15 Jul 2011

Taxation treatment of carbon permits under the Carbon Price Mechanism

by Andrew Sommer

The income tax and GST law will be amended to deal with the implications of the imposition of a price on carbon.

The Government has announced the manner in which it intends the income tax law and the GST law will interact with the carbon pricing mechanism. At this stage, no draft legislation has been received and only general indications of the intended treatment have been released. It remains to be seen whether the implementation of the scheme and the proposed amendments successfully achieve the intended result.

How will the permits be treated for income tax purposes?

During the fixed price period, businesses will purchase the permits they require from the Government. In the flexible price period, permits may be acquired from the Government, from other businesses or from other carbon abatement programs overseas.

The purpose of the amendments to the income tax law is to ensure that, irrespective of the source of the permits, a taxpayer will be entitled to a deduction for the purchase price of the permits. Similarly, the proceeds from selling a permit will be assessable income in the year in which the permit is sold.

The timing of the deduction for the acquisition of permits will be determined through the "rolling balance method". This is similar to the existing rules which apply for trading stock. That is, the deduction will be deferred until such time as the permit is surrendered or sold. Accordingly, no deduction will be available for the amount paid for permits which remain "on hand" (ie. not surrendered or sold) at the end of a financial year.

What other income tax implications arise under the scheme?

No special provisions are currently proposed to deal with the income tax consequences of assistance which is provided as part of the transition to a carbon price. As such, any assistance which is provided in the form of cash grants will be treated under the existing tax law and will generally give rise to an assessable receipt by the taxpayer. Similarly, assistance which is provided in the form of freely allocated permits will be treated in the same way as a cash grant. The market value of the permits received will be included in the taxpayer's assessable income in the income year in which it is received. A deduction will arise for the taxpayer in the year of income in which the permit is surrendered or sold. Accordingly, where taxpayers sell permits which they receive freely, the resultant income will be assessable to the taxpayer.

Under special rules, freely allocated permits which are provided under the Jobs and Competitiveness Program will be valued at zero provided that the income year ends before the surrender date for the compliance year in respect of which they were issued. These rules are intended to avoid the situation where an emission intensive trade exposed entity is required to pay tax on its permits before it has an opportunity to use them and creating the need for a distortion of the production decisions it would otherwise have made.

How will the permits be treated for GST purposes?

Rather than allow the existing provisions of the GST law to dictate the consequences of the issuance or transfer of permits, the Government proposes to amend the GST law to ensure that all supplies of permits will be GST-free – whether they are being issued by the Government or transferred between taxpayers. Of course, as a change in the base of GST, this will be problematic and cannot be unilaterally implemented by the Federal Government. Rather, approval will be required by each of the State and Territory Governments if this change is to be made.

As a GST-free supply, it will not be necessary to remit GST in connection with the making of a supply or permits, nor will it be necessary to claim input tax credits for the acquisition of permits. Importantly, this should avoid any distortions which could otherwise have arisen between permits directly acquired from the Government and permits acquired by trading with other taxpayers.

While the GST law will be amended to ensure that the supply of the permits themselves will be GST-free, the general provisions of the GST law will apply to derivatives. This means that the supply of subsidiary interests which do not give the holder a right to physical delivery of a permit will be input taxed supplies.

What other GST implications arise?

Importantly, the normal GST rules will apply to the receipt of financial assistance. While the receipt of assistance will generally be assessable for income tax purposes, not every receipt of assistance will be consideration for a supply being made by a taxpayer. Unless there is a "supply" being made by a taxpayer in consideration for the financial assistance, no GST will be payable by the taxpayer on that assistance. As such, it will be necessary to carefully consider the arrangements under which the assistance is received in order to determine whether or not GST will be payable.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.