for them from its commencement.
- The six greenhouse gasses originally targeted in the Kyoto Protocol (carbon dioxide, methane, nitrous oxide, perfluorocarbons, hydrofluorocarbons and sulphur hexafluoride) will be the focus of the carbon tax, but the seventh Kyoto gas (nitrogen trifluoride) is excluded due to the absence of this gas from South African industrial emissions.
- The Bill includes the following thresholds and exemptions (which are more numerous and complex than before, particularly their inter-relationship):
- A basic 60% tax-free threshold during the first phase.
- An additional 10% tax-free allowance for process emissions.
- An additional tax-free allowance for trade exposed sectors of up to 10%.
- An additional tax-free allowance of up to 5% as recognition for early actions and/or efforts to reduce emissions that beat the industry average.
- A carbon offsets tax-free allowance of between 5% and 10%.
- A phase one-specific additional 5% tax-free allowance for companies participating in the Department of Environmental Affairs carbon budgeting system in recognition of their participation and of the role of carbon budgets in the overall tax design.
- Phase one tax-free exemptions will range between 60% and 95% of total emissions, implying that the carbon tax will be imposed on 5% to 40% of actual emissions during the period.
- In phase one, an initial marginal carbon tax rate of R120 will be imposed per tonne of carbon dioxide equivalent (“tCO2e”), but the effective carbon tax rate will vary between R6 and R48/tCO2e with a comprehensive application of the system of tax-free allowances.
In relation to the potential economic consequences of the carbon tax, the accompanying explanatory memorandum indicates that a 2012 economic modelling exercise initiated by the National Treasury found that “…a carbon tax with broad sector coverage implemented gradually and complemented by effective and efficient revenue recycling will contribute towards significant greenhouse gas emission reductions, and have only a marginal negative impact on economic growth over the short-term”. There are at least two considerations that arise from this statement:
- Firstly, the idea that the carbon tax will have only a marginal negative economic effect over the short-term is unlikely to be of any comfort to those industries and their customer bases that will feel the negative impact. In any event, the economic modelling that has been released to date on the carbon tax is relatively superficial and the conclusions have been challenged. One of the imperatives going forward must be a comprehensive economic modelling of the anticipated impact of the carbon tax as input to public and private sector strategic decision-making around the tax.
- Secondly, by its reference to the carbon tax’s potential to contribute to greenhouse gas emissions reduction, the statement locates the carbon tax within the national and international political landscape of the climate change negotiations and the explanatory memorandum describes the carbon tax as “integral” to domestic climate change policy. In fact, the carbon tax is relevant to a number of macro-economic concerns, not least of which is power generation and the future energy mix. For example, the explanatory memorandum indicates that the carbon tax aims to change the behaviour of firms, incentivising them to shift towards cleaner technology when replacing/renewing machinery, technology or processes. While the carbon tax may drive the market in this direction, it is also true that, in the absence of a systemic change in our power sector, the carbon tax will not drive the significant opportunity for greenhouse gas emissions reduction, namely a shift to less emissions-intensive forms of electricity generation. This is because the energy mix is not determined by market forces, but by the Integrated Resources Plan, 2030 (“IRP”) which does not offer energy-sources alternatives for energy-consumers other than Eskom’s emissions-abundant power. The pending revision of the IRP might introduce some flexibility which would tend to support the effectiveness of the carbon tax as a driver towards a less emissions-intensive electricity sector, but this remains to be seen.
It is only with an appreciation of where and how it fits into broader macro-economic concerns that a proper understanding of the carbon tax can be formulated. Due to the complexity of the proposed tax design and the myriad of strategic and operational implications that the imposition of the tax will have for industry, this article is the first of a series that will examine the context for and various features of the proposed carbon tax. Future articles in this series will explore the policy, legal and strategic positioning of the carbon tax, with a view to inform this understanding.