Climate action Climate action Climate action

The Climate Action and Low Carbon Development (Amendment) Act 2021 initially announced in October 2020 set Ireland on a legally binding path to climate neutrality by 2050. The main tenet of the Act is to see Ireland become a climate neutral economy no later than 2050. One of the key mechanisms for securing a climate neutral economy is the introduction of a series of economy wide 5-year carbon budgets with sectoral emission ceilings for each relevant sector. A key milestone in this programme is 2030 whereby the first two carbon budgets should deliver emissions savings of 51% in line with the Programme for Government established in 2020. These ambitious emissions reductions are aligned to overall EU ambitions. 

On 14 July, the European Commission (EC) passed a crucial milestone by adopting the EU “Fit for 55” package to transform the European economy. The package of interconnected legislative proposals will align the EU’s climate, energy, land use, transport and taxation policies with the target of reducing net greenhouse gas emissions by at least 55% by 2030, compared to 1990 levels. 

This commitment is part of the EU Green Deal, which is a comprehensive package of tax and non-tax measures aimed at developing a growth strategy whereby there are no net emissions of greenhouse gases in 2050 and where economic growth is decoupled from resource use. Within its toolkit the EU is proposing several tax and carbon price reforms as part of the Green Deal, namely: 

• Extension of the Emissions Trading System (ETS), including possible phasing out of existing free permit allocations for many participants. 
• Introduction of the Carbon Border Adjustment Mechanism (CBAM). 
• Reform of the Energy Taxation Directive (ETD). 

The EU ETS puts a price on carbon and lowers the cap on emissions from certain economic sectors every year. Over the past approximately 16 years it has reduced emissions from power generation and energy-intensive industries by 43%. The EC is proposing to lower the overall emission cap even further, increase annual rates of reduction and phase out free emission allowances for aviation. A new separate emissions trading system to address the lack of emissions reductions in road transport and buildings is also proposed. 

With the ETS carbon price above €60 per tonne as of October 2021, this mechanism now has material economic implications for corporates and has the potential to influence corporate decision making. 

Increasing ambitions for emissions reduction raises concerns about potential “carbon leakage”. This is the concern that consumers/producers in the EU with higher emissions ambition will be encouraged to purchase imports or move operations to low ambition regions where the cost of production is lower. 

In order to address risks of carbon leakage from these developments, the EC released a consultation process in 2020 on the design features of alternative approaches to introducing a CBAM. This could take a number of forms, including: 

• A tax on imports (a carbon border tax imposed through the tariffs); 
• Importers being incorporated within the existing ETS; 
• A mechanism based on the ETS but involving a separate system for importers; or 
• A new (excise-style) tax charged both within the EU and on imports, based on the average carbon intensity of certain products (sometimes referred to as a carbon excise tax). 

At this preliminary stage, it is understood that the products proposed to be covered in the first instance will include aluminium, steel, cement, glass, paper, and heavy chemicals. The precise form which the proposed CBAM will take will only become clear once the EC tables draft legislation in the form of a proposed directive. 

The existing Energy Taxation Directive (ETD) is close to 20 years old and does not reflect the current developments in green energy. The reformed ETD has several ambitions; to address harmful effects of energy tax competition; securing revenues for EU Member States from green taxes; removing outdated exemptions and incentives of fossil fuels usage and promoting investment in new and innovative green industry. 

To achieve these ambitions, the EC is proposing a new structure of tax rates based on the energy content (expressed in EUR/GJ, e.g. gas oil & petroleum at €10.75/GJ, renewable Hydrogen at €0.15/GJ) and broadening of the taxable base by adding products and removing exemptions such as those in the areas of aviation and shipping fuels. The ETD proposal suggests minimum rates of taxation that encourage a switch to more sustainable fuels while reflecting the extent to which they are at risk of carbon leakage. There is also a 5-year review period to keep the ETD up to date. 

As the new ETD is a revision of an existing directive, its unanimous acceptance by all members of the EU Council is required. Provided unanimity is achieved, the ETD should come into force in January 2023. 

Companies that procure or consume products covered within the scope of the EU ETS, e.g. manufacturing, could face significant additional cost pass-through from existing suppliers if the CBAM is implemented, due to the significant emissions occurring in geographies without commensurate low carbon policies and the emissions associated with transport of the goods to the EU. Corporates should ensure that they understand the geographical composition of their emissions to enable them to undertake a supply chain review, where required, making conscious cost versus carbon trade-offs and ensuring the resilience of their pricing model to the proposed changes. 

The EC measures above are part of a programme of interventions, with individual components categorised as “pricing”, “targets” or “rules”; that will operate together to achieve its objectives. These undertakings are a proactive approach to using tax policy as an instrument to fight climate change, a potential feature of the EU landscape for many years to come.