VAT – Reverse charge for Emissions Allowances

Hartley Foster, Tax Partner, Olswang

The Emissions Allowance system in the EU

In January 2005, the European Union’s Greenhouse Gas Emission Trading System (“ETS”) commenced operation. ETS works on a ‘cap and trade’ basis. Under ETS each EU Member State is allocated a CO2 allowance for each year and the Member State then divides that allowance between all installations that are covered by the scheme and that are operating within its jurisdiction. That allocation to an installation of what the Member State considers is the appropriate number of one-tonne emission allowances (“EAs”) operates as a cap on that installation’s CO2 emissions. If an installation exceeds its cap, it faces a substantial financial penalty. Companies which reduce their actual emissions to a level below their allocated EA limit can either sell their surplus EAs or ‘bank’ them for future use. Once in issue, EAs have a market value; they can be traded between buyers and sellers either on a spot or on a forward basis. Transfers of EAs between taxable persons are treated as a supply of services for VAT purposes.

MTIC fraud

The high value of EAs, and the fact that they can be easily traded in (lightly regulated) specialised markets, made the carbon trade market susceptible to Missing Trader Intra-Community (MTIC) fraud. Between July to September 2009, carbon traders noticed surges in trading volumes on the markets that they considered could be attributed only to fraud. As a result, the governments in the three countries with the main carbon exchanges acted quickly to try to prevent further fraudulent trading.

However, each government adopted a different measure. The Dutch Government introduced the reverse charge mechanism; the French Government removed the application of VAT from carbon markets; and the UK Government made carbon trading zero-rated (see HMRC Brief 46/09) and raided 27 businesses and private addresses in relation to a suspected £38 million VAT fraud on EAs.

The approach by the European Commission

On 29 September 2009, the Commission produced a proposal on temporary measures for a consistent response to carousel fraud (the Proposal). Laszlo Kovacs, Commissioner for Taxation and Customs, noted that it was important that Member States be able to take rapid action against MTIC fraud but added that ‘actions taken against this fraud should be taken in a consistent manner across the EU’.

The proposal by the Commission is to amend the VAT Directive to enable Member States to introduce the reverse charge mechanism for certain categories of goods and services. These categories are: mobile telephones, computer chips, perfume, precious metals and EAs. If the proposal is implemented it will apply until 31 December 2014.

Finance Bill 2010

The UK will follow the Commission’s lead: legislation in Finance Bill 2010 will introduce the reverse charge mechanism for supplies of EAs from 1 November 2010. The effect of this will be that a VAT registered business purchasing allowances will account for and pay the VAT chargeable instead of the supplier. This will replace zero-rating (which had been introduced in July 2009).

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