Julie Butler, Founding Director of Butler & Co, examines the tax rules and guidance around woodland carbon units.
Environmental income streams such as ‘carbon credits’ are becoming more commonplace, but there is currently a lack of guidance on the tax treatment.
Advisers need to forensically understand the management of woodland that gives rise to the credit to justify the appropriate tax treatment.
For woodland in England, when the taxpayer has obtained the carbon credits under the woodland carbon guarantee (WCaG) scheme, the property owner basically calculates how much CO2 they can capture (or sequester) by growing trees. They then have the option to sell that captured carbon in the form of woodland carbon units (WCUs) to the government for a guaranteed price every five or 10 years until 2055/56. When selling to the government, the guaranteed price is set by entering a woodland carbon guarantee auction in advance of planting. Alternatively, they can sell the WCUs on the open market to buyers seeking to offset their carbon emissions.
Other nations within the UK can have a woodland planting project verified to create WCUs, but the WCUs can only be sold on the open market.
To determine whether there is a tax liability, one should consider the nature of the units and the underlying woodland.
Income tax on woodland generally
There are arguments to say that the income from the sale of WCUs can be tax free if the woodland is commercially managed. Section 768, Income Tax (Trading and Other Income) Act (ITTOIA 2005), ‘Commercial occupation of woodlands’ says:
“(1) No liability to income tax arises under Chapter 8 of Part 5 (income not otherwise charged) in respect of income arising from the commercial occupation of woodlands in the UK.
“(2) For this purpose the occupation of woodlands is commercial if the woodlands are managed:
(a) on a commercial basis, and
(b) with a view to the realisation of profits.”
HMRC’s Business Income Manual at BIM67701 provides similar guidance.
However, in the absence of any specific HMRC guidance on the sale of WCUs, opinion is divided as to the tax treatment, and sellers may take a more cautious approach on the basis that this is a separate contract relating to the offsetting units.
Sellers may therefore provide for tax liabilities in the financial projections relating to the proposal. The first government auction of units was in early 2020, so any position adopted by HMRC may not yet have been tested in tribunal.
The government’s WCaG scheme does, however, provide relevant but non-binding comments. The advice and guidance for customers applying for WCaG implies that the s768, ITTOIA 2005 exemption is available on the sale of the carbon credits covered by that scheme (see tinyurl.com/TX-WoodCarbGuide). Similar guidance can be found in a Forestry Commission document, Creating a new woodland: woodland carbon guarantee (see tinyurl.com/TX-ForestComm).
However, how certain can tax professionals be that the carbon credits fall within the exemption for woodlands? Full disclosure in the tax return of the treatment adopted may well be the best course of action to take.
VAT on the sale of carbon credits
The sale of voluntary carbon credits, such as the WCaG, is not currently chargeable to VAT. For VAT purposes, a distinction is drawn between compliance market credits, which are subject to VAT at the standard rate, and non-compliance market credits, which are outside the scope of VAT.
Carbon credits on the voluntary market, such as those explored here, are known as verified emission reductions (VERs). These are seen as promises that carbon has been or may be reduced somewhere in the world. While purchasing a VER may benefit the reputation of a business, no particular service is being provided to an identifiable consumer, nor is there a benefit that can be identified as a cost component of the business. There is therefore no consumption, and VERs fall outside the scope of VAT.
As stated in HMRC’s VAT Supply and Consideration manual at VATSC06584: “The mere fact that something is or may be done in exchange for a payment is insufficient to bring such a transaction within the VAT system. The public at large cannot constitute a specific recipient of the kind which must exist in order to give rise to a transaction chargeable to VAT.”
Author bio
Julie Butler FCA, Founding Director, Butler & Co