We will address the taxation of financial transactions involving Carbon Credits and related commodities.
If a market participant is engaged in a trading business, the analysis of the tax consequences of the purchase and sale by it of Carbon Credit instruments would most likely be similar to the analysis of the tax consequences of any other commodity trading activity. The expenditures made to acquire emissions instruments would be treated as cost of goods sold and inventoried accordingly.
The distinction between a company that is a trader and dealer of emission-allowance and emission-reduction commodities and a company that is investing in these instruments for the purposes of complying with environmental regulations may be difficult to make and will depend as always on all of the relevant facts of each case.
A useful hedging instrument for companies requiring Carbon Credits is assimilated to a future commodity. Typically, these will involve a financial institution agreeing notionally to supply a given quantity of Carbon Credits at a future date and at a fixed price in return for the agreement of a Canadian GHG-emitter to notionally supply the same quantity at the same future date, but at the then market price. On settlement, the difference between the two prices is paid by one party to the other. In the above-mentioned hedge, there is no physical delivery but merely a payout based on the value difference of the notional holdings of both parties.
For income tax purposes, the Canadian emitter may be taxed as earning business income, just as is the case with most derivative products. The complex income tax considerations of commodity futures will be treated in a subsequent article.
Recent interest in Carbon Credits as an investment or as a speculative instrument from which profits can be derived has sparked the interest of financial institutions and hedge funds in the carbon market.
Sales tax on Carbon Credits Commodities
In our view, CRA’s administrative policies related to commodities should apply for Carbon Credits Commodities. In summary, no sales tax should apply if the transaction is cash settled on a recognized commodity exchange. However, the sales tax would apply if the underlying commodities, the Carbon Credits, are in fact delivered.
An “option for the future supply of a commodity” includes a right, but not an obligation, to buy or sell a commodity at a specified price within a stipulated future time period. The option buyer pays a premium to the dealer for this right, in addition to the usual commission. The supply of a commodity option where sold on a recognized commodity exchange should be an exempt financial service, thus not subject to sales tax. However, if the option is exercised, because of the taxable status of the Carbon Credits, sales tax should be applicable.
A “futures contract” is an agreement to buy or sell a specific amount of a commodity at a particular price on a stipulated future date. Contrary to a commodity option, a futures contract obligates the buyer to purchase the underlying commodity and the seller to sell it, unless the contract is sold to another before the exercise date. The supply of a futures contract where sold on a recognized commodity exchange is also an exempted financial service not subject to sales tax. However, when the exercise date becomes due, sales tax should be applicable on the taxable supply of the Carbon Credits.
Admittedly there is still a great deal of uncertainty with regard to the tax treatment of the purchase and sale of emission allowances and Carbon Credits although some tendencies seem to be emerging. To date, it seems that current tax principles are being canvassed and compared against specific fact situations in order to derive a logical tax characterization for each transaction and from there to determine the applicable tax consequences.
It is therefore imperative for companies looking to engage in this market to carefully consider the possible tax planning opportunities and risks created by these uncertainties and to monitor the tax developments in this field with the help of a tax professional.