Isra-Mart srl: Tax and fiscal incentives for environmentally friendly behaviour in the UK

There are various fiscal incentives in the UK to encourage environmentally friendly behaviour. This article summarises the main regimes.

Climate Change Levy

Introduced in 2001, the CCL is a tax on energy suppliers – when supplying to business. The tax applies to "taxable supplies" of "taxable commodities" unless excluded.

Broadly speaking, a "taxable supply" is:

1. a supply of electricity by an electricity utility or from a partially exempt combined heat and power station
2. a supply of gas made by a gas utility
3. a supply of any other taxable commodity in the course or furtherance of a business.

A taxable commodity includes:

1. electricity
2. gas (of a kind supplied by a gas utility)
3. petroleum gas/gaseous hydrocarbon in liquid state
4. coal; and
5. coke

but excluding hydrocarbon oil or road fuel gas.

Certain taxable supplies are however excluded from the levy. Most notably these include:

1. supplies for domestic use or charity use
2. supplies for export
3. certain supplies used in transport
4. supplies to combined heat and power stations*
5. electricity from renewable sources
6. electricity produced in combined heat and power stations*

* subject to the application of the changes to be introduced as part of the carbon floor. (see below)

Levy exemption certificates (LECs) are issued to providers of exempt electricity (notably from combined heat and power stations and from renewable sources). These are required evidence by electricity suppliers to supply exempt electricity to end users.

Combined Heat and Power Station ("CHPs") are seen as environmentally friendly as they use the heat generated through electricity production – which would otherwise be wasted. Good Quality CHPs ("GQCHPs") therefore benefit from a number of the tax breaks and incentives, As well as the above CCL exemptions (but see below in respect of the carbon price floor), ECAs are available on eligible expenditure on GQCHPs, they benefit from business rates exemptions, as well as ROC benefits.

Certain sector associations have entered into agreements "(Climate Change Agreements"/"CCAs") with the secretary of State for Energy and Climate Change committing their members with energy intensive installations and facilities to targets in respect of energy efficiency and CO2 emissions. In return the members obtain a reduced CCL rate (currently 65% but increasing to 80% in April 2013). HMRC have power to recover CCL where an installation fails to meet the agreed targets.

In the 2011 Budget it was announced that a carbon price floor would be introduced through reform of CCL and fuel duty. The carbon price floor will start at around £16 per tonne of CO2 and increase to £30 per tonne by 2020. The effect of this should be:

* fossil fuels used in electricity generation will be taxed under the CCL and fuel duty
* supplies of fossil fuels used in electricity generation will be liable to CCL other than oils which will be liable to fuel duty
* supplies will be charged at the relevant carbon price support rate
* for fossil fuels liable to CCL the carbon price support rate will be different from the main CCL rates

The carbon price support rate will equal the target carbon price less the market carbon price multipied by the emissions factor. The market rate is determined using futures prices for the carbon price averaged over a 12 month period.

Enhanced Capital Allowances ("ECAs")

In the UK, trading profits are generally calculated in accordance with accounting profits. There are, however, exceptions to this. One of which is that there is no deduction for capital expenditure. Instead, certain items, notably plant and machinery, are subject to capital allowances.

For certain types of environmentally friendly equipment, enhanced capital allowances are available whereby 100% of the capital cost of the equipment is deductible in the accounting period in which it is incurred.

The types of plant and machinery which are qualifying technology are:

* Energy-saving plant and machinery (as specified in the "Energy Technology Product List and the "Energy Technology Criteria List")
* Environmentally beneficial plant and machinery (broadly, water-efficient equipment)
* Cars with low carbon dioxide emissions
* Natural gas, biogas and hydrogen refuelling equipment

Tax credits are available for companies with losses arising from ECAs in energy saving and environmentally beneficial plant and machinery at up to 19% of the surrendered loss (subject to a cap of £250k or if less PAYE/NIC payable by the company).

On 31 May 2011 HMRC published a consultation document in which it was proposed not only to exclude expenditure on plant and machinery that could qualify for FITs or RHI tariffs from ECAs, but to apply lower ("special") rate capital allowances on such expenditure such that they are depreciated for tax purposes at 8% per annum (rather than the normal rate of 18%).

CRC Efficiency Scheme

The Carbon Reduction Commitment (CRC), renamed the CRC Energy Efficiency Scheme in April 2010, is a mandatory scheme designed to improve energy efficiency and cut carbon dioxide emissions in large public and private sector organisations.

The CRC aims to significantly reduce UK carbon emissions not covered by other pieces of legislation by covering all organisations using more than 6,000MWh per year of electricity (roughly equivalent to an annual electricity bill of £500,000).

The scheme combines financial and reputational incentives to encourage organisations to develop energy management strategies which promote a better understanding of energy usage. In October 2010, the government announced a number of changes to the scheme, which comprises three main elements:

1. Reporting

Participants are under an obligation to follow a specific set of rules to measure and report their carbon emissions.

2. Pricing

From 2012, participants will be able to buy allowances from the government every year to cover their emissions in the previous year. The 2011 Budget set the price of allowances at £12 per tonne of carbon dioxide. Organisations that decrease their emissions will therefore have lower costs under the CRC.

3. Annual Performance League Table

The scheme includes an annual league table that ranks participants based on their energy efficiency performance. The table is publicly available and will show how each participant is performing compared to others in the scheme. Organisations that are doing well and rank highly in the league table may benefit from a significant boost to their reputation.

Carbon Trading

Carbon trading is a form of emissions trading that targets carbon dioxide. This form of trading is often used by countries in order to meet their obligations under the 1997 Kyoto Protocol on climate change.

Under Kyoto, 37 industrialised countries and the EC (the Annex B countries) have committed themselves to reducing their greenhouse gas (GHG) emissions during the period 2008 to 2012.

In order to meet their targets, Annex B countries have three options. They can reduce emissions from existing emission sources, invest in new "cleaner" technologies or acquire emissions reductions achieved elsewhere or by others through one or more of the following mechanisms:

1. The clean development mechanism (CDM) and/or joint implementation (JI)

Annex B countries can invest in projects that will reduce carbon emissions in developing countries (CDM) and/or fund projects which will reduce carbon emissions in other industrialised countries (JI) in exchange for tradeable credits. The units generated can be used by Annex B countries in meeting their own targets.

2. International emissions trading

Annex B countries can acquire 'spare emissions capacity' from other Annex B countries. An example of such an initiative is the EU Emissions Trading Scheme. Under this scheme, big carbon emitters within member states are allocated permits by the government to emit a certain amount of carbon dioxide in the course of their operations. Emitters that manage to cut emissions to below their target and have permits left over can sell those permits to other companies who may be emitting too much - and can do so at a profit. There is, therefore, a financial incentive to cut emissions as well as a penalty for failing to do so.

Renewables Obligation

The Renewables Obligation (RO) places an obligation on all UK licensed electricity suppliers to produce evidence that they have sourced specified amounts of electricity from renewable sources.

The RO is regulated by the Office of Gas and Electricity Markets (Ofgem). Generators of electricity from renewable sources are awarded a Renewable Obligation Certificate (ROC). These can be sold to suppliers with the electricity that they buy and/or traded independently. ROCs may also be issued directly to electricity suppliers in certain situations and are tradeable subject to procedural rules. This means that suppliers may also be able to purchase ROCs from other electricity suppliers if they have not already met their targets.

Suppliers meet their obligations by presenting a sufficient number of ROCs to Ofgem, by paying a penalty known as the "buy-out price" or by a combination of the two.

Renewable Heat Incentive

The Renewable Heat Incentive (RHI) and the Feed-In Tariff (FIT) are government-backed measures aimed at encouraging the production of renewable heat and electricity in the UK.

The idea behind the RHI is to provide a financial incentive to install renewable heating instead of fossil fuels and revolutionise the way that heat is generated and used in buildings and homes. In October 2010, the government announced £860 million of new support over the spending review period to support renewable heat measures.

The government intends to introduce the scheme in two phases. The first phase will:

* target big emitters in the non-domestic sector with long-term tariff support; and
* provide support of around £15 million to households who install renewable heat through the Renewable Heat Premium Payments

The second phase, which will be introduced in 2012, will provide long-term tariff support to the domestic sector.

The Feed-In Tariff

The feed in tariffs ("FIT"s) have been introduced to help increase the level of renewable energy in the UK. The FITs incentivise small scale (less than 5MW), low carbon electricity generation.

The FITs are based on the electricity generated by a renewable energy system which is used in a property. An additional payment is due for any energy produced which is then exported to the electricity grid, providing a greater incentive to be energy efficient. The aim is to make it more straight-forward and cost effective for individuals, households, communities and businesses operating outside of the electricity market to buy the required units.

The financial benefit of participating in the scheme is threefold. It includes:

1. a generation tariff payment, which is based on the total electricity generated and the energy type;
2. an export tariff payment, which is for any energy exports made when generating more than is used;
3. lower bills from suppliers for the electricity that is imported from them

With effect from 1 August 2011 the FITs for large scale solar PV installations have been significantly lowered making such projects considerably less attractive for investors.

Other tax incentives/measures

There are various other incentives designed to encourage environmentally friendly behaviour.

A number of these are aimed at homes. Specifically under the Landlords Energy Savings Allowance landlords can apply for relief on capital expenditure on insulation and draft-proofing. There is also a reduced VAT rate of 5% on the installation of certain energy-saving products and materials in residential properties.

Further incentives are aimed at employment. For example, the company car rules have been modified over the years to encourage the use of low emission vehicles. Also, there is a tax exemption for providing bicycles to employees to cycle to work.

The aggregates levy is a tax aimed at reducing commercial quarrying activities (and associated environmental damage). It is charged on extraction of sand, gravel or rock for commercial exploitation. It is charged at a basic rate of £2 per tonne.

Landfill tax is aimed at reducing waste and is payable on waste disposal at licensed landfill sites.