On 20 June 2016, the South African National Treasury published, for public comment, the Draft Carbon Offset Regulations (the Draft Regulations) setting out the mechanics according to which carbon offset allowances may be claimed. In this article we provide an overview of the proposals for how the offset allowance will operate and highlight some if its key features.

Introduction

The South African government has committed itself to reducing greenhouse gas (GHG) emissions by 34% by 2020 and 42% by 2025. To this end, the draft Carbon Tax Bill (the Bill) will be the platform for introducing a carbon tax system in South Africa, in which taxpayers will be taxed for their GHG emissions. As part of this system, it is envisaged that taxpayers will be incentivised to engage in energy efficiency projects that qualify for carbon offset allowances. These allowances will reduce their potential carbon tax liability.

On 20 June 2016, the South African National Treasury published, for public comment, the Draft Carbon Offset Regulations (the Draft Regulations) setting out the mechanics according to which carbon offset allowances may be claimed. In this article we provide an overview of the proposals for how the offset allowance will operate and highlight some if its key features.

Overview

The Draft Regulations are similar to carbon pricing schemes used internationally such as the European Union Emissions Trading Scheme (EU ETS) and schemes used in California and the Canadian province of Alberta. It is based on the premise that incentivising taxpayers to engage in energy efficiency, for which they would receive carbon offset credits reducing their carbon tax liability, is a cost-effective mechanism to reduce their GHG emissions.

Carbon offsets are investment in specific projects that reduce, avoid or sequester emissions. The Explanatory Note to the Draft Regulations describe carbon offsets as being external investments that allow a firm to access GHG mitigation options at a lower cost than its investment in current options. In this regard, a stated purpose of the offset system is to create a flexible mechanism that will enable an industry to deliver “least cost mitigation” being GHG mitigation at a lower cost than would otherwise have been achieved through its own operations. It encourages mitigation projects to be undertaken in sectors that are not directly covered by the carbon tax or which benefit from other government incentives, such as the transport, agriculture, forestry and other land use (AFOLU) and waste sectors.

The first benefit for taxpayers with the carbon tax system is that, depending on the sector in which it operates, it will be able to reduce its carbon tax liability up to a maximum of 5% or 10% of its total GHG emissions. Secondly, the system is not an absolute carbon tax but rather a hybrid that combines the carbon tax with emissions trading activities. It is envisaged that project-based emission reduction credits may be traded between market participants through various channels. For example, trading may occur in accordance with the EU ETS through established exchanges or voluntarily through over-the-counter trading and auctions. There is also potential for trading carbon to occur as a commodity on the Johannesburg Stock Exchange which has successfully been active in this regard since March 2015. It is understood that private sector actors have expressed interest in developing a trading platform in South Africa and the National Treasury anticipates that, although these actors will lead this activity, the National Treasury will provide inputs during this process to ensure that an adequate regime is put in place.

Eligibility criteria

South African Projects

International investors should note that, in its initial stage, only projects in South Africa are eligible for offset credits under the carbon offset system envisaged in the Draft Regulations. Accordingly, investment in energy efficiency projects outside South Africa will not be recognised, irrespective of the sector in which they occur.

External Projects

As indicated above, carbon offsets may only be claimed in respect of projects that are outside the scope of the taxpayer’s activities and ordinarily subject to the carbon tax. In other words, projects in sectors that are not directly covered by the carbon tax (such as the transport, AFOLU and waste sectors) may qualify for an offset allowance. The difficulty, however, is how to treat projects that occur across sectors and whether they will qualify for the offset allowance.

Excluded Projects

Offset allowances may not be claimed for projects that benefit from other governmental incentives since this would otherwise result in a double counting of emission benefits and financial incentives for the project. This includes, amongst others, projects registered for the Energy Efficiency Tax Incentive in terms of section 12L of the Income Tax Act, 1962 and the Renewable Energy Independent Power Producers Procurement Programme (REIPPPP). However, the National Treasury recognised that further discussions will be had with the REIPPPP office situated in the Department of Energy in order to discuss whether specific renewable energy projects (such as small and medium-sized renewable energy projects) should qualify. As background, it should be noted that initially the National Treasury took the view that REIPPPP already received government benefits in the form of committed power purchase agreements (PPA) that were supported with cost premiums for renewable energy. However, renewable energy industry groups have expressed the concern that, as REIPPPP is subject to competitive bidding processes, securing a PPA should not be regarded as a benefit. Accordingly, they argue that it would not constitute double benefits if such programmes are recognised for carbon tax allowances.

Measurement standards and timing

For measurement purposes, it expected that the carbon offset scheme will initially rely on existing international carbon offset standards, such as the Clean Development Mechanism (CDM), Verified Carbon Standard (VCS), the Gold Standard (GS) and their associated institutional market infrastructure. However, in time, there is scope for local standards and methodologies to be adopted but these would need to be appropriate and independently verifiable.

The carbon offset scheme envisaged in the Draft Regulations is expected to be implemented by 1 January 2017. Offsets generated after this date will accordingly be fully eligible under the scheme. However, offsets in existence before 1 January 2017 may only be used on the carbon tax scheme until 31 December 2017 while offsets not in existence before 1 January 2017 (but which are generated by projects activities that were registered before this date) may only be used in the carbon tax scheme for six months after the offsets.

Conclusion

The introduction of a carbon tax offset allowance in the Draft Regulations is welcomed for the purpose of establishing an active carbon market in South Africa that is in line with the trend followed internationally. In addition to leading to a surge in the carbon market, it is expected to generate sustainable development benefits and employment opportunities by encouraging investments in energy efficiency and renewable energy projects. A copy of the Draft Regulation may be found here.