VAT on Voluntary Carbon Credits

HMRC have issued a Brief stating that they will be implementing a change of policy on 1 September 2024 in respect of the trading of voluntary carbon credits.

There are two types of carbon credit: those issued by the compliance market and the voluntary non-compliance market.

The sale of compliance market credits is already within the scope of VAT. Compliance market credits are issued by government-regulated regimes established as a result of the Kyoto protocol. This includes the UK Emissions Trading System (UKETS) and EU Emissions Trading System (EUETS) which are mandatory for certain businesses: generally those which are the worst polluters. Businesses must ensure they have enough allowances to cover their emissions, and if they have not been allocated sufficient they will need to purchase more credits to avoid penalties. There has long been a secondary market for compliance market credits. As it is necessary for certain businesses to acquire such credits in order to conduct their business, HMRC consider that those credits are capable of consumption and so fall within the scope of VAT.

Compliance market credits are standard rated, however, the domestic reverse charge regime applies to UK and some EU ETS credits. Where applicable, when selling to another VAT-registered business it is the customer who accounts to HMRC for the VAT rather than the supplier.

The change on 1 September 2024 is happening in the voluntary market where the trading of credits has historically been viewed by HMRC as outside the scope of VAT. As a result of changes in the market, on the back of significant growth in the sector in recent years, HMRC now consider that voluntary credits can be incorporated into a business’s onward supply and so fall within the scope of VAT. Going forwards, HMRC’s policy will therefore be to treat the supply of voluntary credits as subject to VAT at the standard rate (20%). Credits which are within the scope of the Terminal Markets Order (i.e. those traded on commodities markets) will qualify for the zero rate of VAT applicable to wholesale commodity transactions.

Voluntary carbon credits are carbon credits that have developed independently of government targets and are any credits which are not compliance market credits. The voluntary market is not, in the main, government regulated although independent verifications have emerged. However, there is no universal standard. Examples include credits issued under the Woodland Carbon Code and the Peatland Carbon Code which are government-regulated but voluntary. The rule changes may well be relevant to landowners who are increasing seeing carbon credits as an alternative to agricultural income. Affected businesses will also want to consider the impact on input VAT recovery.

Not all transactions involving voluntary carbon credits will be subject to VAT. There are exceptions for the first issue by a public authority, holding as an investment, donations and sales from self-assessed projects without third-party verification. The rules are complex and specialist advice should be taken to ensure the correct treatment is applied.