Written by Franz Rental, originally published on LinkedIn on February 20, 2019
Yesterday, 19 February, the National Assembly passed the long-awaited carbon tax bill, clearing a key hurdle in keeping the measure on track to enter into force 1 June 2019. The bill will now be submitted to the Council of Provinces before it is sent to President Ramaphosa to be signed into law.
Under the Bill, offsets can be used to help companies pay less carbon tax. And these savings can be considerable. Many companies, including the large emitters most impacted by the tax, are not aware that by using carbon offsets they can pay up to 20% less in carbon tax, while at the same time boost their Corporate Social Investment mandate.
MARGINAL VS EFFECTIVE TAX RATE
The Bill will apply a marginal tax of R120 rand/tonne of CO2e on virtually all areas of South Africa’s economy, covering greenhouse gases sources from fossil fuel combustion, fugitive emissions, and industrial processes.
The levy will rise annually by 2% plus inflation until the end of the first phase in 2022, and then align with inflation after that.
However, emitters will initially face an effective tax rate of R6 – R48/tonne based on the suite of tax allowances available and the admissibility of offsets, with some companies able to reduce their tax burdens by as much as 95%.
Seeing that the effective tax rate is only R6 – R48 per tonne many people are under the false impression that offsets need to be priced under this rate in order to pay less carbon tax and therefore using offsets will hardly make a difference in reducing a company’s carbon tax.
But this is not the case, as I will explain below.
CARBON TAX OFFSETS
Carbon offsets, or carbon credits, from projects certified under the CDM, Gold Standard, and Verified Carbon Standard (Verra) will be allowed providing they meet certain criteria.
Some project types have been branded ineligible including HFC-23, N2O adipic acid, nuclear, CCS, and installations that have renewable energy generation capacity in excess of 50 MW.
The regulations also stipulate that projects can only be eligible if they don’t benefit from other government incentive programmes such as the Energy Efficiency Savings Tax Incentive (12L) or the Renewable Energy Independent Power Producers Procurement Programme (REIPPPP).
Carbon offsets generated by activities that are covered under the carbon tax are also not eligible. For example, if a company implements a project that reduces the coal use in their boilers the project activity cannot be registered as a carbon offset project for use under the carbon tax as this project will result in a company paying less carbon tax (i.e. to avoid double counting).
SAVINGS FROM USING CARBON TAX OFFSETS
As mentioned above, the marginal tax rate is R120 / tonne, which means that for those emissions you are taxed on, you pay R120 / t. The effective tax rate is calculated if you divide the R120/t by the % allowances.
So for example, if your company has 1000tCO2 of process emissions you do not have to pay tax on the first 70% (tax free allowance) and therefore you only pay tax on 300t (this is your “taxable emissions”). This means you have to pay R36,000 in carbon tax (300t X 120/t).
The effective tax rate is then calculated as follows:
(R120 / 100) X 30 = R36/t.
This means you are paying R36 / t on the full 1000t (and R120 / t on the 300t). From 2022 the basic tax free allowance of 70% falls away, then you are paying R120 / t on the full 1000t.
In terms of offsets, using the above example, a company would be allowed to use 5% of the total 1000t in offsets (process emissions allows 5% offset use). This would be 50t. If this company buys offsets for, say R60, then they would save R60 / t (R120/t tax rate less R60/t offset price). Their carbon tax saving would be calculated as 50t X R60/t = R3000.
So if this company does not make use of offsets they would pay R36,000 in carbon tax. If they use offsets they only pay R33,000 (R36k – 3k). This is a saving of 8%.
As such it can be clearly seen that even though the company paid R60 / t for the offset (much higher than the R36 / t effective tax rate) they still saved carbon tax.
To conclude, as long as a company purchases offsets for less then the price of the marginal tax rate they will still pay less carbon tax.
Generally, how much carbon tax a company can save by using offsets will depend on:
- price of the offsets – the lower the price, the higher the savings (but offsets are not free!)
- percentage offset allowance – combustion emissions allow for 10% offset allowance – hence higher the savings compared to using 5% offset allowance for process and fugitive emissions
- emissions profile – a company with mostly combustion emissions will save more carbon tax when using offsets compared to a company that has mostly process and/or fugitive emissions (this is due to the fact that combustion emissions have a 60% tax free allowance compared to 70% tax free allowance for process and fugitive emissions).
Due to the considerable tax savings to be had, and the fact that there will be more at least 5 times more offset demand than supply, carbon tax liable companies are advised to develop a carbon offset strategy that addresses the following crucial questions:
- To purchase offsets, and save tax, or not?
- Linking offsets to broader company objectives?
- Linking offsets to CSI / social development programmes?
- Purchasing a function of price and / or project type?
- Who will manage this process (internally or outsourced?)
- When to act?
Climate Neutral Group can help your company lower its carbon tax liability through a robust carbon tax offsetting strategy. We also have a large portfolio of eligible South African carbon offsets thereby maximising your carbon tax savings.