Firms Urged To Exploit CO2 Tax Planning Opportunities

by Robert Lee, Tax-News.com, London

23 May 2006

Significant uncertainties and inconsistencies in relation to the tax treatment of emissions trading across the European Union presents companies with tax planning and arbitrage opportunities, according to a report by PricewaterhouseCoopers.

The report, entitled ‘Taxation of Emissions Trading within the EU’, compares the way in which EU Member States handle the taxation of emissions trading.

The report concludes that few European countries have issued definitive guidance on the treatment of CO2 trading for tax purposes, and following the withdrawal of international guidance on accounting for emission rights in June 2005, significant divergence in the approach to both accounting and tax treatment has arisen.

The report also notes differences between countries regarding tax qualification and the tax deductibility of penalties, and divergent treatment of emissions trading for VAT purposes.

In addition, the report states that number of important issues remain to be answered in relation to the tax treatment of clean development mechanism (CDM) and joint implementation (JI) transactions.

Richard Gledhill, leader of climate change services at PricewaterhouseCoopers, noted that the imperfections and inefficiencies in the market will need to be addressed by the European Commission and EU member states.

However, in the meantime, Mr Gledhill observed that these inefficiencies "present tax planning and arbitrage opportunities for companies, particularly those with operations in multiple jurisdictions”.

Marco Lubbelinkhof, European tax leader of climate change services at PricewaterhouseCoopers NV added that penalties are a good example of where inconsistencies exist, explaining that they are tax deductible in Germany and France, but not in the Netherlands and Poland.

"As a result, international groups of companies put their shortages of emission rights in a country with the most favourable tax regime saving on the corporate income tax levied on the penalty. The existing situation therefore offers arbitration opportunities for internationally operating organisations," he observed.

The report also found that the tax treatment of emissions rights varies from country to country. For example, one country may regard the rights as inventory, while in another country they are treated as either current or non-current intangible assets.

This affects the valuation, amortisation and profit recognition of emission rights, which might in turn result in double taxation or no taxation at all. This lack of harmonisation also provides opportunities for countries to distinguish themselves from their peers in emission trading, and some countries apply a special tax regime, according to PwC.

“Hungary is a particular example of this, since so-called pooling entities in this country use a scheme under which they may deduct 50% of the proceeds as costs," continued Mr Lubbelinkhof.

"Furthermore, pooling entities can very well be used for compliance, monitoring and trade activities within a group of companies," he added.

Mr Gledhill concluded that: “The tax treatment of emissions trading is an important issue for companies covered by the EU Emissions Trading Scheme. Companies should not leave this to chance."

"They should be looking now at the potential tax exposures and also the tax planning opportunities, particularly given the recent volatility in the carbon markets.”

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