Tax treatment of emissions trading units

(Clauses 22, 33 and 34)

Summary of proposed amendments

Amendments are being made to the way that income is recognised following the free allocation of emissions units to the industrial and agricultural sectors under the emissions trading scheme. The new provisions require businesses to recognise income according to the business’s entitlement to receive emissions units for the income year. Previously, the rules would have required businesses to look at units they actually held, and recognised income on the basis of the units which were properly attributable to the current year.

Application date

The amendments apply from 1 July 2010, the date on which the industrial sector became subject to the ETS.

Key features

Section ED 1B is being extensively rewritten to provide new valuation rules for free units (zero-value units) that have been allocated and which the business holds at the end of the income year. Under the proposed rules, income arises from valuing an appropriate number of zero-value units at market value, and if necessary, supplementing that amount with the difference between the entitlement and the number of units held (see example 2).

The starting point for the valuation of zero-value units is the entitlement to units which the business has for the income year. This is determined in accordance with the formulas in sections 83 and 84 of the Climate Change Response Act 2002. This calculation is made independently of the number of zero-value units which the business has been allocated for the relevant period, or which it actually holds at the end of it.

The business may have already sold or surrendered some of the units it received for free. This number of units is deducted from the number of units required to be given a market value, as the sale and surrender processes give rise to income in their own right. The number of units remaining is the number of zero-value units held which are to be assigned a market value at the end of the year.

In some instances the entitlement which the business is required to recognise will exceed the number of zero-value units which the business has on hand at the end of the year. If this happens, an additional sum of income will be recognised (see example 2) and be carried forward to apply against zero-value units received in the following year.

In other instances the business may hold more zero-value units at the end of the year than it is required to recognise. If this happens, the surplus units will be carried forward at a zero value (see example 1).

Background

Under the Climate Change Reform Act 2002, certain trade-exposed businesses are entitled to an allocation of emissions units. The basis of allocation was changed in 2009, and allocations are now calculated by reference to:

• the level of assistance which applies to the business in the relevant emissions year; and
• the business’s production output for the emissions year.

Businesses will be allocated free emissions units, with an interim allocation being made early in the calendar year, and a square-up early in the following calendar year.

The changes to the basis of allocation in 2009 required changes to the provisions in the Income Tax Act 2007 which deal with the taxation consequences of the receipt of free emissions units.

There are two basic issues which the current amendments deal with:

• What is the appropriate amount of income for the business to recognise in the income year as a result of its entitlement to receive free units?
• What value should the free units be recorded at in the business’s tax accounts?

The following examples illustrate how the amended rules would work.