Abstract
Currently, carbon offset credits are gaining momentum in the voluntary and compliance markets. Many investors, private companies, or public entities look at them as a way to implement or supplement their decarbonization strategies. These tools are easily available to utilize for meeting the declared sustainability goals by compensating carbon emissions that are impossible or just hard to mitigate. At the same time, they can serve to comply with the regime of nationally determined contributions according to the Paris Agreement. However, they often pose challenges from a public and private perspective, both in a domestic or multinational scenario. There is a blatant lack of legal certainty concerning their treatment for tax purposes. This affects the agents involved in the different processes of the carbon offset credits’ lifecycle (their generation, trade, and use). The growing nature of this problematic situation simultaneously derives from qualitative and quantitative factors. A greater dose of international cooperation among the stakeholders is needed to provide balanced solutions between public and private interests. Special attention should be paid to the developing and developed countries’ positions. The following pages describe the state of the art and explain what the main concerns are with regard to the application of these credits in the framework of the existing tax systems. In many cases, carbon taxes are not mature enough, or their interaction with other economic instruments is not well defined. The innovative work of the United Nations Subcommittee on Environmental Taxation in this regard is reviewed. In an attempt to sort out the observed obstacles due to the configuration and features of the schemes up to date, some alternative proposals are mentioned. Final remarks stress that future regulations should not only facilitate but ensure a global positive environmental impact on society in line with the UN 2030 Agenda. Public finances, particularly, tax legislators and authorities have a decisive role to play in this uncharted area.
Principal Investigator of AudIT-S project (PID2019-105959RB-I00) https://www.ucm.es/proyecto-audit-s/.
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Notes
- 1.
Also named “voluntary carbon offsets (VCOs)” that allow a business to create a net reduction in GHG emissions by funding atmospheric carbon reduction actions of another party. White (2022).
- 2.
There are different types of double counting, i.e., for credit, finance, and reporting. Authorization by a government should not be required unless the credit was to be counted towards Nationally Determined Contributions (NDCs).
- 3.
Colombia considers carbon credits as intangible property under a form of a right to offset or reduce the purchaser’s carbon footprint for exchange of a price (Estatuto Tributario Nacional, Article 420) and therefore regards them as a supply of services. Through tax ruling 13505 from 2017, these intangible assets represent a right for one tonne of CO2 removal or reduction which is transferable for exchange of a price. Australia defines carbon credits as financial instruments in the Corporations Act 2001. The potential categorization of a carbon credit as a set of contractual rights to benefit from the verification process is considered and suggested by the ISDA in its paper on the legal implications of voluntary carbon credits (https://www.isda.org/a/38ngE/Legal-Implications-of-Voluntary-Carbon-Credits.pdf). Salway et al. (2022).
- 4.
Companies would have to get authorization by the government to sell or trade those credits because it has a direct impact on the NDC. Article 6.2 on bilateral actions contains guidelines covering internationally transferred mitigation outcomes that must be reported and recorded in registries. Article 6.4 establishes a multilateral mechanism with a supervisory board to approve projects adjusted to the circumstances. Article 6.8 addresses non-market international cooperation among governments.
- 5.
“Companies that have announced climate targets (for instance: becoming ‘net zero’ by 2050) represent a market capitalization of over $20 trillion. Almost all of them will rely on carbon offsets purchased on the voluntary carbon market (VCM) to reach their target.” Battocletti et al. (2023).
- 6.
Michaelowa et al. (2019).
- 7.
In the United States, the cost of carbon credits may be currently deductible under Section 162 of the Internal Revenue Code if it can be shown that the cost of voluntary carbon offsets is a taxpayer’s current ordinary and necessary expense. However, if they provide a long-term benefit, under Section 263 of the Internal Revenue Code and the regulations, the cost may be capitalizable. Some companies obtain them by funding projects undertaken by a not-for-profit entity. Payments made to entities related to such projects can generally be treated as a charitable contribution to not-for-profit organizations.
- 8.
The best solution for carbon offsets must still be sought irrespective of whether they are linked to an immovable or a movable project or intangibles. A thorough discussion on the qualification of the income is crucial. Coverage might be provided by Articles 7 and 9 of the model treaties although, for the kind of credits linked to change of land use or nature-based solutions, this qualification may not be evident. Setting a different system may entail a risk of lowering investments in that country.
- 9.
Sometimes the word “offset” is understood as what is obtained when employing a carbon credit towards reducing its overall carbon price (by offsetting its carbon footprint or by offsetting the carbon tax liability).
- 10.
For the Voluntary Carbon Markets Integrity initiative, the Science Based Targets initiative and Climate Impact X. See respectively https://vcmintegrity.org https://sciencebasedtargets.org https://www.climateimpactx.com.
- 11.
Pizarro (2021), p. 70.
- 12.
“Section 12K of the Income Tax Act is an incentive available for any person holding a CDM [Clean Development Mechanism] project registration while that person implements the project. Essentially, amounts received or accrued upon disposal of these CERs [Certified Emission Reductions] are exempt from normal tax and capital gains tax purposes”. Steenkamp, L.A. 2017. To incentivise or penalise: an analysis of the proposed carbon tax in South Africa, in Weishaar et al. (2017), p. 51. “Under the carbon tax policy framework, firms will be able to reduce their carbon tax liability by using offset credits up to a maximum of 5 or 10 per cent of their GHG emissions, depending on the time of emissions”. Machingambi (2017), p. 69.
- 13.
“[T]he Canadian federal carbon tax and its various provincial surrogates would do well to consider the benefits of the South African offset allowance”. Gilder and Stiles (2019), pp. 270–279.
- 14.
Unofficial translation. Agreement No.17/2022 for a Regulation of projects for the reduction of pollutant emissions to offset taxed emissions in accordance with the provisions of article 8 of Act 20,780.
- 15.
“If offset buyers were interested in purchasing only offsets that correspond to true reductions of CO2, then reputational sanctions might prevent market players from inflating offsets. But most of the demand of the VCM comes from corporations that have all the interest in purchasing cheap and inflated offsets. Cheap and inflated offsets allow corporations to reach their climate target at a lower cost. And, given that their end-consumers are unable to assess the quality of the offsets they purchase, the expected reputational sanctions that corporations face for relying on inflated offsets are extremely low. Further, carbon offsets certified by the leading standard setters increasingly provide regulatory benefits”. Cf. Battocletti et al. (2023).
- 16.
“Instead, we argue that any attempt to improve the functioning of the VCM should simultaneously achieve three things: i) increase the transparency of the market, ii) provide agents that possess the relevant information with the necessary and sufficient incentives to identify low-quality offsets, and iii) strengthen reputational sanctions for inaccurate certifications”. Cf. Battocletti et al. (2023).
- 17.
The framework bilateral agreement “establishes the conditions and rules for both the cooperation between the countries and the activities that will result in the transfer of mitigation outcomes, e.g., ITMOs (Internationally Transferred Mitigation Outcomes). Such an agreement thereby confirms the host country’s willingness to make a so-called corresponding adjustment when the mitigation outcomes are transferred to Sweden.” https://www.energimyndigheten.se/en/cooperation/swedens-program-for-international-climate-initiatives/paris-agreement/bilateral-climate-agreements/.
- 18.
For example, as stated in Chile: Article 2. e. “Offset of emissions: act by which emissions reductions that are included in an emissions reduction certificate issued by the Ministry of the Environment, in accordance with the respective regulation, are discounted from the emissions taxed with the tax established in Article 8 of the Law”. The Ministry of the Environment Regulation establishes the obligations and procedures related to the identification of the taxpayers affected and that establishes the administrative procedures necessary for the application of the tax levied on emissions into the air of particulate matter, nitrogen oxides, sulfur dioxide, and carbon dioxide as provided in Article 8 of Law No. 20,780, as amended by Law No. 21,210. No. 63.- Santiago, November 2, 2022. Official Journal of the Republic of Chile, No. 43,465, January 31, 2023.
- 19.
White (2022), pp. 18–24.
- 20.
For an extended explanation in Spanish, Grau Ruiz (2022) https://revistatecnicatributaria.com/index.php/rtt/article/view/2308/4777.
- 21.
Porsborg-Smith et al. (2023). There is an ongoing debate on whether a double claim may be appropriate, however, i.e., once against a host country’s Nationally Determined Contribution (NDC) and once by a company in the private sector using a voluntary credit to compensate their GHG emissions. If credits are to be used once, it should be used either by the private company to offset its emissions or by the host country as a tool to meet its NDCs. A counterargument to this is that forbidding host countries to use credits produced in their territory and used by private companies as offsets would slow down the deployment of carbon projects.
- 22.
“Clearer demand signals would help give suppliers more confidence in their project plans and encourage investors and lenders to provide with financing” Blaufelder et al. (2021).
- 23.
A new analysis of large-scale forest protection schemes in the Colombian Amazon by Carbon Market Watch claims that they may be dramatically overstating their impact on preventing deforestation. The report warns that millions of carbon credits have likely been generated with no benefit to the climate. https://carbonmarketwatch.org/publications/two-shades-of-green-how-hot-air-forest-credits-are-being-used-to-avoid-carbon-taxes-in-colombia/.
- 24.
There are a number of “add-on” certification schemes focused on the social and environmental impacts of carbon offset projects. The certifiers can be organizations like the Climate, Community & Biodiversity Alliance (CCBA) and SOCIALCARBON, for example. Broekhoff et al. (2019). Available at: https://www.offsetguide.org/wp-content/uploads/2020/03/Carbon-Offset-Guide_3122020.pdf.
- 25.
Committee of Experts on International Cooperation in Tax Matters, Twenty-sixth session New York, 27–30 March 2023 E/C.18/2023/CRP15 - Co-Coordinators’ report https://financing.desa.un.org/document/crp15-environmental-taxation-co-coordinators-report-0 E/C.18/2023/CRP7 - Co-Coordinator’s Report, Annex C https://financing.desa.un.org/document/ec182023crp7 The Report of the 25th Session of the Committee of Experts on International Cooperation in Tax Matters (E/2023/45-E/C.18/2022/5) at para. 52. https://financing.desa.un.org/document/report-25th-session-committee-experts-international-cooperation-tax-matters.
- 26.
Committee of Experts on International Cooperation in Tax Matters, Twenty-sixth session, Geneva, 17–20 October 2023. E/C.18/2023/CRP35 - Co-Coordinators’ report https://financing.desa.un.org/sites/default/files/2023-10/CRP.35%20Environmental%20Co-Coordinators%20Report_1.pdf and CRP.35 Annex D (Carbon Offsets) https://financing.desa.un.org/sites/default/files/2023-10/CRP.35%20Annex%20D%20%28Carbon%20Offsets%29_1.pdf.
- 27.
In preparing his report in response to General Assembly Resolution 77/244, the secretary-general invited written input from Member States and relevant stakeholders on the range of issues addressed in the resolution. Grau Ruiz (2023).
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Grau Ruiz, M.A. (2024). International Fiscal Cooperation to Better Integrate Public and Private Efforts on Sustainability: The Case of Carbon Offset Credits. In: Saraiva, R., Pardal, P.A. (eds) Sustainable Finances and the Law. Economic Analysis of Law in European Legal Scholarship, vol 16. Springer, Cham. https://doi.org/10.1007/978-3-031-49460-4_12
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