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VAT changes ahead for voluntary carbon credits

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From 1 September 2024, voluntary carbon credits (non-compliance market credits) will be subject to VAT at the standard rate.

18th Jun 2024
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HMRC has revised the existing guidance around voluntary carbon credits, bringing them into the scope of VAT.

A carbon credit is a tradable instrument issued by an independently verified carbon-crediting programme. It represents a reduction or removal of one metric tonne of carbon dioxide, or an equivalent amount of greenhouse gases from the atmosphere measured by reference to a baseline scenario. Voluntary carbon credits are any carbon credits that are not compliance market credits.

Carbon credits allow organisations to offset their carbon emissions by investing in projects that reduce greenhouse gases elsewhere. These projects might involve reforestation, renewable energy or energy efficiency improvements. Credits are certified by recognised standards to ensure their legitimacy and companies can buy and sell these credits on the carbon market. By doing so, they contribute to global emission reduction efforts.

Governments set an overall limit/cap on the amount of emissions allowed from various industries (energy, automotive and so on). Permits are issued up to this limit. If a company reduces its carbon emissions, it can trade the permits it does not need on the carbon market for cash or if the business cannot meet its carbon obligations, it has to purchase additional permits/credits from the carbon market.

Current VAT position

HMRC manuals VATSCO6584 defines “compliance market credits” as being a supply of services subject to the standard rate of VAT although certain carbon credits fall under the domestic reverse charge rules due to excessive missing trader fraud in the sector. So it is important to differentiate between what type of compliance market credit is being traded.

However, non-compliance market credits are currently outside the scope of VAT.

Compliance market credits are standard rated or reverse charge because the business must consume these credits if it is to legally operate without environmental penalties being incurred. HMRC sees these carbon credits as consumables and therefore a service and usual place of supply of services rules are in play and they are also subject to the domestic reverse charge rules.

Non-compliance market credits (voluntary carbon credits) are a promise and do not directly relate to the taxable activities of the business as these credits are often in addition to the compliance market credits the business already possesses.

There was no particular market for trading these voluntary credits and HMRC could not see how they could be incorporated into an onward supply made by the business, so it took a view that these voluntary credits were not for a supply of anything and therefore outside the scope of VAT.

However, HMRC’s view has changed because of evidence that businesses are regularly onward trading in these voluntary carbon credits and secondary market trading, which has prompted the revision of the existing guidance.

Changes on the way

From 1 September 2024, voluntary carbon credits (non-compliance market credits) will be subject to VAT at the standard rate and subject to the same domestic reverse charge rules where applicable.

There is a short list of exceptions where voluntary carbon credits will remain as outside the scope of VAT:

  • the first issue of a voluntary carbon credit by a public body 
  • the holding of voluntary carbon credits as an investment, where there is no economic activity
  • donations made to voluntary carbon credit projects
  • sales of voluntary carbon credits from self assessed projects with no independent or third-party verification.

A fairly logical change, removing the differentiation between the two different kinds of carbon credits, in theory making things much simpler going forwards. If this is a sector you operate in, it is worth reading all of the HMRC internal manuals on this subject and also the Public notice 735 relating to reverse charge transactions and when reverse charge is triggered.

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