Australian tax implications of carbon farming and trading

With the transition towards Net Zero in full swing, many taxpayers are necessarily turning their minds to the Australian tax implications of relevant activities such as carbon farming and carbon trading. 

The purpose of this Tax Insight is to assist taxpayers by providing a high-level summary of relevant provisions and their practical operation. 

BIFURCATED APPROACH

The Australian income tax implications of farming or trading in carbon units depends on whether the relevant carbon units constitute ‘registered emissions units’ (REU¹) . In summary, the Australian income tax implications of REUs is governed by Division 420 of the ITAA 1997, whereas the Australian income tax implications of all other carbon units must be determined by reference to the ordinary assessment and deduction provisions.

The Australian GST implications of farming or trading in carbon units is similarly bifurcated. Whilst the GST treatment under the A New Tax System (Goods and Services Tax) Act 1999 (“GSTA”) turns on whether a carbon unit is an ‘eligible emissions unit’ (EEU), the definitions of EEU and REU align².

REUs

Division 420

As noted above, Division 420 of the ITAA 1997 applies to REUs³ , which are legislatively defined as any of the following for which there is an entry in a Registry account pursuant to the Australian National Registry of Emissions Units Act 2011⁴:

• Kyoto units;
• Australian carbon credit units⁵ ; and
• Safeguard mechanism credit units.

The principal operative feature of Division 420 is the ‘rolling balance’ treatment of REUs, which is not dissimilar to Australia’s trading stock provisions⁶ . Specific aspects of this ‘rolling balance’ operative feature include:

• The cost of an REU being deductible at acquisition⁷ , subject to specific provisions that reverse such deductions where a taxpayer ceases to hold an REU, and that cessation is unrelated to gaining assessable income.
• Proceeds from the disposal of REUs constituting assessable income⁸ , with the following sub-features:
  • Deeming of Australian source⁹ ; and
  • Market value substitution rule for non-arm’s length dealings and dealings with associates¹⁰.
• The requirement for taxpayers to bring to account for income tax purposes any difference between the value of REUs held at the start and end of the income year¹¹. Specifically:
  • any excess of the value at the end of the income year over the start of the income year is included in the taxpayer’s assessable income;
  • any excess of the value at the start of the income year over the value at the end of the income year is deductible; and
  • three valuation methods are available to taxpayers¹² :
    • the FIFO cost method;
    • the actual cost method; and
    • the market value method.

There are also specific provisions dealing with incoming international transfers or carbon unit and outgoing international transfers of REUs.

Following enactment of the Treasury Laws Amendment (2023 Measures No. 2) Bill 2023, with effect from 1 July 2022, eligible individual primary producers may be able to treat the net proceeds from the sale of Australian carbon credit units (a subset of REUs) as primary production income. Eligible individual primary producers will also not be taxed on changes in the value of their Australian carbon credit units each year.

GSTA

Per Subdivision 38-S of the GSTA, EEUs are GST-free, which means GST does not apply to any sale thereof, but that input tax credits may still be claimed for the price of purchases used in connection with the sale.

NON-REUs

Income Tax

The Australian income tax treatment of carbon units other than REUs (“Non-REUs”) falls outside of Division 420. Popular examples of such carbon units include Gold Standard Verified Emission Reduction Units and Verra Verified Carbon Units.

The specific Australian income tax implications will vary depending on the relevant taxpayer’s purpose in acquiring the Non-REU. Relevant considerations in this regard include whether the Non-REU is held on capital or revenue account and, if the latter, whether the Non-REU constitutes ‘trading stock’, in which case any income tax deduction for the cost of acquisition will effectively be deferred until the time of disposal.

To the extent a Non-REU is not held for a private or domestic purpose, or for the purposes of manufacture, sale or exchange in the ordinary course of a business (e.g., to voluntarily surrender for carbon offsetting purposes), having regard to seminal case law such as Magna Alloys & Research v FC of T 80 ATC 4542, the cost of acquisition should generally be immediately deductible under section 8-1 of the ITAA 1997 owing to the nexus to the production of assessable income. This has been expressly recognised by the Commissioner in recent private binding rulings¹³.

GSTA

Non-REUs are not covered by Subdivision 38-S of the GSTA and, accordingly, the supply of a Non-REU will generally attract GST. This includes the acquisition of a Non-REU from an entity outside Australia if the supply is connected with Australia. Supplies of Non-REUs to entities outside of Australia will generally be GST-free.

OTHER AUSTRALIAN TAX CONSIDERATIONS

There are various other Australian tax considerations to which taxpayers involved in carbon farming or carbon trading must have regard. 

Examples include:

• The Australian income tax treatment of project costs referable to carbon farming or sequestration, noting that at least for Australian carbon credit units, such costs are generally not dealt with by Division 420 (except the costs of applying for a certificate of entitlement or offsets report) ;
• Land tax, noting that that the potentially availability of an exemption for land being used for primary production purposes may vary across states and territories ; and
• Stamp duty, noting that the stamp duty position for carbon units is largely untested and currently only Revenue NSW has issued any specific guidance (Revenue Ruling DUT 043) to confirm that the transfer of carbon units is not dutiable.

For more information

RSM Australia has significant expertise with respect to the Australian tax implications of carbon farming and carbon trading. Please contact your local RSM advisor for further information. 

¹Income Tax Assessment Act 1997 (ITAA 1997), section 420-1.

²GSTA, section 195-1.

³Excluding derivatives. , which may BE subject to the TOFA provisions contained in Division 230 of the ITAA 1997.

⁴ITAA 1997, section 420-10.

⁵As defined by the Carbon Credits (Carbon Farming Initiative Act) 2011.

⁶ITAA 1997, Part 2-25.

⁷ITAA 1997, section 420-15.

⁸ITAA 1997, section 420-25.

⁹ITAA 1997, subsection 420-25(3).

¹⁰ITAA 1997, section 420-30.

¹¹ITAA 1997, Subdivision 420-D.

¹²The taxpayer makes a choice for the first income year where it holds REUs at the end of the income year. In the absence of such a choice, the default valuation method is the FIFO cost method. Taxpayers may change their valuation method at any time after they have used a particular method for the four most recent income years they held REUs at the end of the income year, although no direct change from the FIFO cost method to the actual cost method is permitted for integrity reasons.

¹³See, for example, PBR 1052056725429.