The voluntary carbon credit market has seen significant changes in recent times. With the emergence of secondary market trading, businesses began incorporating these credits into their onward supplies. So, HMRC has stepped in — its new business brief and updated guidance heralds change for the VAT treatment of voluntary carbon credits.
What are carbon credits?
Carbon credits are seen as part of the ecosystem service market and are tradable instruments issued by an independently verified carbon-crediting program. Carbon credits represent a reduction or removal of one metric tonne of carbon dioxide from the atmosphere, or an equivalent amount of greenhouse gases (GHGs), measured by reference to a baseline scenario.
Voluntary carbon credits are any carbon credits that are non-compliance market credits.
What is the current VAT position on carbon credits?
Voluntary carbon credits are currently treated as outside the scope of UK VAT. This is because when they were first introduced, HMRC’s view was that they could not be incorporated into an onward supply and there was no evidence of a secondary market.
What is the new VAT position voluntary carbon credits?
HMRC has issued a new business brief (7/24) and updated its guidance on the VAT treatment of voluntary carbon credits. From 1 September 2024, the sale of voluntary carbon credits must be treated as taxable for VAT at the standard rate where the place of supply is in the UK.
The following activities will remain outside the scope of VAT:
- the first issue of a voluntary carbon credit by a public authority
- the holding of voluntary carbon credits as an investment, where there is no economic activity
- donations made to voluntary carbon credit projects
- sales of voluntary carbon credits from self-assessed projects with no independent or third-party verification.
The Terminal Markets Order
The ‘Terminal Markets Order’ provides a VAT zero-rate for wholesale commodity transactions made by members on specified terminal markets.
From 1 September 2024, HMRC will allow the VAT relief granted under the Terminal Markets Order to apply to contracts in taxable voluntary carbon credits traded on terminal markets, within the terms of the relief.
We recognise that this change in approach by HMRC is a positive step, however, we consider the lack of a Domestic Reverse Charge (DRC) to mitigate VAT fraud in the carbon credit market to be a concern.
HMRC’s amended guidance also leaves the VAT treatment of “offsetting activity” unchanged, which leads to a distinction between the supply of credits and their retirement. To clarify, businesses that acquire carbon credits for retirement (rather than resale) — especially those with restricted input VAT recovery (e.g. banks) — will face an increased VAT cost from 1 September. HMRC has indicated their default position would be to link VAT recovery to output VAT charges, which requires careful management of tax points around the implementation date for full recovery.
If you’d like further information or advice on the VAT treatment of supplies of carbon credits or to discuss HMRC’s latest guidance, contact our specialist VAT team at VAT@ct.me or call on 0131 558 5800.
Author: Andy Young, CT: VAT
