Anita Monteith discusses the traded instruments sprouting from the ambition to achieve net zero, including Pending Issuance Units, Woodland Carbon Units and the Woodland Carbon Guarantee Scheme.
Those with good memories may recall the article, The profitability of woodland, written by Julie Butler and Fred Butler in TAXline November 2019, in which they discussed the taxation of woodlands and reminded readers about the generous tax reliefs and exemptions available for growing timber. Coincidentally, having finished my training contract in the early 1980s, one of my first experiences of a real tax department was taking clients to visit the woodlands that the Big Eight firm for which I then worked was proposing as a good tax investment. Hindsight is a wonderful thing.
While the tax treatment has barely changed, the focus on woodland as an investment most certainly has. Although current world events have seemingly distracted the UK from its Net Zero Strategy, this must be temporary. Businesses and households will soon return to the challenge of how they might continue their own paths to net zero for carbon by 2050.
While some change will be fairly straightforward, there will also be residual carbon emissions requiring an alternative approach. The clue lies in the use of the word ‘net’. We are seeing a business model where the main purpose is to plant trees and maintain them while they grow in an environmentally sustainable way, but where an important income stream will be to create carbon units available for net emitters of carbon to buy and use as offsets. Job done, the UK is Net Zero.
There is now a growing market where carbon units are traded. As ever with new products, there are spin-off products and it isn’t always clear how these should be taxed. Our experience of cryptocurrencies is, to my mind, an analogous product, where many who invested didn’t even realise they had made gains that are taxable. It has taken several years for those less interested in tax to consider their record-keeping problem.
This time, steps will be taken to keep track of the buyers and sellers; hopefully the data collected will be used to inform owners of their tax obligations in due course. It will also be useful data for government policy makers to design and adapt in the future. Nothing ever stays the same for long.
In the case of carbon units, the current relatively unknown product to market is the Pending Issuance Unit (PIU). The PIU is a pragmatic solution to achieving an earlier return for growing timber, because trees take such a long time to grow. Even better, their ability to sequester (remove) carbon from the atmosphere will increase as they grow.
Here is a short reminder of some basic woodland tax principles, although do read the Butlers’ article for more depth. Commercial occupation of woodlands is not classified as a trade, so income from the trees is still not taxable and the expenses incurred in managing the growing timber are still not eligible for tax relief. There is no capital gains tax on the sale of growing timber, although the part of the gain relating to the disposal of the land is chargeable; nor is there any inheritance tax on woodlands left in an estate on death. This does mean some apportionment of costs and sale proceeds might be needed where there is an element of mixed use, such as growing woodlands alongside farming for example, but that is not our concern here. Growing timber is great from a low tax perspective. The only problem is that as an investment, trees take a long time to mature and for some species this means several generations in human terms.
For most people, locking up a considerable sum for such a long time is not an attractive prospect and it will be necessary to extract value as decades pass.
Capturing carbon and data
Trees sequester increasing amounts of CO2 from the atmosphere as they get bigger. The sequestration is measured in carbon units and it is possible to measure the number of units to be sequestered by an area of woodland for the years ahead. The UK Land Carbon Registry is the UK database of all Woodland Carbon Code and Peatland Carbon Units projects in the UK. Its database holds publicly available information about the ownership of the projects and the use of carbon units. Importantly, all transactions in UK-based projects must be recorded on this database.
There are steps to go through: each project must first be registered; then it will be validated; and then it is verified.
At the validation stage, a number of PIUs will be allocated to the project. These indicate the amount of carbon the trees in that project are expected to sequester in the coming years.
The PIUs are listed in time periods, or vintages, which indicates how much carbon is expected to be sequestered on a cumulative basis at five-year intervals over the next 100 years. In the early years, the cumulative claimable carbon sequestration is likely to be negative once soil loss and other aspects of the plot are taken into account. Many reading this article will like data and I recommend taking a look at some of the projects listed. Be warned: you can get quite side-tracked!
I have made an analogy to cryptocurrencies, but there is a big difference. PIUs and Woodland Carbon Units (WCUs) only exist on the UK Land Carbon Registry and ownership can only be transferred between registry account holders. So the PIUs must be traded through the registry.
While the sale proceeds should be easy to establish, the costs of sale may be less obvious. Are we to presume that acquisitions of PIUs for a particular project should be kept separately identifiable and matched when sold, or will they be pooled for each project within a particular vintage? Or will all PIUs for a project be pooled, applying the same principles as for shares? Perhaps the answer lies in looking to financial reporting principles where we look to the cost at which assets are recorded.
How do the tax rules apply?
I should just mention one further aspect covered by Julie Butler in the April 2022 issue of TAXline specifically in relation to the Woodland Carbon Guarantee Scheme. This is a special scheme only available in England that allows a landowner to sell verified carbon units from their growing timber to the UK government for a guaranteed fixed price every five or 10 years until 2055/56.
The article highlights the guidance from the Forestry Commission indicating that the income from the sale of WCUs can be tax free if the woodland is commercially managed, under s768, Income Tax (Trading and Other Income) Act 2005. However, other than in HMRC’s Business Income Manual at BIM67701, which takes a similar view in general terms, we do not yet have specific guidance from HMRC.
For example, if a business buys WCUs for carbon offsetting, will they get tax relief for the cost on the basis that they are not involved in the commercial management of the woodland?
If you are beginning to think this is an area of tax that seems to be developing on a just-in-time basis, I’d agree with you. We are seeing here new types of income stream and it feels like we are back-filling the tax rules. Which brings me to the latest issue...
The traditional model of commercial woodlands has indeed progressed to much greater productivity and profit potential has expanded beyond just selling the wood. While the income of the woodland is ‘outside the scope’, I am fairly sure the same cannot be said for the sale of PIUs or WCUs in all cases. For now, if you have to take a view, the safest approach for a taxpayer is to make full disclosure of the position taken on their tax return. Meanwhile, ICAEW and the other professional bodies are continuing discussions with HMRC to agree answers.
About the author
Anita Monteith, Head of Taxation Policy, ICAEW