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Budget 2023 - Climate Action and Tax Paper

Indirect Tax Matters - September 2022

The Department of Finance of the Irish Government has published the Climate Action and Tax Paper (the Paper) as part of the Budget 2023 Tax Strategy Group papers prepared by the Tax Strategy Group (TSG). The TSG is not a decision-making body and the papers produced by the Department are simply a list of options and issues to be considered in the Budgetary process.

The Paper examines the current energy and environmental taxation at both EU and national level and presents options for consideration in future Budgets.

EU Legislation

As part of the European Green Deal, the EU has set a binding target of achieving carbon neutrality by 2050. The European Commission has released the “Fit for 55 Package”, a set of proposals to revise and update EU legislation with the purpose of cutting greenhouse gas emissions by at least 55% by 2030, as an intermediate step.

Energy tax directive (ETD)

As part of the Fit for 55 Package, the European Commission has proposed to revise the ETD to better align the Directive with EU climate action goals. The main points of the revision are the following:

  • Minimum rates based on energy content and environmental performance rather than volume;
  • Fossil fuel subsidies are to be phased out over a ten-year period from 2023 – 2033;
  • The tax base will be broadened via the inclusion of new fuels such as biofuels and hydrogen.

Council technical discussions on the proposal have been ongoing since September 2021. Due to the different political and economic interests of each Member State, the negotiations are moving at a slow pace. The current Czech Presidency of the EU Council wishes to advance the pace of negotiations, in light of the current energy crisis.

Carbon Border Adjustment Mechanism (CBAM)

The European Commission has proposed a Carbon Border Adjustment Mechanism (CBAM), which will put a price on third country imports of certain high-polluting goods based on their carbon content, as a climate measure that should prevent the risk of carbon leakage.

The aim of this proposal is to ensure that the same carbon price will be paid by domestic and imported products, while guaranteeing the compatibility with World Trade Organization (WTO) rules and other international obligations of the EU. Once approved, CBAM will be gradually introduced and initially apply to imports of cement, iron and steel, aluminium, fertilisers and electricity as these sectors are considered to have a high risk of carbon leakage and high carbon emissions.

CBAM will be based on a system of certificates to cover the embedded emissions in imported products. The CBAM certificate price will be based on the EU ETS allowance price. The intention is for a transitional period to apply from 2023, when importers will have to start reporting relevant transactions and full returns and payments will commence in 2026.

Agreement was reached on a General Approach at the Ecofin Council of Finance Ministers in March 2022. In June 2022, the European Parliament adopted a position on the CBAM which involved a more ambitious approach, including the extension of the scope of the CBAM to additional products and to indirect emissions. The negotiation is currently ongoing.

Emissions Trading System (ETS)

Under Emissions Trading System (ETS), greenhouse gas allowances are treated as a commodity or product that can be traded on the EU carbon market. The overall volume of greenhouse gases that can be emitted by all the companies covered by the ETS is subject to a cap or limit, which is set at an EU level. The EU decides how much and how quickly the total emissions should decrease. The cap or limit moves downwards each year to meet the emissions reduction target.

As part of the Fit for 55 Package, the European Commission has proposed to revise the EU ETS through its extension to the maritime sector over the period 2023-2025 and phasing out by 2027 the free emissions allowances that aviator operators currently receive.

In addition, the Commission has also proposed to apply emissions trading to road transport and buildings sectors by 2026. According to the Paper, this proposal would have a significant importance to Ireland. In fact, the expansion of emissions trading system to those sectors could impose a double taxation on the emissions associated with energy use in the transport and buildings sector, given these emissions are also subject to the domestic carbon tax. A mentioned in the paper, it is Ireland’s position that the Commission’s proposal is less ambitious, in terms of emissions reductions, than the domestic carbon tax and would significantly reduce the revenue available to Ireland to meet the costs of decarbonisation efforts across the economy. Ireland requested that this be recognised and that a derogation be made available for Member States where effective carbon pricing is already extant, if the national carbon tax is equivalent or higher than the auction price for allowances in the ETS for the buildings and road transport sector. This position has been reflected in the Council’s general approach on the revision of the ETS.

Irish Legislation

Mineral oil tax and Carbon Tax

Mineral oil tax (MOT) is an excise duty that is charged on mineral oils (e.g. petrol, diesel, kerosene and heavy fuel oil). The tax is payable on a per litre basis depending on the specific mineral oil type used. MOT is composed of a non-carbon component and a carbon component that is based on the amount of carbon dioxide (CO2) emitted by each fuel type.

As provided by Finance Act 2020 and confirmed in Budget 2022, there will be a progressive increase to the annual carbon tax rate leading to a rate of €100 per tonne by 2030.

The Paper confirms that the increase in 2023 will be based on charging an additional €7.50 per tonne of CO2 emissions, bringing the overall amount charged per tonne of carbon dioxide emitted to €48.50. The increase will apply from midnight on budget day 12th October 2022 for diesel and petrol and from 1st May 2023 for all other fuels to allow for the winter heating season.

However, due to recent international events and the consequential significant rise of the fuel prices, the Irish Government has decided to intervene to mitigate the increasing costs for businesses and consumers with the following provisions:

  • Temporary reductions to the rates of Mineral Oil Tax applied to auto diesel, petrol and Marked Gas Oil to lessen the inflationary impact of rising fuel prices on households and businesses.
  • VAT inclusive reductions in the order of 15 and 20 cents were applied to auto diesel and petrol in March 2022 to continue until 11 October 2022.
  • Reduction of the non-carbon component of Marked Gas Oil has also been reduced by over 5 cents VAT inclusive relative to the start of the year.
  • Temporary reduction of VAT from 13.5% to 9% applies to supplies of natural gas used as a heating fuel between 1 May 2022 and 31 October 2022.

Business mitigation measures for carbon tax

There are some relief schemes in place to mitigate the impact of the carbon tax for business sectors which are heavily reliant on fuel as a business input, such as haulage and agriculture. Examples of those measures are the Diesel Rebate Scheme, the reduced rate of taxation on Marked Gas Oil, and the double income tax relief scheme for farmers. As mentioned in the Paper, those reliefs have been subject to criticism from an environmental perspective as they are fossil fuel subsidies. Both national and international commitments look to a future that is less reliant on fossil fuels and phasing out those subsidies will be necessary.

Electricity Tax

Electricity Tax is an excise duty that is charged on supplies of electricity. The tax is charged on the final supply of electricity to the consumer and the liability arises at the time the electricity is supplied. There is a full relief from electricity tax for electricity used by households. The revised Energy Tax Directive proposes a gradual removal of this exemption, however it does provide for a continued ten year exemption until 2033 for households classed as vulnerable and a provision for reduced rates (not below the minima) thereafter.

The current minimum rates for electricity tax under the ETD are €1.00 per megawatt hour (MWh) for non-business usage and €0.50 for business usage. The revised ETD proposes equalising the minimum rates resulting in a reduction for the non-business rate and an increase in the business rate. Currently the rates in Ireland are €1.00 for both categories of usage.

The revised Directive seeks to promote the use of alternative and renewable energy sources, as such combined heat and power generation may continue to qualify for preferential treatment. Electricity produced on board a craft as well as electricity used in chemical, electrolytic and metallurgical processes can also continue to benefit from exemption under the revised Directive.

As mentioned in the Paper, Ireland is on a legally binding path to carbon neutrality by 2050 via the Climate Action and Low Carbon Development Amendment Act. The pathway to this target involves a gradual phasing out of fossil fuels from the economy and a greater reliance on electricity supplied as a renewable energy. In the long term, if no changes to tax policy occur, this will lead to a loss in Exchequer revenue. In light of current exemptions, reliefs and low rates, current revenue from electricity tax is very low. Therefore, if the shortfall in Exchequer revenue arising from the transition to carbon neutrality is to be met in some way through electricity tax revenue, a change to the current reliefs and rates may be needed.

Vehicle Registration Tax (VRT)

Vehicle Registration Tax (VRT) is a tax chargeable on the registration of most vehicles in the State and is levied as a percentage of the open market selling price of the vehicle.

The Department of Transport have previously suggested funding the retention / expansion of Battery Electric Vehicles (BEV) supports using increased VRT rates on combustion engine vehicles (ICEVS). However, this already has happened to a large degree as VRT rates have been increased quite significantly in the higher emission bands and data indicates that as a result, the volume of registrations has fallen dramatically in those bands. According to the Paper, this shows that the policy is working, which consequently leaves very limited scope for revenue raising by increasing rates on the highest emitting vehicles. Revenue could be raised by taxing BEVs more, though this would have to be considered in the context of the Government’s targets for increasing BEV registrations.

The 2019 Department of Public Expenditure and Reform spending review paper on EVs estimated that if the current Climate Action Plan 2030 for Electric vehicles (EV) target is achieved, the Exchequer will lose approximately €1.5 billion worth of revenue annually from motor tax, VAT, fuel excise. The financial sustainability of supports for EVs will have to be considered as fleet numbers increases. In this regard, the Energy Tax Directive revision proposes a structure for taxing electricity and hydrogen used in vehicular transport to replace current fossil fuel tax streams.

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