Carbon taxes are anticipated to come into operation by early 2017 and will have significant financial implications for companies.

Draft Regulations on Carbon Offsets were published by Treasury on 20 June 2016 under the Carbon Tax Bill for comment, with the window for commentary closing this week.  The Proposed Carbon Offsets will give effect to one of a number of tax allowances in the Carbon Tax Bill, to lower these companies’ tax liability and establish a carbon-offset scheme for South Africa.

However, experts from Cliffe Dekker Hofmeyr’s environmental practice caution that there are a number of potential obstacles that will need to be overcome before the system will be fully implemented.

Using the proposed Scheme, entities will be able to reduce their taxable emissions by 5 to 10% of their total greenhouse gas (GHG) emissions, depending on the sector the entity falls within, by investing in carbon reduction offset projects. The Scheme proposes to allow entities to reduce their carbon tax liability by investing in Offset Projects of other entities that reduce, avoid, or sequester GHG emissions, at a lesser cost than having to invest in mitigation options in their own operations.

But Director in Cliffe Dekker Hofmeyr’s environmental practice, Sandra Gore, says the procedure involved in developing and validating offset projects though independent specialists and registering them on international registries under Existing Offset Schemes and methodologies is costly and time consuming.

“The Scheme proposes that a South African specific methodology is developed. This may streamline the lengthy procedure and reduce the costs of Offset Projects. The methodology will however still need to be developed under the onerous requirements of the Paris Agreement (which deals with greenhouse gas emission mitigation and was opened for signature in April this year) and it is unlikely that the procedure and costs will be reduced,” she says.

The Proposed Carbon Offsets in the initial stage will apply to Offset Projects approved by existing international carbon offset standards and structures, being the:

• Clean Development Mechanism (CDM) contained in the Kyoto Protocol, an agreement under the United Nations Framework Convention on Climate Change (UNFCC). The Kyoto Protocol is the predecessor to the Paris Agreement, which is also an agreement under the UNFCC, and was recently opened for signature on 22 April 2016). CDMs may be used until 2020 in terms of the Kyoto Protocol.
• Verified Carbon Standards; and
• Gold Standard

“The Scheme provides in the initial stages that Offset Projects must still be verified according to the very costly, technical and lengthy processes under the Existing Offset Schemes,” says Gore.

Offset Projects will also have to meet South African specific requirements under the proposed Scheme, in particular they must:

• be located in South Africa;
• not be subject to carbon tax under the Carbon Bill; and
• satisfy local eligibility criteria, including contributing to meeting South Africa’s development priorities.

Associate in the firm’s environmental practice, Valencia Govender says the proposed Scheme will primarily centre on sectors and technologies not directly subject to carbon tax, for example projects in energy efficiency (excluding projects claiming an energy efficiency tax incentive), waste, public transport and transport energy efficiency, agriculture and forestry. “It is envisaged that the list could expand as the proposed Scheme develops,” she says.

The Designated National Authority within the DoE (initially tasked with administering CDM projects under the UNFCCC) will administer the proposed Scheme and manage registering Offset Projects on a South African registry. This will include assessing Projects to ensure they comply with local eligibility criteria prior to implementation or transfer of certified emission reduction (CERs) to the South African registry, registering projects and issuing offset certificates.

“Creating a carbon registry in South African will require the Department of Energy to implement significant institutional capacity and data management systems. It appears unlikely that this will be in place by early 2017,” says Gore.

The Scheme will apply to all offsets generated after 1 January 2017 (which is the intended date for implementation of the Scheme). CERs generated by Existing Offset Schemes prior to 1 January 2017 can be used to offset carbon tax liability, if the CERs are transferred from an international registry to the South African registry within twelve months of implementation of carbon tax. For projects that are currently under development and will be registered under the Existing Offset Schemes on international registries before the commencement of carbon tax, the CERs must be transferred from an international registry to the South African registry within six months of the CERs being issued.

CERs generated by a company that will be liable for carbon taxes will need to be submitted to the South African Revenue Services for the company to qualify for a reduction in carbon taxes.

The CDM and future international Offset Projects provide South African companies with the advantage of receiving potential economic and environmental benefits through the implementation of “clean facilities” at no costs to the South African company.

However, under the international CDM market, developed countries were slow in taking advantage of implementing CDMs in South Africa, despite its ranking as one of the highest per capita carbon emitters in the world and thus being an attractive host country for implementing CDM Projects. Only 12 CDM projects were issued with CERs in South Africa as at January 2016, in comparison to Asia, which has approximately 600 registered CDMs. It remains to be seen whether this will change under the Paris Agreement and if there will be an increased interest in companies developing Offset Projects in South Africa.

“Given the costs of implementing an Offset Project, there may not be a significant reduction in carbon tax liability. This is particularly for companies whose carbon tax liabilities will not be relatively high. It must still be assessed whether South African CERs can best be traded on existing international trading platforms or if developing a South African trading platform would be more appropriate,” says Gore.

Furthermore, new Offset Projects will take several years before they are generating sufficient carbon offset volumes to meet demand, thus making the allowance mechanism initially less effective.

Treasury has stated that it has not yet decided whether SA’s CERs should be traded on international platforms or whether it would be more appropriate to develop a local trading platform. If trading on international platforms is pursued, the extent of the international market for CERs under the Paris Agreement is presently uncertain.

Written comments must be submitted to Treasury before 29 July 2016.