Currently, ETS forms the core of the carbon market that works on a “cap and trade” principle. As per the scheme, a specified limit is set for emission of greenhouse gases and the same is issued to manufacturers as certificates/ permits. Accordingly, any emission beyond the limit is penalised. Within said limit, industries are also allowed to receive or acquire emission allowances that can be traded with other companies, on a need basis. Instance, each allowance being a tradeable instrument is equivalent to one tonne of carbon dioxide (CO2).
The price per tonne of CO2 is nomenclated as carbon price and the same is to be determined via market trends. Manufacturers that require permits to emit beyond the cap can also buy allowances from others having surplus cap, albeit the trade could be at a higher rate. Accordingly, a rise in the carbon price would put EU producers at the risk of carbon leakage, i.e. losing out to low-cost imports from territories with less stringent climate regulations.
To combat carbon leakage, the EU is embarking on an experiment that would expand its climate change policies to imports. The policy is called Carbon Border Adjustment Mechanism (‘CBAM‘) alias Carbon Border Tax which imposes importers and non-EU manufacturers to pay for the carbon emission linked to the goods they sell within EU limits.
The CBAM will walk on the footprints of ETS, i.e., importers will be required to purchase carbon import certificates/ permits for each metric ton of CO2 brought into the EU through specified goods. The price of certificates could depend on carbon intensity of goods being imported and carbon price per metric ton which will be the same as domestic carbon price being paid by EU producers.
This tax is proposed to be implemented by the EU in 2 stages entering into force on October 1, 2023. Under the 3 years transitional phase, only carbon emission reporting regulations would apply and there would be no requirement to pay Carbon Border Tax. After the transition period, tax would be levied on varied goods in a phased manner from 2026 to 2034. By 2034, all the goods and materials imported in the EU will be encased with the applicability of CBAM.
BASIC countries feeling knocked sidewaysAt all times, new policies, simulate despair among developing countries due to related adverse implications that it may have. For India, the implementation of Carbon Border Tax by EU on imports could significantly impact the prices of Indian-made goods in the EU markets, thereby upsetting demand. It could heavily bear up the supply chain portion of industrial sectors such as automotives, construction, cements, packaging, and consumer appliances as costs for key inputs such as steel and aluminium may rise by 15-30 percent leading to a change in purchasing behaviour of end customers, forcing companies to take actions to maintain competitiveness.
Ministers of Brazil, South Africa, India and China representing the “BASIC” group released a joint statement on November 15, 2022 and retaliated against the proposed Carbon Border Tax by stating that “Unilateral measures and discriminatory practices, such as carbon border taxes, that could result in market distortion and aggravate the trust deficit amongst parties must be avoided. BASIC countries call for a united solidarity response by developing countries to any unfair shifting of responsibilities from developed to developing countries.”
While all the BASIC countries have put in place their strategies to reduce carbon emissions in a phased manner, developing nations require predictable and appropriate support, including climate finance and access to technology and markets from developed nations to ensure and enable their sustainable development. India too aims to become a net-zero emitter by the year 2070 under its “Long-Term Low-Carbon Development Strategy” and has recently announced the domestic carbon credit trading system in a new promulgation in the upper house of the Parliament.
Unilateral taxes have often led to multinationals locking horns. In a similar occurrence related to tax equalisation on domestic products/ services and imports, the USA had opposed imposition of Equalization Levy (‘EL’)/ Digital taxes on e-commerce transactions, by countries such as India, Italy, Turkey, UK etc, by contemplating that it diverged from US or international tax norms due to its applicability on non-resident entities.
As a retaliation measure, US had proposed to levy additional tariffs of up to 25 per cent on certain items exported from India to mop-up the EL that could be collected by India from US companies. On a similar tone, BASIC countries have already voiced their concerns and it is anticipated that the EU may face retaliation from other countries as well against the imposition of Carbon Border Tax considering the macro impact it would have on taxation and consequently, pricing, at a global level.
Abiding by World Trade Organization’s (‘WTO’) non-discriminatory policies
Carbon Border Tax would need to pass the litmus test of WTO’s non-discrimination and trade law principles. In a similar context, a dispute settlement panel of the Geneva-based WTO had ruled that India’s export-related schemes (including Special Economic Zone Scheme) are in the nature of prohibited subsidies under the Agreement on subsidies and countervailing measures and are hence inconsistent with WTO norms. Consequently, the “Development of Enterprise and Service Hubs Bill” was conceptualised to comply with the global trade rules of the WTO.
Turning over a new leaf
Carbon Border Tax appears to be a climate-based trade barrier and industries may want to keep their fingers crossed on further developments. Meantime, industries should gear up to thrive in the new regulatory environment by analysing the possible exposure, determining the carbon footprint of products dealt by them and exploring the greener technology available for production of goods to mitigate risks and minimise cost impact.
Companies at the forefront of tackling carbon emissions would surely have a powerful strategic advantage in the new regulatory environment and will have a head start as nations adopt carbon-pricing instruments in the fight to mitigate climate change.
Rakesh Nangia is Chairman and Sandeep Jhunjhunwala, Partner, Nangia Andersen LLP
