UK scraps carbon VAT to tackle fraud

The UK government has moved to tackle VAT fraud on carbon credits by removing VAT from emission allowances.

The new law, which takes effect from midnight tonight, follows concerns that fraudsters are using carbon trading to steal VAT revenues from the UK. The change will prevent fraudsters from charging and collecting VAT and then not paying it to HM Revenue & Customs (HMRC).

In the UK, where the majority of carbon trading takes place in Europe, any exchange-based trade of carbon credits are already treated with a zero-rate of VAT, but today's move gives a zero-rating of VAT on all over-the-counter (OTC) carbon trades.

The decision follows similar moves in Europe made in an effort to tackle the risk of VAT fraud in carbon trading. This month, the French government also scrapped VAT on the trading of carbon credits, after an unexpected spike in volumes on French carbon exchange BlueNext raised suspicions. A similar spike in volumes at Dutch carbon exchange Climex prompted the Dutch government to reform the way carbon permits would be taxed. A 'Reversed Charge Mechanism' was introduced, whereby the buyer is charged VAT rather than the seller.

But some UK carbon traders are concerned that the decision will have negative side-effects. James Emanuel, commercial director of UK-based carbon trading firm CantorCo2e says the move raises two important issues. "First, zero rating commodities for VAT is something that the EU ordinarily need to sanction... so the French and the UK governments may face a legal challenge," he says.

"Secondly, governments were generating a great deal of revenue through the collection of VAT on the multi-billion Euro carbon market and so, if a small minority of fraudsters ever did exist, the governments have now shot themselves in the foot by turning away the VAT revenue that they have collected to date from the bona fide participants in the market," he adds.

However, Louis Redshaw, head of carbon trading at Barclays Capital says the move is a welcome development. "It takes away the uncertainty that was starting to creep into the carbon markets and it makes carbon trading a much simpler process," he says.

According to Redshaw, the abolition of VAT on carbon credits has a number of benefits. "It makes the offsetting business considerably more competitive, it reduces administration for trading business and most importantly it means any potential for fraud is nipped in the bud early," he says. "We now have to wait for the other member states to follow suit for the market to be tidied up," he adds.

Emanuel favours the Dutch government's decision to introduce a reversed charge mechanism as a more pragmatic approach. "The Dutch government is able to accord with EU law by applying VAT to carbon credits at their normal domestic rate, while also enabling them to collect the vast VAT receipts generated by the carbon market," he says. "While the move of the UK government will flush out any criminal element that may have been operational in the UK, it does nothing to solve the problem for the EU carbon market as a whole. Any fraudsters will now simply set up camp in another EU jurisdiction," he adds.

According to Emmanuel, the UK should have waited until the European Union collectively tacked this problem by changing this VAT rules across Europe. "CantorCO2e believe that it is time that the EU Commission took pervasive action to combat this problem Europe wide," he says.

According to reports by carbon analysts Point Carbon, the European Commission is set to introduce a pilot scheme to tackle the risk of VAT fraud on carbon credits across the 27-nation bloc, later this year. The EC appears to favour the reversed charge mechanism adopted by the Dutch government, rather than the steps taken by France and the UK.

According to UK-based legal practice Hunton&Williams, although the government's changes have reduced the potential for VAT fraud on carbon transactions made in the UK, other risks remain. Cross-border carbon transactions and transactions on non-UK exchanges such as the European Energy Exchange in Germany and Spanish carbon exchange Sendeco2 are still exposed to the risk of VAT fraud.