Carbon credits are now being regularly traded, and a common query is how these should be taxed.
There is currently no speciﬁc guidance from HMRC on this matter, so the advice below uses general principles of taxation, which we would expect HMRC tofollow.
Is it income or capital?
Where an asset is only sold once, and is thereafter never again available for the original owner, it is likely to be a capital disposal, and subject to capital gains tax (CGT).
Standing timber is exempt from CGT and so where there is a sale of trees whose value is inﬂated due to the available carbon credit thereon, that will fall to be part of the tree value, and therefore also be exempt. Conversely, when the unit is sold without any underlying tree, then the value traded is subject to CGT.
If the credit is not a single sale, but a regular income stream, then this is not generally a disposal of the right, but rather an exploitation of this for proﬁt, and thus subject to income tax rules.
If it is income, how is it taxed?
Income may be taxed under many parts of the tax code. The detail will depend on whether this is deemed farming, commercial land management, woodland or simply a by-product of holding land.
If the income received is to compensate for a lack of farming income or a change in farming behaviour this could be argued to be farming proﬁt. Compensation for a lack of farming income will include schemes where the grant is to prevent land being used for farming practices, which is what the old Farm Woodland Premium Scheme was designed to do. This compensated farmers for loss of proﬁts and was deemed taxable for the farmer who had ceased certain activities, even although it was related to forestry.
The same principles are likely to apply to any new grant or incentive schemes, including carbon credits unless speciﬁc guidance overrules this, such as the Woodland Carbon Code, as notedbelow.
However, even here, care is required. If the woodland is subsequently sold on, then the new owner had not ceased any activity, and obtains the credit due to the fact he holds woodland, and therefore such income should be treated as woodland income in their hands, and therefore exempt from income tax (IT), having previously been farming income, and therefore taxable.
If the regular receipt of income is linked to the commercial management of woodland then it could be exempt. This includes payments under the Woodland Carbon Code which guarantees the price of units being sold to the government every ﬁve or 10 years, and is speciﬁcally noted by the government to be tax free as related to woodland management.
If income is linked to commercial management of land with a view to a proﬁt, it will form part of the taxable proﬁts from that trade. This may include peatland management schemes where the management of the land is commercial and proﬁtable.
Otherwise, any regular income from a land based carbon credit will be property income, and subject to IT but not to national insurance contributions.
Care is also required to establish whether there is a supply of goods and services, which will fall within the VAT rules, or whether there is only a promise to make something good in the future, in which case there is likely to be no VAT point. This will impact on both the VAT on the sale of the units, and the ability to obtain relief for any input VAT.
Carbon credits are complicated fortax purposes, and with the current taxation diﬀerences between woodland at nil, CGT at 20%, or IT at 46% in Scotland, the cost of getting the structure wrong can be signiﬁcant. Early advice is highlyrecommended.
Margi Campbell is a director of Saffery Champness, Inverness