Climate Change Response (Emissions Trading) Amendment Act 2008

The Climate Change Response (Emissions Trading) Amendment Act 2008 (Climate Change Act) has the principal purpose of amending the Climate Change Response Act 2002 to introduce a greenhouse gas emissions trading scheme in New Zealand. However, the Climate Change Act also includes amendments to the Income Tax Act 2004, the Income Tax Act 2007, and the Goods and Services Tax Act 1985 (GST Act) to cover the income tax consequences to the forestry sector and the GST consequences to all sectors of transactions in emissions units. These amendments are the subject of this article.

This article also includes subsequent amendments to the Inland Revenue administered Acts.

Sections CB 29, CW 3B, CX 44F, DB 46, DB 47, EB 2(3)(ah), ED 1(5B), EW 5(3B), GD 16 and OB 1 of the Income Tax Act 2004

Sections CB 36, CW 3B, CX 48B, DB 60, DB 61, EB 2(3)(i), ED 1(8B), EW 5(3B), GC 4B and YA 1 of the Income Tax Act 2007

Sections 2(1), 11(1)(n), 11A(1)(s), (t), (u) and (v) of the Goods and Services Tax Act 1985

Background

The Climate Change (Emissions Trading and Renewable Preference) Bill was introduced into Parliament on 4 December 2007. It received its first reading on 11 December 2007 and its second reading on 28 August 2008. The provisions dealing with amendments to the GST Act were introduced by Supplementary Order Paper 231 at the Committee stage of proceedings. The resulting Climate Change Response (Emissions Trading) Amendment Act 2008 and the Electricity (Renewable Preference) Amendment Act 2008 received Royal assent on 25 September 2008.

The Climate Change Act amends the Climate Change Response Act 2002, inserting provisions under which:

• businesses in certain sectors will be required to surrender emissions units based on their actual emissions, or emissions treated as being made as a consequence of their activities
• the government may allocate emissions units to businesses in certain sectors.

Amendments to income tax legislation are required to ensure that the income tax treatment of emissions units is clear, and that income and expenditure are recognised for income tax purposes in a way which is consistent with the objectives of the emissions trading scheme and the income tax system.

Amendments to GST legislation have been made to ensure that GST compliance impacts are minimised and to facilitate the trading of emissions units on international markets.

Key features

Income tax legislation has been amended to provide for the tax consequences of transactions in emissions units related to forestry businesses. The main features of the changes are:

• emissions units are ordinarily treated as being on revenue account
• emissions units are treated as excepted financial arrangements, so are valued using a cost basis methodology
• the cash basis of taxation, which generally applies to transactions entered into by forestry businesses, also applies to emissions unit transactions entered into by forestry businesses
• while the ordinary rule of revenue account treatment applies to transactions relating to post-1989 forest land (including the Permanent Forest Sink Initiative), emissions units transactions relating to pre-1990 forest land are an exception from the general rule and are generally treated as being on capital account
• capital account treatment applies where an allocation is made to an interim entity pending a Treaty of Waitangi settlement and then the units are eventually transferred to the ultimate owner following a Settlement in relation to pre 1990 forestry land
• units allocated for an expected drop in fishing quotas capital value will be on capital account
• the transfer of units will be at market value except for certain specific circumstances
• any transfer in accordance with a forestry rights agreement (registered under the Forest Rights Registration Act 1983) at market value will not trigger a tax liability
• transactions relating to emissions units are zero-rated for GST purposes.

The legislative changes apply only to emissions units which are New Zealand units, Kyoto units and units issued by overseas registries that can be transferred into an account in the New Zealand registry. They do not apply to voluntary or "unofficial" emissions units, which remain subject to ordinary income tax and GST rules.

Application date

The income tax changes generally apply from 26 September 2008. The GST changes generally apply from 1 January 2009.

Detailed analysis

Income tax valuation methodology

The legislation treats emissions units as excepted financial arrangements. Accordingly, either the first-in first-out (FIFO) or weighted average cost valuation methods apply. There is no requirement to revalue emissions units if their market changes.

Income tax treatment of emissions unit transactions relating to post-1989 forestry

Emissions unit transactions relating to post-1989 forest land (including the Permanent Forest Sink Initiative) follow ordinary principles and are treated as being on revenue account. While the underlying concepts are that the acquisition of emissions units is deductible, and their disposal is assessable, the application of the cash basis of taxation, and detailed timing and matching rules mean that each transaction must be considered against the applicable legislation.

The treatment of each common transaction is as follows (statutory references are to the Income Tax Act 2007):

• no taxable income arises on the allocation of units to the forestry business by the government (CX 48B.
• a tax liability arises on the sale of government-allocated units. The taxable amount will be the entire proceeds of the sale, because these units have no direct costs (indirect costs have already been deducted) (CB 36)
• where units are purchased to replace units previously sold ("replacement ETS units"), an income tax deduction is available (DB 60(3) and ED 1(8B))
• where "additional" units are purchased, no income tax deduction will be available if those units are still held at the end of the tax year (ED 1)
• no income tax deduction arises when a deforestation liability arises (principles of cash basis taxation method)
• no income tax deduction arises when government-allocated units are surrendered (ED 1)
• no income tax deduction arises when replacement ETS units are surrendered (the deduction was already given on their purchase) (CB 36(3) and ED 1(8B))
  an income tax deduction is available when additional units purchased are surrendered (CB 36(3) and ED 1).

Income tax treatment of emissions unit transactions relating to pre-1990 forestry

Emissions unit transactions relating to pre-1990 forestry are generally treated as being on capital account, which means that no income tax liabilities arise from, and no income tax deductions are created by, these transactions. Specifically:

• no taxable income arises on the receipt of "free" units from the government (CW 3B(2))
• no taxable income arises if any of those "free" units are sold (CW 3B(3))
• no income tax deduction arises if additional units are purchased to satisfy a deforestation liability, or where units are purchased in excess of any potential liability and remain held at the end of the year (ED 1)
• no income tax deduction arises when a deforestation liability arises (principles of cash basis taxation method)
• no income tax deduction arises when units are surrendered to the government to meet a deforestation liability (CB 36(5)).

The capital account treatment applies only to transactions in emissions units which are related to pre-1990 forestry land. If a business which owns pre-1990 forest land purchases emissions units and later sells them, any gain will be taxable and any loss will be deductible, as they would be for a business which did not own pre-1990 forest land (CB 36(2)).

There is an exception to capital account treatment. Certain businesses, such as property developers and land traders, will hold pre-1990 forest land on revenue account. Emissions unit transactions carried out by such businesses in relation to pre-1990 forest land will be on revenue account. Their treatment will generally be the same as transactions relating to post-1989 forest land, described above (CB 36(4)(b) and CW 3B(3)).

GST treatment of emissions unit transactions

The supply of emissions units (other than "unofficial" emissions units) is zero-rated. Under zero-rating, emissions units are treated as being subject to GST for the purposes of measuring taxable supplies made by businesses. However, the amount of GST actually charged and so the GST to be accounted for by both transferor and transferee is nil.

Transactions that are supplies of emissions units and that are zero-rated include (section references are to the GST Act):

• the allocation of emissions units by the government to a business (11A(1)(s))
• the surrender of emissions units by a business to the government (11A(1)(t))
• the sale of emissions units by a business, whether to a buyer in New Zealand or overseas (11A(1)(v))
• the purchase of emissions units by a business from the government (11A(1)(v))
• the purchase of emissions units by a business from another business, whether the selling business is in New Zealand or is overseas (11A(1)(v)).

When emissions units are awarded by the government to a business, without a cash payment being made by the business, any actual supply which the business makes in exchange for those units, or is deemed to make in accordance with the GST Act, will also be zero-rated (11A(1)(u)).

When the transaction is one where an express monetary price has been agreed for the units, then the value of that supply will be the price agreed for the units.

When the transaction is one where the government supplies emissions units, and an actual or deemed supply is made in exchange for that supply of emissions units, the value of both supplies is the market value of the emissions units.