Carbon credits sales subject to UK VAT from September 2024

One tax expert said the change should prompt businesses involved in the initial creation, subsequent sale, or purchase of carbon credits to carefully review their commercial contracts.

Voluntary carbon credits provide greenhouse gas emission allowances that businesses can buy in order to offset their emissions beyond what is required by regulation. Voluntary carbon markets in which carbon credits can be purchased have been developed globally – they are provided for under international climate accords, including under Article 6 of the 2015 Paris Agreement that was formally adopted following COP26.

The voluntary carbon credit market exists separately from the UK's specific emissions trading scheme (ETS) that provides for the auctioning off of carbon credits. Like in other jurisdictions, the number of allowances being auctioned off under the UK ETS will reduce over time as the UK moves towards its 2050 ‘net zero’ emissions target.

The development of secondary trading markets and the use of voluntary carbon credits in supplies of goods and service has meant that  HMRC has now changed its VAT policy.

HMRC said: “Voluntary carbon credits are currently treated as outside the scope of UK VAT. This is because when they were first introduced, HMRC’s view was that they could not be incorporated into an onward supply and there was no evidence of a secondary market.”

“When [voluntary carbon credits] were first introduced, HMRC’s view was that they could not be incorporated into an onward supply and there was no evidence of a secondary market. HMRC recognises that there have been significant changes in the voluntary carbon credit market, including the emergence of secondary market trading and businesses incorporating voluntary carbon credits into their onward supplies. Because of this, from 1 September 2024, the sale of these carbon credits must be treated as taxable for VAT where the place of supply is in the UK,” it said.

HMRC said the standard VAT rate – currently 20% – will typically be levied on the sales, although it highlighted examples of where VAT will not be charged and where VAT relief could also be claimed.

The activities that will not be subject to VAT are: the first issue of a voluntary carbon credit by a public authority; the holding of voluntary carbon credits as an investment, where there is no economic activity; donations made to voluntary carbon credit projects; and sales of voluntary carbon credits from self-assessed projects with no independent or third-party verification, HMRC said.

The updated guidance will take effect from 1 September 2024. It will apply to transactions involving voluntary carbon credits on or after that date.

“Carbon credits have historically benefited from a slightly anomalous VAT treatment as a service which was treated as being outside the scope of VAT,” said tax expert Bryn Reynolds of Pinsent Masons. “Making these credits subject to VAT is a substantial change in HMRC policy. Anyone involved in the initial creation, subsequent sale, or purchase of these credits will want to review their commercial contracts carefully to ensure the change in VAT treatment is adequately addressed. Otherwise, there may be significant unintended financial consequences. This should also include reviewing whether the reverse charge is being properly applied on purchases of voluntary carbon credits from overseas suppliers.”