The government provides further details on UK carbon pricing after Brexit.

On 14 July 2020, the UK government published the draft Greenhouse Gas Emissions Trading Scheme Order 2020 (the Order), establishing a framework for the potential UK Emissions Trading System (UK ETS). Subsequently, on 21 July 2020, the government published a consultation on the operation of a potential new carbon emissions tax.

The developments arise as the UK is scheduled to exit the EU Emissions Trading System (EU ETS) at the end of this year, coinciding with the end of the Brexit transition period (31 December 2020). The government aims to ensure a UK carbon price after the expiry of the transition period in all scenarios.

UK Carbon Pricing Options: An Overview

The government has been assessing the UK’s long-term approach to carbon pricing, including whether to:

  • Continue participating in the EU ETS
  • Implement a UK ETS (either linked to the EU ETS, or stand-alone)
  • Implement a carbon emissions tax

The government has indicated its preference to introduce a UK ETS linked to the EU ETS “if it suits both sides’ interests”. However, the potential for the UK ETS to link to the EU ETS is subject to ongoing Brexit negotiations (for further details, see this post). In the event that a linked UK-EU ETS cannot be agreed upon, the government plans to introduce either a stand-alone UK ETS or a new carbon emissions tax. To date, the government has not expressly indicated a preference between a standalone UK ETS and a carbon emissions tax.

Draft Greenhouse Gas Emissions Trading Scheme Order 2020

To enable regulators to prepare for the transition from the EU ETS to the UK ETS at the beginning of 2021, the Order will come into force on the day after it is made, and the Order’s requirements on UK ETS participants will take effect from 1 January 2021. The UK ETS will apply to all of the UK.

The Order divides the UK ETS into phases, with the first phase (or “allocation period”) running from 2021 to 2025. The second phase will run from 2026 to 2030.

Scope

The Order provides that the UK ETS will cover the same greenhouse gases (GHGs) and sectors as the EU ETS. The Order’s scope reflects the government’s previous UK ETS proposals, published 1 June 2020 (for further details, see this post).

Similarly, the Order establishes that the UK ETS will include aviation emissions from UK domestic flights, flights between the UK and Gibraltar, and flights from the UK to the EEA.

The Order provides an opt-out of the UK ETS for hospitals or small emitters.

Allowance cap

The UK ETS’s cap will initially be set 5% below the UK’s notional share of the EU ETS cap for Phase IV of the EU ETS (for further details, see this post). The initial cap will be reduced annually, so that it remains 5% below what the UK’s notional share of the Phase IV EU ETS cap would have been each year.

As set out in an explanatory memorandum to the Order, this will be a temporary cap. The UK’s Committee on Climate Change (CCC) is expected to provide advice on the Sixth Carbon Budget in December 2020, when it will also advise on the appropriate UK ETS cap level in order to achieve the UK’s carbon neutrality goals. The government will consult on the appropriate trajectory of the cap for the remainder of the UK ETS’s first phase within nine months of the CCC’s advice. The memorandum further sets out the government’s aim to align the cap with a net-zero trajectory by 2023 (and no later than January 2024).

The government aims to give UK ETS participants at least one year’s notice of any changes to the UK ETS cap.

Permits

The Order stipulates that UK ETS participants must apply for a GHG emissions permit, as well as surrender allowances, as required by the GHG emissions permit in each scheme year. Each UK ETS scheme year will run from 1 January to 31 December.

In relation to the aviation sector, the Order additionally establishes requirements to apply for an emissions monitoring plan, as well as obligations to monitor and report emissions.

Enforcement and appeals

If a regulated operator contravenes a requirement of the Order (including the monitoring and reporting requirements), a GHG permit, or an emissions monitoring plan, a regulator may issue an enforcement notice setting out how the contravention must be remedied.

Further, a regulator may issue a civil penalty in respect of any breaches. A regulator may use its discretion to issue a civil penalty for certain breaches. However, a regulator is required to issue a civil penalty for other breaches, including: (i) when entities fail to surrender allowances in certain circumstances, (ii) when hospitals and small emitters exceed their emissions target, and (iii) when the reportable emissions of ultra-small emitters exceed the maximum amount. The Order additionally contains provisions governing the appeal process against a regulator’s decisions.

Future legislation

Once the Finance Bill 2020 receives Royal Assent and becomes the Finance Act 2020, the government will enact secondary legislation governing the auction of emissions allowances, as well as mechanisms to support market stability.

Additionally, secondary legislation under the Climate Change Act 2008 will be enacted in November 2020, providing for: (i) the free allocation of UK ETS allowances to sectors at highest risk of carbon leakage (largely mirroring the EU ETS’s policy under Phase IV), and (ii) the UK ETS registry for holding UK ETS allowances.

In the event the government negotiates a linked UK-EU ETS, legislation providing for a linked system is projected to be laid in the first half of 2021.

Carbon Emissions Tax Consultation

The government’s consultation on the potential carbon emissions tax (the Consultation) is open until 29 September 2020. The Consultation discusses the aspects of the carbon tax that have already been legislated, and seeks views on HMRC’s proposals for the operation of the new tax. The government has described the new carbon emissions tax as a “fallback carbon pricing option”.

Legislated aspects of the carbon emissions tax

Scope and liability

The Consultation explains that both “main scheme installations” and “small emitters” under the EU ETS would become a taxable person under the carbon emissions tax. Holders of permits issued under the EU ETS before 2021 would be liable to pay the carbon emissions tax from 2021, if they emit above the tax emission allowance set for their installation. Regulators will make minor amendments to permits to reflect the end of participation in the EU ETS, as well as to highlight the permit holder’s liability to carbon emissions tax (if the tax is introduced).

For those taxable persons, the permit holder would be liable on 31 March each year to pay the carbon emissions tax on each tonne of CO2 above their allowance for the previous calendar year. This rule would apply even if there were a change of permit holder within this period; those taking over a permit should therefore consider their liability for tax on emissions made before the permit was transferred to them.

Determining the level of emissions

To calculate tax liability, HMRC would utilise data from an installation’s annual emissions report. The Consultation states that the utilisation of data that regulators already hold on installations (e.g. names, addresses, and details about their level of emissions) would reduce the administrative burden on businesses by removing the need to submit tax returns.

Aspects yet to be legislated

The Consultation seeks views on the following proposals for the operation of the carbon emissions tax:

  • Tax emission allowances: Installations that would not have been eligible for free allowances under Phase IV of the EU ETS would pay tax on all their emissions (as their tax emission allowance would be zero). The methodology for calculating the tax emission allowances for each applicable installation will be laid out in secondary legislation later this year; however, the Consultation notes that the methodology will be largely the same as that calculating the level of free allocation of allowances under a UK ETS. The government will publish confirmed tax emissions allowances annually in the fall of the relevant tax year, beginning in the fall of 2021.
  • Rate of tax in 2021 and 2022: The government proposes to set the carbon emissions tax rate using EU ETS price data. Additionally, the government proposes adjusting the tax rate downwards if it turns out to be higher than the average EU ETS auction clearing prices in 2021 and 2022 by £1 or more.
  • Payments to reward decarbonisation for main scheme installations: The government proposes to introduce a payment system rewarding any main scheme installations that reduce their emissions beneath their tax emissions allowance, if the reductions result from genuine steps to decarbonise (as opposed to a reduction in activity). The Consultation seeks views specifically on the eligibility criteria for the payments, how to measure the decarbonisation of activities, the verification of data, the payment rate, and the timing of payments.
  • Process: HMRC would send a carbon emissions tax bill to each installation that emitted in excess of its tax emissions allowance over the emissions reporting period in August of each year (starting in 2022). The deadline for payment of the tax would be 30 days from the date the tax bill was issued.
  • Enforcement: HMRC would be responsible for enforcement and compliance with the tax. Regulators would be responsible for enforcement and compliance with emissions and activity level monitoring and reporting. Permit holders would continue to be liable for civil penalties for breaching permit obligations, or for failing to report activity level changes. Permit holders will have the right to request a review from the authorities, and then appeal to the First-tier Tribunal (Tax).

Additionally, the Consultation seeks views on how the tax may evolve in the future, in order to help deliver the UK’s net-zero target. The Consultation suggests potentially broadening the scope of the tax (e.g. to other sectors) after 2021. Additionally, the Consultation seeks views on how the carbon emissions tax might support the emergence of new negative emissions technologies and industries (e.g. direct air capture, bioenergy, or carbon capture and storage).